Securities Snapshot
January 15, 2019

Supreme Court Grants Certiorari to Decide Whether Section 14(e) of the Exchange Act Allows a Private Right of Action Based on Negligence

Supreme Court grants certiorari to decide whether Section 14(e) of the Exchange Act allows a private right of action based on negligence; Second Circuit upholds securities fraud conviction for Robert Schulman; Second Circuit upholds securities fraud conviction for Rajat Gupta; Southern District of New York allows the Winklevoss brothers’ bitcoin claims to go forward.

On January 4, 2019, the Supreme Court granted certiorari in Emulex Corp. v. Varjabedian, to resolve a circuit split between the Ninth Circuit and five other courts of appeals—the Second, Third, Fifth, Sixth and Eleventh Circuits. The question presented in the petition was whether Section 14(e) of the Securities Exchange Act of 1934 supports a private right of action based on negligence or whether plaintiffs must allege scienter. Section 14(e) prohibits, in connection with any tender offer, any untrue statement of a material fact or omission of any material fact necessary to make the statement not misleading. In Emulex, there was a merger between Emulex Corp. and Avago Technologies Wireless (USA) Manufacturing Inc. by way of a tender offer. After the tender offer was initiated, an Emulex shareholder filed a securities class action in the federal court for the Central District of California seeking to enjoin the merger for failing to disclose allegedly material analyses of the premiums received in 17 transactions involving semiconductor companies between 2010 and 2014.

The district court dismissed the complaint and rejected plaintiffs’ argument that they needed only to allege negligence to state a claim under Section 14(e), explaining that no federal court has held that allegations of negligence alone would suffice. The Ninth Circuit reversed.  In doing so, it recognized that it was parting ways with the case law established in five different circuits, which all required plaintiffs to allege scienter. It held that Section 14(e) requires a showing of only negligence and not scienter, and rejected the other circuits’ reasoning that the similarity in language between Section 10(b) of the Exchange Act and Section 14(e) meant that Section 10(b)’s scienter requirement should also apply to Section 14(e). The Supreme Court’s ultimate ruling in this case would both confirm the existence of a private right of action under Section 14(e), which it has never previously recognized, and determine the appropriate degree of culpability required to maintain such a claim.


On January 10, 2019, the Second Circuit affirmed former Hunton & Williams LLP partner Robert Schulman’s convictions for securities fraud. On appeal, Schulman argued that his convictions should not stand because there was insufficient evidence at trial of his criminal intent. Schulman was convicted for sharing confidential information concerning King Pharmaceutical’s merger with Pfizer with his investment manager, Tibor Klein, with the intention that his communication would lead to the purchase and sale of King’s stock. According to Schulman, the only comment he made to Klein concerning King was that “[I]t would be nice to be king for a day.” Schulman argued that the comment was only intended as a “joke” and could not have been sufficient to show criminal intent. The Second Circuit disagreed, explaining that the evidence presented at trial cannot be viewed “piecemeal or in isolation.” It held that the jury “was entitled to disbelieve” that Schulman communicated nothing more than “it would be nice to be king for a day” since Klein subsequently told his childhood friend that he had insider information concerning King and Pfizer. The court also held that the record was “replete” with evidence supporting the inference that Schulman intended Klein to trade on that information because Klein was Schulman’s “money manager,” Klein immediately bought hundreds of thousands of dollars of King stock after their meeting, and Klein had previously purchased stock in one of Schulman’s clients. Accordingly, the Second Circuit affirmed the district court’s denial of Schulman’s motion to vacate pursuant to Federal Rule of Criminal Procedure 29.


On January 7, 2019, the Second Circuit issued a summary order affirming the judgment of the Southern District of New York denying petitioner Rajat Gupta’s motion to vacate his securities fraud convictions on the ground that the court’s instructions to the jury were legally invalid in light of a subsequent Second Circuit decision, United States v. Newman. The jury instructions at issue concerned whether the “personal benefit” element of the insider trading offense needed to be financial or tangible in nature. The district court’s instruction was that it does not, but Newman subsequently held that “a personal benefit must take the form of an ‘exchange’—a quid pro quo.” The district court denied Gupta’s motion to vacate because it found that Gupta procedurally defaulted on his objection by not raising it in the direct appeal from his conviction, that he made no showing that would excuse the default,  and, in any case, that the jury instructions were consistent with Newman

On appeal, Gupta conceded that he procedurally defaulted on his challenge concerning the jury instructions, but argued that the default should be excused due to either cause and prejudice or actual innocence. In order to excuse the default due to cause, a party must show that the objection it sought to raise was so novel that it was unavailable at the time of direct review and could only be raised to due subsequent developments. Further, the party must also show that there was such prejudice that “the ailing instruction by itself so infected the entire trial that the resulting conviction violates due process.” To prove actual innocence, a party must show that “in light of all the evidence, it is more likely than not that no reasonable juror would have convicted him.” The Second Circuit held that Gupta had not made sufficient showings that his default should be excused on any of those grounds. It reasoned that defendants in similar cases have previously objected to the jury instructions that Gupta was objecting to now, and Gupta himself even objected to the jury instructions during trial, which shows that the argument he was raising was hardly so novel as to be unavailable at the time of his direct appeal. Also, it held that the instructions that the district court gave the jury were not so flawed as to deny Gupta due process because the instructions were consistent with prior Supreme Court decisions, and the formulation of “personal benefit” in Newman has since been expressly rejected by the Supreme Court in Salman v. United States. The Second Circuit also held that Gupta had not demonstrated actual innocence because the record contained “ample evidence” that Gupta participated in and sought to benefit from insider trading in violation of the securities laws by, among other things, sharing confidential information he learned in Goldman Sachs board meetings with his friend and business associate, Raj Rajartnam, who traded on the basis of that information.


On January 7, 2019, the Southern District of New York issued an opinion explaining the reasoning for its December 20, 2018 order denying defendant Charles Shrem’s motions to dismiss and to strike plaintiff Winklevoss Capital Fund, LLC’s (“WCF”) complaint for misappropriation of its bitcoin. According to the complaint, in 2012, Shrem offered to help WCF buy bitcoin “at the best price,” and WCF sent Shrem $750,000 with which to purchase bitcoin. Shrem failed to provide a full accounting for the bitcoin purchases he made using WCF’s funds, and WCF subsequently hired an accountant to perform an audit of Shrem’s transactions. The accountant found that Shrem could not account for $61,000 of WCF’s funds, which was equal to approximately 5,000 bitcoin at the time. Another company hired by WCF allegedly found that Shrem’s bitcoin address received 5,000 bitcoin on December 31, 2012.

Shrem argued that WCF’s complaint should be dismissed for lack of subject matter jurisdiction and failure to state a claim. He claimed that the court lacked subject matter jurisdiction because the value of the missing 5,000 bitcoin underlying WCF’s fraud claims is $61,000, which is less than the $75,000 amount in controversy requirement to establish diversity jurisdiction in federal court. However, the court held that Shrem failed to show to a “legal certainty” that all of WCF’s claims cannot exceed $75,000 because the complaint is seeking to recover $31 million for the value of the 5,000 bitcoin at the time of filing and because WCF’s other claims provide broad remedies allowing for additional monetary relief. Shrem also argued that WCF’s complaint should be dismissed for failure to state a claim because WCF failed to adequately plead its fraud claim under the heightened pleading standards of Rule 9(b) and failed to allege that a fiduciary duty existed between Shrem and WCF, as opposed to a “conventional business relationship.” The court was not persuaded by Shrem’s arguments and held that the complaint alleged two misrepresentations: first, that Shrem would “secure . . . the best price,” and second, that Shrem would provide an accounting. It also held that the specificity requirement for fraud claims under Rule 9(b) need not be satisfied for allegations concerning scienter as long as the events alleged give a “strong inference” that the defendant acted with scienter. With regard to WCF’s claim for breach of fiduciary duty, the court further held that the complaint plausibly alleged a fiduciary relationship between WCF and Shrem because Shrem had discretionary control over WCF’s funds and acted as WCF’s agent in purchasing bitcoin.

The court denied Shrem’s motion to strike, holding that the allegations Shrem sought to strike either went to the core of WCF’s case or were not prejudicial to Shrem.