Securities Snapshot
November 21, 2017

Second Circuit Affirms Class Certification in Barclays Securities Fraud Case Relating to Alleged Dark Pool Misstatements

Second Circuit affirms class certification relating to alleged dark pool misstatements; Tenth Circuit declines to rehear D&O coverage case; Massachusetts District Court dismisses shareholder class action for failure to allege knowledge and scienter; Delaware Chancery Court dismisses books and records demand where plaintiff had no proper purpose; parties settle class action regarding diet drug; first class action relating to Initial Coin Offering filed.

In Waggoner, et al. v. Barclays PLC, et al, the Second Circuit recently affirmed the grant of class certification in a suit involving Barclays American depository shares, or ADSs, holding that plaintiffs need not present direct evidence of market efficiency (such as through an event study) in order to certify a class alleging federal securities fraud. The plaintiffs had filed an action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in the U.S. District Court for the Southern District of New York, alleging that Barclays PLC, its American subsidiary, and certain of its officers had falsely stated that Barclays was protecting its clients from aggressive high-frequency trading activity and predatory traders in a private venue, or “dark pool,” known as Liquidity Cross. The plaintiffs alleged that the price of Barclays ADSs fell more than seven percent when the New York Attorney General filed an action alleging that a number of Barclays’ public assertions regarding its dark pool platform violated state law. The district court initially certified a class of buyers of Barclays’ ADSs, ruling that Barclays failed to show that the bank’s stock price was not impacted by the alleged fraud, and Barclays appealed. The Second Circuit first rejected Barclays’ arguments that misstatements and omissions allegedly made by the bank regarding the safety of its dark pools had no “statistically significant” impact on the price of the Barclays’ ADSs, and that its dark pool revenue (purportedly 0.1% of total revenue) was insufficient to materially impact shareholders. The Second Circuit further rejected Barclays’ arguments that the lower court improperly refused to hear the defendants’ evidence of price impact, that it erred by shifting the burden of persuasion to the defendants to rebut the Basic, Inc. v. Levinson presumption of reliance, and that the shareholders failed to show that damages could be calculated on a class-wide basis. The court concluded that the defendants must rebut the presumption afforded by Basic with a preponderance of the evidence once plaintiffs have shown that the market is efficient. The court held that the defendants had not met this burden because, although they contended that the plaintiffs’ event study was flawed, all seven of the other Cammer factors “weighed so clearly in favor of concluding that the market for Barclays’ ADS was efficient” that the defendants did not even challenge them. As a result, securities plaintiffs no longer need to present an event study to prove market efficiency when moving for class certification. Separately, the Second Circuit agreed with Barclays that the lower court judge erred by allowing a class certification based on the investors’ reliance on information omitted by the bank, but it deemed that error harmless. Consequently, the Court found that Barclays failed to meet its burden of countering the investors’ claims that their losses were tied to Barclays’ misrepresentations, and the suit was allowed to proceed as a class action. On November 20, 2017, Barclays asked the Second Circuit to partially rehear its class certification decision.


In MusclePharm Corp. v. Liberty Ins. Underwriters Inc., the Tenth Circuit Court of Appeals recently declined to rehear a case that found the formal announcement of an investigation by the Securities and Exchange Commission into MusclePharm Corp. was insufficient to trigger coverage under the company’s directors’ and officers’ liability insurance policy. In 2013, the SEC had issued a formal order of investigation after the government began investigating whether the company’s CEO, along with other executives, failed to report certain benefits.  MusclePharm spent approximately $3 million in defending against the SEC investigation prior to the issuance of a Wells notice in 2015. Ultimately, MusclePharm settled with the SEC for approximately $1 million, and it subsequently sought insurance coverage for investigation expenses under its D&O policy with Liberty. Liberty denied the claim, and MusclePharm sued. In August 2017, the U.S. District Court for the District of Colorado ruled for Liberty, finding that an investigation became an insured “claim” under the policy only when MusclePharm had received a Wells notice. Because the pre-Wells investigation did not allege a wrongful act by MusclePharm or its executives, the costs incurred by MusclePharm were not covered by Liberty. On appeal, the Tenth Circuit agreed, without explaining its reasoning. In doing so, the Tenth Circuit contributed to a growing circuit split on this issue of whether D&O liability insurance coverage is triggered by the SEC’s announcement of an investigation or by the issuance of a Wells notice. The Second and Eighth Circuits have made rulings that directly contradict the Tenth Circuit’s decision, emphasizing that courts must not “underestimate the seriousness of such a probe.” The Sixth and Eleventh Circuits, conversely, have issued rulings in favor of insurers. 


On November 7, 2017, the U.S. District Court for the District of Massachusetts in In re Psychemedics Corp. Securities Litigation dismissed a putative shareholder class action complaint alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on the grounds that the plaintiff had failed to allege the required knowledge of the allegedly undisclosed information and intent to defraud. The complaint alleged that Psychemedics misled investors by failing to disclose that its independent distributor in Brazil, Psychemedics Brasil, had become secretly entwined in a cartel scheme with a competitor, Omega Brasil, in violation of Brazilian law. A Brazilian court ruled that Omega Brasil’s relationship with Psychemedics violated Brazil’s anti-competition laws, and ordered Psychemedics Brasil to indemnify Omega Brasil’s U.S.-parent company for lost profits. Upon disclosure of the Brazilian court ruling, Psychemedics’ stock price dropped by approximately twenty-five percent. In dismissing the complaint, the court held that the plaintiffs’ allegations of knowledge on the part of Psychemedics were inadequate. As Judge Richard G. Stearns stated, “[t]he critical defect here is that the Complaint is devoid of any factual allegations that would tend to support an inference (much less direct evidence) that Psychemedics knew of the anti-competitive cabal between Psychemedics Brasil and Omega Brasil prior to it coming to light in the Brazilian lawsuit.  Instead, the Complaint simply asks the court to assume knowledge on the part of Psychemedics and to impute a concomitant duty of disclosure to investors.” The court went on to conclude: “It is axiomatic that defendants cannot have committed fraud if they did not know at the time that the failure to provide additional information was misleading.” The court thus dismissed the complaint without leave to amend.


On November 13, 2017, the Delaware Chancery Court in Wilkinson v. A. Schulman, Inc. dismissed a books and records demand against A. Schulman Inc., holding that the shareholder who brought the suit lacked a proper purpose and served only as a rubber-stamp for plaintiff’s law firm. The complaint filed in February 2017 said that the plaintiff was seeking access to A. Schulman’s records to determine if a stock award granted to the former CEO by the board of directors exceeded what the CEO had earned under his performance bonus plan. At a deposition, however, the plaintiff testified that he began the process of seeking access to the books and records because he was unhappy with the company’s losses, and that he was unaware of any wrongdoing in connection with the CEO’s compensation. The plaintiff further testified that his counsel had written both the reasons for his demand and the particular books and records he sought to inspect. After a trial on the paper record, the Chancery Court held that the plaintiff had not shown a proper purpose and was solely a “nominal plaintiff” for his law firm, Levi & Korsinsky. In so doing, Vice Chancellor J. Travis Laster held that “a stockholder seeking an inspection and retaining counsel to carry out the stockholder’s wishes is fundamentally different than having an entrepreneurial law firm initiate the process, draft a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue the inspection and litigate with only minor and non-substantive involvement from the ostensible stockholder principal.” On the record presented in this case, Vice Chancellor Laster held, “the Company proved that [plaintiff’s] purported purposes were not his actual purposes. They were his counsel’s purposes.” As a result, the Chancery Court entered judgment in favor of A. Schulman.


On November 8, 2017, Arena Pharmaceuticals, Inc. agreed to settle a securities class action lawsuit that had been pending for seven years in California federal court in exchange for payment of $24 million in cash and stock. The suit in Schueneman v. Arena Pharm, Inc., et al. began in 2010, when the Food & Drug Administration published documents showing agency concerns about whether Arena’s diet drug lorcaserin caused cancer in humans. On the day following the publication of the documents, Arena’s stock price dropped forty percent. Ultimately, an independent panel determined that Arena had over-reported incidents of tumors in lab rats to the FDA and found that the incidence of rat cancer was likely caused by a hormone issue not found in humans.  The drug was approved for sale in June 2012. The investors’ suit alleged that Arena had wrongfully concealed early findings and FDA concerns and had wrongfully presented lorcaserin as safe and on-track for approval. The suit was twice dismissed by the U.S. District Court for the Northern District of California, but in October 2016 the Ninth Circuit reversed an earlier dismissal, finding that Arena’s discussion of animal studies in its public disclosure documents obligated Arena to tell shareholders about the FDA’s concerns, and that the plaintiffs had adequately pleaded that the company knew it was wrong to withhold the information from investors. With the case revived in the district court and discovery pending, the two sides reached the settlement. In exchange for dropping their claims, the shareholders would receive roughly $12 million in cash and $12 million in common stock. As part of the deal, Arena did not admit wrongdoing or liability.


On October 25, 2017, the first securities class action relating to an Initial Coin Offering, Baker v. Dynamic Ledger Sols., Inc., was filed in California Superior Court. Tezos, a Swiss company formed for the purpose of conducting the ICO, sold over 600 million tokens known as “Tezzies” from July 1 to July 14, 2017. The complaint alleged that in the months leading up to the ICO, Tezos executives, Dynamic Ledger Solutions (the owner of Tezos’ intellectual property), and Brew Strategies (a public relations firm hired to promote the ICO) made numerous misleading statements in relation to Tezos and the sale, including advertising the Tezzies as a security without registering it with the U.S. Securities and Exchange Commission. The plaintiffs seek rescission of the token purchases, a return of all token sale proceeds to Tezzies’ purchasers, a declaration that the defendants’ alleged conduct violates federal securities laws, and a payment of penalties and fines, including punitive damages, attorneys’ fees, and legal costs.