The FDIC’s Proposed Standards for Corporate Governance and Risk Management

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Michael J. Wernke

On October 11, 2023, the Federal Deposit Insurance Corporation published for comment in the Federal Register proposed standards for corporate governance and risk management (“Proposed Standards”) for the financial institutions it regulates that have $10 billion or more in total assets (“covered institutions”). Under its safety and soundness powers in Section 39 of the Federal Deposit Insurance Act, the FDIC is able to publish such standards that go beyond mere guidance. The new standards are part of the FDIC’s regulatory response to the bank failures that took place in the spring of 2023. Referring to the post-mortem evaluations conducted by the FDIC and the Federal Reserve Board following the Signature Bank and Silicon Valley Bank failures, the preamble to the Proposed Standards asserts that poor governance and risk management practices were contributing factors that led to the collapse of those banks.

The FDIC’s Proposed Standards are based on the principles set forth in the Office of the Comptroller of the Currency’s Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches (the “Heightened Standards”), but with key differences. The Proposed Standards include more details on what the FDIC expects from the boards of directors as well as the banks that the FDIC regulates. They also set a notably lower minimum asset threshold (five times lower) than the OCC’s Heightened Standards to determine which banks are covered.

The Proposed Standards were approved 3-2: Chairman Gruenberg, CFPB Director Chopra, and acting Comptroller Hsu voted in support; Vice Chairman Hill and Director McKernan voted against the proposal.

Comments on the Proposed Standards are due by February 9, 2024. (This date was extended from the original deadline of December 11, 2023).

Background

The FDIC’s Proposed Standards delve into legal issues that—in the case of banks that do not have a federal charter—have typically been determined by state law. These include the duties and responsibilities of bank boards, directors, and management, including their duties of care and loyalty, as well as related concepts such as the business judgment rule.

While banks are primarily governed by state corporate governance law, there are instances in which federal oversight is enforced. For example, federal law imposes audit standards and a gross negligence “floor” on the conduct of bank directors and officers. Federal law also requires that federal banking regulators impose operational and managerial standards, compensation standards, and appropriate standards relating to asset quality, earnings, and stock valuation.

Specifically, following the poor risk management that led to the 2008 financial crisis, federal banking regulators enacted increased oversight of the governance and risk management of banks. The OCC initially imposed heightened expectations for the governance and oversight of the larger banks that it regulated and, in 2014, it adopted those Heightened Standards as a specialized standard for safety and soundness at larger federally chartered banks. Also in 2014, the Federal Reserve implemented part of the Dodd-Frank Act by establishing several risk management requirements for larger bank holding companies. This was followed in 2021 by expectations for effective governance by larger bank boards. 

Proposed Guidelines

Note that in some specific instances, a covered institution may leverage its parent company’s risk management program or board to meet the standards of the Proposed Guidelines.

Obligations Covered directors would have a duty to safeguard the interests of the bank, confirming that the bank operates in a safe and sound manner and in compliance with applicable federal and state law. In supervising the bank, a board should consider the interests of all of its so-called stakeholders, going beyond shareholders and depositors to include creditors, customers and even the regulators themselves.

Composition The Proposed Guidelines set out minimum standards for board composition, requiring a majority of its members to be independent and outside directors. Boards would also be expected to consider the diversity of their members, including social, seniority, and educational differences, among others. The Proposed Guidelines also caution against excessive influence from a “dominant policymaker.”

Duties Covered boards would need to (i) set an appropriate tone and establish a responsible, ethical corporate culture; (ii) evaluate and approve a strategic plan; (iii) approve and annually review policies; (iv) establish and annually review a written code of ethics; (v) actively oversee the bank’s activities, including all material risk-taking activities; (vi) exercise independent judgment; (vii) select and appoint qualified executive officers; (viii) establish and adhere to a formal training program; (ix) conduct an annual self-assessment of its effectiveness; and (x) establish and annually review compensation and performance management programs.

Committees The Proposed Guidelines require boards to maintain a risk committee and compensation committee in addition to the audit committee required by Section 36 of the FDI Act and Part 363 of the FDIC’s regulations. Risk committees would need to meet at least quarterly and maintain records of their proceedings, including risk management decisions.

Risk Management The Proposed Standards would impose expectations for the risk management program that a bank should develop and maintain. These expectations largely match the OCC’s Heightened Standards. For example, like the Heightened Standards, the Proposed Guidelines would require covered institutions to adopt a three-lines-of-defense risk management framework with a front-line unit (exclusive of the legal department), an independent risk management unit led by a Chief Risk Officer, and an internal audit unit led by a Chief Audit Officer.

The Proposed Guidelines provide that the risk management program would need to address a wide variety of potential risk categories, ranging from credit, interest rate, and liquidity risks to anti-money laundering and third-party partnership and outsourcing risks. Further, material breaches of risk limits and emerging risks would need to be reported in a timely manner to the board and the chief executive officer.

Identifying and Reporting Violations of Law The Proposed Guidelines would require a covered institution’s board to establish and annually review processes that would require either front-line units or the independent risk unit to report all violations of applicable laws and regulations to law enforcement or any appropriate federal or state regulatory agency. This would represent a shift from the FDIC’s current practice of encouraging, but not requiring, self-reporting of violations.

Questions The FDIC asks multiple questions in order to scope banks that should be subject to the Proposed Guidelines, including whether FDIC-supervised institutions with $10 billion or more in total consolidated assets is an appropriate threshold and whether other financial institutions should fall under the definition of a covered institutions.

Implications and Objections

Collectively, the escalation of reporting requirements imposed by the proposal would appear to increase the likelihood of FDIC enforcement actions. The rule passed by a 3-2 vote of the FDIC Board. Each of the two Republican-affiliated Board members (Director McKernan and Vice Chairman Hill) issued a public dissenting statement.

Critics such as Director McKernan have pointed out that certain requirements in the Proposed Standards would exceed, or simply differ from, the Heightened Standards in prescriptiveness and stringency, creating confusion. For example, the FDIC sets its threshold for application ($10 billion or more in consolidated assets) much lower than the Heightened Standards (federally chartered banks with at least $50 billion in consolidated assets). The Proposed Standards also lean toward a rules-based approach to corporate governance, in contrast to the principles-based approach that is prevalent under state law. Critics have asserted that the Proposed Standards are presented as “good corporate governance” without appreciating that what is “good” for one bank may not be “good” for another with FDIC Vice Chairman Hill saying regulators need to resist “one-size-fits-all” best practices.

FDIC Director McKernan also asserted in his dissent that the requirement that the bank board “consider the interests of all its stakeholders, including shareholders, depositors, creditors, customers, regulators, and the public” could be at odds with bank directors’ fiduciary duties under applicable state law, for example, if a director voted against the interests of shareholders in order to serve the interests of customers or the “public.”

As mentioned above, the period for comment was extended to close on February 9, 2024.

What’s in an Acronym? (Or, Can Bill Ackman “SPARC” a Fix to SPACs?)

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Louis C. Ludwig

A recent innovation in the realm of investment vehicles, SPACs, or Special Purpose Acquisition Companies, have experienced a dramatic rise and fall in the past few years. Unlike traditional IPOs, SPACs go public without a business model, later acquiring or merging with an existing company with a defined business. In so doing, SPACs circumvent many of the disclosures required of a traditional IPO. This provides a quicker path to going public, however avoiding the safeguards that the disclosures impose has led to a disturbing string of frauds and scandals. This, in turn, has resulted in SPACs trading for under $10 per share, as well as some companies withdrawing from previously announced SPAC deals, even if they have to pay millions of dollars to the SPAC for backing out. The sense that SPACs are endangered may be what prompted billionaire investor (and former SPAC aficionado) Bill Ackman to step into the arena of SPAC reform. Ackman’s innovation comes in the form of the suspiciously-similar-sounding “SPARC,” or Special Purpose Acquisition Rights Company.  However, the question remains: is this enough to save the SPAC from extinction?  The answer: quite possibly.

SPACs are sometimes referred to as “blank check companies” because they are created for the sole purpose of acquiring another company and taking it public. They recall the 1980s penny stock market where highly speculative stocks sold for less than $5 per share. Most penny stock offerings were similarly made by blank check companies whose stated purposes were to merge with a to-be-identified target. While penny stocks were cheaper than shares sold on reputable exchanges such as the NYSE, the unregulated market on which they were traded was rife with manipulation and outright fraud, subsequently dramatized in classic films like Boiler Room and The Wolf of Wall Street. By 1990, annual investor losses of $2 billion prompted Congress and the SEC to finally regulate the penny stock market through the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (PSRA) and Rule 419, respectively.

Fortunately for fans of Wild West-style investing, two bankers developed the concept of a SPAC in the 1990s as an end-run around the PSRA and Rule 419. Like the penny stocks of yore, SPACs lack their own business model; initial investors simply have no idea what type of company they will ultimately be investing in. When formed, SPACs usually have an industry in mind, such as mining or software, but no specific acquisition target. The gap between the empty holding company and the entity that ultimately emerges through the SPAC process has led some observers to note that a more accurate term is “SCAMs.”

The typical SPAC timeline is as follows: first, the SPAC’s sponsors, who often possess significant financial and reputational clout, e.g., Martha Stewart and Shaquille O’Neal, provide the starting funds for the SPAC; second, the sponsors, assisted by underwriters, take the SPAC public through a standard IPO, which allows the SPAC to raise funds that are held in a trust, pending identification of an acquisition target; and third, assuming the sponsors identify a target company within 18 to 24 months and obtain shareholder approval, the SPAC merges with the target company in a process known as “De-SPAC-ing.” Once the de-SPAC is complete, the resultant company retains the name and operations of the target company, which then trades publicly on a stock exchange. Shareholders can typically redeem their investment if the 18 to 24-month window lapses and shareholders vote to extend the period for the SPAC to find an acquisition target, or if an acquisition target is found but the shareholders don’t like it.

As the number of SPACs skyrocketed from 2019 into 2021, the informational disadvantage to investors inherent in the penny stock market began to reproduce in the SPAC space. SPACs have raised vast sums selling warrants as part of their IPOs, which can be used to buy shares in the de-SPAC-ed company. In the de-SPAC process, sponsors receive compensation in the form of a large ownership stake for a nominal cost, setting up a textbook conflict of interest. As The D&O Diary’s Kevin LaCroix aptly put it, “[t]he conflict arises from the SPAC sponsor’s financial interest in completing a merger even if the merger is not value-creating, which may conflict with the shareholders’ interest in redeeming their shares if they believe that the proposed merger is disadvantageous.” What’s more, these lucrative sponsor compensation arrangements create dilutive effects affecting investors in the SPAC.

Even where they can show they’ve been wronged, SPAC investors are likely to have the courthouse doors slammed in their faces. Freed from the constraints of a traditional IPO, SPAC operators are permitted to speak directly to the market about the SPAC’s financial prospects. SPAC projections are generally protected by the safe harbor for forward-looking statements afforded by the Private Securities Litigation Reform Act (PSLRA), whereas projections made in connection with traditional IPOs are beyond the PSLRA’s safe harbor.

Almost as soon as SPACs became popular, scandals began to erupt. Nikola and Clover Health Investments, two of the biggest SPACs to go public in 2020, found themselves embroiled in fraud investigations conducted by the SEC and DOJ.  In July 2021, Ackman’s own SPAC, Pershing Square Tontine Holdings, abandoned a deal to buy 10% of Vivendi’s flagship Universal Music Group after the SEC flagged several elements of the deal. According to Ackman, a colorful figure best known for his crusades against Herbalife and Harvard President Claudine Gay, the SEC “said that, in their view, the transaction did not meet the New York Stock Exchange SPAC rules and what that meant was what I would call a dagger in the heart of the transaction.” Ackman was forced to return $4 billion to investors.

In response, the price of Directors and Officers insurance for SPACs was reported to have almost doubled by the end of 2020. Democratic legislators in the U.S. House of Representatives introduced the “Holding SPACs Accountable Act of 2021,” which would have excluded all SPACs from the safe harbor, and the “Protecting Investors from Excessive SPACs Fees Act of 2021,” which would have compelled the SEC to adopt a rule requiring SPACs to disclose compensation arrangements in the interest of transparency. While both pieces of legislation passed the Committee on Financial Services, neither became law. For its part, the SEC has increased its scrutiny of SPACs, tightened disclosure regulations, and clarified that the safe harbor applies only to private litigation action and not SEC enforcement.

After the SEC spiked his SPAC’s Universal deal in mid-2021, Ackman debuted a new take on the faltering investment vehicle, the SPARC. SPARCs do not require up-front money from investors like SPACs do. Instead of shares, SPARCs issue rights. Because the SPARC gives rights away, no money is held in trust. Once the acquisition target is identified, SPARC investors are given the chance to either walk away or opt in. Only if these investors approve the acquisition target and the amount that the SPARC is asking them to fork over (which will vary based on the size of the deal), can the deal close. At this point, the acquisition target gets the money and becomes public, and the SPARC rights transform into shares of the new public company. Importantly, SPARCs do not offer IPO warrants, which are used by SPACs as a way to enhance the capital raised in an IPO. This means that SPARC investors will not be diluted by such warrants and will therefore retain more of the company. Finally, SPARCs will have 10 years to complete an acquisition, in contrast to the 18 to 24-month period typically allocated to SPACs. 

Though the future of the SPARC remains uncertain, it appears to address several of the concerns that have imperiled SPACs. Most prominently, SPARC investors, unlike their SPAC counterparts, have the ability to hold back their investment while they evaluate the target. The increased control granted to SPARC investors also avoids the elimination of the safe harbor, and investors will have a greater chance to probe the specifics of the proposed acquisition. Lastly, SPARCs sidestep the share dilution endemic to SPAC compensation agreements, the precise concern underlying the “Protecting Investors from Excessive SPACs Fees Act of 2021.” The SPARC is accurately characterized as shifting risk from the investor to the sponsor, who must corral investors without the leverage that comes from holding a pool of money in trust. In early October 2023, Ackman announced that he had received SEC approval to use a SPARC to raise a minimum of $1.5 billion from investors for the acquisition of a private company.  Ackman seems to have bet that regulators will be more receptive to a model that simultaneously levels the informational playing field and endows investors with more discretion. Given his early victory in bringing the SPARC to fruition, it’s a wager that may have already begun to pay dividends.

The Future of Item 303-Based 10b-5 Claims

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Elina Rakhlin

A major unresolved question in securities litigation is headed back to the Supreme Court this term.  In Macquarie Infrastructure Corp. v. Moab Partners, L.P., SCOTUS will consider whether failing to disclose information required by Item 303 of the SEC’s Regulation S-K can support a private claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.  For plaintiffs seeking to hold companies accountable for misleading their investors by omitting material information from SEC filings, the stakes could not be higher.

Item 303’s Disclosure Duty and the Absence of a Private Right of Action

Item 303 requires that public companies include a Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section in their periodic SEC filings.  The MD&A must describe known trends, demands, commitments, events or uncertainties that are reasonably likely to materially impact the company’s financial condition or operating performance.  The SEC has made clear that Item 303 imposes an affirmative duty to disclose material information.  A company violates Item 303 by omitting information about a known trend or uncertainty that investors would consider important.

However, courts have widely recognized there is no private right of action under Item 303 itself—in other words, investors cannot sue directly for a company defendants’ nondisclosures.  Instead, plaintiffs are forced to seek recovery for these Item 303 violations within an existing securities fraud claim that does have a private right of action—most commonly, under Section 10(b) and Rule 10b-5.

This raises a key unsettled question–when does an Item 303 violation form the basis for an omissions case under Section 10(b)?

The Split: Can an Item 303 Violation Support a 10b-5 Claim?

To prevail on a Rule 10b-5 omission claim, plaintiffs must prove (1) the company had a duty to disclose, and (2) the omitted information was material.  All courts agree that violating Item 303 breaches the duty to disclose.  Where they diverge is whether an Item 303 violation, without more, makes the omission material for purposes of 10b-5.

Some circuits have held that Item 303 does not create a Section 10(b) duty to disclose.  The Ninth, Third and Eleventh Circuits have held that just because a trend or uncertainty should be included under Item 303 does not mean that omitting it is a violation of Section 10(b). In their view, an Item 303 violation alone cannot establish a 10b-5 claim.  Even if the omission breached Item 303, plaintiffs must separately prove materiality and scienter under 10b-5’s standards.

The Second Circuit disagrees.  It has held that omitting information required by Item 303 is “indeed an omission that can serve as the basis for a Section 10(b) securities fraud claim.”  Under this theory, violating Item 303 satisfies 10b-5’s materiality element automatically.  Plaintiffs need only adequately allege the other 10b-5 requirements, such as scienter.

This divide is pivotal given the broad consensus among the courts that there is no private right of action under Item 303.  As such, investors must look to Section 10(b) and Rule 10b-5 as one of their only avenues to obtain redress for Item 303 violations.  The Circuit split thus determines whether investors can hold companies liable at all for these omissions. 

This split also formed the basis for the Supreme Court’s 2017 decision to grant review in a case presenting the same question, Leidos Inc. v. Indiana Public Retirement System.  However, the case settled before oral argument.  Macquarie gives the Court an opportunity to finally resolve the split.

The Macquarie Litigation

In Macquarie, plaintiff Moab Partners brought 10b-5 claims against Macquarie Infrastructure and its executives.  Moab alleged that Macquarie concealed the known risk that impending regulatory changes restricting use of “high-sulfur fuel oil” in shipping would materially and adversely impact its storage and transportation business.  Specifically, Moab claimed Macquarie violated Item 303 by failing to disclose in its SEC filings the company’s significant exposure to high-sulfur fuel oil and the risks posed by the new regulations.

The district court dismissed the case, finding Moab failed to sufficiently allege either an Item 303 violation or scienter.  The Second Circuit reversed the district court’s decision.  Critically, it held that Macquarie’s omission of the fuel oil exposure and regulatory risks, in violation of Item 303’s disclosure duty, was sufficient to plead a material omission under 10b-5.  The court also found scienter adequately alleged.

Macquarie’s Petition for Certiorari

Macquarie petitioned the Supreme Court for certiorari on the question of whether the Second Circuit erred in holding that “a failure to make a disclosure required under Item 303 can support a private claim under Section 10(b).”  Macquarie argues that this holding improperly expands liability under 10b-5 beyond what the statute and Court precedent permit. In its view, 10b-5 reaches only “deception”—i.e., misleading statements—not pure omissions of information that Item 303 requires be disclosed. Macquarie contends that the Second Circuit’s decision conflicts with Basic v. Levinson, which held that silence, absent a duty to disclose, is not misleading under 10b-5.  Macquarie argues that Item 303’s more expansive disclosure standards make it ill-suited to support 10b-5 liability, which requires materiality be plead with specificity under the PSLRA.

Macquarie further contends that allowing 10b-5 liability for Item 303 omissions will compel companies to make overly defensive disclosures and spur meritless litigation.  Macquarie claims that the Circuit split causes problematic forum shopping, with plaintiffs disproportionately bringing these claims in the Second Circuit.

Moab Partners’ Opposition

In its opposition brief, Moab first argues that Macquarie’s petition should be denied because the Leidos question is not as important as it once seemed.  It claims the Circuit split has proven “superficial,” with most courts dismissing Item 303-based claims on other grounds, such as immateriality or lack of scienter.

Moab defends the Second Circuit’s position as correctly reflecting 10b-5’s text and the principle that misleading omissions are actionable.  It argues that Item 303 creates a mandatory disclosure duty whose breach can mislead investors.  Moab distinguishes “pure omissions” from “half-truths,” arguing that Macquarie’s affirmative statements in SEC filings (like touting steady performance) also triggered a duty to disclose the Item 303 trend.

Finally, Moab argues that allowing 10b-5 liability for Item 303 omissions does not improperly expand the private right of action.  Plaintiffs must still plead and prove materiality, scienter, and all other 10b-5 elements.  Moab contends the robust 10b-5 requirements appropriately limit these claims.

What’s Next?

On September 29, 2023, the Supreme Court granted certiorari in Macquarie Infrastructure Corp. v. Moab Partners.  The case is currently set for oral argument on January 16, 2024.  For years, federal courts have disagreed on whether failing to make required Item 303 disclosures can support private securities fraud suits under Section 10(b) and Rule 10b-5.  The Supreme Court will likely finally resolve this dispute.

The Second Circuit allows these suits; the Ninth Circuit bars them unless plaintiffs show the omission also made affirmative statements misleading.  The Court cares about uniformity in federal securities laws, and the Second Circuit’s approach impacts markets nationwide; so the stakes are high.

Plaintiffs currently have an easier path bringing Item 303-based claims in the Second Circuit.  To plead such a claim there, plaintiffs must adequately allege: (1) defendants violated Item 303; (2) the omitted information was material; (3) defendants acted with scienter; (4) plaintiffs’ purchase/sale of the securities at issue; (5) plaintiffs’ reliance on the omission; and (6) the omission caused losses. 

The Ninth Circuit imposes more stringent requirements, in which plaintiffs are not only required to sufficiently allege those same elements but also show that defendants’ Item 303 nondisclosures made affirmative statements materially misleading.  This increased burden steers plaintiffs to the Second Circuit whenever possible.

If the Court sides with Macquarie, it will be harder for plaintiffs to hold companies liable for misleading omissions in periodic SEC filings.  Ruling for Moab keeps another tool in investors’ anti-fraud arsenal.  No matter the outcome, plaintiffs likely must meet heightened pleading standards for these claims going forward.  If the Supreme Court permits Item 303-based suits under 10b-5, plaintiffs still must rigorously allege facts supporting each element—especially materiality, scienter, and the PSLRA’s particularity mandate.  If the Court bars these suits absent misleading affirmative statements, the path forward is harder still.  Indeed, significant unknowns exist regarding the future of Item 303-based claims as the Court could impose greater requirements on investors seeking to bring these claims or issue a decision that produces more confusion than clarity, leaving the question open to further interpretation and differing applications of the law among the lower courts.  Either way, more vigorous pleading and tighter case screening is the future for Item 303-based 10b-5 actions.

Pomerantz to Host First European Corporate Governance Roundtable with Sir Tony Blair

POMERANTZ MONITOR | JULY AUGUST 2023

According to Pomerantz Partner Jennifer Pafiti, it all started in 2015 with an informal conversation among fiduciaries discussing securities litigation and the ways it could benefit their funds. “There were ten of us around a table. It was simply an opportunity to bring together professionals facing similar issues regarding the value of their pension funds and the beneficiaries they owed a duty to.” Iin the years since, that niche discussion has morphed into the Pomerantz Corporate Governance Roundtable, a highly anticipated gathering of decision makers in the worlds of law and institutional investing. Covering everything from ESG to the SEC, past Roundtables have been held in New York and California, with speakers that have included journalist Bob Woodward and former U.S. President Bill Clinton. This year, for the first time ever, the Roundtable will go international, kicking off in Rome in late October with former British Prime Minister, the Right Honourable Sir Tony Blair, slated to give the keynote address.

Given current trends in finance, and Pomerantz’s significant presence in Europe and deep-rooted history, Rome seemed the ideal location for the 2023 Roundtable. European regulators are at the forefront of ESG issues, a major concern to institutional investors, wherever they are situated. Also, global investing in various jurisdictions amidst changing regulations and evolving case law affects the day to day running of large institutional funds. For Pomerantz Director of ESG and UK Client Services, Dr. Daniel Summerfield, the global theme of the Roundtable is about increasing the scope of investor education. He brings up the example of SPACs, a rising trend in U.K. finance that seems to ignore the lessons learned in the U.S. “We want to keep this conference as global as possible,” says Summerfield, “because sometimes you run the risk of looking just within your own market and not looking overseas. That’s why governance has become a global activity – learning from best practice where it exists and learning from mistakes where they have occurred.”

A certain highlight of the roundtable will be the opportunity to hear from the Special Guest Speaker. Both Pafiti and Summerfield enthusiastically described the 2022 Roundtable, when Pomerantz Managing Partner Jeremy Lieberman interviewed former U.S. President Bill Clinton. “It was astonishing, you could hear a pin drop in that room,” recalled Summerfield. Even though politics was not the central subject of the conference, Pafiti found that President Clinton’s experiences during his time in office applied neatly to the world of corporate governance. She recounted Clinton’s discussion of his talks with an adversarial head of state as “laying the grounds for engagement as a tool before you start a war. It’s no different with our pension funds, engagement can be a useful tool in the world of governance before the big guns are brought out!” Summerfield sees the opportunity for similar insights with this year’s guest speaker, former British Prime Minister Sir Tony Blair. “They’re very close with one another, and the Blair-Clinton outlook on the world and geopolitics is similar. Their center-left ideology is pretty clear … and investor rights tend to be more associated with that center ground.”

Beyond the Special Guest Speaker, this year’s Roundtable features a host of notable panelists, including professors from Cambridge and the University of Glasgow, prominent investment managers and corporate lawyers, heads of ESG, and top executives from some of the most influential pension funds around the globe. Some of the panel topics will be familiar to attendees of previous Roundtables. This year will feature the return of “Unleash the Lawyers,” a popular session devoted to recent developments in case law and the ways litigation can serve as a tool for recovery as well as corporate engagement.

Other sessions have a more topical bent. There will be panels on the downfall of crypto currency and SPACs, a session on the fall of the Silicon Valley Bank, and a discussion of greenwashing. For Pafiti, this contemporary focus is one of the factors that sets the Pomerantz Roundtable apart from other conferences: “A lot of educational platforms won’t be talking about things that are happening in the moment because there is no conclusion, and the landscape might be changing in real time.” Pomerantz seeks to provide a forum to discuss developing issues as they’re occurring. To support this, the Roundtable has a strict “no press” policy and all conversations are held under Chatham House Rule, meaning any discussion can only be attributed to the group at large, not a specific speaker.

For Pafiti and Summerfield, it is this lively and unencumbered discussion among the participants that lies at the heart of the Roundtable. “From the very first Roundtable, it was important that the concept is led by our attendees and that is a theme we have continued,” explains Pafiti. “It’s peers who are speaking, they’re not only part of the discussion but they are leading it. It is very much guided by the desires of the conference attendees and the topics they want to hear about.” It is easy to see why Pafiti and Summerfield are so excited about participant discussions - the conference brings together CEOs, CIOs, CFOs, General Counsel, Trustees and Heads of ESG for some of the largest pension funds and asset managers across the globe. “We’re bringing together a diverse set of individuals: different backgrounds, different positions, different thoughts, different education, so that we have diversity of thought in the room, but it’s small enough that it’s still an intimate environment,” Pafiti explains. “It’s still a round table, just with a much larger table.”

For additional information or to reserve your place at this year’s event, please email pomerantzRoundtable2023@pomlaw.com.

Pomerantz Prevails Against Motion to Dismiss Its SPAC Litigation

POMERANTZ MONITOR | JULY AUGUST 2023

By Tamar Weinrib

Pomerantz, as sole lead counsel, recently won an important victory for investors in a securities fraud litigation against PureCycle Technologies, Inc., certain of its executives (collectively, the “PureCycle Defendants”), and Byron Roth. On June 15, 2023, Judge Byron of the Middle District of Florida denied defendants’ two motions to dismiss the Sections 10(b), 14(a), and 20(as) claims set forth in plaintiffs’ Second Amended Complaint, as well as defendants’ motion to strike, only dismissing the claims as to one of the five individual defendants.

PureCycle is a plastic recycling company that went public via a “de-SPAC” reverse merger with Roth CH Acquisition I Co., a special purpose acquisition company (“SPAC”). SPACs are shell companies set up solely to raise money through an IPO to eventually acquire another company. PureCycle had the dubious honor of being merely one in a long line of questionable reverse mergers Byron Roth has brought public, while misleading investors regarding the underlying business, only to slap a “buy” rating on the stock and collect millions in compensation, leaving innocent investors to suffer the consequences.

To date, PureCycle has never earned any revenue and has only one product -- a process it claimed could cost effectively recycle polypropylene, a common plastic that, since its invention in 1951, has stymied all efforts of the top scientists and chemical companies researching a way to effectively or economically recycle it. As the Court how now twice ruled (in the June 15, 2023 order and a previous order granting defendants’ motion to dismiss the First Amended Complaint in part), the PureCycle Defendants and Roth issued false and misleading statements throughout the November 16, 2020 - November 10, 2021 Class Period, claiming to have achieved the impossible. Specifically, defendants represented in proxy statements, a registration statement, and in press releases, that their recycling process is “proven” to convert waste polypropylene (called feedstock) into virgin polypropylene resin more cost effectively than manufacturing virgin polypropylene traditionally and utilizing a broader range of feedstock than traditional recycling. In reality (as multiple industry experts have attested), the technology underlying the process is unproven, presented serious issues at lab scale, could not be achieved cost effectively, and could not utilize a broader range of feedstock than traditional recycling. Defendants further touted the PureCycle management team -- which claimed to have solved the previously unsolvable polypropylene recycling problem -- as having “broad experience across plastics,” and decades of experience scaling early-stage companies in public markets and leading transformational projects, though they in fact had no background in plastics recycling and previously brought six other early-stage companies public that subsequently imploded, causing substantial investor losses. In the order, the Court held, “Defendants have failed to present any new argument that would cause the Court to reverse what it has already determined.”

The Court further held that plaintiffs sufficiently alleged scienter (a culpable state of mind) for purposes of the § 10(b) claim (the sole basis for the Court’s prior partial grant of defendants’ motion to dismiss the First Amended Complaint); Section 14(a), which is based on false and misleading statements in the proxy statements, does not require scienter. With regard to the PureCycle Defendants, the Court found scienter because the Second Amended Complaint avers with “greater specificity…the repeated instances wherein Defendants collectively and individually flaunted their past experience without disclosing their alleged prior business failings.” The Court reached this conclusion for two reasons: 1) the “shift in phrasing” demonstrating that “each Defendant individually ‘acted with the required state of mind’ by touting his own experience while omitting previous failures,” and 2) “Plaintiffs more precisely emphasize the repeated manner in which Defendants touted their experience.”

Though not determinative on its own, the Court also noted the PureCycle Defendants’ repeated “willingness to bolster their own credibility” as compared to their utter silence when their credibility was attacked in the short seller report that revealed the fraud in this case at the end of the Class Period, causing PureCycle’s stock to plummet 40%. As part of its holistic analysis, the Court also based its scienter ruling on defendants’ significant financial gain from the SPAC merger, access to internal company information, lack of experience with polypropylene recycling, and an SEC investigation that commenced in September 2021 “pertaining to, among other things, statements in connection with PureCycle’s technology, financial projections, key supply agreements and management.”

With regard to defendant Roth, the Court correctly rejected his piecemeal attacks and found scienter based on his “checkered history,” financial motive to act fraudulently, the “core operations” doctrine, Roth’s signing of the S-4, Schedule 14A (which contained the SPAC merger agreement), including the initial Proxy Statement and then later the amended Proxy Statement for Special Meeting of Stockholders of Roth Acquisition with the SEC which showed his “ongoing involvement with the SPAC merger over a period of several [pivotal] months,” and his access to information during that time including the “personnel, books, records, properties, financial statements, internal and external audit reports, regulatory reports, Contracts, Permits, commitments and any other reasonably requested documents and other information of [PureCycle Inc.], when Roth issued his misstatements.”

Defendants filed a motion on June 30, 2023 asking the Court to reconsider its order, claiming that “recent developments,” i.e., that PureCycle’s first plant just started producing “post-industrial recycled pellets” undermine plaintiffs claim. However, as plaintiffs argued in an opposition brief filed on July 14, 2023, the misleading statements set forth in the Second Amended Complaint pertained to the status of PureCycle’s technology almost two years ago, not the status of its technology today. Moreover, the misstatements concerned defendants’ claims that PureCycle could recycle polypropylene into virgin-like resin, more cost effectively than traditional recycling methods, and using a broader range of feedstock than traditional recycling. Defendants have not introduced a single fact to suggest that these recently produced pellets are virgin-like, produced more cost effectively than traditional recycling methods, or using a broader range of feedstock. In fact, less than a year ago, the FDA told PureCycle that it could only recycle polypropylene into packaging for food and drink as long as the feedstock comes solely from drink cups, the antithesis of a broad range. Defendants alternatively argued that the Court committed legal error in its scienter ruling, relying on new arguments they did not raise in their motions to dismiss (and thus are foreclosed from arguing now) and basing their arguments on mischaracterizations of the Order.

The discovery process is set to begin, and plaintiffs will file their motion for class certification in the coming months.

The Questionable Use of Free Speech Defenses in Securities Litigation

POMERANTZ MONITOR | JULY AUGUST 2023

By Villi Shteyn

Corporate actors trying to evade liability for fraud have used some questionable defenses, but the least credible may be trying to hide behind the First Amendment of the United States Constitution under the banner of free speech. The Supreme Court has stated that “the First Amendment does not shield fraud,” but that has not stopped companies from trying. This sets the backdrop for Massachusetts Attorney General Maury Healey’s suit against ExxonMobil Corp. (“Exxon”) brought in Massachusetts State Court back in October 2019.

The suit included claims that oil giant Exxon lied to consumers by marketing its products as environmentally friendly and, importantly, that Exxon misled investors by downplaying any climate-driven financial risks to its bottom-line financials. Specifically, the suit alleged that in the past, Exxon’s former CEO stated that the scientific evidence on climate change is inconclusive, as part of a campaign by Exxon to deceive consumers and investors despite decades-long internal knowledge to the contrary. The suit claims that Exxon more recently tells investors that climate change risks are a management priority, but its financial projections continue to deceive investors by asserting that virtually none of Exxon’s fossil fuel assets will be at risk. The complaint details how Exxon has internally analyzed and known these risks for over forty years but has failed to disclose them to investors. Instead, while publicly stating that the company accounted for climate change-related risks in its business planning, Exxon actually grossly undercounted such risks in its financials.

Exxon tried to claim that these statements, rather than being targeted to investors, were merely Exxon’s participation in the public discourse on a controversial issue of public concern and were directed at lawmakers or the public. This is despite the fact that examples included the statement that Exxon will “face virtually no meaningful transition risks from climate change.”

In a ruling issued last year, the Massachusetts Supreme Judicial Court rejected Exxon’s First Amendment defense to Attorney General Healey’s suit. The Court largely ignored the substance of the argument and simply found that Massachusetts’ anti-Strategic Lawsuit Against Public Participation (“anti-SLAPP”) law did not apply to civil enforcement proceedings brought by the state’s Attorney General, and that it was instead meant to block lawsuits brought by private actors. This ruling may leave private securities litigants wanting, but the Court did specify that the legislative history for the anti-SLAPP statute was meant “especially” for developers attempting to prevent local opposition to zoning approval.

Also, in positive news for investors, recent developments in the case law have shown courts to be highly skeptical and unconvinced by First Amendment defenses.

Ohio-based electrical utility company FirstEnergy Corp. also tried an extremely craven First Amendment defense in an investor class action. In a 2022 opinion, Chief Judge Marbley of the Southern District of Ohio found FirstEnergy’s First Amendment defense to strain[] credibility.” FirstEnergy attempted to argue, in a manner similar to Exxon, that corporations have a First Amendment right to speak on issues of public importance. But in this case, the supposedly protected statements were bribes. Specifically, this argument was made in the face of allegations of political contributions through the use of 501(c)(4) entities that were bribes to corrupt politicians and regulators. The court rejected this nonsensical argument and found that the bribery payments and deception of investors about the nature of the political activity undertaken by the company were not protected speech.

Similar First Amendment challenges have also failed in other securities fraud class actions, such as in a 2021 opinion in Pomerantz’s action in the Altria and JUUL securities fraud litigation in the Eastern District of Virginia. There, the court rejected use of the Noerr-Pennington doctrine for protections of petitioning activity because “the First Amendment offers no protection when petitioning activity ... is a mere sham to cover an attempt to violate federal law[,]” and fraud allegations under the Exchange Act raise this sham exception. A 2020 Northern District of California Court found similarly, despite the speech in question being a letter to Congress.

Judge Liman of the Southern District of New York issued a 2022 opinion equally unconvinced of this type of defense. In 2018, Tesla CEO Elon Musk agreed to a consent decree with the Securities and Exchange Commission (“SEC”) in the wake of settling charges by the SEC under the Exchange Act for false and misleading statements. The consent decree prevents him from communicating about Tesla without pre-approval by Tesla, to ensure the accuracy of the statements and consistency with what Tesla reports. In an attempt to terminate the consent decree, Musk argued that his First Amendment rights were intruded upon. However, Judge Liman found this argument wholly unconvincing and stated that Musk’s free speech rights do not allow him to engage in speech that is fraudulent or otherwise violates the securities laws. Judge Liman further found that the consent decree waived any First Amendment rights implicated. This decision was appealed to the Second Circuit of Appeals. The Second Circuit was no more receptive to the First Amendment argument and affirmed Judge Liman’s decision in a summary order.

Pomerantz has also had success in litigating a case involving statements relating to climate preparedness. In Vataj v. Johnson, settled favorably on behalf of defrauded investors in 2021, plaintiffs alleged false and misleading statements regarding a utility’s preparation and risk-minimization for wildfires.

            Thus, courts still view these dishonest First Amendment protections for what they are: pretextual rationalizations to try to evade liability for deceiving investors. It is well-settled law that the First Amendment does not protect fraud, and courts are unlikely to prevent investors from enforcing their rights to be protected from false and misleading statements under the false guise of free speech. While securities fraud defendants will certainly continue to use questionable tactics to attempt to shield themselves from liability for false or misleading statements, courts’ patience with these attempts, especially with the attempted use of the First Amendment, is wearing thin.

Navigating Section 220 Demand for Corporate Books and Records

POMERANTZ MONITOR | JULY AUGUST 2023

By Ankita Sangwan

Section 220 of the Delaware General Corporation Law (“Section 220”) grants shareholders the right to access corporate books and records, provided they fulfil the necessary “form and manner” requirements specified in the statute, and provided the demand is in furtherance of a “proper purpose.” Per Section 220, a proper purpose is one that is “reasonably related” to the shareholder’s interest as a shareholder. Most commonly, shareholders use Section 220 to investigate potential corporate misconduct, such as breaches of fiduciary duty by directors or officers, cases of mismanagement, corporate waste, or other wrongdoing, all of which have been recognized as “proper purposes” by Delaware courts. 

To proceed, a stockholder must demonstrate a “credible basis” for suspecting wrongdoing or mismanagement, which is the “lowest possible” burden of proof under Delaware law. While mere speculation, curiosity, and suspicions do not satisfy it, the threshold is satisfied through documents, logic, testimony, or otherwise demonstrating that there may be legitimate issues of wrongdoing or mismanagement. Further, the Delaware Supreme Court has affirmed that “where a stockholder meets this low burden of proof … [the] stockholder’s purpose will be deemed proper under Delaware Law” and that the stockholder “is not required to specify the ends to which it might use the books and records.” Thus, a stockholder is not required to demonstrate that the suspected wrongdoing it seeks to investigate is “actionable” under Delaware law. Once a stockholder establishes proper purpose and credible basis, they are entitled to access the relevant corporate books and records that are considered “necessary” to investigate the specific wrongdoing that the stockholder has identified in their Section 220 Request.

The Delaware Court of Chancery has encouraged stockholders to avail themselves of the ‘tools at hand’ and request company books and records before filing derivative complaints and has admonished plaintiffs when they have not attempted to gather reasonable information to substantiate their allegations before filing a derivative complaint. Section 220 has thus become a popular and widely used tool for stockholders seeking to investigate corporate wrongdoing and mismanagement. This wide usage of Section 220 has led to an evolution of Delaware’s jurisprudence reflecting judicial efforts to maintain a balance between the rights of stockholders to obtain information based on credible allegations of corporate wrongdoing and the rights of corporations to manage their business without undue interference from stockholders. The “credible basis” standard forms part of judicial efforts to maintain this balance. Courts have thus ruled against plaintiffs where investigations are deemed to be “indiscriminate fishing expeditions," and thus adverse to the interests of the corporation.

In “The Paradox of Delaware’s ‘Tools at Hand’ Doctrine: An Empirical Investigation,” published by Duke University School of Law in 2019, James D. Cox, Kenneth J. Martin, and Randall S. Thomas state that the results of their study “support[s] the positive social benefits of Delaware’s innovative tools at hand doctrine.” In recent years, they found, a trend emerged with defendants increasingly treating Section 220 actions as a “surrogate proceeding to litigate the possible merits of the suit” and to “place obstacles in the plaintiffs’ way to obstruct them from employing it as a quick and easy pre-filing discovery tool.” Courts have reprimanded corporations that use such “overly aggressive” litigation tactics while responding to Section 220 demands. Pomerantz has successfully litigated against such defense campaigns by different corporations. In a case filed against Biogen where plaintiff sought to investigate potential corporate wrongdoing and mismanagement arising from a federal investigation and a former employee’s allegations in a wrongful termination suit, the Delaware Court of Chancery noted that Biogen followed “the recent trend in adopting what has been referred to as an “overly aggressive defense strategy” in opposing inspection and granted plaintiffs access to board-level materials.

In another instance, Pomerantz, along with two other firms, filed a complaint against Gilead, when Gilead employed similarly aggressive strategies against plalintiffs’ Section 220 demands. The purpose of these demands was to investigate possible wrongdoings concerning the production, marketing and sales of Gilead’s HIV drugs. In her decision, Chancellor McCormick (Vice Chancellor at the time) noted that “Gilead exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.” Chancellor McCormick also found that Gilead’s approach called for fee-shifting since Gilead had engaged in bad faith conduct. Ultimately, defendants were sanctioned and ordered to pay Pomerantz and other plaintiffs’ counsel $1.76 million in attorney’s fees.

Another emerging trend is that stockholders are using Section 220 demands to investigate a company’s commitments to diversity and other ESG concerns. In Asbestos Workers Phila. Welfare & Pension Fund v. Scharf, No. 3:23-cv-1168 (N.D. Cal. Mar. 15, 2023), shareholders relied on information and documents received pursuant to a Section 220 demand to allege that the Wells Fargo Board disregarded “pervasive issues of discrimination” and further alleged that the bank conducted fake interviews with minority candidates. Similarly, a Tesla stockholder relied on Section 220 documents to allege that the Tesla Board fostered a company culture of tolerating sexual harassment and racial discrimination.

In a recent case on this issue, Simeone v. The Walt Disney Company (Del. Ch. June 27, 2023), the Delaware Court of Chancery rejected an action filed by a Walt Disney stockholder seeking to compel inspection of books and records relating to the company’s opposition to Florida’s “don’t say gay” law – in a stance that allegedly caused Florida’s Governor and state legislature to retaliate against the company by stripping it of special state-granted tax treatment and other benefits. In ruling against the stockholder, the Court held that he had not established a proper purpose for his Section 220 demand because the stated purpose belonged to the stockholder’s counsel, rather than to the stockholder himself. The stockholder testified that he had been solicited to make the Section 220 demand and had been put in touch with the Thomas More Society, a “public interest law firm championing Life, Family, and Freedom.” He also testified that his only purpose in requesting inspection was to “know the person or persons who were responsible for making th[e] political decision at Disney to publicly oppose” the law. The Court also held that  “[t]he plaintiff is not describing potential wrongdoing.  He is critiquing a business decision.  A stockholder cannot obtain books and records simply because the stockholder disagrees with a board decision, even if the decision turned out poorly in hindsight.” The Court further explained that a corporation’s “choosing to speak (or not speak) on public policy issues is an ordinary business decision,” even if the topic is a “divisive” one, and even if it is “external to [the company’s] business.” The Court concluded that “At bottom, the plaintiff disagrees with Disney’s opposition to [the Florida law]. He has every right to do so. But disagreement with [a] business judgment is not evidence of wrongdoing warranting a Section 220 inspection.”

The Walt Disney case differs from the other decisions and is interesting for several reasons, one being that it focuses on the stockholder’s – not their lawyers’ – purpose, and emphasizes that even if an alleged bad corporate decision has been made, it does not necessarily mean that a wrongdoing at the level of a breach of fiduciary duty occurred. Delaware Courts have consistently emphasized that “bad” or “misguided” business decisions that do not involve legal violations typically do not qualify as breaches of fiduciary duty. Furthermore, there have been discussions among courts and experts questioning whether such decisions can be considered breaches of fiduciary duty if they are not connected to any legal violations. In any event, these spates of decisions highlight the growing trend of ESG-related litigation, which continues to be bolstered by Section 220 requests.

Given the popularity of Section 220 requests and their usefulness in investigation of corporate wrongdoings, it will be interesting to see how these trends develop and evolve.

Slack Ruling

POMERANTZ MONITOR | MAY JUNE 2023

By Christopher Tourek

On June 1, 2023, the Supreme Court decided Slack Technologies, LLC v. Pirani – a much-watched case in the securities litigation field – and overturned the Ninth Circuit’s holding that would have dramatically lowered the bar for plaintiffs to bring Section 11 and 12(a) claims involving direct listings. In doing so, the Court upheld the “tracing requirement” for Section 11 claims, while also signaling a de-coupling of Section 11 and Section 12(a) (2) claims.

The Securities Act of 1933 requires companies to make disclosures through a registration statement and a prospectus before they can offer certain shares to the public for sale. Under Section 11 of the Securities Act of 1933, anyone who acquired a security that was sold in connection with that registration statement and prospectus can sue if the registration statement was materially false or misleading and that investor lost money. Similarly, under Section 12(a)(2) of the Securities Act of 1933, anyone who acquired a security that was sold in connection to a prospectus that contained a material misstatement can sue if they suffered a loss. Unlike actions brought under Section 10(b) of the Securities Act of 1934, Section 11 and 12(a) (2) actions impose strict liability on defendants, meaning that defendants can be guilty even if the misstatements were unintentional. However, because of this strict liability, courts have generally limited the availability of Section 11 and 12(a)(2) claims to plaintiffs who can plead and prove that they bought securities registered under the registration statement at issue. This requirement is known as the “tracing requirement.”

It was against this legal backdrop that the securities litigation against Slack arose. Slack is a software company that went public in June 2019 through a direct listing of its shares, rather than a traditional Initial Public Offering (“IPO”). Unlike in an IPO where newly registered shares are traded on an exchange for an initial period before pre-existing unregistered shares are traded, a direct listing allows both new shares subject to the registration statement and existing shares not subject to the registration statement to be traded immediately. In pursuing this direct listing, Slack filed a registration statement registering 118 million shares which were offered simultaneously with 165 million unregistered shares.

In September 2019, investor Fiyyaz Pirani, filed suit against Slack and a number of its directors and officers under Sections 11 and 12(a)(2) of the Securities Act of 1933, alleging misrepresentations in connection with Slack’s direct listing. Slack moved to dismiss Pirani’s complaint, arguing that Pirani had no standing because he could not satisfy the tracing requirement. In effect, Slack argued that Pirani was unable to show that he purchased some of the 118 million registered shares, and not some of the 165 million unregistered shares. In making its argument, Slack focused on language found in Sections 11 and 12(a) specifying that liability claims under those sections may be brought by a person acquiring “such security” – a phrase Slack argued referred to a security registered pursuant to a registration statement. The Northern District of California District Court ultimately denied Slack’s motion to dismiss despite Slack’s tracing requirement argument. Slack subsequently appealed this decision to the Ninth Circuit.

In September 2021, the Ninth Circuit, in a 2-1 opinion, affirmed the District Court’s holding and stated that, “Slack’s shares offered in its direct listing, whether registered or unregistered, were sold to the public when ‘the registration statement . . . became effective,’ thereby making any purchaser of Slack’s shares in this direct listing a ‘person acquiring such security’ under Section 11.” The Ninth Circuit added that were the Court to adopt Slack’s reasoning, the outcome “would essentially eliminate Section 11 liability for misleading or false statements made in a registration statement in a direct listing for both registered and unregistered shares.” The dissent argued that the majority’s holding reflected a departure from more than 50 years of jurisprudence applying the tracing requirement. Unsurprisingly, Slack appealed the Ninth Circuit’s decision to the Supreme Court.

In its briefs, Slack argued that only persons who could definitively trace their shares to the June 2019 registration had standing to assert claims under Sections 11 and 12(a)(2) and that the Ninth Circuit’s holding undercuts the longstanding application of the tracing requirement. Slack also argued that Sections 11 and 12(a)(2) offer the plaintiff a tradeoff – the benefits of strict liability if a plaintiff can meet the sometimes high standard of the tracing requirement. Slack further dismissed policy concerns that its position would provide companies de facto immunity from Section 11 claims for direct listings, arguing that there are several other avenues for justice, including Section 10(b) of the Securities Act of 1934.

In rebuttal, Pirani argued that the Ninth Circuit was correct in holding that he had standing to sue under Sections 11 and 12(a)(2) because the registered and unregistered securities were sold at the same time, under and pursuant to Slack’s first and only registration statement. Pirani also argued that while there must be some connection between the offering of shares and the registration statement, Section 11 does not necessarily apply only to registered shares. Instead, Pirani contended that anyone who purchased shares that required a registration statement in order to be sold (which would include both registered and unregistered shares in a direct listing) could bring suit under Sections 11 and 12(a)(2). Pirani also emphasized that it is nearly impossible to discern whether shares purchased in a direct listing are registered or not, thus creating an impossible hurdle when trying to establish standing.

The implications of the parties’ arguments were clear enough. Slack’s position would essentially grant immunity from Section 11 and 12(a) claims for anything stated (or misstated) in a registration statement or prospectus connected with a direct listing. Pirani’s position would essentially abolish the tracing requirement entirely and allow Sections 11 and 12(a) claims to be brought by anyone who purchased a security that needed a registration statement in order to be sold, regardless of whether that security was registered to the (misleading) registration statement.

During oral arguments, the Supreme Court appeared open to Slack’s view of Section 11, with Chief Justice Roberts telling Pirani’s counsel, “The statute says, ‘such security.’ I mean that’s a big hurdle for you to get over.” Additionally, Justice Kagan told Pirani’s counsel, “It does seem to me like you have a hard row to hoe here.” Nevertheless, the Court appeared hesitant to endorse Slack’s position on claims under Section 12, saying that there is little case law and the SEC has not weighed in on the issue. Highlighting this reticence was Justice Kavanaugh, who told Slack’s counsel, “[t]hat strikes me as a big issue for these direct listings and something that I’m not sure we’re fully equipped at this moment to chime in on.” Indeed, both Justices Kavanaugh and Gorsuch suggested that they might side with Slack on the Section 11 claim but return the case to the Ninth Circuit to revisit the Section 12 claim. Justice Kavanaugh made a point that he was “worried about making a mistake” given that neither the lower courts nor the SEC had extensively analyzed the Section 12 issue.

Ultimately, the Supreme Court held that plaintiffs bringing claims under Section 11 of the Securities Act are still required to satisfy the tracing requirement, even when the case involves a direct listing. In reaching the decision, Justice Gorsuch wrote that the better reading of Section 11 “requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement.” The Court then remanded the case back to the Ninth Circuit. However, the Supreme Court did not expressly apply this ruling to the Section 12 claim, and instead admonished the Ninth Circuit for its previous belief that Sections 11 and 12 “necessarily travel together,” instead cautioning that “the two provisions contain distinct language that warrants careful consideration.”

What this ruling will mean for plaintiffs is unknown, but it will likely increase the difficulty for plaintiffs attempting to sue a company that sells shares pursuant to a direct listing, since distinguishing between registered and unregistered shares sold at the time of a direct listing could prove impossible. Because of this difficulty, a cottage industry may be created of experts whose sole purpose is to identify whether a share was registered or unregistered when purchased. Finally, while it is unknown how the Ninth Circuit (and Supreme Court) will interpret Section 12 in light of this ruling, the Court’s opinion at least signals a divergence between Section 11 and Section 12 jurisprudence.

The SEC’s Proposed Rules: Protecting Investors in Cryptocurrencies

POMERANTZ MONITOR | MAY JUNE 2023

By Thomas H. Przybylowski

On January 4, 2023, the United States Office of Information and Regulatory Affairs (“OIRA”) released the Fall 2022 Unified Agenda of Regulatory and Deregulatory Actions (the “Agenda”). The Agenda, which outlines the short- and long-term regulatory actions planned by various administrative agencies, includes rules submitted by the U.S. Securities and Exchange Commission (“SEC”) in the proposed or final rule-making stage. In a statement published that same day, SEC Chair Gary Gensler stated, in relevant part:

I support this agenda as it reflects the need to modernize our ruleset, moving deliberately to update our rules in light of ever-changing technologies and business models in the securities markets. Our ability to meet our mission depends on having an up-to-date rulebook—consistent with our mandate from Congress, guided by economic analysis, and shaped by public input.

The SEC’s regulatory actions on this unified agenda would help make our markets more efficient, resilient, and fair, including through rulemaking items we have been directed by Congress to implement. Taken together, the items on this agenda would advance our three-part mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

The SEC’s contributions to the Agenda include proposed rules designed to enhance company disclosures regarding human capital management and corporate board diversity, changes to registered investment companies’ fees and fee disclosure, and rules focusing on “cybersecurity and [the] resiliency of certain commission registrants.” Furthermore, the SEC is considering amendments to “modernize rules related to equity market competition and structure such as those relating to order routing, conflicts of interest, best execution, market concentration, pricing increments, transaction fees, core market data, and disclosure of order execution quality statistics.”

Perhaps most relevant to the current economic climate are the SEC’s proposals related to the cryptocurrency industry. For example, in March 2023, the SEC released a draft proposed rule pertaining to “Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure.” The draft rule specified that the SEC is proposing, inter alia, “amendments to require current reporting about material cybersecurity incidents,” and “proposing to require periodic disclosures about a registrant’s policies and procedures to identify and manage cybersecurity risks, management’s role in implementing cybersecurity policies and procedures, and the board of directors’ cybersecurity expertise, if any, and its oversight of cybersecurity risk.” The intention behind the proposed rule, the draft indicates, is to “better inform investors about a registrant’s risk management, strategy, and governance and to provide timely notification of material cybersecurity incidents.”

Similarly, in an April 14, 2023 press release, the SEC announced that it was reopening the comment period for proposed amendments to the definition of “exchange” under Rule 3b-16 of the Securities Exchange Act of 1934 (the “Exchange Act”). The proposed amendment concerns the applicability of existing rules to platforms that trade crypto asset securities and would “provide supplemental information and economic analysis for systems that would be included in the new, proposed exchange definition.” In support of the reopening, Gensler stated that the supplemental release would help answer questions and comments raised by various market participants, and added, in relevant part, “[m]ake no mistake: many crypto trading platforms already come under the current definition of an exchange and thus have an existing duty to comply with the securities laws. Investors in the crypto markets must receive the same time-tested protections that the securities laws provide in all other markets.”

The SEC’s cryptocurrency-related proposals are particularly pertinent given the recent failure of several “crypto-facing” banks. In November 2022, cryptocurrency exchange FTX collapsed among allegations of fraud and mishandled customer funds, resulting in a wide-ranging disruption of the cryptocurrency markets. By March 2023, the disruption spread to various banks that had cultivated crypto-heavy deposit bases, such as Silvergate Bank and Signature Bank, significantly undermining their financial stability. As a result, Silvergate was forced to voluntarily wind down its operations and Signature experienced a bank run that ultimately lead to receivership. Accordingly, the fall of FTX and subsequent bank failures signaled to the SEC and the market at large that cryptocurrency remains inherently volatile and must be closely monitored.

Following the announcement of its proposals, the SEC was met with harsh criticism from representatives of the Republican party. Specifically, in a House Financial Services Committee (the “Committee”) hearing held on April 18, 2023, Republican lawmakers claimed that the SEC was rushing the pace of its rulemaking in the areas of climate change risks and cryptocurrency. Moreover, Republican representatives criticized the number of enforcement actions the SEC has recently brought against cryptocurrency firms and accused Gensler of refusing to provide clarity on the applicability of securities laws on cryptocurrency and how cryptocurrency firms should comply with those laws. In addition to Republican lawmakers, several business groups have also expressed disagreement with the SEC’s 2023 proposed rules. For example, the National Association of Manufacturers sent a letter to the Committee arguing that “over the last two years the SEC has instead advanced an ambitious policy agenda that will impose costly regulatory burdens on manufacturers and hamper long-term value creation for shareholders.”

In response to these criticisms, Gensler defended the SEC’s authority to regulate the cryptocurrency industry and argued that the U.S. capital markets are as profitable and secure as they are because of federal oversight. Indeed, Gensler stated that he was “trying to drive [the digital asset industry] to compliance and if [digital asset firms are] not complying with the laws then they shouldn’t be offering their products to U.S. investors.” Noncompliance, Gensler asserted, “not only puts investors at risk, but also puts at risk the public’s trust in our capital markets.” Gensler was joined by Democratic lawmakers who also advocated for heightened regulation of the cryptocurrency industry. Representative Brad Sherman, for example, reasoned that legislation categorizing all crypto assets as securities would make it clear that “investors in crypto get the same protection as investors in stock, bonds and other intangible assets acquired for an investment purpose.” Likewise, in her opening statement at the April 18, 2023, Committee hearing, Representative Maxine Waters stated that, in the wake of the collapses of Silicon Valley Bank and Signature Bank, she “[couldn’t] believe that [the] Committee [was] rushing to take off more guardrails when we should be adding them.”

A 2022 study published by the CFA Institute revealed that 94% of state and government-sponsored pension funds are invested in one or more cryptocurrencies despite the obvious risks. Former SEC attorney Edward Seidle, in an October 3, 2022 article in Forbes, wrote:

According to Anessa Allen Santos, a Florida attorney and Special Magistrate who specializes in blockchain and fintech, one glaring reason why no pension fund should be toying with cryptocurrencies right now is “the rapid increase in regulatory hostility exercised without restraint toward cryptocurrency issuers by several federal administrative agencies.”

Whether or not the SEC’s proposed rules are adopted, it is evident that companies should pay attention to them. This is particularly relevant to businesses in the cryptocurrency industry, given the inherent volatility of digital assets and the plurality of enforcement actions the SEC has recently taken against crypto companies. As such, it would be prudent for companies to review their cybersecurity policies, procedures, controls, and response measures. This includes an analysis of a company’s governance structure to determine if any changes need to be made to the composition of boards or committees, including identifying any members that could be considered cybersecurity experts. In addition, companies may engage an outside third-party cyber penetration testing firm to review the company’s current procedures or retain a Cyber Managed Services Provider to conduct external monitoring to supplement the company’s internal processes. Ultimately, the current economic and regulatory climates, especially within the cryptocurrency industry, suggest a company is likelier to be in compliance with the SEC’s proposed rules for 2023, should they be enforced, the greater the number of preventive measures that company takes.

It remains to be seen whether the SEC’s proposed regulations for cryptocurrencies will help investors sleep better at night.

Empowered Investors, Enhanced Accountability

POMERANTZ MONITOR | MAY JUNE 2023

By Jessica N. Dell

My first encounter with environmental, social, and governance issues, or ESG, came 20 years ago when I was a college intern compiling survey results on “Corporate Citizenship and Sustainability.” At the time, the “G” – governance – was investors’ main area of focus. When they did turn their attention to environmental issues, investors primarily concentrated on how to distinguish companies that were “greenwashing,” – i.e., promoting environmental initiatives without making substantive changes – from those undertaking real reforms, and on developing tools to measure and report their returns on ESG investments.

Two decades later, as investors increasingly seek ways to integrate ESG into their investment decision-making processes, ESG issues have become a leading topic. Institutional investors are wielding their combined power to demand increased transparency, accountability, and opportunities for engagement from corporations and their boards. This article will address ESG investing from four vantage points: (1) recent trends in proxy voting; (2) what investors should expect from boards; (3) regulatory oversight and recourse under securities laws; and (4) the current backlash from conservative politicians.

In April 2023, Deloitte & Touche LLP released the results of their Global Boardroom Program’s analysis of the voting records of 101 large investors around the world. The results highlighted key concerns for the 2022 season of annual general meetings on topics including ESG, diversity, equity and inclusion (DEI), board composition and board independence, and executive pay. Deloitte’s analysis found that nearly half or more of investors across Australia, the UK, and the US called for reporting aligned with the Task Force on Climate-Related Disclosure (TCFD) guidelines. “Over half of US investors sought disclosures of industry-specific metrics published by the Sustainability Accounting Standards Board (SASB). In contrast, only one in five global investors expected that their investee companies should follow SASB industry-specific guidance. In the UK, over half of investors asked companies to align their targets with other specific metrics, such as the Paris Agreement’s 1.5°C target.”

Among investor votes on social issues, diversity stood out as a major concern. The voting policies of two-thirds of UK and three quarters of US institutional investors pointed to the importance of ethnic diversity considerations.

Deloitte’s April report dovetails with the results of their “Global Boardroom Program Frontier” survey, published in February 2023. There, respondents predicted that ESG and climate change would rank higher in priority than customer experience, innovation, and cybersecurity. Survey respondents placed responsibility for these priorities firmly with corporate CEOs and Board members, citing their leading role in cultivating and maintaining shareholder trust.

The Conference Board, a global, nonprofit think tank and business membership organization, recently convened more than 200 executives for a series of roundtables to discuss the changing role of the board in the era of ESG investing and stakeholder capitalism. Its findings confirmed that over the next five years, corporate boards should expect ESG issues to have a “significant and durable impact.” Paul Washington, Executive Director of the Conference Board’s ESG Center, identified “five key areas in which investors should expect more from boards—and be alert to red flags.” According to Washington, investors should:

1. Seek clear evidence the board is making well-informed decisions as to what ESG issues to focus on and how they are balancing the interests of stake holders.

2. Have heightened expectations of board composition and capabilities, demanding that board members have experience in strategic planning and human capital. Boards, according to Washington, should have “a robust and ongoing education program that ensures board fluency in key areas.”

3. Expect that boards have the right leadership and committees. “A board leader needs not only to be respected by fellow directors and management, but also to be open to change.”

4. Focus on how directors engage with their stakeholders; “investors should be alert to boards that seem to operate in a bubble.”

5. Look for boards to evaluate the company’s, senior management’s, and their own performance in ESG as an integral part of their annual review processes.

With increased scrutiny on ESG measures, there has also been a dialogue around enforceability, both through regulatory oversight and recourse under securities laws. An article posted on May 15, 2023, by Professor James Park of UCLA on the Harvard Law School Forum on Corporate Governance provides a useful description of the nexus between ESG and securities fraud. Park notes that courts have aggressively dismissed ESG securities cases, “primarily by applying the puffery doctrine – a longstanding presumption that rosy statements of optimism should not be taken literally.” Park argues that the current approach of courts “should be replaced by a more holistic approach that emphasizes assessment of the materiality of the ESG risk at issue.”

In January 2023, SEC Commissioner Mark Uyeda addressed ESG concerns in a talk given to the California ‘40 Acts Group, a nonprofit forum that facilitates discussions regarding matters that impact the investment management industry. Addressing the fact that ESG investment products often charge high fees, he said that touting a product as being ESG is good for business, but cautioned that “[a]lthough ESG investing is wildly popular, it is difficult to ascertain exactly what ESG means, so it is challenging to identify when an ESG investment strategy is properly labeled as such.”

Although the SEC has not to date given full guidance on ESG risk disclosures, Uyeda noted that beyond the risk of mislabeling a strategy as ESG, ESG strategies are often not adequately disclosed to clients. He stated that “an adviser can only pursue an ESG investment strategy if the client expresses a desire to pursue such a strategy after receiving full and fair disclosure regarding the salient features of the strategy, including the strategy’s risk and return profile.”

A final consideration is the impact of politics on investors’ access to ESG investing. When President Biden first took office, ESG issues were high on his list of priorities. As Robert Eccles of Oxford University and Eli Lehrer of R Street Institute commented in a recent post by the Harvard Law School Forum on Corporate Governance, the debate over ESG standards has revealed stark policy contrasts between red and blue states in the US. Blue states have considered mandating divestment from companies connected to such products as firearms and fossil fuels. On the other side, Florida Governor Ron DeSantis recently led an alliance of 18 states to push back such divestment. They propose to remove all state pension funds and state-controlled investments from firms that follow the ESG model that DeSantis and his colleagues label as “politics before fiduciary duty.”

According to Messrs. Eccles and Lehrer, neither the divestment strategy nor the anti-divestment strategy makes economic sense. They suggest a solution that they claim both the left and right should agree upon: “clear fiduciary duty laws that define who is responsible for state investment, allow them to consider ESG factors only when they contribute to economic value creation and assure that state employees in defined contribution plans can select non-ESG options.”

It is clear that the ESG landscape is changing significantly on a global level, with an increasingly complex range of challenges for investors that include, among many others, greenwashing, as described above, and “green hushing” – the under-reporting or under-communicating of sustainable practices.

Pomerantz has long championed ESG issues – whether by creating forums for institutional investors and governance experts to share knowledge, or by litigating for improved corporate governance and financial redress for damaged investors. In October 2022, Pomerantz opened an office in London, co-managed by Partner Jennifer Pafiti, who is dually qualified to practice law in the US and the UK, and Dr. Daniel Summerfield, Director of ESG and UK Client Services. Prior to joining Pomerantz, Dr. Summerfield spent 20 years at the Universities Superannuation Scheme, the UK’s largest private pension fund. Most recently, Daniel was Head of Corporate Affairs of USS, following a period of 16 years as Co-Head of Responsible Investment.

“ESG stands at a critical juncture in its development on both sides of the Atlantic,” according to Dr. Summerfield. “Its future will be determined by all market participants and their consideration of their fiduciary responsibilities and the needs and requirements of the ultimate pension fund beneficiaries.”

Pomerantz Achieves $74 Million Settlement for Arconic Investors

POMERANTZ MONITOR | MAY JUNE 2023

By The Editors

On May 2, 2023, Chief U.S. District Court Judge Mark R. Hornak of the Western District of Pennsylvania granted preliminary approval to a $74 million settlement on behalf of defrauded investors in Howard v. Arconic et al., No. 2:17-cv-01057 (W.D. Pa.), a securities class action in which Pomerantz is Co-Lead Counsel. A final approval hearing is scheduled for August 9, 2023. Arconic, Inc. is an American industrial company specializing in lightweight metals engineering and manufacturing. The company’s Reynobond insulation panels consist of two sheets of thin aluminum bonded to a thermoplastic core. The panels can be constructed with a Fire-Resistant (“FR”) core, or a less expensive but combustible Polyethylene (“PE”) core. Due to their combustible nature, Reynobond PE panels are known to be unsuitable for use in any structures measuring ten meters or higher. In multiple instances, Arconic had explicitly warned against using Reynobond PE for buildings taller than ten meters, including in marketing brochures on their website, which stated that “as soon as the building is higher than the firefighters’ ladders, it has to be conceived with incombustible material.”

On June 14, 2017, a devastating fire broke out in the Grenfell Tower block of flats in London, United Kingdom, resulting in the deaths of 72 people and injuries to more than 70 other tenants. In the wake of the tragedy, numerous investigations were conducted, ultimately revealing that, while an electrical fault within a refrigerator located on the fourth floor instigated the blaze, Arconic’s Reynobond PE panels, which covered the outside of the building, likely acted as an accelerant, contributing to the rapid spread of the flames to the floors above.

Considering this revelation, questions about why the panels were present in the tower’s infrastructure were raised, with many fire safety experts agreeing that the decision was “disturbing” and “shocking.” In an effort to distance itself from liability, Arconic argued that it “had known that the panels would be used at Grenfell Tower but that it was not its role to decide what was or was not compliant with local building regulations.” Despite these claims, less than two weeks after the fire, Arconic announced that it would discontinue global sales of Reynbond PE for use in high-rise buildings.

In August 2017, Pomerantz filed a securities class action against Arconic alleging that its stock price was artificially inflated by the company’s misstatements about the safety of its Reynobond PE insulating panels. In June 2019, Chief Judge Hornak granted defendants’ motion to dismiss the case while allowing plaintiffs to provide an amended complaint, citing the need for more concrete evidence demonstrating that Arconic and its executives had sufficient knowledge to conclude that the insulation panels they were selling posed a significant safety risk. In response, Pomerantz filed a Second Amended Complaint in July 2021, which did just that.

The second amended complaint cited numerous instances in which Arconic sold Reynobond PE panels for use in other high-rise towers in the UK and across the globe. In the UK alone, the amended complaint cited at least ten additional buildings that had been constructed or refurbished using Reynobond PE panels. Additionally, despite claims to the contrary, multiple witnesses with firsthand knowledge of Arconic’s business practices testified that the company kept exhaustive records of its Reynbond PE sales, which included the building specifications for each project. Thus, in selling flammable panels for these structures, Arconic ignored its own safety recommendations and created a serious risk to public safety.

Notably, despite the United States’ near universal ban of combustible Reynobond for buildings taller than twelve meters (40 feet), plaintiffs found that Arconic had sold these panels for use in the construction of numerous structures measuring twelve meters or higher throughout the country, including: a terminal at the Dallas/Fort Worth airport (around 26 meters); Ohio’s Cleveland Browns stadium (52 meters); and a clinic at the University of Texas Southwestern Medical Center (20 meters). The complaint also pointed to at least eighteen other instances in which deadly fires had spread through exterior wall assemblies, most of which involved high-rise buildings. The new allegations included in the second amended complaint convinced Chief Judge Hornak to not only change his mind on many of the claims he had previously dismissed, but also to make new law in plaintiffs favor on several significant issues, including the element of scienter, i.e., intent to deceive investors.

Pomerantz Partner Emma Gilmore, who leads Pomerantz’s litigation of the case, stated, “We are gratified that the court found that the amplified allegations in the second amended complaint transform the context in which defendants’ alleged misrepresentations were made. The court’s decision sets important new precedents in favor of investors.”

The $74 million settlement represents approximately 22% of recoverable damages for defrauded Arconic shareholders, an amount far exceeding the 1.8% median recovery for all securities class action settlements in 2022.

Another Wynn Win

POMERANTZ MONITOR | MARCH APRIL 2023

By the Editors

Pomerantz is Lead Counsel in a high-profile securities fraud class action against Wynn Resorts alleging a decades-long pattern of sexual abuse and harassment by the company’s founder and former Chief Executive Officer, Stephen (Steve) Wynn that was unchecked, tacitly permitted, and eventually covered up by defendants. Partner Murielle Steven Walsh leads the litigation.

Wynn Resorts owns and operates luxury hotels and destination casino resorts, including Wynn Las Vegas and Encore in Las Vegas, Nevada, Wynn Boston Harbor in Everett, Massachusetts, and Wynn Macau and Wynn Palace in Macau, China.

When, in July 2021, U.S. District Judge Andrew P. Gordon of the District of Nevada denied, in part, the defendants’ motions to dismiss the Second Amended Complaint, he stated:

At this stage, the plaintiffs have sufficiently alleged that Wynn, Maddox, Sinatra and Cootey were aware of information contradicting their statements that denied misconduct allegations. The inference that these defendants were aware of Wynn’s alleged misconduct at the time of their statements is cogent and compelling.

On March 2, 2023, Pomerantz secured a major victory for defrauded Wynn investors when Judge Gordon granted plaintiffs’ motion for class certification.

Particularly noteworthy is the court’s analysis of the defendants’ price impact arguments. First, defendants claimed that there was no front-end price impact because the stock price did not increase after the fraudulent statements. The court agreed with Pomerantz that front-end price impact is irrelevant in a price maintenance case such as ours. The theory of price maintenance, or inflation maintenance as it is also called, asserts that defendants’ fraud prevented the stock price from falling by misrepresenting or concealing bad news. In 2021, in Arkansas Teacher Retirement System, et al. v. Goldman Sachs Group, Inc., a Second Circuit panel endorsed the inflation-maintenance theory of securities fraud. Second, defendants raised “mismatch” arguments, i.e., that there is a “mismatch” between the alleged misstatements and the corrective disclosures. The court rejected these arguments too, noting that a corrective disclosure need not be a mirror image of the prior fraudulent statements, and that it is sufficient that the disclosure renders “some aspect” of the prior statements false or misleading. This decision is therefore a clear plaintiffs’ win. Also highly important is the court’s rejection of defendants’ efforts to narrow the class period.

Finally, the court rejected the defendants’ garden-variety attacks on the lead plaintiffs and found our proposed representatives to be typical and adequate. Two of the lead plaintiffs are a married couple; only one of them actually executed the trades. The court, however, found that the other spouse was nonetheless typical and adequate to represent the class.

The first complaint was dismissed by Judge Navarro, who granted Pomerantz leave to replead. Our second amended complaint was later upheld in part by Judge Gordon.

The case suffered a slight setback when Magistrate Judge Youchah effectively stayed merits discovery until class certification was decided. Pomerantz subsequently discovered that Judge Youchah had previously represented the Wynn defendants in a case arising out of the same allegations as in our case but did not disclose that fact. Pomerantz moved for her recusal, which she reluctantly granted.

On March 16, 2023, defendants petitioned the district court for permission to file an appeal of the court’s Order Granting Plaintiffs’ Motion to Certify Class.

“We are gratified that the court granted our certification motion,” stated Murielle Steven Walsh. “Plaintiffs will now proceed with merits discovery into the alleged misconduct by Stephen Wynn against Wynn’s female employees and the enabling actions by Wynn management that allowed it to go on for years. This case continues to demonstrate that corporate integrity and accountability are important issues to investors.”

Pomerantz Wins Ninth Circuit Reversal of Forescout Dismissal

POMERANTZ MONITOR | MARCH APRIL 2023

By Omar Jafri

On March 16, 2023, the Ninth Circuit Court of Appeals reversed, in part, the dismissal of Pomerantz’s securities fraud class action against Forescout Technologies, Inc. and its senior officers. In so doing, the Ninth Circuit also set important precedents that significantly strengthen investor rights.

Forescout specializes in providing network security from malware and potential infiltrators for large computer networks. The operative complaint alleges that the defendants misled investors about the strength of the company’s sales pipeline to falsely support a bullish guidance and otherwise justify poor financial results when the company repeatedly failed to meet its touted objectives.

For its initial public offering in October 2017, Forescout reported growth averaging more than 30% a year in revenues for the fiscal years prior to the IPO. This steady growth continued in fiscal year 2018, with a 32% increase in reported revenues. However, as the company entered FY 2019, it encountered heightened competition from other industry players, primarily because Forescout’s products were not as well suited as theirs to providing solutions for cloud-based cybersecurity and remote working. Nonetheless, defendants provided revenue guidance to investors of 24% annual growth in revenue for FY 2019, despite the fact that a large amount of Forescout’s deals that were identified as “committed” in its sales pipeline had only a 50% chance of closing, according to a confidential witness (“CW”) in the case.

In 2020, Forescout’s alleged deception on the market continued, following its announcement that it had entered into a merger agreement with Advent International, Inc., a private equity firm. Under the terms of the agreement, Advent would acquire Forescout for $33 per share. However, Advent soon learned that the 2020 revenue projections Forescout had provided were inconsistent with the serious deterioration in the sales pipeline that the company had already experienced.

Just three months after Forescout’s announcement of the merger, Advent privately notified the company that it was terminating its acquisition, but defendants withheld these material facts from investors. Following litigation initiated by Forescout to force Advent to proceed with the merger, both parties entered into an agreement providing for Advent to acquire Forescout for $29 per share – a $300 million discount.

In 2021, the U.S. District Court for the Northern District of California dismissed the investors’ securities fraud lawsuit twice, ruling that the plaintiffs had insufficiently alleged that the statements made by the defendants were knowingly or recklessly false and misleading when made.

Plaintiffs appealed that decision to the United States Court of Appeals for the Ninth Circuit. The Court’s decision not only allows the plaintiffs to proceed with their complaint, but it also clarifies and establishes important standards regarding pleading falsity, misleading statements, and the use of information provided by confidential witnesses.

Regarding falsity, the Ninth Circuit’s decision confirms that:

• No “dual pleading” standard exists where courts can “comingle” the lower standard for falsity with the higher standard for scienter unless the facts pleaded to support both elements are exactly the same.

• Plaintiffs can rely on an expert opinion to bolster allegations of falsity.

Regarding misleading statements, the Ninth Circuit’s decision established that:

• Defendants cannot ask courts to disregard the plain words of their own statements at the pleading stage, while instead crediting their attorney’s reimagination of what the statement said or meant.

• Concrete” statements of material fact do not need to consist of “hard numbers” and “benchmarks.” Even vague claims like “we have a very large pipeline” can mislead investors, and the law in the Ninth Circuit has not held otherwise since at least the 1990s.

• Misleading statements in direct response to specific analyst questions concerning the alleged fraud itself cannot be mischaracterized as puffery.

• A defendant cannot rely on the disclosure of hypothetical risks to escape liability for a failure to disclose that he or she already has information suggesting that an event “might not” occur.

• A risk does not need to actually materialize for cautionary language to be ineffective. A defendant’s awareness of a “significant likelihood” that the risk would materialize is enough.

• Awareness of omitted facts that render a statement misleading is sufficient to demonstrate “actual knowledge” and overcome the PSLRA’s safe harbor.

While investigating the claims in this case, Pomerantz found twenty CWs who provided information that supported the allegations made in the complaint but who had no direct contact with any individual defendant. We successfully argued that this lack of direct contact was not dispositive even though many lower courts had previously dismissed securities class actions on this very ground. As a result, regarding CWs, the Ninth Circuit’s decision clarified that:

• In pleading securities fraud, CWs do not need to talk to, hear from, or present information directly to an individual defendant.

• When a defendant quibbles that a CW does not provide evidentiary minutia, a plaintiff can cite this decision to state that the defendant is attempting to create an “impossible” standard that the PSLRA never even contemplated.

• In securities fraud cases related to misrepresentations regarding sales pipelines, a CW need not provide information about the “guidance” or “corporate level trends.”

• Courts can consider even an “estimate” provided by a single CW.

• A CW’s factual representations cannot be mischaracterized as presumed “disagreements” of “opinion” with higher level managers when the CW is reporting facts as opposed to merely expressing his or her own beliefs and opinions.

• Plaintiffs can rely on a lower-level CW who hears from a third person that a defendant did something wrong or had awareness of certain facts that rendered his or her statements materially misleading.

• Plaintiffs can rely on a CW who prepares reports for a mid-level manager, who is then alleged to have provided pertinent information to the individual defendant even if the CW did not directly present the information to the individual defendant or talk to or hear from the individual defendant.

• If CWs state that a defendant did something or knew something during the Class Period, it is not necessary for the CWs to state that any of this happened before a particular statement was made.

With the Ninth Circuit holding that plaintiffs adequately stated claims under Section 10(b) and reversing the district court’s dismissal of the Section 20(a) claims for control person liability, Pomerantz’s Forescout class action has been remanded to the district court for further proceedings.

The Firm’s Forescout litigation team is led by Partner Omar Jafri and includes Senior Counsel Patrick V. Dahlstrom and Associate Brian O’Connell.

The Sacrosanct Right to Vote

POMERANTZ MONITOR | MARCH APRIL 2023

By Gustavo F. Bruckner and Henry Tan

Among the most important rights belonging to a stockholder is the right to vote. Alongside the rights to sue and sell, the right to vote is treated by the Delaware Chancery Court as “sacrosanct.” Therefore, any challenge to a free and fair election is rigorously scrutinized by the Court as are challenges to the accuracy of information provided to stockholders in advance of an election. One issue that periodically emerges is whether a board has set out the correct voting standard, in particular as it pertains to the treatment of broker non-votes.

Today, most stockholders are no longer “stockholders of record” but rather “beneficial shareholders.” That is, they do not hold stock certificates and do not own their shares directly. Instead, they hold their shares in “street name,” while their brokerage firms act as the “stockholders of record.” During stockholder meetings, brokers have full discretion on how to vote these shares on routine matters, such as the approval to hire an independent accounting firm. However, for non-routine matters, beneficial shareholders must give instructions to their brokers on how to cast their vote. Beneficial shareholders who fail to instruct their brokers will have their shares recorded as “broker non-votes.”

Broker non-votes are not considered “votes cast” under Delaware law, so any vote that requires a majority of votes cast will not include broker non-votes in the “denominator” for purposes of tallying votes. However, if the vote requires a majority of “outstanding shares,” then broker non-votes will be included in the denominator because they are included within outstanding shares. In this situation, a broker non-vote essentially amounts to a vote against the proposal. Because broker non-votes raise the number of “yes” votes that will be needed to pass proposals, some companies have sought to circumvent the issue by failing to tabulate broker non-votes or lumping the broker non-votes with “yes” votes.

The Astrotech case illustrates the issue. On May 12, 2020, Astrotech Corporation filed a proxy soliciting stockholder approval for various proposals, including a Certificate Amendment that would authorize 35,000,000 new shares. Under the company’s rules, approval of the Amendment required a majority of outstanding shares. Since 7,575,464 shares of common stock were outstanding, approval of the proposal required 3,787,733 “For” votes. The Certification Amendment was a non-routine matter, meaning a stockholder’s failure to vote on the proposal would create a broker non-vote, effectively a vote against the Amendment.

On June 29, 2020, Astrotech held its annual shareholder meeting and released the results of the vote. The Certificate Amendment was approved by 5,306,464 “For” votes to 1,030,210 “Against” votes; however, not a single broker non-vote was tabulated. This omission was even more glaring considering that broker non-votes were correctly tabulated for the other two non-routine proposals – the votes on the directors and the vote on the Plan Amendment. All five directors and the Plan Amendment proposal received exactly 3,500,819 broker non-votes. The discrepancy suggests that Astrotech improperly counted the broker non-votes as “For” votes to pass the Certificate Amendment.

Properly tabulated, the Certificate Amendment received 1,805,645 “For” votes, 1,030,210 “Against” votes, 35,509 abstentions, and 3,500,819 broker non-votes. The voting standard required a majority of outstanding shares, and because only 1,805,645 of the 7,575,464 outstanding shares voted “For,” the Certificate Amendment failed to pass. By tacking the broker non-votes to the “For” votes, Astrotech had circumvented the will of its stockholders and improperly approved the issuing of 35,000,000 new shares.

The voting error raised new problems when the company scheduled its next shareholder meeting in 2021. Specifically, Astrotech improperly issued 9,596,206 shares over the 15,000,000 authorized limit. These unauthorized shares represented approximately 40 percent of the proper voting power. If the 2021 shareholder meeting were allowed to proceed, the unauthorized shares would have rendered the outcome invalid because it would have been impossible to tell whether the proposals were approved by valid or invalid shares. At this point, Pomerantz intervened on behalf of an Astrotech stockholder and initiated litigation in the Delaware Chancery Court to void the 2019 Certificate Amendment.

The company admitted its error and negotiated a settlement whereby Astrotech agreed to file a motion for approval under the Delaware General Corporation Law § 205, which allows the Chancery Court to approve and remedy corporate actions that were tainted by technical errors that may result in accidental harm. In this case, the Court used § 205 to approve the 2019 Certification Amendment and the shares issued under the Amendment’s authorization.

Astrotech also agreed to implement certain corporate governance policies. Specifically, the Audit Committee Charter was amended to require proxy review procedures, such as requiring an outside advisor to aid the Board in evaluating proxies for errors and omissions. Such a third-party review would likely have caught the error in the applied voting standard.

Given the opportunity for mischief that surrounds broker non-votes, shareholders can expect to see more cases concerning defective proxies due to broker non-vote issues.

The Slippery Status of NFTs

POMERANTZ MONITOR | MARCH APRIL 2023

By Brandon M. Cordovi

Non-fungible tokens (“NFTs”) have become scorching hot commodities, which has led the largest and most powerful brands across various industries to mint their own. Like cryptocurrencies, the surge in popularity of NFTs has raised difficult questions concerning whether they function as securities, which would subject them to regulation by the U.S. Securities and Exchange Commission (“SEC”) and compliance with securities laws.

NFTs are digital assets whose authenticity and ownership are recorded, or minted, on a blockchain. These assets may range from digital artwork created by a known artist, such as Alec Monopoly, to an NBA video highlight of Jalen Brunson draining a game-winning shot for the Knicks. The unique identification code and metadata assigned to each NFT is baked into its token and makes it non-fungible. NFTs can be traded and exchanged for money, cryptocurrencies, or other NFTs. NFTs, like cryptocurrency, are stored in digital wallets. Although the image linked to one NFT may be identical to the image linked to another NFT, the tokens themselves are not interchangeable. This distinguishes NFTs from cryptocurrencies. Cryptocurrencies are interchangeable, or fungible, tokens. A digital crypto coin on one blockchain is equal in value to any other digital crypto coin on the same blockchain, in the same way one dollar equals, and is exchangeable with, any other dollar. On the other hand, there may be countless NFTs of the same image – a baseball card, for example – but each NFT has its own unique identifier, akin to a numbered series of the same baseball card, and although it can be traded, it is not interchangeable with any other NFT.

Significantly, when an NFT is purchased, the purchaser only acquires the NFT. Generally, ownership rights over the image attached to the NFT remain with the creator of the work. NFTs derive their perceived value based on their scarcity. Thus, NFT developers often issue their NFTs in limited drops, making them more difficult to obtain. The rarer in NFT is, the higher its value. Additionally, the work attached to the NFT also impacts its value.

A blockchain, on which an NFT’s authenticity and ownership are recorded, provides a unique decentralized method of digitally storing information. The information is collected and stored in blocks which are linked together via cryptography. The key perceived benefit of a blockchain is that it is more secure and trustworthy than centralized authorities because it stores its information in multiple locations and intentionally makes it more difficult to add, change or remove information.

The definition of a security in the Securities Act is broad and includes the term “investment contract” within it. However, the Securities Act itself does not clarify what constitutes an “investment contract.” The Supreme Court addressed this issue and provided a framework for determining what is an investment contract, and, therefore, a security that must be registered with the SEC, in S.E.C. v. W.J. Howey Co., 328 U.S. 293 (1946).

Based on the definition set forth in Howey, courts have applied a three-pronged test to determine what constitutes an investment contract. To satisfy the Howey test, the moving party must demonstrate: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profits derived from the efforts of the promoter.

The manner in which NFTs are acquired should satisfy the first prong of the Howey test without opposition. To obtain an NFT, an individual or entity must purchase it in exchange for money.

The second prong of the Howey test, establishing a common enterprise, is a little trickier. A common enterprise can be demonstrated through a showing of either horizontal or vertical commonality. Plaintiffs will likely focus on horizontal commonality to satisfy this prong as it is more favorable, given how NFTs function. Horizontal commonality requires: (1) the sharing or pooling of the funds of investors; and (2) that the fortunes of each investor in a pool of investors are tied to one another and to the success of the overall venture.

To demonstrate the sharing or pooling of funds, the movant must first demonstrate that the funds received by the promoter through an offering are reinvested by the promoter into the business or, more broadly, are tied to an improvement of the ecosystem as a whole. Whether a particular NFT offering meets this requirement may vary on a case-by-case basis, based on the amount of entanglement and dependence there is between the developer of the NFT and the operator of the blockchain on which it is recorded. In a recent decision in the Southern District of New York (“S.D.N.Y.”), Judge Marrero found that this requirement was met where the defendant was the owner and operator of the NFT platform and also the creator, developer and operator of the blockchain on which it ran. Because the success of the NFT was entirely dependent upon the success of the blockchain, it could be plausibly alleged that the company operating both would use funds generated to grow the totality of its network. For similar reasons, the court found that the second requirement – that the investors and enterprises’ fortunes be tied – was also met.

However, the S.D.N.Y. decision was narrow and explicitly limited to the particular facts of that case. Many NFT platforms are structured differently, with separation between the owner and operator of the NFT platform and the blockchain on which it relies. Without the overt substantial entanglement between the two, it will be more challenging to establish horizontal commonality, which will largely turn on just how close the relationship between the two is. Additionally, this prong may turn on whether plaintiffs make specific allegations regarding how the funds at issue are being used in conjunction with both the NFT platform and its infrastructure.

The third prong of the Howey test is also subject to debate, presenting another hurdle to clear for plaintiffs looking to establish that NFTs are securities. It requires the expectation of profits derived from the efforts of a promoter. Courts have consistently held that this is an objective test.

The expectation-of-profits prong likely turns on the public statements disseminated by the developer of a particular NFT in conjunction with the totality of the circumstances surrounding its issuance. Public statements that explicitly tout the ability to generate profit through the purchase of a particular NFT should easily satisfy the first portion of this prong. Further, Judge Marrero, in the S.D.N.Y., recently rejected an argument that statements that do not explicitly reference gains or losses do not give rise to the expectation of profits. Consistent with this decision, statements, such as those touting record sales of a particular NFT, may give rise to the expectation of profits when considering the cost of acquiring NFTs on that platform.

Another argument related to the third prong, which may prove more difficult for plaintiffs to overcome, is whether purchasers of NFTs do so based on their desire to collect and consume them. For example, a die-hard New York Mets fan may purchase Mets-affiliated NFTs, with no intention on turning a profit, because of their strong passion for the team and their personal enjoyment. Drawing this distinction may pose a difficult challenge. However, one court has already determined that drawing this distinction is not necessary at the dismissal stage, despite such challenges.

Whether profits are derived from the efforts of the promoter poses similar questions to those assessed when evaluating horizontal commonality. This will require a case-by-case assessment of how the particular operation is organized and functions to determine how dependent those who purchase a particular NFT are on the efforts of its developer.

Since the Howey test depends on a wide range of factors that are unique to both the NFT platform being assessed and the blockchain on which it operates, determining whether an NFT is a security requires a case-by-case analysis. Given NFTs’ recent rise to prominence, as more class action litigation is brought against NFT developers, it will become clearer what plaintiffs must plead to establish that an NFT is a security subject to the securities laws. Additionally, it will be important to track whether the SEC takes a particular interest in NFTs, as it has identified the regulation of emerging technologies and crypto assets as one of its 2023 priorities. The landscape of NFTs is ever-evolving and more clarity regarding whether they are securities, subject to regulation by the SEC, should be obtained as courts and relevant agencies hone in on them.