Securities Snapshot November 16, 2022

Delaware Court of Chancery Holds Buzzfeed Not Bound by Pre-SPAC Merger Employment Agreements

In This Issue

Delaware Court of Chancery Holds Buzzfeed Not Bound by Pre-SPAC Merger Employment Agreements; Mistrial Declared in Fannie Mae, Freddie Mac Net Worth Sweep Suit After Jury Deadlock; District of Massachusetts Stands with Second Circuit on Hack-and-Trade Trading Scheme; Investor Damage Claims Advance in Delaware Chancery Court SPAC Suit; SEC Now Investigating Private Equity Firms’ Use of Messaging Apps as “Record Retention” Crackdown Expands

In This Issue
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On October 28, 2022, Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery ruled that the declaratory action brought by Buzzfeed Inc. against 91 current and former employees is not bound by arbitration provisions in pre-SPAC merger employment contracts.

The action arises out of the employees’ filing of mass arbitrations in March 2022 claiming that the Buzzfeed shares offered pursuant to the company’s pre-merger employment agreements could not be converted in a timely way into tradeable shares after Buzzfeed closed a SPAC merger in November 2021.

The court’s decision rested on its conclusion that, upon the close of the merger, the post-close Buzzfeed entity (New Buzzfeed) was a separate corporate entity from the pre-merger Buzzfeed and, as such, was not bound by pre-merger employment agreements. Specifically, under the merger agreement, a subsidiary of New Buzzfeed – not New Buzzfeed itself – was the successor-in-interest to those employment agreements. For this reason, the court denied the employees’ motion to dismiss, which argued that the court lacked jurisdiction to hear disputes that should have been arbitrated in accordance with the pre-SPAC merger employment agreements. Under the same rationale, the court permanently enjoined the arbitration from proceeding. However, the court declined to grant New Buzzfeed’s request for declaratory judgment that the employees must pursue their claims in the Court of Chancery under the forum selection clause because the controversy was not yet ripe, as defendants (i.e., the employees) had not filed claims in the Court of Chancery or elsewhere. It remains to be seen whether defendants choose to pursue their claims in court following the anti-arbitration injunction.

This decision serves as a reminder that dealmakers should take care to understand the survivability of employee contracts – and consider providing repeated, clear disclosures to personnel to avoid triggering an unwanted litigation tail to a successful transaction.

Mistrial Declared in Fannie Mae, Freddie Mac Net Worth Sweep Suit After Jury Deadlock

On November 7, 2022, U.S. District Judge Royce C. Lamberth of the District of Columbia declared a mistrial in a lawsuit brought by shareholders of the U.S. government-backed mortgage companies Fannie Mae and Freddie Mac when jurors were unable to reach a verdict after a three-week trial and 19 hours of deliberations.

In 2013, a class of holders of preferred stock or common stock issued by Fannie Mae or Freddie Mac brought suit against the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac. The class alleged that FHFA caused the mortgage fund companies to write down their assets and then amend stock purchase agreements to allow the U.S. Treasury to take the resulting profits, thereby breaching the implied covenant of good faith and fair dealing. These amendments, known as “net worth sweep,” increased the U.S. Treasury’s dividend from 10% of total investment to 100% of Fannie Mae and Freddie Mac’s current and future net worth. The shareholders argued that the net worth sweep precluded them from ever receiving dividends and that FHFA’s decision to amend the stock purchase agreements was arbitrary and unreasonable. FHFA argued that the decision was reasonable after years of negative net worth and fallout from the 2008 mortgage crisis. Shareholders claimed $1.6 billion in damages, roughly the total decline in value of Fannie Mae and Freddie Mac stocks upon announcement of the net worth sweep.

During the jury’s deliberations, the judge received several notes from the jury indicating that they were “deeply divided” and had vastly different interpretations of the evidence presented. Counsel for the shareholders moved for a mistrial twice because they felt that any verdict that could be returned after such a difference of opinion would be “tainted.” Judge Lambert denied both motions. The eight-person jury then reported that they were deadlocked for a third time, at which point Judge Lamberth issued an anti-deadlock instruction. When the jury still could not come to a verdict, Judge Lamberth declared a mistrial.

This rare investor class-action trial makes clear that even the most complicated class actions can be successfully defended at trial. Although a mistrial is of course not a defense verdict — the case will be retried if not settled or dropped — the fact that the jury deadlocked should give those accused of securities fraud confidence that these cases are hard for plaintiffs to try and win (i.e., fighting is an option).

District of Massachusetts Stands with Second Circuit on Hack-And-Trade Trading Scheme

On October 31, 2022, U.S. District Judge Patti B. Saris of the District of Massachusetts joined the Second Circuit in allowing the United States government to press ahead with a securities fraud charge against an individual perpetrating a “hack and trade” scheme, absent any allegations that the hacker had a duty to disclose or abstain.

In March 2021, federal prosecutors in Massachusetts charged Vladislav Klyushin, the owner of Russian cybersecurity firm M-13, and two co-conspirators with charges of computer intrusion, wire fraud, and securities fraud for perpetrating an $82 million “hack and trade” scheme — trading on the basis of information obtained through unauthorized intrusions of a corporation’s computer networks. Klyushin thereafter moved to dismiss the securities fraud charge from his case, arguing that he could not be criminally liable for stock fraud under federal securities laws because he did not owe a fiduciary duty to the hacked agents, nor to the open markets on which the securities are traded. As this is an issue of first impression in the First Circuit, the government opposed the motion by asking the court to rely on SEC v. Dorozhko, precedent involving a similar “hack and trade” decided by the Second Circuit. In Dorozhko, the Second Circuit upheld a securities fraud claim against a hacker charged with trading on information stolen from the servers of an investment firm, finding that even absent a fiduciary duty to disclose or abstain from trading, the hacker had an affirmative obligation not to mislead the public. The act of hacking was a “deceptive” device or contrivance under Section 10(b) of the Securities Exchange Act of 1934, and the hacker had affirmatively misrepresented himself in order to access non-public information.

The court rejected Klyushin’s arguments that he owed no fiduciary duty to the hacked companies, relying on Dorozhko to rule that the government had sufficiently alleged that Klyushin’s misrepresentations and hacking were themselves “deceptive” devices or contrivances under Section 10(b).

Investor Damage Claims Advance in Delaware Chancery Court SPAC Suit

On October 26, 2022, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery denied a motion to dismiss fraud claims against P3 Health Group Holdings LLC (P3 Health) and its co-founders in connection with the company’s 2021 public merger. The case rests on claims by Hudson Vegas Investments SVP LLC (Hudson) that P3 Health and other defendants fraudulently induced its $50 million investment in what Hudson claimed was, in fact, an imperiled and unprofitable healthcare management company.

Vice Chancellor Laster found that Hudson put forth “the barest minimum of allegations” needed to support the fraud claim against P3 Health and its co-founders. In its complaint, Hudson alleges that it was induced by P3 Health’s board members and key managers into investing into P3 Health’s 2021 public offering while stripping Hudson of $100 million in options and other rights.

The Court found that “the complaint’s allegations — though scant — clear the bar for pleading a fraud claim. At a later stage of the case, the claim may fail. But Hudson can proceed past the pleadings stage.” One of Hudson’s key allegations was that P3 Health projected earnings of $12.7 million when, in fact, it reported at a $40 million loss that year. “The fact that a projection does not come to fruition, standing alone, often will be ‘legally insufficient to support a fraudulent claim.’ . . . But at least one possible inference is that the near-term projection was knowingly false. At the pleading stage, Hudson is entitled to the inference that is favorable to its claim.”

SEC Now Investigating Private Equity Firms' Use of Messaging Apps as "Record Retention" Crackdown Expands

On November 8, 2022, private equity firms Apollo Global Management (Apollo), the Carlyle Group, and KKR & Co. (KKR) each reported their involvement in SEC investigations concerning firm’s record retention practices — in particular, business use of WhatsApp and other personal device messaging applications.

Apollo, the Carlyle Group, and KKR all face similar inquiries about whether exchanges via text or common messaging applications like WhatsApp and WeChat, used for business-related communications, have been properly preserved pursuant to SEC requirements. Each firm disclosed that it was cooperating with SEC requests for information and documents.

The requests arise in connection with the SEC’s ongoing efforts to scrutinize the use of messaging applications like WhatsApp and WeChat for business-related communications, and to ensure that financial firms comply with their regulatory recordkeeping obligations. The inquiries come on the heels of recent negotiated regulatory settlements with sixteen financial firms, totaling $1.8 billion, all of which had conducted business via texting and messaging apps and were investigated by the SEC and the Commodity Futures Trading Commission for alleged violations of recordkeeping requirements. SEC Chair Gary Gensler stated in recent remarks that the SEC will continue to use “sweeps, initiatives, and undertakings to shape market behavior” and to prevent future violations of regulatory recordkeeping requirements.  Financial firms should continue to ensure that their employees and managers comply with record retention requirements, including by preventing the use of texting, personal email, and messaging applications to conduct business.

The message is clear: Registrants should assume that the SEC will bring enforcement actions for perceived organizational failure to take ownership of business communications conducted on personal devices and likely resolve the great majority of them with oversized settlements. Now may be the time for registrants to assess their practices, which will not bar any SEC inquiry into the past but may substantially mitigate risk should regulators come knocking.


Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

Editorial Board
Jennifer Burns Luz
Jonathan Shapiro

Contributing Authors
Angela Berkowitz
Ilana Saltz
Anya Treyzon
Zoe Bellars