Securities Snapshot June 05, 2020

Delaware Chancery Court Keeps Alive Aiding and Abetting Claim Against J.P. Morgan Chase & Co. in Long-Running Stockholder Suit Concerning Private Equity Firm Apollo Global Management LLC's Takeover of Fresh Market, Inc.

Summary

Delaware Chancery Court Keeps Alive Aiding and Abetting Claim Against J.P. Morgan Chase in Stockholder Suit Concerning 2016 Apollo Takeover Of Fresh Market; Second Circuit Affirms Dismissal of Securities Fraud Claims Against Kimberly-Clark Despite Guilty Verdict in State Court on Related Consumer Fraud Charges; First Circuit Affirms Conviction of Former State Street Executive on Securities and Wire Fraud Charges but Sidesteps Question of Wire Fraud Statute’s Extraterritoriality; Western District of Washington Magistrate Leaves Undisturbed Ninth Circuit Precedent Supporting Section 14(e) Private Right of Action in Report Recommending Dismissal of Putative Class Action Against Papa Murphy’s Holdings.

On June 1, 2020, in Morrison v. Berry, the Delaware Court of Chancery entered its latest decision in the long-running putative stockholder class action regarding the $1.4 billion go-private sale of Fresh Market, Inc. to private equity firm Apollo Global Management, LLC and its affiliates. Vice Chancellor Sam Glasscock granted all but one of the defendants’ motions to dismiss that related solely to the claims of aiding and abetting a breach of fiduciary duty by Fresh Market’s board when it approved the takeover back in 2016.

In 2017, Vice Chancellor Glasscock initially decided to dismiss, on Corwin grounds, the stockholder challenge to the transaction—i.e., he found judicial review would be of “little utility” where “an uncoerced and fully informed vote of the common stockholders ha[d] ratified a decision of the directors.” But the Delaware Supreme Court disagreed, reversing the decision in 2018. In his 2019 decision, Vice Chancellor Glasscock allowed putative class claims against three top officers of Fresh Market to move forward—while tossing the claims against independent board directors—but put off ruling on the aiding and abetting claims against the company’s financial advisor J.P. Morgan Chase & Co., its outside counsel Cravath Swaine & Moore LLP, and the Apollo group of buyers.

In its latest decision, the Court of Chancery found the allegations against Apollo to be lacking and conclusory and those against Cravath as “fanciful.” The Chancery Court kept alive, however, the claims against J.P. Morgan. Here, the court found the second amended complaint adequately pled facts establishing that J.P. Morgan knowingly misled the Fresh Market board in a way that made the board’s review of the transaction flawed and unreasonable under Revlon. According to the court, the pleadings detailed numerous backchannel communications—between J.P. Morgan and Apollo—that allegedly “channel[ed] confidential information to Apollo that arguably gave Apollo an edge in the bid process,” and allegedly provided to the board a “conflicts disclosure memorandum that fail[ed] to mention these substantive backchannel communications.”

J.P. Morgan has until June 11, 2020 to file its answer to the second amended complaint.

SECOND CIRCUIT AFFIRMS DISMISSAL OF SECURITIES FRAUD CLAIMS AGAINST KIMBERLY-CLARK CORP. DESPITE RELATED CALIFORNIA JURY VERDICT FINDING DEFENDANT GUILTY OF CONSUMER FRAUD

On May 27, 2020, in Jackson v. Abernathy et al., the Second Circuit affirmed the Southern District of New York’s decision to dismiss all claims that Kimberly-Clark Corp. and its executives violated Section 10(b) of the Securities Exchange Act when it allegedly lied—in a series of allegedly fraudulent misstatements in 2016—about the quality of its “MicroCool” surgical gown line. Additionally, the Second Circuit affirmed the lower court’s denial of plaintiffs’ request to file an amended complaint that included several new allegations based on a successful California state consumer fraud case against Kimberly-Clark concerning the same MicroCool surgical gown. Plaintiffs had suggested that the issues in the two proceedings were substantively identical, and that the evidence presented in the California consumer fraud litigation was sufficient to plead fraud under Section 10(b). The Second Circuit was not convinced.

As the Second Circuit noted, “it is not at all apparent that the individuals whose states of mind are relevant to prove corporate [intent] in the context of consumer fraud action are the same individuals whose states of mind are relevant in the context of a securities fraud action.” According to the court, plaintiffs could not meet the heightened pleading standard, demanded under the Private Securities Litigation Reform Act (PSLRA), by simply alleging—without particularity—that company executives must have known particular statements were false because of “general allegations of warnings made to unidentified senior executives” regarding the surgical gown by lower level employees.

The decision is an important reminder that the federal standard for pleading securities fraud under PSLRA is notably different from (and should not be confused with) pleading standards under state consumer fraud statutes, and that while two statutes may share the concept of fraudulent intent, that intent may apply to different actions taken by the defendants. For example, under the PSLRA, intent for securities fraud suits is focused on the intent with respect to statements made to investors.

FIRST CIRCUIT AFFIRMS CONVICTION OF FORMER STATE STREET EXECUTIVE ON SECURITIES AND WIRE FRAUD CHARGES; LEAVES OPEN QUESTION REGARDING EXTRATERRITORIAL APPLICATION OF WIRE FRAUD STATUTE

On May 20, 2020, in United States v. McLellan, the First Circuit Court of Appeals unanimously upheld former State Street executive Ross McLellan’s convictions on multiple counts of securities and wire fraud. After a three-week trial in 2018, a jury—at the U.S. District Court for the District of Massachusetts—had found McLellan guilty of leading a scheme to defraud overseas institutional investors by applying hidden commissions on the purchase and sale of U.S. securities. McLellan, with two lower-level directors, initially offered low commission rates (or even no-commission flat fees) on successful bids to broker multibillion-dollar transactions for various overseas clients, including U.K.-based Royal Mail and Ireland-based Eircom. As alleged by the government, McLellan and his subordinates subsequently included commissions on the various large dollar trades.

The First Circuit panel rejected McLellan’s argument that the lower court erred when it held that the wire fraud statute (18 U.S.C. § 1343) applied extraterritorially to McLellan’s foreign conduct. Noting that the wire fraud statute presented complex questions regarding congressional intent, the First Circuit panel decided to sidestep the question of territoriality, finding that the facts underlying McLellan’s conviction “suffice[d] to establish a domestic application” of the statute.

The question of the territoriality of the wire fraud statute has already split the Second and Third Circuit Courts of Appeal (the former holding § 1343 does not apply extraterritorially and the latter holding that it does). Moreover, government attorneys continue to push for the application of the statute extraterritorially (most recently in briefing before the Ninth Circuit). As the issue continues to be litigated in federal courts, foreign corporations and business leaders are advised to appropriately manage their legal exposure in the face of the statute’s potential long reach.

FEDERAL MAGISTRATE JUDGE FOR WESTERN DISTRICT OF WASHINGTON RECOMMENDS DISMISSAL OF PUTATIVE SECURITIES CLASS ACTION AND EXPRESSLY LEAVES UNDISTURBED NINTH CIRCUIT PRECEDENT SUPPORTING PRIVATE PARTIES’ RIGHT OF ACTION UNDER SECTION 14(E)

On May 20, 2020, in Brown v. Papa Murphy’s Holdings Inc., in the Western District of Washington, U.S. Magistrate Judge J. Richard Creatura filed a report recommending dismissal without prejudice of a putative securities class action against Papa Murphy’s, its executives and its advisor. Brown alleged that defendants violated Sections 14(e) of the Securities Exchange Act by understating financials—ahead of an April 2019 merger with MTY Food Group Inc.—for the purpose of inducing investors into approving the merger at an unfairly low price.

In his amended complaint, plaintiffs specifically accused Papa Murphy’s and its executives of “negligently” endorsing a fairness opinion prepared by North Point Advisors that contained the allegedly misleading financial projections. But Magistrate Judge Creatura found that Brown’s amended complaint failed, under the PSLRA, to plead with particularity any facts giving rise to a “strong inference” of negligence—as required by Ninth Circuit authority. Further, the Magistrate Judge found that Brown also failed to allege facts sufficient to establish that the financial projections were misleading or objectively and subjectively false.

Magistrate Judge Creatura also shot down defendants’ attempt to disturb current Ninth Circuit precedent (Varjabedian v. Emulex Corp.) holding that Section 14(e) provides private plaintiffs with a right of action. The U.S. Supreme Court last year granted a writ of certiorari to review the Ninth Circuit’s Emulex holding—which is in express disagreement with five other courts of appeals—but then dismissed the writ as improvidently granted. Papa Murphy’s potentially tees the issue up again for future Supreme Court review.

Plaintiffs have until June 5, 2020 to file written objections to the Magistrate Judge’s report if seeking review by the district judge. Plaintiffs are also free to file an amended complaint by June 20, 2020.