Securities Snapshot
July 6, 2017

Supreme Court Clarifies Bounds of Criminal Forfeiture Statute

Supreme Court limits criminal forfeiture statute to property acquired by the defendant; Supreme Court grants certiorari to resolve circuit split over scope of Dodd-Frank Act whistleblower protections; Second Circuit rejects “extreme departure” test for materiality of omissions under Section 11 in favor of “total mix of information” test; Second Circuit rules that contractual disclaimers do not preclude criminal liability for extra-contractual misrepresentations; Western District of Washington denies motion to dismiss class action suit involving clinical trial disclosures; Central District of California dismisses securities class action, finding disclosures related to proposed regulations sufficient; Southern District of New York grants motion to suppress evidence gathered on the basis of faulty warrants; and SEC settles charges against executives for failure to provide adequate MD&A disclosure. 

In Honeycutt v. United States, the Supreme Court recently held that, under 21 U.S.C. § 853(a)(1), the government may seek forfeiture of only such property that the defendant actually acquired as a result of the crime at issue. In this case, defendant Terry Honeycutt was convicted of conspiracy to distribute iodine used for the production of methamphetamine. The defendant’s brother, Tony Honeycutt, owned and operated a hardware store which sold Polar Pure, an iodine-based water purification product frequently used in the production of methamphetamine. Terry was a manager at Tony’s store. Despite warnings from police, the store sold large quantities of Polar Pure over a three-year period, grossing almost half a million dollars. The government sought forfeiture from Terry of nearly $70,000 in profits from the sale of Polar Pure, even though Terry had no ownership interest in the hardware store and did not personally benefit from the Polar Pure sales. In an opinion by Justice Sonia Sotomayor, the unanimous Court (except Justice Neil Gorsuch, who did not participate) rejected the government’s argument that co-conspirators can be held jointly and severally liable under Section 853(a)(1), concluding that “Section 853(a)’s limitation of forfeiture to tainted prop­erty acquired or used by the defendant, together with the plain text of §853(a)(1),” limit forfeiture to property that the defendant acquires himself and does not extend to property of a co-conspirator in which the defendant holds no interest. The Court’s decision in Honeycutt is already impacting pending cases. For instance, on June 15, the former CEO of ArthroCare Corporation, Michael Baker, filed a motion to dismiss wire fraud charges under 18 U.S.C. § 1343 based on the Supreme Court’s interpretation of the phrase “obtained, directly, or indirectly, as a result of” in Honeycutt. Although the Honeycutt decision involves the forfeiture statute, Baker argues that the Court’s interpretation of Section 853(a)(1) should apply equally to Section 1343, limiting wire fraud liability to only those who personally acquire property from a victim, in that case investors who were defrauded by an alleged scheme of creating fake sales to inflate the company’s revenue.            

Supreme Court Grants Certiorari in DIGITAL REALTY TRUST

On June 26, 2017, the Supreme Court granted certiorari in Digital Realty Trust Inc. v. Somers, teeing up for decision the question of whether the Dodd-Frank Act prohibits retaliation against company whistleblowers who make internal disclosures as opposed to disclosing directly to the SEC. The issue has been the subject of a circuit split in recent years. In 2013, the Fifth Circuit held in Asadi v. GE Energy USA LLC that the statute’s whistleblower protections extend only to those who report to the SEC. Two years later, in Berman v. Neo@Ogilvy, the Second Circuit ruled that courts must defer to SEC guidance to interpret the provision, which in effect interpret the provisions to extend protections to all those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC. In March 2017, the Ninth Circuit, in Somers v. Digital Realty Trust Inc., expressly acknowledged the existence of the inter-circuit disagreement  but followed the Second Circuit and concluded that the SEC’s regulation “is consistent with Congress’s overall purpose to protect those who report violations internally as well as those who report to the government” and “correctly reflects congressional intent to provide protection for those who make internal disclosures as well as those who make disclosures to the SEC.” In seeking Supreme Court review, Digital Realty Trust relied heavily on the existence of the circuit split as grounds upon which the Court should take up the case. The U.S. Chamber of Commerce filed an amicus brief in support of the petition, arguing that the Ninth Circuit’s interpretation of the Dodd-Frank Act “would greatly expand the number of employees authorized to pursue the enhanced remedies of the Act, and the period of time in which they may sue for alleged retaliation, without yielding the law enforcement benefits Congress intended when it enacted a ‘bounty’ and heightened protections for persons who complain to the Securities and Exchange Commission.” In taking up the case, the Supreme Court will not only have the opportunity to address the split between the circuits on the issue, but it may also have the opportunity to take up the “Chevron deference” issue. Under this doctrine, which refers to the U.S. Supreme Court’s 1984 decision in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., courts defer to agency interpretations of statutory mandates unless the interpretations are unreasonable. 

Second Circuit Rejects First Circuit’s “extreme departure” test FOR MATERIALITY OF OMISSIONS UNDER SECTION 11

In Stadnick v. Vivint Solar, Inc., the Second Circuit recently affirmed dismissal of a securities class action claim alleging violations of Section 11 of the Securities Act of 1933. In reaching its decision, the Second Circuit held that the materiality of an omission is not determined by asking whether the omitted information constitutes an “extreme departure from the range of results which could be anticipated,” as set forth by the First Circuit in Shaw v. Digital Equipment Corp., but rather by asking whether the reasonable investor would view the omission as “significantly alter[ing] the ‘total mix’ of information made available” as set forth in the Second Circuit’s own decision DeMaria v. Anderson. The claim in Vivint arose out of the IPO of the residential solar panel installer Vivint Solar. Before its 2014 IPO, Vivint disclosed financial results for the six quarters preceding the third-quarter of  2014, but did not disclose results for the third-quarter, which ended the day before the IPO. The disclosed results revealed “ever increasing overall net loses” because Vivint was installing many solar systems and had not yet begun to realize the bulk of the revenue from selling electricity. Several weeks after the IPO, Vivint issued a press release announcing its third-quarter results, which disclosed significant declines in net income. The plaintiffs sued, claiming that Vivint’s failure to disclose its third-quarter earnings before the IPO was a material omission, and that Vivint’s registration statement violated Section 11. The district court granted Vivint’s motion to dismiss, finding that the plaintiffs failed to plead a material misrepresentation. On appeal, the Second Circuit rejected the defendants’ heavy reliance on the First Circuit’s decision in Shaw, observing that the “extreme departure” test “leaves too many open questions” and can be “analytically counterproductive.” Instead, the Second Circuit applied its “total mix” of information test set forth in DeMaria to determine whether Vivint’s failure to disclose its third quarter financial performance, representing significant losses to shareholders, constituted a material omission. Applying the “total mix” test, the court nevertheless affirmed the dismissal of the complaint, concluding that plaintiff had focused on a single metric when alleging materiality of the omission, ignoring other relevant considerations, and that Vivint’s nondisclosure of the third-quarter earnings was not actionable because the fluctuations were in line with its disclosed business practices.

Second Circuit Affirms Conviction Based on Extra-ContractUAL Representations

On June 21, the Second Circuit affirmed Edward Weaver’s conviction for conspiring to commit mail and wire fraud relating to his role as CEO of the vending machine company, Vendstar. During his time with Vendstar, Weaver oversaw a scam of soliciting investors by misrepresenting that investment in a Vendstar vending machine was a lucrative business opportunity involving little risk. Weaver argued that these misstatements were not material, and therefore could not form the basis for his conviction, because investors were required to sign a contract that explicitly disclaimed reliance on extra-contractual representations. The Second Circuit rejected this argument, holding that “contractual disclaimers of reliance on prior misrepresentations do not render those misrepresentations immaterial under the criminal mail and wire fraud statutes.” While such disclaimers may in some circumstances defeat a civil claim for damages based on fraud, the Second Circuit held, they do not bear on the defendant’s criminal liability. Importantly, the court noted, because the mail and wire fraud statutes  do not require the fraud to be successful in order for the defendant to be criminally liable, the contractual disclaimers (although relevant to the jury’s determination of Weaver’s guilt) did not render extra-contractual misrepresentations immaterial as a matter of law. 

Western District of Washington Denies Motion to Dismiss Securities Class Action Against Juno Therapeutics

In a recent decision, the U.S. District Court for the Western District of Washington denied defendants’ motion to dismiss in In re Juno Therapeutics, Inc., finding that plaintiffs had adequately pleaded material misstatements and scienter. The plaintiffs, asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, alleged that Juno had misrepresented key information about the safety and efficacy of its immunotherapy drug, JCAR015, which at the time was in a Phase II clinical trial for the treatment of acute lymphoblastic leukemia. In particular, the plaintiffs alleged that three patients in the Phase II trial (out of approximately 20 patients enrolled) had died due to severe neurotoxicity of JCAR015, and that Juno failed to disclose to investors the significant risk of neurotoxicity leading to death associated with JCAR015, claiming instead that it was the addition of fludarabine in combination with JCAR015 that resulted in the patient deaths. Serving as a reminder to defendants that the PSLRA’s heightened pleading standard is not an absolute shield, the Court held that plaintiffs had provided enough factual basis to show the misleading nature of the statements at issue to withstand a motion to dismiss, emphasizing that plaintiffs are not required to prove their case at this stage of litigation. Specifically, Judge Ricardo Martinez held that the court could not conclude, as a matter of law, that Juno had no duty to disclose the patient deaths at issue, or that its non-disclosure did not render Juno’s other statements materially misleading. The court also held that plaintiffs’ allegations of suspicious stock sales in the class period, a motive to win the race to the market, and the “theory that infers that facts critical to a business’s ‘core operations’ … are known to a company’s key officers” were sufficient to plead scienter at the motion to dismiss stage.

Central District of California dismisses exchange act claims against Yirendai Ltd.

On June 20, 2017, in Lefter v. Yirendai Ltd., the U.S. District Court for the Central District of California dismissed a securities class action suit brought by shareholders of Yirendai Ltd., a Cayman Islands corporation headquartered in Beijing that operates a peer-to-peer lending platform that connects borrowers and lenders outside the regular banking system in China. In 2015, the Chinese government had publicly disclosed draft regulations governing peer-to-peer lending that, if implemented, would significantly limit Yirendai’s business. Although Yirendai disclosed the draft measures and their potential impact on its business in its public filings, plaintiffs asserted that these disclosures failed to offer sufficient warning of the detrimental effects of the draft regulations and therefore violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The court disagreed, holding that Yirendai had “alerted investors to forthcoming changes in the regulatory market,” “specifically pointed investors to the publicly-available Draft Measures,” warned “that any finalized measures could impose a limitation on offline business activities,” and cautioned “that … [its] business and results of operations may be adversely and materially affected.” In so ruling, Judge Michael Fitzgerald stated that “Yirendai’s disclosures never created the impression that the [draft regulations] did not put its business model at risk; they simply did not explain the risk in the manner or level of detail that [plaintiffs] would have preferred.” The court dismissed the complaint without prejudice but warned plaintiffs that if the dismissed complaint represented their “best attempt” it expected to be notified in order to enter judgment in favor of the defendants.  

Southern District of New York Grants Motion to Suppress Evidence Seized Based on Faulty Warrant

In a recent decision, the U.S. District Court for the Southern District of New York in U.S. v. Wey granted the defendant’s motion to suppress evidence seized during government searches of his residence and the offices of his consulting firm. Defendant Benjamin Wey is charged with fraud and money laundering, and failure to disclose beneficial ownership of publicly traded companies, based on government allegations that he set up an elaborate scheme to surreptitiously obtain ownership of large blocks of stock in a number of public companies, manipulated stock prices to sell his shares at artificially inflated rates, and laundered the proceeds from these sales. In 2012, the FBI obtained search warrants for Wey’s residence and business authorizing the government to search for a dozen broad categories of documents, limited in scope only by their connection to a list of more than two hundred people and entities allegedly involved in the scheme. Further, the warrants did not specify the crimes under investigation or connect the evidence sought to any alleged crimes. And in executing the warrants, the government exceeded the broad scope by seizing irrelevant documents including recreational sports schedules and Wey’s son’s PSAT scores. Accordingly, the court granted Wey’s motion to suppress, finding that the warrants were both overbroad and lacked particularity. The court also found that the “all-records” exception to the particularity and overbroad requirements did not apply because the warrant applications failed to show that the entire business was permeated by the alleged fraud. Moreover, the court concluded that the Fourth Amendment’s good faith exception did not apply because the warrants were so facially deficient that it was objectively unreasonable to rely on them.   


On June 15, executives of UTi Worldwide Inc. settled SEC charges that they had violated their duty under the securities laws and rules to provide adequate disclosures under the Management Discussion and Analysis section of UTi’s Form 10-Q for the third quarter of 2013.  In 2013, following the rollout of UTi’s proprietary freight forwarding operating system, 1View, the company began experiencing liquidity issues. Shortly after the rollout, the company discovered that certain software glitches in 1View were causing invoicing delays leading to reduced liquidity. Although UTi disclosed its cash flow problems in its third-quarter 10-Q, it failed to explain the specific cause of these problems, namely, that 1View had failed to timely issue invoices, in the MD&A section of the 10-Q. In its cease-and-desist order, the SEC emphasized that the MD&A section is intended to provide investors with “an opportunity to look at the company through the eyes of management by providing both a short- and long-term analysis of the business of the company,” and that Regulation S-K Item 303, in particular, requires registrants to disclose “any known trends or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.” The SEC stated that UTi’s disclosures regarding the company’s liquidity and capital resources in its third-quarter 10-Q did not disclose any of the specific known 1View billing problems and were inadequate under the standards of Item 303 of Regulation S-K. Accordingly, as certifiers of the 2013 third quarter 10-Q, each UTi executive was ordered to pay a civil money penalty of $40,000.