Securities Snapshot
September 25, 2018

Second Circuit Affirms Use of Common Law Discovery Rule in Aiding and Abetting Claim

The Second Circuit affirms a grant of summary judgment to defendants based on common law discovery rule; the Northern District of California dismisses securities class action for insufficiently pled price-fixing and price-erosion claims with leave to amend; the Northern District of Texas dismisses securities claims for failure to allege knowledge of a material falsity; the Southern District of New York grants motion to dismiss because intent to control, as opposed to actual control, does not create disclosure obligations; the Department of Justice secures its first FATCA conviction; the District of Maryland dismisses complaint that only alleged statements of corporate optimism and puffery; and the District of New Jersey denies motion to dismiss for failure to plead reliance under the fraud-on-the-market theory.

On September 6, 2018, the Second Circuit affirmed the Northern District of New York’s decision granting summary judgment to the defendants in Ayers v. Piaker & Lyons, P.C. The case arose out of a 2010 SEC action against McGinn, Smith & Co. Inc., an Albany brokerage firm, for allegedly running a Ponzi scheme and violating the federal securities laws. Over the next few years, the SEC proved its case against McGinn Smith, and in August 2013, the founders of the company were sentenced to significant terms of imprisonment and paid millions of dollars in forfeiture and restitution. On September 11, 2014, this civil litigation followed, when a group of investors in McGinn Smith companies filed suit against Piaker & Lyons, Ronald Simons and Timothy Paventi, who served as the McGinn Smith companies’ auditors, alleging aiding and abetting claims in connection with the Ponzi scheme. The only issue on appeal was whether plaintiffs’ claims were time barred on statute of limitations grounds. The statute of limitations for New York—the forum state—and Pennsylvania, Delaware, New Jersey and Florida—the states where the plaintiffs reside—all incorporate some form of the “discovery rule,” which tolls the statute of limitations until the date that plaintiffs knew or should have known that they were defrauded. Plaintiffs argued for the application of a special variation of the discovery rule, where “they should be charged with knowledge sufficient to trigger the statute only when the discoverable facts would enable them to describe defendants’ involvement in a pleading ‘with sufficient detail and particularity to survive a 12(b)(6) motion to dismiss.’”

The Second Circuit disagreed, explaining that this application of the discovery rule, which was articulated in a prior Second Circuit decision, City of Pontiac General Employees’ Retirement System v. MBIA, Inc., should only be applied to actions under Section 10(b) of the federal securities law and not to the aiding and abetting claims here. The court held that, because there was no federal securities law claim, the common-law discovery rule applied in this case and plaintiff’s duty to inquire arose “when the circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded.” Under this standard, the court found that the plaintiffs did not file within the statute of limitations because plaintiffs learned that they were defrauded in 2010, at the time of the SEC action, but did not investigate their claims until 2014. This case clarifies that the higher standard for the discovery rule applies only to federal securities law claims and not to state law claims that may be based on federal securities law violations.


On September 7, 2018, in Fleming v. Impax Laboratories Inc., the Northern District of California granted a motion to dismiss a class action brought against Impax Laboratories Inc. and its senior officials. The plaintiff investors alleged that defendants colluded with their competitors to fix the prices for two generic pharmaceutical drugs, digoxin and pyridostigmine bromide, and then misled investors by attributing the price increases to natural market factors. The court agreed that the defendants’ explanations for the price increases were materially misleading, but found that the plaintiffs did not show (i) that the defendants acted with scienter; or (ii) that there was a corrective disclosure linking the alleged misstatements and the subsequent decrease in Impax’s stock prices. In particular, the court found that the plaintiffs failed to allege how the individual defendants controlled the pricing of the drugs or how their knowledge of the price increases proved that defendants acted intentionally or recklessly as opposed to on a “good faith but mistaken determination.”

The court similarly rejected plaintiffs’ price-erosion claim that “to offset the diminishing returns, [defendants] concealed adverse revenue trends and market share erosion” on another drug, diclofenac. The court held that defendants’ statements concerning diclofenac were not “objectively untrue” and plaintiffs failed to precisely plead which of the defendants made the allegedly false statements. Although the court found both of plaintiffs’ claims to be insufficiently pleaded, it gave plaintiffs leave to amend, finding that “it appears possible that Plaintiff could state its price fixing and price-erosion claims with sufficient specificity.” This case demonstrates that an allegation that defendants must have known or controlled a price-fixing scheme based solely on their positions in the company is insufficient to show scienter, absent specific allegations of intentional or reckless conduct.


On September 11, 2018, the Northern District of Texas dismissed plaintiffs’ third amended class action complaint against Global Power Equipment Group, Inc. and its former officers in Budde v. Global Power Equipment Group Inc. The court had previously dismissed plaintiffs’ second amended complaint for failure to allege scienter and loss causation. In the current motion to dismiss, defendants once again argued that plaintiffs’ complaint failed to plead that Global Power’s allegedly false and misleading financial reports were the result of individual defendants’ knowledge or reckless disregard of accounting errors and deficiencies in internal controls. But while the court found that the plaintiffs’ allegations supported the conclusion that individual defendants knew they were publishing false information—or were at least severely reckless as to their falsity—the court held that the pleadings did not show that the individual defendants knew they were publishing materially false information. The court found that Global Power’s financial reports were false and misleading due to “a number of issues,” with the alleged accounting errors being only one of those issues. All in all, the court found that the alleged accounting errors only caused the financial results to be off by a “couple of million dollars,” which was not material “considering that Global Power reported nearly $500 million in revenue and $400 million in cost.” This dismissal highlights the difference between knowledge of a falsity and knowledge of a material falsity, and emphasizes that only the latter is sufficient to sustain a claim for a securities violation.


In Sachsenberg v. IRSA Inversiones y Representaciones Sociedad Anonima, the Southern District of New York granted defendants’ motion to dismiss plaintiffs’ class action for failure to plead a material misstatement and scienter. According to the complaint, defendant IRSA, an Argentine real estate company, violated U.S. securities law when it acquired an interest in IDB Development Corporation Limited and did not consolidate IDBD in its annual or quarterly financial statements. The court found that the “core of the parties’ dispute” was whether IRSA controlled IDBD such that its failure to disclose that control and consolidate IDBD into its financials was a material misstatement. Drawing all inferences in plaintiffs’ favor, the court found that plaintiffs had not alleged how defendant could have installed its directors on IDBD’s board in the relevant time period, and, thus, failed to allege how IRSA had control over IDBD, such that its failure to consolidate IDBD in its financials was a misstatement or omission. Also, on the issue of scienter, the court found that plaintiffs have shown “[a]t most” that IRSA’s subsidiary purchased a majority of IDBD shares and that defendants hoped to obtain control over IDBD, but failed “to provide any basis for a conclusion that Defendants had a motive to defraud” or engaged in conscious misbehavior or recklessness. This decision is significant because it shows that a majority interest and intent to control an entity without actual control is not enough to create disclosure obligations of that control on financial statements.


On September 11, 2018, Adrian Baron, the former Chief Business Officer and Chief Executive Officer of Loyal Bank Ltd., a foreign bank with offices in Hungary, Saint Vincent and the Grenadines, pleaded guilty to conspiring to defraud the United States by failing to comply with the Foreign Account Tax Compliance Act. According to court records, Mr. Baron and Loyal Bank opened multiple bank accounts for an undercover agent, who posed as a U.S. citizen involved in stock manipulation schemes, without ever requesting or collecting any information required by FATCA. Baron’s guilty plea was entered in U.S. v. Kyriacou, a case before Judge Kiyo A. Matsumoto in the Eastern District of New York. Baron may face up to five years in prison at sentencing. Baron is the first person convicted under FATCA, a federal law that requires foreign financial institutions to report certain information about financial accounts that are held by U.S. taxpayers. The law was enacted in 2010 and designed to prevent U.S. taxpayers from using offshore accounts to commit federal tax offenses. 


In In re Under Armour Securities Litigation, the District of Maryland dismissed a class action alleging various violations of the securities laws. According to plaintiffs, “Defendants concealed their sales and revenue problems during the Class Period, making false claims of explosive growth and strong customer demand while downplaying the ballooning inventory liquidations and gross margin compression.” The court first addressed whether plaintiffs’ Section 11 claims were barred by the statute of limitations. Plaintiffs argued that the Supreme Court modified the standard for inquiry notice under the Securities Act in its decision in Merck & Co. v. Reynolds. In Merck, the Supreme Court held that the limitation period only starts to run “once the plaintiff did discover or a reasonably diligent plaintiff would have ‘discover[ed] the facts constituting the violation.’” While the court agreed that Merck applied to modify the statute of limitations period under Section 11, that court found that the plaintiffs’ claims were not timely because there were earlier disclosures that “were sufficient triggers to allow Securities Act Plaintiff to have investigated, and to reasonably have discovered” the relevant facts supporting their pleading. The court also found that the majority of the alleged misstatements concerning revenue projections and growing interest in the Under Armour brand constituted corporate optimism, or “puffery,” and that plaintiffs did not offer any evidence that the statements were false at the time that they were made. Finally, the court dismissed the remaining alleged misstatements, including statements concerning inventory and Under Armour’s ability to improve its margins, because the plaintiffs failed to adequately plead any evidence of “Defendants’ contemporaneous knowledge that the statement was false when made.” This decision is significant for extending the Supreme Court’s “reasonable diligence” holding in Merck to modify the statute of limitations for the Securities Act. It also emphasizes the importance of offering contemporaneous evidence showing that an alleged misstatement is false or misleading.


On September 14, 2018, the District of New Jersey denied defendant Global Digital Solutions, Inc.’s motions to dismiss a securities class action against the company and its former directors and officers in Hull v. Global Digital Solutions, Inc. The key issue before the court was whether plaintiffs had sufficiently pleaded market efficiency, such that there was a presumption of reliance under the fraud-on-the-market theory. In considering the adequacy of the pleadings, the court looked to the Cammer factors, which the court viewed as “an acceptable basic framework for evaluating whether a plaintiff’s allegations of efficiency are plausible.” The Cammer factors include (1) percentage of weekly trading volume; (2) coverage of a company’s stock in securities analyst reports; (3) the reported number of market-makers; (4) the company’s eligibility to file an S-3 registration statement; and (5) quick responses in stock price caused by unexpected corporate events or financial releases. Plaintiffs argued that at least four of the Cammer factors were satisfied in this case, while defendants argued that plaintiffs’ allegations were “contradictory” and “threadbare.” The court found that it was sufficient at this stage for plaintiffs’ allegations to show that two of the factors—the average weekly trading volume and market reaction—supported a finding of market efficiency. The court held that plaintiffs’ failure to plead facts in support of all the factors did not justify dismissal, and even though the facts alleged by the plaintiffs were not “resoundingly” or “overwhelmingly” in plaintiffs’ favor, the “allegations suffice at this stage to permit Plaintiff to go forward.” This decision highlights the relatively low standard that applies during the pleading stage, where a plaintiff need only plead rather than prove the facts supporting its claim of fraud-on-the-market.