Securities Snapshot November 03, 2020

Delaware Supreme Court Holds Appraisal Action Is Not “Securities Claim” Covered By D+O Insurance Policy

Delaware Supreme Court Holds Appraisal Action is Not “Securities Claim” Covered by D&O Insurance Policy; Delaware Supreme Court Affirms Dismissal of Derivative Claims Against Life Sciences Company For Failure to Plead Demand Futility; Central District of California Allows Securities Enforcement Action to Proceed Against Dropil; Congressmen Introduce Two New Bills Intended to Clarify Regulation of Cryptocurrency Tokens and Trading; Northern District of California Dismisses Securities Act Claims Arising Out of IPO of Dropbox; Southern District of Ohio Dismisses With Prejudice Securities Claims Against L Brands

In an en banc decision issued on October 23, 2020, the Delaware Supreme Court held in In re Solera Insurance Coverage Appeals that software company Solera Holdings, Inc. (“Solera”) cannot seek coverage under its directors’ and officers’ (“D&O”) insurance policies for pre-judgment interest and expenses in defending against an appraisal action under Delaware law.

In 2016, an affiliate of Vista Equity Partners acquired Solera, which triggered an appraisal action filed by objecting Solera shareholders. Following the conclusion of the appraisal action, Solera sought coverage from its primary and excess D&O insurance carriers for more than $50 million in fees and pre-judgment interest incurred in defending against the appraisal action. The insurers denied coverage, asserting that the appraisal action was not a “securities claim” covered by the relevant policies, which was defined as a claim “made against [Solera] for any actual or alleged violation of any federal, state or local statute, regulation, or rule or common law regulating securities.” Accordingly, Solera filed an action in Delaware Superior Court against the insurers, alleging breach of contract and seeking a declaratory judgment regarding coverage. Although the primary-layer insurer settled, the excess-layer insurers moved for summary judgment, arguing that the appraisal action did not constitute a securities claim because there was no alleged wrongdoing and thus no “violation” of any securities law. In denying the excess carriers’ motions for summary judgment, the Superior Court held that an appraisal action was a covered securities claim under the policy, and that the policy term “violation” did not require an allegation of wrongdoing.

The Delaware Supreme Court reversed and held that judgment should be entered on behalf of the insurers. Specifically, the court concluded that the appraisal action was not a covered securities claim under the policy because it did not involve a violation of securities law. The court first looked to the “plain meaning of the word ‘violation’” as used in the Solera policy, finding that it “involves some element of wrongdoing, even if done with an innocent state of mind.” Applying this definition in the context of the Delaware appraisal statute, the court examined the statute’s historical background, text, underlying purpose, and prior treatment under Delaware caselaw in determining that the statute was a “neutral” remedy that is not meant to “adjudicate wrongdoing.” Therefore, the court reasoned, the appraisal action did not involve a violation, or alleged violation, of securities law, and thus did not meet the policy’s definition of a securities claim.

Delaware Supreme Court Affirms Dismissal Of Derivative Claims Against Life Sciences Company For Failure To Plead Demand Futility

On October 29, 2020, in Owens v. Mayleben, the Delaware Supreme Court affirmed dismissal of a derivative lawsuit against several current and former directors and officers of Esperion Therapeutics, Inc. (“Esperion”).

In 2015, Esperion was entering Phase 3 clinical trials for its LDL-cholesterol-lowering drug bempedoic acid. Following an End-of-Phase 2 meeting with the FDA to discuss the regulatory path forward for bempedoic acid, Esperion issued a press release in August 2015 in which the company disclosed, among other things, that it would not need to complete a long-term cardiovascular outcomes trial before seeking FDA approval for an indication to lower LDL-cholesterol in high-risk patient populations. Six weeks later, after Esperion received the FDA’s official minutes of the End-of-Phase 2 meeting, the company issued a second press release disclosing that the FDA encouraged Esperion to “initiate” a cardiovascular outcomes trial “promptly” because any concerns regarding safety and efficacy during Phase 3 trials “could necessitate” a completed outcomes trial before approval. In February 2020, the FDA approved bempedoic acid (under the brand name Nexletol®) after Esperion had initiated, but before it completed, a cardiovascular outcomes trial.

In 2016, after receiving books and records related to the August 2015 press release pursuant to a Section 220 stockholder demand but without making a litigation demand on Esperion’s board, the plaintiff filed a derivative suit alleging that the company’s current and former directors and officers breached their fiduciary duties. Specifically, the complaint alleged that the defendants (i) knowingly and in bad faith issued misleading disclosures in the August 2015 press release, or (ii) at least recklessly breached their Caremark oversight duties by approving the press release. Asserting that a majority of Esperion’s board either faced a substantial likelihood of liability or was not independent, the plaintiff argued that a litigation demand was futile and therefore excused.

But in a 31-page decision, the Delaware Court of Chancery granted the defendants’ motion to dismiss, concluding that the plaintiff failed to plead demand futility for two reasons. First, as to whether a majority of Esperion’s board faced a substantial likelihood of liability for breaching their fiduciary duties, the court explained that the complaint contained “not one particularized allegation of intentional misconduct” by Esperion’s directors and did not support a reasonable inference that any defendants “knew that anything in the press release was false.” Instead, the directors “relied on” the assessment of the Esperion officials who attended the End-of-Phase 2 meeting, “as they are entitled to do” under Delaware law. The Court of Chancery further noted that it was “not surprising” that the complaint failed to plead a reasonable inference of bad faith by Esperion’s board because the plaintiff “failed to provide any facts that would offer a conceivable explanation of why any of the defendants, let alone outside directors, would intentionally lie to the market knowing full well the official FDA minutes would contradict their statements in a matter of weeks.” Second, the court found that the plaintiff’s allegations created “no reasonable doubts” about the independence of any of Esperion’s seven outside directors.

Following the plaintiff’s appeal and substantial briefing and oral argument, the Delaware Supreme Court affirmed the Court of Chancery’s decision dismissing the complaint, finding it “evident” that the plaintiff failed to plead demand futility for the reasons explained in the Court of Chancery’s decision.

Goodwin represented the defendants in this matter.

Central District Of California Allows Securities Enforcement Action To Proceed Against Dropil

On October 23, 2020, in Securities and Exchange Commission v. Dropil, Inc., the United States District Court for the Central District of California denied a partial motion to dismiss and motion to strike in an enforcement action alleging violations of the Securities and Exchange Acts against Dropil, Inc. (“Dropil”) and several Dropil executives.

In 2017, Dropil launched an Initial Coin Offering (“ICO”) of “DROPS,” a form of digital asset securities. Following the ICO, the SEC commenced an enforcement action, alleging that the defendants made material misrepresentations during and after the ICO in a “White Paper” and on Dropil’s website that misrepresented the success of the ICO, the nature of Dropil’s automated digital asset trading bot, and the sources of the distributed returns. The SEC further alleged that the defendants misappropriated funds from the ICO and responded to subpoenas with fabricated documents, as well as that one defendant “knowingly provided false testimony.”

Dropil and two of the individual defendants filed a partial motion to dismiss, arguing both that the SEC failed to allege reliance on specific misstatements and that the complaint failed to plead fraud with specificity as required by Rule 9(b). The court disagreed with both arguments and denied the motion to dismiss. Addressing defendants’ first argument, the court reasoned that the Ninth Circuit has explicitly rejected reliance as an element of claims based on Section 10(b) of the Exchange Act or Rule 10(b)(5). Similarly, the court held that the complaint satisfied Rule 9(b)’s particularity requirement. In particular, the court reasoned that the complaint adequately alleged scienter, stating that “[b]ecause the SEC has set forth, in detail, a number of allegedly material misrepresentations that define the contours of the scheme and subsequent cover up, an inference of scienter can be drawn and is sufficient at the pleading stage.” The court also rejected an argument that the complaint did not sufficiently allege that DROPS are securities, noting that defendants supported the argument with evidence, specifically a verified accounting of Dropil’s activity and an accompanying letter, that could not be considered on a motion to dismiss.

Congressmen Introduce Two New Bills Intended To Clarify Regulation Of Cryptocurrency Tokens And Trading

In late September 2020, lawmakers introduced two bills which would provide additional guidance on the status of cryptocurrency tokens and trading mechanisms. The Securities Clarity Act was introduced by Representative Tom Emmer, and the Digital Commodity Exchange Act of 2020 was introduced by Representative Michael Conaway. These Acts represent an important potential change in the regulation of cryptocurrency tokens and trading platforms as they will likely curtail SEC enforcement actions.

The Securities Clarity Act is meant to “amend the securities laws to exclude investment contract assets from the definition of a security.” The Act responds to a perceived trend among lawmakers that “investment contracts,” which are securities, and the assets sold pursuant to the contracts, “have been unnecessarily conflated in the context of digital assets.” According to the Act, this approach “differs from the approach taken in many other major jurisdictions around the world, has discouraged development of the digital asset sector in the U.S., and has hindered innovation in that industry.” The Act therefore clarifies that assets sold pursuant to an investment contract “whether tangible or intangible (including an asset in digital form)” do not become securities simply as a result of being sold pursuant to an investment contract. The Digital Commodity Exchange Act aims to “provide for orderly and secure digital commodity exchange markets.” The Act provides a general framework for the trading of digital assets and specifically proposes that trading platforms for digital assets be regulated by the U.S. Commodity Futures Trading Commission.

Northern District Of California Dismisses Securities Act Claims Arising Out Of Ipo Of Dropbox

On October 21, 2020, in In re Dropbox Securities Litigation, the United States District Court for the Northern District of California dismissed a putative securities class action alleging violations of Sections 11 and 15 of the Securities Act against Dropbox, Inc. (“Dropbox”), several Dropbox officers and directors, and the underwriters of the company’s IPO.

On behalf of a putative class, the plaintiff alleged disclosure deficiencies in a registration statement that Dropbox filed with the SEC in connection with its 2018 IPO. Specifically, the amended complaint alleged that the registration statement “failed to disclose that the rate at which Dropbox was converting its non-paying registered users to paying subscription users was decelerating, causing Dropbox to experience a material decline and/or slowdown in revenue growth.” The lead plaintiff pointed to three sets of allegedly misleading disclosures in the registration statement: (i) a chart summarizing the number of users who paid for Dropbox from 2015 to 2017; (ii) a statement that Dropbox’s current non-paying registered user base “represents a significant opportunity to increase our revenue” through transition to paying subscribers; and (iii) statements describing monthly subscription levels.

The defendants moved to dismiss all counts, primarily arguing that the amended complaint contained no factual allegations regarding Dropbox’s conversion rate that the company failed to disclose. In granting the defendants’ motions to dismiss, the court agreed, explaining that while it ran “a fine-tooth comb through” the amended complaint, it could not find “a single factual allegation about Dropbox’s user conversion rate,” resulting in “an elephant-sized hole” in the plaintiff’s theory of liability. Further, the court reasoned that the plaintiff “conflate[d] user conversion rate with paying user and revenue growth rates” and failed to “explain why Dropbox’s omission of its allegedly flagging user conversion rate” created a false impression of its current state of affairs, particularly given “abundant evidence” that Dropbox disclosed in detail its declining subscription growth rates. Addressing the specific alleged misleading statements, the court concluded that they were either accurate statements of historical data or non-actionable opinion statements. Further, the court held that the amended complaint failed to allege sufficient facts supporting a claim for omission of a known material trend under Item 303 of SEC Regulation S-K, finding that the amended complaint contained no “factual allegations about Dropbox’s user conversion rate, let alone a data point or trend line.”

Finally, the court held that plaintiff’s Securities Act claims were time-barred by the applicable one-year statute of limitations. Noting that, although a “motion to dismiss is usually not the appropriate juncture for the Court to make a conclusion about inquiry notice,” the court highlighted the “straightforward nature of the metrics at issue” in explaining that the plaintiff was on inquiry notice of his claims more than one year before filing the original complaint. Ultimately, however, the court granted the plaintiff leave to amend, noting that “it is not yet futile” for the plaintiff to attempt to cure the amended complaint’s deficiencies.

Southern District Of Ohio Dismisses With Prejudice Securities Claims Against L Brands

On October 19, 2020, in Walker v. L Brands, Inc., the United States District Court for the Southern District of Ohio dismissed with prejudice a complaint alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act against L Brands, Inc. (“L Brands”) and the company’s CEO and CFO.

The plaintiff alleged that the defendants issued a number of false and misleading statements about the company’s financial performance, specifically related to its ability to maintain its dividend. The amended complaint detailed the company’s declining performance in its Victoria’s Secret and PINK brands due to increased competition. Despite that declining performance, L Brands continued to pay a dividend that, according to the plaintiff, “was extremely high compared to other publicly-traded companies,” and reassured investors that it would not cut its dividend. But, in November 2018, the company announced its intent to reduce its annual dividend “in order to deleverage the balance sheet,” which resulted in an 18% drop in its stock price.

In analyzing the defendants’ disclosures on a statement-by-statement basis, the court held that none were actionable. For example, the court held that the CFO’s statement “[w]e have the cash flow needed and cash balances, et cetera, to sustain the dividend” was a true statement of present fact when made in May 2018, particularly because L Brands maintained the dividend for several subsequent quarters until deciding to cut it in late 2018. Further, the court rejected the plaintiff’s claims premised on the CFO’s statement that “the dividend is very safe,” finding that such a statement was non-actionable puffery or “too vague to be considered material.” Likewise, the court found the CFO’s statements concerning the company’s “ability to maintain the dividend” in the future were statutorily immunized forward-looking statements accompanied by “two layers of cautionary language,” including both (i) a general warning regarding forward-looking statements in the company’s disclosures and (ii) more specific cautions that the company’s dividend depended on its cash flows. Turning to the plaintiff’s allegations that the defendants violated Item 303 of SEC Regulation S-K, the court declined to resolve an open question in the Sixth Circuit as to whether Item 303 supports a private right of action. Instead, the court held that the alleged trends concerned forward-looking information, which “is not required to be disclosed pursuant to Item 303.” Finally, in dismissing the amended complaint with prejudice, the court found it was “clear” that the “deficiencies in this case cannot be cured; the facts are what they are and they are not sufficient to establish securities fraud.”

Editorial Board:
David R. Callaway