Securities Snapshot
June 15, 2021

Former Theranos CEO Denied Attorney-Client Privilege Over Communications with Company Attorneys

Former Theranos CEO Denied Attorney-Client Privilege Over Communications with Company Attorneys; District of Massachusetts Allows Putative Securities Class Action to Proceed Against OvaScience Investors; Delaware Chancery Court Dismisses $700M Insider Trading Shareholder Suit for Lack of Standing; Florida Federal Judge Dismisses Putative Class Action Investor Suit Over COVID-19 Response

On June 3, 2021, in U.S. v. Holmes, a California federal judge held that former Theranos CEO Elizabeth Holmes could not claim attorney-client privilege over communications with Theranos attorneys at Boies Schiller Flexner LLP to prevent federal prosecutors from using them at her upcoming fraud trial, currently set for August 31, 2021.

Boies Schiller began representing Holmes and Theranos in an intellectual property dispute in 2011, and although the parties never signed a formal engagement letter or established any formal guidelines describing the scope of the firm’s legal representation, Boies Schiller continued to offer Holmes and Theranos a variety of legal services in relation to Theranos’s patent portfolio, press interactions and inquiries from government agencies and departments.  In June 2020, the government served its exhibit list for Holmes’s upcoming trial, which included thirteen documents, all of which Holmes claimed implicated her attorney-client privilege.  Holmes argued that Boies Schiller jointly represented both Theranos and her individually, not merely as a representative of the company. The government moved for an order holding that Holmes lacks an individual privilege interest in Theranos’s corporate documents.

The Court applied the Ninth Circuit’s so-called Graf test, which requires persons seeking to assert individual privilege to satisfy all of the following factors to establish a joint representation: (1) they approached counsel for the purpose of seeking legal advice; (2) when they approached counsel, they made it clear that they were seeking legal advice in their individual rather than in their representative capacity; (3) the counsel saw fit to communicate with them in their individual capacity, knowing that a possible conflict could arise; (4) their conversations with counsel were confidential; and (5) the substance of their conversations with counsel did not concern matters within the company or the general affairs of the company.

The Court found that Holmes failed to satisfy the second, fourth, and fifth prongs of the Graf test, as there was no engagement letter relating to Boies Schiller’s representation of Holmes nor financial records showing that Holmes paid Boies Schiller from her own accounts, and none of the contested documents included conversations exclusively between Holmes and Boies Schiller, nor did they discuss Holmes’s individual legal interests.  Rather, all thirteen documents related to Holmes’s “official duties” at, or the “general affairs” of, the company. Thus, the court held that the documents were only subject to Theranos’ assignee’s corporate privilege, which the assignee waived by informing the government that it would not assert privilege over the materials.

District of Massachusetts Allows Putative Securities Class Action to Proceed Against OvaScience Investors

On May 28, 2021, in Dahhan v. OvaScience, Inc., et al., the District of Massachusetts allowed alleged control person liability claims under Section 20(a) of the Securities Exchange Act of 1934 to proceed against certain outside investors in defendant OvaScience, Inc.  In doing so, the court rejected arguments that the control person claims were untimely. Citing a line of cases requiring allegations of “actual control” to adequately plead Section 20(a) claims, the court held that the two-year statute of limitations applicable to the control person claims does not begin to run until a plaintiff uncovers, or should have uncovered, evidence that the control person actually controlled the primary violator.  In denying motions to strike and dismiss the Section 20(a) claims, the court held that public documents showing a relationship between the control person defendants and OvaScience were evidence of merely the control person defendants’ ability to control, but not evidence of their actual control, as would be necessary to start the clock for the statute of limitations on Section 20(a) claims.

Delaware Chancery Court Dismisses $700M Insider Trading Shareholder Suit for Lack of Standing

On May 28, 2021, in In re SmileDirectClub, Inc. Derivative Litigation, the Delaware Chancery Court dismissed a stockholder derivative suit against directors and officers of SmileDirectClub Inc. (“SDC”) arising out of SDC’s September 2019 $1.3 billion IPO.  The stockholder suit alleged that SDC’s directors and officers breached their fiduciary duties and were unjustly enriched when they agreed for the Company to use the majority of the IPO proceeds to buy back nearly $700 million in pre-IPO units from various insiders, including certain of SDC’s directors and officers.
In connection with its IPO, SDC’s Form S-1 registration statement disclosed that SDC intended, and the board agreed, to use IPO proceeds to complete certain insider transactions for SDC stock that was pre-valued at the opening IPO price of $21.85 per share.  SDC’s Form S-1 also disclosed that these transactions would dilute its public stockholders.  SDC’s sales in the IPO ultimately never reached $21.85 per share, but SDC followed through with its pre-IPO agreements and used the majority of the IPO proceeds to make the pre-planned insider transactions at the $21.85 price per share.
The co-lead stockholder plaintiffs, who purchased SDC stock in the IPO, alleged that SDC’s board members breached their fiduciary duties by opting to cause SDC to pay an “excessively high price” for the stock acquired in the insider transactions.  The defendant board members moved to dismiss, arguing that plaintiffs lacked standing to pursue the derivative claims because the transactions’ terms were determined before the IPO, and as a result, before the plaintiffs became SDC stockholders.  
Citing Delaware Supreme Court precedent, Vice Chancellor Zurn held that it is proper to assess standing to assert a breach of fiduciary duty claim based on when the terms of a challenged transaction are established, as opposed to when the transaction ultimately is carried out. Thus, VC Zurn held, where a plaintiff acquires stock only after a challenged transaction’s terms are set by the board, the stockholder plaintiff lacks standing to bring a derivative claim challenging those terms.  Because the SDC stockholders plaintiffs in this case purchased SDC stock in the IPO — and not before it — they could not establish that they were SDC stockholders when the board approved the insider transactions’ terms before the IPO, and thus lacked standing to pursue their derivative claims.

Florida Federal Judge Dismisses Putative Class Action Investor Suit Over COVID-19 Response

On May 28, 2021, in In re Carnival Corp. Securities Litigation, a Florida federal judge held that investors failed to show “severe recklessness” on the part of Carnival Corporation in connection with the cruise line’s public statements regarding its commitment to and prioritization of health and safety during the height of the COVID-19 pandemic.
The co-lead shareholder plaintiffs alleged that Carnival “publicly downplayed the risk of COVID-19” in a January 2020 news article and in its 2019 Form 10-K, even after one of Carnival’s vendors — based in Wuhan, China — had alerted Carnival of the “scale and severity of COVID-19.”  Plaintiffs further alleged that passengers and crewmembers became severely ill aboard various Carnival ships, including 712 people on just one of Carnival’s cruise ships who tested positive for coronavirus, of whom 12 died.  The Complaint alleged that, despite these tragic events, Carnival still encouraged its sales staff to push selling cruises and to continue to tout its commitment to health and safety while omitting references to the risks of COVID-19 in public statements.
In the months that followed, Carnival’s stock price declined, and Plaintiffs filed a consolidated class action complaint in December 2020, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and SEC Rule 10b-5 thereunder.
U.S. District Judge K. Michael Moore, however, disagreed with plaintiffs’ allegations that Carnival failed to warn its customers of the risks of COVID-19.  Notably, Judge Moore found that Carnival was not required to choose a different course of action — "based on a conversation with a battery manufacturer in Wuhan, China” — rather than basing its decision on “guidance and recommendations from public health officials,” such as the Center for Disease Control or World Health Organization.  Judge Moore also found that most of Carnival’s statements concerned its business goals, which “cannot be objectively measured in the face of a rapidly evolving global pandemic such as coronavirus.”  Judge Moore also refused to “infer” that just because passengers and crewmembers ultimately fell ill aboard its ships, Carnival was noncompliant with health and safety standards.
Finally, Judge Moore held that plaintiffs failed to allege a strong inference that Carnival acted with the requisite scienter, as it was “plausible” that Carnival believed that the risk to its business and passengers was relatively low, given that cases outside of China were only then starting to surface, and because Carnival took measures to further its health and safety goals, “even if those efforts [] ultimately prove[d] to be unsuccessful in the face of a global pandemic.”

Morgan Mordecai

Dylan Schweers