(Article from Securities Law Alert, Year in Review 2024)
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Second Circuit: Decides Two Matters of First Impression Concerning Challenged Statements on Scientific Studies and Data Interpretation
On December 26, 2023, the Second Circuit affirmed the dismissal of a putative securities fraud class action against a tobacco products manufacturer and certain of its executives alleging that they made various false and misleading statements about the company’s smoke-free products in violation of Section 10(b) and Rule 10b-5. In re: Philip Morris Int’l Sec. Litig., 89 F.4th 408 (2d Cir. 2023) (Sullivan, J.). Notably, the panel decided two matters of first impression in the Second Circuit. First, the court held that a securities fraud defendant’s challenged statements that its scientific studies complied with a methodological standard that is published and internationally recognized, but stated in general and inherently subjective terms, were properly analyzed as statements of opinion rather than fact. Second, the court held that where a securities fraud defendant’s challenged statements express an interpretation of scientific data, which is later ultimately endorsed by the FDA, such statements are per se reasonable as a matter of law under Tongue v. Sanofi, 816 F.3d 199 (2d Cir. 2016).
By way of background, the FDA authorized the company to market its smokeless tobacco product in the U.S. in 2019 and later further authorized the company to market it with claims that it reduced exposure to harmful chemicals. Subsequently, investor plaintiffs alleged that defendants had made false or misleading statements regarding the methodology and results of the scientific studies that the company submitted in support of its FDA authorization applications. In 2021, the district court dismissed with prejudice finding that plaintiffs had failed to adequately plead falsity or scienter and concluding that each such finding provided an alternate basis for dismissal.
On appeal, plaintiffs challenged the district court’s conclusion that defendants’ statements—that the company’s studies were “conducted according to Good Clinical Practice” (“GCP”)—were inactionable statements of opinion because defendants failed to couch their statements with words like “we think” or “we believe” citing Omnicare v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015).[1] The Second Circuit stated that defendants’ reliance on Omnicare was misplaced, explaining that under Omnicare “language like ‘we believe’ or ‘we think’ is sufficient – not necessary – to render a statement one of opinion rather than fact.” The Second Circuit stated that Omnicare clarified that if a statement expresses an “inherently subjective” assessment then that is also sufficient to render it pure opinion. The Second Circuit concluded that whether the requirements of GCP (that clinical trials should be “scientifically sound,” that “qualified” individuals should conduct the trials and that the investigator should have “adequate resources”) were met, and the ultimate question of whether the clinical trials complied with GCP, were “all questions that require inherently subjective assessments, and thus do not lend themselves to resolution as matters of objective fact.”
Second Circuit: Decentralized Crypto-Exchange Transactions Plausibly Alleged to Be Domestic Under Morrison
On March 8, 2024, the Second Circuit reversed and remanded a district court’s dismissal of a putative securities fraud class action brought by plaintiff token purchasers alleging that an online crypto exchange–that denied that it had a physical headquarters in any geographic jurisdiction–violated federal and state securities laws by promoting, offering and selling tokens that were not registered as securities. Williams v. Binance, 96 F.4th 129 (2d Cir. 2024) (Nathan, J.). The Second Circuit held that plaintiffs plausibly alleged that the transactions were domestic transactions, under Morrison v. National Australia Bank, 561 U.S. 247 (2010), because they became irrevocable within the U.S. The court found that two transactional steps gave rise to an inference that irrevocable liability occurred in the U.S. First, the transactions were matched–and therefore became irrevocable–on U.S.-based servers. Second, plaintiffs transacted on the exchange from the U.S. and their buy orders became irrevocable when they were sent, pursuant to the exchange’s Terms of Use.
The district court dismissed on the basis that plaintiffs’ claims constituted an impermissible extraterritorial application of securities law under Morrison. On appeal, the Second Circuit held that “[p]laintiffs have adequately alleged that their claims involved domestic transactions because they became irrevocable within the United States and are therefore subject to our securities laws.” Under Morrison, the Supreme Court interpreted the Exchange Act as applying only to “[1] securities listed on domestic exchanges, and [2] domestic transactions in other securities.” The Second Circuit explained that “to sufficiently allege the existence of a domestic transaction in other securities, plaintiffs must allege facts indicating that irrevocable liability was incurred or that title was transferred within the United States.” The court continued that “[i]rrevocable liability attaches when parties become bound to effectuate the transaction or enter into a binding contract to purchase or sell securities.” The court explained that “[t]o determine whether a transaction is domestic, courts must therefore consider both when and where the transaction became irrevocable.” The court held “that irrevocable liability was incurred in the United States because Plaintiffs plausibly alleged facts allowing the inference that the transactions at issue were matched on U.S.-based servers.” The court concluded it was appropriate to locate the matching of transactions where the exchange had its servers in the absence of an official locus of the exchange. Further, the court found that the fact that plaintiffs alleged that their purchase orders were submitted from U.S. locations rendered it more plausible that the trades at issue were matched over servers located in the U.S., as opposed to servers located elsewhere.
On January 13, 2025, the Supreme Court denied defendants’ certiorari petition seeking to overturn the Second Circuit’s decision. Defendants had asserted that the Second Circuit’s approach was inconsistent with Morrison and was an improper revival of the “conduct and effects” test that the Court had rejected as inconsistent with the presumption against extraterritoriality.
Second Circuit: Reaffirms Donoghue Holding That Short-Swing Trading Inflicts Injury Sufficient for Constitutional Standing
On June 24, 2024, the Second Circuit reversed a district court’s dismissal of a shareholder’s Section 16(b)[2] derivative suit for lack of constitutional standing based on its determination that TransUnion LLC v. Ramirez, 594 U.S. 413 (2021) abrogated Donoghue v. Bulldog Investors General Partnership, 696 F.3d 170 (2d Cir. 2012). Packer v. Raging Cap. Mgmt., 105 F.4th 46 (2d Cir. 2024) (Cabranes, J.). The Second Circuit concluded that the district court erred in dismissing and held that “nothing in TransUnion undermines Donoghue[.]”
This litigation arose when a retail company shareholder filed suit against an investment firm, its founder, and its investment manager alleging that they violated Section 16(b) by buying and selling the retailer’s stock while they were 10% beneficial owners during a six-month period in 2014 and 2015. The district court dismissed concluding that the Supreme Court’s 2021 decision in TransUnion (establishing that for an intangible injury[3] to be sufficiently concrete to confer constitutional standing, courts are to identify a “close historical or common-law analogue for the asserted injury”), abrogated the Second Circuit’s 2012 Donoghue decision (holding that a violation of Section 16(b) inflicts an injury that confers constitutional standing). Finding that Section 16(b) merely protected against “speculative harm,” the district court determined that the alleged violation did not confer standing in light of the TransUnion holding that “risk of harm” alone does not qualify as “concrete” harm.
Reversing, the Second Circuit concluded that the “deprivation of [short-swing] profits inflicts an injury sufficiently concrete to confer constitutional standing.” The Second Circuit pointed out that in TransUnion, the Supreme Court instructed that to determine whether an intangible injury is sufficiently concrete to confer constitutional standing, a court should identify a “close historical or common-law analogue for their asserted injury.” The Second Circuit continued that “[i]n Donoghue, we had identified such an analogue for a Section 16(b) injury: breach of fiduciary duty.” The Second Circuit explained that, “[a]s Donoghue made clear, because Section 16(b) makes 10% beneficial owners into statutory fiduciaries, a close historical or common-law analogue to short-swing trading by a 10% beneficial owner is breach of fiduciary duty.” The Second Circuit stated that plaintiff did not base his standing argument on a risk of harm and that the concrete injury that conferred standing was, “the breach by a statutory insider of a fiduciary duty owed to the issuer not to engage in and profit from any short-swing trading of its stock.”
Seventh Circuit: Raises the Possibility of Sanctions Against Class Counsel Seeking Mootness Fees
On April 15, 2024, the Seventh Circuit issued a long-awaited opinion addressing a would-be intervenor’s objection to mootness fees paid in connection with M&A strike suits brought challenging proxy disclosures in a public company merger transaction. Alcarez v. Akorn, 99 F.4th 368 (7th Cir. 2024) (Easterbrook, J.). The Seventh Circuit vacated an order denying the shareholder’s motion to intervene and remanded, instructing the district court to treat him as an intervenor. Notably, the Seventh Circuit raised the possibility of sanctions against plaintiffs’ counsel pointing out that a district judge has discretion over the choice of sanction under Federal Rule of Civil Procedure 11(c)(4). The Seventh Circuit’s decision is believed to be the first federal appellate court review of mootness fee payments to resolve M&A strike suits.
After learning that the company in which he was an investor had made some supplemental disclosures and paid $322,500 (so-called “mootness fees”) to obtain the voluntary dismissal of six lawsuits claiming that the company’s proxy statement failed to make certain disclosures in violation of Section 14(a) of the Securities Exchange Act, the stockholder sought to intervene and requested disgorgement of the mootness fees or an injunction blocking them in future cases. While some of the attorneys disclaimed the fees, attorneys in three of the suits continued to seek them. In these three cases, the district judge permitted the shareholder to participate as an amicus curiae and ordered counsel to return the fees to the company concluding that the complaints were frivolous and that the extra disclosures were worthless to investors. House v. Akorn, 385 F. Supp. 3d 616 (N.D. Ill. 2019). Two plaintiffs appealed, seeking an order that would allow two attorneys to retain the fees. The shareholder also appealed, seeking to intervene and additional relief.
The Seventh Circuit stated that it was inclined to agree with the district court’s analysis concluding that plaintiffs’ cases “should have been dismissed out of hand” based on its findings that the disclosures were worthless to shareholders; that the company paid the fees to avoid the nuisance of ultimately frivolous lawsuits; and that the settlements caused the company to lose money. The Seventh Circuit stated that the district court should have relied on §78u–4(c)(1) of the PSLRA and FRCP 11 rather than on its “inherent authority” to abrogate the settlement agreements and order plaintiffs’ counsel to return the mootness fees. The PSLRA states that in any private action arising under the Securities Exchange Act, the court shall include in the record, upon final adjudication of the action, specific findings regarding compliance by parties and their attorneys with each requirement of FRCP 11(b).[4] The Seventh Circuit then noted that the six suits invoked Section 14(a) of the Securities Exchange Act, the dismissal of each suit was a “final adjudication of the action” and then stated that the statute “obliges the judge to determine whether each suit was proper at the moment it was filed.” The Seventh Circuit then observed that “because Rule 11(c)(4) gives the district judge discretion over the choice of sanction, the court would be entitled to direct counsel who should not have sued at all to surrender the money they extracted from [the company]. But selecting an appropriate remedy (if any) should await resolution of the proceedings under §78u–4(c)(1) and, derivatively, Rule 11.”
Ninth Circuit: Writing and Disseminating Favorable Articles Is Solicitation Within the Meaning of a Securities Purchase Agreement
On April 5, 2024, the Ninth Circuit largely reversed the dismissal of a putative securities fraud class action alleging that a company misled investors when it represented in a securities purchase agreement (“SPA”) that it had not compensated any entity to solicit its securities, when, in fact, it had retained a stock promoter to write and disseminate favorable articles about it. In re Genius Brands Int’l, 97 F.4th 1171 (9th Cir. 2024) (Mendoza, J.). Relying on the plain meaning of solicit and Pino v. Cardone Capital, 55 F.4th 1253 (9th Cir. 2022), which defined “solicitation” broadly, the Ninth Circuit concluded that writing and disseminating favorable articles amounted to solicitation within the meaning of the SPA.
After the company experienced a stock drop, plaintiff stockholders sued alleging that the company had concealed its relationship with a stock promoter it retained in violation of Section 10(b) and Rule 10b-5(b), because the company later stated in an SPA that the company “has not . . . paid or agreed to pay any Person any compensation for soliciting another to purchase” its securities. The district court dismissed finding that plaintiffs “did not allege that anything in the [stock promoter’s] articles themselves was false or misleading and because [the stock promoter] had no duty to disclose [the company] as the source of its funding.”
On appeal, the Ninth Circuit stated that the dispositive question was whether the company, by representing in its SPA that it did not hire anyone to solicit its securities, had made a misleading statement when it compensated the stock promoter to publish favorable articles about it. The Ninth Circuit explained that “[t]o determine whether a statement or omission is misleading, our central inquiry is whether a reasonable investor would have been misled” and that the court must assess “whether an investor who had been reasonably diligent in reviewing the statement or omission at issue would have been misled.”
Examining the plain meaning of “solicit,” the Ninth Circuit concluded that “a person solicits the sale of a security where she petitions, entices, lures or urges another to purchase a security.” In Pino v. Cardone Capital, in the course of determining whether a company alleged to have made misleading statements on social media to encourage people to invest in its equity funds, was a statutory seller within the meaning of Section 12(a)(2) of the Securities Act, the Ninth Circuit considered the definition of solicitation. Choosing to define solicitation broadly, the Ninth Circuit concluded that “a person can solicit a purchase, within the meaning of the Securities Act, by promoting the sale of a security in a mass communication.” Drawing on the plain meaning of solicit and Pino, in this case, Ninth Circuit concluded that the stock promoter solicited the purchase of the company’s securities because plaintiff alleged that the company retained the stock promoter “to publish and disseminate favorable information about [the company’s] shares.” Further, the court stated that the articles solicited the purchase of the securities because “they urged or lured readers into purchasing [the company’s] stock.” The court reasoned that it “plausibly follows” that the company misled investors when it represented in the SPA that it “had not paid or agreed to pay to any Person any compensation for soliciting another to purchase any other securities of the Company.” The court concluded that reasonable investor would have taken the company’s statements to mean that it had not retained any person or any entity to promote its securities, when the company had, in fact, done so.
Ninth Circuit: Antibody Statements Not Materially Misleading When Read in Context
On March 25, 2024, the Ninth Circuit affirmed the dismissal of a securities fraud class action alleging that a biopharmaceutical company and two of its executives falsely claimed early on in the pandemic that the company’s new antibody was a cure for COVID-19. Zenoff v. Sorrento Therapeutics, 97 F.4th 634 (9th Cir. 2024) (Callahan, J.). The Ninth Circuit held that, “in context, Defendants’ representations were not false, and [plaintiff’s] pleadings do not support the requisite strong inference of scienter.” The court explained that “[a] fair reading of the press release and the articles reveals that there was no promise of an immediate 100% cure.”
In May 2020, the company announced its development of a COVID-19 antibody. While the company’s stock price increased following the initial announcement, the company experienced a stock drop after questions arose concerning the importance of the development. Plaintiff filed suit alleging that the company falsely claimed to have developed a COVID-19 cure, misleading investors in violation of Section 10(b) and Rule 10b-5. The district court dismissed finding that the assertion, “We want to emphasize there is a cure. There is a solution that works 100 percent,” was “a statement of corporate optimism” that “cannot state an actionable material misstatement of fact under federal securities law.” The district court concluded plaintiff failed to sufficiently plead the existence of false or misleading statements when the court reviewed the statements within the context of each entire article.
On appeal, the Ninth Circuit affirmed concluding that while defendants’ “enthusiasm . . . might have been overblown, in context, their statements were not materially misleading.” The court further concluded that despite defendants’ enthusiasm, in context, all of the articles revealed that the antibody’s development was only at the lab testing stage. The court determined that plaintiff failed to show “that a reasonable person reading the articles would think that Defendants were representing that [the antibody], without further testing, was an immediate cure for COVID-19.” The Ninth Circuit further took issue with plaintiff’s reasoning that because there is still no cure for COVID-19 that defendants could not have thought that the antibody was a cure and pointed out that the failure to survive the testing required for FDA approval “is hardly evidence that the developer’s initial enthusiasm was unwarranted or inherently false at the time.”
[1] In Omnicare, the Supreme Court rejected the argument that a defendant stating that “we believe we are following the law conveys that we in fact are following the law.”
[2] Under Section 16(b), owners of more than 10% of a company’s stock are required to disgorge profits (so-called “short-swing profits”) made by buying and selling that company’s stock within a six-month window. See 15 U.S.C. § 78p(b).
[3] Examples of intangible injury include reputational harms and disclosure of private information compared to tangible harms such as physical harms and monetary harms.
[4] Generally, FRCP 11(b) provides that by presenting a document to the court, an attorney certifies that it is not being presented for any improper purpose (such as needlessly increasing the cost of litigation); that the claims, defenses, and other legal contentions are warranted by existing law; that the factual contentions have or will have evidentiary support; and that the denials of factual contentions are warranted.