On July 2, 2021, in Pivotal Software, Inc. v. Tran, No. 20-1541, the U.S. Supreme Court granted certiorari to decide whether the automatic discovery stay established by the Private Securities Litigation Reform Act of 1995 (“PSLRA”) applies to cases under the Securities Act of 1933 when they are brought in state court. The PSLRA’s automatic discovery stay generally stays all discovery during the pendency of a motion to dismiss.
The case arises out of Pivotal’s April 2018 IPO and subsequent August 2019 merger with VMware, Inc. Pivotal’s investors filed actions in both federal and state court, alleging, among other things, that Pivotal’s 2018 registration statement was prefaced on misleading statements about its cloud-based software and applications products. The state-court plaintiffs agreed to pause their case while the federal court action was pending. But soon after Pivotal was successful in moving to dismiss the federal action, the state-court plaintiffs immediately sought discovery from the company. In response, Pivotal requested that the California Superior Court stay discovery pursuant to the PSLRA. The court, however, decided that the automatic stay provision applied only to actions in federal court, such that Pivotal could not avail itself of it. The California Court of Appeal and California Supreme Court refused to consider the issue, prompting Pivotal to seek input from the U.S. Supreme Court.
Whether the PSLRA’s automatic discovery stay applies to Securities Act cases brought in state court has taken on greater significance since the U.S. Supreme Court’s decision in Cyan, Inc. v. Beaver County Employees Retirement Fund (2018), holding that state courts possess concurrent jurisdiction over Securities Act claims. As a result of the Cyan decision, the number of Securities Act claims filed in state court has increased and state courts remain deeply divided as to the applicability of the PSLRA’S automatic discovery stay.
The U.S. Supreme Court’s decision in Pivotal could have a significant impact on securities litigation (decision expected in early 2022). A ruling that the PSLRA’s automatic discovery stay applies to Securities Act cases brought in state court, just as in federal court, would help ensure that such cases are litigated under similar rules whether filed in state or federal court. A ruling that the PSLRA’s automatic discovery stay does not apply to Securities Act cases brought in state court, however, might result in a further shift of Securities Act cases to state court and increased litigation and litigation-related costs for defendants. Further details on the case and its potential impact can be found in Goodwin’s July 8, 2021 Client Alert.
Delaware Court of Chancery Dismisses Stockholder Suit Against FedEx for Failure to Make Pre-Litigation Demand
On June 28, 2021, in Pettry v. Smith, No. 2019-0795 (Del. Ch.), the Delaware Court of Chancery kicked a stockholder derivative suit on behalf of FedEx Corporation alleging that the company’s board of directors and two of its officers breached their fiduciary duties to the company. The court held that the action could not survive because lead-plaintiff did not demand that the FedEx Board investigate her claims and did not adequately plead that such a demand would have been futile.
The case stems from FedEx’s purported illegal shipment of cigarettes between 2006 and 2016 and associated state enforcement actions against the company. In December 2018, FedEx settled these actions for $35 million after it was found liable for violations of the Contraband Cigarette Trafficking Act and other regulatory shortcomings based on delivery of untaxed cigarettes into the state. As a result, in October of 2019, plaintiff brought a derivative claim on behalf of FedEx against members of the board for breach of the duty of loyalty and against certain FedEx officers for gross negligence, claiming that they “disregard[ed] illegal activity associated with cigarette shipments.” Specifically, the complaint alleged that the board was aware of the company’s allegedly illegal cigarette shipments as early as July 2012, but “did nothing to remediate the shipments.”
Defendants moved to dismiss, arguing that plaintiff did not make a pre-suit demand on the Board or plead that such a demand was excused as futile. Defendants separately moved to dismiss for failure to state a claim, arguing that the complaint’s conclusory allegations of the board’s inaction were contradicted by the board’s decisions to investigate the shipments in 2014, punish responsible employees, ban all cigarette shipments, and implement specific training and compliance programs.
The court dismissed the complaint, with prejudice, holding that plaintiff did not “demonstrate demand on the board would have been futile” because there were no “particularized facts” establishing that it was “reasonably conceivable a majority” of defendants “face[d] a substantial likelihood of liability for ignoring red flags in a manner demonstrating a conscious failure to monitor or oversee corporate operations.” In so doing, the court focused primarily on the robust actions the board took upon becoming aware of the cigarette shipments. For example, after receiving the first “red flag” of a problem in July of 2012, the board immediately engaged counsel “with respect to illegal cigarette shipments that occurred between 2006 and 2012, and then with respect to allegations that illegal shipments continued after 2012.” Additionally, the board responded to a litigation demand from a shareholder on the issue by “delegat[ing] its authority to investigate and respond” to a committee, which decided not to pursue claims on behalf of the company, and did not “sit on its hands and do nothing.” Moreover, FedEx reprimanded employees and banned cigarette shipments altogether in April of 2016. Thus, according to the court, “[w]hen viewing the Board and management’s actions in their totality,” between 2012 and 2018 “[i]t [wa]s not reasonably conceivable that the Board acted in bad faith in consciously disregarding its duty to oversee the affairs of the [c]ompany.”
Delaware Supreme Court Reverses Court of Chancery’s Entire Fairness Ruling
On June 28, 2021, in Coster v. UIP Companies, Inc., No. 2018-0440 (Del. 2021) the Delaware Supreme Court reversed the Delaware Court of Chancery’s ruling on the conclusive effect of its entire fairness review of a stock sale of UIP Companies, Inc. and remanded for consideration of the board’s motivations and purpose for the stock sale.
The case results from two equal stockholders of UIP who were deadlocked and could not elect new directors. One of the stockholders, Marion Coster, filed suit in the Delaware Court of Chancery, requesting appointment of a custodian for UIP under 8 Del. C. § 226(a)(1). In response, the three-person UIP board of directors — composed of UIP’s chairman, Steven Schwat, and two other directors aligned with him — voted to issue a one-third interest in UIP stock to fellow director Peter Bonnell. The defendants, UIP, Schwat, and Schwat Realty LLC, allegedly issued the stock to dilute Coster’s UIP ownership interest below 50%, block her attempts to elect directors, and avoid a possible court-appointed custodian.
Coster filed a second action in the Court of Chancery, claiming that the board breached its fiduciary duties by approving the stock sale, and asking the court to cancel the stock sale. The Court of Chancery consolidated and found that the conflicted UIP board issued stock to Bonnell to dilute Coster’s UIP interest below 50%, break the stockholder deadlock for electing directors, and avoid a custodian action. Regardless, the Court of Chancery decided not to cancel the stock sale, because the “UIP board approved the Stock Sale at a fair price and set that price through a fair process” and, as a result, satisfied the entire fairness standard of review. Thus, the court held that the board did not breach any fiduciary duty owed to Coster.
The Delaware Supreme Court reversed the Court of Chancery decision on the conclusive effect of its entire fairness review, and remanded for the Court of Chancery to consider the board’s motivations and purpose for the stock sale. The Delaware Supreme Court observed that it may well be that the price at which the board agreed to sell the one-third UIP equity interest to Bonnell was entirely fair, but “inequitable action does not become permissible simply because it is legally possible.” In other words, if the board approved the stock sale for inequitable reasons, the Court of Chancery should have cancelled the stock sale. Further, if the board, acting in good faith, approved the stock sale for the purpose of thwarting Coster’s vote to elect directors or reduce her leverage as an equal stockholder, a compelling justification for such action should have been demonstrated to withstand judicial scrutiny.
The Delaware Supreme Court ultimately left the Court of Chancery with the direction that, after remand, if the court decides that the board acted for inequitable purposes or in good faith but for the “primary purpose of disenfranchisement without a compelling justification,” it should cancel the stock sale and decide whether to appoint a custodian for UIP.
Eleventh Circuit Vacates Denial of Class Certification as Untimely, Citing PSLRA’s Automatic Discovery Stay
On June 29, 2021, in Rensel v. Centra Tech Inc., No. 20-10894 (11th Cir.), the U.S. Court of Appeals for the Eleventh Circuit vacated a district court’s denial of class certification in a putative securities class action filed by investors in Centra Tech, Inc. The Eleventh Circuit held that the district court erred in finding that the investors’ motion was untimely, since the PSLRA’s automatic stay provision “effectively deprived them of any opportunity to conduct discovery in support of class certification.”
The dispute centers around Centra Tech’s Initial Coin Offering (“ICO”) taking place between July 2017 and April 2018. During the ICO process, Centra Tech made a variety of false statements to its investors, including informing them that major credit card companies had signed on in support of Centra Tech’s products, and Centra Tech’s founders ultimately plead guilty to criminal securities and wire fraud charges as a result.
Prior to the criminal convictions, an ICO investor filed suit against Centra Tech and some of its executives in December 2017, alleging that they sold unregistered securities in violation of Sections 12(a)(1) and 15(a) of the Securities Act of 1933. Defendants moved to dismiss, which triggered the PSLRA’s automatic discovery stay. In September 2018, the district court granted lead plaintiff leave to file an amended complaint (and simultaneously denied the still-pending motion to dismiss as moot), which led to a short-lived lifting of the PSLRA’s discovery stay. It was, however, back in effect in December 2018 when defendants moved to dismiss the amended complaint (alleging similar unregistered securities claims, adding allegations of material misrepresentations in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and naming additional defendants). In January of 2019, the court entered default judgment against Centra Tech for failure to appear. Plaintiffs eventually voluntarily dismissed all of their claims against the other defendants, leaving Centra Tech as the sole defendant by June 2019. At this point, no motions to dismiss remained pending, and the PLSRA’s discovery stay finally lifted. Later that month, Plaintiff moved for default judgement against Centra Tech and for certification of three subclasses.
The U.S. District Court for the Southern District of Florida denied the motion for class certification, providing two alternative reasons for its decision. First, the court held that plaintiff’s motion was untimely under Federal Rule of Civil Procedure 23(c)(1)(A), which dictates a class should be certified at an “early practicable time.” The court reasoned that the eighteen months between the initial complaint and the motion for class certification, and the six months between the amended complaint and the motion, rendered it untimely, and that there was no excuse for plaintiffs’ delay. Second, the court held that the proposed sets of subclasses were not ascertainable, as required under Rule 23, because plaintiffs did not “propose an administratively feasible method of identifying absent class members.”
After entry of final judgment, plaintiffs appealed the district court’s class certification denial. The Eleventh Circuit vacated and remanded, holding that the district court abused its discretion in denying plaintiffs’ motion. The Eleventh Circuit primarily addressed the timeliness of plaintiffs’ motion, reasoning, among other things, that because the PSLRA’s discovery stay was in place for roughly fifteen of the eighteen months the litigation was pending, plaintiffs were essentially prevented from moving for class certification any earlier than June of 2019. The Eleventh Circuit also noted that the district court did not set a deadline by which plaintiffs were required to file a motion for class certification, which “deprived [them] of any notice” their June 2019 motion could be “denied as untimely.”
SEC Files Complaint Against Parallax Health Sciences, Inc., Alleging Healthcare Company Misled Investors Concerning Ability to Capitalize on COVID-19 Pandemic
On July 7, 2021, the SEC filed a complaint in the U.S. District Court for the Southern District of New York against Parallax Health Sciences, Inc. and two of its executives alleging that the healthcare company misled investors when it issued a series of press releases purportedly containing misrepresentations about its COVID-19 screening test and the company’s access to personal protective equipment.
Specifically, the complaint asserts violations of Sections 17(a)(1) and (3) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against the company and its CEO, with the Parallax’s CTO facing a count of violating Section 17(a)(3) of the Securities Act of 1933. The complaint alleges that between March and April of 2020, Parallax released a series of seven press releases that “mislead investors about the company’s ability to capitalize on the COVID-19 pandemic” by deceiving investors as to the impending availability of its COVID-19 test, as well as the company’s access to PPE.
According to the complaint, the first release, issued in March of 2020, disclosed that Parallax intended to develop a rapid screen test for COVID-19 and was in discussions with the Centers for Disease Control and World Health Organization on these efforts. The company also issued three additional press releases that same month representing that the screening test would be “available soon.” The complaint alleges that the company and its CEO either “knew or recklessly ignored” that it was not actually in discussions with CDC or WHO and that “the test would not be available within the timeframes . . . represented to investors.” The SEC also alleged that the company was either aware, or recklessly ignored, that Parallax was insolvent (a fact allegedly not disclosed to investors), and therefore “lacked the funds to develop a COVID-19 test.”
Finally, the complaint also alleges that Parallax “falsely stat[ed]” that it “had available for immediate sale” COVID-19 tests produced by other companies as well as PPE and other medical equipment. The SEC pointed to a series of press releases, issued between March 23, 2020, and April 9, 2020, in which the company stated, among other things, that it could “immediately provide a solution to fill the void of overwhelming demand” for PPE. Parallax also purportedly offered equipment for sale on its website that it did not actually possess, but was only in the process of acquiring through a supplier. But, according to the complaint, Parallax was insolvent and unable to complete the PPE transaction due to financial constraints and, therefore, “was not in a position to deliver” any PPE whatsoever.
The complaint alleges that the company and its executives issued the misleading statements “with the intent to artificially increase, or at least stabilize, Parallax’s stock price,” which had dipped from $0.070 per share to a low of $0.025 per share between January and March of 2020. According to the SEC, Parallax’s average stock price increased 20% from $0.045 per share prior to the press releases to $0.054 per share after. Notably, to further its fraud allegations, the SEC’s complaint references the fact that Parallax’s CEO and CTO were uniquely “impacted by Parallax’s declining stock price, because each had accepted stock and options in lieu of salary.” The SEC’s statement on the complaint noted that “[e]ach party has offered to settle the charges.” Moreover, the SEC noted that the Commission temporarily suspended trading in Parallax’s common stock on April 10, 2020, due to questions about the accuracy of the company’s statements.