On April 7, 2022, the Delaware Court of Chancery dismissed a derivative suit against certain of Cigna Corporation’s (“Cigna”) directors and officers alleging breach of their fiduciary duties in connection with the failed merger of Cigna and Anthem, Inc. (“Anthem”) in 2016. Vice Chancellor Travis Laster, who also presided over an earlier suit between the two companies regarding the termination of the merger, ruled from the bench that the plaintiffs had failed to adequately plead demand futility.
The derivative suit arose out of alleged interference on the part of the defendants in the merger of Cigna and Anthem, a proposed transaction that was originally announced in 2015. While Cigna CEO David Cordani sought to be the leader of the combined company and had strong support from the Cigna board, the merger agreement ultimately named Anthem’s CEO, Joseph Swedish, to serve as the CEO of the combined company, with the majority of the surviving board also being appointed by Anthem. After the deal was originally approved by Cigna stockholders in December 2015, conflicts between Cigna and Anthem management continued over the lengthy post-signing period, including disputes between Cordani and Swedish over the leadership of the combined company after the merger and the scope of Cordani’s responsibilities.
After attempts to garner support to confirm a path for Cordani to eventually succeed Swedish as combined-company CEO proved unsuccessful, Cigna allegedly hired consultants to launch a “covert communications campaign” to develop a media narrative portraying the merger as anti-competitive, anti-consumer, and anti-innovation. When the U.S. Department of Justice (“DOJ”) informed Cigna and Anthem that it had concerns regarding the competitive impact of the merger, Cigna obstructed Anthem’s divestiture efforts aimed at addressing these concerns. In July 2016, the DOJ sued to block the merger as anticompetitive. Cordani allegedly supported the DOJ’s suit by providing testimony helpful to the antitrust regulators at his deposition and at trial. The DOJ ultimately prevailed in its suit and obtained a preliminary injunction to block the merger on February 8, 2017, which was affirmed on appeal.
On February 14, 2017, Cigna delivered a notice of termination to Anthem. Anthem sued Cigna later that day in the Delaware Court of Chancery for breach of contract and moved for a temporary restraining order to preclude Cigna from terminating. Cigna simultaneously filed a separate suit alleging that Anthem breached its obligations to obtain regulatory approval, and seeking recovery of a $1.85 billion reverse termination fee under the terms of the merger agreement. The court ultimately denied Anthem’s preliminary injunction application, the merger was then officially terminated on May 12, 2017, and the two cases were then consolidated and continued as a damages action.
Following an eventual bench trial, the Court of Chancery concluded in an August 2020 post-trial opinion that Cigna’s efforts to undermine the merger constituted a breach of the merger agreement and Cigna was therefore not entitled to a termination fee. The court awarded no damages to Anthem, however, finding that the DOJ still would have obtained an injunction against the merger, even without Cigna’s efforts. Following the court’s ruling, the plaintiffs filed the instant derivative suit in November 2020, asserting breach of fiduciary duty and related claims against Cordani, six other Cigna directors, and Cigna’s general counsel. The claims were premised upon the court’s factual findings that the defendants’ efforts to undermine the Anthem-Cigna merger forfeited Cigna’s right to a termination fee once the merger was enjoined by the DOJ.
Because the plaintiffs did not make a demand upon the Cigna board before filing the derivative action, they were required to show such a demand would be futile because a majority of directors at the time of filing either (1) received a material personal benefit from the alleged misconduct, (2) faced a substantial likelihood of liability as a result of the alleged misconduct, or (3) lacked independence from someone who received a material personal benefit or faced a substantial likelihood of liability. The plaintiffs contended that such a demand would be futile because seven of Cigna’s thirteen directors were either beholden to Cordani or faced a substantial likelihood of liability for sabotaging the merger to serve Cordani’s interests. Applying the demand futility standard set out in the Delaware Supreme Court’s recent Zuckerberg decision, the court rejected the plaintiffs’ demand futility arguments, finding that only Cordani and one other director rather than a majority of the Cigna board — could not have impartially considered a demand.
First, the court found that the Cigna board members’ alleged general resistance to the merger was insufficient to establish that the board members faced a substantial likelihood of liability for breaching their fiduciary duties. The court noted that, while Cigna’s actions aimed at undermining the merger were found to have constituted a breach of contract in the earlier litigation, it did not “necessarily follow that those actions constituted a breach of duty,” because “[t]he directors could have concluded that it was in the best interests of Cigna and its stockholders to escape from the merger agreement, even if that meant losing the termination fee or exposing Cigna to damages for breach.” Accordingly, the only way for the plaintiffs to challenge the directors’ independence or disinterestedness was to demonstrate that they were beholden to Cordani and therefore opposed the merger to further Cordani’s (rather than Cigna’s) interests. The court observed that the plaintiffs’ claims focused primarily on “Cordani's preternaturally charismatic leadership and the bonds that he's been able to forge in the boardroom,” rather than, as is more typical, “an employment relationship or a family connection or years of close friendship,” which the court ultimately deemed to be insufficient.
When considering the directors individually, the court found — and the defendants did not contest — that Cordani could not have properly considered a demand. The court also agreed with the plaintiffs’ contention that one director with whom Cordani had a “very close relationship” could not have impartially considered a demand. The court then considered two directors who had been selected by Cordani to remain on the board of the post-merger company. Though the court inferred that their selection indicated that they were “part of the group ... [that was] the most loyal to Cordani,” the court ultimately found that these directors had merely shown “strong support” for Cordani’s leadership, which was not sufficient to impugn their ability to independently consider a demand. Finally, the court found the plaintiffs’ allegations as to the remaining three directors, who were not asked by Cordani to join the board of the post-merger company, to be insufficient, because these directors’ resistance to the merger did not “inherently equate to a fiduciary breach” where the plaintiffs had failed to establish any connections between these directors and Cordani. As the plaintiffs did not challenge the ability of the six other directors that had joined Cigna’s board after the failed merger to consider a demand, the court found that the plaintiffs failed to adequately allege that a derivative demand would have been futile as to a majority of Cigna’s board members, and therefore demand was not excused.
The PCAOB Sanctions Former KPMG Vice Chair Of Audit For Failure To Supervise Senior Members Of KPMG's Audit Practice
On April 5, 2022, the Public Company Accounting Oversight Board (the “PCAOB”) issued a release instituting disciplinary proceedings, making findings, and imposing sanctions on Scott Marcello, who served as Vice Chair of Audit for KPMG LLP from July 2015 until April 2017. The PCAOB censured and imposed a civil monetary penalty of $100,000 on Marcello after finding that he failed to reasonably supervise senior members of KPMG’s audit practice pursuant to Section 105(c)(6) of the Sarbanes-Oxley Act of 2002.
The PCAOB found that several of Marcello’s subordinates, including his direct report, obtained confidential lists of the PCAOB’s selected audits in advance of its 2016 and 2017 inspections of KPMG, and that the individuals enhanced KPMG’s audit documentation for those selected audits in order to improve the inspection results. The PCAOB found that Marcello’s subordinates’ misconduct violated PCAOB rules and federal securities laws related to the preparation and issuance of audit reports and the obligations and liabilities of accountants.
The release described how the PCAOB had found that the number of inspected audits in which KPMG failed to obtain sufficient evidence to support its audit opinions (or failed to fulfill the objectives of its role when it was assigned work by another auditor) increased from 22% in 2010 to 54% in 2014. In response to these findings, KPMG took steps to improve its results, including by hiring personnel directly from the PCAOB’s Division of Registration and Inspections. The PCAOB also found, however, that between 2015 and February 2017, members of the Inspections group of KPMG’s Department of Professional Practice began conspiring with a PCAOB employee to obtain confidential lists of intended PCAOB inspections and areas of focus, and then used that confidential information to target KPMG’s resources to those areas. In particular, in March 2016, the Inspections group obtained a confidential list of several KPMG issuer clients whose audits the PCAOB intended to review as part of its 2016 inspection. The Inspections group then re-reviewed the audit work for the clients on the list and attempted to address any alleged concerns or problems in advance of the PCAOB audit. Similarly, in February 2017, the Inspections group received a confidential list of all of the KPMG clients whose audits the PCAOB intended to review as part of its 2017 inspection. At this time, a KPMG partner recognized that the list was confidential information that KPMG should not have access to, and immediately reported the list to a supervisor, who informed Marcello. Marcello then escalated the matter to KPMG’s Office of General Counsel, which conducted an internal investigation and escalated the issue to the SEC.
The PCAOB found that Marcello, who was responsible for KPMG’s audit practice, including the Inspections group, was a “supervisory person” of KPMG under Section 105(c)(6). The PCAOB further found that Marcello failed in his supervision of his subordinates because he did not take appropriate and immediate steps when he allegedly learned from his direct subordinate both in March 2016, and again in February 2017, that KPMG had received confidential PCAOB inspection information. Instead, the PCAOB found that Marcello did not report the receipt of the confidential information until one week after receiving the information from his subordinate in February 2017, when he learned that the information was going to be escalated within the organization through other channels.
Marcello submitted an offer of settlement pursuant to PCAOB Rule 5205, through which he consented to censure and the civil monetary penalty of $100,000, which is the largest monetary penalty ever imposed on an individual in a settled case.
Arising out of this same misconduct, on June 17, 2019, in Release No. 86118, the SEC announced a settlement with KPMG for violations of PCAOB Rule 3500T. Under the terms of the settlement, KPMG was ordered to cease and desist from further violations of PCAOB Rule 3500T; consented to censure; agreed to comply with certain enumerated remedial measures, including certifying yearly that it is meeting ethical standards; and agreed to pay a civil penalty in the amount of $50 million to the SEC.
And while Marcello himself has not faced criminal liability arising out of this misconduct, the former KPMG executives whom Marcello supervised have, including David Middendorf, who was sentenced on September 11, 2019, to one year and one day in prison for participating in a scheme to defraud the PCAOB, and David Britt, who pled guilty on October 3, 2019, for participating in the scheme and was sentenced to six months of home confinement and then removed from the United States to his native Australia.
Ninth Circuit Affirms Dismissal Of CytoDyn Shareholders' Bid To Force CEO To Disgorge Short-Swing Profits
On April 8, 2022, the U.S. Court of Appeals for the Ninth Circuit affirmed a district court’s dismissal of a suit by alleged shareholders of CytoDyn, Inc. (“CytoDyn”), a publicly-traded biotechnology company incorporated in Delaware. The plaintiffs sought to force CytoDyn’s CEO, Nader Pourhassen, to disgorge profits that he earned from alleged short-swing sales of CytoDyn stock in violation of Section 16(b) of the Securities Exchange Act of 1934. The Ninth Circuit affirmed the lower court’s conclusion that the transactions at issue fell within an exception for the sale of stock that was acquired from the company with the approval of the company’s board of directors.
In December 2019, CytoDyn’s board granted Pourhassen options to purchase 2 million shares of CytoDyn stock and warrants giving him the right to purchase an additional 2 million shares of CytoDyn stock. The award of options and warrants was approved during a meeting of four out of five members of CytoDyn’s board, including Pourhassen. Three of the four board members voted in favor of the award; Pourhassan did not cast a vote. Pourhassen exercised his options and sold all 2 million shares in April and May of 2020.
Although Section 16(b) requires corporate insiders, including executives, officers, and directors, to return to the company any profits that they realize from buying and selling company stock within any six month period, regardless of whether the transactions were actually based on any inside information, the SEC has created several exemptions from this strict liability provision, including SEC Rule 16b-3(d)(1), which exempts transactions involving acquisitions of stock from the issuer that were “approved by the board of directors of the issuer.” The plaintiffs argued that this exception was inapplicable because Pourhassen’s options were not approved by all members of CytoDyn’s “full board” of five directors. The Ninth Circuit rejected this argument, noting that “[t]he operative text from the rule is ‘approved by the board of directors’; the two component phrases are ‘approved’ and ‘board of directors.’” In examining the term “approved,” the Ninth Circuit found that the approval of options by a bare majority of board members constituted “approval” under both Delaware law and CytoDyn’s bylaws. In examining the term “board of directors,” the Ninth Circuit found that there was no support in Rule 16b-3(d)(1) itself or other SEC guidance for the position that the “board of directors” meant that each and every director must approve a transaction for the Rule’s exception to apply. In particular, the Ninth Circuit noted that the term “full board” does not appear anywhere in the rule itself, and found that the inclusion of the term “full board” in the rule’s preamble stating that Rule 16b-3(d) requires the “approval of either the full board, the committee of Non-Employee Directors or shareholders” was merely intended to distinguish between exemptions which require the approval of the board of directors as a whole and those which require approval of a committee of the board.
Accordingly, the Ninth Circuit disagreed with the plaintiffs’ contention that SEC Rule 16b-3(d)(1) required the approval of the “full board” and concluded that approval of Pourhassen’s option awards by three of Cytodyn’s five directors was sufficient to trigger the exception to Section 16(b)’s short-swing disgorgement requirement. The decision affirms that a board’s approval of an insider’s acquisition of securities from the company by a vote that complies with state corporate law and the company’s bylaws will protect the insider from having to disgorge profits from the sale of securities under Section 16(b).
Southern District Of California Dismisses Class Action Claims Against Biopharmaceutical Company Developing COVID-19 Treatment
On April 11, 2022, the U.S. District Court for the Southern District of California dismissed a putative securities class action complaint against Sorrento Therapeutics, Inc. (“Sorrento”), a clinical-stage biopharmaceutical company, and certain of its executive officers, holding that the plaintiff failed to sufficiently plead with particularity how statements made during a one-week period in May 2020 were materially false or misleading, and also failed to sufficiently plead scienter.
On May 26, 2020, the plaintiff filed a consolidated class action complaint, asserting claims against defendants Sorrento; Chairman, President, and CEO Henry Ji; and Senior Vice President of Regulatory Affairs Mark Brunswick under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b–5 promulgated thereunder. The plaintiff alleged that between May 15, 2020, and May 20, 2020, the defendants made false statements about the efficacy of a monoclonal antibody treatment Sorrento was developing to treat COVID-19. In particular, the plaintiff alleged that Ji and Brunswick made statements in a Fox News article, a Biospace article, and an appearance on Yahoo! Finance, suggesting that Sorrento’s monoclonal antibody known as STI-1499 — still in preclinical testing at the time — could be a cure for COVID-19, causing Sorrento’s stock price to rise. By May 20, several publications questioned the accuracy of these statements, and Sorrento issued statements clarifying that STI-1499 “might be” or “potentially” could be a cure, causing Sorrento’s stock price to decline. The plaintiff alleged that these statements caused damage to the shareholders who had purchased Sorrento stock during that time.
The court dismissed the initial consolidated class action complaint on November 18, 2021 with leave to amend, holding that the complaint failed to establish a strong inference of scienter.The plaintiff filed the amended complaint on November 30, 2021, adding allegations that defendants manipulated preclinical trials and deceived investors in order to artificially inflate stock price, raise capital, and retire high-interest debt.
The court dismissed the amended complaint, holding that it did not sufficiently plead with particularity how each challenged statement was allegedly misleading. Specifically, the court found that the defendants’ statements about the efficacy of STI-1499 were non-actionable generalized assertions of corporate optimism or “mere puffery,” and that the defendants had also disclosed that Sorrento’s monoclonal antibody treatment had not yet moved to Phase I trials and lacked FDA approval.
The court also held that the amended complaint failed to plead a strong inference of scienter. Specifically, the court found that the plaintiff did not make any specific factual allegations showing an intent to manipulate or deceive, and that generalized assertions of motive based on potential profit are insufficient to meet the heightened pleading requirements. The court also found that the amended complaint failed to allege contemporaneous statements by the defendants showing their knowledge of the alleged falsity of the statements, and that the plaintiff’s allegations of the defendants’ knowledge were conclusory. The court concluded that, when compared to the original complaint, the amended complaint did not add any additional information as to scienter.
Eastern District Of New York Dismisses Putative Securities Class Action Against Brazilian Airline In Connection With Disclosures Made During COVID-19 Pandemic
On April 12, 2022, the U.S. District Court for the Eastern District of New York dismissed a putative securities class action complaint against Brazilian airline GOL Linhas Areas Inteligentes S.A. (“GOL”) and several GOL officers. The court found that the plaintiffs failed to adequately plead that GOL’s May 2020 earnings report contained material misstatements or omissions of fact, and that the plaintiffs failed to adequately plead scienter.
The plaintiffs alleged that statements in GOL’s May 2020 earnings report that touted GOL’s “effective and structured liquidity management,” reported a profit for the airline’s loyalty program, and noted the company’s experience navigating times of stress were false and misleading in light of a June 2020 audit report, filed with the SEC, disclosing substantial doubt about the company’s financial future in light of the COVID-19 pandemic and disclosing material weaknesses in GOL’s internal controls over financial reporting (“ICFR”). Those weaknesses included inadequate information technology controls; concerns over the authorization and administrative functions granted to the chairman of the board, including the ability to initiate and approve certain transactions; and the inadequate preparation of the consolidated financial statements, including concerns with the policies and procedures related to the identification and disclosure of material uncertainties in the going concern analysis and concerns with the effective review of financial statement information, and related presentation and disclosure requirements. The June 2020 audit report also disclosed that its auditor identified substantial doubt about the company’s ability to continue as a “going concern,” and that there were concerns that GOL could not meet its financial obligations when they came due in light of the COVID-19 pandemic.
In September 2020, the plaintiffs filed a putative securities class action complaint, amended in March 2021, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b–5 promulgated thereunder. Specifically, the plaintiffs alleged that the defendants made materially misleading statements in the May 2020 earnings report because they failed to disclose the ICFR weaknesses and “going concern” doubts that were later disclosed in the June 2020 audit report. Defendants moved to dismiss the amended complaint for failure to state a claim.
The court granted the motion, finding that the plaintiffs failed to allege specific facts sufficient to infer that the defendants learned of any auditor concerns prior to the May 2020 earnings report. In particular, the court found that the plaintiffs failed to allege specific facts as to how or when these ICFR and “going concern” issues were purportedly known by defendants. And while the plaintiffs claimed that the auditor must have reported concerns to defendants in a “timely fashion,” the court held that this allegation was insufficient to give rise to an inference that these concerns were escalated before the May 2020 earnings report, as the audit report was not filed until almost two months later.
As to scienter, the court found that the plaintiffs failed to adequately plead fraudulent intent, as the amended complaint did not contain specific allegations that the defendants had knowledge of facts contradicting their public statements at the time that they were made. Specifically, there was no allegation that the auditor provided its draft findings before the May 2020 earnings report. While the plaintiffs also pointed to GOL’s termination of its relationship with the auditor after the publication of the June 2020 audit report, the court found that this, without any further facts suggesting a culpable explanation, did not support an inference of conscious misbehavior or recklessness.
Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.
Charles A. Brown
Meghan K. Spillane
Charles A. BrownPartner
Meghan K. SpillanePartner
Viktors M. DindzansAssociate