Securities Snapshot
June 7, 2017

Supreme Court Rules SEC Disgorgement is a “Penalty” Subject to 5-Year Limitations Period

United States Supreme Court rules that SEC disgorgement is a “penalty” subject to a 5-year limitations period; Ninth Circuit extends American Pipe tolling to permit serial class actions; J.P. Morgan alleged tippees must stand trial in California district court despite alleged tipper’s acquittal; Massachusetts district court dismisses securities class action against Imprivata; SEC stays securities proceedings before its own ALJs pending resolution of “appointments clause” issue; SEC settles insider trading claims against hedge fund founder in exchange for compliance oversight and fine; Second Circuit affirms the subordination of employee RSU claims; New Jersey court dismisses securities class action against Eagle Pharmaceuticals; and New York federal judge denies preliminary approval of proposed class action settlement, questioning whether the practice is appropriate.

On June 5, 2017, the United States Supreme Court resolved a circuit split in Kokesh v. SEC, ruling unanimously that SEC disgorgement operates as a penalty subject to the applicable statute of limitations for the alleged misconduct. In 2009, the SEC commenced an enforcement action alleging that investment advisor Charles Kokesh violated several securities laws by misappropriating money from four companies from 1995 through 2009 and filing false and misleading SEC reports and proxy statements to conceal the misappropriations. A jury found that Kokesh violated securities laws in connection with his conduct within the five-year limitations period. The district court subsequently ordered Kokesh to pay a $34.9 million disgorgement for the money he obtained illegally during the entire time period—even for conduct outside of the statute of limitations. Kokesh appealed the district court’s order, but the Tenth Circuit affirmed the lower court’s ruling, holding that the five-year statute of limitations for “an action suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture” under 28 U.S.C. § 2462 did not apply because disgorgement was not a penalty nor a forfeiture. The Tenth Circuit’s ruling was consistent with those in the First Circuit and D.C. Circuit, but it split from the Eleventh Circuit, which held that disgorgement is akin to forfeiture and thus subject to the five-year limitations period. The Supreme Court decided to address this circuit split when it granted certiorari to hear Kokesh’s appeal in January 2017. The Court’s recent decision, written by Justice Sonia Sotomayor, resolves the circuit split and makes clear that “[d]isgorgement in the securities-enforcement context is a ‘penalty’ within the meaning of §2462” because it “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.” The Court rejected the SEC’s argument that disgorgement is remedial not punitive, determining that “disgorgement does not simply restore the status quo; it leaves the defendant worse off,” including, for example, when courts disgorge benefits accrued to third parties or disregard defendants’ expenses that reduce their illegal profits. In light of the Supreme Court’s ruling, SEC disgorgement is now limited to ill-gotten gains received during the preceding 5-year limitations period. Goodwin's recent alert regarding the Kokesh decision is available here.


The Ninth Circuit recently revived a shareholder class action filed by investor Michael Resh against China Agritech, Inc. and its managers and directors in Resh v. China Agritech, Inc., et al., holding that the claims were timely under American Pipe & Construction Co. v. Utah because they were tolled by two previous would-be class actions against many of the same defendants, where Resh was an unnamed member, and where class certification was denied. Plaintiff Resh alleged in June 2014 that the fertilizer manufacturer violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by overstating its revenue numbers, leading to artificially inflated stock prices. The district court dismissed the claims as time-barred by the applicable two-year statute of limitations, determining that the previous would-be class actions tolled Resh’s individual claims but not those of potential class members in the new would-be class action. Judge R. Gary Klausner reasoned that a contrary ruling “would allow tolling to extend indefinitely as class action plaintiffs repeatedly attempt to demonstrate suitability for class certification on the basis of different expert testimony and/or other evidence.” The plaintiffs appealed the lower court’s ruling and argued that their claims should be tolled pursuant to American Pipe because the filing of a putative class action tolls the statute of limitations for all members of a proposed class who make timely motions to intervene after class certification is denied. Defendants countered that extending American Pipe tolling to new class actions would allow potential class members to reargue the question of class certification by filing new but repetitive complaints. The court sided with the plaintiffs, stating that “unnamed class members in previously uncertified classes” should be able “to avail themselves of American Pipe tolling.” The panel reasoned that this decision does not create “unfair surprise” to defendants because the prior class action provided notice to defendants of the claims against them and the potential plaintiffs. It also promotes “economy of litigation” by avoiding repetitive class actions because potential plaintiffs “have little to gain from repeatedly filing new suits” similar to ones where class certification has already been denied, and principles of preclusion and comity, rather than tolling, will address the threat of serial would-be class actions. In so ruling, the Ninth Circuit has extended American Pipe to the tolling of “an entirely new class action based upon a substantially identical class.” Only time will tell whether this expansion will lead to an increase in the filing of serial class actions.


A California district court judge has denied Shahriyar Bolandian and Kevin Sadigh’s motions to dismiss their criminal charges in U.S. v. Aggarwal, et al. despite the acquittal and subsequent dismissal of all charges against their former co-defendant, the alleged tipper in the alleged insider trading scheme, Ashish Aggarwal. Federal prosecutors charged all three defendants with one count of conspiracy to commit securities and tender offer fraud, thirteen counts of securities fraud, thirteen counts of tender offer fraud, and three counts of wire fraud, in addition to one count of money laundering for Bolandian. The government alleged that Bolandian received a tip from his college friend and J.P. Morgan investment banking analyst, Mr. Aggarwal, and that Bolandian later disclosed the information to his other friend, Sadigh. In October 2016, the court granted Mr. Aggarwal’s motion to sever his trial from Bolandian and Sadigh. In January 2017, the jury acquitted Mr. Aggarwal of 26 counts but deadlocked on four counts related to two trades executed before a company acquisition was announced. Mr. Aggarwal’s counsel, Grant Fondo and Derek Cohen of Goodwin Procter, filed a motion to dismiss the remaining four counts, arguing that collateral estoppel precluded retrial of the four counts because they related to issues that were “necessarily decided” by the jury’s acquittal in the prior trial. Mr. Cohen convinced Judge Terry Hatter Jr. that the remaining four counts were barred, and Judge Hatter dismissed the remaining charges. In light of Mr. Aggarwal’s win, Bolandian and Sadigh sought to use his acquittal and argued that Mr. Aggarwal’s acquittal collaterally estopped and should preclude the charges against them, but Judge Hatter rejected this argument, holding that non-mutual collateral estoppel does not apply to the acquittal of a co-defendant where the co-defendant was tried separately. In the alternative, Bolandian and Sadigh argued that their charges should be dismissed because “[i]n insider trading, everything flows from the insider,” and thus, Aggarwal’s acquittal should “flow[] derivatively down to Mr. Sadigh and Mr. Bolandian.” Prosecutors argued that Bolandian and Sadigh fought for severance from Mr. Aggarwal in order to exclude evidence that Mr. Aggarwal had told a friend he accidentally disclosed the insider information, and that they should not now be able to have it both ways by admitting evidence that Mr. Aggarwal was acquitted. Judge Hatter agreed with the prosecutors, denying Bolandian and Sadigh’s motions to dismiss their charges and suggesting that the co-defendants efforts to sever their case from Mr. Aggarwal’s may have backfired. The charges against Bolandian and Sadigh are set for trial this upcoming August.


A Massachusetts federal court recently granted defendants’ motions to dismiss a putative class action filed against Imprivata, Inc., its former CEO and CFO, three of its outside directors, and three funds with ownership interests in Imprivata. In Hensley v. Imprivata, Inc., et. al., the plaintiff alleged that Imprivata’s revenue forecast for the quarter ended September 2015, which was issued two months earlier in July 2015, was false and misleading. More specifically, the plaintiff alleged–based on statements attributed to five unnamed former employees–that the defendants knew, and should have disclosed earlier, that (i) demand for Imprivata’s solutions had fallen off; (ii) the integration of a newly merged company was not going well; and (iii) due to regulatory changes in the healthcare industry, the upcoming quarter was an unlikely time for Imprivata’s customers to purchase the company’s solutions. In addition, the plaintiff alleged that the individual and fund defendants engaged in unusual insider trading when they allegedly profited from sales of Imprivata stock during the class period. Judge Leo T. Sorokin dismissed the case in full and with prejudice, holding that the alleged misrepresentations were not actionable because, among other reasons, Imprivata’s revenue forecasts fell squarely into the Private Securities Litigation Reform Act’s safe harbor provision, which immunizes forward-looking statements from liability when they are accompanied by meaningful cautionary language. In addition, the court held that there was no strong inference of scienter because after issuing its third quarter guidance, the company continued to warn investors of risks, and the fact that the company pre-released its third quarter 2015 results undermined any inference that defendants acted with intent to defraud. As to the allegations attributed to former employees, the court held these were “unduly threadbare and/or subjective” and could not survive the “hard look” necessary for scrutinizing confidential witness allegations in the First Circuit. It found significant that none of the former employees were alleged to have been involved in the revenue guidance process. In addition, the court rejected the insider trading allegations, holding that (i) nowhere did the plaintiff plead that the CEO’s or CFO’s class period trading was in any way unusual when compared to their trades outside the class period; and (ii) alleged trading by the fund defendants could not on its own support a strong inference of scienter given the “dearth of other compelling evidence of scienter.”


On May 22, 2017, the Securities and Exchange Commission reacted to the Tenth Circuit’s denial of rehearing en banc of Bandimere v. SEC by issuing a stay halting all administrative proceedings before its in-house administrative law judges that pertain to violations of certain securities laws and that would be appealable to the Tenth Circuit. The SEC explained that the stay will remain in effect until its time to appeal the Bandimere decision has expired or until it issues a contrary order. In Bandimere, the Tenth Circuit held that the SEC’s five administrative law judges (ALJs) were unconstitutionally appointed to their jobs in violation of the Appointments Clause because the SEC’s ALJs exercise “significant discretion” when presiding over enforcement hearings, and thus are “inferior officers” that must be appointed to office by the president, heads of departments or other courts. In March, the Tenth Circuit denied the SEC’s petition seeking rehearing or rehearing en banc of the December opinion. The Tenth Circuit’s ruling created a circuit split with the D.C. Circuit, which has since been resolved as the D.C. Circuit later vacated its opinion in Lucia v. SEC, which previously held that SEC ALJs are employees rather than inferior officers subject to the Appointments Clause, and agreed to rehear the issue en banc. The Tenth Circuit’s ruling and the SEC’s subsequent stay represent a significant win for defense lawyers who have decried the SEC’s growing use of administrative proceedings rather than federal litigation, where defendants are afforded the safeguards of the Federal Rules of Civil Procedure. In contrast, Judge Monroe McKay warned in his dissenting opinion that this decision may have broader sweeping consequences than intended by the majority, effectively placing “all federal ALJs [] at risk of being declared inferior officers,” including ALJs overseeing Social Security Administration benefits or ALJs of the Consumer Financial Protection Bureau.


The SEC recently agreed to settle insider trading claims against hedge fund investor, Leon Cooperman, in SEC v. Leon G. Cooperman and Omega Advisors, Inc., for a fine and oversight of the hedge fund by an independent compliance consultant, but Cooperman notably escaped suspension and time out of the industry. In September 2016, the SEC alleged that Cooperman, the founder of hedge fund Omega Advisors Inc., violated insider trading laws and the SEC’s beneficial ownership rules by using his role as a major shareholder of Atlas Pipeline Partners to gain information about the company’s impending asset sale from a company executive and later trading on that information before the $682 million sale was announced. Cooperman filed a motion to dismiss, but the Pennsylvania federal judge denied his motion in March 2017, holding that the misappropriation theory of insider trading could be satisfied even though Cooperman only agreed to refrain from trading on the tip after he received the information. Although Judge Juan R. Sanchez acknowledged that liability under the misappropriation theory based on a post-disclosure agreement was “novel,” he decided that proof of a duty of trust at the time of trading is sufficient because the “central concern of insider trading under the misappropriation theory is the deception that occurs at the time the outsider uses material nonpublic information to trade in securities.” Cooperman subsequently filed an interlocutory appeal in April. Prior to any ruling on his appeal, Cooperman and the SEC agreed to settle the case for a $4.9 million fine, but no suspension and no industry bar, in exchange for Cooperman agreeing to retain an independent compliance consultant to review his trades, conduct firm trainings, and report back to the SEC for the next five years. Defense attorneys will likely utilize this settlement going forward to try to persuade the SEC to forego suspension and industry bars in exchange for oversight by compliance consultants. It remains to be seen whether the Cooperman settlement reflects a shift in SEC policy in favor of using compliance consultants or simply its desire to avoid litigating the post-disclosure misappropriation issue before the Third Circuit.


The Second Circuit has affirmed a ruling in In re Lehman Brothers Holdings Inc. that the bankruptcy claims of Lehman Brother’s employees holding restricted stock units must be subordinated to creditors pursuant to Section 510(b) because they arise from the purchase or sale of securities. When Lehman Brothers Holdings Inc. filed for bankruptcy in 2008, thousands of its employees who held unvested restricted stock units (RSUs)—a form of equity-based compensation in the company—did not receive common stock, rendering their RSUs worthless. The plaintiff employees filed proof of claims in bankruptcy court in the S.D.N.Y. seeking to recover the value of their RSUs. The bankruptcy court denied their request, holding that their claims must be subordinated to those of general creditors pursuant to the absolute priority rule cemented in 11 U.S.C. § 510(b) because the employees’ claims arise from the purchase or sale of securities. The district court affirmed the bankruptcy court’s ruling, and the employees appealed to the Second Circuit. The Second Circuit similarly subordinated the employees’ claims pursuant to Section 510 because: (1) the RSUs are securities; (2) the employees acquired them in a purchase; and (3) the damages arise from the purchase or rescission of the RSUs. The court reasoned that the RSUs are securities under subsection 101(49)(xiv) because the employees had limited voting rights, the dividends were in the form of additional RSUs, and the employees shared the same risk and reward as shareholders. These RSUs, or securities, were received through a “purchase or sale,” the court determined, because Lehman Brothers awarded the RSUs to employees as compensation for their labor. Finally, the court held that the employees’ claims arose from the purchase of a security because it is well-settled that this clause is to be interpreted broadly and all that is required is that “the transaction is part of the causal link leading to the alleged injury.” Accordingly, the Second Circuit treated the employee RSUs under the absolute priority rule that shareholder claims must be subordinated to those of creditors in bankruptcy.


On May 19, 2017, a New Jersey district court in Bauer v. Eagle Pharmaceuticals, Inc. and Scott Tarriff dismissed shareholder class action claims that Eagle Pharmaceuticals and its CEO Scott Tarriff violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and SEC Rule 10b-5 The plaintiffs alleged in their amended complaint that Eagle Pharmaceuticals made a “series of materially misleading statements and omissions concerning [their] failed attempt to secure FDA approval of its ready-to-use liquid Bivalirudin product,” which Eagle submitted a 505(b)(2) New Drug Application for. In particular, the plaintiffs alleged that defendants misrepresented that the product was a “ready to use” liquid version of Angiomax”—an already approved drug—and they “assured investors that the Company was engaged in an ongoing, positive dialogue with the FDA” and gave the impression to investors that approval of the product was “highly likely.” When the FDA denied the NDA, the price of Eagle shares predictably dropped, and the investors sued the company. In moving to dismiss, the defendants arguing that the complaint failed to sufficiently plead a material misrepresentation or omission, that the statements were protected by the safe harbor for forward-looking statements, and that the statements were mere puffery that is not actionable. The court agreed that the complaint had “not sufficiently pled particularized facts demonstrating how any representations regarding the composition of the Product were false.” Similarly, with respect to the statements regarding the likelihood of FDA approval, the court held that these were forward-looking statements accompanied by cautionary language, and thus were protected by the safe harbor. Relatedly, the court held that the plaintiffs did not sufficiently plead that defendants had “actual knowledge” of the falsity of the statements so as to bar application of the safe harbor provision. Further, the court held that any remaining statements were mere “puffery,” not actionable misstatements.


A New York federal court recently refused to preliminarily approve a proposed monetary settlement to a class action against CHC Group Ltd. in Rudman et al. v. CHC Group Ltd., et al. because absent class members could conclude that the court already made up its mind before they had the opportunity to object to the settlement, therefore making any future settlement objections futile. In May 2015, the plaintiffs filed a putative class action against the commercial helicopter company, some of its officers and directors, and the underwriters of the company’s June 2014 initial public offering, alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. In November 2016, while the parties were finalizing a settlement agreement, the court granted the defendants’ motion to dismiss the complaint as time-barred. In light of the court’s order, the parties re-entered settlement negotiations while the plaintiffs’ appeal of the order was pending, and the parties reached a settlement agreement. The plaintiffs filed an unopposed motion for preliminary approval of the class action settlement pursuant to Federal Rule of Civil Procedure 23. Preliminary approval is designed to allow the court to make an initial determination as to the fairness, reasonableness, and adequacy of the proposed settlement so that notice of the proposed settlement may be sent to the class and a hearing may be set to determine the fairness of it. The plaintiffs argued that preliminary approval of the proposed settlement was warranted because “informed, arm’s-length negotiations” occurred and that the settlement is “within the range of what might be found fair, reasonable, and adequate.” Judge Lewis A. Kaplan denied the plaintiffs’ request for preliminary approval, however, and instead instructed the parties to amend the settlement agreement and class notices such that that they no longer require preliminary approval. Judge Kaplan stated that he has a practice of not granting preliminary approval of proposed class action settlements because “such characterizations, made before full consideration of a proposed settlement, risk conclusions on the part of absent class members that the deck is stacked against them even before they have had an opportunity to object and be heard.” In so doing, Judge Kaplan questioned whether it is appropriate for a judge to preliminarily approve any class action settlement.