Securities Snapshot October 22, 2019

Northern District of California Holds That Equitable Tolling Does Not Apply to Section 12(A)(1) of the Securities Act of 1933

Summary

Northern District of California holds that equitable tolling does not apply to Section 12(a)(1) of the Securities Act of 1933; DOJ releases guidance on evaluating a business organization’s inability to pay a criminal fine or penalty; Pennsylvania federal court dismisses securities class action based on restated financials; and CFTC, FinCEN, and SEC issue joint statement on AML/CFT obligations related to activities involving digital assets.

On October 4, 2019, in Fabian v. LeMahieu, the Northern District of California, addressed a question that has not yet been resolved by the Ninth Circuit Court of Appeals: whether equitable tolling—a principle under which the statute of limitations will not bar a claim if the plaintiff, despite the exercise of reasonable diligence, did not discover the alleged violation until after the limitations period—applies to Section 12(a)(1) of the Securities Act of 1933. The district court adopted the holding of various other Courts of Appeals that “equitable tolling does not apply to Section 12(a)(1) claims, regardless of the circumstances.”

The question arose in the context of a putative class action alleging securities fraud and related state-law claims against various defendants for their promotion of a cryptocurrency called “XRB” or “Nano Tokens.” Plaintiffs alleged that throughout the class period from April 1, 2017 to March 31, 2018, certain defendants encouraged the public to purchase XRB through, and store XRB holdings at the “BitGrail Exchange,” which, according to the complaint, experienced a number of problems (e.g., an inability to verify new users in a timely fashion, the reliability of the trading platform and user account balances, and the loss of $170 million of XRB on account of “unauthorized transactions”) of which defendants were aware yet continued to issue reassuring statements to the public regarding the safety of funds on BitGrail.

The court dismissed as time-barred the claims under the Securities Act of 1933 (while it permitted plaintiff to proceed with state-law claims for negligence, fraud, and negligent misrepresentation). Because plaintiff’s last purchase of XRB was on December 12, 2017, the January 3, 2019 initial complaint fell outside the one-year limitations period for Section 12(a)(1). Plaintiff argued that equitable tolling may apply to Section 12(a)(1) under certain circumstances, such as when a defendant convinces the purchaser to defer timely action. The court found persuasive the fact that the text of Section 12(a)(1) does not include a discovery rule, even though the text of the very next Section, 12(a)(2), does, and also reasoned that a discovery rule would not be appropriate because the registration of securities is readily discoverable. The court also rejected plaintiff’s argument for tolling under the Supreme Court’s rule in American Pipe & Construction Company v. Utah, 414 U.S. 538 (1974), which allows for tolling of a limitations period in certain circumstances upon timely filing of a class action, because the Supreme Court recently had rejected the application of the American Pipe rule to successive class action lawsuits and so a previously filed class action regarding the same issues did not toll the statute of limitations for this class action.

DOJ RELEASES GUIDANCE ON EVALUATING A BUSINESS ORGANIZATION’S INABILITY TO PAY A CRIMINAL FINE OR PENALTY

On October 8, 2019, the U.S. Department of Justice (“DOJ”) released a memorandum providing guidance to Criminal Division personnel regarding the evaluation of business organizations’ inability to pay criminal fines or monetary penalties. The federal Sentencing Guidelines allow for the reduction of a criminal fine where an organization is not able to pay, but the reduction “shall not be more than necessary to avoid substantially jeopardizing the continued viability of the organization.” The DOJ memorandum emphasizes that, irrespective of any inability-to-pay issue, the parties must first reach agreement on a monetary penalty “that is appropriate based on the law and facts.”

In considering an inability-to-pay-argument, Criminal Division attorneys must consider the sentencing factors in 18 U.S.C. § 3572(a) and (b), the guidelines in U.S.S.G. §§ 8C2.2 and 8C3.3, and the Justice Manual’s principles regarding consideration of collateral consequences in the resolution of criminal cases. Although a business organization’s ability to pay will often be determined from the information provided in response to an Inability-to-Pay Questionnaire (attached to the DOJ memorandum), “[w]here legitimate questions exist regarding an organization’s inability to pay, the analysis can be more complex, requiring the consideration of a range of factors,” including:

  • The context giving rise to the organization’s current financial condition, including any recent expenditures of capital, investments, and related-party transactions.
  • The availability of alternative sources of capital, including the organization’s ability to raise capital through credit facilities or sales of assets; the existence of insurance or indemnification agreements or booked reserves; and any plans for acquisition or divestment of assets.
  • Potential collateral consequences likely to result from the imposition of a fine or penalty, including any impact on the organization’s ability to fund pension obligations or make expenditures to meet legal or regulatory requirements, and the likelihood that the penalty will prompt layoffs, product shortages, or significantly disrupt market competition. The memorandum also emphasizes that certain collateral consequences—including adverse impact on growth, or adverse impact on planned or future opportunities, product lines, dividends, compensation, and hiring or retention—are generally not relevant to the inability-to-pay analysis.
  • Potential impairment of the organization’s ability to make restitution to victims.

The memorandum advises that when Criminal Division attorneys determine that an organization is unable to pay a fine or penalty, they should recommend an adjustment but only to the extent it is necessary to avoid threatening the organization’s ongoing viability or ability to pay restitution. An adjustment may include a reduction in the fine or penalty amount, or the use of an installment schedule. All reductions require supervisor approval, and any reduction exceeding 25% will also require approval from the Assistant Attorney General for the Criminal Division.

PENNSYLVANIA FEDERAL COURT DISMISSES SECURITIES CLASS ACTION BASED ON RESTATED FINANCIALS

On October 9, 2019, in Kumar v. Kulicke and Soffa Industries, Inc., the Eastern District of Pennsylvania dismissed without prejudice a securities class action against Kulicke and Soffa Industries and Kulicke’s CEO and CFO based on financial statements that the Company filed on Form 10-K with the SEC in November 2017 and amended in May 2018 because, as the Company announced, it had discovered “certain unauthorized transactions by a senior finance employee.” The complaint alleged that these unauthorized transactions were made by the CFO, who had resigned soon after the November 2017 10-K, and the CFO and Company therefore must have known that there were material misrepresentations in the November 2017 10-K (and accompanying Sarbanes-Oxley Act certifications).

The court rejected this “must have known” theory and dismissed the complaint for failure to plead fraudulent intent, or scienter. According to the court, the complaint’s “speculation” linking the CFO’s resignation to the Company’s knowledge of the unauthorized transactions was insufficient to satisfy the heightened pleading standard for scienter under the Private Securities Litigation Reform Act. The resignation was announced at least four months before the announcement of the discovery of the unauthorized transactions and more than six months before the Company restated its financials. The court also rejected plaintiffs’ argument that the Company’s announcement that it was considering remedial action supported a strong inference of scienter; instead, the court found that it supported a non-culpable inference that the Company was attempting to correct the mistake after discovering it. The court also rejected the application of the “corporate scienter” doctrine, which has not been accepted by the Third Circuit, because there was no evidence in the amended complaint of widespread, sustained wrongdoing or a “large-scale cover-up scheme.” This decision underscores a securities fraud plaintiff’s significant burden to plead scienter, even where the underlying facts involve wrongdoing by senior management.

CFTC, FINCEN, AND SEC ISSUE JOINT STATEMENT ON AML/CFT OBLIGATIONS RELATED TO ACTIVITIES INVOLVING DIGITAL ASSETS

On October 11, 2019, the leaders of the U.S. Commodity Futures Trading Commission (“CFTC”), the Financial Crimes Enforcement Network (“FinCEN”), and the U.S. Securities and Exchange Commission (“SEC”) issued a joint statement “to remind persons engaged in activities involving digital assets of their anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act (BSA).” The joint statement serves as a reminder that all entities falling within the BSA’s definition of “financial institutions” (including futures commission merchants and introducing brokers who must register with the CFTC; money services businesses as defined by FinCEN; and broker-dealers and mutual funds that must register with the SEC) are obliged to fulfill certain AML/CFT obligations, including the establishment of an effective anti-money laundering program, recordkeeping requirements, and reporting requirements, including suspicious activity reporting (“SAR”) requirements.

The joint statement defines “digital assets” as including “instruments that may qualify under applicable U.S. laws as securities, commodities, and security- or commodity-based instruments such as futures or swaps.” While digital assets may be referred to under many different labels, market terminology is not determinative and it “is the facts and circumstances underlying an asset, activity or service, including its economic reality and use” that determine the categorization of the asset, the regulatory treatment of the asset-related activity, and the ultimate question of whether the entities involved in the activity are “financial institutions” under the BSA. The joint statement also notes that “[t]he nature of the digital asset-related activities a person engages in is a key factor in determining whether and how that person must register with” the Agencies. Further, certain obligations (including development of an anti-money-laundering program and SARs) apply under the BSA without regard to whether the particular transaction at issue involves a “security” or “commodity” as defined under the federal securities laws or the Commodities Exchange Act.