Ninth Circuit Creates Splitover Applicable Mental Standard In Section 14(e) Tender Offer Cases

On April 20, 2018, the Ninth Circuit Court of Appeals in Varjabedian v. Emulex Corp, reversed and remanded a decision of the United States District Court for the Central District of California dismissing a purported securities class action suit brought under Sections 14(d)(4), 14(e), and 20(a) of the Securities Exchange Act of 1934. The plaintiff alleged that Emulex had made materially misleading statements and omissions in certain securities disclosures made in connection with a proposed tender offer for Emulex’s outstanding common stock by a subsidiary of Avago Technologies Wireless Manufacturing, Inc. The district court had granted Emulex’s motion to dismiss, ruling that claims brought under Section 14(e) require a showing of scienter in order to avoid dismissal and that the plaintiff had failed to plead scienter. With varying levels of clarity, the Second, Third, Fifth, Sixth, and Eleventh Circuits had previously ruled the same, requiring heightened pleading of scienter similar to that required for a claim made under Section 10(b) of the 1934 Act and Rule 10b-5, promulgated thereunder. The Ninth Circuit disagreed, concluding that only negligence needs to be pleaded and proven for a Section 14(e) claim, creating a circuit split. The Ninth Circuit grounded its reasoning in Supreme Court cases decided after the earliest of these circuit decisions, in particular the Supreme Court’s 1976 decision in Ernst & Ernst v. Hochfelder. Ernst & Ernst had concluded that scienter was an element of a claim under Section 10(b) based on specific language found in that statute, which allows the SEC to regulate only “manipulative or deceptive device[s].” Conducting a textual analysis of Section 14(e), the Ninth Circuit concluded that that critical language was missing from Section 14(e), and that negligence was therefore the required mental standard for a Section 14(e) violation. The Ninth Circuit went on to remand the Section 14(e) claim, along with the derivative control-person Section 20(a) claim, to the district court for a determination in the first instance as to whether the requirements of the claim had been met. Separately, the Ninth Circuit concluded that there is no private right of action under Section 14(d)(4), implemented in part by SEC Rule 14d-9, and affirmed the dismissal of that claim. Both conclusions will have a significant impact on subsequent securities cases in the tender offer context, but in particular, the Section 14(e) ruling will have broad implications. The Ninth Circuit’s rule now permits plaintiffs to bring claims for even negligent misstatements or omissions in tender offer documents, will reduce plaintiffs’ burden in pleading and proving Section 14(e) tender offer claims, and may make defending such claims more difficult. The next dismissal of a Section 14(e) claim may very well set up a request for review by the Supreme Court to resolve the now-apparent circuit split. Until the Supreme Court weighs in, we can expect to see a shift of Section 14(e) filings to district courts within the Ninth Circuit.

SECOND CIRCUIT AFFIRMS DISMISSAL OF SECURITIES CLASS ACTION OVER GENERICALLY POSITIVE STATEMENTS AND OPINIONS

On April 24, 2018, the Second Circuit Court of Appeals issued an order in Altayyar v. Etsy, Inc., affirming the dismissal of a putative securities class action lawsuit against Etsy, certain of its officers and directors, and the underwriters of its 2015 initial public offering. The plaintiffs had brought claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as well as under Sections 11, 15, and 12(a)(2) of the Securities Act of 1933, accusing Etsy of concealing risks concerning counterfeit goods on its online store, the disclosure of which later led to a stock plunge after its IPO. In a summary order, the three-judge panel affirmed the decision of the United States District Court for the Eastern District of New York, dismissing the case with prejudice. Even under the relatively liberal pleading standards the court applied to the 1933 Act claims, the Second Circuit concluded that the plaintiffs failed to show the sort of false statements necessary to support their securities claims. The Second Circuit concluded that the purported misstatements challenged by the shareholders, such as “[o]ur values are integral to everything we do,” were the types of vague aspirational statements, opinions, or descriptions of company policies and values that do not qualify as actionable misrepresentations or omissions. While the short opinion breaks no new ground in its analysis, the Second Circuit makes clear in Altayyar v. Etsy that general laudatory and optimistic statements that a company makes about itself should not lead to a viable securities lawsuit.

FIFTH CIRCUIT DECISION INVALIDATING FIDUCIARY RULE STANDS AFTER DEPARTMENT OF LABOR DECLINES TO SEEK EN BANC REVIEW AND PANEL DENIES LEAVE TO INTERVENE

On May 2, 2018, the Fifth Circuit denied without explanation the AARP’s motion to intervene, as well as that of various state attorneys general, in U.S. Chamber of Commerce v. Department of Labor, a decision that may signal the demise of the Department of Labor’s Fiduciary Rule. In March, the Fifth Circuit struck down the Fiduciary Rule, an Obama-era regulation from the DOL, which requires retirement advisers to prioritize clients’ financial interests. A split Fifth Circuit panel enjoined the rule nationwide, with the majority finding in favor of the U.S. Chamber of Commerce and other business groups that the DOL had overstepped its authority and that its redefinition of “fiduciary” was unreasonable. The DOL had until May 1 to seek en banc review of this decision, but it declined to do so. It was only after that date that the Fifth Circuit ruled on the motions to intervene filed by the AARP and state attorneys general, which the U.S. Chamber of Commerce had opposed. While the DOL has until June 13 to file a petition for certiorari in the Supreme Court, it is not expected to seek further review, which would spell the end of the DOL Fiduciary Rule. On May 7, 2018, however, the DOL issued a field assistance bulletin in which it announced that financial advisers are free to continue relying on the Fiduciary Rule for the time being, although they will not be penalized if they stop.

SECOND CIRCUIT VACATES CONVICTION OF RMBS TRADER FOR SECOND TIME

On May 3, 2018, the Second Circuit Court of Appeals vacated, again, the securities fraud conviction of former Jefferies & Company residential mortgage backed securities trader Jesse Litvak in United States v. Litvak. The government originally charged Litvak with ten counts of securities fraud for alleged misrepresentations over price made in the course of trading with counterparties. At his first trial, the district court had prevented Litvak from introducing expert testimony concerning the materiality of his price representations. On appeal, the Second Circuit vacated and remanded for a new trial the securities fraud counts, ruling that Litvak should be allowed to present that theory. At oral argument before the Second Circuit, the government abandoned as well its theory that Litvak, as a broker-dealer, had any fiduciary or agency relationship with his counterparties. At retrial, Litvak was able to present expert evidence concerning the materiality of the misstatements. But despite the government abandoning the agency theory on appeal, in one of the ten charges, it presented testimony from one of Litvak’s counterparties that he believed Litvak was acting as an agent. The jury convicted Litvak of that one count, but acquitted him of the other nine. On appeal a second time, the Second Circuit ruled that while, as a matter of law, Litvak’s misrepresentations could be material, and so his conviction could not be reversed on that ground, it was clear the jury had found in his favor on materiality on the other nine counts. With the only distinguishing feature of the count of conviction being the admittedly irrelevant subjective belief of Litvak’s counterparty, the Second Circuit concluded there had been prejudicial error in admitting that testimony, vacated the conviction again, and remanded the case back to the district court.

DISTRICT OF MASSACHUSETTS DENIES SUMMARY JUDGMENT FOR PHARMACEUTICAL EXECUTIVE IN SECURITIES CLASS ACTION

On April 20, 2018, the United States District Court for the District of Massachusetts denied a motion for summary judgment in the case SEC v. Johnston. The case involved disclosures made by the pharmaceutical company AVEO Pharmaceuticals, Inc., concerning its flagship cancer drug candidate, tivozanib, or Tivo. The SEC initially brought claims against AVEO, its chief executive officer, its chief financial officer, and its chief medical officer under Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13a-14 promulgated thereunder, as well as under Section 17(a) of the Securities Act of 1933. The SEC alleged that the defendants made material omissions when they failed to disclose communications with the FDA indicating that the FDA would likely require a second Phase III clinical trial of Tivo before it would approve the drug. After the other defendants settled, David Johnston, the company’s CFO, filed a motion for summary judgment. Judge Nathaniel M. Gorton denied the motion in its entirety. The court first concluded that the details concerning the potential need for a second Phase III trial could be considered material to a reasonable investor, and noted in particular that, unlike other precedent within the First Circuit, AVEO’s disclosures did not contain specific warnings of risk concerning the possible need for additional trials. The court also cited to internal AVEO documents that “highlighted the ‘high risk’ of non-approval . . . if AVEO chose not to pursue a second clinical trial.” The court also held that it could not grant summary judgment in Johnston’s favor on the issue of scienter, noting that scienter is often a question for the jury. In particular, the court pointed to a script prepared for an investor call in which the company was to answer particular investor questions by not disclosing the recommendation of a second Phase III trial. That document contained an answer explaining in more detail the FDA’s hesitation to approve, but indicated it was to be discussed only “IF PUSHED.” The incongruity between the public statements and internal reflections supported scienter, the court ruled. The court also did not accept Johnston’s arguments that AVEO had no duty to disclose this information, ruling that the company’s other disclosures were rendered misleading by this omission. Finally, the court also allowed the claim under Rule 13a-14 to proceed, despite the defendant’s argument that there was no private right of action created by the rule. The court noted that the Ninth Circuit had previously found a private right of action under Rule 13a-14, and it declined to hold otherwise.

FLORIDA DISTRICT COURT DISMISSES WITH PREJUCE DISCLOSURE CLAIMS AGAINST MAJOR MORTGAGE SERVICER

On April 30, 2018, the United States District Court for the Southern District of Florida, in Carvelli v. Ocwen Financial Corp., et al., dismissed with prejudice a purported securities class action against Ocwen Financial Corp. and two of its executives. The plaintiff had asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, alleging that Ocwen had misstated its compliance with various consent judgments it had entered into concerning its mortgage servicing business because its servicing software was fundamentally flawed, preventing full compliance. Judge Robin L. Rosenberg ruled that the various statements alleged by the plaintiff failed to rise to the level of material misstatements or omissions necessary for the 1934 Act. The court grouped the plaintiff’s alleged misstatements into various categories. First, several disclosures (for example, “we are committed to correcting any deficiencies remediating any borrower harm and improving our compliance management systems and customer service”) were ruled to be non-actionable puffery. These generalized, non-verifiable, vaguely optimistic statements, the court concluded, are not actionable because investors do not rely on them as a matter of law. Second, the court concluded that several statements (for example, that Ocwen “want[s] to resolve [its] remaining legacy, regulatory, and legal concerns”) were forward-looking statements and were surrounded by sufficient cautionary language, and were therefore not actionable under the Private Securities Litigation Reform Act’s safe harbor. Third, many of the alleged misstatements (for example, Ocwen “believe[d] its significant investments in [its] servicing operations, risks and compliance infrastructure over recent years will position [it] favorably relative to [its] peers”) were merely statements of opinion, and the complaint did not sufficiently allege that those opinions were not sincerely held. Finally, several of the alleged misstatements were accurate as stated or alleged mere corporate mismanagement, and so were not actionable under the 1934 Act. With all statements alleged by the plaintiff found to be non-actionable, the court dismissed the case in its entirety and concluded that leave to amend would be inappropriate. This case highlights how a thorough and detailed analysis by the court (backed by detailed briefing by the parties) can lead to dismissal even at the early stages of a securities case.