Securities Snapshot
December 19, 2017

Second Circuit Reinstates Securities Class Action Over Alibaba IPO

Second Circuit reinstates Alibaba IPO class action; Sixth Circuit reverses dismissal of Community Health Systems class action; Northern District of California grants partial summary judgment to plaintiffs in Volkswagen class action on issues of falsity and scienter; Florida federal court finds work product protection waived by oral downloads to SEC; Delaware Supreme Court increases risks for boards in making discretionary compensation awards; New Hampshire Superior Court dismisses 1933 Act class action for lack of personal jurisdiction; and New York state appeals court throws out two breach of contract suits based on California statute of limitations.

On December 5, 2017, the Second Circuit reinstated a putative securities class action against Alibaba Group Holding Ltd. and several executives in Christine Asia Co. Ltd., et al. v. Ma, et al., after finding that the district court improperly dismissed a complaint tied to the company’s $25 billion initial public offering. The plaintiffs sued Alibaba and certain of its officers and directors for fraud, alleging that the defendants disregarded reports that the e-commerce giant was secretly threatened by Chinese regulators with enormous fines just before the offering, and asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. After the district court dismissed the complaint for failure adequately to plead material misstatements or scienter, the plaintiffs appealed. The Second Circuit found that the district court had inappropriately discredited significant allegations on which the plaintiffs’ claims relied, failing to treat the complaint in the light most favorable to the plaintiffs, and to draw reasonable inferences in the plaintiffs’ favor, as required with respect to a motion to dismiss under Rule 12(b)(6). Specifically, the Second Circuit said that it was inappropriate for the district court to have discredited the complaint’s allegations that a secret meeting took place between China’s powerful commerce regulator and Alibaba, at which the regulator allegedly threatened to levy huge daily fines unless Alibaba ceased to host a marketplace for the sale of counterfeit goods on its website. The complaint asserted that the allegedly concealed information was highly material to investors because the threat required Alibaba to choose between giving up an important source of its revenue or risking substantial fines, where either outcome would have had significant negative impact on Alibaba’s revenues and on the success of its IPO. The Second Circuit agreed with the plaintiffs that the allegedly omitted facts were material and that the defendants had a duty to disclose those facts, in a manner that accurately conveyed the seriousness of the problems Alibaba faced, so as not to render the defendants’ public disclosures inaccurate, incomplete, or misleading. Having reinstated the case, the Second Circuit remanded the case for further proceedings consistent with its opinion.


On December 13, 2017, the Sixth Circuit in Norfolk County Retirement System, et al. v. Community Health Systems, Inc., et al. reversed the district court’s dismissal of an $891 million shareholder class action against Community Health Systems, Inc. The plaintiffs, asserting claims under Section 10(b) of the Securities Exchange Act of 1934, alleged that the company lied to cover up a Medicare fraud scheme, and that a disclosure suggesting that the company’s profits depended largely on Medicare fraud caused the company’s share price to fall. Specifically, when Community Health Systems sought to acquire another hospital company, Tenet Healthcare Corporation, Tenet filed suit alleging that Community’s hospitals were engaged in a scheme to defraud Medicare. The district court dismissed the complaint for failure adequately to plead loss causation, finding the plaintiffs’ causation theory to be implausible because the disclosure came in the form of a complaint, which it said the market would have regarded as comprising mere allegations rather than truth. On appeal, the Sixth Circuit reversed, stating that “whatever the merits of that proposal as a general rule, the . . . complaint at least plausibly present[ed] an exception to it.” The Sixth Circuit also noted that the plaintiffs alleged that the market “received similar disclosures from another source: namely Community itself, whose senior executives—after trying for several months to lull the market with still more misrepresentations—eventually corroborated much” of what was alleged in the Tenet complaint. Following the disclosures by senior executives, the Sixth Circuit said, the company’s shares fell again. Based on those allegations, the Sixth Circuit found that the plaintiffs had plausibly alleged that the value of the company’s shares fell because of a series of revelations about practices that the company had previously concealed and remanded the case for further proceedings consistent with its opinion.


On December 6, 2017, the District Court for the Northern District of California in In re Volkswagen “Clean Diesel” Marketing, Sales Practices, and Products Liability Litigation granted in part and denied in part the plaintiffs’ motion for partial summary judgment. The litigation followed Volkswagen’s guilty plea earlier this year as a result of the company’s “clean diesel” emissions scheme. The plaintiffs, asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, contended that Volkswagen’s admissions in its plea agreement established, as a matter of law, that the company made 37 false statements, either in investor reports, press releases, or on engine compliance labels, with knowledge that the statements were false. The court considered whether collateral estoppel applied, such that partial summary judgment on the issues of falsity and scienter was appropriate in a securities fraud suit against the company. In considering whether collateral estoppel applied, Judge Charles R. Breyer found that the issue turned on whether the issues on which the prior convictions were offered—the falsity and scienter of each of the 37 challenged statements—were “of necessity . . . decided” in the prior criminal proceedings. The court found that the 31 challenged statements made in Volkswagen’s investor reports were not referenced in Volkswagen’s plea agreement and that collateral estoppel on the issue of falsity was inappropriate as to those statements. The court similarly found that none of the five press-release statements were referenced in Volkswagen’s plea agreement, and that the differences between the challenged statements and Volkswagen’s admissions made collateral estoppel inappropriate on the issue of falsity. The court also did not find that the plea agreement established scienter for the aforementioned 36 statements. However, the court found that Volkswagen did admit in its plea agreement that it affixed a label to the engine of each of the subject vehicles, which stated that the vehicles “complied with applicable EPA and CARB emissions regulations and limitations,” and that Volkswagen admitted that this statement was false because the subject vehicles “did not meet U.S. emissions standards.” Judge Breyer found that this admission “directly determined” the falsity of the compliance statement, and that Volkswagen made the statement knowing that it was false (thereby satisfying Section 10(b) and Rule 10b-5’s scienter requirement). The court therefore found that collateral estoppel applied as to the statement on the engine compliance labels and that partial summary judgment as to the issue of scienter with respect to that statement was appropriate.


On December 5, 2017, a Florida magistrate judge in SEC v. Mathias Francisco Sandoval Herrera, et al. found that a law firm had waived work product protection for witness interview notes and memoranda its attorneys disclosed to the U.S. Securities and Exchange Commission in so-called “oral downloads.” The issue arose after the law firm conducted an internal investigation into General Cable Corp. in 2012 and 2013, which included interviewing dozens of the company’s personnel and then preparing notes and memoranda about those interviews. When the SEC launched its own investigation into the company, it asked the law firm for its findings, and the law firm orally conveyed to the SEC “at least twelve” interview memoranda from its internal investigation. In 2017, the SEC brought suit against two former General Cable executives, accusing them of concealing $46.7 million in accounting errors.  The former executives asked the court to order the law firm to produce the interview memoranda that it had read or orally summarized to the SEC. The law firm claimed work product privilege, but Magistrate Judge Jonathan Goodman rejected this argument and ordered the firm to turn over the materials, finding that there “[was] little or no substantive distinction for waiver purposes between the actual physical delivery of the work product notes and memoranda and reading or orally summarizing the same written material’s meaningful substance to one’s legal adversary.” In a December 12, 2017 motion, the law firm asks the magistrate judge to clarify or reconsider the ruling.  Specifically, the law firm argues that the notes of the October 29, 2013 meeting at which it provided the oral downloads were actually the “the best evidence of what was orally described to the SEC” and asks that the court require it to produce only those and the portion of an interview memorandum that it read to the SEC. Magistrate Judge Goodman has yet to rule on that motion to clarify or reconsider.


On December 13, 2017, the Delaware Supreme Court issued a decision in In re Investors Bancorp, Inc. Stockholder Litigation, holding that director compensation awards made pursuant to an equity compensation plan that permits directors discretion in making such awards will not be reviewed under the business judgment rule, which treats them as presumptively valid. Rather, such discretionary awards will be subject to review under the entire fairness standard, which places the burden of proof on the directors to show that the awards were entirely fair to the corporation. Under Delaware law, corporate directors are authorized to set their own compensation. Absent stockholder approval, if such director compensation decisions are challenged, they are subject to entire fairness review as self-interested decisions. Under the entire fairness standard, the directors bear the burden of showing that the awards were entirely fair to the corporation. In contrast, if director compensation awards are approved by a majority of the disinterested shareholders in a fully informed vote, the awards will be reviewed using a deferential business judgment standard of review. In Investors Bancorp, the plaintiffs alleged that the company’s directors breached their fiduciary duties by awarding themselves equity compensation that, although consistent with the terms of the Investors Bancorp shareholder-approved equity compensation plan, was supposedly excessive in dollar amount. The Delaware Court of Chancery dismissed the plaintiffs’ claims, concluding that the challenged awards were subject to business judgment rule review because the prior stockholder approval of the equity compensation plan effectively constituted stockholder approval of the board’s discretionary grant decisions consistent with the plan’s terms. The Delaware Supreme Court reversed, holding that the challenged awards were not subject to business judgment rule review, even though there was no dispute that the awards did not exceed the range within which the Board was authorized to grant compensation to directors and otherwise complied with the terms of the stockholder-approved plan. The Supreme Court explained that “[w]hen the directors submit their specific compensation decisions for approval by fully informed, uncoerced, and disinterested stockholders, ratification is properly asserted as a defense in support of a motion to dismiss. The same applies for self-executing plans, meaning plans that make awards over time based on fixed criteria, with the specific amounts and terms approved by the stockholders. But, when stockholders have approved an equity incentive plan that gives the directors discretion to grant themselves awards within general parameters, and a stockholder properly alleges that the directors inequitably exercised that discretion, then the ratification defense is unavailable to dismiss the suit, and the directors will be required to prove the fairness of the awards to the corporation.” Finding that the Investors Bancorp equity compensation plan conferred discretion on directors in awarding themselves compensation and that the plaintiffs had sufficiently alleged that the directors exercised that discretion inequitably, the Supreme Court concluded that the directors were required to prove the entire fairness of the challenged awards to Investors Bancorp. Turning to the plaintiffs’ allegations comparing the size of the challenged awards with other director compensation awards both at Investors Bancorp and at other corporations, the Supreme Court concluded that “[t]he plaintiffs have alleged facts leading to a pleading stage reasonable inference that the directors breached their fiduciary duties in making unfair and excessive discretionary awards.”

Investors Bancorp represents a significant development in Delaware director compensation law that increases the potential exposure of corporate directors. Such risk can be minimized where the equity compensation plan contains a non-discretionary formula regarding how much compensation directors may be awarded or otherwise specifically dictates how much directors may receive, thereby taking away any discretion from the board, and that plan is then approved by a majority of disinterested stockholders in a fully informed vote (presumably in connection with an annual stockholder meeting). Alternatively, companies can choose to have specific director awards ratified after the fact by a fully informed disinterested stockholder vote. One thing seems certain – the Delaware Supreme Court’s decision is likely to lead to increased stockholder derivative litigation challenging director compensation awards as excessive.


On December 4, 2017, the New Hampshire Superior Court dismissed a class action lawsuit filed against NovoCure Limited, certain of its officers and directors, and the underwriters of its October 2015 initial public offering. The complaint in Donahue, et al., v NovoCure Limited, et al., alleged that the defendants violated Sections 11 and 15 of the Sections Act of 1933 by issuing materially false or misleading offering materials. The plaintiffs alleged (among other things) that NovoCure’s IPO offering materials failed to comply with Item 303 of SEC Reg. S-K by supposedly not disclosing significant adverse trends and uncertainties that the plaintiffs claimed would impede market acceptance of NovoCure’s product, which attacks solid brain cancers using electromagnetic energy. The defendants moved to dismiss the complaint, arguing that the plaintiffs had not alleged sufficient contacts with New Hampshire to permit the New Hampshire court to exercise personal jurisdiction. The plaintiffs did not dispute the absence of sufficient contacts with New Hampshire, but they invoked the 1933 Act’s nationwide service of process provision to argue that the exercise of personal jurisdiction could be based on the defendants’ nationwide contacts with the United States as a whole. Judge David Anderson agreed with the defendants that the court lacked personal jurisdiction, rejecting the plaintiffs’ “nationwide” contacts argument as meritless and concluding that the nationwide service of process provision applies only when 1933 Act claims are filed in federal court. The decision is significant in light of the recent uptick of securities class actions filed in state courts, and it affirms an important limitation on the 1933 Act’s nationwide service of process provision that has received scant judicial attention. Goodwin represents the underwriting syndicate in the NovoCure class action.


A New York state appeals court recently threw out two suits brought by Deutsche Bank National Trust Co. against Barclays PLC and HSBC Bank USA NA, in Deutsche Bank National Trust Co. v. Barclays Bank PLC and Deutsche Bank National Trust Co. v. HSBC Bank USA, NA. In each action, Deutsche Bank National Trust asserted a cause of action for breach of contract based on the defendant’s alleged breaches of the representations and warranties in connection with the sale, in 2007, of residential mortgage-backed securities. Although the defendants conceded that the claims against them would be timely under New York’s six-year statute of limitations, each defendant moved to dismiss the action against it, arguing that, because Deutsche Bank’s principal place of business was in California, the New York “borrowing statute” applied, and Deutsche Bank’s contractual claim was barred by California’s four-year statute of limitations. The New York Supreme Court denied the motions to dismiss the claims as untimely, and the defendants appealed. The Appellate Division reversed, stating that the New York borrowing statute, CPLR 202, requires that an action brought by a nonresident plaintiff, “based upon a cause of action accruing without the state,” be timely under the respective statutes of limitations of both New York and the place without the state where the cause of action accrued. The Appellate Division went on to conclude that the breach of contract claims accrued in California, and that they were brought too late under California’s statute of limitations and were therefore untimely under the New York borrowing statute.