Securities Snapshot
February 14, 2017

Goodwin Litigators Score Insider Trading Defense Verdict

Goodwin scores first insider trading verdict in the nation after Salman; federal courts of appeal weigh in on the applicability of Dura Pharmaceuticals’ loss causation holding to criminal penalty determinations under the federal Sentencing Guidelines and the use of aggregate data regarding Medicaid reimbursements to support FCA claims; the Delaware Supreme Court muscles up business judgment protection in unconflicted M&A deals and also affirms dismissal of second-filed derivative claim on grounds of issue and claim preclusion; and federal district courts school practitioners on pleading requirements for securities claims and the non-retroactivity of Dodd-Frank’s statute of limitations.

In United States v. Aggarwal, a federal jury in the Central District of California found Goodwin client Ashish Aggarwal not guilty of 26 of 30 counts of conspiracy, insider trading, and wire fraud relating to allegations that he tipped two friends about two impending corporate acquisitions while employed as an investment banking analyst at J.P. Morgan. U.S. District Judge Terry J. Hatter, Jr. declared a mistrial on the four remaining deadlocked counts. Prosecutors alleged that Aggarwal had tipped a former college classmate with whom he was co-trading stocks, who in turn allegedly tipped a mutual friend. The defense verdict was fueled, in part, by Goodwin’s ability to secure a pretrial order severing his trial from the alleged tippees (who allegedly earned $650,000 in the subject trades), and by its defeat of the government’s efforts to stay a parallel SEC civil case, which enabled Goodwin litigators to obtain valuable pretrial testimony from government witnesses. The acquittal is the first successful defense of an insider trading case since the Supreme Court’s December 2016 decision in Salman v. United States, which government attorneys argue lowered the bar for prosecutors by holding that tippers can be convicted of insider trading even without deriving a direct financial benefit from a tip to a trading relative or friend. Goodwin partners Derek Cohen and Grant Fondo were profiled as the national Litigators of the Week in The American Lawyer for their successful defense of Aggarwal.


In United States v. Stein, the Eleventh Circuit became the fifth Court of Appeals (of eight that have addressed the issue) to reject the application of the loss causation methodology announced in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), a civil case, to loss calculations in the criminal sentencing context. In Dura, the Court held that the “loss causation” element of federal securities fraud claims requires plaintiff stockholders to show a causal connection between the defendant’s fraudulent conduct and the plaintiff’s alleged loss. Plaintiffs may not, in other words, merely allege that they purchased stock at a price that was artificially inflated by a defendant’s fraud—they must also prove that the stock declined in value as a result of that fraud. White collar defendants have sought, with mixed success, to import Dura into the criminal setting in an effort to limit penalty enhancing loss calculations under the federal Sentencing Guidelines. The Stein court offered a ray of hope for defense attorneys, however, ruling that where a defendant can show that an intervening event aside from his fraud depressed the stock price, and that intervening event was not “reasonably foreseeable,” courts “should approximate the effect of such intervening events and subtract this amount from its actual loss calculation.” The court remanded the Stein case for resentencing in light of the district court’s failure to account for the effect of possible intervening factors in the stock’s price decline.  


The First Circuit, in U.S. ex rel. Booker v. Pfizer, Inc., affirmed summary judgment for Pfizer in a False Claims Act case alleging that Pfizer engaged in off-label promotion of the antipsychotic drug Geodon. Less than a year after Pfizer’s 2009 settlement with the Department of Justice for allegedly promoting Geodon for off-label uses, relators filed a qui tam complaint in the District of Massachusetts, alleging that Pfizer continued to promote Geodon off-label, knowingly inducing third-parties to submit false reimbursement claims to federal health care programs in violation of the FCA. The First Circuit affirmed the district court, holding that relators had failed to provide “competent evidence” that Pfizer’s off-label promotion actually resulted in the filing of false claims for payment from the government, as required to survive summary judgment. Rather, “relators’ only proffered evidence consisted of aggregate data reflecting the amount of money expended by Medicaid for pediatric Geodon prescriptions (an off-label use),” which was insufficient to establish that false reimbursement claims were in fact submitted to government insurance programs. The court also rejected a retaliation claim in the case brought by a dismissed relator-employee who had complained about the off-labeling to management. According to the court, the FCA protects employees only if their complaints specifically concern the submission of false claims, as opposed to general complaints of legal violations. Here, the court observed, while the relator objected to Pfizer’s alleged off-label promotion, he did not complain to his supervisor that this conduct could lead to the submission of false claims.


The Delaware Supreme Court, in Laborers’ District Council Construction Industry Pension Fund, et al. v. Bensoussan, et al., affirmed Chancellor Andre Bouchard’s June 2016 decision dismissing a stockholder suit against lululemon athletica, Inc. on the grounds that the Southern District of New York had previously dismissed a derivative complaint based on the same facts. In April 2014, the New York court had dismissed a derivative suit against lululemon founder Dennis Wilson and members of the company’s Board of Directors—alleging, respectively, breach of fiduciary duties for insider trading and failure to investigate—after Wilson netted nearly $50 million selling about 600,000 shares one day prior to then-CEO Christine Day’s resignation in June 2013. The New York court held that the stockholders failed to make a pre-suit demand on lululemon’s Board or establish that such demand would have been futile, as required for stockholders to pursue derivative claims under Delaware law. In July 2015, after obtaining books and records from the Company pursuant to 8 Del. § 220, two other stockholders filed a similar suit in the Delaware Chancery Court. Like the New York plaintiffs, the Delaware plaintiffs failed to make a pre-suit demand on lululemon’s Board, asserting that doing so would have been futile because the company’s directors were not independent—the same argument that the New York court had considered and rejected. Thus, the New York court had previously decided “the same demand futility issue that is decisive [in the Delaware action].” Chancellor Bouchard held that because the Delaware plaintiffs had intervened in the New York lawsuit, they had a full and fair opportunity to contest that court’s prior determination and were consequently precluded from “re-litigating the issue of demand futility in this action.”  


The Delaware Supreme Court, in In re Volcano Corp. Stockholders Litig., affirmed Vice Chancellor Tamika Montgomery-Reeves’ June 2016 decision extending irrebuttable business judgment rule protection to a merger effected under Section 251(h) of the Delaware General Corporation Law. In February 2015, Philips Holding USA Inc. acquired Volcano Corporation in an all-cash purchase consummated through a two-step tender offer under Section 251(h), which closed with nearly 90% of Volcano’s outstanding shares having tendered. Former Volcano stockholders subsequently filed suit against the company’s board and its financial advisor, Goldman Sachs, alleging breach of fiduciary duty and aiding and abetting claims against them, respectively. Dismissing the stockholders’ complaint, the Chancery Court held that the business judgment rule “irrebuttably applie[d]” to the merger because Volcano’s disinterested, uncoerced, fully informed stockholders tendered a majority of outstanding shares into the tender offer, thus insulating the transaction from all challenges other than waste. Reasoning that the first-step tender offer in a two-step merger “essentially replicates a statutorily required stockholder vote,” the court concluded that irrebuttable business judgment protection is “equally applicable” to a Section 251(h) merger approved by a majority of informed, disinterested, uncoerced stockholders. Vice Chancellor Montgomery-Reeves then held that the stockholders in Volcano were in fact adequately informed in tendering their shares, triggering the irrebuttable business judgment standard of review. The Delaware Supreme Court affirmed this June 2016 ruling in a two-sentence order issued on February 10, 2017.


In In re Fisker Automotive Holdings Inc. S’holder Litig., the District of Delaware denied Fisker Automotive’s motion to dismiss a stockholder suit alleging that the electric carmaker made false statements about its financial position prior to its 2013 bankruptcy. The plaintiff stockholders claimed that, on December 8, 2011, Fisker Automotive’s Board of Directors approved a “pay to play” capital call imposed on all company investors. During a conference call with investors one week later, plaintiffs alleged, Fisker Automotive’s then-CEO responded to an investor’s question concerning battery fires by stating that it was “not a risk for [the company].” Approximately another week later, on December 21, 2011, the National Highway Traffic Safety Commission sent a non-public letter to the company, acknowledging a recall of “239 Fisker Karmas due [to] a battery problem that could cause a fire.” On December 29, 2011—the day after the first deadline to invest in the December 2011 capital call—Fisker Automotive publicly announced the recall. Plaintiffs also alleged that the company failed to disclose that former CEO Henrik Fisker’s resignation in February 2012 violated loan covenants, falsely stated that it had met vehicle production milestones required by its lender, and had also made material misrepresentations regarding the company’s “precarious cash position” in advance of the December 2011 capital call. The court rejected defendants’ arguments that stockholders had received offering documents that “repeatedly and extensively” warned them of the “very risks and facts that they claim were concealed and misrepresented.” The court reasoned that it is inappropriate at the motion to dismiss stage to consider documents containing potential warnings to stockholders for purposes of assessing what they in fact knew.  


The Southern District of New York, in Jones, et al. v. Party City Holdco Inc., et al., dismissed a putative class action brought by stockholders of Party City Holdco Inc., who alleged that Party City failed to disclose prior to its April 2015 initial public offering how important sales of merchandise related to Disney’s movie Frozen had been to the company’s 2014 sales figures. Plaintiffs contended, for example, that Party City’s statement in offering documents that none of its third-party licenses was “individually material to [its] aggregate behavior” was false because “Frozen’s impact was so material to Party City’s business in the second half of 2014 that it could not be offset by Party City’s other licenses in the second half of 2015.” Judge Lewis Kaplan rejected this argument, holding that plaintiffs failed to adequately plead that any alleged misstatement was actually false—in other words, “that Frozen in fact was material” to Party City’s “aggregate business.” The court noted that “just because the [c]ompany described Frozen’s performance as ‘extraordinary,’ ‘anomalous,’ or ‘phenomen[al]’ does not mean that it had a material impact on the [c]ompany’s aggregate business.” Instead, plaintiffs relied only on “a handful of buzz words and a single financial metric, brand comp sales.” The court concluded that plaintiffs offered “no facts from which the [c]ourt could plausibly infer that Frozen sales were material to Party City’s business as a whole”; thus, plaintiffs failed to allege that Party City made any material misstatements in advance of the company’s 2015 IPO.


The District of New Jersey, in United States v. Gentile, dismissed a criminal securities fraud indictment against Guy Gentile, the owner of a New York broker-dealer accused of orchestrating a $17.2 million “pump and dump” scheme to illegally inflate the value of certain microcap stocks, holding that a five-year statute of limitations to charge Gentile had already expired when he was indicted in March 2016. Gentile had been charged with obtaining control over large blocks of the free trading shares of two companies, Raven Gold Corp. and Kentucky USA Energy Inc., then working with stock promoters in 2007 and 2008 to inflate the prices of those shares through manipulative trading and misleading promotional materials. Gentile argued that his case was covered by the five-year statute of limitations in effect at the time of the alleged misconduct—which meant that the latest date he could have been charged (accounting for tolling waivers he had executed) was June 30, 2015. Prosecutors countered that the 2010 Dodd-Frank Act created a six-year statute of limitations that extended their deadline for filing an indictment until June 2016. Judge Jose Linares, however, rejected the government’s bid to retroactively apply Dodd-Frank, observing that the relevant statutory provision “contains no discussion nor mention of retroactivity, let alone clear intent that Congress intended that section to apply to crimes committed prior to its enactment.” The court concluded that the applicable statute of limitations was five years and dismissed the indictment on the grounds that it was indeed untimely.