Securities Snapshot July 18, 2017

Second Circuit Finds Lower Court Committed Legal Error In Certifying Classes And Clarifies Rule 23 Ascertainability Test

Summary

Second Circuit finds legal error in certifying classes of globally-traded note purchasers and clarifies Rule 23 ascertainability test; Delaware Chancery Court clarifies Section 202 stock transfer restriction notice requirements; Northern District of California dismisses Williams Act claims over Brocade Communications’ acquisition of Ruckus Wireless; federal jury convicts former American Realty Capital Partners CFO; Department of Justice declines FCPA charges because of company’s timely investigation and disclosure; and Southern District of New York dismisses Wendy’s derivative action for failure to show demand futility. 

Second Circuit Finds Lower Court Committed Legal Error In Certifying Classes And Clarifies Rule 23 Ascertainability Test

On July 7, 2017, the Second Circuit Court of Appeals issued an order in In re Petrobas Securities holding that the lower court erred in certifying two classes under Federal Rule of Civil Procedure 23(b)(3), vacated that portion of the order, and remanded it for further proceedings in line with the opinion. The district court had certified separate classes for claims under the Securities Act of 1933 and the Securities Exchange Act of 1934. The Second Circuit permitted defendants to appeal under Rule 23(f) and stayed the case pending resolution of the expedited interlocutory appeal. On appeal, the defendants challenged both class definitions insofar as they included all otherwise eligible persons who purchased Petrobras debt securities, which do not trade on a domestic exchange, in “domestic transactions.” The Second Circuit held that the district court erred by not including in its Rule 23 analysis whether common questions predominated over individual questions with respect to “domesticity,” citing the Supreme Court’s 2010 decision in Morrison v. National Australia Bank Ltd. The court found no abuse of discretion in the district court’s analysis of direct and indirect market efficiency, and affirmed the district court’s holding that the plaintiffs were entitled to “a presumption of reliance on the market price of the Petrobas Securities.” The Second Circuit also clarified the “scope of the ‘implied’ Rule 23 requirement of ‘ascertainability,’” holding that a class is ascertainable if it “is defined using objective criteria that establish a membership with definite boundaries.” The court declined to adopt the Third Circuit’s more stringent two-part ascertainability test, set forth in  Byrd v. Aaron’s Inc., which requires that a class be defined by objective criteria and that there is an administratively feasible way to determine the class members. Applying this less stringent standard to the lower court’s class definitions, the court found them to be “ascertainable” as the criteria were “clearly objective,” and it was therefore “objectively possible” to determine which securities were acquired in domestic transactions. Given the split among the circuits as to ascertainability, the Supreme Court may ultimately need to grant certiorari to resolve the conflict.

DELAWARE CHANCERY COURT CLARIFIES SECTION 202 STOCK TRANSFER RESTRICTION NOTICE REQUIREMENTS

In Henry v. Phixios Holdings Inc., the Delaware Chancery Court recently granted a shareholder access to Phixios’s books and records, rejecting the company’s arguments that the plaintiff was no longer a valid stockholder because his shares had been revoked per a company stock transfer restrictions that prohibited competing with the company. While the plaintiff acknowledged receiving a copy of the bylaws containing the restrictions, the restrictions were not noted on the stock certificate and the plaintiff denied having actual knowledge of them. In a decision by Vice Chancellor Tamika Montgomery-Reeves, the Chancery Court agreed with the plaintiff, holding that under Section 202(a) of the Delaware General Corporation Law, “in order for a stockholder to be bound by stock transfer restrictions that are not ‘noted conspicuously on the certificate or certificates representing the security,’ he must have actual knowledge of the restrictions before he acquires the stock.” Additionally, if the stockholder does not have actual knowledge of the stock transfer restrictions at the time he or she acquires the stock, he can become bound by them, “only if he affirmatively assents to the restrictions, either by voting to approve the restrictions or by agreeing to the restrictions.” Vice Chancellor Montgomery-Reeves found that, in this case, the plaintiff did not have actual knowledge prior to purchase, or assent to be bound by the restrictions.

NORTHERN DISTRICT OF CALIFORNIA DISMISSES WILLIAMS ACT CLAIMS AGAINST BROCADE

In Hussey v. Ruckus Wireless, Inc., a California federal judge dismissed with prejudice a shareholder securities class action against Brocade Communications over its acquisition of Ruckus Wireless Inc., as the shareholder plaintiffs had repeatedly failed to show how they were misled by the alleged misstatements. Plaintiff brought claims for violations of Section 14(e) and 20(a) of the Securities Exchange Act of 1934, along with related state law breach-of-fiduciary duty claims, in connection with Brocade’s tender offer for Ruckus’s outstanding common stock. Plaintiff alleged that defendants failed to disclose that Morgan Stanley, Ruckus’s financial advisor, based its discounted cash flow analysis of the value of the merger to Ruckus shareholders on the assumption that Brocade’s stock was worth $13.58 to $19.52 per share, and that this assumption inflated the value of Brocade’s stock. Judge Edward Chen of the Northern District of California dismissed the second amended complaint because plaintiff failed to allege that the discounted cash flow analysis was material to Morgan Stanley’s fairness opinion; that the conclusion of the discounted cash flow analysis was erroneous; and that, even if the discounted cash flow analysis overvalued the merger consideration, that the overvaluation was due to the assumption about the value of Brocade’s stock. The court also held that plaintiff failed to allege scienter because plaintiff failed to allege that Morgan Stanley performed, or that the other defendants were aware of, a standalone valuation of Brocade stock.

JURY IN SOUTHERN DISTRICT OF NEW YORK CONVICTS FORMER AMERICAN REALTY CAPITAL PARTNERS CFO

On June 30, 2017, in United States v. Block, a federal jury in the Southern District of New York convicted Brian Block, the former CFO of American Realty Capital Properties, of two counts of filing false SEC reports, two counts of filing false certifications, and one count of conspiracy. The government had charged that Block, aided by ARCP’s former chief accounting officer Lisa McAlister and director of financial reporting Ryan Steel, both of whom cooperated and testified against Block, plugged unsupported numbers into the company’s SEC filings to prop up ARCP’s adjusted funds from operations, or AFFO, per share, a metric watched closely by investors and analysts as an indication of a real estate investment trust’s ability to pay a dividend. AFFO per share is calculated by taking the funds from operation, adding back depreciation to net operating income and other nonrecurring costs, then dividing the resulting figure by the number of shares. ARCP switched its method of computing AFFO for the second quarter of 2014, after Steel recommended a different method of calculation.  When the new accounting left the first quarter’s AFFO per share noticeably below what had already been reported, the government contended that Block “harmonize[d]” the current numbers with previously reported AFFO per share and ARCP’s guidance for the second quarter. The conspiracy charge carries a sentence of up to five years in prison, while each of the other charges carries maximum 20-year prison sentence. Block is scheduled to be sentenced by Judge J. Paul Oetken on October 26.

DEPARTMENT OF JUSTICE DECLINES FCPA PROSECUTION  BECAUSE OF COMPANY’S TIMELY INVESTIGATION, DISCLOSURE AND OTHER REMEDIAL EFFORTS

In a letter posted to its website, the Department of Justice stated that it was declining to prosecute engineering and construction group CDM Smith Inc. for violations of the Foreign Corrupt Practices Act and closed its investigation of the company. According to the government’s letter, employees of CDM and its Indian unit paid more than $1 million in bribes to officials with the National Highways Authority of India. The payments, usually worth 2 - 4 percent of the contract, were paid to sham subcontractors that did no work on the projects. Another $25,000 was paid to officials in Goa, a state on India’s west coast, as part of a water project contract. The bribery ran from 2011 to 2015. Although the DOJ found that CDM Smith paid $1.18 million in bribes to Indian officials in exchange for contracts resulting in approximately $4 million in profits, it decided to close its investigation without bringing charges due to CDM Smith’s timely investigation, its self-disclosure, its cooperation, its decision to disgorge profits and terminate the responsible employees, and its efforts to “to enhance its compliance program and its internal accounting controls.”

SOUTHERN DISTRICT OF NEW YORK JUDGE GRANTS WENDY’S MOTION TO DISMISS

The Southern District of New York recently issued an order in Tricky v. Brolick, granting the defendants’ motion to dismiss a derivative action against ten of the eleven members of The Wendy’s Company’s board of directors. (The eleventh director had previously been dropped from the case because his presence destroyed diversity jurisdiction.) The plaintiff, a Wendy’s shareholder, alleged that the board had breached its fiduciary duty by not having Wendy’s join the Fair Food Program, an alliance between farms and food retailers that seeks to ensure “humane wages and working conditions” for farm workers. The amended complaint alleged that Wendy’s failure to join the Fair Food Program had led to protests and boycotts of the company, harming it financially. Judge Paul A. Engelmayer granted the motion to dismiss because the amended complaint did not convincingly allege demand futility. The amended complaint, Judge Engelmayer held, “lacks the ‘factually intensive, director-by-director analysis’ necessary to demonstrate demand futility under the applicable test. It included no factual allegations that any of the ten accused board members either acted in bad faith or were not up to speed when the decision not to join the Fair Food Program was made. Given its “threadbare pleadings,” Judge Engelmayer held, the amended complaint, “effectively disables the Court from finding that the Board’s decision not to participate in the program was reached through an irrational process or one employed other than in a ‘good faith effort to advance corporate interests.’” 

TEXAS FEDERAL COURT JUDGE ALLOWS ENGLISH-LAW CLAIMS TO MOVE FORWARD IN DEEPWATER HORIZON SECURITIES LITIGATION

On June 30, 2017, the Southern District of Texas issued an order in In re BP p.l.c. Securities Litigation, denying in part defendant BP p.l.c.’s motion to dismiss and allowing certain investors to proceed with their “holder” claims under English common law. The plaintiffs allege that BP’s misrepresentations surrounding the 2010 Deepwater Horizon oil spill induced them to hold their BP stock, leading to losses when the price of the stock declined. BP’s motion had challenged the sufficiency of the holder claims, which, unlike federal securities claims, required the pleading of actual reliance under Rule 9(b) of the Federal Rules of Civil Procedure. Noting the “relative dearth” of federal case law interpreting the standard for pleading reliance with particularity in the securities fraud context, Judge Keith Ellison held that “Plaintiffs must allege that they reviewed specific statements; that they evaluated whether to hold or sell their shares; and, most important, they must allege facts—which must include more than mere references to plaintiffs’ ‘unrecorded thoughts and decisions’—showing that the statements motivated them to hold their shares rather than sell them.” Certain of the plaintiffs’ holder claims met these standards, according to Judge Ellison, while others’ did not. The court also rejected BP’s argument that the plaintiffs’ claims only related to a decline in value that was solely attributable to the wearing off of a post-incident price boost caused by the alleged misstatements. Judge Ellison ruled that the plaintiff investors were claiming losses cause by a number of factors after the incident, not merely the end of an artificial inflation of the stock price.