In 2019, the Supreme Court issued an important securities law decision in Lorenzo v. SEC, which clarified the scope of "scheme liability" under Rule 10b-5(a) and (c). However, the Supreme Court's year was noteworthy more for the cases the Court declined to decide than for the cases it did decide. The Court declined to rule on several significant issues arising from the Ninth Circuit, including whether plaintiffs must show that the defendant acted with scienter when bringing claims under Section 14(e), whether foreign issuers can face liability with respect to unsponsored American Depositary Receipts under Morrison, and the standard for establishing loss causation.

The circuit and district courts also addressed several contested securities laws topics, including a significant ruling from the Tenth Circuit in SEC v. Scoville, which held that the Dodd-Frank Act permits the SEC to bring claims based on sales of securities that do not constitute domestic transactions within the meaning of Morrison. The Second Circuit also found limits to the extraterritorial reach of the CEA in Prime International Trading v. BP P.L.C. when the transactions at issue were "predominantly foreign."

With respect to M&A litigation, the Delaware Supreme Court continued to clarify its jurisprudence with respect to appraisal methodology as well as the protection MFW affords to controlled transactions. The Court also released important opinions pertaining to oversight duties for boards of directors and the fiduciary duties of activist investors. The Delaware Court of Chancery continued to see a rise in litigation pertaining to books and records demands under Section 220. It also issued decisions reflecting its continued strict enforcement of the plain language of provisions in merger agreements.


Supreme Court Rules On "Scheme Liability" Under Rule 10b-5(a) And (c)

In March, the Supreme Court held in Lorenzo v. SEC that an investment banker could be primarily liable under Rule 10b-5(a) and (c) for circulating misleading emails to investors, even though the investment banker did not personally author the content of the emails.1

The case arose out of allegations that Francis Lorenzo, the director of investment banking at a broker-dealer, sent investors emails containing false statements that were drafted by his supervisor. The D.C. Circuit concluded that Lorenzo was not a "maker" of a misleading statement for the purposes of 10b-5(b) liability, but held that he could be liable for deceptive practices in violation of Rules 10b-5(a) and (c). The Supreme Court had previously restricted liability under Rule 10b-5(b) to a "maker" of a misleading statement, meaning someone with ultimate authority over the statement.2

In Lorenzo, the Supreme Court clarified the relationship between "making" a false statement under Rule 10b-5(b) and engaging in deceptive conduct—so-called "scheme liability"—under Rule 10b5(a) and (c). The Court explained that the three subsections of Rule 10b-5 overlap rather than apply to mutually exclusive conduct, and that the scheme liability provisions can reach a defendant who disseminates a false statement with intent to defraud, even if the defendant does not qualify as the "maker" of the statement and therefore could not be held liable under Rule 10b-5(b). The Court rejected Lorenzo's argument that the scheme liability provisions of Rule 10b-5 should apply only to conduct other than misstatements.

The Lorenzo decision shows that cases involving misstatements are not exclusively the province of Rule 10b-5(b). But the decision does not precisely define the reach of "scheme liability" with respect to false statements, and it seems likely to lead to questions in SEC enforcement actions and private litigation about when exactly defendants can be held primarily liable for statements that they did not themselves make.

Tenth Circuit Rules On SEC's Authority To Bring Securities Fraud Claims Over Certain Foreign Transactions

In January, the Court of Appeals for the Tenth Circuit held in SEC v. Scoville that the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") allows the SEC to bring fraud claims and claims under Section 17 of the Securities Act based on sales of securities that do not qualify as domestic transactions, where defendants engage in fraudulent conduct within the United States.3

Scoville arose out of an SEC civil enforcement action against Traffic Monsoon, LLC and its founder, alleging that the defendants operated a Ponzi scheme in violation of various securities laws. Traffic Monsoon sold online advertising packages, many of which were purchased by foreign individuals in transactions that may not have been domestic under the Supreme Court's decision in Morrison v. National Australia Bank Ltd. The Tenth Circuit nonetheless held that, in the context of governmental actions, the antifraud provisions of the securities laws reached the sales of advertising packages to those individuals outside the United States.

In reaching this holding, the Tenth Circuit concluded that the Dodd Frank Act abrogated in part the Supreme Court's rule in Morrison that fraud claims under the federal securities laws can only be brought with respect to transactions in securities listed on a U.S. exchange or transactions in other securities in the United States. The Tenth Circuit found that the Dodd-Frank Act's jurisdictional amendments with respect to enforcement actions brought by the SEC were intended to codify the conduct-and-effects test for evaluating the extraterritorial application of the securities laws, which was the test universally applied prior to Morrison. Under the conduct-and-effects test, courts apply the securities laws to foreign transactions if the wrongful conduct occurred in the United States or had a substantial effect in the United States.

Scoville provides a strong precedent for the SEC and DOJ to continue to bring securities fraud actions or for the SEC to bring an action under Section 17 of the Securities Act concerning certain foreign transactions. This decision also portends a potential increase in the risk of liability for companies with significant U.S. operations or companies that engage in investor relations related activities in the United States, but that have no securities listed or sold here, or for companies located abroad but whose activities result in injury to investors in the U.S. market. A petition for certiorari was denied in November.

Second Circuit Rules On Statements Of Regulatory Compliance Forming Basis For Securities Fraud Claim

In March, in Singh v. Cigna Corp., the Second Circuit held that plaintiffs failed to identify a materially false statement as a matter of law when they alleged that Cigna's statements about its commitment to regulatory compliance procedures were materially misleading in light of an undisclosed history of non-compliance with Medicare regulations.4 The Second Circuit affirmed the district court's decision dismissing the plaintiffs' case, finding that Cigna's statements with respect to its policies and procedures in its Code of Ethics were plainly an example of "puffery." The Second Circuit's decision provides a strong defense for companies accused of securities fraud following the revelation of corporate mismanagement or regulatory violations. The decision also gives comfort that a company's disclosure of its Code of Ethics and description of its compliance efforts cannot alone provide the basis for an investor suit in the event that the company or its employees violate ethical policies.

Third Circuit Addresses Defendants' Burden To Rebut Presumption Of Reliance Under Halliburton II

In May, in Vizirgianakis v. Aeterna Zentaris, Inc., the Third Circuit affirmed a district court order granting class certification to a group of shareholders who alleged that Aeterna Zentaris, Inc., a biopharmaceutical company, violated Section 10(b) of the Exchange Act and Rule 10b-5 by misrepresenting the efficacy of a particular drug.5 The district court found that the plaintiffs properly invoked the "fraud-on-the-market" theory of reliance, which provides plaintiffs a rebuttable presumption of class-wide reliance when plaintiffs traded securities in an efficient market. On appeal, Aeterna did not contest that plaintiffs raised the presumption of an efficient market, and instead argued that the district court erred in finding that it had not rebutted the presumption of reliance by proving that the alleged misstatements did not have a price impact under Halliburton Co. v. Erica P. John Fund, Inc. ("Halliburton II").6 In particular, Aeterna argued that it had rebutted the presumption by presenting an expert declaration "pointing out that [plaintiffs' expert] had not proven—to a 95% confidence level—that the alleged misrepresentations ... impacted the price of Aeterna's common stock."7 But the Third Circuit held that the plaintiffs' "failure to do so is not necessarily proof of the opposite,"8 namely a lack of price impact, and otherwise deferred to the district court's competency in weighing conflicting testimony and making factual findings with respect to market efficiency.

This decision is another example of the difficulties that defendants have faced rebutting the presumption of reliance under Halliburton II.

Second Circuit Finds Limits to the Extraterritorial Reach of the CEA

In August, in Prime International Trading v. BP P.L.C., the Second Circuit held that Sections 6(c)(1) and 9(a)(2) of the Commodities Exchange Act (CEA) do not apply extraterritorially and concluded that the transactions at issue, although domestic, were outside the scope of the CEA because they were "predominantly foreign."9 Therefore, the Second Circuit affirmed the District Court's dismissal.

The case arose out of allegations of benchmark rigging for the price of Brent crude oil. Plaintiffs had brought action against BP and other entities involved in the production of Brent Crude oil, alleging that the defendants manipulated the trading of Brent-related futures and derivatives contracts by executing fraudulent transactions.

In considering whether the CEA had extraterritorial scope, the Second Circuit used the two-step framework set out in RJR Nabisco10 and Morrison.11 First, courts examine the text of the statute to see whether there is a "clear indication of extraterritoriality," and then if there is no such indication, whether the domestic activity that took place was the "focus of congressional concern." Under the second factor, the Second Circuit found the allegations to be "predominately foreign" under the rule established in Parkcentral. In Parkcentral, swap investors in the U.S. sued over trades that referenced Volkswagen stock, which are traded on European stock exchanges. Though some of the equity swaps could potentially be classified as domestic transactions, the Court held that domestic transactions are a necessary, but not sufficient factor when examining wholly extraterritorial conduct. Similarly, in Prime International, plaintiffs failed to plead any domestic conduct by defendants. This case shows the continuing vitality of the Parkcentral holding in the Second Circuit, notwithstanding the Ninth Circuit's rejection of that holding in Stoyas.12

Third Circuit Holds that SLUSA Preclusion in an Opt-out Action Requires Actual Coordination with the Class Action

In September, the Third Circuit held that preclusion of state claims under the Securities Litigation Uniform Standards Act (SLUSA) in an opt-out action requires actual coordination with the class action.13 The Third Circuit reversed the dismissal of several state law securities actions against Merck and Schering-Plough, holding that SLUSA did not prohibit their individual action because they were filed after the settlement of the class action and had not "proceed[ed] as a single action for any purpose" with the class action.

However, the decision leaves unanswered the precise degree of coordination required to trigger SLUSA preclusion, as well as whether state law claims should be dismissed where an opt-out action is consolidated with a class action "over an opt-out plaintiff's objection." Defendants facing securities class actions with significant numbers of opt outs should consider these issues in deciding whether to stay any opt-out actions during the pendency of the class action, the degree to which to coordinate discovery across the actions, and in considering the timing and scope of any class action settlement.

Second Circuit Holds that the Nondisclosure of Illegal Activity in a Securities Fraud Complaint Must Be Pleaded with Particularity

In December, the Second Circuit, in Gamm v. Sanderson Farms, held that when a securities fraud complaint alleges that statements were rendered false or misleading through the non-disclosure of illegal activity, the facts of the underlying wrongdoing must be pleaded with particularity in accordance with Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act, raising the bar for securities claims based on undisclosed wrongdoing.14

The case arose out of an alleged conspiracy among poultry producers to manipulate the prices of chicken in violation of the Sherman Act, an underlying claim that need not satisfy heightened pleading standards.

However, the Second Circuit affirmed the dismissal of the lawsuit, holding that "when a complaint claims that statements were rendered false or misleading through the non-disclosure of illegal activity, the facts of the underlying illegal acts must also be pleaded with particularity."15 The decision places a high bar on Section 10(b) claims based on undisclosed wrongdoing, requiring that the details not only of the misstatement or omission be pleaded with particularity, but also those of the underlying misconduct. It thus will make it far more difficult for plaintiffs to plead similar claims in the future.

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1. Lorenzo v. Sec. & Exch. Comm'n, 139 S. Ct. 1094 (2019).

2. Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135 (2011).

3. Sec. & Exch. Comm'n v. Scoville, 913 F.3d 1204 (10th Cir. 2019).

4. Singh v. Cigna Corp., 918 F.3d 57 (2d Cir. 2019).

5. Vizirgianakis v. Aeterna Zentaris, Inc., 2019 WL 2305491 (3d Cir. May 30, 2019).

6. Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014).

7. Vizirgianakis, 2019 WL 2305491, at *2.

8. Id.

9. Prime International Trading v. BP P.L.C., 937 F.3d 94, (2d Cir. Aug. 29, 2019).

10. RJR Nabisco, Inc. v. European Cmty, 136 S. Ct. 2090 (2016).

11. Morrison v. Nat'l Australia Bank Ltd., 561 U.S. 247 (2010).

12. Stoyas v. Toshiba Corp., 896 F.3d 933 (9th Cir. July 17, 2018).

13. North Sound Capital LLC v. Merck & Co., 938 F.3d 482 (3d Cir. Sep. 12, 2019).

14. Gamm v. Sanderson Farms, Inc., No. 18-0284-cv, 2019 WL 6704666 (2d Cir. Dec. 10, 2019).

15. Id. at *8.

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