Securities Snapshot
July 30, 2019

Federal Court Decision Provides Guidance on Proximate Causation Standard Under the False Claims Act & Appropriate Penalties Under Firrea

Federal Court Decision Provides Guidance on Proximate Causation Standard Under the False Claims Act and Appropriate Penalties Under FIRREA; Third Circuit Deems Board Observers Exempt from Section 11 Liability; Ninth Circuit Revives CFTC’s $290 Million Fraud Suit Against Metal Broker; Second Circuit Upholds Martin Shkreli’s Conviction; Delaware Court of Chancery Dismisses Siris and Its Management from Second Suit Over $643 Million Xura Merger.

On July 10, 2019, following a remand from the United States Court of Appeals for the Seventh Circuit, the United States District Court for the Northern District of Illinois issued an opinion and order in United States v. Luce. The United States alleged that Robert S. Luce violated the False Claims Act (FCA) and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) by making false statements on annual verification forms submitted to the U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA) by Luce’s mortgage company, a loan correspondent for HUD and the FHA. In its 2017 opinion remanding the case, the Seventh Circuit held that proximate causation, not but-for causation, applies to FCA claims, overturning Seventh Circuit precedent as articulated in United States v. First National Bank of Cicero, and remanded the case to enable the district court to evaluate the evidence under the proximate cause standard.

The government alleged that Luce, a former SEC attorney who subsequently formed and served as president of MDR Mortgage Corporation, falsely certified in MDR’s 2006, 2007 and 2008 verification forms that none of MDR’s principals, owners, officers, directors, and/or employees was involved in a proceeding or investigation that could or did result in criminal conviction or certain other consequences, when in fact Luce had been criminally indicted in 2005. On remand, the district court addressed the Seventh Circuit’s new FCA proximate cause standard, which it described as “a difficult one for [the government] to meet.” Focusing on the requirement of foreseeability—namely, that the type of injury is one that a reasonable person would see as a likely result of his conduct—the court rejected the government’s argument that the unrelated indictment proximately caused loan defaults because the allegedly false statements violated the verification forms’ function of screening out “untrustworthy gatekeepers.” The court held that there was no “nexus” between the alleged false statements and the loan defaults, as required to show proximate causation. As a result, the court found that Luce could not be liable under the FCA.

The district court also assessed the appropriate amount of penalties under FIRREA, which does not require proximate causation for liability. The court considered five factors: (1) the good or bad faith of the defendant and the degree of his scienter; (2) the injury to the public; (3) the egregiousness of the violation; (4) the isolated or repeated nature of the violation; and (5) the defendant’s financial condition and ability to pay. Weighing all five factors, the court concluded that a penalty of $500,000 was appropriate—a significant penalty that also acknowledged that Luce’s conduct “does not put him within the worst class of FIRREA violators.”

Luce’s articulation of what is required to show proximate causation may be instructive in other FCA cases including in the healthcare context where causation is often at issue. Its guidance regarding calculation of an appropriate FIRREA penalty is also instructive, given what the court described as an absence of statutory guidance and the limited number of cases addressing the issue.


On July 23, 2019, the Third Circuit Court of Appeals reversed the lower court’s denial of summary judgment in Obasi Investment LTD et. al, v. Tibet Pharmaceuticals, Inc. et. al, on the ground that nonvoting board observers are not subject to liability under Section 11 of the Securities Act of 1933. The case arises from the initial public offering of Tibet Pharmaceuticals, Inc. Plaintiffs alleged various material omissions in the company’s registration statements, including an omission relating to the company’s need to repay a loan on which it subsequently defaulted and another related to the government of China freezing the assets of one of the company’s subsidiaries. Plaintiffs named as defendants, among others, two board observers that the company’s placement agent appointed.

In its opinion, the Third Circuit analyzed the company’s registration statement to discern whether the board observers fit within the class of individuals subject to strict liability under Section 11—i.e., whether each was a “person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner.” In assessing whether the observers performed “similar functions” to directors, the court identified three features that differentiated observers from directors: (1) because the observers cannot vote for board action, they “lack directors’ most basic power”; (2) as agents of the company’s placement agent, the observers’ interests aligned with the placement agent as opposed to with the company or its shareholders; and (3) the observers could not be removed by shareholder vote, unlike the company’s directors. In view of these three features, the court held that the observers were exempt from liability under Section 11 and provided helpful guidance on the limits of such liability.


On July 25, 2019, the Ninth Circuit reversed the dismissal of the Commodity Futures Trading Commission’s enforcement action against Monex Credit Company in U.S. Commodity Futures Trading Commission v. Monex Credit Company, et. al. Through Monex’s Atlas Program, investors can purchase precious metals on margin. The CFTC claims that Monex violated the Commodity Exchange Act (CEA) because the Atlas Program is an illegal and unregistered retail commodity transaction market. The CFTC further alleges that Monex defrauded mom-and-pop investors by assuring them that they could not lose their investments, despite the fact that allegedly 90% of Atlas investors had lost money, with individual losses totaling in the hundreds of thousands of dollars. The lower court dismissed the action on two grounds: (1) under the CEA’s “actual delivery” exception, the statute does not apply to leveraged retail commodity sales that result in “actual delivery” of the commodity within 28 days; and (2) the CEA covers only fraud-based manipulation claims, not standalone fraud such as the fraud count in the complaint.

The Ninth Circuit panel reversed on both grounds. The panel held that actual delivery required at least some meaningful degree of possession or control by the customer. While it is possible for the exception to be satisfied if the commodity sits in a third-party depository, the exception does not apply if, as here, metals are in the broker’s chosen depository, never exchange hands, and are subject to the broker’s exclusive control; and customers have no substantial, non-contingent interests in the commodity. The panel separately found that the CEA’s language was unambiguous and allowed the CFTC to sue for fraudulent activity, regardless of whether it amounted to market manipulation. The Ninth Circuit’s holding underscores the broad anti-fraud authority that the CFTC has under the CEA.


On July 18, 2019, in a short summary order, the Second Circuit affirmed Martin Shkreli’s criminal conviction and sentence. In August 2017, following a closely-watched jury trial in the Eastern District of New York, Shkreli was convicted of securities fraud and conspiracy to commit securities fraud, based on evidence that he made misrepresentations to investors in his hedge funds, MSMB Capital and MSMB Healthcare, regarding the funds’ size and performance and conspired to control the share price in the biotech firm he controlled at the time, Retrophin Inc. He was acquitted on other counts, including wire fraud conspiracy charges related to the hedge funds and allegations that he defrauded Retrophin.

In April 2018, Shkreli was sentenced to 84 months’ imprisonment and more than $7 million in forfeiture, in addition to being ordered to pay restitution and a fine. Shkreli’s appeal focused primarily on two grounds: First, he argued that the district court incorrectly instructed the jury that Shkreli could be convicted of securities fraud even if the jury found investors suffered no ultimate harm from his actions (the “NUH instruction”). Second, Shkreli took issue with having been ordered to forfeit the total amount invested in his hedge funds. Shkreli contended, among other things, that the Second Circuit should reduce the forfeiture award to zero because of investors’ returns from their investments.

The Second Circuit was not persuaded by any of Shkreli’s arguments, and its decision illustrates that the lack of investor harm is not dispositive of liability or forfeiture issues in securities fraud cases. The court held that the NUH instruction was consistent with Second Circuit precedent and noted that, in fact, the absence of such an instruction would have been a “windfall” for Shkreli, where he had argued that his belief that investors would ultimately make money negated criminal intent. With respect to forfeiture, the Second Circuit upheld the forfeiture order because, among other things, forfeiture is based on a defendant’s gains, not the losses or gains to victims.


On July 12, 2019, the Delaware Court of Chancery issued an opinion in In re Xura, Inc. Stockholder Litigation, granting a motion to dismiss Siris Capital Group, its managing partner, and its principal (the “Siris Defendants”) from the second shareholder lawsuit stemming from the merger of Xura, Inc. and an affiliate of Siris. In the first lawsuit related to the merger, Obsidian Management LLC alleged breach of fiduciary duty against Xura’s CEO, as well as aiding and abetting breach of fiduciary duty against the Siris Defendants. Just ten days after the Court of Chancery dismissed the Siris Defendants from Obsidian’s suit, another plaintiff filed a new suit on behalf of a class of Xura stockholders alleging the same claims against the Siris Defendants.

The Siris Defendants moved to dismiss the second complaint based on res judicata and failure to state a claim. While the court noted the similarities between the two suits, including that the second petitioner is represented by the same attorneys as Obsidian, it refrained from dismissing the suit based on res judicata and instead dismissed again for failure to state a viable claim for aiding and abetting breach of fiduciary duty. Despite the fully developed discovery record available to plaintiff’s counsel from the Obsidian suit and their “attempt[] to plug in the pleading gaps the Court identified in the Obsidian Opinion,” the second complaint still lacked well-pled allegations that the Siris Defendants “knowingly participated” in the alleged breaches of fiduciary duty. Principally, Plaintiffs failed to adequately allege that the Siris Defendants had actual knowledge of the Xura CEO’s breach of fiduciary duty and participated in that breach. The ruling makes clear that, to survive the pleading stage, a claim of aiding and abetting breach of fiduciary duty requires well-pled allegations of knowing participation—not just conclusory allegations that the defendant “should have known” of the underlying breach.