Securities Snapshot
October 9, 2018

Second Circuit Reverses Dismissal Of Derivative Suit For Lack Of Standing Where Plaintiff No Longer Has Financial Stake

Second Circuit reverses dismissal of derivative suit for lack of standing where plaintiff no longer has financial stake; District of Massachusetts dismisses with prejudice securities class action against Foundation Medicine Inc. for failure to plead scienter; Brazilian state-controlled oil and gas company Petrobas settles Department of Justice international investigation into bribery scheme; DOJ official speaks on FCPA Corporate Enforcement Policy and its broadened application to corporate resolutions; Federal district court reaffirms that all virtual currency is a commodity subject to CFTC regulation; SEC announces $11.5 million settlement with regional center for noncompliance with EB-5 foreign investment program requirements; Investment advisor settles cybersecurity claim with SEC relating to data theft of 5,600 customers; Delaware Chancery Court approves $19.5 million settlement for Saba Software stockholders relating to 2015 merger; Massachusetts’ highest court rejects imputing actions of low-level employees to plaintiff company in in parti delicto cases.

On October 2, 2018, in Terry Klein and Qlik Technologies, Inc. v. Cadian Capital Management, LP, et al, the Second Circuit revived a derivative lawsuit previously dismissed on standing grounds. After Plaintiff originally filed her lawsuit against Cadian Capital Management, the company was acquired by Qlik Technologies, Inc. in an all-cash merger while the litigation was stayed. Defendants then moved to dismiss for lack of standing, arguing that Plaintiff had lost her financial interest in the litigation following the merger. When Plaintiff then moved to substitute Qlik as the plaintiff under Fed. R. Civ. P. 17(a)(3), the United States District Court for the Southern District of New York denied the motion, finding that plaintiff’s lack of standing had deprived it of jurisdiction over the lawsuit and Qlik could not be substituted because it had not made an “honest mistake” in failing to join the action earlier. The Second Circuit reversed, holding that once the plaintiff lost her personal stake in the action, the only jurisdictional question was whether the case had become moot, and the court maintained jurisdiction to determine whether a substitute plaintiff would avoid the question of mootness. The court held that Rule 17 allows substitution of the real party in interest, so long as the substitution does not change the substance of the action or reflect bad faith from the plaintiff or unfairness to the defendants. This decision emphasizes that companies may not seek to avoid class action litigation through corporate transactions that would eliminate a would-be plaintiff’s financial interest in the underlying litigation.


On September 20, 2018, the United States District Court for the District of Massachusetts, in Marc F. Mahoney et al v. Foundation Medicine, Inc. et al, dismissed with prejudice a class action complaint against Foundation Medicine, Inc., as well as the company’s officers and directors. Foundation develops, manufactures and sells diagnostic tests that identify genomic mutations associated with cancer. The complaint alleged a fraudulent scheme to artificially inflate the price of Foundation common stock between 2014 – 2015 through a series of purported misstatements and omissions. Plaintiff alleged that Foundation officers and directors made material misstatements and omissions about the company’s performance in press releases, public filings, and earnings calls, including positive and encouraging statements about (i) the result of Foundation’s clinical tests; (ii) the company’s competitive advantage and growth prospects; and (iii) anticipated Medicare coverage and reimbursement. Plaintiff also alleged omissions regarding the extent of competitive pressures that negatively affected test volumes and the lack of clinical utility of the tests. Following oral argument, the Court dismissed the complaint with prejudice, holding that Plaintiff had failed to allege the required “strong inference” of scienter as to any of its claims. This decision was particularly significant because the court dismissed the complaint with prejudice, finding that Plaintiff had had substantial time to revise his allegations, had previously already amended his Complaint, and failed to assert or support that he could cure the scienter deficiencies. Goodwin represented Foundation in this matter.


On September 26, 2018, the United States Department of Justice and Brazilian state-owned-and-controlled oil and gas company Petrobas entered into a non-prosecution agreement resolving a four-year long Foreign Corrupt Practices Act investigation by the DOJ and Brazilian authorities into a multibillion-dollar bribery scheme involving former Petrobas company executives. The settlement requires Petrobas to pay $853.2 million in criminal penalties. In related proceedings, Petrobras reached a settlement with the U.S. Securities and Exchange Commission, as well as an agreement to reach a settlement with Brazilian authorities. Under the non-prosecution agreement, the DOJ will credit the amount that Petrobras pays to the SEC and Brazil under their respective agreements, with the DOJ and the SEC receiving 10 percent ($85,320,000) each and Brazil receiving the remaining 80 percent ($682,560,000). In connection with the resolution, Petrobras admitted that former high-level executives of the company facilitated the payment of hundreds of millions of dollars in bribes to Brazilian politicians and political parties. Several of the former executives have been convicted in Brazil of charges related to the bribery scheme. In announcing the resolution, the DOJ stressed that the decision to agree to a non-prosecution agreement with the company was based on the factors presented by this case, including that Petrobras is a Brazilian-owned company and was entering into a resolution with authorities there. In addition, while Petrobras did not voluntarily disclose the misconduct, the company fully cooperated with the investigation and fully remediated the misconduct. The DOJ announced that Petrobras’s cooperation included conducting a thorough internal investigation, proactively sharing facts discovered during the internal investigation in real time and sharing information that would not have been otherwise available to the DOJ, by making regular factual presentations to the government, facilitating interviews of foreign witnesses, and voluntarily gathering and organizing extensive evidence and information for the DOJ in response to its requests. The remedial measures taken by Petrobras included replacing several key executives, implementing governance reforms and disciplining certain employees involved in the misconduct. In the related SEC matter, Petrobras also agreed to pay to the SEC disgorgement and prejudgment interest totaling $933,473,797, and the SEC and Petrobras agreed that this amount will be reduced by the amount of any payment Petrobras makes to a class action settlement fund established in a securities class action against the company pending the Southern District of New York.

The DOJ conducted the investigation in collaboration with Brazilian law enforcement, and the case demonstrates the DOJ’s continued efforts to prosecute misconduct by foreign companies that affects the U.S. financial markets. In addition, the resolution is an example of the DOJ’s recent policy announcements regarding corporate enforcement – including crediting companies that fully cooperate with the DOJ and engage in remedial conduct under the DOJ’s FCPA Corporate Enforcement Policy, and considering resolutions with foreign law enforcement and other regulatory agencies to avoid “piling on” penalties – in practice.


On September 27, 2018, Deputy Assistant Attorney General Matthew S. Miner of the DOJ’s Criminal Division spoke at the 5th Annual GIR Event in New York City regarding recent corporate resolutions, including Petrobas, under the FCPA Corporate Enforcement Policy. During his speech, Miner stressed that companies should view the DOJ as a “partner” and not an “adversary” and revealed the department’s continued commitment to, and widening application of, the Policy to cases that do not involve FCPA violations. The DOJ announced the Policy in November 2017, with the goal of motivating self-reporting of misconduct by companies who had discovered wrongdoing by delineating clearer guidelines for companies to follow to obtain cooperation credit in the context of FCPA violations. Miner noted the Petrobas settlement as one of four (out of eight) corporate FCPA resolutions in the past year that involved coordination with foreign authorities, which represented approximately $925 million in total U.S. criminal fines, penalties, and forfeiture. Miner also pointed to recent FCPA declinations of prosecution in cases involving evidence of executive misconduct, emphasizing that such aggravating circumstances will not be fatal to a company’s successful cooperation under the Policy. Miner further emphasized a willingness to apply the Policy to non-FCPA cases, pointing to the DOJ’s declination in connection with misconduct by Barclays FX traders who misappropriated confidential information from Hewlett Packard, in light of Barclay’s timely self-disclosure of the wrongdoing and its initiation of an internal investigation. In addition, Miner underscored previous remarks he made regarding the application of the FCPA Corporate Enforcement Policy in the context of mergers and acquisitions, i.e., where an acquiring or successor company learns of misconduct within the acquired company during the course of an acquisition. He noted that this extension of the policy relates not only to instances where the successor entity discovers conduct violating the FCPA, but any criminal wrongdoing. Goodwin previously analyzed the DOJ’s extension of the FCPA Corporate Enforcement Policy to mergers and acquisitions in a client alert, which can be read here.


On September 26, 2018, the United States District Court for the District of Massachusetts, in CFTC v. My Big Coin Pay, Inc. et al, bolstered the CFTC’s position that all cryptocurrencies—not just bitcoin—qualify as a commodity under the Commodity Exchange Act. In My Big Coin Pay, the CFTC sued a virtual currency company and several affiliated companies and individuals alleging fraud and misappropriation in the sale of the virtual currency “My Big Coin.” The CFTC claims that defendants perpetrated a $6 million fraud by falsely representing to purchasers that My Big Coin was “backed by gold,” could be used anywhere Mastercard was accepted, and was being “actively traded” on several currency exchanges. Certain of the defendants filed a motion to dismiss the action, arguing, among other things, that the virtual currency involved in the scheme is not a commodity as defined under the Commodities Exchange Act (CEA) and asserting that the CFTC lacks jurisdiction. The court rejected defendants’ argument, finding that Congress intended to grant the CFTC broad authority under the CEA to regulate categories of products, such as cryptocurrencies, without regard to whether individual products within a category were or were not the subject of a futures contract. This decision will allow the CFTC to continue policing not only futures contracts and swaps involving commodities, but also fraud or manipulation of virtual currencies traded in interstate commerce.


On September 21, 2018, the Securities and Exchange Commission announced it had accepted an $11.5 million settlement offer from Illinois regional center, CMB Export, its CEO, Patrick F. Hogan, and 37 affiliated partnerships relating to claims arising out of an offer of unregistered securities to foreign investors between 2011 and 2015 under the EB-5 Immigrant Investor Program. The EB-5 Program—created in 1990 to spur foreign investment in the U.S.—allows foreign investors to become lawful permanent residents in exchange for investing at least $1 million in commercial enterprises that create or maintain at least 10 full-time jobs for domestic U.S. workers. Regional centers like CMB Export are federally-approved, third party entities that connect foreign investors with developers in search of funding. According to the SEC, CMB Export, Hogan, and the affiliates entered into agreements with “referrers” who acted as liaisons between the foreign investors and CMB, recommending EB-5 securities to foreigners and facilitating the transfer of investment funds to CMB export without registering the EB-5 securities. Following the initiation of an investigation, Hogan instituted the development and implementation of a compliance program designed to strengthen the company’s adherence to the securities laws, which contributed to the SEC’s decision to accept the settlement offers, stressing the importance for companies to preemptively enact compliance programs aimed at addressing the perceived areas of misconduct.


On September 26, 2018 the SEC announced the settlement of an enforcement action under the agency’s Identity Theft Red Flags Rule and the Safeguards Rule against Iowa-based investment adviser Voya Financial Advisers, Inc. According to the SEC, in 2016 cyber thieves accessed the personal information of 5,600 VFA contractor customers, including addresses, dates of birth, and in some cases full Social Security numbers, by calling CFA’s support line and requesting that their passwords be reset. The SEC alleged that VFA’s policies and procedures to protect customer information and respond to cybersecurity incidents were not reasonably designed to be applied to contractor representatives and caused delays in discovering and responding to the data theft. While not admitting or denying the SEC’s findings, VAF agreed to pay a $1 million penalty and will also retain a consultant to evaluate its procedures and policies for compliance with federal cyber securities rules. The SEC’s Cyber Unit Chief stated that the case should be a wake-up call to brokers and investment advisers that cybersecurity procedures to protect customers from identity theft must “be reasonably designed to fit their specific business models.”


On September 24, 2018, the Delaware Chancery Court approved a $19.5 million settlement to stockholders in the case of In re Saba Software, Inc. Stockholder Litigation. Stockholders filed suit in 2015 alleging that the Board of Directors, including senior executives, violated their fiduciary duties by pressing stockholders to approve an underpriced $400 million sale to an affiliate of private equity firm Vector Capital Management. Back in 2013, Saba’s stock had been delisted from the Nasdaq following years of failures to restate earnings related to alleged fraudulent acts by an Indian subsidiary that overstated earnings by $70 million. Saba previously moved to dismiss the lawsuit, arguing that the Delaware Supreme Court’s seminal ruling in Corwin v. KKR Financial Holdings LLC required business judgment deference to be afforded to transactions approved by a majority of fully informed, uncoerced disinterested stockholders. The Court rejected the dismissal, finding that the Saba board was “hellbent” on selling the company due to the regulatory chaos it was facing as a result of its delisting. But while the Court of Chancery acknowledged that the settlement was below the minimum estimated damages of $34 million, it ultimately found the settlement to be fair, reasonable, and adequate to the stockholders. In so finding, the court noted the difficulties that the stockholders might have in ultimately connecting their damages to the transaction itself, rather than the prior fraud allegations that had already materially impacted the stock. The court reasoned that the settlement was fair because, if the defendants ultimately succeeded in their loss causation argument, there was a chance that the stockholders could end up with nothing.


On September 27, 2018, the Massachusetts Supreme Judicial Court in Merrimack College v. KPMG LLP clarified the scope of the in pari delictodoctrine, which bars a plaintiff who has participated in wrongdoing from recovering damages for loss resulting from that wrongdoing. In doing so, it reopened a lawsuit brought by Merrimack College against KPMG, its independent auditor from 1998 until 2004. During that period, Merrimack’s financial aid director was engaged in a $6 million fraudulent student-loan scheme, which involved issuing loans to students without their consent. When the scheme was eventually uncovered in 2014, the former financial aid director was convicted of federal mail and wire fraud charges and Merrimack incurred more than $6 million in costs related to writing off the fraudulent loans and repaying students. Merrimack sued KPMG alleging, inter alia, professional auditor malpractice, breach of contract, and negligence relating to its failure to discover the fraudulent scheme. The Superior Court granted summary judgment to KPMG under the doctrine of in pari delicto, holding that the financial aid director’s wrongdoing could be imputed to Merrimack under agency law and the doctrine of respondeat superior. The Supreme Judicial Court reversed, holding that for purposes of measuring fault under the in pari delicto doctrine, only conduct of senior management may be imputed to the plaintiff organization. Because the financial aid director was not a member of senior management at Merrimack, the Superior Court vacated the summary judgment order and remanded. The ruling will make it more difficult in Massachusetts for advisors to rely on the in pari delicto doctrine where senior management at the plaintiff company was not directly involved in or aware of the wrongdoing, and could motivate plaintiffs in similar cases to file suit in the Commonwealth.