(Article from Securities Law Alert, Year in Review 2024)
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Supreme Court: Overturns Chevron Deference
Overturning nearly 40 years of precedent, on June 28, 2024, the Supreme Court held by a 6-3 vote: “Chevron is overruled.” Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244 (2024) (Roberts, C.J.).[1] Under Chevron v. Natural Resources Defense Council, 104 S. Ct. 2778 (1984), federal courts were required to defer to an administrative agency’s interpretation in cases involving statutory questions of agency authority as long as the agency’s interpretation was not unreasonable. Writing for the majority, Chief Justice Roberts concluded that Chevron could not be reconciled with the Administrative Procedure Act (“APA”), which governs federal administrative agencies, because the APA requires a reviewing court to exercise its independent judgment in deciding whether an agency has acted within its statutory authority, but Chevron requires the court “to ignore, not follow,” the reading the court would have reached had it exercised this independent judgment.
The Court further criticized Chevron’s presumption–that Congress understood that a statutory ambiguity would be resolved, first and foremost, by the agency, and desired the agency to possess whatever degree of discretion the ambiguity allows–stating that it “is misguided because agencies have no special competence in resolving statutory ambiguities.” Chief Justice Roberts stated that “[t]he very point of the traditional tools of statutory construction–the tools courts use every day–is to resolve statutory ambiguities.” He noted that this is particularly true when the ambiguity concerns the scope of the agency’s own power, which he described as “perhaps the occasion on which abdication in favor of the agency is least appropriate.”
Although the Court found that past judicial decisions have shown Chevron to be “unworkable” and unreliable as a result of inconsistent application by the lower courts, it did “not call into question prior cases that relied on the Chevron framework.” Rather, the Court concluded that “[t]he holdings of those cases that specific agency actions are lawful—including the Clean Air Act holding of Chevron itself—are still subject to statutory stare decisis despite our change in interpretive methodology.”
Supreme Court: In-House SEC Tribunals Violate Securities Fraud Defendants’ Seventh Amendment Right
On June 27, 2024, the Supreme Court held that the SEC’s adjudication of an enforcement action, seeking civil penalties for alleged securities fraud in an in-house tribunal before an administrative law judge, violated defendants’ Seventh Amendment right to a jury trial. SEC v. Jarkesy, 144 S. Ct. 2117 (2024) (Roberts, C.J.). By a 6-3 Justice majority, the Court concluded that this action implicates the Seventh Amendment because the antifraud provisions at issue “replicate common law fraud, and it is well established that common law claims must be heard by a jury,” considering the Seventh Amendment’s guarantee that in “suits at common law the right of trial by jury shall be preserved.”
The case arose when the SEC initiated an in-house enforcement action against an investment fund founder and an investment adviser seeking civil penalties and other remedies, alleging that defendants had violated the antifraud provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act. The proceedings resulted in a final order against defendants with a civil penalty of $300,000. Defendants petitioned for judicial review and a divided Fifth Circuit panel vacated the final order, holding that adjudicating the matter in-house violated defendants’ Seventh Amendment right to a jury trial. Jarkesy v. SEC, 34 F. 4th 446 (5th Cir. 2022). After the Fifth Circuit denied rehearing en banc, the Supreme Court granted certiorari.
Writing for the majority, Chief Justice Roberts affirmed the Fifth Circuit’s decision as consistent with the Court’s rulings in Granfinanciera, S. A. v. Nordberg, 492 U. S. 33 (1989) and Tull v. United States, 481 U. S. 412 (1987). Under Granfinanciera, the Seventh Amendment “extends to a particular statutory claim if the claim is legal in nature.” The Court explained in Tull that “[t]o determine whether a suit is legal in nature, we directed courts to consider the cause of action and the remedy it provides.” The Court continued, that “[s]ince some causes of action sound in both law and equity, we concluded that the remedy was the more important consideration.” The Court then stated that “the civil penalties in this case are designed to punish and deter, not to compensate. They are therefore a type of remedy at common law that could only be enforced in courts of law.” The Court explained that its conclusion effectively decided that this suit implicated the Seventh Amendment and that a defendant would be entitled to a jury on these claims.
Supreme Court: Pure Omissions Not Actionable Under Rule 10b-5(b)
On April 12, 2024, the Supreme Court issued a unanimous opinion holding that a company’s failure to make disclosures required by Item 303 of SEC Regulation S-K[2] cannot in itself support a private securities claim under Section 10(b) of the Securities Exchange Act of 1934, which makes it unlawful to use or employ any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security, and Rule 10b-5(b)[3] thereunder where the omission did not render any of the company’s affirmative statements misleading. Macquarie Infrastructure Corp. v. Moab Partners, L.P., 144 S. Ct. 885 (2024) (Sotomayor, J.). “Pure omissions are not actionable under Rule 10b-5(b).” The opinion resolves a circuit split on the issue between the Second Circuit, on the one hand, and the Third and Ninth Circuits, on the other.
This litigation began when an investor sued alleging that the defendant company’s public statements were false and misleading because it concealed from investors that its subsidiary’s single largest product was No. 6 fuel oil, which was subject to a United Nations regulation that would significantly restrict its use. Plaintiff claimed that under Item 303 the company had “a duty to disclose” how much of its subsidiary’s storage capacity was devoted to No. 6 fuel oil and, by violating that duty, the company violated Section 10(b) and Rule 10b-5. The district court dismissed, concluding that plaintiff had not actually pled an uncertainty that should have been disclosed or in what SEC filing or filings the company should have disclosed it. The Second Circuit reversed, concluding that the company’s Item 303 violation alone was enough to sustain claims under Section 10(b) and Rule 10b-5.
Justice Sotomayor, writing for the Court, explained that Rule 10b-5(b), in essence, prohibits false statements and prohibits “omitting a material fact necessary to make the statements made not misleading.” The Court stated that the issue was “whether this second prohibition bars only half-truths or instead extends to pure omissions[,]” which occur “when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.” Concluding that “Rule 10b-5(b) does not proscribe pure omissions” the Court reasoned that “the Rule requires identifying affirmative assertions (i.e., statements made) before determining if other facts are needed to make those statements not misleading.” Citing Matrixx Initiatives, Inc. v. Siracusano, 563 U. S. 27 (2011), the Court emphasized that Section 10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information, and that disclosure is required under these provisions only when necessary to make statements already made not misleading.
Supreme Court: Dismisses Both Securities Suits That It Took Up This Term
On November 22, 2024 and December 11, 2024, the Supreme Court issued per curiam opinions stating that the writs of certiorari granted in Facebook v. Amalgamated Bank, No. 23-980 and Nvidia v. E. Ohman J:Or Fonder AB, No. 23-970 were dismissed as improvidently granted. Decisions in these cases were eagerly anticipated as they could have potentially provided insights concerning the Private Securities Litigation Reform Act (“PSLRA”). In Facebook, the issue concerned whether public company risk disclosures are false or misleading if they do not disclose that a risk has materialized in the past. In Nvidia, the issue concerned pleading requirements, namely whether expert witness allegations about internal company documents must plead with particularity the documents’ contents and whether an expert opinion can substitute for particularized allegations of fact. Following the Court’s dismissals, each case is expected to return to a California federal district court for further proceedings.
In Facebook, plaintiff shareholders alleged that a social media company and certain of its executives violated Section 10(b) and Rule 10b-5(b) by making materially misleading statements and omissions when the company warned of the risk of improper access to user data when in fact improper access had already occurred. After the case’s dismissal, the Ninth Circuit partially reversed in 2023 holding that plaintiffs adequately pled the falsity of the company’s risk statements in its 2016 10-K concerning the risk of third parties improperly accessing and using user data as purely hypothetical while the company allegedly knew that a political consulting firm had already done so when it filed its 10-K. The Ninth Circuit further held that plaintiffs adequately pleaded falsity as to the statements warning that misuse of user data could harm the company’s business, reputation, and competitive position.
In its Supreme Court certiorari petition, the company asked “[a]re risk disclosures false or misleading when they do not disclose that a risk has materialized in the past, even if that past event presents no known risk of ongoing or future business harm?” The company urged the Justices to rule that public companies need not disclose past events if there is no known risk of future harm. At the November 6, 2024 oral argument, the company’s attorney initially urged the Justices to adopt an approach where a typical risk disclosure cannot be misleading simply because the triggering event had occurred in the past but a forward-looking risk disclosure could be misleading based on an embedded premise about the current state of affairs, depending on the statement’s content. Justice Sotomayor observed that it appeared the company was in fact seeking a categorial rule (such that risk disclosures under Item 105 make no implied representation about a company's past experiences) and would consider context only as to whether there was a misrepresentation, not a misleading representation. Justice Barrett similarly noted that it appeared the company was advocating for a categorical rule. Justice Barrett also noted the difficultly of drafting a rule, asking how to articulate a rule that would handle anything more than the case before the Court. Chief Justice Roberts pointed out that if the Court adopted the standard that a probabilistic statement could sometimes carry an inference that something has already occurred then it would lead to a substantial expansion of disclosure obligations. Justice Kavanaugh expressed concern that if the Court required disclosure it would create separation of powers and fair notice issues, stating that “[t]he SEC knows how to write regulations that require disclosure of past events.” He further questioned whether such a requirement would result in over disclosure.
In Nvidia, plaintiff shareholders alleged that a technology company, its CEO and two officer defendants violated Section 10(b) and Rule 10b-5 by failing to state or substantially understating the extent to which the company’s revenue growth for its processers depended on crypto mining rather than video gaming.[4] Plaintiffs claimed that the CEO made public statements that were contrary to the company’s internal reports. However, plaintiffs’ allegations did not rely on actual internal reports and instead relied on a retained expert’s analysis of the company’s cryptocurrency market share and its cryptocurrency revenues to conclude that defendants understated the company’s crypto-related sales by over $1 billion. The district court dismissed plaintiffs’ amended complaint under Rule 12(b)(6) for failing to sufficiently plead that defendants’ allegedly false or misleading statements were made knowingly or recklessly.[5]
The Ninth Circuit affirmed in part and reversed in part, holding that plaintiffs stated a claim under Section 10(b) and Rule 10b-5 against the company and CEO, but not the other two officer defendants. E. Ohman J:Or Fonder AB v. Nvidia, 81 F.4th 918 (9th Cir. 2023). The Ninth Circuit held that plaintiffs sufficiently alleged that the CEO made false or misleading statements and did so knowingly or recklessly.[6] The Ninth Circuit found that plaintiffs sufficiently pleaded scienter under the PSLRA as to the CEO because the allegations supported “a strong inference” that he reviewed sales data showing that a large share of the processors sold were being used for crypto mining. The Ninth Circuit also held that the plaintiffs had sufficiently pleaded falsity based on the analyses of plaintiffs’ expert as well as an international investment bank, which reached an “almost identical” conclusion. The Ninth Circuit noted that “the PSLRA nowhere requires experts to rely on internal data and witness statements to prove falsity.” The Ninth Circuit pointed out that to do so “would place an onerous and undue pre-discovery burden on plaintiffs in securities fraud cases. We decline to turn the PSLRA's formidable pleading requirement into an impossible one.”
Defendants’ petition for a writ of certiorari to the Supreme Court asked whether plaintiffs: (i) seeking to allege scienter under the PSLRA based on allegations about internal company documents must plead with particularity the contents of those documents; and (ii) can satisfy the PSLRA’s falsity requirement by relying on an expert opinion to substitute for particularized allegations of fact. At the November 13, 2024 oral argument, several Justices noted that while defendants’ petition initially seemed to propose new categorical legal rules aimed at clarifying the PSLRA, defendants’ position shifted to a fact-bound application of agreed-upon legal principles. While defendants’ attorney asserted that the Ninth Circuit did not engage in the comparative analysis required under Tellabs v. Makor Issues & Rights, 551 U.S. 308 (2007) (as to whether or not plaintiffs’ allegations were as cogent and compelling as any competing inferences), Justice Gorsuch pointed out that the Ninth Circuit did perform a comparative analysis albeit, “may be not emphasized enough for your taste, and therefore, may be wrong as a matter of error correction.” Noting that the Court does not often grant certiorari to error correct, Justice Sotomayor questioned “[i]s this entire case just error correction?” Justice Sotomayor continued, stating that “I'm not actually sure what rule we could articulate that would be clearer than our cases already say.”
[1] The Court’s decision arose from a pair of cases, Loper Bright Enterprises v. Raimondo and Relentless v. Department of Commerce, where the District of Columbia Circuit and the First Circuit, respectively, upheld a regulation issued by a federal agency as a reasonable interpretation of a federal statute.
[2] Item 303 of SEC Regulation S–K requires companies to “describe any known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 CFR § 229.303(b)(2)(ii).
[3] Among other things, Rule 10b-5 makes it unlawful for issuers of registered securities to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” 17 CFR §240.10b–5(b).
[4] The significance of this is that crypto-related demand is “notoriously volatile” because cryptocurrency prices can swing wildly causing mining to become unprofitable. This leads crypto miners, who use the processors to mine cryptocurrency, to stop purchasing the processors and to resell them on the secondary market at steep discounts.
[5] The district court found that allegations did not raise a strong inference of scienter as plaintiffs did not adequately tie the specific contents of any data sources about crypto-related demand to particular statements to show that each specified statement was knowingly or recklessly false. The district court did not reach the question of whether the amended complaint failed to sufficiently plead that the statements were materially false or misleading.
[6] Securities fraud cases are subject to the PSLRA and to sufficiently plead scienter under the PSLRA, a plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2)(A). In the Ninth Circuit, the required state of mind includes intent to deceive, manipulate, or defraud, and deliberate recklessness.