Securities Snapshot January 31, 2017

U.S. Supreme Court Agrees to Hear Appeals on Securities Law Timeliness Issues

Summary

The U.S. Supreme Court agrees to hear two cases involving time limitations under the securities laws; the Delaware Supreme Court addresses disclosure obligations under the implied duty of good faith and fair dealing; federal circuit courts of appeal issue opinions on Dodd-Frank whistleblowers and SLUSA preemption; and trial courts rule on insider trading convictions, securities claims based on statements made after the purchase commitment, and Delaware supermajority voting requirements for removing directors.

U.S. SUPREME COURT AGREES TO HEAR APPEALS ON SECURITIES LAW TIMELINESS ISSUES

The U.S. Supreme Court recently granted two petitions for certiorari in cases of interest to securities practitioners and class action litigants. First, the Supreme Court agreed to hear an appeal of a Second Circuit decision in CalPERS v. ANZ Securities Inc., et al. In CalPERS, a member of a putative damages class attempted to opt out of a timely-filed class action and pursue its claim independently. The Second Circuit  refused to allow the individual class member to spin off its own claim on the grounds that the individual’s suit was filed more than three years after the conduct at issue and was time-barred. The Supreme Court agreed to hear the appeal of whether the earlier filing of the putative class action was sufficient to satisfy the three-year time limitation with respect to spin-off claims of putative class members.

The Supreme Court also granted certiorari in Kokesh v. SEC, which will address a Circuit split on whether the Securities and Exchange Commission is subject to time limits when seeking disgorgement of ill-gotten gains. In Kokesh, the Tenth Circuit found that the five-year statute of limitations on civil penalties does not apply to an SEC order that required investment advisor Charles Kokesh to disgorge $35 million (plus $18 million in prejudgment interest and a $2.4 million penalty) and enjoined him from violating certain provisions of the federal securities laws. The Tenth Circuit’s holding in Kokesh was consistent with prior decisions by the First and D.C. Circuits also holding that the statute of limitations did not apply to actions for disgorgement and injunctive relief, as opposed to actions for monetary penalties. The Eleventh Circuit, meanwhile, held earlier in 2016 that an agency cannot seek disgorgement for conduct older than five years.

A decision from the Supreme Court is expected in late spring 2017 in both CalPERS and Kokesh.

DELAWARE SUPREME COURT REVERSES DISMISSAL OF UNITHOLDER MERGER SUIT FINDING “OBVIOUS” DUTY NOT TO MISLEAD UNDER IMPLIED DUTY OF GOOD FAITH AND FAIR DEALING

The Delaware Supreme Court reversed a Chancery Court dismissal of a challenge brought by a limited partner unitholder to the merger of Regency Energy Partners LP with its affiliate Energy Transfer Partners LP in Dieckman v. Regency. The plaintiff-unitholder alleged that Regency’s conflict committee – the committee responsible for approving interested transactions – included two individuals who became directors of a company controlled by Energy Transfer Partners after the deal, but that a proxy statement issued prior to the unitholder vote did not disclose any conflicts in the committee membership or in its review process. The partnership agreement expressly waived fiduciary duties and also provided that, in connection with any merger, the limited partnership need only disclose to unitholders a copy (or a summary of) the merger agreement. In dismissing the challenge, the Chancery Court had reasoned that “the express waiver of fiduciary duties and the clearly defined disclosure requirement . . . prevent the implied covenant [of good faith and fair dealing] from adding any additional disclosure obligations.” The Delaware Supreme Court, however, held that the implied covenant operated to “imply contractual terms that are so obvious – like a requirement that the general partner not engage in misleading or deceptive conduct to obtain safe harbor approvals – that the drafter would not have needed to include the conditions as express terms in the [LP] agreement.” According to the Delaware Supreme Court, once the limited partnership went beyond the minimal disclosure requirements of the LP agreement, there was an implied obligation not to mislead investors.

SIXTH CIRCUIT UPHOLDS DISMISSAL OF RETALIATION LAWSUIT UNDER TWOMBLY BUT AVOIDS WEIGHING IN ON WHO QUALIFIES AS A WHISTLEBLOWER UNDER DODD-FRANK

The Sixth Circuit upheld the dismissal of a former Morgan Stanley employee’s retaliation lawsuit in Verble v. Morgan Stanley Smith Barney LLC. Verble, a former Morgan Stanley financial advisor, had asserted a claim under the anti-retaliation provisions of the Dodd-Frank Act of 2010. Verble alleged that, after learning of purportedly illegal activity by Morgan Stanley and its clients, he served as a confidential informant to the FBI and cooperated with the SEC, and that Morgan Stanley had illegally discharged him as a result. The district court dismissed the suit,  holding that Verble did not qualify as a whistleblower under Dodd-Frank because he did not allege that he provided information directly to the SEC. In its review, the Sixth Circuit observed that whether individuals like Verble qualified as whistleblowers under Dodd-Frank “has divided the courts,” with the Second Circuit (deferring to the SEC’s interpretation) holding that reporting violations internally or to any federal law-enforcement agency is sufficient, and the Fifth Circuit requiring direct reporting to the SEC. The Sixth Circuit found that Verble’s complaint “suffer[ed] from a more fundamental defect” – namely, failure to allege sufficient facts to state a plausible claim for relief under either standard. It went on to hold that Verble’s complaint was “entirely devoid of any factual material describing his work with any law-enforcement agency, including the FBI or SEC,” and therefore it did not allege “enough facts to state a claim to relief that is plausible on its face” under Twombly.

NEW YORK FEDERAL COURT UPHOLDS INSIDER TRADING CONVICTIONS ON CIRCUMSTANTIAL EVIDENCE THAT DEFENDANTS UNDERSTOOD “INSIDE” NATURE OF INFORMATION AND TIPPER’S PERSONAL BENEFIT

The Southern District of New York, in United States v. Goffer, refused to vacate insider trading convictions despite defendants’ claim that their convictions should be overturned in light of the Second Circuit’s 2014 decision in United States v. Newman, which held that downstream tippees who did not know they were receiving inside information are not guilty of insider trading. One of the defendants, Zvi Goffer, had received tips from his friend, an attorney who had conveyed inside information he received from two attorneys at another law firm about the firm’s M&A clients. That defendant then passed the information along to others, including his close friend Michael Kimelman, the other defendant. In upholding the convictions, the Southern District found that the defendants were aware that the information was “insider” in nature, “rather than [from] mere non-insider eavesdroppers who had fortuitously gained access to the information.”

With respect to defendant Goffer, the court found that the evidence supported the conclusion that he “well knew the nature and source of the material nonpublic information on which he was trading,” and that the record was replete with evidence (including “distributing disposable cell phones, using fake research to cover his illegal trades, and refusing to speak about sensitive topics on the telephone”) that he “believed he was engaging in illicit behavior.” The court also found that Kimelman, a former M&A lawyer, “knew or consciously avoided knowing that the information he traded on came from insiders who had received a personal benefit for passing that information along.” According to the court, a reasonable juror could have inferred that Kimelman understood that the lawyer-tipper would not risk his career for “no benefit to himself.”

KANSAS FEDERAL COURT ALLOWS SECURITIES CLAIMS BASED ON POST-PURCHASE COMMITMENT STATEMENTS TO PROCEED

In NCUAB v. UBS Securities, LLC and NCUAB v. Credit Suisse Securities (USA) LLC, a federal district court in Kansas refused to grant summary judgment to the defendants on claims brought by the NCUA in its capacity as conservator for several credit unions under the 1933 Act and state securities laws based on alleged misstatements in prospectus supplements, free writing prospectuses and mortgage loan schedules filed after the plaintiff committed to purchase residential mortgage-backed securities. The defendants had argued that the alleged misstatements could not form the basis of 1933 Act liability because they post-dated the credit unions’ decisions to purchase the RMBS, thereby negating any reliance. The court concluded that, pursuant to SEC Rule 430(B), prospectus supplements are deemed to be part of the corresponding registration statement and can give rise to Section 11 liability. For purposes of Section 12(a)(2) and the corresponding state law claims, the court concluded that post-sale misstatements in SEC filings can give rise to liability, noting that reliance is not an element of Section 12(a)(2) claims.

DELAWARE CHANCERY COURT REJECTS SUPERMAJORITY REQUIREMENT FOR DIRECTOR REMOVAL

The Delaware Court of Chancery ruled in Frechter v. Zier that a corporate bylaw provision that required a supermajority of corporate shares to remove a director was unlawful under Delaware law. Specifically, the Court found that the supermajority requirement was contrary to Section 141(k) of the Delaware General Corporation Law, which states that “any director . . . may be removed … by the holders of a majority of the shares then entitled to vote at an election of directors.” The defendants contended that use of the word “may” rendered Section 141(k) permissive, rather than mandatory. The Chancery Court rejected this argument, holding that the supermajority requirement was inconsistent with both the statutory language and recent judicial decisions interpreting Section 141(k).