On December 19, 2018, the Delaware Court of Chancery issued a decision in Sciabacucchi v. Salzberg, declaring “ineffective and invalid” federal forum-selection provisions (“Federal Forum Provisions”) in Delaware corporations’ bylaws or charters requiring claims under the Securities Act of 1933 (the “1933 Act”) to be brought in federal court. Federal Forum Provisions were becoming increasingly common in reaction to the Supreme Court’s decision in Cyan, Inc. v. Beaver County Employees Retirement Fund, in which the Court held that state courts maintained concurrent jurisdiction over class action lawsuits asserting claims under the 1933 Act. Examining Federal Forum Provisions in three companies’ certificates of incorporation on cross-motions for summary judgment, the Court of Chancery (by Vice Chancellor Laster) concluded that “[t]he constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” In other words, the Court of Chancery held, claims “external to the corporation”––such as securities claims arising under the federal 1933 Act––do not “involve the internal affairs of the corporation,” and therefore cannot be controlled by internal governance documents of Delaware companies. The Court of Chancery explained that Federal Forum Provisions purporting to govern 1933 Act claims are external to the corporation, and thus invalid, because they seek to regulate the forum in which parties “external to the corporation (purchasers of securities)” may sue “under a body of law external to the corporate contract (the 1933 Act).” Conversely, as the Court of Chancery held in a 2013 decision, forum-selection provisions requiring claims concerning the internal affairs of a corporation (e.g., derivative and fiduciary duty claims) to be brought exclusively in the Court of Chancery remain valid. In the wake of Cyan and the Court of Chancery’s decision in Sciabacucchi, issuers of securities should be prepared to litigate securities class actions under the 1933 Act in the less familiar realm of state courts, including any jurisdiction in which a plaintiff can establish personal jurisdiction over the issuer.
DISTRICT OF MASSACHUSETTS DISMISSES WITH PREJUDICE SECURITIES CLASS ACTION AGAINST PREMIUM WOMEN’S CLOTHING RETAILER AND UNDERWRITERS FOR FAILURE TO PLEAD ANY ACTIONABLE MISSTATEMENTS OR OMISSIONS IN IPO FILINGS
On December 20, 2018, the District of Massachusetts, in The Pension Trust v. J.Jill, Inc., dismissed with prejudice a putative securities class action case brought against clothing retailer J.Jill, Inc. (“J.Jill”), certain of J.Jill’s officers and directors, three of the underwriters of J.Jill’s March 2017 IPO, and a private equity fund alleged to be J.Jill’s controlling shareholder. The amended complaint brought claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 and Items 303 and 503 of Regulation S-K, alleging that J.Jill’s registration statement and prospectus “created the misleading impression that the company’s unique business strategy had insulated it from adverse industry trends” by making allegedly material misstatements about J.Jill’s business prospects and failing to disclose certain supposedly known risks, adverse trends, and uncertainties that caused its business to suffer during the second half of 2017. In making these assertions, plaintiff relied heavily on the temporal proximity between the March 2017 IPO and remarks by the company’s CFO during a May 2017 investor call regarding J.Jill’s expectations for the fiscal year and specifically “the back half of the year.” In examining the CFO’s remarks in their full context, including questions from analysts on the call and answers the CFO provided in response to other questions, the court concluded that nothing in the CFO’s statements provided a basis for inferring that the company knew about existing undisclosed adverse trends or uncertainties on the date of the IPO. The court explained that the IPO occurred only two-thirds of the way through the first quarter of 2017, and that any adverse results during the second quarter “support[ed] only the inference that [those] problems arose in the second quarter.” As to statements of belief that appeared in the IPO registration statement and prospectus, the court held that they were statements of opinion not actionable under the Supreme Court’s decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund because the amended complaint failed to allege that those beliefs were not sincerely held, that any of the facts referenced in those beliefs were untrue, or that defendants failed to conduct a reasonable inquiry in making those statements. Similarly, the court rejected plaintiff’s argument that the IPO offering materials contained actionable omissions, noting that either the offering materials disclosed the supposedly omitted risks, adverse trends, and uncertainties, or that plaintiff had not alleged non-conclusory facts showing that such risks, trends, and uncertainties existed at all. The ruling demonstrates that courts remain willing to consider the full context in which alleged untrue statements and omissions are made. The decision also suggests that plaintiffs will face difficulties in pleading plausible claims under Items 303 or 503 of Regulation S-K for failure to disclose supposedly known adverse trends or uncertainties based on alleged knowledge of events occurring part-way through a quarter. In that regard, courts generally hold that issuers have no duty to make predictions about fiscal quarters then in progress. Goodwin represented the underwriters sued in this matter.
THIRD CIRCUIT REVIVES ITEM 503(c) NON-DISCLOSURE CLAIMS ARISING OUT OF MERGER BUT AFFIRMS DISMISSAL OF CLAIMS PREMISED ON OPINIONS UNDER OMINCARE
On December 26, 2018, the Third Circuit in Jaroslawicz v. M&T Bank Corporation vacated in part and affirmed in part the dismissal of a putative class action arising out of the 2015 merger of consumer banks Hudson City Bancorp (“Hudson”) and M&T Bank Corporation (“M&T”), which took more than thirty months to close due to delays arising from regulatory investigations into M&T’s allegedly deficient compliance programs. Former Hudson shareholders brought suit under Section 14(a) of the Securities Exchange Act of 1934 and SEC Rule 14a-9, which incorporates Item 503(c) of Regulation S-K, alleging that the joint proxy materials misleadingly omitted significant risk factors relating to the merger’s regulatory approval, including M&T’s history of consumer-protection law violations and deficiencies in M&T’s anti-money laundering (“AML”) compliance program. The second amended complaint also asserted that the non-disclosure of M&T’s allegedly non-compliant practices rendered misleading the banks’ statements of opinion concerning M&T’s adherence to regulatory requirements and the prospects for prompt merger approval. While acknowledging that Item 503(c) does not impose a duty to disclose all material facts or all corporate wrongdoing, the Third Circuit vacated the district court’s dismissal of the Item 503(c) claims, concluding that plaintiffs plausibly alleged that the consumer-protection violations and AML compliance deficiencies presented significant risks to the merger’s closing. The court also found that the risk factors concerning the consumer-protection violations were “too generic to be adequate” because they were “not company-specific” and “could easily apply to any consumer bank in the industry.” Additionally, the court found that the risk factors contained in a proxy supplement addressing M&T’s AML compliance were insufficient because investors received the supplement only six days before the shareholder vote. However, the court affirmed the district court’s dismissal of the claims premised on two statements of opinion in the joint proxy materials––that the banks believed the merger would timely close and that M&T’s AML compliance program complied with the Patriot Act. Plaintiffs alleged that the banks neglected to perform sampling of M&T’s AML deficiencies and therefore failed to conduct a meaningful inquiry before forming their opinions. The Third Circuit declined to decide whether the Supreme Court’s decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund applies to claims brought under Section 14(a) of the Securities Exchange Act of 1934, but nevertheless, it held that the opinions were not actionable even under Omnicare because no reasonable investor would have been misled by them since they appeared in the context of the proxy materials’ “hedging” description of increased scrutiny of AML compliance across the industry and cautionary language warning of the uncertainties facing future regulatory approval. The court’s decision is significant because it demonstrates the requisite level of specificity in describing risk factors that is necessary to avoid liability under Item 503(c). It also provides guidance on how courts will apply Omnicare to opinion statements that are allegedly misleading by omission.
HOUSE MEMBERS INTRODUCE BIPARTISAN BILL TO EXEMPT CRYPTOCURRENCIES FROM SECURITIES LAWS
On December 20, 2018, Congressmen Warren Davidson, R-Ohio, and Darren Soto, D-Fla., jointly introduced the Token Taxonomy Act, a bill that, if enacted into law, would define “digital tokens” to exclude them from the statutory definition of a security under federal securities laws and affect how cryptocurrencies are regulated and taxed. The bill seeks to amend the Securities Act of 1933 and the Securities Exchange Act of 1934 and clarify the Supreme Court’s decision in SEC v. Howey Co., under which courts have largely thus far concluded that cryptocurrencies constitute “investment contracts” that are subject to SEC regulation. To date, the SEC has contended that most cryptocurrencies are securities that fall within its regulatory and enforcement authority. The impetus behind the bill is the desire for regulatory certainty that is necessary for America’s cryptocurrency markets to compete with international markets that have fostered growth in initial coin offerings without interruption for regulation and measures taken for consumer protection. Additionally, the bill would clarify ambiguities and help reduce the potential for over-enforcement arising from regulatory overlap. As it stands, cryptocurrencies could be regulated by potentially at least three federal agencies: the SEC, which regulates securities; the Federal Trade Commission, which monitors web services; and the Commodity Futures Trading Commission, which polices commodity derivatives. While the bill will have to be reintroduced in 2019 when Democrats take control of the House, its bipartisan roots suggest that it could gain traction in 2019 or potentially inform regulatory guidance on cryptocurrencies that is expected from the SEC in the near future.
Charles A. BrownPartner
James D. GattaPartner
Meghan K. SpillanePartner