Securities Snapshot
August 28, 2018

The Ninth Circuit Clarifies Its Views on Proper Use of Judicial Notice and the Incorporation by Reference Doctrine

The Ninth Circuit clarifies its views on proper use of judicial notice and the incorporation by reference doctrine; the Second Circuit holds that a foreign national with no U.S. ties cannot be liable as a co-conspirator or accomplice under the FCPA; the District of New Jersey dismisses a security class action for failure to articulate clear theories of liability; the Southern District of New York grants class certification to investors for a second time in CDO case; and the SEC warns against “old-school” investor fraud schemes utilizing digital currency.


On August 13, 2018, the Ninth Circuit Court of Appeals reversed, in part, the lower court’s dismissal of a securities fraud complaint in Khoja v. Orexigen Therapeutics, Inc., citing improper use of judicial notice and the incorporation-by-reference doctrine. Karim Khoja, an Orexigen investor, filed a three-count complaint in the Southern District of California, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5. The plaintiff alleged that Orexigen and several of its executives made false or misleading statements regarding the Light Study, which was the Company’s clinical trial for its obesity drug, Contrave. When moving for dismissal, the defendants requested that the court consider 22 documents–including FDA filings, press releases, and the transcript of an investor conference call–that were not attached to the complaint. The lower court granted the defendants’ request and judicially noticed or incorporated by reference 21 of the 22 documents. On appeal from the dismissal of the complaint, the Ninth Circuit noted a “concerning pattern in securities cases,” where procedures such as judicial notice and the incorporation-by-reference doctrine are exploited “to defeat what would otherwise constitute adequately stated claims at the pleading stage.” In analyzing three documents that had been judicially noticed, the court found that only a patent application could qualify, because the procedure should be limited to an “adjudicative fact if it is ‘not subject to reasonable dispute.” In examining the challenged documents that had been incorporated by reference, the Ninth Circuit stated that a defendant may incorporate a document into a complaint “if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff’s claim.” In applying this standard, the court held that certain documents – including a press release that was not referenced in the complaint and a blog post that was quoted in a footnote in the complaint–were improperly incorporated because they were referred to only in passing (if at all) and did not form the basis of the plaintiff’s claim. In light of these findings, the Ninth Circuit reversed the district court’s dismissal of certain of the alleged misstatements and allowed the plaintiff an opportunity to file an amended complaint. Where such issues are often considered in a footnote, the Orexigen court’s extensive treatment of judicial notice and the incorporation by reference doctrine offers rare insights by a Court of Appeals into the permissible scope of such practices and the court’s reluctance in this case to rely upon materials outside the four corners of the complaint at the critical motion to dismiss stage.


On August 24, 2018, in a rare appellate decision interpreting the U.S. Foreign Corrupt Practices Act (the FCPA), a three-judge panel for the U.S. Court of Appeals for the Second Circuit issued a long-awaited decision in U.S. v Hoskins, which rejected the Department of Justice’s attempt to use aiding and abetting and conspiracy theories to prosecute a foreign national for FCPA violations, where the alleged crimes occurred outside of the United States, and where the defendant did not have sufficient ties to the United States. The court also provided a synopsis of the four categories of “persons” covered by the FCPA, noting that “[t]he single obvious omission is jurisdiction over a foreign national who acts outside the United States, but not on behalf of an American person or company as an officer, director, employee, agent, or stockholder.” Notably, this holding is directly contrary to past guidance that the DOJ and U.S. Securities and Exchange Commission have issued with regard to the reach of the FCPA. It was not a complete win for the defense, however, as the Second Circuit confirmed that the government could prosecute the Defendant as an agent of a U.S. subsidiary, because that is a category of persons expressly covered by the FCPA. For a more detailed discussion of Hoskins, please see Goodwin’s client alert about the case.


On August 21, 2018, U.S. District Judge Kevin McNulty dismissed a class action complaint in the United District Court for the District of New Jersey alleging securities fraud in In re Galena Biopharma, Inc. Securities Litigation. Galena shareholders alleged that the company, as well as several executives, violated Item 303 of SEC Regulation S-K and Section 20(a) of the Exchange Act by failing to disclose that a significant portion of the Company’s revenue from Abstral, it’s pain drug, were derived from an illegal off-label prescription scheme. While there is no private right of action under Item 303, the court found that an Item 303 omission “can give rise to a Rule 10b-5 claim if the Item 303 omission renders other statements materially misleading.” In the instant case, because the complaint did not allege that the defendants’ Item 303 omissions rendered other disclosures such as the earnings and revenue statements misleading, the court held that the complaint failed to state a claim under Rule 10b-5. Although the court further held that the plaintiffs failed to clearly identify and explain why each alleged misstatement was false and/or misleading, the court gave plaintiffs 30 days amend their complaint.


On August 14, 2018, U.S. District Judge Paul A. Crotty of the Southern District of New York granted class certification for a second time to the plaintiffs in In re Goldman Sachs Group, Inc. Securities Litigation. In 2015, the court had previously granted certification to the class of plaintiffs alleging violations of Sections 20(a) of the Exchange Act and Section 10(b) of the Exchange Act and Rule 10(b)-5. The plaintiffs alleged that Goldman Sachs and certain of its executives made material misstatements in connection with the sale of the ABACUS, Hudson and other collateralized debt obligations (CDOs). On appeal of the 2015 ruling, the Second Circuit agreed that the plaintiffs had satisfied the requirements of Rule 23(a), but vacated the class certification order and remanded the case, encouraging the district court to hold an evidentiary hearing to determine “whether Defendants ha[d] rebutted the Basic presumption [of reliance] by a preponderance of the evidence.” On remand, the district court held that the defendants could rebut the Basic presumption by “‘demonstrat[ing] that the misrepresentation did not in fact affect the stock’s price.’” The plaintiffs argued that the alleged misstatements impacted Goldman’s stock price, citing the stock price declines that followed three corrective disclosures announcing both Goldman’s client conflicts and enforcement actions filed against the bank. In response, the defendants argued that the plaintiffs could not establish that the alleged misstatements caused any stock price movement, noting that prior to the three corrective disclosures, 36 reports were published that commented on Goldman’s client conflicts, with no resultant movement on the stock price. Defendants argued, therefore, that the stock price decline was due entirely to the news of the enforcement actions that were also announced in the corrective disclosures. The court held that the absence of price movement on the 36 dates cited by defendants was insufficient to rebut the Basic presumption, and that the corrective disclosures cited by plaintiffs included new information beyond the 36 reports, detailing the extent of Goldman’s client conflicts for the first time. Because the corrective disclosures included a level of detail not previously reported, the court found that defendants failed to establish that the corrective disclosures regarding the conflicts did not contribute to the stock price decline. The decision in this case is another example of how difficult it has been for securities defendants to show absence of price impact in the years since the Supreme Court decided Halliburton Co. v. Erica P. John Fund, Inc. in 2014.


The Securities and Exchange Commission, on August 14, 2018, permanently barred David T. Laurence, founder of Tomahawk Exploration LLC, from acting as an officer or director of a public company and from participating in any offering of penny stock after concluding that he had participated in conducting a fraudulent initial coin offering (ICO). From July through September 2017, Laurence and Tomahawk, an oil and gas company, sold digital assets called Tomahawkcoins through an online ICO. The company was attempting to raise $5 million to purportedly fund oil drilling in Kern County, California. The company advertised, on its website and in a white paper, that the Tomahawkcoins could be traded in for profits and, at a later date, could be converted into Tomahawk equity. The company also published its oil production projections, stating on its website that Tomahawk expected to “‘to have 50 well locations averaging 100,000 [barrels].’” The SEC found that the materials promoting the ICO were materially false and misleading, as they contained false statements about Tomahawk’s prospects for success, falsely suggested that Tomahawk had a lease or property right to drill in Kern County, and did not disclose Laurence’s prior conviction for defrauding investors in penny stock companies. These statements, the SEC held, violated Sections 5(a) and 5(c) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-5. In the press release announcing the sanctions imposed on Laurence and Tomahawk, which included a $30,000 civil penalty, the SEC warned that “‘[i]nvestors should be alert to the risk of old-school frauds, like oil and gas schemes, masquerading as innovative blockchain-based ICOs.