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SEC v. Cook: Nearly $156 Million in Disgorgement and Prejudgment Interest Ordered Following Convictions 

In SEC v. Cook, No. 09-3333, 2016 BL 7948 (D. Minn. Jan. 12, 2016), the United States District Court for the District of Minnesota granted the United States Securities and Exchange Commission’s (“SEC”) Motions for Summary Judgment against Defendants Patrick Kiley and Jason Beckman (the “Defendants”) regarding alleged violations of Section 5(a) and (c) and Section 17(a) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder, and Section 206(1) and (2) of the Investment Advisers Act of 1940 (“Advisers Act”). The court permanently restrained and enjoined Defendants from further violating the securities laws and ordered disgorgement of Defendants’ ill-gotten gains in addition to prejudgment interest totaling nearly $156 million.

In July 2012, a jury found Defendants guilty of criminal charges including wire fraud, mail fraud, conspiracy to commit mail and wire fraud, and money laundering arising from a fraudulent scheme in which Defendants fraudulently sold investments in a purported foreign currency trading scheme from at least July 2006 through July 2009. The scheme was alleged to have resulted in approximately 1,000 investors losing at least $190 million. 

The SEC brought actions against Defendants, moved for summary judgment, and asserted that the criminal proceedings estopped Defendants from disputing the facts in the civil proceeding. Because the evidence introduced in the criminal trial was the same evidence underlying the SEC’s claims, the court determined Defendants were estopped from disputing the facts, which supported the SEC’s Motions for Summary Judgment. As such, the court considered whether the SEC was entitled to judgment as a matter of law in regard to each alleged violation.

First, to establish violations of the anti-fraud provisions of the Exchange Act, a plaintiff must show the defendant: (1) engaged in a fraudulent scheme; (2) in connection with an offer or sale of a security; (3) through the use of interstate commerce; (4) with scienter. In addition, to establish a violation of the Advisers Act, the plaintiff must prove that the defendant: (1) acted as an investment adviser; (2) perpetrated the fraud on existing or prospective clients; and (3) acted at least negligently in doing so.

The court found the criminal convictions satisfied all of the requirements for collateral estoppel and, thus, entitled the SEC to summary judgment regarding the securities fraud charges. Specifically, because the jury in the criminal matter found Defendants devised a scheme to defraud investors to obtain money through materially false pretenses, did so knowingly and with intent, and based its findings on the same factual basis as the SEC’s claims, the court concluded all of the elements for violations of the anti-fraud provisions were established. 

Second, to succeed on a claim for a violation of the Securities Act registration provision, a plaintiff must show: (1) did not file a registration statement for the offering of securities with the SEC; (2) sold or offered to sell securities, directly or indirectly; (3) through the use of interstate facilities or mails. An “investment contract” constitutes a security if: (1) a person invested money; (2) in a common enterprise; (3) with the expectation of profit; (4) derived solely from the efforts of the promoter or others. Defendants can escape liability, however, by proving a securities offering at issue qualified for a registration exemption.

Again, the court found the evidence in the criminal matter established the elements for an unregistered, non-exempt offering in violation of the Securities Act. The evidence introduced in the criminal trial demonstrated that investors gave Defendants money to invest in a foreign currency trading venture expecting a profit in return. Additionally, the evidence demonstrated that Defendants comingled the investors’ money in pooled accounts, never filed a registration statement, and failed to demonstrate that a registration exemption applied. The court, therefore, granted the SEC’s Motions for Summary Judgment.

Lastly, the court reasoned the SEC was entitled to permanent injunctive relief because it demonstrated Defendants violated the securities laws and there was a reasonable likelihood of future violations. Moreover, the court determined disgorgement and prejudgment interest were appropriate remedies to prevent Defendants’ unjust enrichment. Thus, the court ordered Defendants to disgorge their ill-gotten gains, with prejudgment interest, in the amount of $155,928,523.    

Primary materials for this case may be found on the DU Corporate Governance website.


Tai Jan Bao v. SolarCity Corporation: Accounting Practices Lead to Securities Fraud Claim

In Tai Jan Bao v. SolarCity Corporation, No. 14-cv-01435-BLF, 2016 BL 2378 (N.D. Cal. Jan. 05, 2016), the United States District Court for the Northern District of California granted SolarCity, Chief Executive Officer Rive, Chief Financial Officer Robert Kelly, and Chairman of the Board of Directors Elon Musk’s (collectively, “Defendants”) motion to dismiss a complaint filed on behalf of purchasers of SolarCity common stock (“Plaintiffs”).

According to the allegations, SolarCity Corporation derived revenue in two ways: renewable twenty-year leases of solar energy products, and sales of solar energy systems. Between December 2012 and March 2014 (“Class Period”), SolarCity’s accounting formulas shifted overhead costs from sales to leases. This enabled SolarCity to amortize costs over a twenty-year period, allowing the corporation to post consistent sales profit during the Class Period. SolarCity filed restated financials in March 2014, showing SolarCity had a negative gross margin for six affected quarters. 

The Plaintiffs claimed Defendants committed securities fraud in violation of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (“Act”) by shifting overhead costs from sales to leases. Specifically, Plaintiffs alleged the Defendants deliberately manipulated accounting formulas to portray profitability and secure financing. The Plaintiffs also sought to hold Chairman Musk jointly and severally liable under Section 20(a) of the Exchange Act.

A successful securities claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 requires the plaintiff show: (1) a material misrepresentation or omission by defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation. To successfully plead scienter, the plaintiff must show a defendant made false or misleading statements either intentionally or with deliberate recklessness.

In seeking to show a “strong inference” of scienter, Plaintiffs relied on statements by eight confidential witnesses (“CWs”). To satisfy pleading requirements, confidential witnesses must describe events with sufficient particularity to establish reliability and personal knowledge, and indicate scienter. While Plaintiffs provided confidential witnesses in an effort to show Defendants knew or deliberately ignored the accounting error, the court found the CW’s statements were too “conclusory, speculative, and/or vague to hold weight.” Specifically, the court noted “most glaringly, not a single “most glaringly, not a single confidential witness alleges that Defendants knew of accounting error central to this case.” Nor did the evidence give rise to “core-operations inferences.” 

The court then held Musk was not jointly and severally liable. To hold the individuals joint and severally liable, a plaintiff must prove a primary violation of federal securities laws where the “defendant exercised actual power or control over the primary violator” by providing specific facts showing specific control over a company’s “preparation and release of allegedly false and misleading statements.”

Plaintiffs claimed Chairman Musk should be held jointly and severally liable because he maintained the power to direct or cause the direction of management or policies of  SolarCity. Plaintiffs argued Musk exercised actual authority, where he signed financial documents, was related to SolarCity’s officers, owned outstanding shares, and because, as CEO Rive explained, Musk “instruct[ed] [Rive] to swerve into a pothole” to avoid invisible walls. Musk may have been a “visionary” but such status did not “suffice to show Musk’s control over SolarCity.” 

Accordingly, the court dismissed all claims under Section 10(b) and Rule 10b-5 with leave to amend, and dismissed the Section 20(a) claim against Musk without leave.    

The primary materials for this case may be found on the DU Corporate Governance website.



In re Sanofi Sec. Litig.: Pharmaceutical Company’s Motion to Dismiss Granted In Federal Securities Fraud Claims

In In re Sanofi Sec. Litig., 2016 BL 3051 (S.D.N.Y. Jan. 06, 2016), the United States District Court for the Southern District of New York granted corporate defendant Sanofi and individual defendant Christopher Viehbacher’s (collectively, “Defendants”) motion to dismiss Meitav DS Provident Funds and Pension Ltd., and Joel Mofenson’s (collectively, “Plaintiffs”) putative class action asserting federal securities fraud claims. 

According to the complaint, Sanofi, a global pharmaceutical company, engaged in an illegal marketing scheme (“Scheme”) to artificially boost the sales of its diabetes product line (“Drug”). Plaintiffs alleged the Scheme consisted of funneling millions of dollars in payments disguised as contracts to Accenture and Deloitte, acting as middlemen, in an attempt to induce pharmaceutical retailers and hospitals to favor the Drug. Plaintiffs further alleged that Viehbacher, as CEO and a member of the board of directors, was in a position to have knowledge of the Scheme but failed to stop it. When two whistleblowers revealed the Scheme, an internal investigation ensued and the Scheme was abandoned, which caused the Drug’s sales to slow and the share value to decline significantly. Plaintiffs brought a putative class action on behalf of all persons who purchased shares of Sanofi between February 7, 2013 and October 29, 2014 (the “Class Period”), alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act.

To state a Section 10(b) securities fraud claim, a plaintiff must plead the defendant: (1) made misstatements or omissions of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which plaintiffs relied, and (5) the reliance was a proximate cause of their injury. Defendants moved to dismiss the complaint pursuant to Rule 9(b) and 12(b)(6) on the grounds that the Plaintiffs failed to adequately allege: (1) any actionable false statements or omissions of material fact, (2) a strong inference of scienter, and (3) loss causation.

A complaint alleging securities fraud based on misstatements must, among other factors, explain why certain defendant misstatements were fraudulent. The court organized the alleged misstatements and omissions into three categories: (1) statements on compliance and corporate integrity; (2) Viehbacher’s Sarbanes-Oxley (“SOX”) certification; and (3) SEC filings, press releases, and conference calls stating the growth of the Drug.

The court found Defendants’ statements on compliance and corporate integrity were not actionable under the securities laws because they were examples of corporate “puffery” and could not mislead a reasonable investor. Similarly, the court determined Defendants’ statements made in SEC filings, press releases, and conference calls were not actionable because they did nothing more than characterize, “albeit it with more fanfare,” the accurate historical data: that the Drug’s sales were growing during the Class Period. Finally, the court held that, since Viehbacher’s SOX certification was a statement of opinion, Plaintiffs were required to plead facts demonstrating Viehbacher did not actually believe what he said. Here, the court found nothing alluding to Viehbacher’s subjective knowledge in the complaint.

Next, one way a plaintiff can establish scienter is through “strong circumstantial evidence of conscious misbehavior or recklessness.” Plaintiffs argued such evidence derived from Defendants’ access to the whistleblower reports and internal investigation. The court disagreed and found the Plaintiffs’ complaint relied on “unsubstantiated conclusions” and did not reference or identify specific facts, reports, or documents that could establish circumstantial evidence of scienter. Thus, the court held Plaintiffs failed to plead a strong inference of scienter.

Finally, to prove loss causation, a plaintiff may show: (1) cause-in-fact proof, or (2) the loss suffered was foreseeable and caused by the materialization of the risk concealed by the fraudulent statements. Plaintiffs theorized that after Defendants abandoned the Scheme, the Drug faced less advantageous pricing in the market, which caused the Drug to sell less, adversely affecting the value of shares. The court agreed Plaintiffs theory could establish loss causation, but found no evidence Defendants’ Scheme actually materially inflated the Drug sales. Here, the court concluded loss causation could not be proven without evidence of a casual relationship between the Scheme being abandoned and the share price declining.

Accordingly, the court dismissed Plaintiffs’ putative class action asserting federal securities fraud claims.

Primary materials for this case may be found on the DU Corporate Governance website


SEC Requests Injunction Against Participant in the Marijuana Business

On February 29, 2016 the Securities and Exchange Commission (“SEC”) filed a complaint in the U.S. District Court for the Western District of Pennsylvania against Fortitude Group, Inc. and CEO Thomas Parilla (“Defendants”), regarding alleged false and misleading public press releases regarding the company’s efforts and performance as a successful marijuana-related business. The SEC requested an injunction from further misrepresentation and the payment of penalties by the defendants, as well as a penny stock and officer and director bar against Parilla.

According to the allegations in the Complaint, Defendants between February 2014 and May 2014 circulated several press releases on portraying the company as active in the legalized marijuana business. Via press releases, Fortitude announced the formation of three new subsidiaries, described two separate plans to issue various pre-paid debit cards that could be used for marijuana transactions, and announced the distribution of a marijuana vaporizer. For the first quarter of 2014, Fortitude reported $412,162 in revenue.  The day Fortitude disclosed its plans for three new subsidiaries, the company’s stock price increased 4900% to $0.01 per share and the volume increased three-fold to over 132 million shares. The price of shares continued to increase, peaking at $0.08 per share on April 4, 2014, two days after the press release regarding Fortitude’s plan to distribute vaporizers.

The SEC alleged that Defendants violated Rule 10b-5 and aided and abetted violations of the rule.  The SEC contended that none of the business pursuits reported in the Defendants’ press releases were executed and Fortitude lacked the requisite licensure, funding, or infrastructure to realize them. Also, that the revenues reflected in Fortitude’s first quarter report were false.  Additionally, that Fortitude’s stock price and trading volume between February 2014 and May 2014 were materially impacted by the public dissemination of the aforementioned misrepresentations. 

To prevent continued violation by the defendants, the SEC requested the court issue an injunction from violation of the federal securities laws alleged and an order for the defendants to pay civil money penalties pursuant to Section 21(d)(3) of the Exchange Act, 15 U.S.C. § 78u(d)(3).  The SEC also requested Parilla be barred from future offering of a penny stock as well as from acting as an officer or director of any issuer of registered securities.

The primary materials for this case can be found on the DU Corporate Governance website.


In re Dole Food Co., Inc.: Merger Breaches Duty of Loyalty

In In re Dole Food Co. Stockholder Litig., No. 8703-VCL CONSOLIDATED C.A. No. 9079-VCL, 2015 BL 276794 (Del. Ch. Aug. 27, 2015), shareholders (the “Plaintiffs”) brought action against David H. Murdock, C. Michael Carter, and David A. DeLorenzo (collectively, “Defendants”) for breach of their duty of loyalty and against Deutsche Bank for aiding and abetting. The Court of Chancery found Murdock and Carter jointly and severally liable, without imposing liability on DeLorenzo and Deutsche Bank.

According to the allegations, Murdock, the CEO and controlling stockholder of Dole Food Company, Inc. (“Dole”), owned 40% of Dole’s common stock. In November 2013, Murdock bought all remaining shares of Dole’s common stock for $13.50 per share as a single-step merger (the “Merger”). A committee of disinterested and independent directors of Dole’s board of directors (the “Committee”) formed to negotiate the transaction.

Although a majority of unaffiliated shareholders approved the Merger, Defendants allegedly made false disclosures and withheld material information from the Committee and shareholders during the process. Specifically, Plaintiffs alleged that the Committee received erroneous information about Dole increasing its income through cutting costs and purchasing farms. Shareholders filed suit, alleging the Defendants breached the duty of loyalty through fraudulent self-dealing.

In transactions involving self-dealing by a controlling shareholder, the applicable standard is entire fairness. Entire fairness depends upon fair dealing and fair price. After examining these two aspects separately, the court considered the issue as a whole to determine entire fairness.

First, the court found the Merger did not involve fair dealing. In reaching this conclusion, the court considered the timing, initiation, negotiation, structure, and approval of the transaction. The court found Carter provided inaccurate information to the Committee. For example, the due diligence of DeLorenzo and Deutsche Bank revealed Dole’s “cost-cutting plan” could achieve $50 million cost savings per year. Although Carter knew this, he claimed in a press release that Dole could only achieve a $20 million cost savings, which caused stock prices to fall 13%.

The court also held that while the price may have been within the range of fairness, Plaintiffs were entitled to a “fairer” price. Id. (“This is because by engaging in fraud, Carter deprived the Committee of its ability to obtain a better result on behalf of the stockholders, prevented the Committee from having the knowledge it needed to potentially say “no,” and foreclosed the ability of the stockholders to protect themselves by voting down the deal.”).

Having found violations of fair price and fair dealing, and thus entire fairness, the court next examined each Defendant separately to determine who was liable. The court found Murdock liable for breaches of the duty of loyalty both as a director and a controlling shareholder. The court also determined DFC Holdings, LLC, an entity controlled by Murdock, was an “acquisition vehicle” for the Merger and aided and abetted the violation.

The court further found Carter liable for damages both as an officer and director. Lastly, the court found that, while a “close call,” DeLorenzo was entitled to rely on the Committee's recommendation of the Merger and was not liable. With regard to Plaintiffs’ suit for aiding and abetting against Deutsche Bank, the court found Plaintiffs failed to meet the third element of the claim, “knowing participation in the breach,” because Deutsche Bank did not knowingly assist in the Defendants’ breach of duty.

Accordingly, the court found Murdock, his entity DFC Holdings, LLC and Carter liable for breach of duty of loyalty in the amount of $148,190,590.18.

The primary materials for this case are available on the DU Corporate Governance website.


Conference on Corporate Compliance: The Rutgers Center for Corporate Law and Governance

I'm happy to pass along the following announcement:

The Rutgers Center for Corporate Law and Governance is presenting a conference on corporate compliance on Friday, May 20, 2016, from 8:30 AM to 3:30 PM, entitled New Directions in Corporate Compliance. The conference will take place at Rutgers Law School, 217 North Fifth Street, Camden, NJ 08102.

Corporate and regulatory compliance has exploded as an area of importance to a variety of business organizations in recent years. Corporate compliance programs must be well planned and rigorously implemented throughout a business organization. Notwithstanding the importance of corporate compliance, there is disagreement over the best way to implement and enforce a compliance program. 

This conference will bring together academics, practitioners, and government officials, who approach compliance from different perspectives. The conference will include sessions on litigating the adequacy of a compliance program, structural issues in the compliance department, and organizational culture and developing a culture of compliance. Andrew Donohue, Chief of Staff of the U.S. Securities and Exchange Commission, will present a keynote luncheon address. 

Other speakers include: Catherine Bromilow, Partner, PwC Center for Board Governance; Stephen L. Cohen, Associate Director, Securities and Exchange Commission; James Fanto, Gerald Baylin Professor of Law, Brooklyn Law School; Donald C. Langevoort, Thomas Aquinas Reynold Professor of Law, Georgetown Law; Joseph E. Murphy, Author of 501 Ideas for Your Compliance & Ethics Program; Donna Nagy, C. Ben Dutton Professor of Law, Indiana University Maurer School of Law; Charles V. Senatore, Executive Vice President, Fidelity Investments, Greg Urban, Arthur Hobson Quinn Professor of Anthropology, University of Pennsylvania; and John Walsh, Partner, Sutherland.   

The conference is free and open to the public. A reception will follow. To RSVP, please contact Deborah Leak at CLE credit is available for NJ, NY, and PA. For additional information about CLE credit, contact Deborah Leak.


SEC v. Gibraltar Global Securities, Inc.: District Court Affirms Magistrate’s Report

In SEC v. Gibraltar Global Securities, Inc., No. 13 Civ. 2575, 2016 BL 7335 (S.D.N.Y. Jan. 11, 2016), the United States District Court for the Southern District of New York adopted its prior October 16, 2015 Report and Recommendation (“Report”), holding Gibraltar Global Securities, Inc., and its president and sole shareholder, Warren A. Davis (collectively, “Defendants”) liable for damages following violations of the Securities Exchange Act of 1934 (“Exchange Act”) as well as Securities Act of 1933 (“1933 Act”). 

The Securities and Exchange Commission (“SEC”) filed a claim against Defendants alleging violations under Section 15(a)(1) of the Exchange Act and Sections 5(a) and (c) of the 1933 Act. On July 2, 2015, the court granted the SEC’s motion for default judgment against Defendants and referred the case to a magistrate for an inquest on damages. When Defendants failed to appear at the damages hearing or to timely object, the Magistrate accepted all facts alleged in the SEC’s complaint as true. Those facts are as follows:

Defendants operated as an offshore, unregistered securities broker-dealer selling millions of shares of unregistered stock in the company Magnum d’Or. Defendants used the Gibraltar website, email, telephone, or mail to complete transactions for customer stock on the open market. Defendants sold unregistered Magnum shares through their U.S. brokers, placed the proceeds in US-based brokerage accounts, and wired any sales proceeds to Defendants’ Royal Bank of Canada account in the Bahamas, where a 2-3% commission was deducted. Defendants sent the remaining amounts back to their U.S. customer, Magnum via mail. Defendants bought and sold over 11 million Magnum d’Or shares between November 2008 and September 2009 to generate $11,384,589 in proceeds.

Under Section 15 of the Exchange Act, it is unlawful for an unregistered dealer to utilize an instrumentality of interstate commerce to effect transactions in, or to induce the purchase of, any security. 15 USC 78o.  Defendants utilized Gibraltar’s website, email, or telephone—instrumentalities of interstate commerce—to receive shares of stock from its customers and deposit the shares into Gibraltar’s U.S.-based brokerage accounts. As such, the court found no clear error in the Report, holding the Magistrate correctly determined Defendants violated the Exchange Act.

Under the 1933 Act, a defendant violates Section 5 (15 USC 77e) if: (1) he or she directly or indirectly sold or offered securities; (2) without registration in effect for the subject securities; and (3) interstate means were used in connection with the offer or sale.  Because Defendants sold unregistered Magnum shares through their U.S. brokers to generate commissions’ proceeds and sent the remainder back to Magnum via mail, the court determined the Report properly found Defendants liable under the 1933 Act.

Based on a magistrate’s finding of a defendant’s liability, the court can adopt a magistrate’s recommendation for damages. Here, the Magistrate recommended disgorgement, disgorgement for prejudgment interest, and second-tier civil monetary penalties. Disgorgement calculations need only be a reasonable approximation of the profits causally connected to the violation, ensuring that the defendant does not profit from his or her gains. The court held the Magistrate’s recommendation to award disgorgement and disgorgement for prejudgment interest was proper and reasonable based on Defendants’ liability. The court, however, determined the Magistrate’s prejudgment interest calculation contained a mathematical error and adjusted the final amount. The court also held each Defendant liable for a second-tier civil monetary penalty for their “abhorrent” conduct.

Accordingly, the court adopted the Magistrate’s report in its entirety notwithstanding the calculation error in prejudgment interest, awarding damages to the SEC.

 The primary materials for this case may be found on the DU Corporate Governance website.


Tongue v. Sanofi: Allegations of Misleading Statements Not Actionable Under Revised Omnicare Standard

In Tongue v. Sanofi, No. 15-588, 2016 BL 66168, (2d Cir., Mar. 4, 2016), the Court of Appeals for the Second Circuit affirmed the United States District Court for the Southern District of New York’s grant of Sanofi Pharmaceutical Inc.’s (“Sanofi”), Genzyme Corporation’s (“Gnzyme”), and Sanofi Executives’ (“Executives”, collectively “Defendants”) motion to dismiss the consolidated class action complaint by all persons (“Plaintiffs”) who purchased Contingent Value Rights (“CRVs”) between March 6, 2012 and November 7, 2013.

According to the allegations, Sanofi in February 2011 acquired Lemtrada , a multiple sclerosis treatment, developed by Genzyme, for $74 per share and one CVR per share. Each CVR entitled the holder to cash payouts upon achievements of milestones, such as receiving approval from the FDA by a specific date. In the years leading up to this deadline, Defendants released optimistic statements about Lemtrada’s clinical testing and the FDA approval process. In a call with investors in April 2012, Sanofi’s CEO claimed that, in regards to Lemtrada, “the data are nothing short of stunning.” Defendants, however, omitted the concerns expressed by the FDA about the use of single-blind, rather than double-blind clinical studies, in the testing for Lemtrada. Ultimately, Lemtrada was not approved by the FDA before the deadline and the value of each CVR dropped by more than 62% from $2.00 to $.077 a share.

On April 28, 2014 Plaintiffs filed a complaint alleging Defendants violated Section 10(b) and Section 20(a) of the Security Exchange Act (“Act”), as wells Rule 10b-5 promulgated thereunder, by making materially false and misleading statements that misled investors when Defendants failed to disclose the FDA had expressed concerns about the single-blind, rather than double-blind, testing.

In the period between dismissal by the district court and the decision in the appeal, the Supreme Court decided Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015). The Court, therefore, applied the analysis in that case. Under the revised standard set forth in Omnicare, an investor must “identify particular (and material facts) in the issuer’s opinion whose omission makes the statement misleading to a reasonable person reading the statement fairly and in context.” While opinions may be actionable if the omitted information makes the statement misleading to a reasonable investor, an issuer failing to disclose facts, which cut against its opinion is not necessarily misleading. A reasonable investor expects the issuer to believe the opinion and that it fairly aligns with the information in the issuer’s possession, but does not expect every fact known to the issuer to support its opinion.

The court determined Sanofi did not make material misleading statements of opinion. While the FDA had concerns with the testing methodology “it also stated that any deficiency could be overcome if the results showed an ‘extremely large effect.’” In effect, the concerns were part of a “dialogue” between the FDA and Sanofi. As the court reasoned, “These sophisticated investors, well accustomed to the ‘customs and practices of the relevant industry,” would fully expect that Defendants and the FDA were engaged in a dialogue, as they were here, about the sufficiency of various aspects of the clinical trials and that inherent in the nature of dialogue are differing views.” Moreover, the dialogue “did not prevent Defendants from expressing optimism, even exceptional optimism, about the likelihood of drug approval.”

Accordingly, the court determined there was an absence of serious conflict between the FDA’s concerns about the testing methodology and the Defendants’ optimism about the approval, affirming the district court’s dismissal.

The primary materials for this case may be found on the DU Corporate Governance website


SEC v. Blackburn: FRCP 9(b) – The Need to Sufficiently Allege Scienter

In SEC v. Blackburn, 2015 BL 293662 (E.D. La. Sept. 10, 2015), the United States District Court for the Eastern District of Louisiana granted in part and denied in part, Defendant Lee C. Schlesinger’s (“Schlesinger”) Partial Motion to Dismiss in a securities fraud case brought against Treaty Energy Corporation (“Treaty”) and six Treaty employees: Ronald Blackburn, Andrew Reid, Bruce Gwyn, Michael Mulshine, Lee Schlesinger (Treaty’s former Chief Investment Officer), and Samuel Whitley (collectively, “Defendants”). 

According to the allegations, Treaty is a publicly traded oil and gas company. The Securities and Exchange Commission (“SEC”) alleged that six of Treaty’s employees violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 by operating a widespread scheme to defraud investors and violate federal securities laws between 2009 and 2013. The SEC alleged Schlesinger aided and abetted Treaty’s reporting violations. The SEC further alleged Schlesinger failed to disclose Ronald Blackburn’s (“Blackburn”) control over Treaty, and Schlesinger took part in unregistered public offerings of restricted stock.

Schlesinger, the former Chief Investment Officer, filed a Partial Motion to Dismiss, challenging the SEC’s securities fraud and aiding and abetting claims against him. Schlesinger primarily argued the SEC’s claims did not specify how he committed any legal wrong.

To prevail on a securities fraud claim for Section 10(b) of the Exchange Act and Rule 10b-5 violations, a party’s claims, if true, must establish the actor made: a misstatement or omission of material fact in connection with the purchase or sale of a security, with the intent to deceive, manipulate, or defraud the public. The SEC may only succeed on an aiding and abetting claim if it can prove: (1) the primary party committed a securities violation; (2) the aider and abettor was generally aware of its role in violating the law; and (3) the aider and abettor knowingly rendered substantial assistance in furtherance of the violation.

A party alleging fraud must satisfy a heightened pleading standard and allege the circumstances constituting fraud with particularity. The Fifth Circuit interprets Rule 9(b) strictly. In order to satisfy this strict interpretation, a plaintiff alleging fraud must specifically identify: (1) statements alleged to be fraudulent, (2) the identity of the speaker, and (3) when and where the statements were made, and must explain why the statements were fraudulent.

In addressing the motion to dismiss, the court considered the SEC’s request to take judicial notice of Treaty’s Forms 10-K filed for the years 2011 and 2012. The court stated it may consider the contents of public disclosure documents that are (1) required to be filed, or (2) are actually filed with the SEC. The court agreed to take judicial notice of statements within the documents but not do so with respect to the truth of those statements.

The court held the SEC failed to state a claim against Schlesinger. The SEC did sufficiently allege that Schlesinger was the maker of false statements because he had signed the relevant reports filed on Form 10-K. The court, however, found that the SEC had not sufficiently alleged scienter. The SEC did not provide specific facts sufficient to demonstrate that Schlesinger acted consciously with respect to the statements alleged to be false or had a sufficient motive to commit securities fraud.

The court also held the SEC’s complaint failed to state a claim against Schlesinger for aiding and abetting. According to the court, Schlesinger’s signature on two Forms 10-K did not support an inference Schlesinger acted with conscious intent or that Schlesinger’s alleged actions constituted an extreme departure from the standards of ordinary care.

The primary materials for this post can be found at the DU Corporate Governance website.


Smith v. Foster: Ne-Yo’s Fraud Claims Dismissed for Lack of Specificity

In Smith. v. Foster, No. 14-Cv-5918 (SHS), 2016 BL 65843 (S.D.N.Y. Mar. 03, 2016), the United States District Court for the Southern District of New York granted David Foster and his firm’s (“Defendants”) motion to dismiss Shaffer Smith’s, the recording artist known professionally as Ne-Yo (“Plaintiff”) third amended complaint (“TAC”). The court held the TAC was not pled properly under Federal Rule of Civil Procedure 9(b) and 15 USC § 78u-4(b)(1).   

According to the allegations, Plaintiff in 2005 contracted Defendants to manage his business affairs. Foster convinced Plaintiff to invest in Imperial Health Research & Development LLC (“Imperial”), which sold a beverage called OXYwater. Plaintiff initially invested $1 million, and another $1 million after learning of sponsorships with NASCAR and the Cleveland Cavaliers. Smith ultimately invested $3.5 million before Imperial’s bankruptcy in 2013. Smith then sued Foster for securities fraud.  

The TAC alleged Foster fraudulently misrepresented Imperial to induce Plaintiff’s investment. Foster never disclosed he was Imperial’s President, CFO, and 66% shareholder. Foster among other things allegedly asserted that Imperial was “on the verge” of taking over Vitamin Water’s market share, “in the process” of going public, and that Plaintiff’s initial investment was “doing great.” Plaintiff also asserted that Foster failed to reveal his relationship with Imperial, including his ownership of a majority of the shares of the company. 

To adequately plead securities fraud under FRCP 9(b) and securities fraud under 15 USC § 78u-4(b)(1), plaintiffs must allege (1) a material misrepresentation or omission; (2) made with scienter; (3) on which the plaintiff relied; (4) which  caused; (5) economic loss; (6) and loss causation. The court addressed only the first two issues in this case.  

First, the court found the TAC failed to plead specific facts providing a basis to conclude that Foster’s statements were false when made. The TAC’s allegations were based on  “information and belief.”  Such a basis was only permissible where “the facts necessary to show falsity ‘are wholly within’ defendants' ‘control,’  or ‘peculiarly within’ defendants' ‘knowledge’” (citations omitted).  The court was not “ersuaded that the purported facts” were “wholly within” Defendants’ control. 

Other statements were considered too vague to establish a claim for fraud.  Allegations that statements about an investment “doing great” while the company was “hemorrhaging money” was not sufficient becuase the “allegation, without any additional facutal support, is too vauge to satisfy the heightened pleading reqruiements of Rule 9(b) and the PSLRA.”  As for the alleged failure to disclose Foster’s status with respect to Imperial, the court determined that the statements did “nothing to cast doubt on anything Foster actually said.”    

Second, the court found that the allegations were insufficient to establish a “strong inference” of scienter.  Scienter in the Second Circuit can be shown through allegations of motiva and opportunity or conscious misbehavior.  The court found that alleged motives to “procure investors” and to “skim the invested funds for his own individual purpose” were insufficient because the behavior was “equally likely” or “consistent” with proper motives.  The court likewise found the allegations of “conscious misbehavior”.    

The court granted Foster’s motion to dismiss Smith’s securities fraud claim with prejudice for failure to plead securities fraud with particularity and specificity.

The primary materials for this case may be found on the DU Corporate Governance website


No-Action Letter for General Electric Company Allowed Exclusion of Litigation Strategy Proposal

In General Electric Co., 2016 BL 32440 (Feb. 3, 2016), General Electric Co. (“GE”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit omission of a proposal submitted by the Sisters of St. Dominic of Caldwell, NJ, among others (“Shareholders”) requesting an independent evaluation assessing potential sources of liability related to PCB discharges into the Hudson River.  The SEC agreed to issue a no action letter allowing for exclusion of the proposal under Rule 14a-8(i)(7). 

Shareholder submitted a proposal providing that:

RESOLVED, shareholders request that GE at reasonable expense undertake an independent evaluation and prepare an independent report by October 2016, demonstrating the company has assessed all potential sources of liability related to PCB discharges in the Hudson River, including all possible liability from NRD claims for PCB discharges, and offering conclusions on the most responsible and cost-effective way to address them.

GE sought exclusion under subsections (i)(7) and (i)(3). 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement.  17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements.  In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the rquirements of the Rule, see The Shareholder Proposal Rule and the SEC.  

Rule 14a-8(i)(7) permits a company to omit a proposal that relates to the company’s “ordinary business” operations, including the company’s litigation strategy and legal compliance. “Ordinary business” refers to those issues that are fundamental to management’s ability to run the company on a day-to-day basis. As such, “ordinary business” issues cannot practically be subject to direct shareholder oversight.

Rule 14a-8(i)(3) permits the exclusion of proposals or supporting statements that are contrary to any of the SEC’s proxy rules or regulations. The subsection applies to proposals that may be inconsistent with Rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials. In addition, the subsection permits the exclusion of proposals that are vague and indefinite, rendering the company’s duties and obligations unclear.   

GE argued the proposal should be excluded under 14a-8(i)(7) because it related to GE’s “litigation strategy.” GE asserted that the proposal “implicate[d] the Company’s litigation strategy in, pending lawsuits involving the Company.”  GE also asserted that the proposal could be excluded because it sought “to micro-manage the manner in which a company complies with its legal obligations.” 

In addition, GE argued the proposal could be omitted under 14a-8(i)(3) because the proposal was vague.  GE contended the proposal would result in a bifurcated request with undefined reference as to what conclusions should be reached and who should undertake the independent evaluation.

Shareholders disagreed.  Shareholders contended that matters that were “the subject of litigation” could nonetheless raise “a significant policy issue for the corporation and its shareholders.”  Shareholders argued that excluding all proposals related to litigation would function as a “get out of jail free” card for companies.

The SEC agreed and concluded it would not recommend enforcement action if GE omits the proposal from its proxy materials in reliance on Rules 14a-8(i)(7).  The staff noted “that the company is presently involved in litigation relating to the subject matter of the proposal.”  

The primary materials for this post can be found here.


An End to the Conflict Minerals Saga?

In a letter dated March 6th from Attorney General Loretta Lynch to House Speaker Paul Ryan the Attorney General announced that the government will not appeal the ruling in SEC v. NAM (the conflict minerals case) to the US Supreme Court—thus ending (for now) the conflict minerals saga (discussed here and here. ) To be clear, the decision not to appeal does not mean that there is no regulation of conflict minerals.  The rule remains in effect and require that covered issuers file a Form SD and make efforts to determine if their products include any conflict minerals and, if so, to carry out a "due diligence" review of their supply chain.   The only portion of the rule struck down in earlier litigation was the requirement to state that certain products had not been found to be “DRC conflict free.” 

In her letter explaining why review will not be sought the Attorney General noted that:  

  • The panel majority and the dissenting judge disagreed as to the proper standard of scrutiny for First Amendment challenges to compelled-disclosure requirements of the sort at issue here. But because the majority concluded in the alternative that the challenged requirements would be unconstitutional even under the more lenient standard, this would be a poor case in which to seek Supreme Court clarification of the proper standard of scrutiny.  

Further she stated:  

  • The panel majority and the dissenting judge also disagreed on the question whether the disclosure requirements at issue here - which compel some issuers to state publicly that their products have "not been found to be 'DRC conflict free"' - are properly characterized as involving "purely factual and uncontroversial information." The need to resolve that case-specific issue could likewise make it difficult for the Supreme Court to provide useful guidance concerning the application of the First Amendment to more typical disclosure requirements.  

Finally she observed: 

  • The panel majority also expressly recognized that its holding of unconstitutionality may apply only to the Commission's rule rather than to the underlying statute. If, after remand, it is determined that the statute itself does not require use of the specific phrase "not been found to be ' DRC conflict free,'" the Commission could promulgate an amended disclosure rule that attempts both to fulfill the statutory mandate and to comport with the court of appeals' view of the First Amendment. The decision not to seek Supreme Court review will allow the Commission or the district court to determine in the first instance, subject to further review, whether such an amended rule can and will be promulgated.  

This decision may comfort issuers who now know the parameters of their disclosure obligations under the rule.  However it should leave those who care about the regulation of commercial speech troubled.  The state of the law in this area is a mess—no one knows what standard of review will be applied to any particular regulation, nor do we know what constitutes “purely factual and uncontroversial information.”  The stakes are high—see the GMO labeling case in Vermont.  For now confusion will reign.



Excavators and Pavers Pension Fund v. Diodes Inc.: Insufficient pleading under the PSLRA

In Excavators and Pavers Pension Trust Fund v. Diodes Inc., No. 14-41141, 2016 BL 9217 (5th Cir. Jan. 13, 2016), the United States Court of Appeals for the Fifth Circuit affirmed the lower court’s decision granting Diodes, Inc.’s (“Diodes”), its CEO Keh-Shew Lu’s (“Lu”), and its CFO Richard White’s (“White”) (collectively, “Defendants”) motion to dismiss the securities fraud class action. The 5th Circuit held Excavators and Pavers Pension Trust Fund’s (“Plaintiff”) claims did not support an inference of scienter under the Private Securities Litigation Reform Act’s (“PSLRA”) heightened pleading requirements.

According to Plaintiff’s allegations, on February 9, 2011, Lu announced Diodes’s revenue would stagnate or drop 5% because its Shanghai production facility experienced labor shortages, which adversely affected manufacturing output. On May 10, 2011, White stated at an industry conference that Diodes had noticed the labor problem, which would affect manufacturing output, around Chinese New Year, and that Diodes intended to hire new workers to replace non-returning workers; however, typical training lasted six to eight weeks. Following White’s announcement, Diodes’s stock price dropped. On June 9, 2011, Diodes again lowered its revenue prediction because labor recovery was slower than expected, and Diodes’s stock price fell again.

Plaintiff’s complaint alleged violations of Sections 10(b) and 20(a) of Securities Exchange Act of 1934. Plaintiff claimed: (1) Defendants must have known or were severely reckless in not knowing Diodes’s internal labor policies would exacerbate labor problems; (2) Defendants made early shipment orders to customers in an attempt to conceal the severity and duration of the labor shortage; and (3) Lu’s stock sales at this time supported a strong inference of scienter. Defendants moved to dismiss Plaintiff’s complaint for failure to state a claim. 

A complaint will survive a motion to dismiss under the PSLRA if the allegations specify: (1) each misleading statement; (2) the reasons why the statement is misleading; and (3) the facts, stated with particularity, which give rise to a strong inference of scienter. Under PSLRA’s heightened standard, a complaint’s cogent and compelling allegations are enough for a court to infer scienter—an intent to deceive or defraud. The complaint’s allegations must do more than create just a reasonable or permissible inference.

The court held the Plaintiff’s allegations were not cogent or compelling enough to conclude that a strong inference of scienter existed. Specifically, the court ruled the allegations failed to show sufficient facts indicating Defendants had actual knowledge the labor shortage was principally caused by Diodes’s workplace policies; rather, its management never denied the existence of labor shortages and accurately predicted the impact on Diodes’s financial results. Additionally, the court held that shipping orders ahead of schedule would enhance the labor shortage problem, rather than conceal the problem as Plaintiff argued, because shipping orders early would deplete inventory and cause Diodes’s inability to fill orders to quickly become apparent. Finally, the court held Lu’s significant stock sales alone did not support a strong inference of scienter; rather, nonculpable inferences drawn from Lu’s stock sales were more compelling than Plaintiff’s culpable inferences.

Accordingly, the court of appeals affirmed the decision to grant Defendants’ motion to dismiss because the complaint failed to satisfy the PSLRA’s heightened pleading requirement.

The primary materials for this case may be found on the DU Corporate Governance Website.


SEC v. LEE: Securities Fraud Under the EB-5 Immigrant Investor Program

In SEC v. Lee, No. CV 14-06865-RGK (Ex), 2015 BL 356931 (C.D. Cal. Oct. 28, 2015), the United States District Court for the Central District of California granted a motion for default judgment filed by the SEC against Justin Moongyu Lee and his five commercial entities (“Entity Defendants”) (collectively, “Defendants”) for securities fraud.

The United States Citizenship and Immigration Service (“USCIS”) administers the EB-5 visa program for immigrant investors seeking permanent residency in the United States. To receive permanent residency, immigrant investors must invest at least $500,000 in a Target Employment Area (“TEA”) and created 10 full-time jobs for United Stated workers. This program allows investors to designate entities as “regional centers” inside a TEA. In 2006, Lee applied to designate one of the Entity Defendants as a regional center. The Entity Defendants raised $11,455,000 in investment contracts from immigrant investors for the construction of an ethanol plant.

The SEC filed a complaint against defendants, claiming the Defendants violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10-5b. The complaint alleged the Entity Defendants never constructed the plant, and used a majority of the money raised by the immigrant investors for other purposes.

Together, Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10-5b prohibit fraud in the offer or sale, or in connection with the purchase or sale of securities. For the SEC to prevail, it had to show: (1) the Defendants made material misrepresentations and omissions; and (3) those statements and omissions were made with scienter.

The complaint alleged Lee misrepresented to investors that major construction on the plant was ongoing, Lee submitted forms with false information to the USCIS, Lee paid off investors in other schemes with the immigrant investor money, and the Entity Defendants were purposed for other tasks. First, the court held the Defendants made material misrepresentations to its investors. The court reasoned that, contrary to the Defendant’s representations to investors, investors’ money did not go towards the plant, was not helping the investors gain permanent residency, and did not create jobs in relation to the project. Because the court found there was a substantial likelihood that a reasonable investor would consider this information before investing in the plant, it held the Defendant’s misrepresentations were material. 

Next, the court turned to the element of scienter to determine if these misrepresentations were committed knowingly or recklessly. Scienter is satisfied by proving recklessness. The court determined the facts supported a claim that Defendants made the misrepresentations with the requisite scienter: (1) Lee headed and controlled each of the Entity Defendants; (2) Lee signed the regional center applications; (3) Lee represented to both investors and the USCIS that the plant would be constructed, even when construction was no longer feasible; (4) Lee provided offering materials to investors; and (5) Lee approved all information regarding the plant in numerous investor seminars.

The court enjoined the Defendants from violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10-5b, ordered Lee to pay a maximum civil penalty of $150,000, and ordered disgorgement of $8,262,403.73 – the approximate amount of immigrant investor money the Defendants misused, after an adjustment for inflation.

The primary materials for this case may be found on the DU Corporate Governance website.


SEC v. DFRF Enters. LLC: An Alleged $15M Fraud Scheme Promising Opportunities to Invest in Gold Mines

In SEC v. DFRF Enters.. LLC, D. Mass., No. 1:15-cv-12857, complaint unsealed (July 2, 2015), the Securities and Exchange Commission (the “Commission”) demanded a jury trial based on allegations against defendants DFRF Enterprises LLC (a Massachusetts company), DFRF Enterprises, LLC (a Florida company)(collectively, “DFRF”), Daniel Fernandes Rojo Filho, Wanderly M. Dalman, Gaspar C. Jesus, Eduardo N. Da Silva, Heriberto C. Perez Valdes, Jeffrey A. Feldman, and Romildo Da Cunha (the “Defendants”). The Commission alleged violations of (a) Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder, (b) Section 17(a) of the Securities Act of 1933 (“Securities Act”), and (c) Sections 5(a) and 5(c) of the Securities Act, seeking injunctive relief, disgorgement plus prejudgment interest, and penalties. 

According to the allegations in the complaint, Filho during the Summer of 2014 began selling “memberships” in DFRF through meetings with prospective investors, which mostly took place in Massachusetts. Since October 2014, Filho promoted DFRF primarily through videos made available to the public on the Internet. Starting in March 2015, the Defendants claimed DFRF had registered with the Commission, was about to become publically traded, and investors could convert their membership interests into stock options at $15.06 per share. By June 2015, Filho claimed, while public trading had not begun, the value of DFRF stock exceeded $64 per share.  From June 2014 to May 2015, according to the SEC, DFRF raised more than $15 million and has only paid about $1.6 million back to investors, using money from other investors.

According to the complaint, while recruiting investors, Defendants claimed DFRF owned more than fifty gold mines in Brazil and Africa and made a 100% gross return on every kilogram it produced. The SEC also alleged Defendants told investors DFRF had a credit line with a Swiss private bank to triple its available funds, offered a 10% credit to investors who recruit new members, and paid 15% per month back to investors. Lastly, the SEC alleged Defendants claimed investors’ money was fully guaranteed by a worldwide insurance company. As the complaint alleges:

The investors' money has not been used to conduct gold mining, pay for a credit line, purchase insurance, or endow charitable activities. DFRF has received no proceeds from mining operations or any credit line. To date, DFRF has paid approximately $1.6 million back to investors. Because it has no independent source of revenue, it is apparent that, in classic Ponzi scheme fashion, DFRF is using money from some investors to pay other investors.

Based on these allegations, the Commission filed a complaint against DFRF in the federal district court of Massachusetts, requesting the court (1) enter a temporary restraining order; (2) grant a preliminary injunction; (3) grant an order freezing all assets; and (4) grant an order for other equitable relief.  Furthermore, the Commission requested the court enter a permanent injunction restraining the Defendants and their agents from directly or indirectly engaging in the conduct described above, or in conduct of similar effect.

Since the filing of the complaint, the SEC announced that Mr. Filho was “criminally charged with defrauding investors.”  see also

The primary materials for this Complaint can be found at the DU Corporate Governance Website


Harris v. TD Ameritrade: Private Relief for Consumers not Found in SEC Rules 

In Harris v. TD Ameritrade, Inc. No. 15-5220 (6th Cir. Oct. 8, 2015), the United States Court of Appeals for the Sixth Circuit affirmed the district court’s grant of TD Ameritrade’s (“TD”) motion for dismissal. The court found that the Plaintiffs, Elsie, Muriel, and David Harris, did not have a private right of action under 17 C.F.R. § 240.15c3-3 (“SEC Rule”) and Nebraska’s Uniform Commercial Code, Neb. Rev. Stat. U.C.C.  § 8-508 (“UCC”). 

According to the allegations, the Plaintiffs in 2005 purchased thousands of shares in Bancorp International Group via TD brokers. TD used the Depository Trust & Clearing Corporation (“DT&C”) to hold the Plaintiffs’ securities. In 2011, the Plaintiffs asked TD to provide a physical certificate signifying the Plaintiffs’ ownership. TD denied this request, citing a global lock by DT&C on all Bancorp International stock.  “Depository Trust had imposed the lock because someone had fraudulently created hundreds of millions of invalid shares of Bancorp International stock.” 

The Plaintiffs filed suit seeking to enjoin TD and require the broker to convert the shares.  TD removed to the United States District Court of Eastern Tennessee.  The District Court granted TD’s 12(b)(6) motion for dismissal on January 5, 2015, available here. The Plaintiffs appealed.  On appeal, the Sixth Circuit examined the claim under Rule 15c3-3 and the Nebraska UCC.  

Rule 15c3-3 provides “absolute right . . . to receive . . . following demand made on the broker or dealer, the physical delivery of certificates for . . . [f]ully-paid securities to which he is entitled.” 17 C.F.R. § 240.15c3-3(l).   The court, however, concluded that the rule did not create a private right of action for the consumer.  Nor would the court agree to use its equitable authority to create such a right.  

With respect to the UCC, plaintiffs pointed to a provision requiring that “[a] securities intermediary shall act at the direction of an entitlement holder to change a security entitlement into another available form of holding for which the entitlement holder is eligible.” The court noted that plaintiffs ran run “into the same problem that blocked their path with respect to the SEC Rule.  The court concluded that Nebraska had not created a private right of action for the relevant provisions.  “The Nebraska legislature created private rights of action when it wanted to, and for reasons of its own did not create one here.” 

The court, however, reasoned that plaintiffs had other avenues of recourse. 

  • They may ask the SEC or a state agency to enforce the federal or state law as the case may be against TD Ameritrade. “The initiation of a proceeding before a regulatory commission” may be “the best remedy available,” Anderson § 8-504:14, for violation of the duties imposed by the SEC Rule or the Commercial Code. For all we know, a non-preempted state common-law right of action may exist in circumstances like these.

For the above reasons, the court affirmed the district court’s dismissal without prejudice.


The primary materials for this case may be found on the DU Corporate Governance website


SEC Gets a Temporary Reprieve in Conflict Minerals Case

The SEC got a temporary reprieve in the on-going conflict minerals case (discussed here and here) when the Chief Justice granted another extension of time for the agency to file a petition for cert. The SEC now has until April 7, 2016 to file its petition.

As things stand now, the conflict minerals rule remains in effect and companies must file the required disclosure document but need to state in such disclosure whether their products were “not found to be DRC conflict free.” That clause was found by the DC Circuit to be compelled corporate speech that violated issuers First Amendment rights.

The potential impact of the ruling in the conflict minerals case is huge as it calls into question the reach of Zauderer v. Office of Regulatory Counsel which uses a relatively lenient standard of review for compelled commercial speech. As things now stand, the state of the law governing compelled commercial speech is hopelessly confused. Courts differ on whether Zauderer review applies broadly or if it is limited (as the conflict minerals rule holding suggests) to disclosures aimed at preventing consumer deception. If the latter is true, many types of disclosure may be subject to challenge. 

If the SEC does file by the new deadline, it will be seeking reconsideration only of the portion of the ruling that dealt with the First Amendment issue. But that issue is critical, not only to the particular case at hand but to the entire field of securities disclosure regulation. It is a case worthy of much closer attention that has been paid to it so far. The SEC almost certainly will seek further review as it cannot allow the current unsettled state of affairs to remain.


In Re ChinaCast Educ. Corp. Litig.: Court Reverses Summary Judgment Ruling Dismissing Securities Fraud Claims

In In Re ChinaCast Educ. Corp. Litig., No. 12-57232, 2015 BL 349540, (9th Cir. Oct. 23, 2015), the United States Court of Appeals for the Ninth Circuit reversed the lower court’s dismissal of a securities fraud claim, holding the investors (collectively, “Plaintiffs”) of Defendant ChinaCast Education Corporation (“ChinaCast”) adequately met the pleading requirements of the Private Securities Litigation Reform Act (“PSLRA”). 

The Plaintiffs’ alleged that ChinaCast’s CEO, Ron Chan (“Chan”), moved hundreds of millions of dollars of corporate assets to outside accounts between June 2011 and April 2012, including one controlled by the son of a ChinaCast vice president, and pledged an additional $37 million in ChinaCast assets to secure loans unrelated to its business. The Plaintiffs further alleged Chan did not disclose any of the fraudulent activities taking place, but emphasized ChinaCast’s financial stability in a number of different communications with investors. The Plaintiffs contended that they relied on Chan’s misleading statements and representations prior to the financial collapse of ChinaCast.

The Plaintiffs filed suit alleging violation of Rule 10b-5 of the Securities Exchange Act of 1934. The complaint argued that Chan acted in his official capacity as an agent of ChinaCast during his commission of these fraudulent activities, and thus his scienter could properly be imputed to ChinaCast.

ChinaCast did not dispute Chan acted within the scope of his apparent authority when he made the alleged misleading statements and misrepresentations regarding the financial health of ChinaCast. In its defense, ChinaCast argued that because Chan’s actions were adverse to the interests of the corporation, imputation of Chan’s scienter to the corporation was improper under the common law adverse interest exception.

Under Section 10(b) of the Exchange Act and Rule 10b-5, a plaintiff must allege: (1) a material misrepresentation (or omission); (2) scienter; (3) a connection between the misrepresentation and the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) loss causation. The PSLRA requires plaintiffs “to state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter.”

In the context of Rule 10b-5, a corporation can be held responsible for a corporate officer’s fraud committed within the scope of his or her employment. The adverse interest exception may prevent a court from imputing knowledge of wrongdoing to a principle when the agent has completely abandoned the interests of the employer, such as by stealing from, or defrauding, it. Knowledge of wrongdoing may be imputed, however, when it is necessary to protect the rights of an innocent third party who dealt with the principle in good faith and relied on the agent’s apparent authority.

The court held Chan’s individual scienter could be imputed to ChinaCast, finding the adverse interest exception failed in the face of the Plaintiffs’ reliance on Chan’s authority and alleged misrepresentations. The court also found imputation comported with the public policy goals of both securities and agency law by encouraging fair risk allocation and careful oversight of high-ranking corporate officials to deter securities fraud. The court explained that when a corporate officer commits wrongdoing, the principal that placed the agent in a position of trust and confidence should suffer, rather than an innocent third party.

Accordingly, the court held the Plaintiffs’ allegations of imputation were sufficient to survive PSLRA’s pleading requirements.

The primary materials for this case can be found on the DU Corporate Governance website.


More Guidance on Books and Records Requests in Delaware


The recent case of Amalgamated Bank v. Yahoo!, Inc., C.A. No. 10774-VCL (Del. Ch. Feb. 2, 2016) offers useful guidance to those interested in the ever evolving law governing Section 220 books and record requests in Delaware.  

In brief, the case involves a Section 220 request made by Yahoo investors seeking information about the hiring and firing of its z9now ex) Chief Operating Officer Henrique de Castro.  Soon after taking over as CEO, Marissa Mayer received an email from Mr.  de Castro who was then at Google as President of Media, Mobile, and Platforms. de Castro invited Mayer to dinner.  During dinner, de Castro expressed interest in serving as Mayer‘s number two executive at Yahoo. Mayer liked the idea, and she and de Castro began discussing his compensation package. 

The process by which the eventual hiring and firing of Mr. de Castro moved from that initial meeting to its ultimate conclusion of termination of de Castro’s employment and payment of a nearly $60 million severance package was the subject of the Section 220 request.  Amalgamated contended that it had a legally recognized purpose for exploring these matters, namely the ―investigation of potential mismanagement, including mismanagement in connection with the payment of compensation to a corporation‘s officers and directors.

There are many important take-aways from the case.  In no particular order— 

1. Exculpatory Provisions do no automatically preclude a Section 220 request

We know after Southeaster Penns. & Trans. Auth v. Abbvie that plaintiffs will not prevail on a Section 220 request if their only purpose in seeking the books and records is to present a claim that is precluded by an exculpatory provision.  In Abbvie, the court “held that a stockholder who sought books and records for the purpose of bringing a derivative action for breach of fiduciary duty lacked a proper purpose for conducting an inspection where the corporation had an exculpatory provision and the stockholder had not identified a credible basis for believing that that the directors had engaged in non-exculpated conduct.”

Amalgamated Bank makes it clear that if plaintiffs can point to other uses of the information requested Abbvie will not preclude their request.  As long as plaintiffs do not limit “the potential uses of the fruits of its investigation” the request may still be proper.  “The Delaware Supreme Court has stated that [s]tockholders may use information about corporate mismanagement, waste or wrongdoing in several ways. For example, they may institute derivative litigation; seek an audience with the board of directors to discuss proposed reform or, failing in that, they may prepare a stockholder resolution for the next annual meeting, or mount a proxy fight to elect directors. Seinfeld, 909 A.2d at 119-20 (quotation marks and alterations omitted); accord Saito v. McKesson HBOC, Inc., 806 A.2d 113, 117 (Del. 2002). Exculpation is not an impediment to the potential use of information obtained pursuant to Section 220 for taking action other than filing a lawsuit. 

2. Inspection Rights are not limited to paper records but include electronically stored records.  

Yahoo argued that electronic documents are beyond the scope of Section 220, because the statute does not mention ―electronically stored information.  The Court disagreed, noting that “[s]tockholder inspection rights in Delaware date from the turn of the twentieth century, when the courts recognized them under the common law. See, e.g., State ex rel. De Julvecourt v. Pan-Am. Co., 61 A. 398 (Del. Super. 1904), aff’d, 63 A. 1118 (Del. 1904). In that era and for a long time afterwards, courts logically focused on paper documents, but times have changed” and citing numerous cases where electronic records have been required to be produced in response to a Section 220 request.  

3. In a matter of first impression the Court agreed that a Section 220 request can be conditioned by requiring incorporation by reference of all documents produced in any complaint later filed by the investor 

In a novel move, the Court conditioned the production of books and records on Amalgamated's agreement to incorporate by reference the resulting documents in any derivative complaint filed by the investor.    The Court noted:  

  • Section 220(c) of the DGCL gives broad discretion to the Court of Chancery to condition a books and records inspection . . . .United Techs. Corp. v. Treppel, 109 A.3d 553, 557-58 (Del. 2014). By statute, the Court of Chancery ―may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other or further relief as the Court may deem just and proper.‖ 8 Del. C. § 220(c). ―The ability to limit the use of information gathered from an inspection . . . has long been recognized as within the Court of Chancery‘s discretion. United Techs., 109 A.3d at 558. This court has used conditions as part of its effort to ―maintain a proper balance between the rights of shareholders to obtain information based upon credible allegations of corporation mismanagement and the rights of directors to manage the business of the corporation without undue interference from stockholders. Seinfeld v. Verizon Commc’ns, Inc., 909 A.2d 117, 122 (Del. 2006). 

Here, incorporation by reference would prevent cherry picking by Amalgamated and thereby protect Yahoo’s legitimate interest in the fairness of use of the produced books and records.



The Director Compensation Project: Hewlett Packard Company (HPQ)

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation. We are for the most part including companies from 2015’s Fortune 500 and using information found in their 2015 proxy statements. 

NASDAQ and the NYSE have similar rules with respect to director independence. NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors. A director does not qualify as “independent” if he or she has a “material relationship with the company.” NYSE Rule 303A.02(a). In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.

The NYSE imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3) (see Rule 303A.06) and requires consideration by the board of directors of certain specified factors in designating directors for the Compensation Committee.  See NYSE Rule 303A.02(a)(ii). 

Finally, as the Commission has noted with respect to director independence: 

  • All compensation committee members must meet the general independence standards under NYSE’s rules in addition to the two new criteria being adopted herein. The Commission therefore expects that boards, in fulfilling their obligations, will apply this standard to each such director’s individual responsibilities as a board member, including specific committee memberships such as the compensation committee. Although personal and business relationships, related party transactions, and other matters suggested by commenters are not specified either as bright-line disqualifications or explicit factors that must be considered in evaluating a director’s independence, the Commission believes that compliance with NYSE’s rules and the provision noted above would demand consideration of such factors with respect to compensation committee members, as well as to all Independent Directors on the board. 

Exchange Act Release No. 68639 (Jan. 11, 2013); see also Exchange Act Release No. 68641 (Jan. 11, 2013).

Independent directors are compensated for their service on the board. The amount of “total compensation” can be seen from examining the director compensation table from the Hewlett Packard Company’s (NYSE: HPQ) 2015 proxy statement. According to the proxy statement, the company paid the directors the following amounts:


Fees Earned or Paid in Cash

Stock Awards

Option Awards

All Other Compensation


Marc L. Andreessen






Shumeet Banerji






Robert R. Bennett






Rajiv L. Gupta






Klaus Kleinfeld






Raymond J. Lane






Ann M. Livermore*






Raymond E. Ozzie






Gary M. Reiner






Patricia F. Russo






James A. Skinner






Margaret C. Whitman*






Ralph V. Whitworth**






*Employee directors

**Compensation reflects fees earned for service during the last four months of the March 2013 through February 2014 Board term and pro-rated fees earned for service during the portion of the first five months of the March 2014 through February 2015 Board term.

Director CompensationAs of the date of the proxy statement, Hewlett-Packard (HP) had five standing committees and held seventeen board of directors meetings, including six executive sessions. Each incumbent director serving during fiscal 2014 attended at least 75% of the aggregate of all board, as well as applicable committee meetings held during the period that he or she served as a director. Each non-employee director serving during fiscal 2014 was entitled to receive an annual cash retainer of $175,000. HP’s stock ownership guidelines required non-employee directors to accumulate shares of HP common stock equal in value to at least five times the amount of their annual cash retainer within five years of election to the board. Currently, all directors who have served five years or more have met the requirement.

Director TenureIn 2014, Mr. Andreessen and Mr. Gupta, who held their positions as members of the board of directors since 2009, held the longest tenures. Mr. Klausfeld is the newest director and was elected to the board in 2014. Several directors also sit on other boards. Mr. Andreessen is a former director of eBay Inc., and current director of Facebook, Inc., and several private companies. Mr. Bennett currently serves as a director of Discovery Communications, Inc., Liberty Media Corporation and Sprint Corporation. Mr. Gupta is a director of Delphi Automotive PLC, Tyco International Ltd., The Vanguard Group, and several private companies. Mr. Reiner is a director of Citigroup Inc. and several private companies and is a former director of Genpact Limited. Mr. Skinner currently serves as a director of Illinois Tool Works Inc. and previously served as a director of McDonald's. Ms. Whitman also serves as a director of The Procter & Gamble Company and is a former director of Zipcar, Inc. Mr. Kleinfeld also serves as a director of Alcoa, Inc. and Morgan.

CEO CompensationMargaret C. Whitman, who served as HP’s President and Chief Executive Officer, earned $19,612,164 during the 2014 fiscal year. Ms. Whitman became President and CEO of HP in September 2011. Ms. Whitman received a base salary of $1,500,058, $8,147,637 in stock awards, $5,355,075 in option awards, and $4,314,000 in incentive compensation. Ms. Whitman also received $295,394 in additional compensation, $251,666 of which accounted for personal use of the company aircraft. Dion J. Weisler, Executive Vice President in the Printing and Personal Systems Group during 2014, received $13,512,792 in total compensation. Mr. Weisler received $831,251 as base salary, $3,133,726 in stock awards, $2,059,650 in option awards, and $1,722,400 in incentive compensation. HP reported that it paid Mr. Weisler $5,765,765 in “all other compensation,” including $5,060,682 in tax gross-up and $665,298 as part of the Mobility Program. 

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