Publications

Third Circuit: A District Court Must Impose “Some Form” of Rule 11 Sanctions When It Finds Rule 11 Violations in Proceedings Governed by the PSLRA

On April 5, 2023, the Third Circuit resolved whether a district court erred in failing to award attorneys’ fees or impose any other sanctions in connection with determining that plaintiffs violated Rule 11 in bringing three federal securities claims following their purchase of unregistered securities in a company’s stock offering. Scott v. Vantage Corp., 64 F.4th 462 (3d Cir. 2023) (Smith, J.). The Third Circuit affirmed the district court’s determination that certain of plaintiffs’ claims violated Rule 11 and that the company’s founder (the only defendant party to the appeal) was not entitled to attorneys’ fees. The court held, however, that the PSLRA “mandates the imposition of some form of sanctions when parties violate Rule 11 in bringing federal securities claims.”

After plaintiffs purchased stock in the company’s 2016 stock offering under SEC Rule 506(b), they brought an unregistered securities claim, a misrepresentation claim, and a Rule 10b-5 securities fraud claim against the defendant company, its president, and the company’s founder. In 2019, the district court granted summary judgment for the company’s founder and the company’s president on the three federal securities law claims. On appeal, the Third Circuit affirmed the district court’s determination that plaintiffs’ unregistered securities claim and their misrepresentation claim against the company’s founder violated Rule 11. The Third Circuit also held that the district court did not abuse its discretion in determining that these claims lacked factual support in violation of Rule 11(b)(3).

Noting that under Mary Ann Pensiero, Inc. v. Lingle, 847 F.2d 90 (3d Cir. 1988), courts should assess Rule 11 compliance by assessing a party’s or attorneys’ conduct based on what was reasonable to believe at the time of the complaint the Third Circuit stated that plaintiffs made only general unregistered securities allegations in the complaint and failed to identify any specific individuals as unaccredited investors. Similarly, as to the misrepresentation claim, the Third Circuit pointed to the district court’s determination that plaintiffs’ pre-filing investigation should have revealed the lack of factual support for their allegation that the offering was public. The Third Circuit also affirmed the district court’s determination that plaintiffs’ 10b-5 securities fraud claim did not violate Rule 11. The Third Circuit concluded that there was no abuse of discretion in the district court’s determination that plaintiffs had a reasonable basis to allege securities fraud. The Third Circuit also noted that while the district court did summarily dismiss the 10b-5 claim, “courts must ensure that Rule 11 ‘not be used as an automatic penalty against an attorney or a party advocating the losing side of a dispute.’” (quoting Gaiardo v. Ethyl Corp., 835 F.2d 479 (3d Cir. 1987)).

Ultimately, the Third Circuit concluded that the district court did abuse its discretion in declining to impose any form of sanctions and vacated the portion of the order that declined to impose sanctions because the text of the PSLRA makes the imposition of sanctions mandatory after a court determines that a party has violated Rule 11. On remand, the Third Circuit instructed the district court to impose “some form of sanction” against plaintiffs in accordance with Rule 11, but took no position on what sanction to impose acknowledging that the district court was better situated to make that determination.

Fourth Circuit: Proxy Statement Need Not Have Included Cash-Flow Projections Given the Array of Other Metrics

On June 1, 2023, the Fourth Circuit affirmed a district court’s grant of summary judgment in favor of a defendant bank holding company, which was alleged to have violated Section 14(a) of the Exchange Act by misleading shareholders about the true value of their shares ahead of a stock-for-stock merger. Karp v. First Conn. Bancorp, 69 F.4th 223 (4th Cir. 2023) (Diaz, J.). Affirming the district court’s ruling, the Fourth Circuit held that no reasonable jury could find the omission from the proxy statement of certain cash-flow projections prepared by the defendant’s financial advisor was material.

In 2018, defendant and another bank holding company proposed a merger. After defendant’s shareholders voted to approve the merger, plaintiff commenced a putative class action alleging that defendant’s proxy statement did not disclose either the specific cash-flow projections used in its financial advisor’s discounted cash flow analysis or a set of “more optimistic” cash-flow projections that defendant’s financial advisor prepared in connection with a previous potential merger. Plaintiff claimed this led shareholders to undervalue their shares and approve the merger. Both parties moved for summary judgment, the district court denied plaintiff’s motion and granted the defendant’s.

On appeal, the Fourth Circuit agreed with the district court that there was no genuine dispute of material fact regarding any of the elements of plaintiff’s Section 14(a) claim. The court explained that to prevail under Section 14(a) “plaintiff must show that (1) the proxy statement contained a material misrepresentation or omission (2) that caused the plaintiff injury and that (3) the proxy solicitation was an essential link in the accomplishment of the transaction.” Rejecting plaintiff’s argument that a reasonable investor would have found the omitted cash flow projections would have been material because they would have shown that the merger consideration was inadequate and that the financial advisor’s valuation was skewed, the Fourth Circuit held that no reasonable jury could find the omission of the cash-flow projections material. The Fourth Circuit agreed with defendant that it was “not enough to speculate that shareholders might have found the projections helpful to the deliberations, so long as the merger proxy ‘provided a thorough and accurate summary’ of the financial advisor’s work.” The Fourth Circuit noted that, “as other courts have held, shareholders aren’t entitled to double-check every aspect of the advisor’s math so long as the proxy statement contains an adequate and fair statement of their work.” The Fourth Circuit concluded that based on “the array of metrics in the proxy statement,” it was unlikely that the more optimistic cash-flow projections “would have significantly altered the total mix of information.”

Fourth Circuit: Affirms Dismissal of Securities Fraud Class Action Alleging Misrepresentations or Omissions Regarding a Clinical Trial Drug

On March 2, 2023, the Fourth Circuit affirmed the dismissal of a putative securities fraud class action alleging that a drug company, its president/CEO and its CFO made material misrepresentations or omissions concerning a new drug, in violation of Section 10(b) of the Exchange Act and Rule 10b-5. Emps. Ret. Sys. v. MacroGenics, 61 F.4th 369 (4th Cir. 2023) (Gregory, J.). The court held that plaintiffs failed to sufficiently allege any actionable misrepresentations or omissions that would give rise to a duty to disclose.

In June 2019 the company presented clinical trial data for its new drug at a scientific conference, including a graph that provided a visual depiction of the interim overall survival data. An analyst described this data as “underwhelming.” Subsequently, the company experienced a stock price drop and plaintiffs sued asserting violations of Section 10(b) and Rule 10b-5 and Sections 11 and 12(a)(2) of the Securities Act. Plaintiffs alleged that the graph depicting interim overall survival data should have been disclosed earlier and showed that the overall survival data was not on track to generate a statistically significant result when the data fully matured.

The Fourth Circuit noted that while a company must disclose information when “necessary to make statements made, in light of the circumstances under which they were made, not misleading,” under Matrixx Initiatives v. Siracusano, 563 U.S. 27 (2011), the Fourth Circuit determined that defendants did not have a duty to disclose the interim overall survival results because their written and oral statements prior to a May 2019 press release—where the company discussed the overall survival data for the first time in detail—“did not ‘speak’ about the [overall survival] data.” Instead, these prior statements had “primarily focused” on the clinical trial’s success in reaching its first endpoint and “[a]ny language concerning the [overall survival] endpoint was preliminary and focused on the ongoing nature of the [overall survival] data’s accumulation.”

Seventh Circuit: Specifies the Correct Pleading Standard for a Breach of the Duty of Prudence Under ERISA in the Wake of Hughes

On March 23, 2023, on remand from the Supreme Court’s decision last year in Hughes v. Northwestern, 595 U.S. 170 (2022), the Seventh Circuit reexamined plaintiffs’ allegations that the defendant plan fiduciary breached its duty of prudence under ERISA. Hughes v. Northwestern, 63 F.4th 615 (7th Cir. 2023) (Brennan, J.). Under the Supreme Court’s decision in Hughes, to plead a breach of the duty of prudence under ERISA, a plaintiff must plausibly allege fiduciary decisions outside a range of reasonableness. The plan fiduciary argued that plaintiffs must plead that a prudent alternative action was “actually available.” Rejecting this, the Seventh Circuit held that “[a]t the pleadings stage, a plaintiff must provide enough facts to show that a prudent alternative action was plausibly available, rather than actually available.”

The Seventh Circuit noted that Hughes directed it “to reevaluate plaintiffs’ allegations based on the duty of prudence articulated in Tibble v. Edison International, 575 U.S. 523 (2015), applying the pleading standard discussed in Ashcroft v. Iqbal, 556 U.S. 662 (2009), and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).” Iqbal and Twombly establish that an obvious alternative explanation for a defendant’s conduct that precludes liability can undermine the claim’s plausibility. The court stated that “[o]nly obvious alternative explanations must be overcome at the pleadings stage, and only by a plausible showing that such alternative explanations may not account for the defendant’s conduct.” The court then concluded that “whether a claim survives dismissal necessarily depends on the strength or obviousness of the alternative explanation that the defendant provides.”

In applying this standard, the Seventh Circuit concluded that plaintiffs plausibly alleged that the plan fiduciary violated its duty of prudence by incurring unreasonable recordkeeping fees. The court noted that plaintiffs alleged that recordkeeping services are fungible, that the market for such services is highly competitive and that the fees were excessive relative to the recordkeeping services rendered. The Seventh Circuit also denied dismissal of plaintiffs’ second claim that the plan fiduciary failed to swap out retail shares for identical, lower-cost institutional shares of the same funds. The court noted plaintiffs’ allegations that the plan fiduciary retained more expensive retail-class shares of 129 mutual funds, when less expensive but otherwise identical institutional-class shares were available.

Ninth Circuit: Affirms Dismissal of Derivative Suit Based on a Forum-Selection Clause in the Defendant Company’s Bylaws

On June 1, 2023, a majority of the Ninth Circuit sitting en banc affirmed the dismissal of a putative derivative action that plaintiff brought in California district court against a retail clothing company incorporated in Delaware in light of a forum-selection clause[1] in the company’s bylaws requiring any derivative action or proceeding to be brought in Delaware Chancery Court. Lee v. Fisher, 70 F.4th 1129 (9th Cir. 2023) (Ikuta, J.). The Ninth Circuit held that enforcement of the forum-selection clause did not violate the Exchange Act’s antiwaiver provision, Section 29(a), and was not contrary to Section 115 of the Delaware General Corporation Law (“DGCL”).

Plaintiff alleged that the company and certain directors violated Section 14(a) of the Exchange Act by making false or misleading statements to shareholders about the company’s commitment to diversity. After the district court dismissed on forum non conveniens grounds, a three-judge panel of the Ninth Circuit affirmed in 2022. The instant Ninth Circuit opinion follows its decision to rehear the case en banc to consider whether a forum-selection clause can require that all derivative actions be brought in a state court in the state of incorporation.

As to the Exchange Act’s antiwaiver provision, the court began its analysis with the text of Section 29(a), which provides that “any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder . . . shall be void.” In Shearson/Am. Exp. v. McMahon, 482 U.S. 220 (1987), the Supreme Court interpreted Section 29(a) as prohibiting “only . . . waiver of the substantive obligations imposed by the Exchange Act.” The Ninth Circuit then framed the issue as whether the forum-selection clause authorized the company to waive compliance with the substantive obligation of Section 14(a) and Rule 14a-9 (i.e., to not to make a false or misleading statement in a proxy statement). While plaintiff argued that enforcing the forum-selection clause would allow the company to waive such compliance by precluding her from bringing a derivative Section 14(a) action in any forum (because the Chancery Court would dismiss her action based on federal courts’ exclusive jurisdiction of Exchange Act violations), the Ninth Circuit explained that plaintiff could still enforce the company’s compliance with the substantive obligations of Section 14(a) by bringing a direct action in federal court. The court noted that the forum-selection clause does not impose any limitation on direct actions.

The Ninth Circuit also concluded that the forum-selection clause was valid under Delaware law because in Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020), the Delaware Supreme Court indicated that federal claims like plaintiff’s derivative Section 14(a) action are not “internal corporate claims” as defined in Section 115[2] of the DGCL, and because no language in Section 115, the official synopsis, or Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013)—which Section 115 was intended to codify—“operates to limit the scope of what constitutes a permissible forum-selection bylaw under Section 109(b)[.]”

Ninth Circuit: Complaint Timely Where Plaintiff Could Not Have Discovered Necessary Facts Until an SEC Order Revealed That a Company’s Statements Were Misleading

On April 11, 2023, the Ninth Circuit reversed and remanded a district court’s dismissal of a securities fraud class action on the ground that it was untimely. York Cnty. v. HP, Inc., 65 F.4th 459 (9th Cir. 2023) (Bybee, J.). The Ninth Circuit determined that the defendant printing supply company’s “allegedly fraudulent statements, on their own, were insufficient to start the clock on the statute of limitations.” The Ninth Circuit held that the complaint was timely, concluding that plaintiff could not have discovered the facts necessary to plead an adequate complaint until after the issuance of an SEC order that revealed the misleading nature of defendants’ statements.

During 2015 and 2016 investor calls the defendant company made statements about whether it was meeting its inventory target ranges. Subsequently, an SEC investigation uncovered that the company had allegedly engaged in sales practices that led to short term gains but harmed overall profits. The SEC issued an order in 2020 (“SEC Order”) instituting cease-and-desist proceedings. The company agreed to pay a fine without admitting or denying the allegations contained in the SEC Order. Within weeks of the SEC Order, plaintiff sued alleging that the company violated Section 10(b) and Rule 10b-5. The company moved to dismiss asserting that plaintiff’s claims were time-barred by the statute of limitations in 28 U.S.C. § 1658(b)(1), which provides “that private actions alleging securities fraud must be brought no more than ‘2 years after the discovery of the facts constituting the violation’ of securities laws.” The district court dismissed the complaint as time-barred.

Relying on Merck & Co. v. Reynolds, 559 U.S. 633 (2010), the Ninth Circuit held that “a defendant establishes that a complaint is time-barred under § 1658(b)(1) if it conclusively shows that either (1) the plaintiff could have pleaded an adequate complaint based on facts discovered prior to the critical date and failed to do so, or (2) the complaint does not include any facts necessary to plead an adequate complaint that were discovered following the critical date.” Under Merck, “the critical date” is defined as the date “two years before the complaint was filed.” Adopting the reasoning of City of Pontiac General Employees’ Retirement System v. MBIA, Inc., 637 F.3d 169 (2d Cir. 2011), the Ninth Circuit further held that a “reasonably diligent plaintiff has not ‘discovered’ one of the facts constituting a securities fraud violation until he can plead that fact with sufficient detail and particularity to survive a 12(b)(6) motion to dismiss.”

In this case, the critical date was April 21, 2019, based on the fact that the complaint was filed on April 21, 2021. The Ninth Circuit noted the allegation that the false statements and misrepresentations were made approximately three years before the critical date. The court then noted plaintiff’s assertion that it did not “discover the facts constituting the violation” until after the critical date because “the SEC Order put [the company’s] prior statements in a new context, revealing that ostensibly innocuous statements were actually intentional misrepresentations.” Because plaintiff pleaded facts that post-dated the critical date, the court explained that the company could still show the claim was time-barred by either showing that: (i) plaintiff “could have pleaded its claim based solely on things that it knew or should have known prior to the critical date”; or (ii) “the SEC Order provided no information necessary” to plaintiff’s claim. The court stated that the company failed to make this showing.

Tenth Circuit: Rejects Motion to Compel Arbitration of ESOP Claims, Holding That the Effective Vindication Exception Applies

On February 9, 2023, the Tenth Circuit affirmed a district court’s denial of a motion to compel arbitration in a lawsuit brought by an ESOP (Employee Stock Ownership Plan) participant alleging that the plan fiduciaries breached their fiduciary duties to the plan under ERISA. Harrison v. Envision Mgmt. Holding, 59 F.4th 1090 (10th Cir. 2023) (Briscoe, J.). On appeal, the Tenth Circuit held that enforcing the arbitration provisions in the plan document would prevent plaintiff from vindicating the statutory causes of action listed in his complaint, and concluded “that the effective vindication exception applies in this case.”

The Tenth Circuit stated that under American Express v. Italian Colors Restaurant, 570 U.S. 228 (2013), the “key question is whether ‘the prospective litigant effectively may vindicate its statutory cause of action in the arbitral forum.’” The court explained that, to determine whether the effective vindication exception applies, it “must first identify the statutory remedies [plaintiff] is seeking” and “then determine whether the arbitration provisions contained in the Plan Document effectively prevent [plaintiff] from obtaining those statutory remedies in the arbitral forum.” The court noted that the statutory remedies plaintiff sought were under ERISA subsections 502(a)(2) and (a)(3), and included a declaration that defendants breached their fiduciary duties under ERISA, among other things.[3]

As to whether the arbitration provisions effectively prevented plaintiff from vindicating the statutory remedies, the court focused on the language in the plan document stating that “each arbitration shall be limited solely to one Claimant’s Covered Claims, and that Claimant may not seek or receive any remedy which has the purpose or effect of providing additional benefits or monetary or other relief to any Eligible employee, Participant or Beneficiary other than the Claimant.” (emphasis in original). The court found that “this sentence would clearly prevent [plaintiff] from obtaining at least some of the forms of relief that he seeks in his complaint pursuant to [Section 502(a)(2)],” including, among other things, a declaration that all defendants breached their fiduciary duties under ERISA. The court explained that these forms of relief would provide additional benefits to the plan as a whole or to all of the plan participants and beneficiaries and would thus be barred by the arbitration provisions. The court concluded that “Section 21(b) is not problematic because it requires [plaintiff] to arbitrate his claims, but rather because it purports to foreclose a number of remedies that were specifically authorized by Congress[.]”