On April 14, 2021, in Melvin Gross v. Biogen Inc., C.A No. 2020-0096 (Del. Ch), Vice Chancellor Paul A. Fioravanti issued a post-trial opinion granting Biogen Inc. (“Biogen”) stockholder, Melvin Gross (“Gross”), the ability to inspect a wide range of the company’s books and records, while denying him access to others. Specifically, the court held that Gross was entitled to certain “board-level” materials concerning a government investigation into Biogen’s alleged violations of the federal Anti-Kick Back Statute, 42 U.S.C. § 1320a-7b(b)(2), but was not entitled to other board-level documents, such as “electronic communications and directors’ notes” related to the investigation.
The opinion stemmed from Gross’s unsuccessful books-and-records demands on Biogen’s board pursuant to Section 220 of the Delaware General Corporation Law. Gross issued three separate demands throughout 2016, all of which sought corporate records concerning Biogen’s “potential corporate wrongdoing and mismanagement” related to a government investigation into Biogen. Biogen denied each demand, primarily contending that Gross lacked the “proper purpose” — i.e., “a purpose reasonably related to [his] interest as a stockholder” — required under Section 220. Undeterred, Gross issued a fourth demand in December 2019, seeking eight categories of records and asserting that his purpose was to: (1) “investigate possible corporate wrongdoing” and (2) “determine the independence of the Board members.” Biogen rejected this demand, too, contending that it still lacked a proper purpose, and that certain of the records sought were not “necessary and essential to” Gross’s stated purposes.
In February of 2020, Gross filed a complaint in the Delaware Court of Chancery, seeking to compel inspection of the Biogen records. The trial took place in August 2020. Throughout the case, Biogen maintained its position that it properly denied Gross’s demands because he lacked the required proper purpose under Section 220. Specifically, Biogen argued that Gross’s stated purpose to “investigate corporate wrongdoing” failed, as: (1) it was not his true purpose, but that of his attorneys; (2) he had not demonstrated a credible basis to suspect wrongdoing; and (3) Gross had not shown that he could bring a lawsuit “based on the wrongdoing he s[ought] to investigate.” Biogen also argued that, because Gross had not established a proper purpose to investigate possible wrongdoing, his stated purpose to investigate the board’s independence necessarily was insufficient.
The court disagreed, first concluding that Gross’s purpose to investigate potential wrongdoing was his own, reasoning that his “heavy” reliance on his lawyers did “not undermine his legitimate concern.” The court was also convinced that Gross met his “minimal burden” of establishing a credible basis for that purpose, as “ongoing governmental investigations,” such as the investigation into Biogen, “can be strong evidence of a credible basis” of wrongdoing. Nor did the court agree with Biogen that Gross’s success depended on showing that he could bring claims based on that wrongdoing, as his demand was not made “solely to pursue litigation.” And because Gross established a proper purpose to investigate corporate wrongdoing, the court determined that he “also stated a proper purpose to investigate” the board’s independence.
Finding a proper purpose, the court next focused on the scope of Gross’s records request. In his first two requests, Gross sought all documents provided to the government during the Biogen investigation and all communications between Biogen and any government agency related thereto. While the court granted Gross access to inspect “board-level” investigation materials, it did not allow Gross access to all documents provided to, and communications with, the government. In denying Gross’s request for the latter, the court explained that many of those documents and communications were simply not “necessary to investigate potential wrongdoing,” and, thus, exceeded the scope of a Section 220 demand.
The court next turned to Gross’s two requests seeking Biogen meeting minutes and policies and procedures related to the government investigation, including “informal” board materials, electric communications, and board notes. The court denied Gross access to the electronic communications, notes, and “informal” board materials, primarily because Gross failed to show that such documents were “necessary” to accomplishing his stated purpose, or that “formal board materials would be insufficient.” The court, however, did grant Gross access to “formal board materials,” such as reports and presentations related to the government’s investigation. The court also granted Gross access to Biogen’s compliance policies and board materials related to Biogen’s oversight of the government investigation. Finally, the court denied Gross access to Biogen’s documents related to “other [similar] stockholders’ demands,” but awarded him access to director independence questionnaires. The court denied access to the former category because Gross failed to explain how they were “necessary and essential” and because Biogen claimed no such demands actually existed. As to the latter, the court permitted inspection because “understanding the directors’ motives and potential conflicts [was] paramount,” and the burden on Biogen to make such production was minimal.
Notably, in granting Gross access to many of the documents he requested in his Section 220 demand, the court noted that this case, and specifically Biogen’s repeated denials to allow Gross to inspect its corporate records, reflected the “recent trend” toward “overly aggressive defense strateg[ies]” by companies opposing books-and-records demands. The case serves as a reminder that such demands must be approached carefully, cautiously, and in good faith.
Southern District of Florida Dismisses Securities Fraud Class Action Against Norwegian Cruise Lines Stemming from Alleged Impacts of COVID-19
On April 10, 2021, a federal judge in the Southern District of Florida granted in full defendants’ motion to dismiss in Douglas et al. v. Norwegian Cruise Lines et al., 1:20-cv-21107 (S.D. Fla.), a putative securities class action case filed by investors in Norwegian Cruise Lines (“Norwegian”). In dismissing the complaint, the court held that none of the challenged statements or omissions was materially false or misleading. Separately, the court held that the plaintiffs failed to sufficiently plead scienter, and that the challenged statements were protected by the safe harbor of the Private Securities Litigation Reform Act (“PSLRA”).
In February 2020, Norwegian and certain of its executives made statements in a press release, conference call, and Form 10-K regarding Norwegian’s Covid-19 marketing strategies, a recent increase in customer cruise bookings, the company’s proactive health safety measures, and its continued adherence to a specified code of conduct. A month later, certain outlets began reporting that Norwegian was engaged in a deceptive marketing scheme to increase cruise bookings during the pandemic, in which Norwegian sales agents were directed to use a series of “one liners” to hesitant customers, including to reassure them that “the coronavirus can only survive in cold temperatures,” and that it “cannot live in the amazingly warm and tropical temperatures that your cruise will be sailing to.”
Alleged Norwegian investors then filed securities class actions, which were consolidated in April and May of 2020. The operative consolidated complaint alleged that Norwegian and certain of its executives violated Sections 10(b) and 20(a) of the Securities Exchange Act (“Exchange Act”) in making the February 2020 statements without disclosing the nature of the allegedly deceptive marketing scheme. Defendants moved to dismiss, arguing that the complaint failed to allege the existence of any material misrepresentation or omission, and failed to properly plead scienter.
In granting defendants’ motion to dismiss, the court held that none of the February 2020 statements was misleading and thus all of the statements were non-actionable, concluding that the statements were “vague and so broad that no reasonable investor would have relied on them,” and amounted instead to mere “corporate puffery.” The court reasoned that statements concerning Norwegian’s marketing strategy did not contain the types of “specific, verifiable facts” investors would reasonably rely upon. Nor did the court find persuasive plaintiff’s “assumption” that Norwegian’s marketing strategy was actually “false or deceptive,” noting that “then-President Donald Trump” made statements similar to the alleged “one-liners,” making it “arguable that [they] were not even deceptive.” The court similarly held that statements regarding Norwegian’s increased customer bookings amounted to no more than puffery, because “no reasonable investor would believe” such statements made “during a global pandemic implied that all was well.” Nor were statements concerning Norwegian’s safety measures actionable, as the plaintiffs failed to allege that any such statements were even false. Finally, the court held that Norwegian’s code of conduct referenced in its Form 10-K did not give rise to a duty to disclose the allegedly deceptive marketing scheme, as the code’s contents therein were classic examples of unactionable “aspirational statements.”
The court separately held that each of the alleged misstatements was protected by the PSLRA’s safe harbor, as each such statement was forward-looking and accompanied by meaningfully cautionary language. And despite the allegations “demonstrate[ing] a troublesome ... scheme to minimize the effects of Covid-19,” the court held that the plaintiffs did not properly plead scienter, reasoning that the allegations were insufficient to establish that Norwegian’s executives “knew about the alleged fraud.”
Ninth Circuit Affirms Dismissal of Securities Fraud Class Action Against Investment Bank
On April 8, 2020, in Prodanova et al. v. H.C. Wainwright & Co. et al., No. 19-56048 (9th Cir.), the Ninth Circuit Court of Appeals affirmed the dismissal of a putative securities class action against investment bank H.C. Wainwright & Co., LLC (“Wainwright”), certain of the Wainwright’s executives, and one of its analysts. The case involved allegations that Wainwright sought to fraudulently inflate the stock price of MannKind Corporation (“MannKind”), a biopharmaceutical company, by publishing a report on October 10, 2017 that set the target price for MannKind stock at $7 per share, but then announcing later that same day that Wainwright would act as a placement agent to connect MannKind with potential investors for a stock offering at $6 per share.
At the end of October 2020, based on Wainwright’s report and MannKind’s subsequent stock offering, a MannKind investor filed a putative class action against Wainwright, its CEO, and the October 10, 2017 report’s author, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, in addition to Section 20(a). Defendants moved to dismiss, arguing, among other things, that plaintiff failed to properly allege scienter. The district court granted the motion, agreeing that plaintiff did not adequately plead scienter. Plaintiff thereafter filed an amended complaint, adding an additional Wainwright executive as a defendant, and supplementary scienter allegations. Defendants again moved to dismiss, arguing that the amended complaint still failed to properly plead scienter. The district court agreed again with defendants, dismissing the amended complaint for failure to adequately plead scienter.
Plaintiff appealed, maintaining that Wainwright published the report with the intent to drive up MannKind’s stock price and increase Wainwright’s compensation from the offering. A three-judge panel of the Ninth Circuit affirmed the dismissal, holding that the complaint did “not offer a plausible motive for [Wainwright’s] actions or provide compelling and particularized allegations about scienter,” but instead actually “supported an inference of nonculpable conduct.”
The Ninth Circuit first held that defendants’ alleged motive — to increase its compensation from the MannKind offering — was implausible. The panel reasoned that this theory did not evidence the “clear financial incentive” needed to support scienter, as the plaintiff failed to explain what Wainwright would gain from a higher per share price when its own compensation was not dependent on that price, and instead was dependent on the offering’s gross proceeds. The panel also reasoned that this alleged motive was implausible, as Wainwright “st[ood] to lose ... from its allegedly fraudulent conduct,” because its error in publishing the report “sull[ied]” its reputation and hurt its relationship with MannKind. The panel thus concluded that “the only plausible explanation” was that Wainright “pulled a Bill Buckner and somehow let a glaring conflict pass by,” equating the slip-up to “an embarrassing Red Sox error [unlike] an elaborate Black Sox fraud.”
The panel then held that the plaintiff failed to allege with the required particularity that any defendant acted with scienter. The panel reasoned that the plaintiff failed to allege any facts demonstrating the report’s author knew about the MannKind stock offering when issuing the report, leaving no basis to conclude he acted with scienter. The panel further reasoned that the plaintiff’s “generalized allegations” failed to show that Wainwright’s executives had any direct involvement with the report, a prerequisite to finding that they acted with scienter. And the panel held that the complaint did not allege “particularized facts” to support plaintiff’s allegation that Wainwright’s compliance department knew about the dilutive offering when it approved the report for publication.
Finally, the panel held that neither the so-called “core operations” doctrine, which presumes corporate executives have “knowledge of the critical core operations of their companies,” nor defendants’ alleged failure to correct the report, supplied the required, but missing, scienter. As to the core operations doctrine, the Ninth Circuit panel reasoned that plaintiff did not plead the particularized level of facts necessary to support application of this doctrine, nor would it be “absurd” to believe that Wainwright’s officers were unaware of the conflicts between the report and the dilutive offering. Regarding the defendants’ alleged failure to correct the report, the panel declined to recognize a duty to correct it, especially as the complaint did not plead the particularized facts required to show that any defendant acted with scienter.
In SEC Enforcement Action Against Ripple Labs, Inc., S.D.N.Y. Court Orders Government to Turn Over Documents Discussing Whether Bitcoin, Ether, or XRP Are “Securities”
On April 6, 2021, in SEC v. Ripple Labs, Inc. et al, 1:20-cv-10832 (AT)(SN) (S.D.N.Y.), U.S. Magistrate Judge Sarah Netburn granted a motion to compel discovery filed by Ripple Labs, Inc. (“Ripple”) and ordered the Securities and Exchange Commission (“SEC”) to search for and produce a wide range of documents — including communications between the SEC and third parties — concerning Bitcoin, Ether, and XRP. The discovery win, secured at a telephonic conference attended by 500 people, is the latest development in what the court called “an incredibly high-stakes, high-value” SEC action against Ripple, its CEO, and Chairman of its Board of Directors.
In December 2020, the SEC filed its complaint alleging that, from 2013 through 2020, the defendants offered and sold more than $1.38 billion worth of XRP, which the SEC alleges is an unregistered security rendering the offers and sales of it a violation of Sections 5(a) and 5(c) of the Securities Act of 1933, 15 U.S.C. § 77e (“Section 5”). The complaint further alleged that Ripple’s CEO and Chairman aided and abetted Ripple’s violations of Section 5 by knowingly or recklessly assisting in Ripple’s sales of XRP over the same period. In response, defendants have argued that (i) XRP is not a security and, therefore, its offering and sale did not require registration, and (ii) Ripple lacked fair notice that its conduct violated the law, due to the asserted absence of clear guidance or interpretation from the SEC concerning XRP.
Last January, the defendants served discovery requests seeking SEC communications regarding XRP, Bitcoin, and Ether. The defendants asserted that such communications are relevant to whether the SEC and market participants viewed sales of XRP as “securities offerings” or instead viewed them as similar to sales of Bitcoin and Ether, which are other digital assets that the SEC previously has recognized as non-securities. In response, the SEC produced only its “investigatory file” for XRP and Ripple, refusing to search for (let alone produce) documents regarding Bitcoin or Ether, or any internal SEC communications at all, even those bearing directly on the status of XRP. In March 2021, defendants moved to compel production of the requested discovery.
In her order, Judge Netburn largely agreed with defendants, determining that much of the information sought, including internal SEC minutes and formal memoranda, was relevant to several key issues in the litigation, including whether (i) the sale of XRP is a “securities offering,” and therefore subject to federal registration requirements, (ii) Ripple’s executives were reckless in thinking that XRP was not a security, and (iii) the defendants were deprived of fair notice that XRP sales required registration based on the SEC’s own conduct. The court denied, however, the defendants’ request for internal SEC emails between or among SEC staff, determining that such communications are “less relevant as ... [to] how the market is considering XRP and ... how it affects [the individual defendant’s] reasonable belief.” The court further held that requiring the SEC to produce such communications would have “the potential to seriously chill government deliberations.”
Even excluding such internal staff-to-staff emails, however, the Court ordered the production of responsive documents from 19 SEC custodians, including former SEC Chairman Jay Clayton and SEC Commissioners Elad Roisman and Hester Peirce, among other former and current high-ranking SEC officials.
In Unusual About-Face, Federal Prosecutors Drop Securities Fraud Case Against Former Brixmor Property Group Inc. Executives
On April 1, 2021, in United States v. Michael Carroll and Michael Pappagallo, 1:19-cr-00545-CM (S.D.N.Y.), a federal court in the Southern District of New York permitted Manhattan federal prosecutors to formally abandon securities fraud charges against two former executives of Brixmor Property Group Inc. (“Brixmor” or “the Company”). Prosecutors concluded that the government could not prove that the allegedly misleading accounting adjustments made by the Company between 2013 and 2015 were part of a scheme to defraud. The government’s decision was prompted by information provided by defense counsel months before a then-scheduled January 2021 trial date that purportedly showed that analysts and auditors were fully aware of the allegedly misleading accounting adjustments when they were made. Subsequently, after further investigation, the government moved for, and the court entered, an order of nolle prosequi dismissing the case.
In July 2019, the former CEO and CFO of Brixmor, a publicly traded real estate investment trust (“REIT”), were charged with six counts of securities fraud arising from an alleged accounting scheme to fraudulently manipulate certain financial metrics contained in Brixmor’s public filings between 2013 to 2015. Specifically, the indictment alleged that the defendants fraudulently manipulated the REIT’s reported figures for Same Store Net Operating Income (“SS-NOI”) Growth — a non-GAAP metric used by REITs to measure financial performance by a quarter-over-quarter comparison — to ensure the numbers were consistent with the REIT’s earnings projections and reflected stable growth. The indictment further alleged that the defendants manipulated these quarterly figures, in large part, through “cookie jar accounting,” which involved illicitly “storing” certain income that should have been immediately recognized to “boost” figures reported in subsequent quarters.
In the government’s March 31, 2021 letter to the court requesting dismissal, the government explained that, in October and November 2020, defendants’ counsel provided presentations to the government regarding particular accounting adjustments that formed a significant portion of the allegedly misstated SS-NOI metric. Specifically, the presentation concerned the REIT’s deferral of a certain category of accounting items affecting the first four quarters of the alleged scheme, which also reflected “the four quarters with the largest misstatements alleged in the Indictment.” In statements to Law360 and the Wall Street Journal, counsel for the defendants later stated that they also provided to the government evidence that the adjustments in question had been fully disclosed to analysts and Brixmor’s auditors. Regardless, after further investigation, the government ultimately concluded that it could not “prove beyond a reasonable doubt that the conduct that resulted in these particular accounting adjustments ... was part of a scheme to defraud.” Without such proof, the government asserted that it would not be able to successfully prosecute the case. Accordingly, the government moved for voluntary dismissal.
Despite dismissal of the criminal charges, defendants, for now, still face a SEC civil enforcement action arising from the same underlying conduct, in SEC v. Carroll, et al, 1:19-cv-07199-AT (S.D.N.Y.). The civil case had been stayed pending the resolution of the parallel criminal proceeding. The SEC has until April 30, 2021 to evaluate the bases of the criminal dismissal before it must inform the court whether it wishes to proceed.