Securities Snapshot November 17, 2020

Ninth Circuit Holds Loss Causation May Be Predicated on Information Potentially Available Under Freedom of Information Act

Ninth Circuit Holds Loss Causation May Be Predicated on Information Potentially Available Under Freedom of Information Act; D.C. Circuit Upholds FINRA’s Permanent Ban of Broker Accused of Misconduct After Finding SCOTUS Penalty Analysis Inapplicable; Connecticut Federal Court Dismisses Trio of Shareholder Suits Against WWE for Failure to Plead Demand Futility; Second Circuit Affirms Dismissal of $102M Suit Against Banks Which Sought to Hold Them Liable for Customers’ Alleged Ponzi Scheme.

On November 3, 2020, in David Grigsby, et al v. BofI Holding, Inc., et al., the Ninth Circuit held that information obtainable by the public under the Freedom of Information Act (“FOIA”) is not per se public prior to its actual disclosure and therefore can constitute a corrective disclosure for the purpose of pleading loss causation.

The Court’s ruling reverses, in part, the district court’s dismissal of a putative securities fraud class action against BofI Holding Inc. (“BofI”) where plaintiffs alleged that BofI  denied it was the subject of a money laundering investigation and  falsely stated that a whistleblower’s separate allegation—that BofI  made  undisclosed loans to criminals—was “disconnected from the reality of BofI’s highly compliant and top-performing business.” 

In support of their theory of loss causation, Plaintiffs relied on two news reports which they alleged were corrective disclosures: an October 25, 2017 New York Post article which—based upon information obtained through a FOIA request—reported that BofI had in fact been subject to a 16-month Securities and Exchange Commission (“SEC”) investigation; and a Seeking Alpha article which purportedly revealed the truth of the BofI whistleblower’s allegations. The district court dismissed Plaintiffs’ complaint as deficient with respect to pleading loss causation after finding, in part, that the New York Post article relied upon “information available from a federal agency through FOIA,” and, thus, already publicly available to “information-hungry” market participants, who must have sought the same information in advance of its publication.  Because public information cannot form the basis for a corrective disclosure, the district court concluded that Plaintiffs’ allegations failed, reasoning that, irrespective of the bureaucratic barriers associated with FOIA requests, “[w]hat matters is whether other investors, seeking information about BofI, would reasonably have been able to obtain [the FOIA] information.”

Plaintiffs thereafter amended their complaint, asserting new allegations, including that the FOIA information reported by the New York Post had not previously been disclosed to the public and that the SEC had received only five other requests concerning BofI during the relevant time period.  The district court dismissed the amended complaint with prejudice after concluding that Plaintiffs once again failed to plead loss causation where the additional allegations were too speculative to plausibly allege that the FOIA-derived information had not already been disclosed to market participants.

On review, the Ninth Circuit limited its examination to the “discrete question of whether information obtained through a FOIA request can be ‘corrective’ of an allegedly false and misleading statement by revealing nonpublic information to the market.” While BofI contended that information discoverable through a FOIA request should be considered public information, the Ninth Circuit rejected this argument on two grounds. First, “the information must be requested before it can be received through FOIA” and, thus, “[i]nformation acquired through FOIA does not simply reside on a shelf somewhere, ready for the taking.” Second, “information must be produced before it is publicly available” and information may be—and often is—withheld by the SEC pursuant to nine statutory exemptions that may be invoked under FOIA to bar public disclosure. Given that all information requested is not instantaneously disclosed simply because a market actor lodges a request, the Court reasoned, “there must be some indication that the relevant information was requested and produced before the information contained in a FOIA response can be considered publicly available for purposes of loss causation.” 

The Ninth Circuit remanded the case to the district court for further proceedings.

D.C. Circuit Upholds FINRA’s Permanent Ban of Broker Accused of Misconduct After Finding SCOTUS Penalty Analysis Inapplicable

On November 6, 2020, in Saad v. SEC, the D.C. Circuit issued an order declining a former broker-dealer’s petition for review of the SEC’s decision to uphold Financial Industry Regulatory Authority’s (“FINRA”) disciplinary decision to permanently bar him from FINRA membership and from associating with any FINRA member firm.  The question before the court was whether the Supreme Court’s decision in Kokesh v. SEC altered the calculus for categorizing sanctions as “punitive” or “remedial” to impact the “excessive or oppressive” standard that governs review of FINRA sanctions under section 78s(e)(2) of the Securities Exchange Act of 1934 (the “Exchange Act”).  In declining to further review Saad’s lifetime bar, the court concluded that Kokesh’s analysis of whether disgorgement is a “penalty” in the context of evaluating the applicability of the five-year statute of limitations does not dictate whether a sanction is “excessive or oppressive” under Section 78s(e)(2) of the Exchange Act. 

John M.E. Saad was permanently barred from the securities industry by FINRA in September 2007 for violating Rule 2010—which requires members to “observe high standards of commercial honor and just and equitable principals of trade”—in connection with two alleged incidents of misappropriation of his employer’s funds through the submission of false expense reports containing forged receipts and misrepresentations, as well as lying to regulatory investigators concerning his conduct. 

After the Securities and Exchange Commission (“SEC”) sustained FINRA’s determination,  Saad sought further review by the D.C. Circuit, which granted Saad’s petition for review in part and remanded the case to the SEC for consideration of whether FINRA’s sanction was “excessive or oppressive” in light of certain potentially mitigating factors such as Saad’s “termination and his personal and professional stress.”  After further consideration, the SEC once again sustained Saad’s lifetime ban from the securities industry and Saad again sought review by the D.C. Circuit.  Upon determining that the SEC “reasonably balanced the relevant mitigating and aggravating factors before determining that the gravity of Saad’s behavior warranted remedial action,” the court remanded the case to the SEC for it to address whether FINRA’s sanction was “impermissibly punitive” in light of the Supreme Court’s recent decision in Kokesh v. SEC. Upon review, the SEC decided that Kokesh did not render FINRA’s sanction improper.  Again, Saad asked the D.C. Circuit to review the SEC’s determination under Kokesh, and the court agreed with the SEC and denied Saad’s petition for review.

In reviewing and denying Saad’s petition, the court noted that it has generally read Section 78s(e)(2) of the Exchange Act’s provision permitting a sanction that is “excessive or oppressive” to be set aside as requiring FINRA to select relief: (1) with “due regard for the public interest and protection of investors;” and (2) for “a remedial purpose” rather than punishment so as to avoid imposing “excessive or oppressive” sanctions.  Turning to Saad’s argument that Kokesh established new principals for determining what constitutes a “penalty,” the court followed the Supreme Court’s analysis to determine whether SEC disgorgement is a “penalty” by addressing the Court’s two guiding principles: (1) “whether the wrong sought to be redressed is a wrong to the public, or a wrong to the individual;” and (2) that a monetary sanction should be construed as a “penalty” only if its purpose is to punish and to deter others from similar conduct.

In rejecting Saad’s argument that the Supreme Court’s analysis in Kokesh was relevant to the evaluation of FINRA’s lifetime ban, the D.C. Circuit found that the Supreme Court explicitly limited its decision to “whether disgorgement, as applied in SEC enforcement actions, is subject to [Section] 2462’s limitations period.”  This was not the issue in Saad’s case.  The court further reasoned that it had previously evaluated the question of whether Section 2462’s “penalty” inquiry extended beyond the statute of limitations context, and its prior decisions “made clear” that such an inquiry does not extend to all other contexts.  For example, the court had previously upheld a lifetime ban where the SEC had adequately justified the bar as “remedial…by offering ‘adequate reasons for holding the sanction[] [was] warranted to protect investors.”  Finally, the court noted that Kokesh involved a different type of sanction, imposed pursuant to a different statutory framework and type of regulatory proceeding, with vastly different remedial and protective implications for private stakeholders.  According to the court, these differences provided it with ample reason to distinguish Saad’s case from Kokesh.   

The D.C. Circuit concluded that binding circuit precedent permits the SEC to “approve expulsion not as a penalty but as a means of protecting investors” notwithstanding the Supreme Court’s decision in Kokesh, and denied Saad’s petition for review. 

Connecticut Federal Court Dismisses Trio of Shareholder Suits Against WWE for Failure to Plead Demand Futility

On November 6, 2020, in Ryan Merholz, et al, v. World Wrestling Entertainment Inc., et al, Judge Victor A. Bolden granted World Wrestling Entertainment Inc.’s (“WWE”) motion to dismiss three derivative suits brought against the Company by three of its shareholders. Together, plaintiff shareholders pursued breach of fiduciary duty, unjust enrichment, corporate waste, insider selling, Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, and other related claims against thirteen of WWE’s officers and/or executives in connection with WWE’s business in the Middle East and North Africa (“MENA”) market.

Specifically, plaintiffs alleged that in July 2014, WWE announced an exclusive, five-year agreement with Orbit Showcase Network (“OSN”) by which the satellite television provider would broadcast WWE’s flagship program, “Monday Night Raw,” in the MENA region. Plaintiffs also alleged that, consistent with its increasingly profitable expansion into the MENA market, WWE announced in March 2018 that it had signed a ten-year deal with Saudi Arabia’s Saudi General Sports Authority (“SGSA”) to host live wrestling events in the country, which analysts estimated was worth approximately $500 million to WWE. Plaintiffs further alleged that after WWE knew the OSN agreement would be terminated early, but prior to disclosing that fact publicly in July 2019, WWE’s management issued a press release touting its expectations that the company would achieve record revenues. Plaintiffs alleged that WWE executives sought to soften the news of the early termination of its media rights agreement with OSN by simultaneously and falsely stating that the Company had an agreement in principle with the SGSA for media rights in the MENA region.

Plaintiffs alleged that the defendants breached their fiduciary duties through their misleading conduct and, moreover, unjustly enriched themselves and violated federal securities laws by selling WWE stock ahead of the public disclosure of the termination of the OSN agreement, which plaintiffs allege resulted in a 60% decline in share price.

In granting the defendants’ motion to dismiss, the court agreed with their argument that plaintiff shareholders failed to adequately plead demand futility, in large part because six of the ten Directors on WWE’s board are outside directors and plaintiffs failed to plead facts to suggest that any of the outside directors had any actual or constructive knowledge that their certification of WWE’s 2018 10-K filings was improper. Moreover, the court noted that plaintiffs’ breach of fiduciary duty, corporate waste, and federal securities allegations were conclusory and deficient, while plaintiffs’ unjust enrichment claims failed because they did not allege defendants received anything beyond their typical compensation.

Second Circuit Affirms Dismissal of $102M Suit Against Banks Which Sought to Hold Them Liable for Customers’ Alleged Ponzi Scheme

On November 13, 2020, in Heinert, et al. v. Bank of America NA et al., the Second Circuit affirmed the district court’s dismissal of a class action suit brought against Bank of America and Citizen’s Bank (the “banks”) on behalf of approximately 637 investors who claim to have lost more than $100 million as result of an alleged Ponzi scheme that Plaintiffs claim was perpetrated by former bank customers Perry Santillo, Christopher Parris, Paul Anthony La Rocco, John Piccarreto, and Thomas Brenner (the “Individual Defendants”).

In its summary order, the Second Circuit rejected Plaintiffs’ argument that the banks acquired actual knowledge of the fraudulent scheme through interactions the Individual Defendants had with bank employees at local branches of the banks and thus were liable for aiding and abetting fraud and breaches of fiduciary duty and conspiracy to defraud. Notwithstanding Plaintiffs’ allegations concerning irregular interactions with bank employees, the court found the fraud allegations deficient because they failed to plead that the banks had actual knowledge of the fraudulent scheme. Specifically, the Plaintiffs failed to allege that the banks: (1) knew of the fraudulent scheme; (2) knew that the Individual Defendants provided loans with illusory rates of return, misrepresented their investment plans, or made false statements to investors concerning returns and other information about their investment companies; or (3) had become aware of the fraudulent scheme through their own internal investigations into the Individual Defendants’ account activity. Moreover, while the court noted that Plaintiffs pleaded facts that at most gave rise to inferences of constructive knowledge of the scheme, even evidence of potential “red flags” is insufficient to satisfy the actual knowledge requirement.

Similarly, the court noted that Plaintiffs failed to adequately plead actual knowledge with respect to the fiduciary duty claim, as banks do not have an inherent duty to monitor accounts to safeguard against fiduciary misappropriation and Plaintiffs failed to allege any specific knowledge on the part of the banks about the details of the offering materials presented to investors or of any misrepresentations the Individual Defendants made to investors.

Finally, the court found that Plaintiffs’ failure to plead actual knowledge on both of the aiding and abetting counts was similarly fatal to its conspiracy claim, as it made no allegations concerning a conspiratorial agreement between the banks or their employees and the Individuals Defendants with respect to the underlying fraudulent scheme.

Editorial Board: 
David R. Callaway

Viktors Dindzans
Dylan Schweers