On August 13, 2019, in Malouf v. Securities and Exchange Commission, the Tenth Circuit affirmed the SEC’s findings and sanctions against Dennis Malouf for various securities law violations. Mr. Malouf had occupied key roles at two firms: one was an investment advisory firm called UASNM, Inc.; the second was a broker-dealer branch of Raymond James Financial Services. Raymond James viewed those dual roles as a conflict, so Mr. Malouf sold his Raymond James branch, but the structure of that sale perpetuated the conflict: Mr. Malouf received installment payments for the sale of his Raymond James branch based on the branch’s collection of securities-related fees. Mr. Malouf facilitated these payments by routing bond trades on behalf of his UASNM clients through the Raymond James branch; in so doing, he failed to seek competing bids for those trades. UASNM failed to disclose Mr. Malouf’s conflict of interest in Forms ADV filed with the SEC, and made statements on its website denying any such conflict.
Following an SEC enforcement proceeding, an administrative law judge found that, by failing to correct UASNM’s false or misleading statements, Mr. Malouf violated (among other provisions) Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, which prohibit fraudulent schemes and artifices. Mr. Malouf acknowledged that the financial arrangement had created a conflict, but, on appeal to the Tenth Circuit, he argued that: (1) the failure to correct UASNM’s misstatements cannot support liability where he was not personally the “maker” of a misstatement; and (2) the finding of scienter was not supported by substantial evidence. In essence, Mr. Malouf argued that he was not responsible for the misstatements, including because he had delegated such work to a chief compliance officer and an outside consultant.
The court disagreed. Relying on the Supreme Court’s March 2019 decision in Lorenzo v. SEC, which held that an individual can be liable under provisions of Rule 10b-5 and the Securities Act of 1933 for knowingly disseminating material misstatements made by others, the Tenth Circuit held that Mr. Malouf’s knowing failure to correct UASNM’s material misstatements can give rise to liability. The court further held that Mr. Malouf acted with scienter because: (1) he was familiar with UASNM’s Forms ADV and with its website, where the misstatements were made; (2) he never informed the chief compliance officer of his conflict of interest; and (3) even after his conflict was discovered by the consultant, Mr. Malouf delayed disclosure for several months. The Tenth Circuit also rejected Mr. Malouf’s other arguments and upheld the SEC’s imposition of sanctions—which included a lifetime bar from the securities industry and a disgorgement of $562,001.26 plus prejudgment interest—on the grounds that Mr. Malouf had acted willfully, failed to accept responsibility, and delayed in disclosing his conflict of interest. Malouf is significant because it applies and arguably broadens the Supreme Court’s recent decision in Lorenzo, by finding that a defendant’s knowing failure to correct material misstatements can give rise to liability, in addition to knowing dissemination of such statements.
EASTERN DISTRICT OF NEW YORK GRANTS SEVERANCE FOR FX TRADERS ACCUSED OF FRAUD
On August 13, 2019, Judge Raymond Dearie of the Eastern District of New York granted defendants John Won's and Tae Hung Kang’s motions for severance in United States v. Kang. Mr. Won and Mr. Kang, who had been facing a joint trial, are charged with engaging in a scheme to defraud investors and potential investors in foreign exchange (“FX”) trading accounts managed by the defendants’ companies, Safety Capital Management Inc. (of which Mr. Kang was the CEO and Mr. Won was the Vice President and Secretary) and GNC Capital Inc. (of which Mr. Won served as President), which both did business under the name “Forexnpower.
The indictment charges the defendants with conspiracy to commit wire fraud, securities fraud and money laundering, along with substantive counts of wire and securities fraud, based on two purported schemes: (1) an “FX trading scheme” pursuant to which the defendants allegedly made misrepresentations and omissions regarding (among other things) their FX trading expertise, Forexnpower’s historical and likely future rates of return, and risks related to FX trading; and (2) a “stock investment scheme” pursuant to which the defendants allegedly solicited investments into one of their companies based on misrepresentations regarding the intended use of investor funds, the majority of which the defendants allegedly misappropriated.
In February 2019, both defendants moved for severance, arguing that a joint trial would violate their Sixth Amendment confrontation rights because each defendant had made statements that implicated the other during depositions in a related civil proceeding at which the defendants did not have the opportunity to question each other. Counsel for Mr. Won also reportedly sent a letter notifying the court that he intends to argue at trial that Mr. Kang made fraudulent assurances to investors without Mr. Won’s knowledge, and did so behind his back specifically because Mr. Won had warned him that making such statements was illegal. Judge Dearie granted the defendants’ motions for severance in an as-yet unpublished decision, noting in particular the representations of Mr. Won’s counsel. The decision is an example of the kind of arguments that may be persuasive when seeking severance in a criminal case, even when the defendants are alleged to have worked closely together.
NORTHERN DISTRICT OF CALIFORNIA DISMISSES SECURITIES CLASS ACTION COMPLAINT AGAINST IMPAX LABORATORIES WITHOUT LEAVE TO AMEND
On August 12, 2019, the District Court for the Northern District of California dismissed plaintiffs’ second amended complaint without leave to amend in New York Hotel Trades Council & Hotel Association of New York City, Inc. Pension Fund v. Impax Laboratories Inc., et al. Plaintiff brought the lawsuit on behalf of persons who purchased Impax Laboratories’ securities between February 20, 2014 and January 11, 2017, alleging securities fraud claims against the pharmaceutical company and certain executives based on price fixing and price erosion. The court had previously dismissed plaintiff’s first amended complaint because plaintiff failed to allege scienter and loss causation with respect to its price fixing allegations, and failed to allege falsity and scienter with respect to its price erosion allegations.
In considering the sufficiency of plaintiff’s second amended complaint, the court once again held that plaintiff failed to state a claim. As to its price fixing allegations, the court held that plaintiff had failed to plead loss causation, noting that “the mere existence of a regulatory investigation is insufficient to show cognizable fraud,” and finding that the second amended complaint failed to identify a corrective disclosure linked to alleged misstatements and omissions and a decrease in Impax’s stock prices. With respect to price erosion, plaintiff’s allegations concerned two of defendants’ products: diclofenac and budesonide. The court found that plaintiff failed to plead falsity or actual knowledge of falsity with respect to diclofenac statements, because such statements were either non-actionable puffery, accurate statements of past performance, non-actionable opinion statements, or were simply not alleged to be false or misleading. The court also dismissed plaintiff’s budesonide allegations for failure to plead scienter, because plaintiff failed to allege that Impax’s alleged overvaluation of the budesonide acquisition was anything other than an “innocent mistake.” The Court noted, however, that an innocent explanation would be less likely – and thus scienter more likely to be sufficiently pled–where a company overestimates its own capabilities, as opposed to the subject of an acquisition. Noting that plaintiff had previously been granted leave to amend and had failed to add the requisite particularity, the court held that further leave to amend is “unwarranted.”
DELAWARE COURT OF CHANCERY FINDS FAIR VALUE OF COLUMBIA PIPELINE STOCK EQUAL TO TRANSCANADA DEAL PRICE
On August 12, 2019, the Delaware Court of Chancery, in In re Appraisal of Columbia Pipeline Group, Inc., found in a statutory appraisal proceeding that the fair value of Columbia Pipeline’s stock in TransCanada Corporation’s acquisition of Columbia is equal to the deal price of $25.50 per share. The Columbia stockholders claimed that Columbia’s stock was worth $32.47 per share based on their expert’s discounted cash flow (DCF) analysis. Defendants claimed that fair value was $20.86 per share in view of $250 million of synergies that they argued should be deducted from the deal price.
In a post-trial decision, the court held that the fair value of Columbia’s common stock was the $25.50 per share deal price because, under Delaware Supreme Court precedent, the deal price was a reliable indicator of fair value where the sale process was sufficiently reliable. The court based that determination on the record evidence that: (1) the merger was an “arm’s-length transaction with a third party”; (2) “the Board did not labor under any conflicts of interest”; (3) TransCanada conducted due diligence and received confidential insights about Columbia’s value”; (4) “Columbia contacted other potential buyers, and those parties failed to pursue a merger when they had a free chance to do so”; (5) “Columbia negotiated with TransCanada and extracted multiple price increases”; and (6) “no bidders emerged during the post-signing phase.” While the “sale process was not perfect,” the facts on the whole compared favorably or were on par with the facts in Delaware Supreme Court cases that relied on deal price. On the other hand, the stockholders’ DCF analysis was the “second-best method to derive value,” in light of the fact that a reliable market-based metric was available. The court also declined to deduct from the deal price because the evidence did not show that TransCanada allocated synergies to Columbia as part of the deal price.
The result in this appraisal action underscores that Delaware courts likely will rely on the deal price to determine the fair value of a stock so long as the deal process was sufficiently robust.
DELAWARE COURT OF CHANCERY HOLDS THAT A STOCKHOLDER CAN CONTRACTUALLY WAIVE STATUTORY APPRAISAL RIGHTS
On August 14, 2019, the Delaware Court of Chancery, in Manti Holdings, LLC v. Authentix Acquisition Company, Inc., denied a motion for reargument on the court’s October 1, 2018 opinion, under which the court had held that stockholders had contractually waived their ability to pursue appraisal rights. But the stockholders argued—and the court agreed—that the court had not addressed a predicate issue to the issue of contract interpretation: “whether a stockholder can, via contract, validly waive her appraisal rights to begin with.” The court answered this question in the affirmative.
The case arises from the sale of a company (Authentix, Inc.) in 2017; a stockholder agreement under which stockholders waived their rights to a statutory appraisal; and the stockholders nonetheless seeking statutory appraisal in connection with the 2017 sale. In their motion for reargument, the stockholders argued that Section 262 of the Delaware General Corporation Law (DGCL), which governs a stockholder’s appraisal rights, is a mandatory provision that cannot be waived ex ante. The court rejected that argument and held that a waiver of appraisal rights is ”permitted under Delaware law, as long as the relevant contractual provisions are clear and unambiguous.” This case makes clear for the first time that stockholders may waive appraisal rights in a stockholder agreement, provided that the stockholder agreement is unambiguous.
Anne E. RailtonPartner
Ashley Moore DrakeAssociate