On September 30, 2022, a panel of the United States Court of
Appeals for the Second Circuit affirmed a decision of the United
States District Court for the Southern District of New York
dismissing a putative securities fraud class action asserting
claims under Section 10(b) of the Securities Exchange Act of 1934
("Exchange Act") and Rule 10b-5 promulgated thereunder
against a flavoring and fragrance products company (the
"Company") and several of its executives. Menora
Mivtachim Ins. Ltd., et al. v. Frutarom Indus. Ltd., et al.,
No 21-1076 (2d Cir. Sept. 30, 2022). Plaintiffs alleged that, from
2002 to 2018, the Company engaged in a "long-running bribery
scheme," and that defendants made materially misleading
statements about the Company's compliance with anti-bribery
laws and its business growth in public documents filed when the
Company was acquired in 2018. The district court granted the motion
to dismiss as against the Company and its officers, holding that
plaintiffs failed to sufficiently allege statutory standing to
pursue their securities fraud claims. The Second Circuit
affirmed.
According to the complaint, when the merger closed in October of
2018, the Company became a wholly-owned subsidiary of the
purchasing company (the "Parent Company"). Plaintiffs
alleged that on October 5, 2019, the Parent Company disclosed that
the Company had made improper bribes in Russia and Ukraine, and the
following day, the Parent Company's share price dropped
approximately 16%. Plaintiffs—purchasers of shares of the
Parent Company—brought suit against the Parent Company, the
Company, and officers of both companies. Defendants moved to
dismiss, and the district court granted the motion, finding that
(1) plaintiffs failed to plead with the requisite particularity
that the alleged misconduct continued into the class period; (2)
the allegedly false statements and omissions were not actionable or
material; and (3) plaintiffs lacked statutory standing to sue the
Company and its officers because plaintiffs were shareholders only
of the Parent Company and never bought or sold shares of the
Company. Plaintiffs appealed the decision only as it related to the
Company and its officers.
Plaintiffs contended that they had standing because there was a
"direct relationship" between the Company's alleged
misstatements and the price of the Parent Company's shares. The
Second Circuit rejected this argument. The Court stated that
"judicially created private rights of action should be
construed narrowly" and noted that this had been emphasized by
the Supreme Court in Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723 (1975). In Blue Chip Stamps, the
Supreme Court adopted the "purchaser-seller rule," which
"limited the class of plaintiffs who could sue under Rule
10b-5 to those who purchased or sold the securities of an issuer
about which a material misstatement was made." The Court noted
that adopting plaintiffs' "direct relationship" test
would erode the Supreme Court's precedent by "adding
further uncertainty to Section 10(b)'s 'rule of liability
imposed on the conduct of business transactions.'"
Further, the Court found that plaintiffs improperly relied on dicta
from an earlier case in which the Second Circuit contemplated
whether "a merger creates a far more significant relationship
between two companies than does the sale of a business unit"
in ultimately holding that plaintiffs lacked standing to sue under
the latter scenario. Ontario Public Service Employees Union
Pension Trust Fund v. Nortel Networks Corp., 369 F.3d 27 (2d
Cir. 2004) ("Nortel"). While acknowledging that
the Nortel decision left that issue open, the Second
Circuit stated that it "now answer[s] that question by holding
that purchasers of a security of an acquiring company do not have
standing under Section 10(b) to sue the target company for alleged
misstatements the target company made about itself prior to the
merger between the two companies." The Court further held that
"Section 10(b) standing does not depend on the significance or
directness of the relationship between two companies. Rather, the
question is whether the plaintiff bought or sold shares of the
company about which the misstatements were made."
Judge Pérez agreed with the holding but authored a
concurrence stating that the reasoning in Nortel was
sufficient to find that "the relationship between one
company's material misstatements about itself and another
company's stock price was 'too remote to sustain an
action' under Section 10(b) and Rule 10b-5," and that the
Court did not need to create new law on the issue to reach the same
result.
Menora Mivtachim Ins. Ltd., et al. v. Frutarom Indus. Ltd., et al.
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