Securities Snapshot December 05, 2017

Department of Justice Announces Revisions to its Foreign Corrupt Practices Act Pilot Program

Summary

DOJ revises its FCPA Pilot Program; SEC ratifies its appointment of administrative law judges in the face of possible Supreme Court Appointments Clause review; Fourth Circuit affirms dismissal of a securities fraud action for lack of scienter; Ninth Circuit affirms dismissal of Yelp securities fraud case for failure to plead loss causation and scienter; Northern District of Texas rules that disgorgement is proper in stock fraud case; and New York Court of Appeals allows derivative action to proceed without permission from Cayman court.

On November 29, 2017, Deputy Attorney General Rod Rosenstein announced that the U.S. Department of Justice has made revisions to its Foreign Corrupt Practices Act Pilot Program. The FCPA was enacted four decades ago to criminalize the payment of bribes by publicly traded companies and their officers, directors, employees, stockholders, and agents to foreign officials in order to assist in obtaining or retaining business. The DOJ’s FCPA Pilot Program, commenced in 2016, was designed to motivate companies to voluntarily disclose misconduct and to reward those that do so. In an effort to more vigorously incentivize corporations to police and report FCPA violations, the DOJ reviewed its FCPA Pilot Program and determined that certain revisions could strengthen it. There are three notable enhancements. First, “when a company satisfies the standards of voluntary self-disclosure, full cooperation, and timely and appropriate remediation, there will be a presumption that the Department will resolve the company’s case through a declination,” which may only be overcome if there are aggravating circumstances or if the offender is a criminal recidivist. Second, if a company voluntarily discloses and satisfies all other conditions, but aggravating circumstances nonetheless compel an enforcement action, the DOJ will recommend a 50% reduction off the low end of the fine recommended by the Sentencing Guidelines. The rationale behind this change is to “provide an incentive for good conduct.” Third, the revised policy will provide details about how the DOJ will evaluate a company’s compliance program, which will vary depending on the company’s size and resources. The DOJ has stated that its overarching goal in making these revisions is to “incentivize responsible corporate behavior and reduce cynicism about enforcement.” The program, which does not require participation, provides rewards otherwise unavailable to companies that do not participate. Regarding companies that do not self-report, Deputy Attorney General Rosenstein stated that “if crimes come to our attention through whistleblowers or other means, the [DOJ] will take appropriate action consistent with the facts.”

SEC RATIFIES APPOINTMENTS OF ADMINISTRATIVE LAW JUDGES IN ANTICIPATION OF THE SUPREME COURT APPOINTMENTS CLAUSE REVIEW

On November 29, 2017, the U.S. Solicitor General submitted a brief in support of the pending petition for certiorari in Raymond J. Lucia, et al., v. Securities and Exchange Commission, arguing that the U.S. Supreme Court should “decide whether administrative law judges of the Commission are inferior officers under the Appointments Clause, U.S. Const. Art. II, § 2, cl. 2.” In the Lucia case, former investment adviser Raymond Lucia, who was banned from the industry for life by an SEC administrative law judge in 2013 for alleged misrepresentations in a retirement wealth management strategy, argued that the ban should be overturned because the in-house judge was not properly appointed. Several other cases arguing the constitutionality of SEC administrative law judge decisions are pending in lower courts, prompting the Solicitor General to argue for the Supreme Court to resolve the issue. The Solicitor General argues in his brief that SEC judges are “inferior officers” and are therefore subject to the Appointments Clause. This is contrary to the position taken by the SEC and adopted by the D.C. Circuit in the Lucia case, which the Solicitor General asked the Supreme Court to appoint amicus curiae to defend. The Supreme Court’s review of the issue would be expected to resolve a circuit split, as the Tenth Circuit Court of Appeals previously found in Bandimere v. SEC that the SEC’s administrative law judges are inferior officers who must be appointed in “a manner consistent with the Appointments Clause.” In an effort to address this dispute, the SEC on November 30, 2017 ratified the appointment of its administrative law judges to clarify its view that their appointment did not violate the Appointments Clause. The SEC also established a procedure for administrative law judges to follow in proceedings with pending decisions and those where no initial decision had been given in light of the ratification. Notwithstanding the SEC’s ratification, the Supreme Court’s ruling on certiorari (and, if certiorari is granted, on the merits of the issue) will be significant to securities enforcement and defense practitioners.

FOURTH CIRCUIT AFFIRMS DISMISSAL OF SECURITIES FRAUD CLASS ACTION SUIT FOR FAILURE TO PLEAD SCIENTER

On November 15, 2017, the Fourth Circuit Court of Appeals affirmed the dismissal of securities fraud class claims in Maguire Financial, LP v. PowerSecure Int’l, Inc. The issue before the court was whether the lower court had erred in finding that a statement by the CEO of PowerSecure International, Inc. regarding a contract renewal could give rise to liability under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, promulgated thereunder. On August 7, 2013, PowerSecure’s CEO announced to securities analysts that PowerSecure had renewed its contract “with one of the largest investor [owned] utilities in the country.” Immediately following that announcement, PowerSecure’s common stock rose then later dropped significantly. The company publicly responded to the drop by divulging that it had “changed the geographies” it previously was serving, which led to increased operating costs in executing the new contract. The plaintiff sued, alleging that the company knew that its operating costs were going to increase and that the CEO’s statement about the new contract was materially misleading. The district court dismissed the amended complaint, holding that the plaintiff had failed adequately to plead scienter on behalf of the CEO. The Fourth Circuit held that the Private Securities Litigation Reform Act of 1995 “clarifies the heightened pleading standard” applicable in securities fraud actions, and that securities fraud plaintiffs must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” The court went on to reject the plaintiff’s argument that because the CEO knew “enough to realize that his characterization was technically incorrect,” he had the requisite intent to deceive. The Fourth Circuit concluded that the allegations in the complaint, viewed holistically, did not permit the court to draw a strong inference, at least as compelling as any opposing inference, that scienter was adequately established. On November 29, 2017, the plaintiff petitioned the Fourth Circuit to rehear the case en banc, arguing that the panel’s standard for pleading scienter conflicts with the Supreme Court’s decision in Tellabs Inc. v. Makor Issues & Rights Ltd. and with a Fourth Circuit decision holding that pleading recklessness suffices to show scienter.

NINTH CIRCUIT AFFIRMS DISMISSAL WITH PREJUDICE OF YELP SECURITIES FRAUD CASE FOR FAILURE TO PLEAD LOSS CAUSATION AND SCIENTER

On November 21, 2017, the Ninth Circuit Court of Appeals affirmed the lower court’s dismissal with prejudice of a securities fraud action in Curry v. Yelp Inc. The plaintiffs complained that Yelp and other defendants made false statements with regard to the “independence and authenticity of posted Yelp reviews” and failed to disclose that businesses had complained to the Federal Trade Commission that Yelp manipulated which reviews appeared on its website based on whether the businesses advertised with Yelp, allegedly in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The district court dismissed the plaintiffs’ complaint for failure to state a claim. The Ninth Circuit affirmed the dismissal on the basis that the plaintiffs failed to plead loss causation and scienter. The Ninth Circuit explained that a securities fraud plaintiff must demonstrate a connection between the alleged deceptive acts and the basis for the claim and injury suffered. The panel held that the plaintiffs failed to establish a connection between the defendants’ alleged false statements regarding the veracity of Yelp reviews and their claim that Yelp’s stock plummeted when a Wall Street Journal article disclosed more than 2,000 complaints about the quality of reviews obtained from the FTC. The panel held that this allegation was insufficient to plead loss causation, stating: “[T]he element of loss causation cannot be adequately made out merely by resting on a number of customer complaints and asserting that where there is smoke, there must be fire.” The Ninth Circuit also found that scienter was not adequately pleaded under the Private Securities Litigation Reform Act of 1995 and Federal Rule of Civil Procedure 9(b), which require “particularized allegations of fraud and strong evidence of scienter,” as to the corporate executive defendants. The panel held that the plaintiffs’ allegations of unusual trading by corporate insiders were inadequate, as the plaintiffs had failed to show that the highlighted trading activity was out of line with historical practices. This defect was not cured by the plaintiffs’ allegation that the defendants had knowledge of certain business practices aimed at manipulating reviews, as a general awareness of business practices without additional evidence linking such knowledge to the alleged fraud was insufficient. Finally, the Ninth Circuit affirmed that granting leave to amend would be futile because the plaintiffs’ proposed amended complaint merely realleges facts regarding the FTC complaints and market speculation about fraud as the basis for loss causation, without providing additional facts that demonstrate fraud. The Yelp ruling should serve as an example of what the Ninth Circuit requires at the pleading stage in securities fraud cases.

STOCK FRAUDSTER FAILS TO ESCAPE SEC DISGORGEMENT PENALTY DUE TO NORTHERN DISTRICT OF TEXAS RULING

In SEC v. Sample, the Northern District of Texas granted the Securities and Exchange Commission’s motion to disgorge ill-gotten gains of defendant Matthew Sample. From 2009 to 2012, Sample raised nearly $1 million from investors in his Lobo Volatility Fund, LLC, but instead of investing those funds and paying returns to his investors, Sample used the funds to purchase personal luxuries and to repay investors from a prior scheme. The SEC brought an action against Sample under a myriad of federal securities laws. The parties eventually reached a settlement, in which Sample denied any wrongdoing, agreed to “be permanently enjoined from violating the securities laws,” and committed to “disgorge his ill-gotten gains” in an amount to be determined by the court and to pay prejudgment interest and a civil penalty. Sample had previously pleaded guilty in a related criminal case brought by the U.S. Department of Justice in New Mexico to mail and wire fraud and paid more than $1 million in restitution to victims of the Lobo Fund scheme and a prior scheme. Even though Sample had agreed to disgorge his ill-gotten gains, he subsequently contended that he could not be required to do so, arguing that under the Supreme Court’s decision in Kokesh v. SEC, disgorgement would be an unlawful penalty, and that the restitution that he was ordered to pay by the federal court in New Mexico precludes him from paying disgorgement. Ruling on the appropriateness and amount of disgorgement, Judge Jane J. Boyle found that Sample “must disgorge $919,875,” which was the full amount that Sample raised from investors in his fraudulent fund less the $50,000 that he had previously returned to those investors. Judge Boyle held that Kokesh only states that disgorgement claims are subject to a five-year statute of limitations and that the restitution Sample made in his criminal lawsuit did not inhibit the SEC’s ability to order him to pay disgorgement. Rather, Sample was only entitled to credit previous restitution to the same victims against the disgorgement amount. The ruling makes clear that disgorgement is not unlawful when restitution may have previously been paid, that disgorgement can be ordered in addition to restitution, and that such restitution can only act to reduce the amount due.

NEW YORK COURT OF APPEALS CLARIFIES THAT PERMISSION FROM CAYMAN COURTS TO PURSUE DERIVATIVE CLAIMS AGAINST A CAYMAN CORPORATION IN NEW YORK IS NOT REQUIRED

In Davis v. Scottish Re Group, Ltd., the New York Court of Appeals recently held that an investor in a Cayman Islands corporation need not obtain leave from a Cayman court to pursue derivative claims in New York, even if the merits of such claims are governed by Cayman law. The lawsuit was originally brought by Paul Davis, an investor in Scottish Re Group, a Cayman Islands-based reinsurance company. Davis brought direct and derivative claims against Scottish Re and other financial companies under the theory that Scottish Re worked with those companies to “implement a series of transactions that enriched themselves, while causing harm to minority shareholders.” The New York Supreme Court originally dismissed Davis’s derivative causes of action on the basis that he did not seek leave from the court to commence the action under Rule 12A of the Grand Court of the Cayman Islands, which requires derivative plaintiffs to apply for and obtain leave to proceed with their claims, and on the alternative ground that he did not have standing. The Appellate Division agreed with the Supreme Court’s finding that Davis had failed to comply with Rule 12A, holding that the rule was substantive not procedural. On further review, however, the Court of Appeals concluded that Rule 12A is “procedural, and therefore does not apply” where a derivative plaintiff is pursuing claims in New York. In reaching this conclusion, the Court of Appeals reviewed the plain language of Rule 12A and determined that the statute was enacted to serve as a gatekeeping function “only as to derivative actions brought in the Cayman Islands, not for derivative actions, wherever brought, concerning Cayman companies specifically.” The Court of Appeals also observed that Rule 12A has no language suggesting that it controls in derivative actions “brought on behalf of Cayman Island companies commenced outside the Cayman Islands.” The ruling allows the plaintiff’s derivative claims against Scottish Re to proceed in the New York courts.