Securities Litigation Premised on Failure to Disclose Alleged Underlying Illegal Conduct

Samuel P. Groner is partner and Fara M. Saathoff is an associate at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum. Related research from the Program on Corporate Governance includes Rethinking Basic by Lucian Bebchuk and Allen Ferrell (discussed on the Forum here); and Price Impact, Materiality, and Halliburton II by Allen Ferrell and Andrew Roper (discussed on the Forum here).

In our Summer 2018 update, we discussed a number of recent district court decisions in securities cases premised on the theory that the company failed to disclose, in alleged violation of the securities laws, that it was engaged in underlying anti-competitive conduct. In each of those cases, the court held that the heightened pleading standard imposed by the Private Securities Litigation Reform Act of 1995 (“PSLRA”)—which requires that fraud be pleaded with particularity—applied not only to the allegations that the securities laws had been breached, but also in determining whether the plaintiff had adequately pleaded the existence of the alleged underlying anti-competitive conduct.

In Gamm v. Sanderson Farms, Inc., 944 F.3d 455 (2d Cir. 2019), that issue came before the Second Circuit. Consistent with the district court decisions discussed in our Summer 2018 update, the Second Circuit held that “when a securities fraud complaint claims that statements were rendered false or misleading through the nondisclosure of illegal activity, the facts of the underlying illegal acts must be pleaded with particularity in accordance with the requirements of Rule 9 and the PSLRA.” Id. at 466-67.


In Gamm, a series of antitrust lawsuits were filed against chicken producer Sanderson Farms and a number of its competitors. The lawsuits alleged that Sanderson Farms colluded with those competitors to manipulate the price of chicken by monitoring supply and suppressing its own supply at times when the price of chicken was high. Among the allegations were claims that Sanderson reduced supply by destroying breeder hens and eggs, exporting eggs from the U.S., and dumping excess chicken inventories in foreign markets where they sold for a fraction of the U.S. market price. This was alleged to have been accomplished, in part, through the manipulation of one of three chicken price indices, the Georgia Dock, which was alleged to have a less rigorous verification process as compared to the other indices.

The antitrust lawsuits, as well as various newspaper articles revealing that the United States Department of Agriculture had started an inquiry into the Georgia Dock index, prompted shareholders to bring securities fraud claims. The shareholders alleged that Sanderson’s failure to disclose the collusive acts rendered various statements issued in its SEC filings false and misleading. In particular, the shareholders alleged that the company’s statements that it was subject to significant competition from regional and national firms were materially false and misleading because of Sanderson’s involvement in the alleged price-fixing scheme.

The district court granted the defendants’ motion to dismiss, holding that because “‘[p]laintiffs fail[ed] to support their allegation of a chicken supply reduction conspiracy with particularized facts,’ they had not properly alleged a Section 10(b) violation.” Id. at 462.

The Second Circuit’s Decision

On appeal, the appellants “acknowledge[d] that their allegations of misstatements and omissions—also known as the ‘falsity’ prong of a 10(b) action—must be pleaded with particularity,” but disagreed with the district court’s determination that “facts of the underlying antitrust conspiracy must similarly be pleaded with particularity.” Id. at 463. Rather, they argued that facts in that latter category “must merely meet the Rule 8 plausibility standard.” Id. They asserted that “‘there is no public policy reason’ supporting the use of a heightened pleading standard for allegations of anticompetitive conduct ‘simply because they underpin a securities fraud class action.’” Id.

In affirming the district court’s decision, the Second Circuit rejected those arguments and held that the “alleged fraud and the facts of the alleged anticompetitive conspiracy [were] inseparable” and that “the clear language of the [PSLRA], the existing case-law, and the stated intent of the securities laws” all lead to the conclusion that “when a complaint claims that statements were rendered false or misleading through the non-disclosure of illegal activity, the facts of the underlying illegal acts must also be pleaded with particularity.” Id. at 463, 465.

Looking to the language of the PSLRA, the Second Circuit emphasized the statute’s requirement that “all facts” be pleaded with particularity. Id. at 463. The court explained that appellants’ “nondisclosure and material omission claims [were] entirely dependent upon the predicate allegation that Sanderson participated in a collusive antitrust conspiracy” and, as such, “[i]n order to properly provide ‘all facts’ upon which their securities fraud claim [was] based, their allegations must also provide particularized facts about the underlying conspiracy.” Id. The court added that “appellants must plead sufficient—though not exhaustive—facts describing the essential elements of that underlying conduct.” Id. at 464.

In reaching that determination, the Second Circuit cited, among other cases, the cases cited in our Summer 2018 update. See Hogan v. Pilgrim’s Pride Corp., 2018 WL 1316979 (D. Colo. Mar. 14, 2018); In re Tyson Foods, Inc. Sec. Litig., 275 F. Supp. 3d 970 (W.D. Ark. 2017). It emphasized that “[d]istrict courts within this circuit have correctly taken the view that when the nondisclosure of an illegal act is the basis of a 10(b) complaint, the illegal act must be alleged with particularity” and that “[d]istrict courts in other circuits that have considered follow-on securities class actions arising out of allegations of antitrust conspiracy have all concluded that antitrust schemes must be pleaded with particularity.” Id. at 463.

Applying that standard, the Second Circuit held that appellants needed to allege with particularity “the basic elements of an underlying antitrust conspiracy, which are: ‘(1) a contract, combination, or conspiracy; (2) in restraint of trade; (3) affecting interstate commerce.’” The Court held that, “appellants provid[ed] no facts alleging that Sanderson or its peers actually reduced supply, and that these reductions were the result of an agreement, or were even interrelated.” Id. at 465. Specifically, “[a]ppellants could have alleged when Sanderson Farms decided on its course of supply reduction, which industry peers were a part of that decision, how specific supply reductions were performed by each of the different poultry products, what information Sanderson Farms knew about its peers’ supply reductions, if any, and—perhaps the most basic of all—whether Sanderson Farms actualy reduced chicken supply, and if so, by what volume.” Id. at 465-466. The court concluded that appellants “failed to plead the first element of antitrust conspiracy agreement at even a basic level, much less with particularity” and that the complaint similarly failed to adequately plead with particularity the second and third elements of an antitrust conspiracy agreement. Id. at 466.

Key Takeaway

Although the Gamm case arose in the context of an alleged underlying antitrust conspiracy, the Second Circuit’s ruling makes clear that its holding applies no matter the nature of the underlying allegedly illegal acts.

For example, a district court recently cited the Gamm decision as the basis for dismissing a securities fraud complaint premised on a supposed failure to disclose an alleged bribery scheme. See Schiro v. Cemex, S.A.B. de C.V., 438 F. Supp. 3d 194 (S.D.N.Y. 2020). As the district court explained, because the company’s statements “were materially misleading only if bribes were actually paid, Plaintiffs must plead sufficient facts describing the essential elements of the alleged bribery” by pleading “factual allegations of exactly who made the payments, to whom the payments were made, when the payments were made, or how the payments were made.” Id. at 198-99. The district court concluded that “[b]ecause Plaintiffs have failed to plead with particularity the existence of an underlying bribery scheme, they cannot plead that [the company] committed fraud by failing to disclose the payment of bribes.” Id. at 199-200.

In sum, whether the underlying allegedly illegal scheme involves anti-competitive conduct, bribery, or any other alleged illegal conduct, we anticipate that the Gamm decision will have significant ramifications in curtailing follow-on securities litigation premised on failure to disclose unproven supposed illegal conduct.

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