On July 24, 2023, Judge Amit P. Mehta of the U.S. District Court for the District of Columbia ordered the law firm Covington & Burling LLP (Covington) to disclose the names of several clients in response to a U.S. Securities and Exchange Commission (SEC) subpoena. Judge Mehta granted in part the SEC’s motion to compel, ruling that the subpoena was tied to the legitimate purpose of ascertaining potential securities violations.
The SEC staff issued the subpoena in question in connection with an investigation related to a November 2020 cyberattack by Chinese hackers. The hackers compromised Covington’s server and gained access to confidential client information. The SEC’s investigation focused on “whether threat actors ‘accessed and traded on the basis of material, non-public information’” and “whether public companies ‘made materially false or misleading statements, or omitted to state material facts, concerning the impact of the [c]yberattack in violation of federal securities laws.’” The subpoena demanded, among other things, documents and communications that identified Covington’s public company clients that were affected.
Covington objected to the request on the grounds that disclosing client names would violate attorney-client privilege and its fiduciary duties to clients, and would constitute a breach of ethics rules, which impose duties of loyalty and confidentiality. When the SEC moved to compel production, Covington also invoked the Fourth Amendment, labeling the SEC’s subpoena a “fishing expedition.”
Judge Mehta agreed that the subpoena was “too broad” but disagreed with Covington’s arguments based on attorney-client privilege, noting that client names are only privileged when “‘disclosure would in essence reveal a confidential communication.’” Judge Mehta also held that the subpoena was a valid exercise of the SEC’s investigative authority and as such did not violate the Fourth Amendment. In a nod to the policy concerns raised by Covington and amici to the case, however, Judge Mehta significantly narrowed the reach of the SEC’s subpoena. In particular, the court ruled that the SEC was entitled to the names of only the seven public company clients whose material nonpublic information Covington had determined was accessed, and not of the 291 other clients whose information Covington stated had not been accessed.
Both Covington and the SEC agreed not to appeal Judge Mehta’s order, and six of the seven clients who Covington was ordered to disclose have agreed to release their names to the SEC on the condition that the SEC makes an effort to keep their identities out of the public eye. The seventh client appealed Judge Mehta’s order as an intervenor, using the alias John Doe. In light of its pending appeal, the intervenor moved to partially stay Judge Mehta’s original order to prevent Covington from disclosing its identity along with the identities of the other clients. On September 21, 2023, Judge Mehta granted the intervenor’s motion, allowing its identity to remain private pending resolution of the appeal before the U.S. Court of Appeals for the District of Columbia. Covington disclosed the identities of the other six clients to the SEC on September 22, 2023.
Court Dismisses Class Action against Chinese News Aggregation App for Failing to Allege Any Actionable Misstatements or Omissions Regarding Advertising Practices
On August 3, 2023, the US District Court for the Southern District of New York dismissed a putative class action against Qutoutiao Inc. (QTT), finding that the complaint failed to allege any actionable misstatements or omissions by the company regarding its advertising practices.
According to the complaint, QTT — a Chinese news aggregation application — misrepresented its ability to meet its revenue targets with legitimate advertisers and its actual reasons for acquiring a new advertising agent (Dianguan) to replace its former advertising agent (Baidu). As a result of these and other misstatements, the complaint alleges, QTT’s share price plummeted as it faced increased regulatory scrutiny and reputational harm.
In dismissing plaintiffs’ claims, the court found that plaintiffs failed to plead any nonconclusory facts that would suggest that QTT’s motivation for acquiring Dianguan was anything other than what it publicly disclosed, specifically rejecting an attempt by plaintiffs to support a claim based on a “mere totality of the circumstances argument.” Additionally, the court ruled that certain public statements by QTT that the plaintiffs alleged to be false and misleading, including that it “always closely followed rules and regulations” and that the quality of its advertisers “consistently improved,” were inactionable puffery. The court also found that another allegedly false statement regarding the company’s expected growth and recovery was inactionable because it was accompanied “immediately thereafter [with] far more cautionary language about [its] expectations.”
This case serves as a welcome reminder that courts require more than conclusory facts and a “totality of the circumstances” argument to plead a securities fraud claim and will scrutinize each alleged misstatement or omission to determine whether each may be actionable.
Court Denies Plaintiffs’ Motion for Reconsideration of Order Dismissing Putative Securities Class Action for Citrix Systems, Inc., Concerning its Business Model Transformation
On August 7, 2023, the US District Court for the Southern District of Florida denied plaintiffs’ motion for reconsideration of its prior order dismissing with prejudice a putative securities class action complaint against Citrix Systems, Inc., and certain Citrix officers in a case concerning the company’s business model transformation.
Earlier this year, the court dismissed the entire case with prejudice, holding that plaintiffs failed to allege facts sufficient to raise a strong inference of scienter. In the motion for reconsideration, plaintiffs argued that the court failed to consider the scienter allegations collectively and in the light most favorable to them. Alternatively, plaintiffs argued that the court should have given them an opportunity to replead based on “newly discovered evidence,” including information from multiple confidential witnesses.
In denying the motion, the court observed that the plaintiffs mischaracterized its original dismissal order and reaffirmed that it had considered all of plaintiffs’ scienter allegations collectively before dismissing the case. Moreover, the court denied plaintiffs leave to file an amended complaint, finding that any such filing would be futile and would not result in curing the deficiencies because the purportedly new allegations merely rehashed the allegations in the operative complaint.
The opinion serves as an example of how courts analyze scienter allegations holistically to determine whether scienter has been adequately pled. The opinion also provides a reminder that courts do not automatically give plaintiffs an opportunity to replead simply based on newly discovered evidence and will instead evaluate whether, even with such evidence, amendment would nonetheless be futile.
Eleventh Circuit Affirms Dismissal of Tupperware Securities Class Action for Failing to Allege that Executives Making Challenged Statements Were Aware of Allegedly Inflated Financials
On August 8, 2023, the US Court of Appeals for the Eleventh Circuit affirmed dismissal of a putative class action against Tupperware Brands Corporation and certain of its officers on the grounds that, among other things, plaintiffs failed to adequately plead scienter. The plaintiffs alleged that management at the company’s direct-to-consumer cosmetic operations in Mexico (Fuller Mexico) falsified the business unit’s accounts receivable by charging resellers for extra inventory that they knew would later be refunded. Fuller Mexico’s inflated top-line numbers were then incorporated into Tupperware’s financial statements, periodic reports, press releases, and earnings calls. Plaintiffs did not allege that any senior executives who either made the relevant public statements or were responsible for them acted with scienter.
The Eleventh Circuit affirmed dismissal on all counts, finding that the complaint could not support a strong inference of scienter absent particularized allegations “creat[ing] the requisite connection between [the Fuller Mexico] corporate officials” who had perpetrated the fraud and “the [challenged] public statements.” Plaintiffs’ allegations that Fuller Mexico executives “approved furnishing the Fuller financials [to Tupperware]” were not sufficient to suggest they were directly involved in or responsible for issuing the challenged statements. The Eleventh Circuit further rejected the plaintiffs’ allegations that scienter could be imputed to Tupperware’s executives simply because they incorporated Fuller Mexico’s financials into the company’s periodic reporting. In addition, the Eleventh Circuit affirmed dismissal of plaintiffs’ “scheme liability” claim under Rule 10b-5(a) and (c) as an impermissible “shotgun pleading” due to the complaint’s failure to allege with particularity what facts constituted the so-called deceptive acts underlying the claim.
On October 2, 2023 the Eleventh Circuit denied Plaintiffs’ petition for rehearing en banc, which challenged the panel’s opinion and pointed to the Eleventh Circuit’s holding in Mizzaro v. Home Depot, Inc., as controlling precedent. With that denial, it appears that the Eleventh Circuit has finally put a lid on this litigation.
Delaware Supreme Court Affirms Application of Lenient Business Judgment Rule to Merger with Controlling Shareholder Despite Higher Third-Party Offer
On August 9, 2023, the Delaware Supreme Court summarily affirmed the Court of Chancery’s dismissal of a proposed class action challenging a merger in which BridgeBio Pharma, Inc., controlling shareholder in Eidos Therapeutics, Inc., acquired the remaining minority shares in Eidos Therapeutics, Inc. The complaint alleged that BridgeBio, as well as three Eidos directors who also served as officers or directors of BridgeBio, breached their fiduciary duties by prioritizing BridgeBio’s offer over a substantially higher offer from a third party, GlaxoSmithKline plc (“GSK”). The Delaware Supreme Court adopted the reasoning of the Court of Chancery, which applied the business judgment rule instead of the more rigorous entire fairness standard, holding that BridgeBio instituted appropriate minority stockholder protections. By doing so, the court complied with the framework established in Kahn v. M&F Worldwide Corp. (MFW).
Under MFW, courts apply the business judgment rule to controlling stockholder transactions if the following requirements are met: (1) the controller conditioned the transaction on the approval of both a special committee and a majority of the minority stockholders, (2) the special committee was independent, (3) the special committee was empowered to freely select its own advisers and definitively reject the transaction, (4) the special committee met its duty of care in negotiating a fair price, (5) the minority’s vote was informed, and (6) the minority was not coerced.
The Court of Chancery first rejected plaintiffs’ threshold argument that MFW should never apply to transactions in which a competing bidder makes an offer that is substantially higher than that offered by the controller and the controller refuses to sell. The court reasoned that a controlling stockholder is not required under Delaware law to “accept a sale to a third party or to give up its control, and its stated refusal to do so does not preclude review under the MFW framework.” Next, the court found that all six requirements under MFW were satisfied. The court reasoned that, unlike other cases in which situational coercion was found, Eidos was not financially distressed, faced no threat of delisting, and still had “realistic alternatives” to the BridgeBio proposal.
The opinion reemphasizes the important benefits of adhering to the procedures established by MFW and related cases in connection with mergers involving controlling shareholders under Delaware law.
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