Securities Snapshot
February 28, 2017

First Circuit Affirms Insider Trading Conviction Despite Error in Jury Instruction

The First Circuit affirms insider trading conviction based on cocktail napkin tip; the Sixth Circuit affirms dismissal of alleged “pump and dump” case; federal district courts weigh in on disclosure obligations in connection with mergers and IPOs and Item 303 of Regulation S-K; a New York appeals court approves “disclosure only” class action settlement; and the Delaware Chancery Court limits award of attorneys’ fees in “simple” case.

In United States v. Bray, the First Circuit affirmed the conviction of Robert Bray for insider trading.  The defendant was convicted in Massachusetts for trading on a tip about an upcoming non-public bank acquisition that he received from his friend on a country club cocktail napkin.  Although the defendant did not discuss what was written on the napkin with his tipper friend, the jury determined that the “surreptitious” manner of the tip was sufficient to convict him of insider trading. The First Circuit determined that the district court erred in instructing the jury that it could convict the defendant if he “knew or under all of the circumstances . . . should have known” that his tipper friend had breached his fiduciary duty to Eastern Bank or if he was willfully blind to his friend’s breach. Nevertheless, the court held that the instruction error did not “seriously impair[] the fairness, integrity, or public reputation of the judicial proceedings” because “[a] reasonable jury could also infer that [the defendant] knew [the tipper] had breached a duty of confidentiality by giving him the [] tip.” In reaching this conclusion, the court addressed the facts that the defendant knew his friend worked for the bank, the defendant’s “furtive behavior in the pub room,” his admission that his trading behavior would seem “ridiculous” to a person possessing only publically-available information, and his assurances to his friend after he traded that he had not “told anybody” and would not tell regulators if they asked him. The court also found sufficient evidence of a “close relationship” and that the friend “disclosed the tip in expectation of a personal benefit” because the tipper friend testified that he “figured [the tip] would enhance” his reputation with the defendant, and the defendant later thanked his friend for the tip and offered to let his friend invest in his project. Thus, the court held that “all of the evidence regarding the tip and its aftermath show that there was a sufficient basis from which a jury could reasonably conclude beyond a reasonable doubt that [the defendant] knew [his tipper friend] had anticipated a benefit and breached a fiduciary duty to his employer.” The First Circuit therefore required some awareness of the tipper’s breach of a fiduciary duty that rises above a mere “should have known” negligence standard.  The First Circuit also notably declined to decide “how ‘close’ a tipper-tippee relationship must be before a jury can infer a gift-based personal benefit” in the absence of a pecuniary benefit, leaving this question open for future courts to decide.


The First Department in New York approved a “disclosure only,” or non-monetary, settlement in Gordon v. Verizon Commn’s, Inc. The settlement arose from a shareholder class action alleging that Verizon’s board of directors breached its fiduciary duties by paying an excessive price for stock in Vodafone subsidiaries. Following settlement discussions, Verizon agreed to provide its shareholders with additional disclosures and a fairness opinion from an independent financial advisor if Verizon were to be sold for more than $14.4 billion in the next three years.  Despite initially approving the settlement, the Supreme Court reversed its decision in December 2014. At that time, Judge Melvin L. Schweitzer held that the agreed-upon disclosure did not “materially enhance shareholders’ knowledge about the merger,” and therefore could not be deemed fair and in the best interests of the class members.  On appeal, the First Department not only applied the five factors established in Matter of Colt Indus. S’holders Litig. to determine whether to approve the settlement, but it also applied two new factors: (1) “whether the proposed settlement is in the best interests of the putative settlement class as a whole;” and (2) “whether the settlement is in the best interest of the corporation.”  In so doing, the court notably placed greater importance on potential benefit to the shareholders and on the best interests of the corporation (including, with respect to the corporation, the benefit of avoiding legal fees). After assessing all seven factors, the First Department approved the proposed settlement. This ruling stands in stark contrast to the Delaware Chancery Court’s recent rejection of a “disclosure only” settlement agreement in Matter of Trulia, Inc. S'holder Litig., and suggests that New York might be friendlier to such means of resolving shareholder litigation going forward.


A Vermont district court recently dismissed a securities class action in Montanio v. Keurig, et al., which asserted violations of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934 Act and Rule 14a-9 against Keurig Green Mountain for allegedly misleading shareholders ahead of its $13.9 billion merger with an investor group led by JAB Holdings.  Investors argued that Keurig’s board of directors disseminated a materially false and misleading proxy statement in order to obtain shareholder support for the merger.  They allege that the proxy failed, among other things, to disclose discussions about the 50% probability weighting that the board used to assess the buyout and alternative scenarios to the proposed buyout.  In particular, Plaintiff alleges that the board “artificially lower[ed] the Company’s value” via the 50% probability weighting in order to strike a deal with JAB Holdings for $92 per share—a premium 78% above its trading price at the time—even though it had been offered $129 per share by another party.  Judge Geoffrey W. Crawford held that the board did not make any improper omissions because proxies need not disclose “every strategic alternative” to a recommended transaction, and because the discussions regarding the 50% probability weighting “would not have ‘significantly altered’ the ‘total mix’ of information available to shareholders.”  Relatedly, Keurig faced several class actions challenging the same buyout that were consolidated in Delaware, but those were resolved in a “disclosure only” settlement. 


In Nguyen v. MaxPoint Interactive, Inc., et al., Judge Laura Taylor Swain of the Southern District of New York recently dismissed a putative class lawsuit filed against MaxPoint Interactive Inc., an advertising technology company, because the shareholders could not identify any significant information that the company failed to disclose leading up to its IPO in March 2015.  The investors alleged violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 against various MaxPoint and underwriter defendants, noting that MaxPoint’s share price had dropped to about one-third of the IPO offering price.  Specifically, the plaintiffs contended that MaxPoint misrepresented its financial position by failing to disclose its reliance on a small number of customers for most of its revenue and failed to disclose under Item 303 of Regulation S-K the “known trend” that it was recently signing mostly small-budget companies.  Judge Swain rejected these arguments, holding that the shareholders could have deduced from a registration statement that MaxPoint filed with the SEC back in July 2014 that the company was generating nearly half its revenue from only five percent of its customers, and thus the omitted computation was not material.  The court further held that events occurring within a two-month period of time prior to the IPO do not establish a “trend” for purposes of the disclosures required by Item 303. As a result of these holdings, all claims against MaxPoint and the underwriter defendants were denied with prejudice.


The Sixth Circuit recently affirmed the district court’s dismissal of a shareholder class action against EveryWare Global Inc. for an alleged “pump and dump” scheme in IBEW Local No. 58 Annuity Fund v. EveryWare Global Inc.  The investors alleged that EveryWare’s officers, directors, principal shareholders, and underwriters violated the Securities Exchange Act of 1934 by materially misrepresenting the company’s finances, and violated the Securities Act of 1933 by verifying those alleged material misrepresentations to be true, and by failing to disclose other material facts in a registration misstatement and a prospectus.  The district court dismissed the complaint, finding insufficient scienter under the Exchange Act and a lack of material statement or omission under the Securities Act.  In particular, the district court found that there were no allegations in the complaint, from a confidential witness or otherwise, that anyone made any statements to the former CEO or other defendants about the projections or the bases for the projections.  “A plaintiff ‘must identify particular (and material) facts going to the basis for the [defendant’s] opinion—facts about the inquiry the [defendant] did or did not conduct or the knowledge it did or did not have—whose omission make the opinion statement at issue misleading to a reasonable person.’”  The district court further reasoned that, even if the former CEO was aware of another employee’s statements disagreeing with the financial projections, and which were not made to the CEO directly, “this fact would be insufficient to show that he had knowledge that the 2013 projections were false or misleading.” The district court also ruled that the plaintiff failed to allege an actionable false or misleading statement regarding the value of EveryWare stock because the company did not calculate the value from the 2013 projections and it fully disclosed how it calculated that value. The Sixth Circuit affirmed the dismissal under the same rationale.  The panel agreed that the shareholders failed to show that the company’s former CEO had actual knowledge that his statements regarding EveryWare’s financial projections were false. The court further agreed that the shareholders had not plausibly pleaded that the company’s registration statement and prospectus contained material misrepresentations.


In Mansour v. iDreamSky Tech. Ltd., et al., a district court in the Southern District of New York largely denied iDreamSky’s motion to dismiss a consolidated class action alleging that the gaming company misled investors ahead of its $115.5 million IPO in violation of Sections 11, 12 and 15 of the Securities Act, Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5.  Shareholders alleged that the company’s 2014 IPO prospectus and registration statement misled investors by failing to disclose monetization problems arising from delays in the release of its mobile game, Cookie Run, in China.  They also alleged that the company failed to disclose problems with its third-party billing platform.  iDreamSky, however, countered that it did not omit the alleged information, and even if it did, those omissions were not material to the company’s performance at the time of the IPO.  The court sided with the shareholders, however, concluding that the company shirked its “obligation to disclose known risks that had already materialized by the time of the IPO.”  Judge Paul Oetken further found the omission to be material because “[t]he failure to acknowledge the then-known delays in the launch of Cookie Run and to update the 2014 revenue projections accordingly is precisely the type of omission that, even if included in the context of an opinion, would be misleading to a reasonable investor.”  In light of the early stage of the proceedings, the court found that the company’s failure to disclose the problems was sufficient to “support a strong inference of scienter.”  The court did, however, rule that iDreamSky’s ADSs were sold pursuant to an effective registration statement and dismissed the plaintiffs’ claim under Section 12(a)(1) that the securities were unregistered. 


A Delaware Chancery Court in Christian v. Echo Therapeutics, et al. recently deemed investors’ request for attorneys’ fees excessive and awarded only $20,000, instead of the $100,000 requested.  The investors primarily alleged that Echo’s board of directors breached its fiduciary duties by failing to remove a provision of the bylaws that allowed fee shifting—or in other words—required stockholders who filed litigation against the company and lost to pay the company’s legal fees.  Delaware had passed legislation in June 2015 prohibiting fee-shifting in such circumstances.  This court determined that a significantly lower fee award was warranted because this was a “simple case.” Namely, Echo’s error was likely inadvertent, and Echo changed the fee shifting provision the very day the complaint was filed, thereby conferring some benefit on the shareholders.  Upon entry of the reduced fee award, the case was dismissed without prejudice.