Securities Snapshot May 08, 2019

The Supreme Court Declines To Comment On The Standard For Bringing Section 14(E) Claims


The Supreme Court remains silent on whether the Securities Exchange Act section 14(e) provides a negligence-based cause of action for damages; “unusual” allegations regarding material omissions and loss causation survive a motion to dismiss in the Northern District of California; stock research report company faces allegations of defrauding investors in failing to provide unbiased research reports on small and microcap companies; shareholder class action attempts to amend complaints to include additional alleged misstatement that amount to mere “puffery” are futile.

On April 23, 2019, the United States Supreme Court dismissed the writ of certiorari from the Ninth Circuit to clarify the standard for bringing certain tender offer claims under the Exchange Act.  On appeal, appellant Emulex Corp. asked the Supreme Court to resolve whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action for plaintiffs based on a negligent misstatement or omission made in connection with a tender offer instead of requiring a plaintiff to allege scienter, as in a securities fraud claim under Rule 10b-5. In its decision, the Supreme Court declined to review this petition in a single sentence: “[t]he writ of certiorari is dismissed as improvidently granted.”

The case arose from a tender offer for Emulex’s outstanding stock. In connection with the tender offer, Emulex issued a recommendation statement which included its board of directors’ recommendation that Emulex stockholders tender their shares. The stockholder plaintiff then sued, alleging that the recommendation statement omitted material information relating to the fairness of the merger, violating federal securities laws, specifically Section 14(e) of the Exchange Act.

The district court dismissed plaintiffs’ claims concluding that Section 14(e) required the plaintiffs to plead facts supporting a “strong inference” that the defendants acted with scienter, which the plaintiffs did not do. On appeal, the Ninth Circuit reversed, holding, contrary to the Second, Third, Fifth, Sixth and Eleventh Circuits, that Section 14(e) provides a negligence-based private right of action and does not require a plaintiff to plead scienter. The Ninth Circuit held that a stockholder asserting a claim under Section 14(e) is required to plead and prove facts showing that the defendant was merely negligent in making a false statement or misleading omission in connection with a tender offer. 

In its petition to the Supreme Court, Emulex Co. requested that the Supreme Court address this circuit split. The Supreme Court heard oral arguments on April 15, 2019. On April 23, 2019, the Court passed on the opportunity to clarify the standard of liability under the securities laws for misleading disclosures about tender offers, disposing of the case in a single line, leaving the circuit split unresolved.


On April 24, 2019, the United States District Court for the Northern District of California denied in part Defendant RhythmOne’s motion to dismiss Edenbrook Capital, LLC’s, a private fund manager, complaint filed on February 4, 2019, alleging that the digital advertising company failed to disclose key terms for its $185 million acquisition of rival YuMe Inc.

Edenbrook claims RhythmOne violated Section 14(e) of the Securities Exchange Act by omitting material information regarding the tender offer, causing it significant loss. Edenbrook claims the disclosures RhythmOne filed with the SEC failed to mention that tendering stockholders would have an option to receive their RhythmOne shares via electronic conversion, while non-tendering stockholders would only receive physical certificates.  As a result of the divergent methods, tendering YuMe shareholders would receive their stock consideration within days of the deal’s consummation, while non-tendering shareholders would have to wait over one month. After the deal closed, tendering YuMe stockholders received the RhythmOne shares they were owed by February 6, 2018, while non-tendering stockholders did not receive their shares until March 8, 2018. During that month, the share price dropped over 20 percent and did not recover. 

The Court found that, though Edenbrook’s claims were “unusual in the securities context”, it had nonetheless “plausibly state[d] a claim for loss causation” based on its inability to sell its shares of RhythmOne until roughly a month after the merger. Though Edenbrook did not allege the typical trope of material omissions leading to the drop in stock price, the Court found convincing Edenbrook’s argument that it suffered a loss by being unable to sell its RhythmOne earlier due to the delay incurred by the time it took RhythmOne to mail its broker the paper stock certificate, and the added time Edenbrook’s broker required to then break the certificate down into units for each of the broker’s clients. The court also found that Edenbrook sufficiently alleged a material omission where RhythmOne failed to explicitly state that non-tendering shareholders would not be given an option to electronically convert their stock, an alleged deviation from typical practice in a merger. This decision demonstrates the ability for securities actions to survive past the motion to dismiss stage even when plaintiffs do not argue traditional loss causation arguments.


On April 26, 2019, the United States District Court for the Southern District of New York denied a motion to dismiss of Ajay and Amit Tandon, brothers and co-founders of the stock research firm SeeThruEquity, LLC. The Court found that the SEC’s complaint, alleging that the brothers and co-founders defrauded investors in violation of the anti-fraud provisions of the federal securities law, contained “ample factual allegations” to show that the firm misrepresented the money it got for promoting publicly-traded small and microcap companies. The complaint alleges violations of Securities Act sections 17(a)(1) and (3) and 17(b) and Exchange Act section 10(b).

The complaint charges Ajay and SeeThruEquity with violating the anti-fraud provisions of the federal securities laws by issuing stock research reports purportedly based on “unbiased” and “not paid for” research when to the contrary the firm and its owners were well paid by the companies for which they published research reports. The allegations further detail that issuers also regularly had input into the substance of the supposedly unbiased research reports, even including the price targets. Other illicit activities include that the Tandons often instructed SeeThruEquity analysts to use different, higher price targets for covered issuers than those yielded through purported quantitative analysis. The complaint alleges that Ajay frequently traded in the same stocks that SeeThruEquity was evaluating, despite stating in published interviews and elsewhere that neither the firm nor its principals traded in securities for which they published research, and engaged in scalping, by making stock recommendations to investors and contemporaneously trading against that very recommendation without adequate disclosure. 

The Tandon brothers moved to dismiss the SEC’s complaint, claiming that (1) the SEC engaged in “shotgun pleading” that did not satisfy the heightened pleading requirement, (2) the SEC failed to plead materiality with particularity, and (3) the SEC inadequately alleged scheme liability and failed to allege a deceptive act that was distinct from misstatements. The court rejected all of defendants’ arguments and denied their motion to dismiss.

With respect to “shotgun pleading”, the court held that the complaint sufficiently described each defendant’s alleged misconduct for: (1) misrepresentations and omissions regarding supposedly “unbiased” and “not paid for research”; (2) SeeThruEquity’s research reports for QFOR, which misrepresented compensation and ownership of a covered stock; (3) misrepresentations and omissions regarding objectivity of SeeThruEquity price targets; (4) misrepresentations concerning “customary trading restrictions”; and (5) the fact that Ajay Tandon “scalped” covered stocks.  The court also held that the SEC sufficiently plead materiality with particularity. Even though defendants alleged that the complaint was devoid of any facts concerning investor conduct or testimony, or other supporting information, the court held that the complaint nonetheless contained ample factual allegations that supported materiality. This included details that the defendants misled their customers into believing that the research reports were “unbiased,” “not paid for,” and created using an objective model, although the defendants received compensation for the research reports and inflated the price targets at the covered companies’ behest. The court also found that the complaint sufficiently alleged that defendants repeatedly made false or misleading statements in their research reports, press releases, and website, citing several examples of such statements. Moreover, the defendants’ entire business model, beyond any misstatements or omissions, was alleged as deceptive, which adequately supported allegations of “scheme liability” claims under Rule 10b-5(a) and (c) and Section 17(a) and (c).


On April 29, 2019, the Second Circuit affirmed an order of the United States District Court for the Southern District of New York denying appellants’ motions for leave to file a fourth amended complaint, on the basis of futility, in a shareholder class action against Endo International PLC (“Endo”), a pharmaceutical company, and its past and present executives alleging securities fraud. The appellants allege that Defendants left investors with the false impression that, after acquiring another pharmaceutical company, Endo would not be making any drastic changes to its generics business, Qualitest Pharmaceuticals. Notwithstanding this representation, Defendants allegedly executed a secret plan to transform Endo’s generics business, and abandoned Qualitest’s business model in favor of the newly acquired company.

The Court held that appellants’ proposed fourth amended complaint failed to plausibly allege that Defendants made any material misrepresentations—either by affirmative misstatement or by omission—in connection with the acquisition of the pharmaceutical company. Because appellants had failed to allege a plausible 10b-5 violation, the district court correctly held that the amendment would be futile, noting that Endo made many disclosures indicating they “planned significant changes” and that the acquisition would be “transformational.” The Court also noted that many of the statements to which the appellants attached significance were nothing more than puffery and the sort of vague and optimistic statements that are too general to cause a reasonable investor to rely upon. In the absence of a plausible Rule 10b-5 violation, the district court correctly held that amendment would be futile. This decision demonstrates that while there is a growing trend of securities class actions levied against pharmaceutical companies, courts continue to resolve these in pre-trial phases in defendants’ favors.