2019 Year in Review: Securities Litigation and Enforcement

Jason Halper and Kyle DeYoung are partners and Adam Magid is special counsel at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. DeYoung, Mr. Magid, Lex Urban, Victor Bieger and Hyungjoo Han.

There was abundant federal securities litigation activity in 2019. Plaintiffs not only continued to file securities lawsuits at record numbers, but repeatedly secured victories in cases on significant issues of law. The tone was set at the top with the Supreme Court’s landmark decision in Lorenzo v. SEC. There, the Supreme Court clarified, in contrast to its 2011 decision in Janus Capital Group, Inc. v. First Derivative Traders, that a person who does not “make” a fraudulent misstatement can nonetheless be held primarily liable for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder for his or her role in disseminating the misstatement. In so ruling, the Supreme Court effectively eviscerated a popular defense in fraud lawsuits since Janus and reaffirmed that the antifraud provisions of the securities laws cover a “wide range of conduct.”

In multiple other cases, federal courts ruled in favor of plaintiffs and established expanded theories of liability for defendants. For example, in North Sound Capital LLC v. Merck & Co., the Third Circuit held that plaintiffs who opt out of a securities class action are not precluded under the Securities Litigation Uniform Standards Act of 1998 (SLUSA) from bringing state law fraud claims in follow-on individual actions, even if federal claims are time-barred. This opens a potentially significant new avenue for plaintiffs to evade heightened federal pleading standards and limitations periods. The Tenth Circuit, in SEC v. Scoville, clarified that the SEC and DOJ may avail themselves of the expansive “conduct and effects” test under the Dodd-Frank Act to reach securities fraud defendants whose U.S.-based conduct affects foreign defendants or who commit frauds abroad that affect U.S. investors. Courts also adopted expansive views of a “security” subject to federal antifraud rules and registration requirements, applying the concept to an internet traffic exchange service (Scoville) and a new digital “coin” (Balestra v. ATBCOIN LLC).

Plaintiffs were particularly successful in achieving certification of classes asserting securities fraud claims. In case after case, courts certified classes where plaintiffs made a threshold showing that stock traded in an efficient market, or the case primarily involved omissions of material fact. In such cases, courts broadly permitted plaintiffs to avail themselves of a presumption of class-wide “reliance” on the fraud (i.e., the Basic and Affiliated Ute presumptions, respectively), and routinely rejected defendants’ efforts to “rebut” the presumption through competing expert opinions and statistical analyses purporting to sever the link between the fraud and plaintiffs’ losses. In addition, courts virtually shut the door on defendants’ efforts under the Supreme Court’s 2013 decision in Comcast Corp. v. Behrend to defeat class certification by challenging plaintiffs’ ability to show class-wide damages.

But 2019 was not a clean sweep for plaintiffs. Although courts routinely quashed efforts to defeat claims on procedural or technical grounds, they balanced this pro-plaintiff stance by closely scrutinizing evidence of fraud—and dismissing claims outright—in several significant cases. Relying on the common law concept of “puffery,” the Second Circuit (Gross v. GFI Group, Inc. and Singh v. Cigna Corp. ) and the Eleventh Circuit (Carvelli v. Ocwen Financial Corp. ) rejected securities fraud claims on the basis that the alleged misstatements (for example, a commitment to compliance in a company’s code of ethics) were too “general” to be actionable. And the Southern District of New York (Tung v. Bristol-Myers Squibb Co. ) and First Circuit (Metzler Asset Management GmbH v. Kingsley ) likewise demanded detailed factual allegations of defendants’ “scienter” (intent to deceive), and dismissed multiple suits for failure to establish a “strong inference” of scienter. Collectively, these courts sent a clear message that the paramount question in a federal securities fraud suit is whether fraudulent conduct occurred; if not, cases will be dismissed.

From an enforcement perspective, like last year, the SEC continued to focus on protecting retail investors and cyber issues. Overall, the SEC brought 862 total actions in FY 2019, 526 of which were “standalone” actions brought in federal court or as administrative proceedings. While this was a slight increase over FY 2018, a significant number of the standalone actions (95) were brought as part of the Share Class Disclosure Initiative (discussed below), which involved self-reported violations and an accelerated resolution process. Consistent with the agency’s focus on retail investors, there was a significant increase in enforcement actions brought against investment advisers and investment companies (191 total actions accounting for 36% of all actions, compared to 108 and 22% in FY 18) and an increase in enforcement actions related to issuer disclosure and accounting issues (up to 92 from 79 in FY 18). This past year was also a very active year for Foreign Corrupt Practices Act (FCPA) enforcement for the SEC and the DOJ. Conversely, there were large drops in the number of SEC enforcement cases against broker-dealers (down to 38 from 63 in FY18) and insider trading cases (down to 30 from 61 in FY 18).

We discuss these developments—as well as our predictions for 2020—in more detail below.

Traits and Trends

The volume of federal securities fraud class action filings in 2019 remained at near-record highs.
During 2019, plaintiffs filed 428 federal securities fraud class actions, surpassing 2017’s record high
of 413. This was nearly double the average number of filings over the past two decades. There were
more than 1,200 filings from 2017 to 2019—a number that accounts for nearly 25% of all of the
filings in the more than 20 years since 1997.

Contributing to these high levels of filings were plaintiffs’ lawyers targeting new industries. If 2017 and 2018 were the years of cryptocurrency filings—which saw the emergence of suits targeting both established currencies and initial coin offerings—2019 may have been the year of cannabis litigation. A notable number of putative class action suits were filed this year, nearly all of which targeted Canadian-based companies that listed their shares on U.S.-based exchanges following Canada’s 2018 legalization of cannabis-related products. These suits mostly relied on time-tested strategies—claiming, after the announcement of a downturn in performance or unexpected regulatory difficulties, that the company’s prior, rosier disclosures were false or misleading. They demonstrated, however, the extent to which an emerging industry can be fertile ground for putative class actions.

Also responsible for some growth was an increase in parallel filings (whether in both federal and state court or multiple state courts) spurred by the Supreme Court’s 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund. Cyan held that securities class actions under the Securities Act of 1933 (Securities Act) can be brought in state court and are not removable to federal court,
where the Private Securities Litigation Reform Act would provide for more robust procedures for
consolidating parallel litigation. From 2010 to 2017, there was an average of fewer than 6 parallel
actions filed per year, but in 2019, there were 22. Together, state and parallel filings constituted
more than 75% of all 1933 Act filings in 2019.

Despite the high overall volume of securities filings, M&A filings were somewhat soft in 2019 compared to recent years, with filings falling from 182 in the prior year to 160. Included in this category were a broad range of suits challenging proposed transactions, including claims targeting a board’s sales process, conflicts of interest among the directors, and the adequacy of public disclosures. It was widely believed that the increase in such filings in 2017 and 2018 stemmed from the Delaware Court of Chancery’s 2016 decision in In re Trulia, Inc. Stockholder Litigation, which limited Delaware’s receptiveness to non-monetary, disclosure-only settlements of actions challenging M&A transactions. From 2017 to 2019—the three years immediately following Trulia—
the number of securities filings challenging M&A transactions brought in federal court were more than
five times higher than the average from 2009 to 2016. Much of that growth was in the Third
Circuit—home to Delaware—which saw its M&A filings skyrocket from an average of fewer than 10
between 2010 and 2016 to 127 in 2019. The Third Circuit in 2019 dwarfed the other circuits in
M&A filings: compared to its 127 filings, all other circuits combined saw only 33, and the next largest
circuit was the Second Circuit, with 9.

The decline seen in 2019 in M&A filings may, therefore, reflect the federal courts’ steady adoption of Trulia’s approach in federal jurisprudence. The case of House v. Akorn, Inc.25 is illustrative of this trend. In that case, the Northern District of Illinois rejected a proposed settlement in a putative class action challenging an impeding merger. After the action was filed, the target company amended its proxy statement to moot the plaintiffs’ disclosure-based claims. The plaintiffs then voluntarily dismissed their claims in exchange for attorney’s fees based on the supposed benefit those disclosures conferred on the shareholders. Echoing Trulia’s skepticism of the value of such supplemental disclosures, the court deemed the company’s additional disclosures in this case to be “worthless to the shareholders” and exercised the court’s “inherent authority” to reject the mootness fee settlement and order plaintiffs’ counsel to return the fee award to the company. The decision is currently on appeal to the Seventh Circuit.

On the regulatory front, the SEC enforcement program continues to prioritize retail investor protection. A particular area of focus is misconduct related to the interactions between investment professionals and investors. This not only includes traditional retail cases such as Ponzi schemes and microcap fraud but also cases against investment advisers and investment companies related to conflict of interests and the failure to adequately disclose fees and costs to investors as well as cases against broker-dealers for excess commissions. An example of this focus going forward is the Enforcement Division’s Teachers Initiative in which the SEC will be “looking at the compensation and sales practices of third-party administrators of teacher retirement plans—often known as 403(b) plans—as well as the practices of their affiliated advisers and broker dealers” for potential conflicts of interest.

This past year was another busy year for cyber enforcement. The SEC brought a number of significant ICO-related enforcement actions related to digital assets, including cases related to the proper registration of coin offerings and fraudulent ICOs. Chairman Clayton has made it clear that the SEC will stay active in this space and continue to scrutinize ICOs and other digital asset securities to ensure they comply with federal securities laws.

Finally, SEC remedies for securities law violations were a hot topic in 2019 and will be in 2020. As we discuss further below, the Supreme Court agreed to review a case that will likely decide whether the SEC has the authority to seek disgorgement in enforcement actions it brings in federal court. The SEC also continues to look for ways to use remedies other than financial penalties to further its enforcement goals. The SEC brought a number of enforcement actions in 2019 where it required parties to comply with detailed undertakings to further the SEC’s remedial objectives and address the wrongdoing at issue and this trend will likely continue.

Looking Ahead

We expect 2020, like 2019, to be an eventful year in securities litigation and enforcement. In particular, we will be watching for noteworthy developments in the following areas:

  • Will plaintiffs’ success continue? In 2019, numerous significant decisions came down in favor of plaintiffs, from endorsing expanded theories of liability to rejecting challenges at the class certification One of the ongoing struggles in securities law is the balance between permitting meritorious claims, on the one hand, and dialing back on frivolous suits and abuses, on the other. We will watch for counter-trends in the year to come.
  • The evolving scope of “scheme liability” in the wake of The Supreme Court’s decision in Lorenzo, discussed above, made clear that the question in a securities fraud suit is not whether someone “made” a misstatement, but whether the defendant participated in a fraudulent “scheme.” We already have seen courts in multiple jurisdictions sustain fraud claims on this basis. We expect defendants to test the outer limits of “scheme” liability, and courts to offer further guidance, in the year ahead.
  • Scope of Morrison in predominantly foreign transactions. As discussed above, in 2019, the Supreme Court refused to hear an appeal from the Ninth Circuit’s decision, in Stoyas, concerning the extraterritorial reach of Section 10(b) The Ninth Circuit held that a foreign issuer can be subject to Section 10(b) liability in connection with a purely domestic transaction in its securities in which the foreign issuer had no direct involvement. That parted ways with the Second Circuit, which has held a domestic transaction is not sufficient, in and of itself, for Section 10(b) liability if the transaction is otherwise “predominantly foreign.” In declining to review Stoyas, the Supreme Court was unmoved by the petitoner’s view that the Ninth Circuit’s decision opened a split “between the two most important circuits in U.S. securities law, on the crucial question of when application of the U.S. Securities Exchange Act is impermissibly extraterritorial.” We will watch the impact of this split, including the potential for forum shopping to drive plaintiffs in these close cases of extraterritoriality to the Ninth Circuit.
  • Duty to update historical information. In 2019, the Supreme Court also refused to hear an appeal of a Ninth Circuit decision holding that a biopharmaceutical company had a duty to disclose new information relating to one of its prior disclosures of the early results of clinical tests of one of its The Ninth Circuit held that while the earlier disclosure was “still technically accurate,” the company had a duty to disclose the new information because that new information “diminished” the “weight” and “value” of the previous disclosures. That decision appears to be in tension with six other circuits, five of which (the First, Second, Third, Fifth, and Eleventh) generally limit the duty to update to two narrow types of prior statements: prior statements that are forward-looking and still “alive” in investors’ minds, and prior statements that deal with a fundamental transaction, like a merger or liquidation. The approach of those circuits seems narrower than the Ninth Circuit’s relatively unconstrained duty that, arguably, would apply any time new information diminishes the “weight” and “value” of prior information. The Seventh Circuit, meanwhile appears to reject any duty to update at all. In the view of one commentator, this “bewildering case law is in dire need of clarification and consistency,” and we will watch how this split plays out in the lower courts.
  • Standard for rebutting presumption of reliance. In a long-running battle in Arkansas Teacher Retirement System Goldman Sachs, Goldman Sachs is challenging before the Second Circuit a district court’s decision to re-certify a class in a suit alleging that Goldman Sachs and several directors made false statements about Goldman Sachs’s conflicts of interest in a major underwriting, which, when revealed, allegedly caused a drop in Goldman Sachs’s stock. The dispute revolves around the evidence necessary to rebut a putative class’s reliance on the “price maintenance” theory at class certification stage—a theory that a misstatement affected a security’s price not by artificially inflating it, but by causing it to remain artificially high until the fraud was finally revealed. In 2018, the Second Circuit held the district court may have imposed too high a bar on the showing a defendant needs to make to rebut that theory and instructed the district court to apply a “preponderance of the evidence” standard to determine whether it was more likely than not that the alleged misstatements caused the security to maintain an artificially-high price. On remand, the district court weighed dueling expert evidence and concluded that, on balance, Goldman Sachs had failed to undercut the evidence the plaintiffs submitted that suggested a link between the misstatements and the price of its stock. Goldman Sachs again appealed, contesting the district court’s view of the evidence and its rejection of Goldman Sach’s argument that certain of the supposed misstatements were not of the type capable of maintaining price inflation in an issuer’s stock. Oral argument was heard in June 2019, and the decision is pending.
  • Disgorgement for securities law violations. As discussed above, the Supreme Court recently granted certiorari in a case that squarely address the question of whether the SEC has the statutory authority to seek disgorgement in District Court A loss in this case would be a major blow to the SEC. The Commission routinely seeks disgorgement in its enforcement actions and obtained orders for more than $2.5 billion in disgorgement in FY 2018 alone. While much of this is obtained through settled actions filed as administrative proceedings—where the SEC is authorized by statute to seek disgorgement—losing the ability to obtain disgorgement in enforcement actions brought in federal court would have a significant impact on the SEC’s enforcement program. At the same time, the Supreme Court’s review of the case also may make Congressional action more likely. The ability of the SEC to make wrongdoers pay back ill-gotten gains is an issue that generally has bipartisan support and Congress has debated providing the SEC with explicit authority to obtain disgorgement in district court cases since Kokesh. Given the very real possibility that the Supreme Court takes away this power, it may provide the impetus for Congress to grant explicit authorization in 2020.
  • Regulation Best Interest. The compliance date for Regulation Best Interest (Reg BI), which was adopted by the SEC in June 2019, is June 30, Reg BI will require broker-dealers to “act in the best interest” of retail customers when recommending securities transactions or giving advice to retail customers. The SEC’s Office of Compliance, Inspections, and Examinations has indicated that it will begin to assess firms’ implementation of the Reg BI requirements after the compliance date. How the SEC will approach potential violations of Reg BI is a big question for the end of 2020 and beyond.
  • Cryptocurrency and ETF fund proposals. The SEC has consistently refused to approve exchange-traded funds (ETFs) based on underlying ownership of cryptocurrency “coins.” In our last update, we noted that we were watching a proposal filed with the SEC by the CBOE BZX Exchange, seeking a proposed rule change that would permit the exchange to list and trade shares issued by the VanEck SolidX Bitcoin After a number of delays (one of which was driven by the 2019 government shutdown), BZX, in September 2019, withdrew its proposal without explanation. A new proposal, filed in mid-2019 by Wilshire Phoenix, contains a twist on past attempts to launch cryptocurrency ETFs: this proposed product would invest in a mix of Bitcoins and U.S. Treasury bills, in a ratio determined by reference to an underlying index with a Bitcoin component and a Treasury bills component that uses a passive, rules-based methodology to rebalance the two asset classes as the volatility of Bitcoin prices fluctuates. Through that approach, the proposal seeks to reduce the level of volatility normally associated with Bitcoin investments to increase the likelihood of obtaining SEC approval. In December 2019, the SEC announced that it would extend the time for it to deliberate on the proposal until February 2020 to allow for sufficient time to evaluate the proposal.

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The complete report, including footnotes, is available here.

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