Second Circuit Reverses Class Certification and Clarifies Standard for Rebutting Basic Presumption

On January 12, 2018, the Second Circuit Court of Appeals in Arkansas Teachers Retirement System, et al., v. Goldman Sachs Group, Inc., et al., reversed a decision of the U.S. District Court for the Southern District of New York certifying a plaintiff class in a securities fraud lawsuit against Goldman Sachs. The plaintiffs asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, alleging that Goldman made material misstatements in various public filings from 2007 to 2010 concerning its efforts to avoid conflicts of interest with clients in connection with certain collateralized debt obligation transactions involving subprime mortgage lending. The plaintiffs further alleged that news of certain government enforcement actions in mid-2010 led to a decline in Goldman’s share price, as the market learned of the alleged failure to adequately monitor conflicts of interest. Before the district court, Goldman had opposed class certification under the Supreme Court’s 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., which permits defendants to rebut the presumption under Basic v. Levinson that the market reacted efficiently to news concerning the stock (i.e., the “fraud-on-the-market” presumption) at the class certification stage with evidence that the alleged misrepresentations had no impact on the price of the issuer’s stock. Goldman had presented arguments based on event studies of both the allegedly misleading statements and the allegedly corrective disclosures, asserting that the evidence showed no relationship between the alleged misstatements and Goldman’s stock price. In the decision below, Judge Paul A. Crotty of the Southern District of New York rejected this argument, holding that Goldman had not “conclusively” severed the link between the news reports and stock price. On appeal, a panel of the Second Circuit vacated the district court’s order certifying a class and remanded for further proceedings to determine whether the defendants had presented sufficient evidence that the alleged misstatements did not impact Goldman's stock price. Following the Second Circuit’s 2017 decision in Waggoner v. Barclays PLC, which held that defendant bears the burden of persuasion to rebut the presumption by a preponderance of the evidence, the panel held that a defendant’s evidence of a lack of price impact must be fully considered at the class certification stage, and that the district court’s “conclusively” language left unclear whether the class was certified under the appropriate standard. The panel further noted that the evidence of a lack of price impact offered by Goldman was appropriate at the class certification stage and instructed the district court, on remand, to consider the defendants’ price impact evidence. The Second Circuit’s decision provides needed clarification on the standard for rebutting the presumption of reliance and promises to serve as a valuable tool for defendants seeking to defeat the certification of improper classes in securities litigation.

ELEVENTH CIRCUIT PARTIALLY VACATES RESTITUTION AWARD FOR COMMODITIES TRADING REGULATIONS VIOLATION

On January 22, 2018, the Eleventh Circuit Court of Appeals, in U.S. Commodity Futures Trading Commission v. Southern Trust Metals, Inc., et al., vacated a portion of a restitution award to a group of investors following a district court judgment in favor of the CFTC on civil commodities fraud claims. Defendant Robert Escobio is the CEO of a holding company that owns defendant Lorelay Overseas Corp., which in turn owns defendant Southern Trust Metals, Inc. Escobio created Southern Trust to provide commodities trading services, specifically in precious metals. According to the CFTC, however, and despite representations to the contrary made to its investors, Southern Trust traded not in physical commodities, but in futures contracts, trading in which requires CFTC registration (which Southern Trust did not have). After a bench trial, the U.S. District Court for the Southern District of Florida found that the defendants had committed fraud with respect to this “unregistered-futures scheme” and with respect to a separate related scheme. The district court permanently enjoined the defendants from employment in the commodities-trading industry, and it awarded just over $2 million in restitution to investors based on both fraudulent schemes. On appeal, the Eleventh Circuit vacated the $559,725 in restitution awarded arising out of the unregistered-futures scheme, concluding that “the district court erred in finding that the registration violation alone proximately caused any loss,” and noting that the connection between the unlawful futures trading was merely correlated to the investors’ losses, not a but-for cause thereof: “As a general matter, losing money is a foreseeable result of investing with an unregistered trader, but this is not because a trader’s failure to register will itself cause any loss. More likely, any loss will result from some other factor, such as the trader’s incompetence or dishonesty, which the failure to register correlates with but does not cause.” Though decided in the context of the Commodities Exchange Act, the court’s opinion may be more broadly applicable to loss causation arguments in securities litigation generally.

N.D. CAL. DISMISSES CLAIMS AGAINST PAYPAL ON BOTH LOSS CAUSATION AND HEIGHTENED PLEADING GROUNDS

On January 18, 2018, the U.S. District Court for the Northern District of California granted PayPal’s motion to dismiss in In re Paypal Holdings, Inc. Shareholder Derivative Litigation. The plaintiffs had alleged that PayPal-subsidiary Venmo had been engaging in unfair and deceptive trade practices, which led to a civil investigative demand from the FTC. The plaintiffs brought state law claims for breach of fiduciary duty, as well as claims under Section 14(a) of the Securities Exchange Act of 1934, for materially misleading statements made in connection with a proxy solicitation to reelect certain members of the PayPal board of directors. Judge Richard Seeborg dismissed the Section 14(a) count on two independent grounds. First, he concluded that the plaintiffs had failed to allege that any statement in the proxy caused them loss. Because this proxy statement only concerned reelecting certain members of the PayPal board, the court held that the plaintiffs had failed to show how the proxy was an “essential link” in furthering the allegedly concealed activity. Second, the court concluded that the plaintiffs had failed to plead an actionable misstatement under the heightened pleading standards of the Private Securities Litigation Reform Act of 1995. The allegedly misleading statements, according to the plaintiffs, “highlighted [PayPal’s] supposed successful oversight.” This, the court said, was “too general to give rise to any particular impression about Venmo’s business practices” and thus was not actionable as a matter of law. As to the fiduciary duty claims, because they had not brought a demand to the board, Judge Seeborg held that the plaintiffs were required under Delaware law to show that a majority of the board faced a “substantial likelihood of liability.” The court found that the plaintiffs’ generalized allegations that board members should have known about the alleged practices at Venmo were insufficiently particularized under the “sufficient likelihood of liability standard” and dismissed the claim. The court did however grant the plaintiffs leave to amend their complaint.

NEW JERSEY FEDERAL COURT ALLOWS SUBSTANTIALLY ALL CLAIMS AGAINST VALEANT PHARMACEUTICALS AND SEVERAL FORMER EXECUTIVES TO PROCEED

On January 12, 2018, in separate decisions in two related cases, the U.S. District Court for the District of New Jersey denied substantially all of several motions to dismiss filed in related cases T. Rowe Price Growth Stock Fund, Inc., et al., v. Valeant Pharmaceuticals International, Inc., et al. and Discovery Global Citizens Master Fund, Ltd., et al. v. Valeant Pharmaceuticals International, Inc., et al. In these cases, the plaintiffs alleged that Valeant had secretly created a captive pharmacy network to give the appearance of greater organic growth in sales volumes. The plaintiffs further alleged that between September 2015 and August 2016 Valeant’s share price dropped from over $262 per share to under $25 as these inflated sales volumes came to light. The plaintiffs asserted claims under Sections 10(b), 18(a), and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, and they also brought state law claims for negligent misrepresentation. For the Section 18 claim, which imposes liability for false or misleading statements made in SEC filings upon which the plaintiff actually relies, the court rejected the defendants’ arguments that plaintiffs must directly link particular trades with particular statements. Judge Michael Shipp concluded that such a holding would not provide improved notice to defendants of the nature of the claims and that pleading “actual ‘eyeball’ reliance” was sufficient. With respect to the Section 10(b) claim, the court declined to grant dismissal as to certain individual defendants, ruling that the complaints had adequately pleaded that, based on those defendants’ positions and responsibilities, along with other allegations throughout the complaints, there was a strong inference of scienter as to their own statements concerning Valeant’s sales and growth. The court further held that the allegations were sufficient, at the pleading stage, to hold statements made by other executives attributable to former corporate controller Tanya Carro under Janus Capital Group, Inc. v. First Derivative Traders. Finally, Judge Shipp held that the state law negligent misrepresentation claims asserted in Discovery Global were preempted by the Securities Litigation Uniform Standards Act of 1998 because of the ongoing securities class action claims in the other action against Valeant. The court noted that formal consolidation of the two actions was not required for SLUSA preemption to apply, and that the level of general coordination was sufficient to trigger SLUSA’s preemption of state law claims relating to misrepresentation.

NEW YORK FEDERAL COURT DISMISSES FOLLOW-ON EXPRESS SCRIPTS DERIVATIVE LITIGATION AFTER DISMISSING SECURITIES CLASS ACTION

On January 23, 2018, the U.S. District Court for the Southern District of New York granted a motion to dismiss without prejudice in Brewer v. Breen, a shareholder derivative action involving Express Scripts Holding Company. The plaintiffs’ allegations related to pharmacy benefits management services provided by Express Scripts on behalf of insurers, specifically under a contract with Anthem, Inc. According to the plaintiffs, Express Scripts improperly monitored its pricing for various prescriptions and in particular, prescriptions filled under Medicare Part D, purportedly leading it to violate its contract with Anthem. The relationship between Express Scripts and Anthem (which the plaintiffs alleged was a major client) broke down, and Anthem sued Express Scripts for breach of contract in 2016. Following the filing of the Anthem lawsuit, a securities litigation was filed against Express Scripts, and a shareholder derivative action was filed against the Express Scripts board and the company as nominal defendant. After the securities class action was dismissed without prejudice in August 2017 on grounds that the investors had failed adequately to plead that Express Scripts omitted or misrepresented any important facts, much less intended to mislead investors, the defendants moved to dismiss the follow-on derivative action. Judge Edgardo Ramos dismissed the derivative action on two principal grounds. First, he held that the plaintiffs had not filed a demand with the board of directors and had failed to plead with particularity that more than half of the board faced substantial liability in this lawsuit. The court concluded that the allegations were not sufficiently particularized to individual board members, and thus, had not shown that the demand would have been futile. Second, the court concluded that the alleged misstatements raised by the plaintiffs, many of which had already been reviewed in the securities litigation, were not actionable. Some statements had not been mentioned in the securities litigation, but for these, the court concluded that they were also insufficient. For example, the court found statements such as that Express Scripts’ business model was “fully aligned with client needs” were “exactly the kind of ‘puffery’ this Circuit has determined is insufficient to generate liability.” However, the court granted the plaintiffs leave to file an amended complaint in an effort to cure their pleading defects.

DELAWARE SUPREME COURT AFFIRMS DISMISSAL OF DELAWARE DERIVATIVE ACTION BASED ON PRECLUSIVE EFFECT OF A FEDERAL ACTION

On January 25, 2018, the Delaware Supreme Court affirmed a grant of a motion to dismiss in California State Teachers’ Retirement System, et al. v. Alvarez, et al., a shareholder derivative action involving Wal-Mart Stores, Inc. The plaintiffs alleged a variety of issues in Wal-Mart’s Mexico-based unit. However, the issue on appeal was whether a previous dismissal by the U.S. District Court for the Western District of Arkansas of a federally-filed derivative action had preclusive effect on California State Teachers, which had been brought in the Delaware Court of Chancery. The plaintiffs in California State Teachers had brought a books and records request pursuant to Section 220 of the Delaware General Corporation law, slowing down their case, while the plaintiffs in the federal action had not. The federal action progressed to a motion to dismiss, which was granted in favor of the Wal-Mart defendants on demand futility grounds. The defendants in California State Teachers then moved to dismiss based on issue preclusion principles. The Court of Chancery initially agreed, dismissing the action. The Delaware Supreme Court remanded for further briefing on the issue of Due Process concerns, in that plaintiffs may be unable to bring a case following an adjudication obtained by separate plaintiffs in a separate action. Following additional briefing, Chancellor Andre G. Bouchard found that under current law, there was no Due Process violation in applying collateral estoppel and dismissing the Delaware action on the same demand futility issue. But he suggested adopting a rule that collateral estoppel should not become effective until after an action has survived a motion to dismiss and discovery has begun (known as the EZCORP rule). The Delaware Supreme Court disagreed and rejected the proposed rule, ruling that in derivative actions, where plaintiffs only have standing by virtue of their derivative rights in the corporation, and where the corporation’s interests were adequately represented in another action, even if the lawyers in that other action make strategic decisions that are ineffective (such as not seeking a Section 220 demand), the prior decision is binding on other pending derivative actions. This decision is expected to have wide implications on the ability of defendants to enforce judgments in their favor when multiple litigations on the same issue are brought around the country.