Securities Snapshot December 04, 2018

Department Of Justice Eases The Standard For Granting Cooperation Credit To Companies In Criminal And Civil Investigations

Summary

Department of Justice Eases the Standard for Granting Cooperation Credit to Companies in Criminal and Civil Investigations; SEC Fails to Demonstrate that Digital Token is Subject to Securities Laws; Third Circuit in Precedential Decision Affirms Dismissal of Shareholder Complaint with Speculative Allegations Of Misrepresentation; Supreme Court Grants Certiorari to Review Appropriate Statute Of Limitations under Qui Tam Provision of False Claims Act; Judge Rules that Some of Yelp’s Investor Statements May Constitute Misrepresentations; Convicted Insider Trader Collaterally Estopped from Relitigating Underlying Facts in Parallel Civil Proceeding.

DEPARTMENT OF JUSTICE EASES THE STANDARD FOR GRANTING COOPERATION CREDIT TO COMPANIES IN CRIMINAL AND CIVIL INVESTIGATIONS

On November 29, 2018, in remarks delivered at the American Conference Institute’s International Conference on the Foreign Corrupt Practices Act, Deputy Attorney General Rod J. Rosenstein announced certain revisions to the Department of Justice’s policies regarding the cooperation of companies in connection with criminal and civil DOJ investigations, specifically with respect to the nature and extent of the information the DOJ expects to receive from companies in order to qualify for cooperation credit. In a memorandum issued by then DAG Sally Yates in September 2015 (often referred to as the “Yates Memo”) the DOJ had announced that companies must provide to federal prosecutors “all relevant facts about the individuals involved in corporate misconduct” to be eligible for any cooperation credit in criminal investigations. Last week, DAG Rosenstein announced that going forward, the DOJ will require that any company seeking cooperation credit identify every individual “substantially involved in or responsible for the criminal conduct.” The DAG noted that the policy change was made in response to concerns raised about “the inefficiency of requiring companies to identify every employee involved [in wrongdoing] regardless or relative culpability,” and he said that the DOJ was making clear that “investigations should not be delayed merely to collect information about individuals whose involvement was not substantial, and who are not likely to be prosecuted.”   

Similarly, in connection with civil investigations, the DAG announced that the DOJ was easing an “all or nothing approach” with respect to civil DOJ attorneys affording cooperation credit.  DAG Rosenstein stressed that if a company seeks to earn maximum credit, it must identify every individual person “substantially involved in or responsible” for the misconduct at issue, but when a company assists in good faith with the government’s investigation, it may still receive some credit without identifying “every employee who played any role” in the subject of the investigation. DOJ attorneys “may reward cooperation that meaningfully assisted the government’s civil investigation, without the need to agree about every employee with potential individual liability,” the DAG said. The changes to the criminal and civil policies were made part of the internal handbook for federal prosecutors now known as the Justice Manual (formerly the United States Attorneys Manual).

While there will certainly be some debate over what it means for an individual to have been “substantially involved” in misconduct, taken as a whole, these policy changes–which give government attorneys more discretion with respect to determining what is required from companies seeking to cooperate with government investigations–also provide company counsel opportunities for advocacy regarding the credit that should be afforded their clients’ cooperation.

SEC FAILS TO DEMONSTRATE THAT DIGITAL TOKEN IS SUBJECT TO SECURITIES LAWS

On November 27, 2018, the United States District Court for the Southern District of California in SEC v. Blockvest, LLC, et al. denied the SEC’s motion for a preliminary injunction against Blockvest, LLC, a company set up to exchange cryptocurrencies, and founder Reginald Buddy Ringgold, III, ruling that the SEC failed to demonstrate that the tokens offered by Blockvest constituted “securities” subject to federal securities laws. The SEC alleged that the defendants had been offering and selling unregistered securities in the form of BLV tokens amounting to transactions in excess of $180,000 prior to a purported $100 million ICO, and sought a preliminary injunction to freeze the defendants’ assets and enjoin them from trading in securities and cryptocurrency. In response, Ringgold asserted that Blockvest never sold any tokens to the public, its exchange was never open for business, and Blockvest’s sole investor, Rosegold Investments LLP, raised money only from Ringgold, non-party Michael Sheppard, and Ringgold and Sheppard’s friends and family.  Ringgold explained that the BLV tokens were “only designed for testing the platform,” and that the 32 test investors who purchased tokens were sophisticated investors who spent less than $10,000 on the Blockvest Exchange.  Because there were disputed facts, the court could not make a determination as to whether the test BLV tokens were “securities,” such that a violation of the federal securities laws had occurred to warrant an injunction. District Judge Gonzalo P. Curiel found no evidentiary support for the SEC’s assertion that the 32 investors relied on representations by the defendants in purchasing the tokens, nor that the test investors, specifically vetted by the company to help with its testing phase, had an expectation of profits from the token purchase.     

This decision provides further guidance to the nascent ICO industry on the reach of the SEC’s jurisdiction over cryptocurrency. The BLV token, when purchased by company affiliates for the purpose of testing the platform, was not considered a security under the federal securities laws when the SEC proffered no evidence showing that there was any expectation of profit for investors.

THIRD CIRCUIT IN PRECEDENTIAL DECISION AFFIRMS DISMISSAL OF SHAREHOLDER COMPLAINT WITH SPECULATIVE ALLEGATIONS OF MISREPRESENTATION

On November 14, 2018, the U.S. Court of Appeals for the Third Circuit in City of Cambridge Retirement System v. Altisource Asset Management Corp., et al. affirmed the dismissal of a securities fraud class action against Altisource Asset Management Corporation and several of its officers. The shareholder plaintiffs alleged that: (1) the defendants misrepresented the benefits of its relationship with an affiliated mortgage company, Ocwen Financial Corporation, and (2) that its executives failed to adhere to its stated policy of recusing themselves from conflicts of interest among Ocwen-affiliated companies. The Third Circuit held in a precedential decision that the suing funds failed to plead facts sufficient under the PSLRA to establish the requisite elements of material misrepresentation, scienter, and loss causation. As to allegations regarding the relationship to Ocwen, the court did not find that Altisource was obligated to disclose its awareness of alleged problems with Ocwen’s loan servicing platform in its 2013 Annual Report. There was “nothing false or misleading” about the report when it “does not imply anything about the quality of Ocwen’s loan servicing, only its capacity (high) and its cost (low).” (emphasis in original). As to allegations regarding Altisource’s recusal policy, the court noted that the plaintiffs relied on an inference from one executive’s alleged conduct with regard to two separate companies. While the court acknowledged that PSLRA’s stringent pleading requirements, as established by In re Burlington Coat Factory Sec. Lit., should be “relaxed somewhat where the factual information is peculiarly within the defendant’s knowledge or control,” it concluded that the complaint simply speculated that an executive violated the recusal policy  because he was suspected to have done so with a company affiliate. The court saw no need to engage in an analysis of the remaining elements of scienter and loss causation when “[b]oth factors are predicated upon a sufficient pleading of false or misleading statements.”

Thus, courts will decline to impose disclosure obligations on a defendant company related to the alleged conduct of a non-party affiliate, when the minor discrepancies do not constitute material misrepresentations.

SUPREME COURT GRANTS CERTIORARI TO REVIEW APPROPRIATE STATUTE OF LIMITATIONS UNDER QUI TAM PROVISION OF FALSE CLAIMS ACT

On November 16, 2018 the Supreme Court of the United States granted certiorari in United States ex rel. Hunt v. Cochise Consultancy, Inc., et al. to address a circuit court split regarding the application of the False Claims Act’s statute of limitations in cases filed by relators under the FCA’s qui tam provision where the government declines to intervene. The FCA requires that actions be brought within six years of “the date on which the violation of [the False Claims Act] is committed.” 31 U.S.C. § 3731(b)(1). However, the FCA also contains a statute of limitations provision that is based on when the government first learned of the alleged violation, providing that cases may be filed “more than 3 years after the date when facts material to the right of action are known or reasonably should have been known by the official of the United States charged with responsibility to act in the circumstances, but in no event more than 10 years after the date on which the violation is committed.” 31 U.S.C. § 3731(b)(2).

The U.S. Court of Appeals for the Eleventh Circuit held in a case of first impression that the three-year limitations period in section 3731(b)(2) applies to an FCA claim brought by a qui tam relator even when the government declines to intervene, while acknowledging that its decision was “at odds” with the published decisions of the Tenth and the Fourth Circuits.  The Eleventh Circuit noted that “nothing in section 3731(b)(2) says that its limitations period is unavailable to relators when the government declines to intervene.” In Hunt, the relator filed suit in 2013, alleging that his former employer and its subcontractor Cochise Consultancy, Inc., defrauded the Department of Defense by bribing an Army Corp of Engineers Officer and steering a subcontract to Cochise. The relator alleged that the defendants violated the FCA “beginning prior to January 2006 until early 2007,” and that he told the FBI about his allegations in 2010.  In other words, the lawsuit was filed seven years after the alleged fraud, but within three years of telling FBI agents about the alleged kickback scheme. The government declined to intervene, and the United States District Court for the Northern District of Alabama dismissed the case, holding that the “government knowledge” statute of limitations provision under section 3731(b)(2) does not apply in cases in which the government has declined to intervene. The Eleventh Circuit reversed, holding that because the three-year period in section 3731(b)(2) “begins to run when the relevant federal government official learns of the facts giving rise to the claim, when the relator learned of the fraud is immaterial for statute of limitations purposes.” 

While the Eleventh Circuit noted that the language of section 3731(b)(2) “government knowledge” statute of limitations applies even in cases where the government does not intervene, the Supreme Court granted certiorari noting, “if Hunt had filed suit in any of those five [the Fourth, Fifth, Tenth, Third, and Ninth] circuits, his complaint would have been time-barred.”

JUDGE RULES THAT SOME OF YELP’S INVESTOR STATEMENTS MAY CONSTITUTE MISREPRESENTATIONS

On November 27, 2018, the United States District Court for the Northern District of California in Azar et al. v. Yelp, Inc. et al., granted, in part, a motion to dismiss the plaintiff stockholders’ putative securities class action against Yelp Inc. and three company executives. Certain of the alleged misleading statements from the complaint—specifically, optimistic financial guidance and future growth projections disclosed to investors—were found to be forward-looking statements and accompanied by cautionary language about uncertainties, falling within the PSLRA’s safe harbor provision. But as to other alleged misrepresentations, including the defendants’ awareness of challenges within its advertising program, the court found that if the circumstances alleged were known at the time of statements, it would amount to a violation of the federal securities laws for reasons set forth by the Ninth Circuit in Brody v. Transitional Hosps. The plaintiffs alleged that Yelp had misled investors by touting the company’s strong local business advertising program and the program’s robust retention rate, despite having knowledge based on real-time metrics that retention trends were tracking downward. Further, as alleged, much of the company’s local revenue growth in 2016 had been attributable to businesses that had only signed single-year contracts with Yelp, who were likely to cancel their contracts at the end of the year-period. Despite knowledge of the retention issue, Yelp allegedly continued to make statements expressing confidence in its local advertisement program, “affirmatively creat[ing] an impression of state of affairs that differed in a material way from the one actually existed.” District Judge Edward Chen thus denied the motion to dismiss, in part, as to the allegations of omissions of the churn issues that would “likely significantly and negatively impact revenue.” 

CONVICTED INSIDER TRADER COLLATERALLY ESTOPPED FROM RELITIGATING UNDERLYING FACTS IN PARALLEL CIVIL PROCEEDING

On November 26, 2018, the United States District Court for the Southern District of New York in SEC v. Afriyie ordered former MSD Capital LP analyst John Afriyie to pay more than $3.2 million in disgorgement and civil penalties for trading on inside information which generated approximately $1.6 million in illegal profits. District Judge Jed Rakoff held that Afriyie’s January 2017 criminal conviction collaterally estopped him from disputing civil charges that he used his mother's brokerage account to profit on insider knowledge of the $15 billion private equity buyout of ADT Corporation. Afriyie had argued in opposition to the SEC’s summary judgment motion that there were factual disputes about the confidentiality and materiality of the information he traded on, his motivations for trading, and his overall exposure to the information. Judge Rakoff rejected these and other arguments, holding that "these statements are exactly the type of effort to relitigate a criminal conviction that collateral estoppel is intended to bar, and such ‘bald assertion[s], unsupported by evidence, [are] not sufficient to overcome a motion for summary judgment.’”