On October 2, 2020, in In re: Mindbody Inc. Shareholders Litigation, the Delaware Court of Chancery denied defendants’ motion to dismiss, in part, thereby allowing plaintiff shareholders to continue their claims against two of three Mindbody Inc.’s (“Mindbody”) officers in a class action challenging Mindbody’s 2018 sale to Vista Equity Partners Management LLC (“Vista”). Relying on the landmark Delaware Supreme Court decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., which held that fiduciaries of a corporation must maximize the sale price of the enterprise, plaintiffs allege that Mindbody’s CEO and other officers breached their fiduciary duties by “tilt[ing] the sales process for reasons inimical to the stockholders’ desire for the best price.” Vice Chancellor McCormick held that plaintiffs had succeeded in pleading a claim for breach of fiduciary duty against Mindbody’s co-founder and former CEO and the company’s Chief Financial Officer, while dismissing the claims against one of Mindbody’s outside directors.
This class action stems from Vista’s 2018 purchase of Mindbody, a then-publicly traded cloud-based business management and wellness service company, for a per share closing price of $36.50. Mindbody’s board unanimously approved the sale and entered into the merger agreement on December 23, 2018, which included a thirty-day “go-shop” period—December 24, 2018 through January 22, 2019—during which Mindbody could solicit and negotiate alternative acquisition proposals. Following the go-shop period, on January 29, 2019, Mindbody shareholders filed a class action lawsuit challenging the validity of the impending February 14, 2019 shareholder vote on the merger.
In their consolidated complaint, Plaintiffs alleged that the three Mindbody defendants breached their fiduciary duties through several conflicts of interest, including that the CEO was motivated by the CEO’s personal need for liquidity and the prospect of future employment with Vista; that the CFO was also motivated by the prospect of future employment; and that an outside director was motivated by the desire of the investor who appointed him to exit its Mindbody investment. Defendants moved to dismiss by attacking plaintiffs’ conflict theories. In addition, defendants asserted that even if the court found that the plaintiffs had successfully pleaded their Revlon claim, the court should still dismiss based on the business judgment rule, per the Delaware Supreme Court’s holding in Corwin v. KKR Financial Holding LLC, because the merger was ultimately ratified by a fully-informed, uncoerced stockholder vote.
In denying defendants’ motion to dismiss against the former CEO and CFO, Vice Chancellor McCormick explained that, at the pleading stage, a court need only decide whether it is “reasonably conceivable” that the fiduciaries were subjectively affected by the alleged conflicts. With regard to the former CEO, Vice Chancellor McCormick found that plaintiffs’ “liquidity-driven and prospective-employment theories” worked in combination “to land a powerful one-two punch,” such that it was reasonably conceivable that the CEO’s interests were in conflict with those of Mindbody shareholders. More specifically, the court found persuasive that almost all of the CEO’s pre-merger net worth was “locked inside” Mindbody stock and that he made several statements regarding his desire for Vista to retain the current senior management team. Vice Chancellor McCormick also credited the allegation that the former CEO tilted the sale process in Vista’s favor during the negotiations by lowering guidance to reduce Mindbody’s stock price and providing Vista with timing and informational advantages over other bidders, such as only allowing a thirty-day go-shop period that spanned the Christmas and New Year’s Eve holidays.
Similarly, the court found that it was reasonably conceivable that the defendant CFO breached his duty of care by acting with gross negligence in helping the CEO tilt the scale in favor of Vista during the sale process. Specifically, the complaint alleged that the CFO delivered the lowered Q4 earnings guidance at the CEO’s direction and failed to provide a robust and substantive data room to potential bidders during the go-shop period. The court dismissed the claims against the outside director, finding that the allegations in the complaint did not support a reasonable inference that he took any action to further his personal interests.
Finally, the court disagreed with defendants’ contention that Corwin’s business judgement rule defeated the Revlon claim. Vice Chancellor McCormick found that the Corwin defense was not available at the pleading stage because the complaint contained sufficient allegations to suggest that the shareholder vote was not informed. First, the complaint plausibly alleged that the CEO was conflicted in his desire for liquidity and future employment with Vista and that the CFO furthered such interests. Second, the complaint included allegations that both the CEO and CFO caused the company’s proxy statement announcing the merger to omit material information related to Vista’s timing and information advantage. And third, plaintiffs pleaded facts sufficient to suggest that the CEO drove down the company’s stock price by lowering quarterly guidance and then failed to disclose actual quarterly financials showing that the company had exceeded the lowered guidance. Based on these well-pleaded allegations suggesting that the shareholder vote was uninformed, the court rejected the defendants’ argument that the any conflicts were “cleansed” by the shareholder vote.
SECOND CIRCUIT UNANIMOUSLY AFFIRMS LOWER COURT’S DECISION ALLOWING MANHATTAN DISTRICT ATTORNEY TO SUBPOENA PRESIDENT TRUMP’S TAX RECORDS
On October 7, 2020, in Donald J. Trump v. Cyrus R. Vance Jr. et al., the Second Circuit unanimously upheld a lower court’s decision dismissing President Trump’s complaint alleging that the Manhattan District Attorney’s grand jury subpoena issued to his accounting firm, Mazars USA, LLP (“Mazars”), was overbroad and issued in bad faith. In affirming the lower court’s decision, the Second Circuit granted the Manhattan District Attorney’s motion to dismiss with prejudice but stayed enforcement of the subpoena pending appeal to the Supreme Court.
President Trump’s latest challenge to the subpoena stems from a 2018 grand jury investigation into certain business transactions involving the Trump Organization and affiliated entities and individuals. While the full scope of the investigation is not publicly known, the grand jury issued an August 1, 2019 subpoena to the Trump Organization seeking documents from 2015 through 2018 relating to payments made to certain individuals and to Michael Cohen’s work for the President and the Trump Organization. The Trump Organization complied with this subpoena, but did not turn over any of President Trump’s tax returns. As a result, on August 29, 2019, the grand jury issued another subpoena directed at President Trump’s accounting firm, Mazars, seeking financial documents dating back to 2011.
Unlike the previous subpoena, the subpoena at issue requested, among other documents, “tax returns and related schedules, in draft, as-filed, and amended form” and “any and all statements of financial condition, annual statements, periodic financial reports, and independent auditors’ reports.” In response, President Trump filed suit in federal court to block the enforcement of the subpoena, claiming that he was immune from state criminal process during his term in office. The case was previously before the Supreme Court, which affirmed the lower courts’ holding that “absolute” presidential immunity from compliance with a state grand jury subpoena was neither “necessary [n]or appropriate under Article II or the Supremacy Clause.”
On remand, President Trump filed an amended civil complaint, rather than a motion to quash the subpoena, seeking injunctive and declaratory relief against the enforcement of the subpoena by alleging that it was both overbroad and issued in bad faith. The overbreadth argument alleged (1) that the requested documents were beyond the scope and timeframe of any payments made by Michael Cohen in 2016 (i.e., the alleged “hush-money” payments) and were therefore unrelated to the grand jury’s investigation, and (2) that the subpoena requested documents from a “broad array” of entities, some of which were outside of New York, in addition to a large volume of documents covering a nine-year period. President Trump also argued that the subpoena was issued in retaliatory bad faith after the President refused to produce his tax returns in response to the original Trump Organization subpoena, as well as being based on improper political motivations to harass and embarrass the President.
In its decision affirming the district court’s dismissal of President Trump’s complaint, the Second Circuit wrote that, to prevail on an overbreadth challenge to a grand jury subpoena, the moving party must show that “a particular category of documents can have no conceivable relevance to any legitimate object of investigation by the grand jury.” As to the bad faith argument, the court explained that grand juries are not “licensed to engage in arbitrary fishing expeditions,” but a grand jury subpoena “enjoys a presumption of validity” that requires a “strong showing to the contrary” to defeat that presumption. The Second Circuit also noted that, while it is unusual for a court to receive a civil complaint challenging a subpoena, as opposed to a motion to quash, a court is still required to apply the same standard to claims of overbreadth of a subpoena or bad faith as it would for any other motion to dismiss under Fed. R. Civ. P. 12(b)(6). The court further held that, at the motion to dismiss stage, the President must allege “well-pled facts that, if accepted as true, would be sufficient to rebut [a grand jury subpoena’s] presumption of validity.”
Based on the presumptive validity of grand jury subpoenas and the “extremely broad nature of grand jury investigations,” the Second Circuit rejected President Trump’s overbreadth and bad faith arguments. As to the overbreadth argument, the Second Circuit agreed with the lower court that the grand jury’s investigation was not solely limited to the 2016 Michael Cohen payments and rejected the argument that, because the Cohen payments were one focus of the investigation, they must have been the only focus. Accordingly, the Second Circuit held that, because the allegations concerning the Michael Cohen payments were not well pled, the President’s remaining allegations amounted to “generic objections that the subpoena is wide-ranging in nature,” and the court further held that “even if the subpoena is broad,” the complaint failed plausibly to allege that it was “overbroad.”
Finally, regarding President Trump’s retaliatory bad faith argument, the Second Circuit found that the allegations failed the plausibility test because the complaint “amount[ed] to nothing more than labels and conclusions” of improper motive. The court also found it persuasive that any documents produced pursuant to the subpoena would be protected from public disclosure by grand jury secrecy rules, which would greatly reduce the plausibility of the allegation that the District Attorney was “acting out of a desire to embarrass the President.”
NINTH CIRCUIT REVERSES LOWER COURT’S DECISION DISMISSING SECURITIES FRAUD SUIT AND JOINS SIXTH CIRCUIT IN APPROACH TO LOSS CAUSATION IN SECURITIES FRAUD SUITS
On October 8, 2020, in HMEPS v. BofI Holding Inc. et al., a divided Ninth Circuit panel reversed a lower court’s decision granting the defendants’ motion to dismiss, thereby allowing the class action plaintiffs to continue their securities fraud suit against defendant BofI Holding, Inc. (now known as Axos Bank) (“BofI”). In a 2 to 1 opinion, the panel disagreed with the lower court that shareholder plaintiffs had failed to adequately plead loss causation. In doing so, the Ninth Circuit joined the Sixth Circuit in rejecting a categorical rule that allegations in a different lawsuit, standing alone, can never qualify as a “corrective disclosure” to prove the loss causation element in a securities fraud suit. The dissenting opinion would have affirmed the lower court, granting the defendants’ motion to dismiss and requiring plaintiffs to provide external confirmation of the alleged fraud in the separate lawsuit for them to count as a corrective disclosure, noting that such “unsubstantiated allegations” may turn out to be “nothing more than wisps of innuendo and speculation” that should not serve as the basis of a securities fraud lawsuit.
The plaintiffs’ securities class action is based on BoFI’s 47% decline in stock price between August 2015 and February 2016. The shareholders allege that BoFI executives committed securities fraud by falsely portraying the company as a safer investment than it actually was. More specifically, the plaintiffs allege that defendants made false or misleading statements promoting the bank’s: i) conservative loan underwriting standards; ii) internal controls; and iii) robust compliance standards. To satisfy the loss causation element, plaintiffs relied on the fraud-on-the-market theory, which allows suing shareholders to prove a defendant’s fraud by showing evidence of “corrective disclosures” to the market (i.e., that the “truth” is revealed) that then cause a decline in the company’s stock price. According to plaintiffs, the first corrective disclosure was a whistleblower suit filed against BoFI alleging rampant fraud at the bank, the details of which were published in a New York Times article on the same day of the filing. As to the second corrective disclosure, plaintiffs argue that it was in the form of eight anonymous blog posts on the website Seeking Alpha. The blog posts all relied upon publicly available information to describe potential regulatory violations and questionable loan origination partnerships.
The district court found that plaintiffs had adequately pleaded five of the six required elements to prove securities fraud, including that defendants made misstatements related to its underwriting standards and internal controls. As for the sixth element, loss causation, the district court disagreed with plaintiffs that the whistleblower lawsuit and blog posts constituted corrective disclosures that caused the company’s stock price to decline. The district court reasoned that the whistleblower’s allegations were “unconfirmed accusations of fraud” and therefore “draw the market’s attention to smoke, but without more,  do not reveal any fire.” With regard to the blog posts, the district court concluded that they could not serve as corrective disclosures because nothing was “revealed” given that they all relied on previously disclosed public information.
The Ninth Circuit panel unanimously agreed with the district court that plaintiffs had adequately pleaded that defendants made misstatements concerning BofI’s underwriting standards, internal controls, and compliance infrastructure. The panel members also all agreed with the district court’s finding that the blog posts did not qualify as corrective disclosures to prove loss causation. The panel was divided, however, on whether a whistleblower suit could constitute a corrective disclosure to prove loss causation. Two of the three panel members were persuaded that the market found the allegations credible as illustrated by the fact that BofI’s stock price dropped by 30% following the whistleblower suit and corresponding New York Times article. The majority reasoned that a price drop of that magnitude would not be expected in response to whistleblower allegations perceived to be unworthy of belief and, thus, “if the market treats allegations in a lawsuit as sufficiently credible to be acted upon as truth . . . then the allegations can serve as corrective disclosure.” As a result, the majority found that plaintiffs had adequately pleaded loss causation and reversed the district court’s judgment dismissing the action with prejudice and remanded for further proceedings.
In his dissent, Judge Kenneth K. Lee rejected the majority’s decision that the whistleblower suit was a corrective disclosure and agreed with the district court that the shareholders should have to provide external confirmation of the suit’s allegations to adequately prove loss causation.
SDNY JUDGE DISMISSES PROPOSED CLASS ACTION AGAINST WUXI PHARMATECH ALLEGING SECURITIES FRAUD RELATED TO $3.3 BILLION GO-PRIVATE MERGER
On October 14, 2020, in Altimeo Asset Management v. WuXi PharmaTech (Cayman) Inc. et al., a federal judge in the Southern District of New York dismissed a proposed securities class action alleging that WuXi PharmaTech Inc. (“WuXi”), a pharmaceutical research and development company, defrauded investors by hiding its plans to relist three of its subsidiaries on foreign stock exchanges following its 2015 go-private merger. In granting the defendants’ motion to dismiss with prejudice, the court found that WuXi’s proxy materials had disclosed the very information that plaintiffs alleged was hidden from investors.
Plaintiff shareholders’ securities fraud claim was based on the December 10, 2015 merger between WuXi and Ally Bridge Group (“Ally”), in which Ally took WuXi private for a $3.3 billion closing sale price. A majority of WuXi’s shareholders voted to approve the merger, and Plaintiffs alleged that, shortly thereafter, WuXi took steps to spin off three of its subsidiaries on various foreign stock exchanges. In May 2018, WuXi’s three subsidiaries completed their IPOs on the Hong Kong Stock Exchange and Shanghai Stock Exchange. Following the spin-offs and relisting, several news articles estimated that the total market value of the three WuXi subsidiaries was nearly $31 billion.
Plaintiffs’ complaint alleged that WuXi and Ally had “concrete plans” prior to their merger to spin off the subsidiaries and relist them on foreign stock exchanges, but failed to disclose these facts to its shareholders in an effort to depress the merger price. Plaintiffs cited to news article that discussed the merger, spin-offs, and surrounding circumstances, including the fact that the spin-offs and relisting occurred relatively soon after the merger. Plaintiffs also alleged that the company and its officers made false or misleading statements in proxy materials related to the merger, specifically concerning: i) the company’s intention to relist the subsidiaries; ii) its viable alternatives to the merger; iii) its reasons for the merger; and iv) the overall fairness of the merger price. The common thread running through all four categories of alleged misstatements was plaintiffs’ allegation that WuXi and Ally had concrete plans prior to the merger to relist the subsidiaries, which they allegedly intentionally concealed to decrease the merger price.
The court disagreed. In granting the defendants’ motion to dismiss with prejudice, the court relied heavily on the fact that WuXi’s proxy materials filed with the SEC before the shareholder vote disclosed that “the buyer group may consider re-listing the Company’s equity on the Chinese or Hong Kong stock exchanges, which may have higher valuations.” Based on this disclosure, the court found that WuXi clearly disclosed the possibility of a future relisting at a higher valuation, and as such, reasonable investors would have understood that possibility. Further, the court held that the vast majority of news articles plaintiffs contended support an inference of a “concrete plan to relist” consist of “speculation by analysts or comments made long after the merger.” In sum, the court agreed with defendants that “this case is predicated on a disclosed omission,” and therefore held that plaintiffs failed to plausibly allege a securities fraud violation.
David R. Callaway