Securities Snapshot
March 28, 2017

Massachusetts Supreme Judicial Court Clarifies the Requirements for Shareholder Inspection Demands

Massachusetts high court provides first-ever guidance on scope of the Massachusetts shareholder inspection statute; Ninth Circuit weighs in on circuit split, holds that Dodd-Frank anti-retaliation protections extend to internal whistleblowers; Eastern District of Pennsylvania rejects novel defense to misappropriation claim; Central District of California grants motion to certify a class where named plaintiffs profited overall on investment; Delaware Superior Court finds common law claims against Verizon are covered "Securities Claims" under E&O liability policy; and federal district courts rule on sufficiency of pleadings of alleged misrepresentations and scienter. 

In Chitwood v. Vertex Pharmaceuticals, Inc., the Massachusetts Supreme Judicial Court provided important guidance on the scope of the Massachusetts shareholder inspection statute, Mass. G.L. 156D § 16.02, as well as a shareholder’s burden when making such a demand, in the SJC’s first decision concerning the statute’s requirements. The shareholder plaintiff demanded inspection of corporate books and records, claiming that they were needed to investigate alleged fiduciary breaches by the Vertex board with respect to the company’s financial reporting and certain insider stock sales. Plaintiff’s inspection demand sought seven categories of records, including the records of a special committee of independent directors that had investigated plaintiff’s previous demand to commence derivative litigation based on the same alleged misconduct. Vertex rejected the demand because the Vertex board, following the special committee’s investigation, had rejected plaintiff’s earlier derivative demand, and because plaintiff’s inspection demand exceeded the scope of the inspection statute.  Plaintiff filed suit to compel inspection, and after a bench trial the trial court dismissed the complaint with prejudice, concluding that plaintiff had failed to meet his burden of showing a “proper purpose” under the inspection statute. The SJC reversed, holding that the proper purpose standard is satisfied where the shareholder seeks to investigate board action with respect to allegations of insider trading after an allegedly inaccurate public announcement. (A companion shareholder class action brought against Vertex under the federal securities laws based on the same allegations was dismissed with prejudice, a ruling that was affirmed in IBEW v. Vertex Pharm., Inc., 838 F.3d 76 (1st Cir. 2016).) The SJC distinguished this from the standard applied to books and records requests under Delaware law, 8 Del. C. § 220, noting that the scope of corporate records that potentially may be inspected under Delaware law is far greater, because the Delaware statute—in contrast to the Massachusetts statute—does not specify the scope of records available for inspection, leaving that to the discretion of the trial judge.  According to the SJC, the vast majority of records sought by Plaintiff—including the records and report of the special committee—were not available for inspection.  Chitwood thus provides greater clarity to Massachusetts corporations and shareholders moving forward: while there may be a low threshold to demonstrate a “proper purpose,” the scope of any shareholder inspection will be strictly limited to the “excerpts” of board meeting minutes specified in the statute. Goodwin served as counsel to Vertex in the case. The client alert is available here.  


In Somers v. Digital Realty Trust Inc., the Ninth Circuit weighed in on a circuit split over whether the anti-retaliation protections of the Dodd-Frank Act extend to whistleblowers who report internally rather than to the SEC. The Ninth Circuit, siding with the Second Circuit, found that the anti-retaliation provisions of the Act do extend to whistleblowers who report suspected violations only internally. On the other side of the circuit split, the Fifth Circuit held in 2013 that Dodd-Frank’s whistleblower provisions apply only to employees making disclosures directly to the SEC. Somers arose when a former Vice President at Digital Realty Trust Inc. was fired after making several reports to senior management about possible securities law violations by the company. The plaintiff-appellee’s firing took place before he was able to report his concerns to the SEC. He later sued DRT for violations of state and federal law, including under the Securities Whistleblower Incentives and Protection section of Dodd-Frank. DRT moved to dismiss the claims, arguing that the plaintiff-appellee was not a “whistleblower” as defined in by the statute and therefore not entitled to its protections. The district court disagreed, and on appeal, the Ninth Circuit affirmed the district court’s decision, holding that extending Dodd-Frank’s anti-retaliation provisions to those who report violations only internally was consistent with the overall purpose of the statute. The Ninth Circuit acknowledged that the term “whistleblower” in the statute was limited to those who report “to the Commission,” but noted that the SEC, by regulation, had interpreted the provision to extend protections to all those who make disclosures of suspected violations, whether internally or to the SEC. In aligning itself with the Second Circuit, the Ninth Circuit concluded that the “regulation accurately reflects congressional intent that [the Act] protect employees whether they blow the whistle internally, as in many instances, or they report directly to the SEC.”


In Altayyar v. Etsy Inc., et al., Judge Ann M. Donnelly of the Eastern District of New York dismissed with prejudice a proposed securities class action against Etsy, Inc. following the company’s IPO. The shareholders brought claims pursuant to Sections 11 and 12(a)(2) of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, alleging that Etsy and its executives made false or misleading statements concerning, among other things, the company’s values, performance metrics, and counter-infringement policies and practices in the IPO prospectus and later public statements, which they alleged inadequately disclosed risks regarding counterfeit goods that led to a stock plunge after the IPO. The plaintiffs also alleged that the defendants made false or misleading statements to correct a drop in the company’s stock price after two investment banks issued reports reflecting doubt on the company’s outlook. Judge Donnelly dismissed the amended complaint in its entirety, finding that plaintiffs failed to plead sufficiently circumstantial evidence of scienter or motive for the Exchange Act claims, and failed to sufficiently plead that defendants made material misstatements or omissions under the more liberal pleading standards of Rule 8 for the Securities Act claims. In so ruling, the court stated: “The plaintiffs’ allegations might show that Etsy’s compliance practices were imperfect—perhaps even awful—and that its managers knew of ongoing infringement problems. The plaintiffs do not, however, establish that the challenged values statements were objectively false or disbelieved when Etsy made them.” The court went on to note that “the challenged statements must be interpreted in the context of the Prospectus as a whole...In context, the challenged statements are not misleading, and it is only by ignoring the Prospectus’s clear limiting language that the plaintiffs can say that they are.” 


A Pennsylvania district court recently denied a motion to dismiss insider trading claims against legendary investor Leon G. Cooperman and his investment advisory firm, Omega Advisors, Inc., in SEC v. Cooperman, et al. The SEC alleged that the defendants violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 by trading on nonpublic information from a pipeline company executive. The defendants moved to dismiss the insider trading claim for failure to state a claim pursuant to Rules 12(b)(6) and 9(b). In denying the defendants’ motion as to the insider trading claims, Judge Sánchez noted that the case presented a “novel issue” as to whether the misappropriation theory of insider trading may be premised on a post-disclosure agreement. Specifically, the SEC alleged that Cooperman, as an outsider, had a duty of trust and confidence toward a pipeline company executive, the source of the confidential information (who was also referred to as “APL Executive 1” in the complaint) as a result of an explicit agreement “that [Cooperman] could not and would not use the confidential information APL Executive 1 told him to trade APL securities.” The agreement may or may not have preceded disclosure of the information from APL Executive 1, but preceded at least some of the defendants’ trades in APL securities using the information. The defendants argued that the insider trading claim should be dismissed because the SEC failed to plead with particularity when, exactly, Cooperman agreed not to use the confidential information provided by APL Executive 1. Judge Sánchez disagreed with the defendants’ argument, based on the language of Section 10(b) and Rule 10b-5, the applicable case law construing those regulations, and congressional intent, finding that “[a] plain reading of the regulation indicates a duty created by an agreement may arise at any time,” that “case law applying the misappropriation theory does not require an agreement not to trade to precede the disclosure of confidential information,” and that “the misappropriation theory may encompass post-disclosure agreements comports with the congressional intent for securities laws to target exactly the type of deception in which Cooperman engaged, deception that is detrimental to the rightful owner of the information, investors, and the public.” Based on these findings, Judge Sánchez held the SEC’s insider trading allegations were sufficiently pleaded. 


The Central District of California recently granted a motion to certify a class in Basile v. Valeant Pharmaceutical Int’l, Inc., et al., in which Plaintiffs assert claims against Valeant Pharmaceuticals International, Inc. and Pershing Square Capital Management, LP for violations of Section 14(e), 20A(a), and 20(a) of the Securities Exchange Act of 1934 arising out of Pershing’s trades on the basis of nonpublic material information. Plaintiffs allege that Valeant informed Pershing that Valeant was going to attempt to acquire Allergan, Inc. Pershing agreed to buy a 10% stake in Allergan and to use that stake to support Valeant’s takeover efforts, and the parties entered into an agreement reflecting the foregoing on February 25, 2014. Pershing then bought nearly 10% of Allergan’s shares. On April 22, 2014, Valeant announced its intent to acquire Allergan, and Allergan’s stock price skyrocketed by $20/share. Valeant offered to purchase Allergan’s share for $200/share, but lost out to another company’s even higher tender offer price of $219/share. Plaintiffs moved to certify a class of all persons who sold Allergan stock contemporaneously with purchases of such stock made or caused by Defendants between February 25, 2014 (the date of the Valeant/Pershing agreement) and April 21, 2014 (the day that Valeant announced its intent to acquire Allergan). Defendants opposed class certification on the basis of lack of typicality, arguing that the proposed class representatives were subject to unique defenses because, although they sold some of their Allergan shares during the proposed class period, they held even more shares, and their gains exceeded their losses. The Court disagreed, reasoning that whether the class representatives held other shares that increased in value, “is irrelevant to whether Plaintiffs were harmed by Defendants’ withholding of information.” The court stated that it was “satisfied that the fact that [the proposed class representatives] may have made money as a result of the merger does not subject them to a unique defense in relation to their insider trading claims such that they are rendered atypical.”


The Delaware Superior Court recently found in favor of Verizon Communications Inc. in its contract dispute with its insurance company over the meaning of a “Securities Claim” in Verizon Communications Inc. v. Illinois National Insurance Co. The case stemmed from Verizon’s spin-off of its print and electronic directories business into a stand-alone company, Idearc, Inc. in exchange for (among other consideration) promissory notes in November 2006. In anticipation of the spin-off, Verizon and Idearc purchased primary and excess insurance to insure against litigation risks arising from the spin-off. The policies required the insurers to provide 100% coverage for any loss, including defense costs, in connection with a “Securities Claim.” The term “Securities Claim” was defined in the policies as a claim “alleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities….” Following the spin-off, Idearc defaulted on the notes, and a number of lawsuits were filed against Verizon and others, including claims for breach of fiduciary duty, promoter liability, and fraudulent transfer. Verizon spent years defending itself in this litigation, and incurred substantial fees. The insurers refused to pay Verizon’s defense costs, arguing that the claims asserted were not “Securities Claims” because they were not claims arising under federal securities laws or state blue sky laws. The court disagreed, concluding that the language of the policy did not exclude common law claims, and that this finding was consistent with the fact that other policies, including an earlier form of the policies in question, expressly provided coverage only for violations of specifically identified federal securities laws.


In Knox v. Yingli Green Energy Holding Co., Ltd., plaintiff-investors asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against solar power company Yingli Green Energy Holding Company Limited. The plaintiffs alleged that Yingli made misleading statements concerning: (a) a Chinese government subsidy program that funded Yingli’s customers and Yingli itself; and (b) the timing of Yingli’s allegedly delayed decisions to make allowances for “doubtful accounts” from which the company could not assure collection. The court granted in part and denied in part defendants’ motion to dismiss the amended complaint. With respect to Yingli’s optimistic statements concerning the subsidy program, the court held that some but not all of such statements were non-actionable puffery. In particular, the court declined to dismiss claims based on Yingli’s statements that it was well-positioned and had potential for growth due to the subsidy program. The court reasoned that these statements may have created a false impression of the current state of affairs, given plaintiffs’ allegations that the company understood the subsidy program might come to a screeching halt due to rampant fraud within the program. However, the court dismissed claims based on the allegation that the company should have disclosed the risk that China would claw back subsidies from developers that failed to complete their solar projects on time, concluding that plaintiffs failed to allege facts showing any likelihood that the company’s customers would not timely complete their projects. The court also concluded that plaintiffs had pleaded material omissions based on the company’s failure to disclose the risk that the Chinese government would shut down the subsidy program and the company’s delay in recognizing the Chaori receivable as a doubtful account, but found that the complaint did not plead scienter with respect to these alleged misstatements.