Securities Snapshot
June 18, 2019

SEC Approves Regulatory Proposals Impacting the Obligations That Broker-Dealers and Investment Advisers Owe to Investors

SEC approves “best interest” standard of conduct for broker-dealers and related interpretive guidance of investment advisers’ responsibilities under the Investment Advisers Act; Second Circuit upholds dismissal of ex-SunEdison employees’ ERISA suit; Second Circuit affirms dismissal of pension fund’s securities suit against Xerox over Medicaid software; FinCEN issues guidance affirming the application of its regulatory framework to convertible virtual currency businesses; SEC issues no-action letter ruling that CorVel Corp. must allow investor vote on LGBT protections; Northern District of California again denies class certification for Finisar investors.

On June 5, 2019, the Securities and Exchange Commission (SEC) adopted Regulation Best Interest, or Regulation BI, which establishes a purportedly enhanced standard of conduct for broker-dealers and their associated persons. Drawing on principles underlying fiduciary obligations, Regulation BI requires broker-dealers to act in the “best interest” of a retail client when recommending a securities transaction or investment strategy involving securities, and provides that broker-dealers cannot place their own interests above those of their clients. Regulation BI provides that these obligations are met only if the broker-dealer satisfies four specific obligations: (1) disclose material facts about the broker-client relationship and broker recommendations of the products and services they provide; (2) exercise reasonable diligence, care, and skill, and understand potential risks, rewards, and costs associated with a recommendation made to a client; (3) implement and maintain written policies and procedures reasonably designed to identify conflicts of interest, which in turn must be disclosed or eliminated; and (4) establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation BI as a whole.

In addition to Regulation BI, the SEC published interpretive guidance regarding the standard of conduct for investment advisers under the Investment Advisers Act of 1940. The SEC’s newly-published guidance provides that investment advisers can now choose to either eliminate conflicts of interest or make a full and fair disclosure such that a client can either provide informed consent to the conflict or reject it. Previously, investment advisers were required to both eliminate and disclose conflicts of interest.

The SEC also adopted a rule requiring broker-dealers and investment advisers to deliver a retail investor relationship summary using the new Form CRS, and published interpretive guidance regarding the “solely incidental” prong of the broker-dealer exclusion from the definition of investment adviser. By June 30, 2020, broker-dealers must comply with Regulation BI and investment advisers must file the Form CRS.


On June 7, 2019, in O’Day v. Chatila, et al., the Second Circuit affirmed the dismissal of claims that SunEdison, Inc. executives breached their fiduciary duties by allowing employees to purchase publicly traded shares of company stock when they knew, or should have known, that the company was on the verge of bankruptcy. The U.S. District Court for the Southern District of New York had dismissed plaintiffs’ complaint on the ground that they failed to plead any “special circumstances” that fiduciaries would have known affected the reliability of the market price as a reflection of the value of SunEdison shares—i.e., the pleading standard that the U.S. Supreme Court established in the 2014 case Fifth Third Bancorp v. Dudenhoeffer.

On appeal, plaintiffs relied on another Second Circuit decision, Jander v. Retirement Plans Committee of IBM, which the U.S. Supreme Court has agreed to hear, to argue that defendants should have responded to non-public information of the company’s financial troubles by making proper disclosures and halting purchases of the company stock. The Second Circuit rejected the argument and distinguished Jander, however, because the SunEdison plaintiffs never claimed that disclosing their former employer’s financial troubles earlier might have caused less damage than a later disclosure, or that halting purchases of stock would have sufficed.

The Second Circuit’s affirmance demonstrates that it will not apply Janderwhere a prudent fiduciary reasonably could have concluded that halting the purchases of stock would have done more harm than good, as was the case here.


On June 6, 2019, the Second Circuit affirmed the dismissal of a proposed class action in Arkansas Public Employees Retirement System v. Xerox Corp. et al., “substantially for the reasons stated by” the U.S. District Court for the Southern District of New York in its March 2018 dismissal. Lead plaintiff Arkansas Public Employees Retirement System alleged that Xerox and a group of former Xerox executives violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 based on allegedly false or misleading statements about the success and prospects of a software platform that Xerox developed to help state governments manage their Medicaid programs. According to plaintiffs, after defendants received government contracts in six states, Xerox officers made three sets of false or misleading statements: (i) Xerox had a platform that was transferrable, reusable, replicable, and scalable, with plug-and-play characteristics; (ii) implementation of the platform was successful; and (iii) implementation of the platform would become profitable. In the district court’s ruling that the Second Circuit adopted, the court found that the majority of the allegedly misleading statements were non-actionable puffery that broadly recited Xerox’s belief in its competitive advantage. The remaining statements were immune from liability under the Private Securities Litigation Reform Act of 1995 because they were either forward-looking and accompanied by meaningful cautionary language, true statements of fact, or statements that plaintiffs did not plead with particularity as to why they were false or misleading.

The Second Circuit’s summary affirmance of the district court’s ruling reinforces the principle that general statements of a company’s confidence in its products and competitiveness, absent specific facts to suggest that defendants did not believe or had no basis for those statements, are not actionable as false or misleading under the securities laws.


On May 9, 2019, the Financial Crimes Enforcement Network of the U.S. Department of the Treasury (FinCEN) issued guidance regarding the application of FinCEN’s money service business (MSB) regulations to certain business models involving money transmission denominated in convertible virtual currencies (CVCs), including digital currencies and cryptocurrencies. FinCEN’s guidance does not establish new regulatory requirements, but rather consolidates and summarizes current regulations, related administrative rulings and guidance involving the regulation of “money transmission” under the Bank Secrecy Act (BSA). It also provides guidance on the application of FinCEN’s regulations to certain current and emerging business models involving CVCs, including those related to CVC wallets, CVC kiosks, Peer-to-Peer (P2P) exchanges and trading platforms, and initial coin offerings (ICOs), among others. FinCEN’s guidance is intended to be a tool to help financial institutions comply with their existing obligations under the BSA as they relate to business models involving CVCs, and a resource for those seeking to introduce innovative products or services that may be subject to the same rules and regulations.


On June 5, 2019, the SEC Division of Corporation Finance issued a no-action letter ruling that CorVel Corp., a risk management solutions company, cannot exclude from its 2019 Proxy Statement a proposal requesting that the company issue a public report detailing the potential risks associated with omitting explicit mention of “sexual orientation” and “gender identity” in its written equal employment opportunity policy.

The SEC’s no-action letter marks a change from other SEC determinations in the 2017 and 2018 proxy seasons, in which the SEC had concluded that companies could omit similar proposals. Here, the SEC noted that the shareholder proposal focused on potential risks associated with the company not having an inclusive non-discrimination policy, rather than an argument that the policy permits discrimination on the basis of sexual orientation and gender identity. The filer of the shareholder proposal–Walden Asset Management, a Boston-based investment firm and a beneficial owner of CorVel common stock–argued that while CorVel’s equal employment opportunity policy includes the terms “sex” and “gender,” there is currently legal uncertainty as to whether these terms afford protection on the basis of sexual orientation and gender identity, creating risk for CorVel.


On May 24, 2019, the U.S. District Court for the Northern District of California, in In re Finisar Corporation Securities Litigation, declined to reconsider its previous denial of class certification for Finisar investors who brought claims under the securities laws based on an allegedly false or misleading statement by Finisar’s CEO concerning the drivers of Finisar’s growth. According to plaintiffs, on a December 2, 2010 analyst call, Finisar’s then-CEO responded to an analyst’s question about whether Finisar’s growth might stall because customers were building up inventory by stating that “we haven’t seen any inventory issues with our product with our customers.” Finisar’s stock price increased and subsequently continued to rise, until Finisar issued a press release on March 8, 2011, in which it indicated that its revenues would be lower than projected due to “previously undisclosed inventory build-up.” Finisar’s stock price experienced a one-day decline of nearly 39%.

On December 5, 2017, the court denied plaintiffs’ motion for class certification because defendants had rebutted the presumption of fraud-on-the-market reliance. The court found that the former CEO’s statement had no price impact where that statement took place after the stock price already had increased from the previous day’s close and analyst reports, which introduced new information into the market about inventory and growth conditions for which defendants were not responsible, severed the link between the former CEO’s statement and the price increase. Plaintiffs sought to renew their motion for class certification based on supposedly new evidence: a new study submitted by plaintiffs’ expert. The court denied plaintiffs motion because (i) the new study did not constitute an “emergence of new material facts” because all of the information underlying the new report existed at the time of the original motion; and (ii) even if the study had been submitted in connection with the original motion, it did not demonstrate that the former CEO’s statement had an impact on Finisar’s stock price for the same reasons as the court’s December 5, 2017 opinion.

The court’s holding underscores that, despite a significant decrease in stock price after an alleged corrective disclosure, defendants still can rebut the fraud-on-the-market presumption of reliance by demonstrating that there was no price impact at the time of an alleged misstatement, as in this case, where defendants established that the stock price increase preceded the alleged misstatement and pointed to events (here, analyst reports) that severed the link between the alleged misstatement and the price increase.