Corporate Securities Law Blog

In City of Livonia Employee Retirement System v. Boeing Co., Nos. 12-1899, 12-2009 2013 WL 1197791 (7th Cir. Mar. 26, 2013), the United States Court of Appeals for the Seventh Circuit (Posner, J.) affirmed the dismissal of a securities fraud class action against the Boeing Company (“Boeing”) and remanded the question of whether sanctions under Rule 11 of the Federal Rules of Civil Procedure should be levied against plaintiffs’ counsel after allegations attributed to a confidential witness, which initially saved the case from dismissal, were later denied by the witness. The Court’s ruling provides a strong reminder that plaintiffs’ counsel in securities cases must exercise great care when using allegations of confidential witnesses to satisfy the heightened pleading standards of the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”).

In Levitt v. J.P. Morgan Securities, Inc., No. 10-4596, 2013 WL 1007678 (2d Cir. Mar. 15, 2013), theUnited States Court of Appeals for the Second Circuit reversed a district court order certifying a class of shareholder fraud plaintiffs in a lawsuit against J.P. Morgan Securities, Inc. and J.P. Morgan Clearing Corporation (“J.P. Morgan”). The decision reaffirms that a clearing broker generally owes no fiduciary duty to the owners of securities that pass through its hands. According to the Second Circuit, absent evidence that the clearing broker instigated or directed the alleged fraud by the securities issuer through high involvement, a plaintiff cannot establish a class-wide presumption of investor reliance sufficient to satisfy the predominance requirement of Rule 23(b)(3) of the Federal Rules of Civil Procedure.

In New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC, 2013 U.S. App. LEXIS 4317 (2d Cir. Mar. 1, 2013), the United States Court of Appeals for the Second Circuit reversed the dismissal of a claim for violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. §§ 77k, 77l, holding that the plaintiff pleaded sufficient facts to support a reasonable inference that defendants misstated mortgage underwriting guidelines to investors. This decision is notable for its application of the Federal Rule of Civil Procedure 8(a) pleading standard, as clarified by the United States Supreme Court in BellAtlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009), to claims under the Securities Act.

In Belmont v. MB Investment Partners, Inc., No. 12-1580, 2013 WL 646344 (3d Cir. Feb. 22, 2013), the United States Court of Appeals for the Third Circuit held that a mere failure by corporate directors to oversee enforcement of compliance protocols which, if properly enforced, might have led to the directors’ knowledge of securities fraud by a corporate employee does not establish the directors’ “culpable participation” in the employee’s misconduct sufficient to support controlling person liability under Section 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78t(a). Third Circuit held additionally that corporate directors may not be held personally liable for misconduct of corporate employers under a theory of negligent supervision. These rulings reinforce protections for directors from personal exposure to damages caused to third parties by harmful acts of employees, even where better corporate oversight might have been able to prevent the harm caused by the employees.

In Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085, 2013 WL 691001 (U.S. Feb. 27, 2013), the United States Supreme Court affirmed the decision of the United States Court of Appeals for the Ninth Circuit holding that a securities fraud plaintiff need not prove that the alleged false statements made by defendants were material in order to invoke the fraud-on-the-market presumption of reliance established by Basic, Inc. v. Levinson, 485 U.S. 224 (1988), at the class certification stage of the proceedings. The 6-3 majority opinion, written by Justice Ginsburg, resolved a split in the Circuits, which had pitted the First, Second, Fifth and, to a certain extent, Third Circuits against the Seventh and Ninth Circuits on this point. The Supreme Court’s decision deprives securities fraud defendants a means of limiting or effectively defeating a securities class action lawsuit at an early stage in the case before the bulk of fact discovery has begun.

In Kleinman v. Elan Corporation, No. 11-3706-cv, 2013 WL 388006 (2d Cir. Feb. 1, 2013), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a securities class action lawsuit alleging that defendants violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by issuing a misleading press release describing the preliminary clinical trial results for an Alzheimer’s drug. The Second Circuit concluded that, in the context of the full presentation of details surrounding the study of the drug, nothing omitted from the press release rendered the release false or misleading to a reasonable investor. This decision reconfirms that in order to be actionable under Section 10(b) and Rule 10b-5, an alleged omission must be misleading, not just material.

In the first SEC enforcement action of its kind, the SEC announced on February 8, 2013 that it had filed civil charges against, and received an emergency order to freeze assets of, the Intercontinental Regional Center Trust of Chicago, a designated Regional Center under the EB-5 Immigrant Investor Program administered by U.S. Citizenship and Immigration Services (USCIS), and the Regional Center’s principal. See full complaint here.

In Freeman Investments, LP v. Pacific Life Insurance Co., No. 09-55513, 2013 WL 11884 (9th Cir. Jan 2, 2013), the United States Court of Appeals for the Ninth Circuit held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precluded plaintiffs’ class claims for violations of California Business & Professions Code § 17200, but did not preclude plaintiffs’ breach of contract claims. The Court held that the Section 17200 claims were predicated on alleged misrepresentations and omissions, whereas the contract claims were not. The Ninth Circuit’s holding reaffirms the courts’ broad application of SLUSA to class claims that are dependent upon allegations of misrepresentations or omissions.

In Gibbons v. Malone, No. 11-3620-cv, 2013 WL 57844 (2d Cir. Jan. 7, 2013), the United States Court of Appeals for the Second Circuit held that the “short-swing profits rule” imposed by Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), requiring corporate insiders to disgorge profits earned from certain purchases and sales of their company’s securities that take place within a six month period, applies only to purchases and sales of the same equity security of the company. This decision clarified the restrictions that Section 16(b) places on the types of securities that are covered by the statute, thereby limiting the scope of the statute.

In In re Century Aluminum Co. Securities Litigation, No. 11-15599, 2013 U.S. App. LEXIS 24 (9th Cir. Jan. 2, 2013), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a claim for violations of Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k, on the ground that plaintiffs’ “tracing” allegations did not meet the pleading standard set forth in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009) (the “Twombly/Iqbal standard”). The Court held that plaintiffs who purchased their shares in the aftermarket must plead facts with “sufficient specificity” to allow the court to draw a “reasonable inference” that their shares can be traced back to those that were issued under the allegedly false and misleading offering materials. This decision marks the first time the Ninth Circuit has applied the heightened Twombly/Iqbal standard to tracing allegations in a Section 11 case.

In In re VeriFone Holdings, Inc. Securities Litigation, 2012 WL 6634351 (9th Cir. Dec. 21, 2012), the United States Court of Appeals for the Ninth Circuit reversed the dismissal of a securities fraud class action. Invoking the old adage that “the sum is greater than the parts,” the Court held that plaintiffs’ allegations of defendants’ scienter gave rise to a sufficiently strong inference of deliberate recklessness when considered “holistically.” In so holding, the panel seems to suggest that the long-standing “dual analysis” approach applied by courts in the Ninth Circuit when analyzing allegations of scienter under the heightened pleading requirements imposed by the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”), should be applied less rigorously in light of the United States Supreme Court’s decision in Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1324 (2011) [blog article here].

In South v. Baker, C.A. No. 7294-VCL, 2012 Del. Ch. LEXIS 229 (Del. Ch. Sept. 25, 2012), the Delaware Court of Chancery adopted a rebuttable presumption of inadequate representation when a stockholder asserts a “Caremark claim” without first investigating the claim using Section 220 of the Delaware General Corporation Law (“Section 220”), a statute allowing under certain conditions stockholder inspection of the corporation’s books and records.  Because the dismissal of a stockholder’s derivative action due to inadequate representation has no preclusive effect on the litigation efforts of other stockholders, the court in South adopted and applied the presumption to ensure that its order dismissing with prejudice plaintiffs’ inadequately pled complaint would not bar other stockholders of the corporation (who had properly opted to use Section 220 rather than sue in the first instance) from later pursuing the same claim on behalf of the corporation.

In Louisiana Municipal Police Employees’ Retirement System v. Lennar Corp., C.A. No. 7314-VCG, 2012 WL 4760881 (Del. Ch. Oct. 5, 2012), the Delaware Court of Chancery, on a motion for summary judgment, rejected a stockholder’s demand under Section 220 of the Delaware General Corporation Law (“Section 220”).  Section 220 provides that a stockholder in a Delaware corporation may, under certain conditions, request and cause the corporation to make available for inspection certain books and records, provided the demand has a proper purpose and some credible basis exists for suspecting mismanagement, waste, or wrongdoing.  In this instance, although the court found the purpose of the demand — investigation of the corporation’s compliance with labor law — to be proper, it held that the evidence presented did not amount to a credible showing that legitimate issues of mismanagement existed to warrant an investigation.

In In re Rigel Pharmaceuticals, Inc. Securities Litigation, No. 10-17619, 2012 WL 3858112 (9th Cir. Sept. 6, 2012), the United States Court of Appeals for the Ninth Circuit held that disagreements between plaintiffs and defendants over statistical methodology and study design are insufficient to allege a materially false statement for purposes of pleading a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. The Ninth Circuit held that merely because the statistical methodology chosen — and disclosed — by the defendant may not have been the best or most acceptable methodology, use of such an allegedly less-than-optimal methodology does not render statements about the results of the methodology false or misleading for purposes of stating a claim. This is a decision of first impression for the Ninth Circuit.

By Jennifer Redmond and Jonathan Sokolowski

In Fillpoint, LLC, v. Maas, Case No. G045057, 2012 Cal. App. LEXIS 914 (Cal. App. Aug. 24, 2012), the California Court of Appeal for the Fourth District recently refused to enforce a covenant not to compete against the former employee and selling shareholder of a video game company. The Court determined that half of a two-part noncompete agreement entered into in the context of the sale of a business was unenforceable, despite the exception for such covenants found in California Business and Professions Code Section 16601 (“Section 16601”). This case answers what had previously been an open question under California law: whether an acquiring company can obtain a non-compete that begins to run upon termination of employment (as opposed to or in addition to a non-compete that begins to run upon closing) from a shareholder who becomes an employee of the buyer. See Hilb, Rogal & Hamilton Ins. Servs. v. Robb, 33 Cal. App. 4th 1812 (1995) (enforcing a noncompete agreement against a selling shareholder that commenced at termination of employment, without any discussion or analysis of whether using termination of employment as the trigger for a noncompete violates Section 16601).

In Yudell v. Gilbert, 2012 WL 3166788 (N.Y. App. Div. 1st Dep’t Aug. 7, 2012), the Appellate Division of the New York Supreme Court, First Department, abandoned its prior ad hoc approach to determining whether a stockholder’s claim is “direct” (i.e., on behalf of the stockholder personally) or “derivative” (i.e., on behalf of the corporation as a whole), and held that the test applied by the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), provides the appropriate analysis for resolving this inquiry. Under the Tooley test, the court must consider (i) who suffered the alleged harm (the corporation or the stockholder) and (ii) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually). If the court determines that the corporation suffered the alleged harm and would receive the benefit of any remedy sought in the stockholder’s claim, then the claim must be brought derivatively, on behalf of the corporation, and is subject to the pre-suit demand requirement. Although the court’s decision appears to provide greater clarity to this often vexing issue under New York law, Delaware cases applying the test show that Tooley is far from the last word on the subject.

In In re Boston Scientific Corp. Securities Litigation, 2012 WL 2849660 (1st Cir. July 12, 2012), the United States Court of Appeals for the First Circuit affirmed the dismissal of a securities class action lawsuit against Boston Scientific Corporation (the “BSC”). The Court held that the alleged misstatements or omissions were not sufficiently material to support a claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and that the complaint’s allegations failed to meet the heightened requirements for pleading scienter under the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”). In so holding, the First Circuit reconfirmed that the federal securities laws do not impose an affirmative duty on management to disclose all information that might affect the price of a company’s stock.

In Analytical Surveys, Inc. v. Tonga Partners, L.P., 2012 WL 1970389 (2d Cir. June 4, 2012), the United States Court of Appeals for the Second Circuit addressed (among other things) the scope of two exceptions that apply to liability for short-swing profits under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b): the exception for derivative securities that do not have a fixed price and the exception for securities acquired in connection with a “debt previously contracted.” The Court concluded that the exception for derivative securities that do not have a fixed price does not apply to hybrid securities exercised at a floating price and that the “debt previously contracted” exception only applies to “mature debts.”

In City of Omaha v. CBS Corp., No. 11-2575, 2012 U.S. App. LEXIS 9535 (2d Cir. May 10, 2012), the United States Court of Appeals for the Second Circuit reaffirmed its decision in Fait v. Regions Financial Corp., 655 F.3d 105 (2d Cir. 2011) [see our prior blog article here], which held that statements regarding goodwill and loan loss reserves were “opinions” that could only be actionable under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, if defendants did not genuinely believe the statements to be true at the time they were made. Separately, the Court also held that plaintiffs’ complaint did not sufficiently allege reliance upon a fraudulently inflated price where the alleged “red flags” purportedly indicating the need for earlier review of CBS’ goodwill were matters of public knowledge and thus were already incorporated into the price of the stock. This decision is notable for its recognition that the presumption that publicly available information, if material, necessarily affects the price of an efficiently traded stock, which typically is used by plaintiffs to support securities fraud complaints, can also be used by defendants to defeat securities fraud complaints.

The staff of the Securities and Exchange Commission (“SEC”) recently released a study on the cross-border scope of the private right of action under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. The study, mandated by Congress following the United States Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), outlines a number of legislative options for extending the scope of private actions for international securities fraud that may provide a roadmap for future Congressional action.

In Roland v. Green, 2012 WL 898557 (5th Cir. Mar. 19, 2012), the United States Court of Appeals for the Fifth Circuit held that in order for a plaintiff’s state law class action lawsuit alleging fraud to be properly removable to federal court and precluded under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), the allegations of the fraudulent activity must be more than “tangentially related” to transactions in “covered securities.” In so doing, the Fifth Circuit adopted the Ninth Circuit’s test regarding the scope of the “in connection with” language under SLUSA, declining to follow what it perceived to be more stringent tests applied by other circuits. In light of the clear circuit-split, this issue appears ripe for review by the United States Supreme Court.

In Absolute Activist Value Master Fund Ltd. v. Ficeto, 2012 WL 661771 (2d Cir. Mar. 1, 2012), the United States Court of Appeals for the Second Circuit held that, for purposes of applying the federal securities laws to transactions involving securities not traded on a U.S.-based stock exchange, a transaction is “domestic,” and thus within the reach of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), “if irrevocable liability is incurred or title passes within the United States.” The decision provides important clarification on the standard laid out by the United States Supreme Court in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), which held that Section 10(b) applies only to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.”

In Dow Chemical Canada ULC v. Superior Court, 2011 WL 6382110 (Cal. App. 2d Dist. Dec. 21, 2011), the California Court of Appeal, Second District, held that “plac[ing] products into the stream of commerce in a foreign country (or another state), aware that some may or will be swept into the forum state[,]” is not, by itself, sufficient to support the forum state’s exercise of personal jurisdiction over the manufacturer of the products. The Court’s decision explores the limits of personal jurisdiction after the recent decision by the United States Supreme Court in J. McIntyre Machinery, Ltd. v. Nicastro, 131 S. Ct. 8780 (2011), and provides more certainty to foreign corporations regarding the likelihood of being forced to litigate in California courts.

In Assured Guaranty (UK) Ltd. v. J. P. Morgan Investment Management Inc., 2011 N.Y. Slip Op. 09162, 2011 WL 6338898 (N.Y. Dec. 20, 2011), the New York Court of Appeals held that the Martin Act, N.Y. Gen. Bus. Law art. 23-A — New York’s “blue sky” law designed to address fraudulent practices in the marketing of securities — does not preempt common law causes of action for breach of fiduciary duty and gross negligence in connection with the marketing or sale of securities, even if the alleged wrongdoing also would fall within the purview of the Martin Act. This decision thus eliminates a defense to New York common law causes of action relating to securities.

In Espinoza v. Hewlett-Packard Co., No. 208, 2011 WL 5838882 (Del. Nov. 21, 2011), the Delaware Supreme Court held that shareholders seeking inspection of corporate books and records under Section 220 of the Delaware General Corporation Law, 8 Del. C. § 220 (“Section 220”), must demonstrate that the records sought are “essential” to the “articulated purpose for the inspection.” In so holding, the Delaware Supreme Court affirmed the Delaware Court of Chancery’s holding that a report prepared in connection with an internal investigation into sexual harassment allegations made against Hewlett-Packard’s (“HP”) former Chief Executive Officer was not “essential” to plaintiff’s “articulated purpose for the inspection.” The decision provides insight into the limits of corporate documents a shareholder may obtain pursuant to a Section 220 demand and the proper legal analysis for determining whether a shareholder is within his or her right to inspect such documents.
 

In Sarei v. Rio Tinto, PLC, Nos. 02-56256, 02-56390, 09-56381, 2011 WL 5041927 (9th Cir. Oct. 25, 2011), the United States Court of Appeals for the Ninth Circuit became the latest Circuit to hold that corporations may be held liable under the Alien Tort Statute (“ATS”), 28 U.S.C. § 1350. As previously reported here and here, the Second Circuit held last year in Kiobel v. Royal Dutch Petroleum Co., 621 F.3d 111 (2d Cir. 2010), that the scope of liability under the ATS does not extend to corporations because imposing liability on corporations for violations of the law of nations has not achieved a sufficiently “specific, universal, and obligatory” character so as to be considered a norm of customary international law. In Sarei, the Ninth Circuit joined the District of Columbia Circuit, the Seventh Circuit and the Eleventh Circuit in reaching the opposite conclusion. The current circuit split will be resolved by the United States Supreme Court, which granted certiorari to Kiobel on October 17, 2011.

In In re Washington Mutual, Inc., No. 08-12229 (MFW), 2011 WL 4090757 (Bankr. D. Del. Sept. 13, 2011), the United States Bankruptcy Court for the District of Delaware denied confirmation of debtor Washington Mutual, Inc.’s (“WaMu”) plan of reorganization.  Standing in the way of confirmation was the equity committee’s motion for leave to file an adversary proceeding against four noteholding hedge funds because of insider trading. The bankruptcy court, in granting the motion, provided guidance to participants in bankruptcy proceedings who might be inclined to purchase or sell stock on information gleaned through the bankruptcy process.
 

In Katz v. Gerardi, No. 10-1407, 2011 WL 3726279 (10th Cir. Aug. 25, 2011), the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of claims alleging violations of Section 11 and Section 12(a)(2) of the Securities Act of 1933 (the “1933 Act”), 15 U.S.C. §§ 77k, 77l(a)(2), against a real estate investment trust (“REIT”). The claims were brought by a former minority unitholder of a REIT who, as part of a “squeeze-out merger” of the REIT with another entity, exchanged his units for cash. The Court held that the merger did not force the plaintiff to purchase newsecurities, but only to sell his old securities. Because Sections 11 and 12(a)(2) of the 1933 Act provide a private right of action only for purchasers, not sellers, of securities, the Tenth Circuit held that plaintiff lacked standing to assert a claim. The decision confirms that shareholders involved in forced sales resulting from a merger may not bring claims under the Section 11 and 12(a)(2) of the 1933 Act.
 

In Fait v. Regions Financial Corp., No. 10-2311-cv, 2011 WL 3667784 (2d Cir. Aug. 23, 2011), the United States Court of Appeals for the Second Circuit affirmed the dismissal of claims under Section 11 and Section 12(a)(2) of the Securities Act of 1933 (“1933 Act”), 15 U.S.C. §§ 77k, 77l(a)(2), alleging that statements concerning goodwill and loan loss reserves contained in a prospectus and registration statement were false and misleading. The Court held that such statements were “opinions” which can be false or misleading only if defendants did not genuinely believe the opinions at the times they were made.  This decision is notable because it recognizes squarely that estimates of goodwill and loan loss reserves are inherently subjective and thus constitute “opinions” rather than statements of fact.
 

In Monty v. Leis, 193 Cal. App. 4th 1367, 123 Cal. Rptr. 3d 641 (2011), the California Court of Appeal, Second District, affirmed the order of the California Superior Court, Santa Barbara County, denying a motion by shareholders of Pacific Capital Bancorp (“PCB”), a California corporation, for a preliminary injunction to enjoin or rescind a transaction by which Ford Financial Fund, L.P. (“Ford”) would acquire between 80 and 91 percent of PCB’s stock. The Court held that because the transaction closed while the motion was pending, the appeal of the preliminary injunction motion was moot, and that California law would not permit the shareholder plaintiffs to seek rescission of the transaction after it had been completed. The Court also rejected plaintiffs’ argument that the investment agreement constituted an improper defensive mechanism because it did not include a provision that allowed PCB to back out of the deal if a better offer was received. Instead, the Court held, there is no requirement under California law that the board of directors negotiate a “fiduciary out” before binding the company to particular strategic transaction. This decision, in which the Court declined to follow Delaware law, underscores the latitude given to a board of directors of a California corporation to cause the company to enter into a strategic transaction.
 

In two recent decisions, the United States Courts of Appeals for the District of Columbia Circuit and the Seventh Circuit each split with the Second Circuit’s 2010 decision in Kiobel v. Royal Dutch Petroleum Co., 621 F.3d 111 (2d Cir. 2010), that corporations cannot be liable under the Alien Tort Statute (“ATS”), 28 U.S.C. § 1350. As we reported, the Second Circuit in Kiobel held that the scope of liability under the ATS does not extend to corporations because imposing liability on corporations for violations of the law of nations has not achieved a sufficiently “specific, universal, and obligatory” character so as to be considered a norm of customary international law. However, in Flomo v. Firestone Natural Rubber Co., No. 10-3675, 2011 WL 2675924 (7th Cir. July 11, 2011), and Doe VIII v. Exxon Mobil Corp., Nos. 09-7125, 09-7127, 09-7134, 09-7135, 2011 WL 2652384 (D.C. Cir. July 8, 2011), the D.C. and Seventh Circuits each concluded that the Second Circuit’s decision in Kiobel relied on factual inaccuracies and ignored the distinction between norms of conduct and remedies. The decisions deepen the circuit split on the question of corporate liability under the ATS, creating a likelihood that the conflict will be resolved by the United States Supreme Court.
 

In two recent decisions issued less than one week apart, Hutchison v. Deutsche Bank Securities Inc., 2011 WL 3084969 (2d Cir. July 26, 2011), and SEC v. Gabelli, 2011 WL 3250556 (2d Cir. Aug. 1, 2011), the United States Court of Appeals for the Second Circuit addressed motions to dismiss securities law claims based upon the immateriality of the defendants’ alleged misstatements or omissions. Generally, the question of whether a misstatement or omission is “material” –– i.e., significant enough that a “a reasonable shareholder would consider it important in deciding how to act” –– is a fact-intensive inquiry not suitable for resolution on a motion to dismiss. The Second Circuit’s decisions confirm that although this holds true in most cases, in a proper case the immateriality of an alleged misstatement or omission can be decided at the pleadings stage.
 

In MLSMK Investment Co. v. JP Morgan Chase & Co., No. 10-3040-cv, 2011 WL 2640579 (2d Cir. July 7, 2011), the United States Court of Appeals for the Second Circuit affirmed the dismissal of claims brought under the Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1962 and 1964, seeking to hold defendants liable for allegedly conspiring with Bernard L. Madoff (“Madoff”) to perpetrate his now-infamous Ponzi scheme.  The Court held that plaintiff’s RICO claims were precluded by Section 107 of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), codified at 18 U.S.C. § 1964(c), which bars civil RICO claims based upon predicate acts of securities fraud. In so holding, the Court resolved in the affirmative the unsettled question whether the Reform Act bars civil RICO claims predicated on acts of securities fraud, even where a plaintiff cannot otherwise pursue a securities fraud action against the defendant.
 

In RGH Liquidating Trust v. Deloitte & Touche, LLP, 2011 WL 2471542 (N.Y. June 23, 2011), the New York Court of Appeals held that a liquidating trust established pursuant to a bankruptcy reorganization plan was a single “person” within the meaning of the “single-entity exemption” in the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA effectively vests federal courts with exclusive jurisdiction over most securities fraud actions involving more than fifty plaintiffs. It provides further that for purposes of counting the number of plaintiffs, “a corporation, investment company, pension plan, partnership, or other entity, shall be treated as one person or prospective class member, but only if the entity is not established for the purpose of participating in the action.”  Here, the Court of Appeals held that the bankruptcy liquidating trust fell within that single-entity exemption because the primary purpose of the trust was not to pursue the litigation. For this reason, the action brought by the trust was not subject to preemption or removal to federal court. With this decision, the Court clarified the scope of state court jurisdiction over securities fraud class actions.
 

In Kahn et al v. Kolberg Kravis Roberts & Co., L.P., No. 1808, 2011 WL 2447690 (Del. June 20, 2011), the Delaware Supreme Court reversed the dismissal of breach of fiduciary duty claims brought by minority shareholders against corporate officers and a controlling shareholder. The Supreme Court held that plaintiffs could state a claim seeking disgorgement by fiduciaries who allegedly profit from using confidential corporate information, even if the corporation did not suffer actual harm. In so holding, the Court rejected earlier, lower court precedent, and declined to limit the disgorgement remedy to a usurpation of corporate opportunity or cases where the insider used confidential corporate information to compete directly with the corporation.
 

In Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525, 2011 WL 2297762 (U.S. Jun. 13, 2011) (Thomas, J.), the United States Supreme Court held that purposes of a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5 , 17 C.F.R. § 240.10b-5, promulgated thereunder, the “maker” of an allegedly false or misleading statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. In so holding, the Supreme Court further narrowed the scope of potential securities fraud liability and aligned with its prior decision which held that a private right of action under Rule 10b-5 does not include suits against aiders and abettors who merely contribute “substantial assistance” to the making of a statement but do not actually make it. Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 180 (1994).
 

In Erica P. John Fund, Inc. v. Halliburton Co.,No. 09-1403, 2011 WL 2175208 (U.S. June 8, 2011), the United States Supreme Court held that securities fraud plaintiffs need not prove loss causation in order to invoke the presumption of investor reliance at the class certification stage. The Court’s unanimous ruling, which reversed the United States Court of Appeals for the Fifth Circuit, focused narrowly on the need to prove loss causation at the class certification stage and expressly declined to address other issues regarding class certification in securities fraud class actions.
 

In Luther v. Countrywide Financial Corp., No. B222889, 2011 WL 1879242 (Cal. App. 2d Dist. May 18, 2011), the California Court of Appeal for the Second District reversed the dismissal of a class action asserting a claim under Section 11 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77k. The trial court had sustained a demurrer on the ground that the court lacked jurisdiction by operation of the federal Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). The Court of Appeal interpreted SLUSA to establish exclusive federal court jurisdiction only over “covered class actions” that involve a defined “covered security.” Because the securities in this case did not fit within that definition, the Court held, the state court had concurrent jurisdiction over the case. The Luther decision draws a fine distinction in SLUSA between class actions that may be removed to federal court and class actions as to which the federal courts have exclusive jurisdiction, thereby distinguishing decisions from other jurisdictions that appeared, at least on their face, to reach a contrary conclusion.
 

In Hellum v. Breyer, No. A127660, 2011 WL 1631662 (Cal. App. 1st Dist. Apr. 29, 2011), the California Court of Appeal for the First District reversed the dismissal of state and federal securities law claims against three outside directors of a closely held California corporation. The Court held that under Section 25504 of the California Corporations Code (“Section 25504”), directors and officers of a corporation are presumptively liable for the corporation’s violations of state securities laws. The Court held that plaintiffs need not allege that directors or officers exercised actual control over the corporation or its purported wrongdoing in order to state a cause of action under Section 25504. This decision makes it easier for a controlling person claim against officers and directors of a California corporation to survive the pleadings stage.
 

In In re Lehman Brothers Mortgage-Backed Securities Litigation, Nos. 10-0712-cv, 10-0898-cv, 10-1288-cv, 2011 WL 1778726 (2d Cir. May 11, 2011), the United States Court of Appeals for the Second Circuit affirmed three lower court decisions holding that various defendant rating agencies, including The McGraw Hill Companies, Inc., Moody’s Investors Service Inc. and Fitch, Inc. (“Rating Agencies”), were not liable as “underwriters” or as “controlling persons” under Sections 11 and 15 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. §§ 77k, 77o.  Rating agencies typically assign credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves; plaintiffs argued, however, that the Rating Agencies here exceeded their traditional, passive role as credit risk evaluators by actively aiding the issuers in the structuring and securitization process, thereby assuming the role of underwriters or controlling persons of the issuers. In rejecting plaintiffs’ arguments, the Second Circuit clarified who would qualify as an underwriter and controlling person under the Securities Act, and in the process stymied yet another attempt by securities plaintiffs to hold rating agencies liable for losses in rated securities.
 

In New Mexico State Investment Council v. Ernst & Young LLP, 2011 WL 1419642 (9th Cir. Apr. 14, 2011), the United States Court of Appeals for the Ninth Circuit reversed the dismissal of securities fraud claims against an independent accountant, holding that the complaint pleaded particularized facts giving rise to a strong inference that the auditor acted with scienter when it certified the financial statements of its client, Broadcom Corporation (“Broadcom”). In doing so, the Ninth Circuit declined to apply a “rule of thumb” that a plaintiff bears a “heavier burden” in pleading a strong inference of scienter against an independent accountant than it would in a similar securities fraud action against in issuer or its executives.
 

In Booth Family Trust v. Jefferies, No. 09-3443, 2011 WL 1237583 (6th Cir. Apr. 5, 2011), the United States Court of Appeals for the Sixth Circuit reversed the district court dismissal of a shareholder derivative action, holding that the special litigation committee (“SLC”) of the board of directors, which recommended the dismissal, was not sufficiently independent of management.  The Court reached its decision despite the fact that one of the two members of the SLC recused himself from considering claims against the defendant Robert S. Singer (“Singer”), CEO of Abercrombie & Fitch Co. (“Abercrombie”), with whom the SLC member had a personal relationship. In fact, the Court held that the SLC member’s recusal constituted an admission that he, and thus the SLC as a whole, lacked independence. This decision, which applies Delaware law, reinforces the high standard of independence imposed on members of SLCs.
 

In Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, 2011 WL 977060 (U.S. Mar. 22, 2011), the United States Supreme Court (Sotomayor, J.) held unanimously that the materiality of an alleged false or misleading statement or omission for purposes of pleading a violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, is inherently fact-specific, depending upon whether a “reasonable investor” would have viewed the relevant information “as having significantly altered the total mix of information made available.” The Supreme Court declined to apply a “bright-line rule” that only “statistically significant” information regarding the safety of drug products is sufficiently material to support a Rule 10b-5 claim against a drug manufacturer based on a failure to disclose. This decision reaffirmed prior Supreme Court precedents holding that materiality is highly fact-specific, although it also made clear that the test of whether information is material is based upon an objective standard of a “reasonable investor.” The Court left open the question of whether a statistically significant reaction by the stock market in response to a corrective disclosure is dispositive to the question of materiality.
 

In the past year, a number of companies have amended their bylaws to require that shareholder derivative lawsuits are resolved in the Delaware Chancery Court. This recent spike in the use of company-friendly forum selection clauses comes at a time when lawsuits challenging mergers are rampant. According to Reuters, such lawsuits have tripled from 107 in 2007 to 335 in 2010, despite a decrease in deal volume.
 

In City of Pontiac General Employees’ Retirement System v. MBIA, Inc., 2011 U.S. App. LEXIS 3813 (2d Cir. Feb. 28, 2011), the United States Court of Appeals for the Second Circuit delineated the standard needed to asses how much information a reasonably diligent investor must have about the facts constituting a securities fraud violation before those facts are deemed “discovered” for purposes of triggering the statute of limitations for a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5.In doing so, the Second Circuit addressed the gap left by the United States Supreme Court in Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1796 (2010) [see blog article here], where the Supreme Court expressly declined to prescribe a list of the facts needed to constitute a securities law violation for purposes of triggering the statute of limitations.
 

On January 14, 2011, the Delaware Chancery Court issued an opinion in In re John Q. Hammons Hotels Shareholder Litigation that a merger transaction in which a controlling stockholder received consideration different than that received by the minority stockholders met the “entire fairness” standard. This opinion followed the Court’s determination in October 2009 that “entire fairness,” was the appropriate standard of review in this case.
 

In King v. VeriFone Holdings, Inc., No. 330, 2010, 2011 WL 284966 (Del. Jan. 28, 2011), the Supreme Court of the State of Delaware reversed a decision by the Court of Chancery dismissing a derivative plaintiff’s action under Section 220 of the Delaware General Corporation Law seeking books and records of a Delaware corporation. The Supreme Court held that the Chancery Court erred as a matter of law when it held that the purpose of plaintiff’s demand to inspect books and records — to assist in bolstering demand futility allegations in a parallel shareholder derivative complaint filed in a California federal court — was improper. The Supreme Court explained that although the plaintiff’s simultaneous pursuit of a derivative action and a Section 220 books and records action was perhaps ill advised, it was not impermissible under prevailing Delaware law.
 

In In re InterBank Funding Corp. Securities Litigation, No. 09-7167, --- F.3d ----, 2010 WL 5299882 (D.C. Cir. Dec. 28, 2010), the United States Court of Appeals for the District of Columbia Circuit affirmed the dismissal with prejudice of a class action asserting securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, based upon a failure to adequately plead the essential element of reliance. The sole issue before the Court was whether the fraud allegations in the complaint involved material omissions, which would allow plaintiffs to invoke the presumption of reliance established by the United States Supreme Court in Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972). In affirming the district court’s decision, the Court held that the complaint’s allegations of fraud focused primarily on affirmative misrepresentations, not omissions, and thus did not qualify for the Affiliated Ute presumption of reliance.
 

In Dronsejko v. Grant Thornton, Nos. 09-4222 and 10-4074, U.S. App. LEXIS 1052 (10th Cir. Jan. 20, 2011), the United States Court of Appeals for the Tenth Circuit affirmed a decision by the United States District Court for the District of Utah dismissing a securities fraud class action brought by investors in iMergent against its independent auditor, Grant Thornton. The district court held that the operative complaint failed to plead particularized facts sufficient to give rise to a strong inference that Grant Thornton possessed the scienter required to support liability under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. Plaintiffs also sought relief from the dismissal under Rule 60(b) of the Federal Rules of Civil Procedure, asserting that subsequent orders by the Public Company Accounting Oversight Board (“PCAOB”) issuing sanctions against two Grant Thornton auditors for their conduct in auditing iMergent’s financial statements added new evidence to their claims. The district court denied plaintiffs’ Rule 60(b) motion. The Tenth Circuit affirmed both decisions, reiterating the high standards for pleading a securities fraud claim against an independent auditor.
 

In Golden Telecom, Inc. v. Global GT LP, 2010 WL 5387589 (Del. Dec. 29, 2010), the Delaware Supreme Court affirmed a judgment of the Delaware Chancery Court in an appraisal proceeding under Section 262(h) of the Delaware General Corporation Law (“DGCL”). Section 262(h) provides that in the event of a merger, a stockholder of a Delaware corporation is entitled to an independent appraisal proceeding regarding the “fair value” of its outstanding shares. In affirming the Chancery Court, the Supreme Court declined to adopt two bright line rules for appraisal proceedings under Section 262(h). First, it rejected the notion that the Chancery Court must consider the merger price agreed to by the parties following arm’s-length negotiations and fair process as necessarily reflecting the “fair value” of the corporation’s shares. Second, it rejected the assertion that a corporation is bound by company-specific data included in its fairness opinion in arriving at a “fair value” under Section 262(h). This decision confirms that the Chancery Court has great flexibility, and is entitled to great deference, in conducting its independent appraisal of the value of a merger target under Section 262(h).
 

In Viterbi v. Wasserman, 2011 Cal. App. LEXIS 25 (Cal. App. Jan. 11, 2011), the Court of Appeal for the Fourth Appellate District of the State of California affirmed the judgment of the Superior Court of San Diego County holding that privity between the purchaser and seller of a security is necessary to maintain an action for rescission under Sections 25504 and 25504.1 of the California Corporations Code. This decision, which follows persuasive authority in the federal courts construing analogous federal law, confirms the limits of the remedy of rescission under the California Corporations Code.
 

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective year-end assessments of securities litigation for 2010. (Their findings and analyses are summarized in press releases here:  NERA, Cornerstone.) Both report that new federal securities class action filings reversed their first-half 2010 decline. (We previously reported on trends for the first half of 2010 here.) One notable development was the increase in class actions by shareholders challenging the fairness of proposed mergers at a pace ahead of the increase in merger activity, suggesting a shift in focus and resources among the plaintiffs’ bar as credit crisis litigation begins to wind down.

For further information, please contact John Stigi at (310) 228-3717.

Public companies and companies registering to go public should be aware of recent fee rate adjustments made by the Securities and Exchange Commission. The following fee rates will be affected by the adjustment:

• the Section 6(b) fee rate applicable to the registration of securities,
• the Section 13(e) fee rate applicable to the repurchase of securities and
• the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions.

On October 18, 2010, the Securities and Exchange Commission (“SEC”) released proposed rules that would implement additional disclosure requirements for certain institutional investment managers to report, at least annually, how they voted on the following executive compensation matters: (i) say-on-executive-pay, (ii) frequency of say-on-executive-pay, and (iii) say on golden parachute arrangements.  The proposed rules are required by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  This blogpost sets forth the background of the proposed new rules, the investment managers that would be subject to the new rules, how the proposed disclosure obligations expand existing disclosure obligations, whether confidential treatment can be obtained, when the changes will become effective and next steps.
 

In Affco Investments 2001 LLC v. Proskauer Rose L.L.P., No. 09-20734, 2010 WL 4226685 (5th Cir. Oct. 27, 2010), the United States Court of Appeals for the Fifth Circuit held that a law firm which allegedly assisted in developing a fraudulent tax shelter scheme could not be held liable under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, for conduct and statements not explicitly attributed to it. In the absence of such express attribution, the Court held, the investor plaintiffs could not demonstrate reliance upon the law firm in deciding whether to invest. This decision echoes a recent, similar ruling by the Second Circuit establishing a “bright line” rule limiting liability of secondary actors only to instances where conduct or statements are expressly attributed to them.

In Lambrecht v. O’Neal, No. 135, 2010, 2010 WL 3397451 (Del. Aug. 27, 2010), the Supreme Court of Delaware answered a certified question of Delaware law from the United States District Court for the Southern District of New York regarding the standing of a plaintiff-shareholder of a parent corporation to bring a “double derivative” action following a merger. The Court held that plaintiffs who were pre-merger shareholders in an acquired company and who, by virtue of a stock-for-stock merger, are current shareholders of a post-merger parent company need not demonstrate for purposes of standing that, at the time of the alleged wrongdoing at the acquired company, (1) they owned stock in the acquiring company, and (2) the acquiring company owned stock in the acquired company.  In so holding, the Court clarified the law allowing for the possibility of double derivative claims where standard derivative claims are extinguished by an intervening merger.
 

In Office Depot, Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pa., No. 09-80554-CIV-MARRA, 2010 WL 4065416 (S.D. Fla. Oct. 15, 2010), the United States District Court for the Southern District of Florida recently concluded that Office Depot, Inc. (“Office Depot” or the “Company”) could not recover $23 million in attorneys’ fees and costs incurred in voluntarily responding to a Securities & Exchange Commission (“SEC”) investigation and in conducting an internal investigation and audit. The court held that these fees and costs did not fall within the policy’s definition of loss “arising from” a covered “Securities Claim” made against the Company or a covered “Claim” made against one of its officers, directors or employees. Companies with policy language similar to that in Office Depot thus take a calculated risk, when committing resources towards voluntary cooperation with the SEC or an internal investigation, that insurance coverage for the attorneys’ fees or costs incurred will not be available.
 

In Kirschner v. KPMG LLP, 2010 NY Slip Op. 07415, 2010 WL 4116609 (N.Y. Oct. 21, 2010), a majority of the New York Court of Appeals declined to expand liability of outside professional service providers who allegedly failed to detect or stop corporate wrongdoing. Through the interplay of two legal principles soundly “embedded in New York law” — namely, the “in pari delicto” defense and the “adverse interest” exception to the general rule that corporate executives’ wrongdoing is imputed to the corporation — the Court rejected attempts by investors to recoup some of their investment losses from the issuers’ outside auditors. If the dissent is to be believed, this decision “effectively immunizes auditors and other outside professionals from liability wherever any corporate insider engages in fraud.”
 

In City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., 1 A.3d 281 (Del. 2010), the Delaware Supreme Court affirmed the dismissal of an action brought under Section 220 of the Delaware General Corporation Law, 8 Del. Code § 220, to review books and records of a corporation. The Court of Chancery had dismissed the action on the ground that plaintiff failed to present “some evidence” suggesting a “credible basis” from which the court could infer a “proper purpose” for the review, such as possible wrongdoing or mismanagement. The decision offers enhanced guidance on the “proper purpose” test, particularly with respect to corporations that follow “plurality plus” governance policies.
 

Public companies and companies registering to go public should be aware of recent fee rate adjustments made by the Securities and Exchange Commission. The following fee rates will be affected by the adjustment:

• the Section 6(b) fee rate applicable to the registration of securities,
• the Section 13(e) fee rate applicable to the repurchase of securities and
• the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions.
   

The SEC has responded to concerns about balance sheet “window dressing” and other perceived liquidity disclosure problems with an interpretive release regarding MD&A liquidity and capital resources disclosure and proposed new rules that would require detailed MD&A disclosure on short-term borrowing arrangements.
 

In Cohen v. Viray, 2010 WL 3785243 (2d Cir. Sept. 30, 2010), the United States Court of Appeals for the Second Circuit held that no private right of action exists under Section 304 of the Sarbanes Oxley Act, 15 U.S.C. § 7243 (“Section 304”), to recover from chief executive officers (“CEOs”) and chief financial officers (“CFOs”) any bonus or similar compensation, or any profits realized from stock sales, they may have received during the twelve-month period prior to a restatement of company financial statements due to misconduct. The Second Circuit concluded further that because only the Securities & Exchange Commission (“SEC”) may enforce Section 304, a settlement agreement between a shareholder derivative plaintiff and a CEO and CFO may not purport to indemnify or release those senior corporate executives from liability under Section 304. This decision follows that of the Ninth Circuit on the question of whether a private right of action exists under Section 304.
 

In Favila v. Katten Muchin Rosenman LLP, 188 Cal. App. 4th 189 (2d Dist. 2010), the California Court of Appeal reversed the trial court’s denial of plaintiff’s motion for leave to amend its complaint and dismissal of plaintiff’s derivative action, holding, in part, that a shareholder’s estate may maintain a derivative action on behalf of a corporation even after the corporation has been dissolved. The holding clarifies that although a corporation is dissolved, it continues to exist for the purpose of winding up its affairs, and its shareholders retain the right to bring shareholder derivative actions.
 

In Kiobel v. Royal Dutch Petroleum Co., Nos. 06-4800-CV, 06-4876-CV, 2010 WL 3611392 (2d Cir. Sept. 17, 2010), the United States Court of Appeals for the Second Circuit dismissed claims by Nigerian citizens against various multinational oil producers under the Alien Tort Statute, 28 U.S.C. § 1350 (“ATS”), alleging that the corporate defendants aided and abetted human rights violations by the Nigerian military. The Court held that the ATS does not provide federal subject matter jurisdiction for claims against corporations. In so holding, the Court reasoned that the scope of liability under the ATS is defined by international law, and that international law does not yet recognize the concept of corporate tort liability.
 

In Iowa Public Employees’ Retirement System v. MF Global, Ltd., No. 09-3919, 2010 WL 3547602 (2d Cir. Sept. 14, 2010), the United States Court of Appeals for the Second Circuit vacated the dismissal of plaintiffs’ securities fraud claims and remanded the case to the district court, holding that the district court applied the “bespeaks caution” doctrine erroneously to statements that contained both present and future elements.  This decision provides guidance as well to the application in the Second Circuit of the safe harbor for forward-looking statements established under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), 15 U.S.C. § 78u-5.
 

In Malack v. BDO Seidman, LLP, No. 09-4475, 2010 WL 3211088 (3d Cir. Aug. 16, 2010), the United States Court of Appeals for the Third Circuit declined to recognize a presumption of reliance based upon the so-called “fraud-created-the-market” theory to state a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and, consequently, satisfy the predominance requirement of Federal Rule of Civil Procedure 23(b)(3) for certifying a class. In so holding, the Third Circuit followed the Seventh Circuit and the recent trend of federal courts to narrow and limit Section 10(b) liability to its current contours.
 

On August 25, 2010, the Securities and Exchange Commission voted 3-to-2 along party lines to adopt a controversial proxy access regime to facilitate shareholders’ ability to nominate a limited number of candidates for election as directors. The new rules, which are primarily contained in new Rule 14a-11 promulgated under the Securities Exchange Act of 1934, will permit a single shareholder or group of shareholders owning at least 3% of the shares entitled to vote for directors to nominate, in accordance with applicable state corporate law, a number of directors up to 25% of the number of authorized directors and have such nominees included in the company’s proxy statement.
 

In In re Aetna, Inc. Securities Litigation, No. 09-2970, 2010 WL 3156560 (3d Cir. Aug. 11, 2010), the United States Court of Appeals for the Third Circuit held that certain allegedly misleading statements regarding the pricing of insurance premiums by a large health insurance company were protected under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 (“Reform Act”), 15 U.S.C. § 78u-5(c)(1). The Court reasoned that the statements warranted protection because they were not only forward-looking — despite containing both present and future elements — but also immaterial. This decision further clarifies the Court’s analysis of mixed present/future statements for purposes of protection under the Reform Act’s safe harbor for forward-looking statements.
 

In Northstar Financial Advisors, Inc. v. Schwab Investments, No. 09-16347, 2010 WL 3169400 (9th Cir. Aug. 12, 2010), the United States Court of Appeals for the Ninth Circuit held that nothing in Section 13(a) of the Investment Company Act of 1940 (“ICA”), as originally enacted or as subsequently amended, either created a private right of action or implied that such a right exists with the clarity and specificity required under United States Supreme Court precedent. In so holding, the Ninth Circuit followed the Second Circuit and the recent trend of federal courts to reject implied private rights of action under the ICA.
 

In NetCoalition v. Securities & Exchange Commission, No. 09-1042 (D.C. Cir. Aug. 6, 2010), the United States Court of Appeals for the District of Columbia Circuit held that the Securities & Exchange Commission (“SEC” or “Commission”) failed adequately to explain the basis of, and failed to provide adequate support for, its approval of a proposed fee by NYSE Arca for access by investors to its proprietary “depth-of-book” product, Arcabook.  The Court vacated the approval order and remanded the matter to the SEC for further consideration of whether the proposed fee is consistent with the requirements and purposes of the Securities Exchange Act of 1934 (“Exchange Act”).
 

In Securities & Exchange Commission v. Platforms Wireless Int’l Corp., No. 07-56542, 2010 U.S. App. LEXIS 15328 (9th Cir. July 27, 2010), the United States Court of Appeals for the Ninth Circuit held that under Section 10(b) of Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, a showing that a statement is so obviously misleading to a reasonable person that the defendant who made the statement must have known of its misleading nature is sufficient on summary judgment to prove defendant’s scienter. The Court held further that a defendant cannot defeat summary judgment merely by denying subjective knowledge of the risk that a statement could be misleading. This decision clarifies two points of law in the Ninth Circuit: first, that the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”), did not alter the substantive requirement for pleading scienter for claims under Section 10(b) and Rule 10b-5, and second, that deliberate recklessness, for purposes of demonstrating scienter, may be proved by an objective, not subjective, evaluation of a defendant’s mental state.
 

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first six months of 2010. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that new federal securities class action filings continued to decline from 2009, as litigation following the 2008 credit crisis winds down. (We previously reported on trends for 2009 here.) If new filings continue at the same pace through the rest of the year, we could see the lowest level of filings since 2006 and the second lowest since 1997.

For further information, please contact John Stigi at (310) 228-3717.

In Morrison v. National Australia Bank Ltd., 2010 WL 2518523 (U.S. Jun. 24, 2010), the United States Supreme Court held that domestic courts lack jurisdiction over claims brought by private citizens pursuant to Section 10(b) of Securities Exchange Act of 1934 (“Exchange Act’), 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, against corporations whose stock is traded exclusively in foreign exchanges. The decision, written by Justice Scalia on behalf of a five justice majority, departs from decades of precedent from the United States Courts of Appeals that allowed such claims to be brought when substantial aspects of the misconduct occurred in the United States or when the misconduct had a substantial effect on U.S. investors.
 

In Skilling v. United States, 2010 WL 2518587 (U.S. Jun. 24, 2010), the United States Supreme Court significantly limited the scope of a criminal statute used frequently by federal prosecutors to criminalize a wide range of behavior by business executives and public officials. The Court held that 18 U.S.C. § 1346, which makes it a federal crime to deprive another of the “intangible right of honest services,” may only be used by prosecutors in cases where the defendant has participated in conduct involving bribery or kickbacks. The justices agreed unanimously that the statute does not apply to cases where the defendant’s conduct merely entails a conflict of interest, self-dealing, breaches of fiduciary duty or unwise business decisions, and that does not include bribery or kickbacks. The Skilling case ends the long running debate between those who perceived this “statute of last resort” as a necessary tool for prosecutors to use in fighting malfeasance by corporate and public officials, and those who contended ambitious and/or unwise prosecutors were abusing the statute to target persons whose behavior may be unpopular, unethical or subject to second-guessing, but was not clearly criminal.
 

In In re Cutera Securities Litigation, 2010 WL 2595281 (9th Cir. June 30, 2010), the United States Court of Appeals for the Ninth Circuit concluded that the Private Securities Litigation Reform Act’s (“Reform Act”) safe harbor provision, 15 U.S.C. § 78u-5, protects forward-looking statements accompanied by meaningful cautionary language” andforward-looking statements in the absence of meaningful cautionary language not made with “actualknowledge” that the statement was false or materially misleading when made. This decision greatly clarifies the law in the Ninth Circuit. Previously, in dicta, a Ninth Circuit court had suggested that if plaintiffs could prove a sufficiently strong inference that a forward-looking statement made with actual knowledge of its falsity, such a statement would not protected by the safe harbor provision of the Reform Act even if accompanied by meaningful cautionary language. In re Cutera puts this notion to rest. A forward-looking statement that is either accompanied by meaningful cautionary language or is made without actual knowledge of its falsity may not form the basis for a federal securities fraud claim.
 

In In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL, 2010 WL 2291842 (Del. Ch. May 25, 2010) (Laster, V.C.), the Delaware Court of Chancery held that minority stockholders established a likelihood of success on the merits of their claim challenging the “entire fairness” of a tender offer by a controlling stockholder intended to “freeze-out” minority stockholders.  The court held that the transaction was not entitled to the less onerous “business judgment” standard of review — which would have applied only if the transaction was (1) negotiated and recommended by a special committee of independent directors and (2) conditioned on the affirmative tender of a majority of the minority shares— because, inter alia, the company’s special committee did not recommend the deal. The court nevertheless declined to enjoin the tender offer, holding that the minority stockholders did not demonstrate a risk of irreparable harm. In this decision, Vice Chancellor Laster applied a “unified standard” to controlling stockholder “freeze-out” transactions that differed from the standard applied in other Chancery Court decisions, urging the Delaware Supreme Court to resolve the conflicting approaches.
 

In United States v. Deloitte LLP, No. 09-5171, 2010 WL 2572965 (D.C. Cir. Jun. 29, 2010), the United States Court of Appeals for the District of Columbia Circuit held, among other things, that the provision of documents containing attorney work product to a company’s independent auditor does not waive the protection of the work product doctrine. This decision, on a matter of first impression, allows companies to deliver work product to outside accountants that might be relevant to their audit of the company’s financial statements without fear that the materials will automatically be discoverable in subsequent litigation.
 

In Solis v. Tennessee Commerce Bancorp, Inc., a three-judge panel of the Sixth Circuit recently reversed a lower court’s decision to enforce a preliminary order by the Department of Labor (“DOL” or “Department”) to reinstate an alleged whistleblower under the Sarbanes-Oxley Act of 2002 (“SOX”). The court avoided determining whether it had authority under SOX to enforce preliminary orders, instead deciding the case based on the “balance of harms” test that applies in all cases seeking preliminary injunctive relief.
 

In Maric Capital Master Fund, Ltd. v. PLATO Learning, Inc., C.A. No. 5402-VCS (Del. Ch. May 13, 2010), the Court of Chancery of the State of Delaware granted plaintiff Maric Capital Master Fund’s (“Maric”) motion for a preliminary injunction to halt a stockholder vote on a proposed merger in which Thoma Bravo, LLC (“Thoma Bravo”) would acquire PLATO Learning, Inc. (“PLATO”). Although the court held that Maric failed to demonstrate a likelihood of success on the merits of its assertion that the directors of PLATO failed to meet their duties under Revlon, Inc. v. McAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the court nonetheless enjoined the vote based upon a determination that three specific disclosures in the proxy statement were materially misleading. The court ordered that corrective disclosures on those items be issued before the vote could proceed. This decision reflects the Chancery Court’s efforts to ensure that proxy disclosures in advance of stockholder votes are not materially misleading.

In MCG Capital Corporation v. Maginn, Civil Action No. 4521-CC, 2010 Del. Ch. LEXIS 87 (Del. Ch. May 5, 2010), the Delaware Court of Chancery granted in part and denied in part the defendants’ motion to dismiss plaintiff preferred stockholder’s complaint alleging both derivative and direct claims. In doing so, the court, for the first time, set forth a rule allowing preferred stockholders to bring derivative suits absent an express limitation in the company’s articles of incorporation or other appropriate document.

In Securities & Exchange Commission v. Jenkins, No. CV-09-1510-PHX-GMS, 2010 WL 2347020 (D. Ariz. Jun. 9, 2010), the United States District Court for the District of Arizona held that the responsibility of a CEO under Section 304 of the Sarbanes-Oxley Act of 2002 (the “Act”) to reimburse an issuer for bonuses, incentive compensation and stock sale proceeds he or she received in the year prior to a restatement of the issuer’s financial statements does not require a showing that CEO committed or even knew of misconduct that led to the restatement. This decision marks the first time a court has applied Section 304 of the Act in the absence of allegations that the targeted CEO personally committed any wrongdoing, enforcing strict liability of CEOs and CFOs in the event of a restatement due to corporate (as opposed to their own) misconduct.

In King v. VeriFone Holdings, Inc., C.A. No. 5045-VCS (Del. Ch. May 12, 2010), the Delaware Court of Chancery dismissed a derivative plaintiff’s Section 220 books and records action on the ground that the purpose for the request — to bolster demand futility allegations in the prematurely filed derivative complaint — was improper. The court criticized plaintiff for filing a derivative complaint before counsel was able to complete his investigation, solely to “win the race to the courthouse.” This decision reflects the Chancery Court’s willingness to impose consequences on plaintiffs who do not follow appropriate procedures in their haste to obtain lead plaintiff status.
 

In Slayton v. American Express Co., No. 08-5442, 2010 WL 1960019 (2d Cir. May 18, 2010), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a securities fraud class action against American Express Company (“Amex”) on the ground that the complaint did not plead a strong inference of defendants’ scienter. While the court affirmed dismissal, it rejected Amex's argument that the alleged misrepresentation was protected by the “safe harbor” for forward-looking statements set forth in the Private Securities Litigation Reform Act of 1995 (“Reform Act”). In doing so, the Court set forth useful guidance for determining when a statement is “forward-looking” and whether cautionary warnings are sufficiently “meaningful” to trigger the protection of the statute’s safe harbor.
 

In Greb v. Diamond Int’l Corp., 2010 Cal. App. LEXIS 566 (Cal. App. 1st Dist. Apr. 26, 2010), the California Court of Appeal for the First District affirmed the trial court’s dismissal of a personal injury claim against a dissolved Delaware corporation, holding that the claim was filed more than three years after dissolution of the corporation in violation of Delaware General Corporation Law Section 278. In doing so, the Court made it clear that, for purposes of lawsuits filed in California against dissolved non-California corporations, the law of the state of incorporation controls whether claims are timely filed.
 

In Merck & Co. v. Reynolds, No. 08-905, 2010 U.S. LEXIS 3671 (Apr. 27, 2010), the Supreme Court of the United States held that a private securities fraud claim accrues for statute of limitations purposes at the earlier of when (1) the plaintiff does in fact discover, or (2) a reasonably diligent plaintiff would have discovered, “the facts constituting the violation.” The Supreme Court held further that “facts constituting the violation” include the “fact” of defendants’ scienter, i.e., “a mental state embracing intent to deceive, manipulate, or defraud.” This unanimous clarification by the Supreme Court of how lower courts should apply the statute of limitations for private securities fraud claims provides a bit more breathing room for would-be plaintiffs.
 

In Pacific Investment Management Co. LLC v. Mayer Brown LLP, No. 09-1619, 2010 WL 1659230 (2d Cir. Apr. 27, 2010), the United States Court of Appeals for the Second Circuit affirmed the dismissal of securities fraud claims asserted against outside counsel to Refco Inc. (“Refco”), holding that such secondary actors can be held liable for damages in a private securities fraud action only if the alleged false or misleading statements are attributed to that secondary actor at the time the statements were disseminated. Without a showing of this so-called “attribution requirement,” secondary actors who participate in the preparation or creation of false statements can be guilty of no more than “aiding and abetting,” which under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), cannot form the basis of a securities fraud claim. This decision confirms the Second Circuit’s strict application of Central Bank and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008), to limit securities fraud claims against secondary actors.
 

In Bezirdjian v. O’Reilly, Case No. A124859, 183 Cal. App. 4th 316, 2010 WL 1212437 (Cal. App. Mar. 30, 2010), the California Court of Appeal for the First Appellate District affirmed the dismissal of a shareholder derivative action against current and former board members of Chevron Corporation. The Court held that the plaintiff failed to allege facts with sufficient particularity to rebut the presumption that the company’s refusal to pursue the case in response to the shareholder demand was protected by the business judgment rule. This decision joins the growing body of California cases that follow or apply Delaware law in protecting the integrity of corporate decision-making.
 

Mutual fund companies have traditionally argued that they are exempt from the whistleblower protections of the Sarbanes-Oxley Act (“SOX”) because the funds themselves do not have any employees. Massachusetts District Court Judge Douglas P. Woodlock soundly rejected that argument in a ruling issued March 31 and, in so doing, may have opened the door to a tidal wave of whistleblower suits against mutual fund companies.
 

In In re Omnicom Group, Inc. Securities Litigation, No. 08-0612-CV, 2010 WL 774311 (2d Cir. Mar. 9, 2010), the United States Court of Appeals for the Second Circuit affirmed the district court’s grant of summary judgment dismissing a securities fraud class action for failure to proffer sufficient evidence to support a finding of loss causation.  The Second Circuit held that plaintiffs failed to show that the decline in the issuer’s stock price occurred as a result of a disclosure of new information about the alleged fraud. At most, the investor losses arose from the negative press and investor concerns about possible accounting problems. As the Second Circuit stated, however, an issuer is not responsible under the securities laws for losses arising merely from “investors’ concerns that other unknown problems [are] lurking.
 

In Securities & Exchange Commission v. Tambone, No. 07-1384, 2010 U.S. App. LEXIS 5031 (1st Cir. Mar. 10, 2010) (en banc), the United States Court of Appeals for the First Circuit, sitting en banc, vacated the three-judge panel’s prior holding and affirmed the district court’s dismissal of a Rule 10b-5 claim asserted by the Securities & Exchange Commission (“SEC”) against defendants James Tambone and Robert Hussey. In doing so, the First Circuit clarified what it means to “make” a statement under Rule 10b-5(b) promulgated under Section 10(b) of the Securities Exchange Act of 1934 (“1934 Act”).
 

In Bixler v. Foster, No. 09-2138, 2010 WL 597477 (10th Cir. Feb. 22, 2010), the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of a class action lawsuit brought by minority shareholders of Mineral Energy and Technology Corporation (“METCO”) against its directors and lawyers. Plaintiffs alleged that defendants violated the civil Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961-1968, for authorizing and facilitating the transfer of METCO’s assets to an Australian corporation. The Tenth Circuit held that, among other things, (1) plaintiffs lacked standing under RICO to assert shareholder derivative claims and (2) allegations of securities fraud did not establish predicate acts under RICO. This decision confirms that the civil RICO statutes generally are not available to shareholders and investors seeking redress for alleged ordinary corporate misconduct.
 

In Operating Local 649 Annuity Trust Fund v. Smith Barney Fund Management LLC, No. 07-5125-cv, 2010 WL 520896 (2d Cir. Feb. 16, 2010), the United States Court of Appeals for the Second Circuit vacated an order dismissing a securities fraud class action brought on behalf of investors against the manager of a family of mutual funds. The Court held, among other things, that the defendants’ alleged misrepresentations regarding transfer agent fees paid by the funds were material under the “total mix” materiality test. This decision provides guidance regarding disclosures to be made by mutual funds concerning the details of transfer fee arrangements.
 

In New York City Employees’ Retirement System v. Jobs, No. 08-16488, 2010 WL 309028 (9th Cir. Jan. 28, 2010), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a class action lawsuit against Apple, Inc. (“Apple”) and fourteen of its officers and directors for the alleged false and misleading proxy solicitation of a stock option plan on the ground that plaintiff-appellant did not adequately plead economic loss in the form of “dilution to shareholder interests.”  This decision provides yet another instance where courts have strictly applied the “loss causation” principles set forth in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in describing the contours of “loss” in private actions under the federal securities laws.
 

In Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., No. 09-10954, 2010 WL 154519 (11th Cir. Jan. 19, 2010), the United States Court of Appeals for the Eleventh Circuit affirmed the dismissal of securities fraud and insider trading claims arising out of options backdating. This decision represents the most recent effort by the Eleventh Circuit to apply the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (“Reform Act”) and the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) [see blog article here], to allegations of securities fraud arising from options backdating.
 

In Konkol v. Diebold, Inc., No. 08-4572, 2009 WL 4909110 (6th Cir. Dec. 22, 2009), the United States Court of Appeals for the Sixth Circuit applied the United States Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (see blog article here), to hold that securities fraud plaintiffs must plead an inference of scienter that is both “cogent and at least as compelling as any opposing competing inference.”  The Sixth Circuit clarified that, under Tellabs, the inference of defendants’ scienter be “cogent” requires plaintiffs to plead “with particularity” facts supporting each individual allegation of scienter. Additionally, the Sixth Circuit held that Tellabs does not impose any burden on defendants to set forth a competing, non-fraudulent inference of scienter at the pleading stage. In reaching its decision, the Court attempted to harmonize Tellabs with the Sixth Circuit leading pre-Tellabs decision on the topic, Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001) (en banc).
 

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for 2009. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that federal securities class action filings decreased from 2008, due to the easing of the financial crisis and reduced stock price volatility since the first quarter of 2009. (We previously reported on mid-year 2009 assessments here.)  One notable trend: an increasing number of cases are being filed six months or more after the end of the putative class periods, instead of immediately after a stock price drop, suggesting that plaintiffs’ counsel have turned to “clearing out inventory” of potential cases.

For further information, please contact John Stigi at (213) 617-5589.

In Bader v. Anderson, No. CV041521, 2009 Cal. App. LEXIS 1880 (Cal. App. Nov. 23, 2009), the California Court of Appeal for the Sixth Appellate District addressed two important issues affecting shareholder derivative actions under California law. First, the Court offered guidance regarding the distinctions between direct claims and derivative claims by shareholders against corporate management, holding that “incidental harm” to shareholders, in the form of reduced share value, does not transform a derivative claim into a direct cause of action. Second, the Court confirmed that no exception to the presuit demand requirement exists for claims alleging misleading statements or omissions in proxy statements.
 

In Electronic Trading Group, LLC v. Banc of America Securities LLC (In re Short Sale Antitrust Litigation), 2009 WL 4350035 (2d Cir. Dec. 3, 2009), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a putative antitrust class action against certain financial institutions that serve as “prime brokers” in connection with short sale transactions, on the ground that the federal securities laws precluded application of antitrust law to the matters at hand. This was the first time the Second Circuit applied the considerations for the implied preclusion of antitrust laws by the securities laws outlined by the United States Supreme Court in Credit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007).
 

Registrants should be aware of recent fee rate adjustments made by the Securities and Exchange Commission in response to President Obama’s recent signing of H.R. 3288, the appropriations bill that includes funding for the Securities and Exchange Commission. Specifically, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions will increase from $55.80 per million dollars to $71.30 per million dollars. Note that the fee rate for Section 6(b) is also used to calculate fees payable with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940. The fee rate adjustments will be effective as of December 21, 2009.
 

In United States v. Berger, No. 08-50171, 2009 WL 4141478 (9th Cir. Nov. 30, 2009), a three-judge panel of the United States Court of Appeals for the Ninth Circuit declined to apply loss causation principles in civil securities fraud litigation established by the United States Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in connection with the sentencing of a defendant in a criminal securities fraud prosecution. Declining to follow two other circuits that had endorsed the application of Dura Pharmaceuticals to criminal sentencing, the Ninth Circuit held that the policies underlying the proper standard for pleading and proving a loss by investors in civil cases are not present in the criminal sentencing context and that applying Dura Pharmaceuticals’ civil rule to criminal sentencing would clash with Congress’ endorsement of that method. Notwithstanding that the split in circuit decisions may prompt Supreme Court review, this decision provides another instance where courts have applied policy distinctions between civil litigation and criminal/enforcement proceedings involving securities fraud.

In Siracusano v. Matrixx Initiatives, Inc., 2009 WL 3448282 (9th Cir. Oct. 28, 2009), the United States Court of Appeals for the Ninth Circuit reversed and remanded a decision by the United States District Court for the District of Arizona granting defendant Matrixx Initiatives, Inc.’s (“Matrix”) motion to dismiss a putative securities fraud class action brought under Section 10(b) of Securities Exchange Act of 1934.  In its decision, the Ninth Circuit rejected older precedent from the Second Circuit and held that the materiality or immateriality of an allegedly false statement generally is not to be determined at the pleading stage, but an issue of fact properly reserved for later stages of the proceeding. Additionally, the Ninth Circuit reiterated the Supreme Court’s recent admonition in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) [see blog article on Tellabs], that a plaintiffs’ failure to plead motive and opportunity is an insufficient basis on which to dismiss a complaint that otherwise alleges scienter with the particularity required by the Private Securities Litigation Reform Act of 1995. This decision in Siracusano largely echoes existing Ninth Circuit authority on the issues of materiality and scienter, as well as the interpretation and application of Tellabs.
 

In Murray v. Metropolitan Life Ins. Co., No. 09-3716-CV, 2009 WL 3080462 (2d Cir. Sept. 29, 2009), the United States Court of Appeals for the Second Circuit reversed an order by the district court disqualifying defense counsel for a life insurance company in an action alleging fraud in connection with the demutualization of defendant life insurance company. The Court held that the law firm did not have an attorney-client relationship with the policyholders (plaintiffs) by reason of counsel’s representation of the insurance company in the demutualization process several years earlier.  The Second Circuit’s decision provides clear guidance as to whether constituents of a mutual company have a direct attorney-client relationship with counsel for the company, slamming shut the door opened by the district court in this case.
 

In United States v. Ruehle, No. 09-50161, 2009 WL 3152971 (9th Cir. Sept. 30, 2009), the United States Court of Appeals for the Ninth Circuit reversed a controversial decision by the United States District Court for the Central District of California, which improperly excluded from evidence in a criminal prosecution certain statements made by a senior officer to corporate counsel conducting an internal investigation that the officer claimed were protected from disclosure by the attorney-client privilege. The Ninth Circuit held that the corporate counsel’s alleged failure to give an “Upjohn warning” — which comes from the United States Supreme Court’s decision in Upjohn Co. v. United States, 449 U.S. 383 (1981), and is sometimes referred to as “corporate Miranda warning” — to the officer does not necessarily bar the government from using the statements made by the officer to corporate counsel. The decision potentially has far-reaching implications for groups as diverse as government prosecutors, individual corporate officers and corporate counsel in connection with the conduct of internal investigations of alleged corporate wrongdoing.
 

On June 10, 2009, the Securities and Exchange Commission, or the SEC, proposed a comprehensive series of rule amendments to facilitate the rights of shareholders to nominate a minority slate of directors on corporate boards.[1]There was speculation that final action could be taken on the proposed rule amendments—known as the direct access proposal—as early as November 2009 and that the changes would be effective for the 2010 proxy season. Commissioner Elisse B. Walter, in a speech on October 2, 2009, indicated that it was unlikely that the proposed rules would be acted upon before the 2010 proxy season but assured that she is "quite serious" about the direct access proposal and expected the SEC to consider an adopting release in early 2010.[2]
 

On September 22, 2009, the Delaware Senate confirmed Wilmington corporate governance litigator J. Travis Laster to become a Vice Chancellor of the Delaware Chancery Court. Laster will replace outgoing Vice Chancellor Stephen Lamb, who retired at the end of his 12-year term. Laster was nominated by Delaware Governor Jack Markell in August and is expected to take his seat on October 9, 2009.
 

In SEC v. Dorozhko, 2009 WL 2169201 (2d Cir. July 22, 2009), the United States Court of Appeals for the Second Circuit held that computer hacking for purposes of obtaining and trading on inside information may be a “deceptive device” under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, even where the hacker owed no fiduciary duty to the issuer. This holding appears in conflict with a 2007 decision from the Fifth Circuit, and can be viewed as expanding the scope of liability for insider trading to those who owe no fiduciary duties to the issuers of the stock being traded.
 

In the latest of a series of chats with high-profile securities lawyers, Law 360 conducted a Q&A session with Sheppard Mullin partner and head of the firm's Corporate/Securities Litigation team, John P. Stigi III.

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first half of 2009. Both appear to report that federal securities class action filings, which had increased in 2008, have stabilized or dropped, due largely to a sharp decline in filings during the second quarter. 

In Institutional Investors Group v. Avaya, Inc., 2009 U.S. App. LEXIS 9110 (3d Cir. April 30, 2009), a panel of the United States Court of Appeals for the Third Circuit applied the United States Supreme Court’s 2007 decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), for the first time to existing case law in the Third Circuit. In Tellabs, the Supreme Court held that a plaintiff who seeks to bring a claim for securities fraud under the Private Securities Litigation Reform Act (the “Reform Act”) must plead an inference of scienter that is “cogent and at least as compelling as any opposing inference of non-fraudulent intent.” [See blog article on Tellabs.] In Avaya, the Third Circuit held that the standard articulated in Tellabs requires courts to review scienter holistically, and not through analysis of any individual allegation of scienter, though the court did confirm that the Reform Act’s particularity requirement for pleading scienter remains a determinative factor when conducting this analysis.
 

In Rubke v. Capitol Bancorp Ltd., 2009 WL 69278 (9th Cir. Jan. 13, 2009), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a class action complaint alleging violations of Section 11 of the Securities Act of 1933 and Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 through materially misleading statements and omissions in connection with a tender offer. The Ninth Circuit carefully considered each alleged misleading statement and omission, ultimately determining that none was actionable. The decision in Rubke highlights the types of statements and omissions that would not be viewed as materially misleading when made by a corporation in connection with a tender offer.

In Pfeffer v. Redstone, 2009 WL 188887 (Del. Jan. 23, 2009), the Delaware Supreme Court confirmed a Chancery Court holding that under Delaware law the heightened scrutiny of “entire fairness “ is not imposed on controlling shareholders, that make non-coercive tender or exchange offers to minority shareholders.  The case arose out of the Viacom's spin off of Blockbuster.  The plaintiffs alleged that Sumner Redstone and the other directors of Viacom and Blockbuster (as well as parent companies) breached duties of disclosure, care and loyalty in connection with a tender offer and related special dividend.  The court rejected the application of “entire fairness” scrutiny to defendants’ Rule 12(b)(6) motion due to the non-coercive nature of Viacom’s proposed tender offer.  The court went on to find that the complaint failed to adequately plead disclosure violations, despite actual misstatements and omissions by defendants, because plaintiffs failed to adequately plead the materiality of those misstatements and omissions.

The Delaware Supreme Court's recent decision in Gantler v. Stephens, No. 132, 2008 (January 27, 2009), confirms that officers of Delaware corporations have the same fiduciary duties of loyalty and care as directors. This has important implications for non-director officers of Delaware corporations, in particular because, as the Court points out in a footnote, there is at present no statutory authorization for the exculpation of officers for monetary liability for breach of their duty of care. The Court also holds that a statutorily required shareholder vote, such as for the approval of a merger, does not constitute ratification of breaches of fiduciary duties. Delaware companies now need to revisit their internal processes and indemnification and insurance arrangements to be sure that their corporate officers are protected.

In Zucco Partners, LLC v. Digimarc Corp., 2009 WL 311070 (9th Cir. Feb. 10, 2009), the United States Court of Appeals for the Ninth Circuit reaffirmed that when pleading a claim for securities fraud under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), plaintiffs are bound by prior Ninth Circuit authority that requires them to plead particularized facts giving rise to a strong inference that defendants knew, or were deliberately reckless in not knowing, that their statements were false when made.  The viability of the Ninth Circuit’s particularity requirement has been the subject of much debate since the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007).  In Tellabs, the Court held that, in order to survive dismissal, plaintiffs must plead an inference of scienter that is “cogent and at least as compelling as any opposing inference of nonfraudulent intent.”  [See blog article on Tellabs.]  In South Ferry LP, No. 2 v. Killinger, 542 F.3d 776 (9th Cir. 2008), a panel of the Ninth Circuit suggested in dicta that Tellabs’ holistic analysis may have superseded the Ninth Circuit’s particularity requirement.  [See blog article on South Ferry.]  That same term, however, two other panels confirmed that the earlier cases governing scienter were controlling.  See Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049 (9th Cir. 2008) [blog article on Metzler]; Glazer Capital Management, LP v. Magistri, 549 F.3d 736 (9th Cir. 2008) [blog article on Glazer].  Now, with its most thorough decision to date on this issue, the Zucco court appears to have definitively resolved this question in favor of particularity, holding clearly that “Tellabs does not materially alter the particularity requirements for scienter claims established in our previous decisions.”

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for 2008.  Both report that federal securities class action filings increased over 2007, due largely to the economic crisis and the Madoff scandal.  The bulk of class action filings were made in the Second Circuit, and were focused heavily on the financial sector.  In fact, nearly one-third of all large investment banks were hit with securities class actions in 2008.  (We previously reported on mid-year 2008 assessments here.)

For further information, please contact John Stigi at (213) 617-5589.

In In re Digimarc Corporation Derivative Litigation, 2008 WL 5171347 (9th Cir. Dec. 11, 2008), the United States Court of Appeals for the Ninth Circuit held that Section 304 of the Sarbanes-Oxley Act (15 U.S.C. § 7243), which provides for the forfeiture of certain bonuses and profits when corporate officers fail to comply with securities law reporting requirements, does not create a private right of action.  Though several district courts had already arrived at the same conclusion, the issue was one of “first impression” for the Ninth Circuit Court of Appeals.  The ruling thus prevents individual shareholders from pursuing recovery of bonuses and stock sale proceeds from officers in situations where the company is required to issue a restatement of its financials as a result misconduct.

In Glazer Capital Management, LP v. Magistri, 2008 WL 5003306 (9th Cir. Nov. 26, 2008), the United States Court of Appeals for the Ninth Circuit held that when pleading scienter as to a corporate defendant, the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) “requires [plaintiff] to plead scienter with respect to those individuals who actually made the false statements.”  This ruling clarifies that in all but the most unusual cases, a plaintiff in this Circuit may not rely upon notions of “collective scienter” — that is, the idea that a corporation’s state of mind for purposes of pleading securities fraud can be inferred from the collective knowledge of the totality of its employees, instead of the knowledge of a particular officer or director — to state a claim for securities fraud against a corporate defendant.  In addition, Glazer reaffirms longstanding Ninth Circuit authority holding that, when alleging scienter as to an individual defendant, the Reform Act requires plaintiff to “plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct” on the part of the defendant.

In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 2008 WL 4457544 (Del. Ch. Sept. 29, 2008), the Delaware Chancery Court, after an expedited six day trial, ruled that Hexion Specialty Chemicals, Inc. had breached various provisions of a July 2007 merger agreement.  By that agreement, Hexion, which is controlled by a private equity group, had agreed to acquire Huntsman Corp. in a leveraged cash transaction at a steep price following a bidding contest.  The terms of the merger agreement left Hexion with no “financing out” if it could not close due to a lack of funding.  Hexion’s efforts to extricate itself from the transaction arose in connection with the continuing crisis affecting the world-wide credit markets.  Hexion had sought to excuse any failure to close on its part by claiming that Huntsman’s operations had suffered a Material Adverse Effect (MAE) under the terms of the merger agreement and that the combined entity would be insolvent.  Issuing its decision before the merger agreement’s October 2, 2008 termination date, the court rejected these claims in a manner that suggested it found them pretextual and ordered Hexion to specifically perform all obligations necessary to close the deal (save the obligation to actually close, which the merger agreement exempted from a specific performance remedy).  This case is significant for its illustration of the approach that Delaware courts take in interpreting and applying a MAE clause when invoked to excuse performance under a merger agreement.  Also notable is the finding that Hexion had breached its covenant to use its reasonable best efforts to consummate the deal, a determination that required the court to reconcile a party’s contractual duty to use reasonable best efforts to consummate a transaction with that party’s alleged perceived need to avoid insolvency.  The case also demonstrates that Delaware courts will not hesitate to impose a specific performance remedy when a contract so provides, even when the consequences to one party may be ruinous.

In In re Heritage Bond Litigation, 2008 WL 4415172 (9th Cir. Oct. 1, 2008), the United States Court of Appeals for the Ninth Circuit held that a class action settlement bar limits only contribution, indemnity or other comparative fault claims against settling defendants where damages are calculated based on the amount of the non-settler’s liability to the class.  The appeal arose from a partial settlement in a securities fraud class action.  The district court’s broad bar order precluded non-settlers from bringing any future claims against settlers “arising out of or related to . . . any of the transactions or occurrences alleged.”  A non-settling defendant later brought breach of fiduciary duty, negligence, labor law and other claims against several settling defendants, including his former employer, and sought “both economic and reputational” damages.  The district court determined that its bar order precluded such claims.  The Ninth Circuit disagreed, vacating the order and remanded the matter to the district court.  The decision offers greater clarity on the scope of settlement bar orders, important mechanisms designed to encourage partial settlements but, at the same time, protect non-settlers’ rights.

In Millowitz v. Citigroup Global Markets, Inc., 2008 WL 4426412 (2d Cir. Sept. 30, 2008), the United States Court of Appeals for the Second Circuit held that the fraud-on-the-market doctrine established in Basic Inc. v. Levinson, 485 U.S. 224 (1988), applies in Rule 10b-5 suits challenging alleged misstatements contained in research analyst reports.  The fraud-on-the-market doctrine creates a presumption of reliance in 10b-5 securities fraud cases, and eliminates the need for plaintiffs to show individual reliance on the alleged fraudulent act.  In Millowitz, the Second Circuit concluded that the district court in the case had properly invoked the doctrine to decide whether common questions of law and fact predominated over individualized ones for purposes of certifying a class under Fed. R. Civ. P. 23(b)(3).  The Second Circuit also ruled that no showing of the analyst’s reports’ actual affect on the securities’ market price is required to trigger the presumption, something defendants had urged.  The decision is important because it may impose a risk of class action liability on public misstatements of fact even when the speaker is neither the issuer nor an agent of the issuer, provided the misstatement is material.

In South Ferry LP, #2 v. Killinger, 2008 WL 4138237 (9th Cir. Sept. 9, 2008), the United States Court of Appeals for the Ninth Circuit held that inferring scienter based upon nothing more than defendants’ senior management positions in a company does not satisfy the heightened pleading standards of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).  The interlocutory appeal in this case arose from a series of apparently conflicting case law within the Ninth Circuit with respect the so-called “core operations inference” in securities fraud actions, i.e., an inference that senior management must be aware of all matters, including wrongdoing, affecting a company’s core operations.  This decision resolves that apparent conflict by reaffirming pre-existing law and distinguishing a handful of seemingly contrary Ninth Circuit decisions.

In In re Gilead Sciences Securities Litigation, 536 F.3d 1049 (9th Cir. 2008), a three-judge panel of the United States Court of Appeals for the Ninth Circuit reversed the dismissal of a securities fraud complaint that the district court had held failed to plead loss causation due to the passage of time between the disclosure of the alleged fraud and the drop in the company’s stock price. The Ninth Circuit held that the delay in market reaction was not dispositive because, according to plaintiffs, the analysts and investors were unaware of the financial impact of the matters discussed in the corrective disclosure until after the company issued its quarterly financial results. This decision comes just two weeks after another panel of the same court cautioned, based on similar facts, that “[e]nabling a plaintiff to proceed on such a theory would effectively resurrect what Dura [Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005),] discredited.”  Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008, amended Aug. 26, 2008) [See blog article].

The SEC today issued an emergency order to temporarily ease the restrictions on the ability of issuers to repurchase their securities.  This change is intended to give issuers more flexibility to buy back their securities and, thereby, help restore liquidity to the securities markets.  The SEC's emergency order is effective at 12:01 a.m. EDT on September 19, 2008 and terminates at 11:59 p.m. on October 2, 2008 unless further extended by the SEC.

On August 5, 2008, the SEC announced the settlement of administrative proceedings against Ernst & Young and Mark C. Thompson, a former director of three public audit clients of Ernst & Young. The proceedings arose from a business relationship between Ernst & Young and Mr. Thompson which the SEC determined impaired the audit firm's independence and, thereby, caused each company to violate the federal securities laws. The proceedings clarify certain aspects of the SEC's rules regarding auditor independence, and highlight the need for public companies to periodically review any changes in the relationship between each director and the company and its audit firm that might affect auditor independence.

In Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008), a case involving an unsolicited, all cash offer from an unrelated strategic acquirer at a substantial premium to the market price, the Court denied the defendants’ motions for summary judgment on breach of fiduciary duties associated with the sale process and the deal protections.  The Court also allowed monetary damages claims against the directors to proceed to trial based on the possibility that the directors’ conduct may have been so far below the standards of care that it involved a lack of good faith – despite there being no conflicts of interest.  The Court was critical of the Board’s response to a filing that put the company “in play,” the seven-day negotiating process for the actual deal, the failure to conduct a pre-signing market check, the failure to negotiate successfully for a post signing "go-shop," and deal protections including a 3% break-up fee and matching rights for a superior proposal.

In United States v. Finnerty, 2008 U.S. App. LEXIS 15296 (2d Cir. July 18, 2008), the United States Court of Appeals for the Second Circuit set aside a guilty verdict imposing securities fraud liability against a New York Stock Exchange Specialist who engaged in “interpositioning” and “trading ahead” transactions, on the ground that the prosecution failed to prove that the defendant’s conduct constituted deceptive conduct under the federal securities laws.  The court held that absent proof that the defendant actually conveyed a misleading impression to customers, finding securities fraud liability would “invite litigation beyond the immediate sphere of securities litigation.”  This decision provides yet another instance where courts have retained and applied traditional limits to securities fraud liability.

In Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal with prejudice of a securities fraud class action, holding that plaintiffs had failed to plead the essential elements of loss causation, scienter and falsity consistent with the requirements of prevailing Supreme Court and Ninth Circuit authority.  Corinthian Colleges is the most recent in a long line of Ninth Circuit decisions since 1999 that apply strictly the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first half of 2008.  Both report that federal securities class action filings are up, due largely to the sub-prime mortgage, credit and auction rate securities crises.  The reports also note a correlation between increased market volatility and increased filings, as well as an increase in investor and market capitalization losses associated with the filed cases.  The increase in filings and losses in 2008 reflects a continuation of a trend that started in 2007 following the sharp decrease in securities litigation activity in 2005 and 2006.  Both summarize their findings and analyses in press releases (NERA, Cornerstone) issued on July 29, 2008.

In Julian v. Eastern States Construction Services, Inc., 2008 WL 2673300 (Del. Ch. July 8, 2008), the Delaware Chancery Court held that board members of a close corporation breached their duty of loyalty and would be required to disgorge bonuses where the directors approved self-compensation without sufficient independent protections.  This case provides guidance regarding the process board members must follow in order for a self-interested directorial compensation decision to survive an “entire fairness” review.

The Delaware Chancery Court recently decided two different motions for preliminary injunctions, with vastly different results. In both cases, the issue was whether disclosures in the respective proxy statements were sufficient to enable stockholders to consider fairly a proposed merger. In Wayne County Employees’ Retirement System v. Corti, C.A. No. 3534-CC (Del. Ch. July 1, 2008), Chancellor Chandler denied plaintiff’s motion for a preliminary injunction to halt a special meeting of stockholders based upon inadequate proxy statement disclosures. In David P. Simonetti Rollover IRA v. Margolis, C.A. No. 3694-VCN (Del. Ch. June 27, 2008), Vice Chancellor Noble granted a preliminary injunction based on inadequate disclosures in the challenged proxy statement. These two decisions, issued just days apart, provide further guidance to practitioners regarding the materiality of information to be included in proxy statements.

In SEC v. Talbot, 2008 WL 2574513 (9th Cir. June 30, 2008), the United States Court of Appeals for the Ninth Circuit held that a board member could be liable for insider trading under the “misappropriation theory” where the board member owed no fiduciary duty to the company whose stock he traded.  This holding reversed summary judgment granted in favor of the board member, and broadened the scope of potential liability for misappropriation of information by board members and officers of companies.

In Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008), the Delaware Chancery Court held that a company’s advance notice provision did not preclude a dissident shareholder from nominating its own slate of directors.  Levitt is part of a trio of cases recently issued by the Delaware Chancery Court that address the issue of the voting rights of shareholders.  Consistent with JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008) [See blog article] and In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008) [See blog article], the Levitt court held that an advance notice provision that purported to require shareholders to give notice 120 days before nominating directors instead allowed shareholders to nominate directors without any independent notice.

In In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008), the Delaware Chancery Court held that management could spin the company into multiple parts without obtaining the approval of the majority shareholder.  The court’s 78-page decision boiled down to a deceptively simple question:  was the majority shareholder required to grant a consent to corporate management before IAC was broken up?  The court held that such approval was not necessary, finding that IAC’s governance agreement did not allow IAC to exercise its voting right.  This case, particularly when read with Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008) [See blog article] and JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008) [See blog article], should signal to shareholders and corporate management alike that shareholder agreements between sophisticated parties will be strictly construed.

In JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008), the Delaware Chancery Court held that CNET’s advance notice bylaw did not preclude JANA from financing and issuing its own proxy solicitation.  This case, in combination with Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008) [See blog article], and In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008) [See blog article], serves to remind companies that advance notice provisions will be narrowly construed under Delaware law, particularly where the franchise of the stockholder is at stake.

The March 17, 2008 issue of The National Law Journal features a special article by Sheppard Mullin partner John Stigi and associate Martin White analyzing how lower courts have applied the Supreme Court’s decision in Tellabs Inc. v. Makor Issues & Rights Ltd., 127 S. Ct. 2499 (2007), in light of pre-existing precedent within the various circuits.  As previously reported here, the Supreme Court in Tellabs addressed the heightened requirements for pleading scienter enacted in the Private Securities Litigation Reform Act of 1995.  Rejecting a relaxed “reasonable inference” approach adopted by the Seventh Circuit, the Supreme Court held that a securities fraud complaint will survive dismissal only if, based upon its factual allegations, the inference of defendant’s scienter is “cogent and at least as compelling as any opposing inference.”  As Stigi and White explain in The National Law Journal:

In Tzolis v. Wolff, 2008 WL 382345 (N.Y. Feb. 14, 2008), a majority of the New York State Court of Appeals held, over a vigorous dissent, that New York law permitted members of a limited liability company (“LLC”) to bring derivative suit on the LLC’s behalf.  As a result, under New York law, the right to bring a derivative suit has been broadened, and is no longer limited to shareholders of a corporation or limited partners of a partnership.  This ruling represents the third decision in just one week by a state’s highest court addressing the scope of legal standing for plaintiffs in shareholder derivative suits.  (We previously reported on decisions by the Delaware Supreme Court and California Supreme Court.)

In Grosset v. Wenaas, Case No. 139285, 2008 WL 383196 (Cal. Feb. 14, 2008), the California Supreme Court held that California law, like Delaware law, imposes a “continuous ownership” requirement on plaintiffs in shareholder derivative suits.  Thus, to have standing to assert and prosecute a shareholder derivative action, a plaintiff shareholder must hold stock in the corporation he or she is suing continuously throughout the entire litigation process.  This requirement applies even where the shareholder is involuntarily divested of his or her ownership interest in the corporation by virtue of a corporate merger.  While it was firmly established previously under both California and Delaware law that a shareholder could lose standing to sue by voluntarily selling his or her shares in the corporation, the decision in Grosset confirms that under California law a shareholder also may lose standing involuntarily by virtue of a merger.

In Schoon v. Smith, 2008 WL 375826 (Del. Feb. 12, 2008), the Delaware Supreme Court “decline[d] to enlarge” the standing requirement for plaintiffs in stockholder derivative actions, holding that non-stockholding directors lack standing to bring a derivative suit.  Although the court expressly reserved the power to grant “equitable standing” — standing that has not been formally granted by statute, but can be granted at the discretion of the court — it refused to make such a grant to non-stockholding directors.  Finding that there was no “failure of justice” sufficient to warrant an expansion of the equitable standing doctrine, the court concluded that the rights of the stockholders could best be protected by the stockholders themselves and not a non-stockholding board member.  This decision from Delaware’s highest court confirms that Delaware courts are unlikely to expand derivative standing to those who lack a personal financial stake in the corporation.