United States: Noteworthy US Securities Law Litigation

United States v. Vilar: Court Limited Prosecution under Section 10(b) of the Exchange Act for Securities Fraud Outside the US

In September 2013, a federal appeals court extended the holding of the US Supreme Court's landmark decision in Morrison v. National Australia Bank to criminal cases and ruled that a defendant could not be prosecuted under Section 10(b) of the Exchange Act for fraud in connection with securities transactions outside of the United States.

In Vilar, two investment managers who ran both US-based and foreign-based investment funds were convicted of securities fraud for lying to their clients about the nature and quality of certain investments. On appeal, the defendants argued that their convictions should be overturned because the transactions underlying their convictions occurred outside the United States and, under Morrison, the extraterritorial transactions could not support a criminal conviction under Section 10(b). The federal appeals court agreed with the defendants and held that Morrison applied with equal force to both civil and criminal securities fraud cases. Despite agreeing that Morrison applied, the court affirmed the defendants' convictions because it found that at least some of the securities transactions at issue in the appeal occurred in the United States.

This decision further clarifies the reach of Morrison and is the first federal appellate court decision to extend the holding of Morrisonto criminal violations of Section 10(b).

Asadi v. G.E. Energy (USA), L.L.C.: Court Clarified Scope of Dodd-Frank's Whistleblower and Anti-Retaliation Protections

In July 2013, a federal appeals court ruled that, in order to qualify for protection from retaliation under Dodd-Frank's whistleblower-protection provisions, an individual must report the securities law violation to the SEC. The individual cannot obtain such protection if he reports the information to his employer only.

In Asadi, a GE Energy executive who was working in Iraq reported to his supervisor and the GE Energy ombudsperson that he was concerned that GE Energy was violating the FCPA. Shortly after making the internal report, he received a negative performance review and a demotion, and was later fired. Asadi filed a complaint in federal court that alleged that GE Energy violated Dodd-Frank's whistleblower-protection provision by terminating him following his internal report of possible FCPA violations. The district court dismissed his complaint.

On appeal, Asadi argued that Dodd-Frank has two conflicting and ambiguous provisions because, although the definition of whistleblower in the statute requires an individual to report a securities law violation to the SEC, the anti-retaliation provision does not and, according to Asadi, the anti-retaliation provision should control his retaliation claim. The federal appeals court rejected Asadi's argument and ruled that there was no conflict between the two provisions because the anti-retaliation provision applies only to an individual who first qualifies as a whistleblower and, in order to qualify as a whistleblower, an individual must report a securities law violation to the SEC.

This decision limits the circumstances under which individuals are protected by the anti-retaliation provision of Dodd-Frank and provides an incentive for individuals to report potential securities law violations directly to the SEC instead of reporting them first to their employers.

In Re ProShares Trust Securities Litigation: Court Interpreted Whether Certain Alleged Omissions were Material for Liability

In July 2013, a federal appeals court affirmed the dismissal of a securities class action under Section 11 of the Securities Act because the court found that the alleged omissions in the registration statements were not material.

In ProShares, the plaintiffs alleged that the registration statements for certain exchange-traded funds ("ETFs") failed to disclose the magnitude and probability of potential losses. The district court dismissed the case based on its conclusion that it was not possible to read the registration statements without understanding that the ETFs were risky and speculative investments. On appeal, the plaintiffs acknowledged that the prospectuses contained warnings that the value of long-term ETF investments may "diverge significantly" from the underlying indices, but argued that the "diverge significantly" disclosure did not warn investors of actual, substantial losses.

The federal appeals court rejected the plaintiffs' arguments and affirmed the district court's decision. The court noted that, although materiality will rarely be dispositive on a motion to dismiss, the Supreme Court has been careful not to set too low a standard of materiality for fear that management would bury shareholders in an "avalanche of trivial information." Consistent with this guidance, the court stated that the plaintiffs' efforts to find a meaningful distinction between "diverge significantly" and "actual loss" strains the plain meaning of the former phrase. The court held that the "significant divergence" disclosure, when read in context, put investors on notice that an ETF's value might move in a direction quite different from what an investor might otherwise expect.

ProShares may be helpful to defendants faced with allegations that focus narrowly on alleged omissions even though, when considered as a whole, the public disclosures adequately describe the overall risk.

More information on the ProShares case is available at:


Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund: Private Equity Funds May Be on the Hook for the Pension Liabilities of Portfolio Companies

A recent decision of the US Court of Appeals for the First Circuit makes it more likely that private equity funds could be liable for the pension obligations of the portfolio companies in which they invest. Key to the decision was the Court's conclusion that the private equity fund in question was a "trade or business" by virtue of its active role in the management of the business of its portfolio companies. Under the Employee Retirement Income Security Act ("ERISA"), each "trade or business" under "common control" is liable for the ERISA liabilities of each member of the "controlled group" of companies. This is a two-part test. First, an entity must be a "trade or business" and under "common control" with another entity that is also a trade or business. Under part one of the test, private equity funds have traditionally taken the position that, as passive investors, the funds are not a "trade or business." Under the second part of the test, funds typically structure ownership to avoid "common control" under the complex but mechanical ownership rules prescribed by ERISA and the Internal Revenue Code for this purpose.

In Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, the Court held that a private equity fund holding shares in a US portfolio company was a "trade or business" for purposes of ERISA. In reaching its conclusion, the Court applied a legal standard referred to as the "investment plus" test and, in applying this test, paid particular attention to the degree of involvement of the fund in the operation of its portfolio companies. The Court determined that the activities of the fund satisfied the "plus" component of the test.

In its analysis, the Court emphasised that the fund's limited partnership agreements and offering documents described the fund as actively involved in the management and operation of its portfolio companies.

The decision in Sun Capital creates potential ERISA liability risk for private equity funds that engage in active management. If a fund is significantly involved in the management and operation of its portfolio companies, the fund may be deemed a trade or business. If the fund, along with a portfolio company, is part of the same ERISA "controlled group," then there is the potential for the fund to be held responsible for the portfolio company's ERISA liabilities.

The Court remanded the case to the district court for a determination on, among other things, the question of common control.

Sun Capital has some important implications for private equity funds. Funds that maintain an active approach to the management of portfolio companies will be more likely to be considered as a trade or business under ERISA and will need, therefore, to consider more carefully the structuring of the actual portfolio company investment to avoid common control for purposes of ERISA. The managers of funds that have a more limited or passive role in the management of portfolio companies will want to review fund documents to remove or revise provisions that reserve more control over the businesses of portfolio companies than is actually exercised. Finally, funds that qualify as venture capital operating companies ("VCOCs") for purposes of ERISA will need to consider whether there is potential ERISA exposure in the companies in which they invest. A typical VCOC acquires management rights in its underlying portfolio companies and is, therefore, more vulnerable under Sun Capital to be considered a trade or business.

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