Our bi-monthly newsletter highlights important developments related to US civil and criminal securities law.
On December 1, 2022, the U.S. Court of Appeals for the Second Circuit vacated and remanded a district court’s decision to certify a class of more than 200,000 retirees alleging that collateralized loans serviced by the Teachers Insurance and Annuity Association of America (TIAA) are prohibited transactions under ERISA. This decision provides guidance beyond the ERISA context regarding what courts are required to consider when conducting a “predominance” inquiry before certifying a class under Rule 23(b)(3) of the Federal Rules of Civil Procedure.
In vacating the district court’s order and remanding the case for further proceedings, the Second Circuit found that the district court “determined that predominance was satisfied without analyzing the § 408 exemptions or TIAA’s claimed variations among the loans,” as it was required to do. Under Rule 23(b)(3), a plaintiff must show that questions of law or fact common to the putative class “predominate” over questions affecting only individual members. This analysis “is not simply an exercise in tallying up issues; it is a qualitative inquiry that entails ‘careful scrutiny’ of the nature and significance of a case’s common and individual issues.” Thus, courts must consider “all factual or legal issues,” including any affirmative defenses, even if the defendant bears the burden of proof on them at the merits stage.
Applying these principles, the Second Circuit concluded that the district court did not properly analyze the § 408 exemptions, including TIAA’s arguments that “individualized proof must be marshalled from non-party plan fiduciaries showing how each plan fiduciary valued the assets and whether, given other options available to the plan, the fiduciary exercised good faith in selecting the terms offered by TIAA,” and that “by submitting only her loan contract, [the named plaintiff] failed to supply the district court with necessary proof that the various plans in the purported class were sufficiently similar.” Further, the Second Circuit found that the district court failed to “engage with the evidence that TIAA submitted to substantiate the purported variations among the plans . . . A district court cannot simply ‘take the plaintiff’s word that no material differences exist.’”
SEC Touts Record-High Recovery of $6.4 Billion
On November 15, 2022, the SEC released its fiscal year-end data on enforcement actions. In total, the Commission filed 760 actions in fiscal year 2022, recovering a record-high $6.4 billion in penalties and disgorgement. Compared with 2021, those figures represent an increase of roughly 9% in the number of enforcement actions filed, and an increase of nearly 60% in the total amount of funds recovered or disgorged. Several notable enforcement trends emerged in 2022. In particular, the total number of offerings-related enforcement actions declined from 142 in 2021 to 106 in 2022. By contrast, almost every other category of enforcement action — other than actions against investment advisors and investment companies, which dropped from 120 to 119 — increased between 2021 and 2022.
Of note, several of this year’s actions were the first of their kind. For example, the Commission charged Western International Securities, Inc. and five of its registered representatives in the first-ever enforcement action pursuant to Best Interest Obligation regulations, also known as Regulation Best Interest, which requires broker-dealers to act in the best interests of retail investor clients when recommending a securities transaction or investment strategy. Additionally, the Commission initiated a significant number of actions this year under the “individual accountability” “pillar” of its enforcement program, which places particular emphasis on specific and general deterrence by charging individual actors. In fact, more than two-thirds of the stand-alone actions this year charged at least one individual with securities law violations, a trend that is consistent with prior years.
In addition, the SEC reported that it took to trial 15 cases, winning 12 at least in part, which it emphasized was its busiest trial year in a decade. In context, however, even a record-setting 15 trials does not change that the Enforcement Division almost never goes to court: if the current run rates of cases tried and filed continues, it will mean that over 98% of those cases “filed” in 2022 will be settled or dropped before any judge or jury decides whether anyone did anything wrong.
Looking ahead, the SEC Enforcement Chief Gurbir Grewal cautioned that he does not expect to be setting more settlement recovery records next year, noting that the SEC does not measure itself by the annual recovery results. In his words: “While we set a Commission record this past fiscal year for total money ordered at $6.4 billion, including a record $4.2 billion in penalties, we don’t expect to break these records and set new ones each year because we expect behaviors to change. We expect compliance.”
California District Court Dismisses EthereumMax Suit Brought Against Celebrity Endorsers
On December 6, 2022, the United States District Court for the Central District of California dismissed with leave to amend, a class-action “pump and dump” complaint filed by a group of cryptocurrency investors against executives of the blockchain-based digital asset EthereumMax/EMAX (the “Executive Defendants”), and a handful of celebrities and athletes, including Kim Kardashian and Floyd Mayweather Jr. (the “Promoter Defendants”). According to the investors, the various defendants enriched themselves by perpetrating a supposed promotional scheme to pump the trading volume and price of the EthereumMax token through allegedly false misrepresentations and omissions repeated through “numerous celebrity endorsements.”
This decision reveals the challenges facing those who sue to recover investor losses from crypto and digital transactions by invoking traditional securities law theories — here, “pump and dump” and “promoter liability” — without even attempting to argue that they actually transacted in securities. Instead, these Plaintiffs tried and failed to shoehorn their investor loss theory into federal racketeering (RICO) claims, and a handful of consumer protection, unfair competition, and false advertising claims. The Court acknowledged that, as alleged: “[t]his action demonstrates that just about anyone with the technical skills and/or connections can mint a new currency and create their own digital market overnight . . . [which has] . . . seemingly allowed unvetted and highly volatile investment ventures to go viral based solely on the paid-for word of celebrity promoters” — but was just as clear that investors must “act reasonably before basing their bets on the zeitgeist of the moment.” From there, the Court dismantled the entire case following a traditional claim-by-claim analysis.
As to the RICO claim, the Court found that Plaintiffs made conclusory allegations with “huge leaps of logic to string together disconnected acts that when read together, supposedly evince a premeditated and well-orchestrated pump and dump scheme in violation of the federal RICO statute.” On the Consumer Legal Remedies Act (CLRA) claims — a law that protects against unfair or deceptive practices in connection with the sale of goods, defined as tangible chattels — the Court found that “[t]he EMAX Tokens at issue here (i.e., cryptocurrency) cannot be described as anything but intangible goods, most akin to investment securities, and therefore, the CLRA does not apply.” The Court also addressed the sufficiency of Plaintiffs’ state consumer protection statutory claims, holding that Plaintiffs failed to allege actual reliance as to “which statements [made by the Promoter Defendants] they viewed or precisely when each Plaintiff purchased EMAX Tokens.”
The Court allowed Plaintiffs to try again with an amended complaint, but put them on a short leash to file it by December 22, 2022. We will see if the next pleading fares any better than the failed predecessor.
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.
Jennifer Burns Luz
Ian Q. Rogers
Jennifer Burns LuzPartner
Ian Q. RogersAssociate