Securities Litigation 2024 Mid-Year Update
Client Alert | September 4, 2024
This update provides an overview of the major developments in federal and state securities litigation since our Securities Litigation 2023 Year-End Update.
Table of Contents
I. Filing And Settlement Trends
II. What To Watch For In The Supreme Court
III. Delaware Developments
IV. Federal SPAC Litigation
V. ESG Civil Litigation
VI. Cryptocurrency Litigation
VII. Lorenzo Disseminator Liability
VIII. Market Efficiency And “Price Impact” Cases
IX. Other Notable Developments
Gibson Dunn’s 2024 Mid-Year Update covers the following developments:
- We review the Supreme Court’s decisions in Macquarie Infrastructure Corp. v. Moab Partners, L.P., which recognizes that a suit under Rule 10b-5 cannot be based on pure omissions, and SEC v. Jarkesy, which limits the SEC’s power to conduct administrative enforcement proceedings in certain cases. We also preview two cases that will address pleading standards and the nature of “materially misleading” statements under the PSLRA.
- We detail significant developments in Delaware corporate law, including a Delaware Supreme Court ruling on advance notice bylaws and a novel ruling on the duties of controlling stockholders when exercising stockholder-level voting power. We also provide updates on Moelis and Tornetta v. Musk.
- We discuss the SEC’s latest rule applicable to SPACs and its significance along with the fact-specific approach courts have taken in SPAC litigation.
- A growing number of lawsuits challenge public companies’ environmental, social, and governance (ESG) disclosures and policies. We survey recent developments in this space.
- Cryptocurrency saw noteworthy developments in private litigation and in actions by the SEC—which has been ramping up enforcement efforts. We discuss these developments along with court rulings and legislative efforts impacting transactions and compliance.
- We continue to monitor case law developments related to the Supreme Court’s 2019 decision, Lorenzo v. SEC, in which the Supreme Court found that even if the disseminator of a false statement did not “make” or draft that false statement within the meaning of Rule 10b-5(b), the disseminator may still be liable under Rule 10b-5(a) and (c) if they disseminate a false statement with intent to defraud.
- District courts continue to engage with defendants’ attempts to defeat or limit class certification by rebutting the Basic presumption of reliance with evidence that the alleged misstatements had no impact on the stock price. We review several of these opinions in Section VIII, Market Efficiency And “Price Impact” Cases.
- Finally, we address several other notable developments including the following: the Seventh Circuit outlining the procedure for reassessment of mootness fees paid to shareholder plaintiffs after a merger following voluntary dismissal of their suit; the Sixth Circuit joining the majority of circuits in holding that the bespeaks caution doctrine survives the PSLRA; the Ninth Circuit providing additional guidance on determining loss causation and alleged misstatements related to COVID-19; and the SEC’s finalization of amendments to Regulation S-P aimed at enhancing data protections.
I. Filing And Settlement Trends
A recent NERA Economic Consulting (NERA) study provides an overview of recent developments in federal securities litigation filings. This section highlights several notable trends.
A. Filing Trends
Figure 1 below reflects the federal filing rates from 1996 through 2024. In the first half of 2024, 112 federal cases were filed. On an annualized basis, that number largely matches the number of federal filings in 2023, but it is considerably lower than in the peak years of 2017-2019. Note, however, that this figure does not include class action suits filed in state court or state court derivative suits, including those in the Delaware Court of Chancery.
Figure 1:
B. Mix Of Cases Filed In 2023
1. Filings By Industry Sector
As shown in Figure 2 below, the distribution of non-merger objections and non-crypto unregistered securities filings in the first half of 2024 varied somewhat from 2023. Notably, after a dip in 2023, the “Health and Technology Services” sector percentage returned to the percentages seen in 2021 and 2022. Similarly, the percentage of “Electronic Technology and Technology Services” filings increased in 2024, returning to levels seen in 2021 and 2022. Together, “Health and Technology Services” and “Electronic Technology and Technology Services” filings once again comprised over 50% of filings after dipping to 41% in 2023. Meanwhile, “Finance” sector filings decreased from 18% to 11%.
Figure 2:
2. Filings By Type
As shown in Figure 3 below, Rule 10b-5 filings make up the vast majority of federal filings so far this year. In fact, projecting out to a full year, filings of other types are slated to end up at their lowest levels in years.
Figure 3:
3. Filings By Circuit
Figure 4 provides insight into the distribution of federal filings by Circuit. Most filings occur in the Second and Ninth Circuits. Notably, the number of filings in the Second Circuit has been trending down since 2021. By contrast, the number of filings in the Ninth Circuit has stayed steady or increased over that same period.
Figure 4:
4. Event-Driven And Other Special Cases
Figure 5 illustrates trends in the number of event-driven and other special case filings since 2020. The number of Artificial Intelligence-related filings already equals the total number of such filings in 2023 and 2022. By contrast, SPAC and Cybersecurity and Customer Privacy Breach filings have decreased steadily since 2021. And after 11 such filings in 2023, zero Banking Turmoil cases have been filed this year.
Figure 5:
C. Settlement Trends
As reflected in Figure 6 below, the average settlement value so far in 2024 is $26 million. That is a sizable drop from the past two years. If it remains at that level, it would be the second-lowest average settlement value on an inflation-adjusted basis in nearly a decade. (Note that the average settlement value excludes merger-objection cases, crypto unregistered securities cases, and cases settling for more than $1 billion or $0 to the class.)
Figure 6:
As for median settlement value, that value has likewise dropped noticeably from 2022 and 2023. (Note that median settlement value excludes settlements over $1 billion, merger objection cases, crypto unregistered securities cases, and zero-dollar settlements.)
Figure 7:
II. What To Watch For In The Supreme Court
A. Recent Supreme Court Decisions
1. Macquarie Infrastructure Corp. v. Moab Partners, L.P. – Rule 10b-5 Does Not Support Private Actions Based On Pure Omissions
On April 12, 2024, the Supreme Court unanimously decided Macquarie Infrastructure Corp. v. Moab Partners, L.P., holding that an issuer of securities does not violate Exchange Act Section 10(b) or the SEC’s Rule 10b-5 by pure omission—that is, by mere nondisclosure of material information—unless that omission renders other, affirmative statements by the issuer misleading. 601 U.S. 257, 265 (2024).
Moab Partners, L.P. filed this private securities-fraud action under Section 10(b) and Rule 10b-5 against the defendants, Macquarie Infrastructure Corp. and related individuals and entities, asserting that the nondisclosure of certain information in Macquarie’s SEC filings constituted an actionably misleading omission of material information. Id. at 261. The information at issue related to the principal assets of a Macquarie subsidiary, storage terminals for a particular high-sulfur fuel oil. Id. The United Nations enacted a 2016 rule that aimed to cap the sulfur content of fuel oil used in shipping, and Macquarie did not disclose in its filings any potential impact of that rule on its subsidiary’s business. Id. In February 2018, Macquarie announced that demand for the subsidiary’s storage had decreased due to a decline in the market for the high-sulfur fuel oil, and Macquarie’s stock price dropped by 41%. Id.
Moab Partners argued that the failure to disclose any risks associated with the 2016 rule violated Macquarie’s duty, under Item 303 of Regulation S-K, to disclose in its annual Form 10-K filing all “known trends or uncertainties that . . . are reasonably likely to have a material . . . impact” on its operations. Id. at 260, 265. According to Moab Partners, nondisclosure of a known trend with material implications in violation of Item 303 constituted a materially misleading omission in violation of Rule 10b-5. See id. at 265.
The Court disagreed, finding no actionable statements or omissions because Moab Partners failed to “plead any statements rendered misleading” by Macquarie’s alleged pure omission. Id. at 265 (emphasis added). Because Rule 10b-5 requires only “disclosure of information necessary to ensure that statements already made are clear and complete,” it covers “half-truths,” but not “pure omissions.” Id. at 264 (emphasis added). A failure to disclose information required by Item 303 can sustain a Rule 10b-5 claim only when the omission renders other affirmative statements misleading. Id. at 265.
This holding affirms the longstanding precedent from Basic Inc. v. Levinson that “[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5.” Id. (quoting Basic, 485 U.S. 224, 239 n.17 (1988)). It also clarifies that “[e]ven a duty to disclose . . . does not automatically render silence misleading.” Id.
2. SEC v. Jarkesy – Successful Constitutional Challenge To SEC’s Method Of Adjudication
On June 28, 2024, the Supreme Court announced its 6-3 decision in SEC v. Jarkesy, holding that the Seventh Amendment right to a jury trial applies in cases where the SEC seeks civil penalties for securities fraud. 144 S. Ct. 2117 (2024).
In the Dodd-Frank Act of 2010, Congress empowered the SEC to seek civil penalties against violators of its antifraud regulations either in federal court or through “in-house” administrative proceedings. Id. at 2126. In these in-house proceedings, unlike in federal court, there is no opportunity to have the case heard by a jury, and cases are tried before an SEC-appointed administrative law judge (ALJ), rather than by a Senate-confirmed Article III judge. Id. at 2125-26.
Respondents George Jarkesy Jr. and Patriot28 LLC were subject to an SEC enforcement action that sought civil penalties for alleged violations of the federal securities laws’ antifraud provisions. Id. at 2124. The SEC proceeded against Jarkesy and Patriot28 before an SEC ALJ, rather than in court. Id. at 2125. The ALJ ruled for the agency and against the respondents, and after review of the ALJ’s decision, the SEC imposed a penalty of $300,000, ordered disgorgement against Patriot28, and prohibited Jarkesy from participating in the securities industry. See id. at 2127.
The respondents sought review by the U.S. Court of Appeals for the Fifth Circuit, raising constitutional procedural and structural objections. See id. A divided panel of the Fifth Circuit ruled for the respondents, citing three constitutional infirmities. First, because enforcement of the antifraud securities laws is “akin to . . . traditional” causes of action involving debts, where a defendant historically would have been entitled to a jury trial, a defendant facing antifraud securities claims is entitled to a jury trial. Jarkesy v. SEC, 34 F.4th 446, 453-54 (5th Cir. 2022). Second, Congress’s grant of “unfettered” discretion to the SEC to bring enforcement actions in court or administratively was an unconstitutional delegation of power. Id. at 459. Third, the agency structure surrounding ALJs restricted the President’s Article II authority, as it gave ALJs two layers of for-cause protection from removal that blocked the President from exercising “adequate power over . . . removal.” Id. at 463.
The Supreme Court granted certiorari to review all three of the Fifth Circuit’s holdings. See Brief for Petitioner at i. However, the Court declined to reach the nondelegation and ALJ-removal questions, affirming the decision below only on the Seventh Amendment issue. Jarkesy, 144 S. Ct. at 2127-28.
In holding that the respondents were entitled under the Seventh Amendment to a jury trial on these claims, the Court explained that the securities antifraud provisions were intended to “replicate common law fraud” claims that require a jury trial. See id. at 2127. The Seventh Amendment jury right extends to all suits that are “legal in nature”—including those that seek monetary damages in order to punish or deter violations, as distinct from equitable relief like disgorgement. See id. at 2128-30. The antifraud provisions’ resemblance to common-law fraud claims, and the legal nature of the damages remedy, confirmed that the Framers would have intended the jury right to apply to actions enforcing these provisions. See id. at 2128-31.
The Court rejected the SEC’s argument that the case fell under the “public rights” exception for cases that “historically could have been determined exclusively by the executive and legislative branches.” See id. at 2132 (cleaned up). While its public rights doctrine has not always charted a clear course, the Court explained that the doctrine emphasizes that traditional suits at common law should be adjudicated in courts and has maintained a “presumption . . . in favor of Article III courts.” Id. at 2134. Thus, even modern regulatory suits modeled after traditional legal claims should remain with Article III courts, no matter where Congress might have assigned them. See id. at 2131, 2135-36.
As the Court explained in conclusion, “a defendant facing a fraud suit has the right to be tried by a jury of his peers before a neutral adjudicator.” Id. at 2139. Because the SEC’s enforcement action against the respondents involved similar fraud-related claims, the proceeding before an SEC ALJ had violated the respondents’ Seventh Amendment rights.
B. Grants Of Certiorari
1. Facebook, Inc. v. Amalgamated Bank – Whether Risk Disclosures Must Acknowledge Past Incidents
On June 10, 2024, the Supreme Court granted the petition for a writ of certiorari in Facebook, Inc. v. Amalgamated Bank, a private securities-fraud class action challenging the adequacy of Facebook’s disclosures about third-party use of personal data.
The plaintiff shareholders allege that Facebook made fraudulent misstatements in filings where it purportedly characterized the risk that third parties might misuse Facebook user data as a “hypothetical” risk. Petition for Writ of Certiorari at 10, Facebook, Inc. v. Amalgamated Bank, No. 23-980 (Mar. 4, 2024). The plaintiffs contend the risk had already materialized through third parties’ actual misuse of Facebook user data. Id.
In the decision below, the Ninth Circuit ruled that a risk disclosure is materially misleading when it fails to disclose that the identified risk has materialized in the past, even if that past event presents no known risk of harm to the company. In re Facebook, Inc. Sec. Litig., 87 F.4th 934, 949-50 (9th Cir. 2023). The Circuit explained that “[b]ecause Facebook presented the prospect of a breach as purely hypothetical when it had already occurred, such a statement could be misleading even if the magnitude of the ensuing harm was still unknown.” Id. at 950.
According to the petition, this holding placed the Ninth Circuit at odds with its sister circuits. As Facebook argued, the First, Second, Third, Fifth, Tenth, and D.C. Circuits have all held that companies must disclose risks that materialize only when the company knows, or believes with near certainty, that the materialized risk will harm the business. Petition at 19-22. The Sixth Circuit, on the other hand, has held that companies are not required to disclose when risks materialized in the past because “[r]isk disclosures like the ones accompanying 10-Qs and other SEC filings are inherently prospective in nature.” Id. at 18 (quoting Bondali v. Yum! Brands, Inc., 620 F. App’x 483, 491 (6th Cir. 2015)).
Gibson Dunn represents the petitioners in this case, which has been scheduled for oral argument on November 6, 2024.
2. NVIDIA Corp. v. E. Ohman J:or Fonder AB – PSLRA Pleading Standards For Scienter and Falsity
On June 17, 2024, the Supreme Court granted the petition for a writ of certiorari in NVIDIA Corp. v. E. Ohman J:or Fonder AB, another private securities-fraud class action originating in the Ninth Circuit involving alleged violations of Section 10(b) and Rule 10b-5. This case raises two questions regarding the pleading standard for private class actions under the Private Securities Litigation Reform Act of 1995 (PSLRA).
This case was brought by investment management fund E. Öhman J:or Fonder AB and other investors against NVIDIA, a producer of graphics processing units (GPUs). As alleged in the plaintiffs’ complaint, NVIDIA’s GPUs include the “GeForce” branded GPU, which is designed and marketed for use in video gaming, but which began around 2017 to also be used for mining cryptocurrency. E. Ohman J:or Fonder AB v. NVIDIA Corp., 81 F.4th 918, 924-27 (9th Cir. 2023); Petition for Writ of Certiorari at 8, NVIDIA Corp. v. E. Ohman J:or Fonder AB, No. 23-970 (Mar. 4, 2024). Plaintiffs alleged that NVIDIA’s CEO and other defendants made statements that misrepresented the connection between the company’s increased revenues and the fact that cryptocurrency miners—not just video game players—were purchasing GeForce GPUs. E. Ohman J:or Fonder AB, 81 F.4th at 925. Because the demand for GPUs tied to cryptocurrency mining has been “extremely volatile,” subject to changes in the price of cryptocurrency, the company’s denials of a link between its growth and cryptocurrency-related usage were allegedly material to investors and analysts. See id. at 924-27.
To support their claims that NVIDIA had knowingly or recklessly misled investors about the source of demand for GeForce GPUs, plaintiffs’ amended complaint relied heavily on witness statements from former NVIDIA employees and the independent analysis of an expert consulting firm. Id. at 929-30, 937-39. The district court dismissed the amended complaint, finding the plaintiffs had not adequately pleaded the element of scienter under the PSLRA, specifically that plaintiffs’ allegations that NVIDIA as a company had access to certain sales and usage data did not plausibly show that each individual defendant had access to that data, and thus spoke with knowledge or recklessness of falsity. Iron Workers Local 580 Joint Funds v. NVIDIA Corp., 522 F. Supp. 3d 660, 674-75 (N.D. Cal. 2021). The Ninth Circuit reversed, reinstating the amended complaint as to NVIDIA’s CEO based on specific statements from former employees about the company and the CEO’s practices. E. Ohman J:or Fonder AB, 81 F.4th at 937-40. The Ninth Circuit also held that the amended complaint adequately alleged falsity, where it relied primarily on a post hoc expert analysis of NVIDIA’s reported revenues compared to the statements by company insiders at the time. Id. at 930-32.
In NVIDIA, the Supreme Court will consider two questions regarding pleading standards under the PSLRA. First, petitioners, NVIDIA and its CEO, argue one existing circuit split exists on the standard for pleading scienter: namely, whether plaintiffs who seek to rely on “internal company documents must plead with particularity the contents of these documents.” Petition at i. Second, petitioners also claim to identify a new circuit split, created by the decision below, on the element of falsity: whether the PSLRA’s falsity requirement may be satisfied at the pleading stage by expert opinions, in lieu of particularized allegations of fact. Id.
Oral argument in NVIDIA is scheduled to be held on November 13, 2024.
A. The Delaware Supreme Court Underscores The Importance Of Fully Informed Stockholders Under MFW
Two recent Delaware Supreme Court cases emphasize (1) the importance of disclosing conflicts of interest when seeking to fully inform stockholders, and (2) that Delaware courts pay close attention to claims that a minority was fully informed when an entity seeks to obtain business judgment review by employing the procedural devices set forth in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (MFW).
In City of Dearborn Police & Fire Revised Retirement System v. Brookfield Asset Management Inc., plaintiffs brought breach of fiduciary duty claims related to a squeeze-out merger. 314 A.3d 1108, 1113 (Del. 2024) (en banc). The trial court dismissed plaintiff’s complaint after concluding defendants complied with MFW’s requirements and applying the business judgment rule. Relevant here, plaintiffs claimed on appeal that the “trial court erred in finding that MFW was satisfied because they failed to adequately plead that the proxy statement was materially deficient.” Id.
Affirming in part and reversing in part, the en banc Supreme Court agreed that the proxy statement omitted important information. Among other things, it held that the “minority stockholders were not adequately informed of certain alleged conflicts of interest between the special committee’s advisors and the counterparty to the Merger.” Id. For example, the proxy failed to disclose that Morgan Stanley—which the controlled target entity’s (TerraForm) special committee retained—had a $470 million stake in Brookfield (TerraForm’s controller). In the Supreme Court’s view, “the $470 million investment, when viewed from the perspective of a reasonable stockholder, was material and should have been disclosed.” Id. at 1133. Similarly, the proxy failed to disclose that Kirkland & Ellis LLP—the law firm TerraForm’s special committee retained—had previously represented “Brookfield and its affiliates” and was “concurrent[ly] represent[ing] . . . a Brookfield affiliate on an unrelated transaction.” Id. at 1134. And, again, the Supreme Court held that “it [wa]s reasonably conceivable that the details of Kirkland’s conflicts, and particularly, the concurrent conflict, were material facts for stockholders that required disclosure.” Id.
City of Sarasota Firefighters’ Pension Fund v. Inovalon Holdings, Inc. is similar in several respects. 2024 WL 1896096 (Del. May 1, 2024) (en banc). There, plaintiffs “asserted several breach of fiduciary duty claims, an unjust enrichment claim, and a claim alleging a breach of the Company’s charter” in connection with “an acquisition of Inovalon Holdings, Inc. . . . by a private equity consortium led by Nordic Capital.” Id. at *1. As in Brookfield, the Court of Chancery dismissed the complaint after finding “the requirements of MFW were met.” Id. at *8. And, as in Brookfield, the Delaware Supreme Court disagreed. Among other things, the Supreme Court explained that the proxy failed to adequately disclose the special committee’s advisors’ conflicts of interest. Id. at *15. Inovalon further underscores the importance of disclosing a special committee’s advisors’ conflicts of interest if an entity wishes to benefit from MFW and the business judgment rule.
B. The Delaware Supreme Court Addresses Advance Notice Bylaws
In Kellner v. AIM ImmunoTech, Inc., the Delaware Supreme Court provided helpful insight into how Delaware courts will review advance notice bylaws. __ A.3d __ , 2024 WL 3370273 (Del. 2024). As explained in our 2023 Year-End Update, the Court of Chancery invalidated several advance notice bylaws that AIM’s Board adopted in connection with a group of stockholders’ activism campaign and proxy contest efforts, reinstated a prior version of one of the bylaws, and then “upheld the board’s rejection of [a stockholder’s] third nomination notice because it failed to comply with the two advance notice bylaws left standing.” Id. at *1.
On appeal, the Delaware Supreme Court affirmed in part and reversed in part. It began by noting the two-part inquiry for assessing challenges to “the adoption, amendment, or enforcement of a Delaware corporation’s advance notice bylaws”: (1) “whether the advance notice bylaws are valid as consistent with the certificate of incorporation, not prohibited by law, and address a proper subject matter,” and (2) “whether the board’s adoption, amendment, or application of the advance notice bylaws were equitable under the circumstances of the case.” Id. The Supreme Court then analyzed the trial record and concluded the advance notice bylaws at issue on appeal were invalid or unenforceable. Id. at *2.
On validity, the Court explained, among other things, that the “DGCL places minimal procedural and substantive requirements on stockholders and directors when addressing bylaws,” that bylaws are “presumed to be valid,” and that a plaintiff challenging a bylaw “must demonstrate that the bylaw cannot operate lawfully under any set of circumstances.” Id. at *9-11. Measured against that lenient standard, the Supreme Court concluded that one bylaw, composed of a 1,099-word single-sentence, was unintelligible and thus invalid, as “[a]n unintelligible bylaw is invalid under ‘any circumstances.’” Id. at *15 (citation omitted). By contrast, the Supreme Court had “no trouble” concluding the remaining bylaws were valid “because they [we]re consistent with the certificate of incorporation, not prohibited by law, and address[ing] a proper subject matter.” Id. at *2, *15.
On enforceability, the Supreme Court reiterated that a finding of facial validity does not preclude a finding of inequity. The Supreme Court then concluded that the board’s actions were inequitable because “it adopted the amended bylaws for the primary purpose of interfering with, and ultimately rejecting, [the at-issue] nominations.” Id. at *2. For example, the Supreme Court reviewed the “agreement, arrangement, or understanding” (AAU) provision and agreed with the Court of Chancery that the “SAP [stockholder associated person] term” included in the AAU provision was unreasonable. That provision “require[d] a nominator to disclose not only personal knowledge but also to take steps to gather information about agreements and understandings between any members of potentially limitless class of third parties and individuals unknown to the nominator.” Id. at *16-17. In other words, “the nominating stockholder must not only respond based on personal knowledge, but also an ill-defined daisy chain of persons.” Id. at *18. The AAU provision thus “functioned as a ‘tripwire’ rather than an information-gathering tool and ‘suggest[ed] an intention to block the ’dissident’s effort.’” Id. at *17 (quoting Kellner v. AIM ImmunoTech Inc., 307 A.3d 998, 1031 (Del. Ch. 2023)). Indeed, the SAP term affected all the valid bylaws, rendering each problematic. Id. at *17-18. Nonetheless, in light of the Court of Chancery’s “findings about [a stockholder’s] and his nominees’ deceptive conduct,” the Supreme Court concluded that “no further action [wa]s warranted.” Id. at *18.
C. Court Of Chancery Issues Novel Ruling Regarding The Exercise Of Stockholder-Level Voting Power By A Controller
On January 4, 2024, the Delaware Court of Chancery issued a novel post-trial decision addressing what it described as “fascinating” dynamics related to a controlling stockholder and a special committee. In re Sears Hometown & Outlet Stores, Inc. S’holder Litig., 309 A.3d 474, 483 (Del. Ch. 2024).
Sears Hometown and Outlet Stores, Inc., a controlled public company, had two business segments, one of which was “good” and one of which was “bad.” Id. at 483. When the controller and a special committee disagreed over how to deal with that divergence, the controller “used his voting power as a stockholder to adopt a bylaw amendment” that complicated—but did not preclude—the special committee’s ability to implement its preferred plan (liquidation of the “bad” business). Id. As the Court explained, the bylaw “ensured that the controller [would] ha[ve] a window to act . . . if the board pursued it[s plan].” Id. In addition, the controller removed “two of the three members of the [s]pecial [c]ommittee” who had “been the most vocal” about the liquidation and replaced them with two individuals he “could be confident . . . . would support his interests.” Id. at 519. As the controller acknowledged at trial, “he had no intention of letting the liquidation plan become reality.” Id. at 483.
With the special committee’s preferred plan effectively off the table, the controller negotiated a transaction with the special committee that ended up eliminating the minority stockholders’ interest in the company. Id. at 502-03. The transaction was not conditioned on a majority of the minority vote, and the board was not permitted to “terminate the agreement to accept a superior proposal.” Id. at 503.
In assessing the events that transpired, the Court noted that, until its decision, “Delaware law [had] not clearly state[d] what standard of review (if any) applies to a controller’s exercise of stockholder voting power.” Id. at 483. To the contrary, “[s]ome authorities suggest[ed] a controller owes no fiduciary duties when voting,” while “[o]ther authorities appl[ied] a fiduciary framework without spelling out the details.” Id.
Ultimately, the Court decided: (1) “[a] controller does not owe any enforceable duties when declining to vote or when voting against a change to the status quo”; (2) “when exercising stockholder-level voting power” to change the status quo, “a controller owes a duty of good faith that demands the controller not harm the corporation or its minority stockholders intentionally”; (3) a “controller . . . owes a duty of care that demands the controller not harm the corporation or its minority stockholders through grossly negligent action”; and (4) “enhanced scrutiny should apply” when a “controller t[akes] action that invade[s] the space typically reserved for the board of directors.” Id. at 483-84, 510, 512.
The Court also contrasted a controller’s duties with those of a director. It noted that whereas “[d]irectors . . . must act affirmatively to promote the best interests of the corporation, and they must subjectively believe that the actions they take serve that end,” “[a] controller need not meet that higher standard when exercising stockholder-level voting rights.” Id.
Applying these principles to the facts of the case, the Court concluded first that the controller “did not breach his fiduciary duties when he engaged in” the interventions discussed above, as he “acted in good faith to protect the Company from a threat of value-destruction,” “identified that threat in good faith, after a reasonable investigation,” and “then responded with a means that fell within the range of reasonableness.” Id. at 519. As the Court explained, “[i]f nothing else had happened, and if the Company had merely continued operating as it had before the [c]ontroller [i]nterven[ed], then judgment would [have] be[en] entered for the defendants.” Id.
But something else did happen. The controller ended up “acquiring the [c]ompany and eliminating the minority stockholders from the enterprise” in the process. Id. Given this, the Court evaluated the transaction under the entire fairness standard. Id. at 519-20. Under that standard, the Court concluded that both the price and process were unfair and held the controller his co-defendants jointly and severally liable for “the difference between the transaction price and the ‘true’ value of the firm.” Id. at 539-41.
D. Court Of Chancery Concludes Plaintiff Failed To Allege Owner Of 26.7% Of Common Stock Was A Controller
In Sciannella v. AstraZeneca UK Limited, the Court of Chancery dismissed a putative class action brought by a former stockholder of Viela Bio, Inc. alleging fiduciary duty breaches by the directors, officers, and former parent company of Viela in connection with their roles “in selling [Viela] to affiliates of Horizon Therapeutics plc.” 2024 WL 3327765, at *1 (Del. Ch. July 8, 2024). One central issue was whether AstraZeneca, “which owned 26.7% of Viela’s outstanding common stock,” “was a controlling stockholder at the time of the [at-issue] transaction.” Id.
In its opinion, the Court found that the “complaint fail[ed] to plead facts to support a reasonable inference” that AstraZeneca was a controlling stockholder. Id. To that end, the Court rejected plaintiff’s claim that the combination of various factors demonstrated that AstraZeneca exercised both general and transaction-specific control.
For example, plaintiff claimed that “AstraZeneca’s equity stake” and “blocking rights” indicated AstraZeneca was a controller. Id. at *17-18. The Court disagreed, finding that a 25% stake and certain blocking rights did not “contribute to an inference of control” because “AstraZeneca only had the right to veto bylaw amendments initiated by stockholders, and then only if the Board did not recommend them.” Id.
Plaintiff also pointed to AstraZeneca having appointed two of Viela’s eight directors and the fact that other defendants had relationships with AstraZeneca, such as by investing in Viela and being previously employed by AstraZeneca. Id. at *19. Again, the Court found these allegations inadequate, either because they were conclusory or insufficient to support a reasonable inference that AstraZeneca dominated the decision-making process. Id. at *19-20.
Plaintiff also highlighted “Support Agreements,” through which AstraZeneca provided support to Viela’s day-to-day operations, including through supply, licensing, and transition services agreements. Id. at *21. Although the Court agreed that these agreements meant “Viela substantially depended on AstraZeneca” in various respects, it nonetheless concluded that plaintiff has not alleged “facts from which it is reasonable to infer that [AstraZeneca] could prevent the [Viela Board] from freely exercising its independent judgment in considering the proposed [M]erger.” Id. at *22 (citation omitted) (alterations in original).
E. Court Of Chancery Issues Opinion In A Suit Alleging Fiduciary Duty Breaches In Connection With Conversion
Palkon v. Maffei addressed the decisions of two Delaware corporations—both of which were controlled by Gregory B. Maffei—”to convert . . . into . . . Nevada corporation[s].” 311 A.3d 255, 261 (Del. Ch. 2024), cert. denied, 2024 WL 1211688 (Del. Ch. Mar. 21, 2024). The two entities were TripAdvisor and Liberty TripAdvisor Holdings, Inc. Liberty owned all of TripAdvisor’s Class B common stock and 21% of its Class A Shares. Id. at 264. As a result, it “exercise[d] 56% of the [TripAdvisor’s] outstanding voting power.” Id. Maffei, Liberty’s CEO and Chairman, “beneficially own[ed] Series B shares carrying 43% of [its] voting power.” Id. For purposes of the motion to dismiss, “defendants concede[d] that Maffei control[ed] both [Liberty] and TripAdvisor.” Id.
Plaintiffs sued, alleging fiduciary duty breaches in connection with the conversion. Id. at 268. They also sought an injunction. Id. at 266. The Court of Chancery denied defendants motion to dismiss after determining entire fairness was the appropriate standard of review while also denying plaintiff’s request for an injunction. Id. at 262.
Accepting the allegations in complaint, the Court explained Maffei effectuated a transaction through which he and the directors received a non-ratable benefit—namely, a “reduction in the unaffiliated stockholders’ litigation rights.” Id. at 261. The absence of a “price” was irrelevant in the Court’s view because entire fairness considers substantive fairness and procedural fairness, and the “floor for substantive fairness is whether stockholders receive at least the substantial equivalent in value of what they had before”—meaning no price is necessary. Id. at 262.
The Court then concluded the plaintiff had pled facts making it reasonably conceivable that the transaction was both substantively and procedurally unfair. On the former, the Court explained that “the stockholders held shares carrying the bundle of rights afforded by Delaware law, including a set of litigation rights” before the conversion, and, “[a]fter the conversion, the stockholders owned shares carrying a different bundle of rights afforded by Nevada law, including a[n allegedly] lesser set of litigation rights.” Id. On the latter, the Court explained that “the goal of procedural fairness is to replicate arm’s length bargaining,” but that defendants made no “effort to replicate arm’s length bargaining.” Id. at 281. Instead, “[m]anagement proposed the conversions, the Board recommended them, and [Liberty] and Maffei approved them.” Id.
The Court nonetheless denied plaintiffs’ requests for an injunction. It found, under the circumstances of the case, that other remedies, such as money damages, could adequately compensate plaintiffs for any losses. Id. at 286-87.
F. Executive Compensation And Post-Trial Ratification – Tornetta v. Musk And Subsequent Developments
The Court of Chancery in Tornetta v. Musk ordered the rescission of Elon Musk’s compensation plan after concluding Musk controlled Tesla with respect to the compensation plan and that defendants failed to prove that Musk’s 2018 compensation plan was entirely fair. 310 A.3d 430 (Del. Ch. 2024). For further details, please see Gibson Dunn’s February 5, 2024 Client Alert.
Several months after the Court’s decision, at its annual stockholders’ meeting, Tesla stockholders approved the ratification of Musk’s pay package. See Press Release, Tesla Releases Results of 2024 Annual Meeting of Stockholders, Tesla (June 13, 2024), https://ir.tesla.com/press-release/tesla-releases-results-2024-annual-meeting-stockholders. The Court has ordered expedited briefing “on the effect of the Tesla stockholders’ June 13, 2024, vote on this action.” Tornetta v. Musk, 2024 WL 3200483, at *1 (Del. Ch. June 27, 2024). With many questions yet to be answered, Gibson Dunn will continue monitoring the case and report on any future developments.
G. Stockholder Agreements And DGCL Section 141 – Moelis And Its Aftermath
As discussed in our February 28, 2024 Client Alert, the Court of Chancery, in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, ruled on the validity of pre-approval requirements and board- and committee-related designation rights included in a stockholder agreement between a public company and its founder that was entered into before the company went public. 311 A.3d 809 (Del. Ch. 2024). In short, the Court held that the pre-approval requirements and board- and committee-related designation provisions violated one or more subsections of Section 141 of the DGCL because they had “the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters” or “tend[ed] to limit in a substantial way the freedom of director decisions on matters of management policy.” Id. at 818 (quoting Abercrombie v. Davies, 123 A.2d 893, 899 (Del. Ch. 1956), rev’d on other grounds, 130 A.2d 338 (Del. 1957)).
At the close of its opinion, the Court noted that the Delaware “General Assembly could enact a provision stating what stockholder agreements can do.” Id. at 881. The General Assembly seemingly took heed. In July 2024, the General Assembly passed S.B. 313, which contained what is now Section 122(18) of the DGCL. As set forth in the bill’s synopsis, Section 122(18) “specifically authorizes a corporation to enter into contracts with one or more of its stockholders or beneficial owners of its stock, for such minimum consideration as approved by its board of directors, and provides a non-exclusive list of contract provisions by which a corporation may agree to.”
In the first half of 2024, the number of SPAC IPOs and the value of de-SPAC transactions have decreased significantly since their peak in 2021 (as noted in our Securities Litigation 2023 Mid-Year Update), with only 20 SPAC IPOs as of end of July (see SPAC Statistics by SPAC Insiders). De-SPAC transactions, however, have given rise to significantly more securities class actions than other IPOs (see Securities Class Action Trends 2023: Not a Repeat of Year 2022). In this mid-year update, we first discuss the SEC’s latest rule applicable to SPACs, which has likely changed the litigation landscape moving forward. Next, we look back to the first half of 2024, which many courts have taken a fact-specific approach to SPAC litigation and have not announced any broadly applicable legal doctrines specific to SPAC litigation.
A. SEC’s Special Purpose Acquisition Companies, Shell Companies, and Projections Final Rule
On January 24, 2024, the U.S. Securities and Exchange Commission (the “Commission”), by a three-to-two vote, adopted new rules, most notably a new subpart 1600 to Regulation S-K, and amendments to certain existing rules under Securities Act, Securities Exchange Act, Regulation S-K, Regulation S-T, and Regulation S-X to enhance disclosure and investor protections in SPAC IPOs and subsequent de-SPAC transactions. Special Purpose Acquisition Companies, Shell Companies, and Projections, 17 C.F.R. §§ 210, 229, 230, 232, 240, 249 (2024) (SPAC Rule). The Gibson Dunn team provided its analysis on the Final Rules earlier this year. See Feb. 2, 2024 Client Alert.
1. Key Provisions
The Final Rules overhaul the protections previously available in SPAC IPOs. The four key components of the Final Rules are as follows:
- Disclosure and Investor Protection. The Final Rules impose specific disclosure requirements with respect to, among other things, compensation paid to sponsors, potential conflicts of interest, shareholder dilution, and the fairness of the business combination, for both SPAC IPOs and de‑SPAC transactions.
- Business Combinations Involving Shell Companies. Under the Final Rules, the Commission now deems a business combination transaction involving a reporting shell company and a private operating company as a “sale” of securities under the Securities Act of 1933, as amended (the “Securities Act”). The Final Rules also amend the financial statement requirements applicable to transactions involving shell companies, and amend the previous “blank check company” definition to make clear that SPACs cannot rely on the safe harbor provision against a private right of action for forward-looking statements under the Private Securities Litigation Reform Act of 1995, as amended (the PSLRA), when marketing a de-SPAC transaction.
- The Final Rules amend the Commission’s guidance on the presentation of projections in any filings with the Commission (not only on de-SPAC transactions, but affecting all projections disclosed in reports filed with the Commission) and adds new guidance only for de-SPAC transactions, in both instances to address the reliability of such projections.
- Status of SPACs under the Investment Company Act of 1940. The Commission did not adopt its proposed safe harbor rule under the Investment Company Act, which would have exempted a SPAC from being treated as an “investment company” as long as the SPAC met certain subjective criteria, related to, among other things, the nature and management of the assets held by the SPAC, and the SPAC’s general purpose. Instead, the Commission takes the position that whether a SPAC falls under the definition of investment company depends on specific facts and circumstances, and provides general guidance on what actions might cause a SPAC to be an “investment company.”
2. SPAC Rule In Securities Litigation
Since the Final Rules were announced in January 2024, even before they went into effect in July, some litigants have sought to use the Rules to advance their positions in ongoing cases. For instance, multiple SPAC defendants facing challenges to their financial disclosures have argued that the Final Rules excuse SPAC companies from having to disclose their “net-cash per share” calculation. See, e.g., Opening Br. in Supp. of Def.’s Mot. to Dismiss, In re AST SPACEMOBILE, INC., S’holder Litig., No. 2023-1292, at *48-49 (Del. Ch. Mar. 15, 2024) (highlighting that the SEC “has reevaluated its SPAC-related disclosure requirements and explicitly rejected net cash per share as a required calculation,” because “‘[n]et cash per share has aspects that make it less useful for investors’ than other measures of dilution”); Def.’s Br. in Supp. of their Am. Mot. to Dismiss the Verified Am. Class Action Compl., Schacter v. N. Genesis Sponsor, LLC, No. 2023-1112, at *14 n.8 (Del. Ch. Apr. 25, 2024) (noting the Final Rules are not adding an “explicit net cash per share disclosure requirement,” but only requiring that shareholders “should have the information to perform this calculation based on the disclosure provided in connection with net tangible book value per share, as adjusted”).
Other parties have relied on the Final Rules to clarify that the PSLRA’s safe harbor, 15 U.S.C § 78u–5, which protects forward-looking statements “accompanied by meaningful cautionary language,” no longer applies to SPACs. See, e.g., Appellant’s Reply Br., In re Danimer Scientific, Inc., No. 23-7674, at *20 (2d Cir. Apr. 10, 2024) (arguing the safe harbor is not available to defendants because the Final Rules “[m]ake the PSLRA safe harbor unavailable to SPACs . . . by defining ‘blank check company’ to encompass SPACs (and other companies that would be blank check companies but for the fact that they do not sell penny stock)”). The rule does not have retroactive effect, see 89 Fed. Reg. at 14158, and some Courts have analyzed whether cautionary statements found in SPAC’s proxy statements were protected forward-looking statements—albeit prior to the Final Rule taking effect. For instance, in In re Grab Holdings Ltd. Securities Litigation, the Court analyzed whether the PSLRA safe harbor applied to the seven pre-merger statements contained in a SPAC’s proxy statement. 2024 WL 1076277, at *1 (S.D.N.Y. Mar. 12, 2024). The Court found that, although some of the statements were forward-looking and cautionary, the safe harbor did not extend to statements about future risk when plaintiff failed to disclose that the risk had transpired. See id. at *18. Notably, it is too early to determine the consequences the Final Rules will have on SPAC litigation: the Final Rules do not have retroactive effect and went into effect recently, on July 1, 2024. 89 Fed. Reg. at 14158. We will continue to analyze the Final Rules’ effect in future securities litigation updates.
B. 2024 SPAC-related Securities Litigation
Although the filing of SPAC-related litigation has slowed, courts have issued at least eight SPAC-related opinions in the first half of 2024. Of those cases, three have been dismissed entirely for failing to allege a securities claim. Five of those cases have survived a motion to dismiss. In the below sections, we highlight some of these district court cases.
1. SPAC Claims Dismissed
In cases dismissing SPAC-related securities fraud, courts have thus far rejected plaintiffs’ attempts to develop any hard and fast SPAC laws. For instance, in In re Lottery.com, Inc. Securities Litigation, a district court in the Southern District of New York noted plaintiffs’ arguments that “SPACs are uniquely fraud-enabling” but ultimately rejected finding scienter on that basis alone, saying that it was “unprepared to hold here that SPACs are an exception to the general principle that the prospect of a public offering, standing alone, is insufficient to establish motive.” 2024 WL 454298, at *32 (S.D.N.Y. Feb. 6, 2024). Likewise, in Shafer v. Lightning Emotors, Inc., the Court found plaintiffs failed to allege the pre-de-SPAC transaction statements were false when made, and otherwise found nothing inherently fraudulent about the de-SPAC transaction. 2024 WL 691458, at *6-20 (D. Colo. Feb. 20, 2024), report and recommendation adopted, 2024 WL 1509166, at *1 (D. Colo. Mar. 26, 2024). In Mehedi v. View, Inc., the Northern District of California dismissed plaintiffs’ Sections 10(b) and 14(a) claims because plaintiffs could not allege that their harms were caused by the alleged misleading proxy statement connected with a de-SPAC transaction. 2024 WL 3236706, at *7–20 (N.D. Cal. June 28, 2024). In one derivative action, a California district court found that when a plaintiff owned stock in a SPAC prior to its acquisition of a company in a de-SPAC transaction, plaintiff had standing to bring a derivative claim on behalf of the acquired entity. In re Faraday Future Intelligent Elec. Inc. Derivative Litig., 2024 WL 404495, at *1 (C.D. Cal. Jan. 22, 2024). The Court dismissed the derivative claim, however, because plaintiffs failed to bring a pre-litigation demand to the company. Id. at *14. Below we include more thorough case descriptions.
In re Lottery.com, Inc. Sec. Litig., 2024 WL 454298 (S.D.N.Y. Feb. 6, 2024): Investors filed an action against a SPAC (Trident), the online lottery company that merged with Trident (Lottery), and certain of the SPAC’s and company’s current and former officers. Id. at *1-2. Investors alleged that Lottery and its officers made false statements, both before and after the merger, regarding its internal financial controls and its financial performance. Id. at *6-10. Plaintiffs brought claims pursuant to Section 10(b), Section 20(a), and Section 14(a). Id at *1. Defendants moved to dismiss the Section 10(b) claim, arguing that plaintiffs had failed to establish falsity and scienter. Id. at *13. As to falsity, the Court dismissed claims based on the pre-merger compliance statements, finding they were “akin to other statements about regulatory compliance and integrity that courts have deemed non-actionable puffery,” id. at *16, and dismissed claims based on the pre-merger financial statements as they were “forward looking statements . . . accompanied by sufficient cautionary language,” id. at *17. As to the post-merger financial statements, the Court held for plaintiffs finding that “each of the post-merger financial-performance-related statements was false [or misleading] at the time it was made,” based on Lottery’s own admission in a later-filed Form 8-K that the post-merger financial statements at issue “overstated [the] available unrestricted cash balance,” “improperly recognized revenue in the same amount,” and thus “should no longer be relied upon.” Id. at *22 (cleaned up). Importantly, the Court refused to hold, as defendants wished, that “a statement believed to be true when made, but later shown to be false, is insufficient to establish that a statement of fact is false for purposes of Section 10(b) and Rule 10b-5.” Id. at *21 (internal quotations omitted). In other words, “[w]hether Defendants knew of their falsity when making the statements is the scienter question, not the falsity question.” Id. at *22 (internal quotations omitted). However, the Court found that plaintiffs had failed to adequately plead scienter as to all the statements, finding that “‘[t]he existence, without more, of executive compensation dependent upon stock value does not give rise to a strong inference of scienter.’” Id. at *31 (quoting Acito v. IMCERA Grp., Inc., 47 F.3d 47, 54 (2d Cir. 1995)). “The Court does not ignore Plaintiffs’ allegations that SPACs are uniquely fraud-enabling . . . [but] is unprepared to hold that SPACs are an exception to the general principle that the prospect of a public offering, standing alone, is insufficient to establish motive.” Id. at *32. The Court also did not find plaintiffs had sufficiently pled conscious misbehavior or recklessness on the part of defendants. Id. at *35. The Court dismissed the complaint but granted leave to amend. Id. at *37.
Shafer v. Lightning eMotors, Inc., 2024 WL 691458 (D. Colo. Feb. 20, 2024), report and recommendation adopted, 2024 WL 1509166 (D. Colo. Mar. 26, 2024): Plaintiffs brought a securities fraud class action on behalf of investors in Lightning eMotors against Lightning, “certain of its officers and directors, and the officers, directors, and certain affiliates of the company’s predecessor entity, GigCapital3, Inc.” Id. at *1. Investors alleged that defendants “attempted to set their SPAC apart by selling investors on what they referred to as their ‘unique’ approach to private equity in the SPAC’s registration statement and prospectus filed with the SEC.” Id. at *2. The complaint alleged “plaintiffs state[d] that this strategy worked as GigCapital3 successfully raised $200 million through its IPO” before merging with Lighting Systems through a de-SPAC transaction. Id. “Defendants allegedly sold the deal with Lightning Systems to investors as an ideal match: not only was Lightning Systems’ management a good candidate for the ‘Mentor-Investor’ approach supposedly employed by the GigCapital team, but the company itself was on the cusp of massive growth.” Id. Defendants allegedly continued to make misleading statements until “GigCapital3 issued and disseminated the definitive proxy requesting that eligible shareholders vote to approve the business combination with Lightning Systems.” Id. Plaintiffs alleged that, in truth, “Lightning Systems was not well-positioned to rapidly scale its operations” and that defendants “knew or were reckless in not knowing” its projected financials were unachievable. Id. at *3. So too were representations that “the GigCapital3 team would remain engaged in the post-combination company.” Id. at *2. The Court granted the motion to dismiss finding that plaintiffs failed to adequately allege that the statements at issue were false or materially misleading when made. Id. at *6-18. Further, the Court dismissed plaintiffs’ claim that defendants’ misstatements were part of a fraudulent scheme to unfairly profit from a business combination in violation of Rules 10b-5(a) and 10b-5(c) under the Exchange Act, first and foremost because “it [was] unclear what fraudulent or deceitful conduct [independent of the misleading statements] occurred.” Id. at *20 (emphasis in original).
Mehedi v. View, Inc., 2024 WL 3236706 (N.D. Cal. June 28, 2024): This is a securities fraud suit brought by investors against the View, Inc., which went public through a de-SPAC transaction with CF II (the SPAC), and certain officers and directors of View and CF II. “Plaintiffs allege that Defendants made material misrepresentations to investors concerning a materially misstated and understated warranty accrual related to Legacy View’s ‘smart panels.’” Id. at *1. We first discussed Mehedi in our 2023 Mid-Year Update when the Court granted defendant’s motions to dismiss.
Plaintiffs have since amended their complaint, and the Court again dismissed most of the claims with the exception of plaintiffs’ Section 20(a) claims against certain directors and officers at View and CF II. Id. at *22. “On August 16, 2021, five months after going public, View announced that its Audit Committee began an independent investigation concerning the adequacy of the company’s previously disclosed warranty accrual and that View would not file its Form 10-Q for the second fiscal quarter of 2021.” Id. at *1 (internal citations omitted). “On November 9, 2021, View announced that the Audit Committee ha[d] now substantially completed its independent investigation and has concluded that the Company’s previously reported liabilities associated with all warranty-related obligations and the cost of revenue associated with the recognition of those liabilities were materially misstated.” Id. (internal citations omitted). View also announced that it would release updated financial statements and that its CFO resigned. Id. The lead plaintiff, Stadium Capital, sold all of its stock on September 24, 2021. Id. at *8. In its motion to dismiss opinion, the Court held that Stadium Capital could not attribute its losses to the August 16, 2021 announcement because the “initial disclosure of an investigation can[not] qualify as a corrective disclosure” and further because Stadium Capital sold its stock before the truth was revealed, and thus it cannot plead loss causation. Id. at *9. Plaintiffs’ Section 10(b) claims were accordingly dismissed. Id. at *12. Regarding plaintiffs’ Section 14(a) claim, the Court found that “Stadium Capital sold all of” the shares it purchased pursuant to the Proxy Statement “on March 9, 2021, well before the truth of any alleged misstatements was revealed.” Id. at *16. “Although Stadium Capital bought more View stock, any alleged economic harm from those purchases was not caused by the Proxy Statement because those purchases occurred after the vote solicited by the Proxy Statement.” Id. “Thus, any loss that Stadium Capital suffered was not caused by any alleged misstatements in the Proxy Statement, and Stadium Capital has failed to allege loss causation.” Id.
In re Faraday Future Intelligent Elec. Inc. Derivative Litig., 2024 WL 404495 (C.D. Cal. Jan. 22, 2024): Two investors brought a derivative suit on behalf of the corporation (Faraday) that went public via a de-SPAC transaction. They originally pursued a mix of federal securities fraud and state law claims, but they “app[arently] conceding[d]” that the only claim at-issue was for alleged violations of Section 14(a) of the Exchange Act against officers and directors of the SPAC (Property Solutions Acquisition Corp or “PSAC”). Id. at *1-4. Defendants argued that plaintiffs lack standing to bring claims because “neither of the named plaintiffs plead[ed] he ever owned PSAC stock prior to the merger.” Id. at *4 (internal quotations omitted). Defendants further argued that “any derivative liability would have been extinguished at the time the [m]erger was complete because former shareholders of a merged corporation can no longer satisfy the continuous ownership requirement of FRCO 23.1.” Id. at *5. (internal quotations omitted). Plaintiffs in turn argued, inter alia, that “their complaint sufficiently alleges that each plaintiff were current shareholders of Faraday Future and held Faraday Future common stock at all relevant times.” Id. (cleaned up). Additionally, plaintiffs contended that a plaintiffs who did not own Faraday stock prior to the merger nonetheless had standing under the “continuous wrong” doctrine. Id. The Court found that one plaintiff “first purchased [PSAC] stock . . . on January 11, 2021, before the defined relevant period in the Derivative Action began and has continuously owned thousands of PSAC shares since February 22, 2021.” Id. The Court found this was sufficient to have standing to bring a derivative claim. Id. However, the Court found that the other plaintiff, who acquired PSAC shares after the merger was consummated, lacked standing and the continuous wrong doctrine did not save his claims because “Delaware law makes it clear that what must be decided is when the specific acts of alleged wrongdoing occur, and not when their effect is felt.” Id. at *6. The Court nonetheless dismissed the complaint because plaintiffs failed to plead that they were excused from making a pre-litigation demand on the board. Id. at *13.
2. SPAC Claims That Survived A Motion to Dismiss
Several SPAC cases have survived motions to dismiss, and we highlight a few here. Most notable of these 2024 opinions is Alta Partners, LLC v. Forge Global Holdings, Inc., where plaintiff’s Section 11 claim survived a motion to dismiss on the grounds, among others, that plaintiff could not trace the purchase of a security to the allegedly defective registration statement at issue. 2024 WL 1116682, at *6-8 (S.D.N.Y. Mar. 13, 2024). The Court in Atla Partners disagreed with defendant and found that a plaintiff who purchased Public Warrants from a SPAC prior to its de-SPAC transaction could sufficiently trace its purchases to the S-4 registration statement despite the company’s claim that the warrants were not exercisable until a S-1 registration statement became effective. Id. In other cases, courts have found that material omissions in SPAC proxy statements are actionable, see, e.g., In re Grab Holdings Ltd. Sec. Litig., 2024 WL 1076277 (S.D.N.Y. Mar. 12, 2024), and, similarly, omissions in SPAC merger pitches are actionable as securities fraud, see, e.g., Felipe v. Playstudios Inc, 2024 WL 1380802 (D. Nev. Mar. 31, 2024).
Alta Partners, LLC v. Forge Glob. Holdings, Inc., 2024 WL 1116682 (S.D.N.Y. Mar. 13, 2024): Plaintiff Alta brought claims under Section 11 and for breach of contract and the implied covenant of good faith and fair dealing against Forge in connection with public warrants issued by the SPAC, which ultimately merged with Forge. Id. at *1. Alta alleged that Forge improperly prevented Alta from exercising its warrants and then redeemed the outstanding warrants at a nominal price. See id. Under the agreement governing the warrants, public warrants became exercisable thirty days after the business combination, provided that the warrants were registered on a registration statement and there was a current prospectus. Id. at *2. The warrant agreement also provided that Forge could redeem all outstanding warrants when (1) “the shares were exercisable”“; (2) the “Reference Value” calculated based on Forge’s stock price during a thirty-day period exceeded $18.00 per share; and (3) “an effective registration statement and current prospectus were in place for the underlying shares” for the thirty-day period. Id. Alta alleged it purchased public warrants issued pursuant to or traceable to the Form S-4 registration statement, which became effective on February 14, 2022. Id. at *12. Beginning on April 21, 2022 (thirty days after the completion of the merger on March 21, 2022), Alta repeatedly sought to exercise its warrants while Forge’s stock price skyrocketed, but Forge replied that warrants were not yet registered on the Form S-4, and could not be exercised as until Forge’s later-filed Form S-1 became effective. Id. at *2-3. The Form S-1 was declared effective on June 8, 2022, by which point the share price was below the exercise price of $11.50. Id. at *3. The following day, Forge noticed redemptions of the warrants for $.01 apiece and redeemed the warrants on July 11. Id. As a result, public warrant holders like Alta were never able to exercise the warrants when the stock price was trading above the warrant exercise price, thereby profiting from the exercise. Id. The Court dismissed Alta’s claim that Forge breached the warrant agreement by redeeming the warrants before all required conditions were met. It explained that Alta was reading in a contractual obligation unsupported by unambiguous terms of the warrant agreement. Id. at *4-5. The Court also dismissed Alta’s breach of implied covenant claim because it was “based on conduct permitted under the contract” and was based on the same set of facts as its breach of contract claim in any event. Id. at *6. However, the Court refused to dismiss plaintiff’s Section 11 claim in its entirety. In relevant part, it found that defendants’ representations “would mislead a reasonable investor to believe that the registration was sufficient to permit exercise” of the warrants. Id. at *7 (internal quotations omitted).
Felipe v. Playstudios Inc., 2024 WL 1380802 (D. Nev. Mar. 31, 2024): Plaintiff brought a securities fraud action against Playstudios, a mobile game company that went public via a de-SPAC transaction, alleging that the company misled investors (including through statements in its Proxy) about the prospects of one of its videogames, Kingdom Boss, even though the company had no experience with games of this genre (role playing games or “RPGs”). Id. at *1-4. Plaintiff alleged that the “launch of Kingdom Boss and expansion into the RPG category was a significant component of the Acies-Playstudios merger pitch.” Id. at *3. In a post-merger press release, Playstudios announced that its revenues had missed the low end of its previous estimates and, on a conference call on the same day, announced that it was suspending the development of Kingdom Boss all together. Id. at *3. The Court found all but one of the statements misleading “because they failed to disclose any of the risks associated with the severe playability issues that had materialized as early as [six months prior.]” Id. at *10. The Court found that “Defendants had multiple opportunities to make such disclosures in order to avoid misleading investors . . . [and that] Defendants could have made these disclosures in June prior to the merger vote.” Id. at *10. The Court also found “the omission of these specific risks . . . material” because Playstudios ability to scale the game and generate revenue was a central part of its pitch for the de-SPAC transaction. Id. at *11. The Court denied the motion to dismiss except as to one non-actionable statement. Id. at *21.
In re Grab Holdings Ltd. Sec. Litig., 2024 WL 1076277 (S.D.N.Y. Mar. 12, 2024): Investors filed a securities fraud action against Grab, a “mobile application [provider] . . . that [provides] . . . consumers with ride-hailing services, food-delivery services, business services, and a digital wallet[,]” and certain of its officers pursuant to Sections 11 and 15 of the Securities Act and Sections 14(a), 10(b), and 20(a) of the Exchange Act. Id. at *2. The complaint alleged that defendants misled investors, in connection with a de-SPAC transaction, about Grab’s use of driver and consumer incentives, which negatively impacted the company’s financial performance. Id. at *1-10. The challenged statements were made both pre- and post-merger. Id. Defendants moved to dismiss. Id. at *10. The Court found that plaintiffs had sufficiently pled that a series of pre-merger statements contained in the Proxy Statement were material and misleading. Id. at *24. The Court reasoned, inter alia, that “cautionary words about future risk cannot insulate from liability the failure to disclose risk that has transpired.” Id. at *16 (citation omitted). Further, the Court also found that “by putting the issues of driver retention and incentive amounts in play, defendants assumed ‘a duty to tell the whole truth.’” Id. at *16 (quoting Meyer v. Jinkosolar Holdings Co., 761 F.3d 245, 250 (2d Cir. 2014)). The Court held that none of the remaining pre-merger statements were actionable, including the post-merger statements by Grab’s CEO during a Squawk Box interview on CNBC. Id. at *19-24. The Court granted leave to amend. Id. at *26.
We will continue to monitor the evolution of SPAC litigation and the effect of the SEC’s SPAC Rule.
An increasing number of lawsuits challenge public companies’ environmental, social, and governance (ESG) disclosures and policies. The following section surveys notable developments in pending cases that involve ESG allegations.
In re Oatly Group AB Securities Litigation, No. 21-cv-06360 (S.D.N.Y. July 26, 2021): We reported on this case in our Securities Litigation 2023 Year-End Update. A class of investors sued Oatly Group AB, the world’s largest oat milk company, and several of its officers and directors for “greenwashing” in public disclosures. ECF No. 1 ¶¶ 1-2, 52. Plaintiffs allege that Oatly made false or misleading statements that overstated the sustainability of its product and minimized its environmental impact, thereby artificially inflating Oatly’s share price. ECF No. 1 ¶¶ 43-45. On November 3, 2023, the parties disclosed an intent to settle the litigation. The Court approved the $9.25 million settlement on July 17, 2024. ECF No. 120.
General Retirement System of the City of Detroit v. Verizon Communications Inc., No. 23-cv-05218 (D.N.J. Aug 18, 2023): We first reported on this case in our Securities Litigation 2023 Year-End Update. Plaintiffs allege that Verizon made false or misleading statements regarding its “extensive network of lead cables, the dangers they were posing to people and to the environment, and the costs associated with cleaning up the cables and compensating for any human injuries.” ECF No. 57 ¶ 16. Plaintiffs further allege that Verizon’s stock price dropped after The Wall Street Journal released an article profiling workers who claimed they were suffering from lead exposure. Id. ¶ 306. On April 24, 2024, defendants filed a motion to dismiss, arguing that plaintiffs failed to properly allege materiality and scienter because defendants did not know “the cables posed material risks not understood by the market” and understood that the “public and market at large were aware of the lead-sheathed cables’ existence.” ECF No. 58-1 at 2-3. Defendants also argued the challenged statements were “honestly held opinions” and “too general to be misleading.” Id. at 3. The motion to dismiss remains pending.
Exxon Mobile Corp. v. Arjuna Capital, No. 24-cv-00069 (N.D. Tex. Jan. 21, 2024): We first reported on this case in our Securities Litigation 2023 Year-End Update. In January 2024, Exxon filed a lawsuit seeking a declaratory judgment that would allow it to exclude from its proxy statement a shareholder proposal by two activist investors. Exxon alleged that defendants’ proposal, which asked Exxon to reduce its greenhouse gas emissions more rapidly, “d[id] not seek to improve ExxonMobil’s economic performance or create shareholder value.” ECF No. 1 ¶ 11. Exxon further contended that it could properly exclude defendants’ proposal under the ordinary business (Rule 14a-8(i)(7)) and resubmission exclusions ((i)(12)). Id. ¶¶ 16-17. On May 22, 2024, the Court held that Exxon’s lawsuit was able to proceed against the United States-based Defendant, Arjuna Capital. ECF No. 37. On June 17, 2024, Arjuna Capital agreed to withdraw its proposal and “unconditionally and irrevocably” agreed not to submit any similar proposal. ECF No. 52 at 1. The Court determined that this agreement mooted Exxon’s claim, and the case was dismissed without prejudice. Id. Gibson Dunn represents plaintiff in this action.
Securities Industry & Financial Markets Association v. Ashcroft, No. 23-cv-04154 (W.D. Mo. Aug. 10, 2023): We reported on this case in our Securities Litigation 2023 Year-End Update. In June 2023, the Missouri Securities Division adopted new rules requiring investment professionals to obtain client signatures before providing advice that “incorporates a social objective or other nonfinancial objective.” ECF No. 24 ¶¶ 69, 78. In August 2023, plaintiff, the Securities Industry and Financial Markets Association (SIFMA), filed a lawsuit against Missouri Secretary of State John Ashcroft and Missouri Securities Commissioner Douglas Jacoby, challenging these rules. ECF No. 1 at 41. Plaintiff alleged that the rules are preempted by the National Securities Markets Improvement Act of 1996 and the Employee Retirement Income Security Act, violate the First Amendment, and are unconstitutionally vague. ECF No. 24 ¶¶ 118-47-42. On January 5, 2024, the Court denied defendants’ motion to dismiss. ECF No. 39 at 1. On June 10, 2024, both parties filed motions for summary judgment as to all the claims at issue. ECF Nos. 69, 71. On August 14, 2024, the court granted the plaintiff’s motion for summary judgment (and rejected defendant’s cross-motion for summary judgment), finding that the rules do in fact violate the First Amendment, are unconstitutionally vague, and are preempted by federal laws, namely, the National Securities Markets Improvement Act of 1996 and the Employment Retirement Income Security Act of 1974. ECF No. 115. The judge concluded that the rules carried a significant risk of harm justifying a permanent injunction prohibiting their enforcement. Id. at 20-22.
Browning v. Alexander, et al., No. 23-cv-03293 (D. Md. Dec. 5, 2023): Investors in Enviva Inc., an energy company that manufactures wood pellets used to substitute coal in power generation, filed a shareholder derivative complaint on December 5, 2023. Plaintiff alleged defendants, who include the company’s CEO and co-founder as well as several board members, caused Enviva to make false and misleading statements about the company’s commitment to ESG policies. ECF No. 1 ¶¶ 1-4, 171-78. As one example, plaintiff alleged Enviva’s practice of procuring wood pellets “drives demand for deforestation,” contrary to defendants’ representation that harvesting forests for wood pellets is “sustainable.” Id. ¶ 98. Enviva has since filed for Chapter 11 bankruptcy, and on April 15, 2024, the Court issued a stay for the pendency of Enviva’s bankruptcy proceedings. ECF No. 24.
Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. 2021): The petitioners sued the SEC, alleging that Nasdaq’s Board Diversity Rules are unconstitutional and contrary to federal statutes. ECF No. 1. The Board Diversity Rules, which the SEC approved, require companies that list shares on Nasdaq’s exchange to (1) disclose aggregated information about board members’ diversity characteristics (including race, gender, and sexual orientation) and (2) provide an explanation if less than two board members are diverse. Id. at 3-4. On October 18, 2023, a unanimous Fifth Circuit panel rejected the petitioners’ challenges (ECF No. 289) after which the petitioners sought rehearing en banc (ECF No. 297). The en banc panel of the Fifth Circuit held oral argument on May 14, 2024. ECF No. 508. On July 18, 2024, the Court requested supplemental briefing regarding the operation of one of the Rules at issue, and on July 25, 2024, the parties filed supplemental briefs. ECF Nos. 519, 520. Both Nasdaq and the SEC contend in their briefs that the deadline for companies to request access to a board-recruiting service has expired and that this moots the petitioners’ challenge to the Board Recruiting Service Rule. ECF Nos. 517, 519. The petitioners, the National Center for Public Policy Research and Alliance for Fair Board Recruitment, argued in their own July 25 briefs that the deadline has passed but that this does not affect the justiciability of the case before the Fifth Circuit. ECF Nos. 520, 522. The Fifth Circuit has not yet issued an opinion in connection with its rehearing en banc. Gibson Dunn represents Nasdaq in this action, which intervened as an interested party to defend the Board Diversity Rules.
The cryptocurrency space has seen considerable activity since our last Update. Below, we discuss significant rulings in private lawsuits and lawsuits brought by the SEC, as well as additional developments that may impact cryptocurrencies going forward.
A. Class Actions
Golubowski v. Robinhood Markets, Inc., 2024 WL 269507 (N.D. Cal. Jan. 24, 2024): On January 24, 2024, the district court dismissed without leave to amend a class action complaint against Robinhood Markets, Inc., a crypto and securities trading platform. ECF No. 106 at 1. The same court previously granted Robinhood’s motion to dismiss plaintiffs’ first amended complaint, finding that plaintiffs failed to plead a violation of Section 11 or 12(a) of the Securities Act. ECF No. 90. In their second amended complaint, plaintiffs asserted a new theory for why Robinhood’s offering documents were false or misleading, alleging that the declines in key performance indicators and revenue sources were undisclosed and misrepresented by the offering documents. ECF No. 92. In its January 24, 2024 decision, the Court again dismissed plaintiffs’ claims, finding that Robinhood made adequate disclosures that put investors on notice of lower trading revenues in the second and third quarters of 2021, the “possibility of downward trends,” and the fact that “Robinhood’s business had substantially shifted to rely more on cryptocurrency trading[.]” ECF No. 106 at *12, *14, *16. The Court also found that leave to amend was not warranted as it “would be futile.” Id. at *19.
Williams v. Binance, 96 F. 4th 129 (2d Cir. 2024): On March 8, 2024, the Second Circuit reversed the district court’s dismissal of a putative class action lawsuit against crypto exchange Binance and its CEO. Plaintiffs asserted numerous causes of action under the Securities Act, the Exchange Act, and the Blue Sky statutes of different states and territories, including that defendants offered and sold unregistered securities. ECF No. 82 at 133, 135. Plaintiffs—purchasers of crypto assets on the Binance international electronic exchange—claimed that Binance unlawfully promoted, offered, and sold billions of dollars’ worth of crypto “tokens,” which were not registered as securities. Id. at 132. The U.S. District Court for the Southern District of New York dismissed plaintiffs’ claims, finding that they were impermissibly extraterritorial, that the federal claims were untimely, and that claims under Blue Sky laws of states where none of the named class members resided lacked a sufficient nexus with the allegations. Id. at 135; ECF No. 77. The Second Circuit reversed and remanded, finding that plaintiffs plausibly alleged that class members engaged in domestic transactions, that a narrow subset of the federal claims were timely, and that state law claims brought on behalf of absent putative class members should not have been dismissed at that stage. ECF No. 82 at 136-45. On May 13, 2024, plaintiffs filed a third amended complaint, alleging 11 causes of action, including under Sections 5, 12, and 15 of the Securities Act. ECF No. 104. Gibson Dunn is co-counsel for Binance in this action.
Oberlander v. Coinbase Glob., Inc., 2024 WL 1478773 (2d Cir. Apr. 5, 2024): As reported in our 2023 Mid-Year Litigation Update, in February 2023, the U.S. District Court for the Southern District of New York dismissed a class action lawsuit against the crypto exchange Coinbase and its CEO on the basis that Coinbase was not the “statutory seller” of the allegedly unregistered tokens at issue. Coinbase operates online trading platforms where users can buy and sell digital assets. ECF No. 74 at *1. The nationwide class consists of all persons or entities who bought or sold certain digital assets on the Coinbase trading platforms from October 8, 2019, to March 11, 2022, and it asserted a mix of claims under the Securities Act, the Exchange Act, and the state securities laws of California, Florida, and New Jersey. Id. On April 5, 2024, the Second Circuit concluded that plaintiffs adequately pleaded that Coinbase held title to digital assets traded on its platform and thus plausibly alleged claims under Section 12(a) of the Securities Act. Id. at *3-4. At the same time, the Court affirmed the district court’s dismissal of the Exchange Act claims, concluding the allegations were repetitive and conclusory, and found that the district court erred in dismissing the state law claims on jurisdictional grounds. Id. at *4-5. On July 29, 2024, defendants moved for judgment on the pleadings. ECF No. 83.
In re Ripple Labs, Inc. Litig., 2024 WL 3074379 (N.D. Cal. June 20, 2024): A putative class of plaintiffs, who purchased Ripple Labs’ cryptocurrency XRP, brought federal and California state securities law claims against Ripple Labs, XRP II, and the CEO of Ripple. Plaintiffs alleged “a scheme by Defendants to raise hundreds of millions of dollars through sales of XRP—an unregistered security—to retail investors in violation of the registration provisions of federal and state securities laws” and sought to “drive demand for and thereby increase profits from the sale of XRP” using “a litany of false and misleading statements regarding XRP.” ECF No. 87, at ¶¶ 1-2. The Court had previously dismissed Plaintiffs’ misrepresentation, consumer-protection, and professional conduct claims under California state law. ECF No. 85, at 2-3, 40. At the summary judgment stage, only five claims remained. ECF No. 419 at 1.
On summary judgment, defendants emphasized that the Court had already found in a parallel action that “XRP, as a digital token, is not in and of itself a ‘contract, transaction[,] or scheme’ that embodies the Howey requirements of an investment contract.” ECF No. 339 at 2; see also SEC v. Ripple Labs, Inc., 2023 WL 4507900 (S.D.N.Y. July 13, 2023) (granting partial summary judgment in favor of Ripple and concluding that institutional buyers had an expectation of profit whereas programmatic buyers had no such expectation). The District Court for the Northern District of California granted in part defendants’ motion for summary judgment on federal and most state class claims but denied it as to one plaintiff’s individual claims under California law. ECF No. 419. The Court found that the statute of repose barred the federal securities claims and that plaintiff failed to raise a triable issue as to California state law’s privity requirement. Id. at *4. That said, the Court found that the cause of action for misleading statements should proceed to trial. Id. at *10. The trial date is currently set for January 21, 2025. ECF No. 434.
Dufoe v. DraftKings Inc., 2024 WL 3278637 (D. Mass. July 2, 2024): On July 2, 2024, the U.S. District Court for the District of Massachusetts denied DraftKings’ motion to dismiss a putative class action for violations of federal securities law and found that DraftKings Non-Fungible Tokens (NFTs) were securities. ECF No. 60 at *21. DraftKings operates the DraftKings Marketplace where individuals can buy and sell DraftKings NFTs with images of professional athletes. Id. at *3. In its motion to dismiss, DraftKings argued that its NFTs were not securities. Id. at *7. The Court rejected this argument, finding that plaintiffs plausibly alleged commonality and reasonable expectation of profits under the Howey test and therefore plausibly pled that the NFTs were securities. Id. at *7-21.
B. Regulatory Lawsuits
SEC v. Genesis Glob. Cap., LLC, 2024 WL 1116877 (S.D.N.Y. Mar. 13, 2024): On January 12, 2023, the SEC filed a complaint alleging that Genesis—a company that pooled crypto assets and lent them to institutional investors—violated the securities laws when it worked with Gemini—a limited liability trust company—to extend its lending and pooling practices to Gemini’s customers, including U.S. retail investors, through the “Gemini Earn” program. ECF No. 1; see also id. at *1-2. The complaint alleged that Gemini and Genesis violated the securities laws under two theories. The SEC’s first theory was that the Gemini Earn program was an unregistered security under the Supreme Court’s Howey test. ECF No. 1 at 17-19. The second theory alleged that the agreements were “notes,” using the Supreme Court’s Reves test. Id. at 13-17. On March 13, 2024, the Court denied a motion to dismiss and allowed the SEC’s complaint against Genesis and Gemini to proceed. ECF No. 54. The district court found that the SEC plausibly alleged both theories. ECF No. 54 at 31. The Court also rejected defendants’ motions to strike the SEC’s requests for a permanent injunction of the companies’ activities and for disgorgement. Id. at 29-31. Following the Court’s March 13 Order, Genesis agreed to a $21 million civil penalty as well as a permanent injunction. ECF No. 56. These actions come after Genesis and two affiliates filed for Chapter 11 bankruptcy in the U.S. District Court for the Southern District of New York on January 12, 2023. The SEC will not receive portions of the civil penalty until the bankruptcy court resolves all claims, including those claims from retail investors. SEC, Genesis Agrees to Pay $21 Million Penalty to Settle SEC Charges (Mar. 19, 2024). As we reported in our May 2024 Digital Assets Recent Updates newsletter, Genesis also agreed to a $2 billion settlement with the New York Attorney General’s Office to compensate defrauded investors on May 20, 2024.
SEC v. Coinbase, Inc., 2024 WL 1304037 (S.D.N.Y. Mar. 27, 2024): On March 27, 2024, the Court presiding over an enforcement action brought by the SEC against Coinbase, one of the world’s largest cryptocurrency trading platforms, granted in part, and denied in part Coinbase’s motion to dismiss the complaint. ECF No. 105. The Court dismissed the SEC’s claim that Coinbase acted as an unregistered broker with respect to Coinbase’s “Wallet” application because the SEC failed to sufficiently allege that Coinbase acted as a broker with respect to its self-custodial digital wallet. Id. at 78-84. The Court refused to dismiss the remaining claims, finding that the SEC sufficiently pleaded that Coinbase operated as an unregistered broker, unregistered exchange, and unregistered clearing agency with respect to certain other products and services, and that at least some digital assets offered on its platform were investment-contract securities under the Supreme Court’s Howey test. Id. at 84. The Court also held that the SEC adequately alleged that Coinbase Global was a control person of Coinbase. Id. at 60-78. The case is now in discovery regarding the remaining claims. Coinbase also asked the district court to certify an interlocutory appeal that would allow the Second Circuit to immediately consider whether the SEC may regulate as “investment contracts” digital asset transactions that involve no obligation running to the purchaser beyond the point of sale. That motion is fully briefed and remains pending.
SEC v. Terraform Labs Pte. Ltd., 2023 WL 8944860 (S.D.N.Y. April 5, 2024): On April 5, 2024, after a nine-day trial, a jury found Terraform Labs and its founder, Do Kwon, liable for securities fraud. SEC, Statement on Jury’s Verdict in Trial of Terraform Labs PTE Ltd. and Do Kwon (Apr. 5, 2024). As reported in our Securities Litigation 2023 Mid-Year Update, the SEC brought claims against Terraform and Kwon under the federal securities laws for sales of unregistered securities and fraud related to Terraform’s crypto assets. ECF No. 1. Defendants moved to dismiss, arguing that none of the crypto assets were securities, but the Court denied the motion. ECF No. 51. And, as reported in our Securities Litigation 2023 Year-End Update, on December 28, 2023, the U.S. District Court for the Southern District of New York granted summary judgment for the SEC on the claim that defendants violated Sections 5(a) and 5(c) of the Securities Act and granted summary judgment for defendants on the claims involving unregistered transactions in security-based swaps. ECF No. 149. Still, the SEC’s fraud claims proceeded to trial. After a trial in late March 2024, a unanimous jury found defendants liable on both claims, under Section 17 of the Securities Act and the anti-fraud provisions of the Exchange Act, and that Kwon was liable as control person. ECF No. 229. On June 12, 2024, the Court entered a final judgment against Terraform for $4.47 billion and against Kwon for $204 million. ECF No. 273. As part of the final judgment, Terraform agreed to waive any right to appeal. Id. at 2.
SEC v. Balina, No. 22-cv-00950 (W.D. Tex.): On May 22, 2024, the Court granted, in part, and denied, in part, the SEC’s motion for summary judgment, and denied defendant Ian Balina’s motion for summary judgment. The SEC alleged that Balina, a cryptocurrency investor, signed a contract to invest $5 million in an offering of Sparkster (SPRK)—a crypto asset—but sold SPRK tokens without disclosing his compensation, violating Section 5(a), 5(c), and 17(b) of the Securities Act. ECF No. 1. The SEC separately accused Sparkster of offering SPRK tokens without registering and sought civil penalties. Id. Balina moved for summary judgment, arguing that he did not violate Section 5 and Section 17, that the SPRK tokens were not a security and the alleged promotions and transactions occurred outside the United States. SEC v. Balina, 2024 WL 2332965, at *4 (W.D. Tex. May 22, 2024). Balina also argued that he did not sell SPRK tokens, that he did not agree to accept compensation, and that any purported sales or offers to sell would be exempt under Section 4(a)(1) of the Securities Act. Id. The SEC argued that SPRK tokens are securities, that U.S. securities laws apply because Balina targeted U.S. investors on U.S. social media platforms, and that it established as a matter of law that Balina violated Section 5. Id. at *5. The district court found that the Securities Act would apply to Balina’s conduct and that SPRK tokens were securities as a matter of law. Id. at *8, *11. The Court declined to decide the Section 17(b) issue on summary judgment. Id. at *11. However, the Court agreed with the SEC that Balina violated Section 5(a) and 5(c) of the Securities Act by selling SPRK tokens and that Balina was not exempt under Section 4(a)(1). Id. at *13. Trial has been set for January 13, 2025. ECF No. 50.
SEC v. Binance Holdings Ltd., No. 23-cv-01559 (D.D.C.): As reported in our Securities Litigation 2023 Year-End Update, on June 5, 2023, the SEC filed an action against Binance Holdings Limited, BAM Trading Services Inc., BAM Management Holdings, and Changpeng Zhao in the U.S. District Court for the District of Columbia. The SEC accused Binance and its subsidiaries of engaging in the unregistered offer and sale of crypto asset securities and of making false statements to investors. On June 28, 2024, the Court granted in part and denied in part defendants’ motion to dismiss. It found that the SEC plausibly alleged that Binance directly offered and sold its cryptocurrency, the Binance coin (BNB), to investors as an investment contract. SEC v. Binance Holdings Ltd., 2024 WL 3225974, at *14-15 (D.D.C. June 28, 2024). However, the Court found that the SEC did not sufficiently allege that secondary sales of BNB were investment contracts, or that Binance offered and sold BUSD, a stablecoin, as an investment contract. Id. at *24. In doing so, the Court rejected the SEC’s theory that the BNB token “embodied” an investment contract. The court expressed frustration with the SEC’s strategy to regulate the cryptocurrency industry through case-by-case, “coin by coin” litigation, noting that such an approach “risks inconsistent results that may leave the relevant parties and their potential customers without clear guidance.” Id. at *11. The court similarly rejected the SEC’s allegations as to some of Binance’s online programs including “Simple Earn,” which allegedly allowed investors who lent their crypto assets to Binance to receive variable rates of interest over time. Id. at *26. The Court also held that claims against BAM Trading Services and BAM Management Holdings could proceed, including a count that alleged statutory violations of the anti-fraud provisions of the Securities Act and a count alleging that a staking program was an investment contract. The Court found that most of the remaining counts of the complaint, which involved registration violations based on the operation of an online exchange, could proceed based on the SEC’s allegations concerning direct sales of BNB, the BNB Vault program, and the staking program allegedly offered by BAM Trading Services and BAM Management Holdings. Gibson Dunn represents Binance Holdings Limited in this action.
SEC v. Consensys Software Inc., No. 24-cv-04578 (E.D.N.Y.): In April 2024, Consensys—which allows trading of the cryptocurrency Ether (ETH)—brought a pre-enforcement challenge in the Northern District of Texas after receiving a Wells notice from the SEC that it intended to bring an enforcement action against Consensys for violating federal securities laws as an unregistered broker-dealer. Consensys Software Inc. v. Gensler, No. 24-cv-369, ECF No. 1 ¶¶ 3, 68, 121 (N.D. Tex. filed Apr. 25, 2024). Consensys sought a declaratory judgment that the SEC lacks authority over ETH because ETH is not a security and that the SEC violated the APA by changing its position on whether ETH is a security. Id. ¶ 121. It also sought a permanent injunction prohibiting the SEC from pursuing enforcement. Id.
On June 28, 2024, the SEC filed a complaint in the U.S. District Court for the Eastern District of New York against Consensys Software Inc., alleging that the company violated the federal securities laws by failing to register as a broker of crypto asset staking platforms. SEC v. Consensys Software Inc., No. 24-cv-04578 (E.D.N.Y.). Specifically, the SEC alleged that Consensys acted as a broker by creating and managing the “MetaMask Swaps” digital platform. Id. at 2. The SEC also alleged that the platform allowed Consensys to offer and sell Lido and RocketPool, two crypto assets that would offer a crypto staking program that the Commission classified as an investment contract. Id. at 4. Consequently, the SEC seeks a final judgment permanently enjoining Consensys from acting as a broker or underwriter and ordering the company to pay civil penalties. Id. at 6. Defendants have since moved to dismiss or, in the alternative, transfer the case to the Northern District of Texas. Consensys Software Inc. v. SEC, No. 4:24-cv-00369-O (N.D. Tex. July 7, 2024), ECF No. 37.
C. Other Developments
1. Crypto Participants And Associations Challenge The SEC’s Authority
Thus far in 2024, four lawsuits have been filed challenging the SEC’s authority to regulate digital assets.
In February 2024, LEJILEX—an operator of a developing a decentralized exchange—and the Crypto Freedom Alliance of Texas (CFAT) filed suit in the Northern District of Texas, seeking a declaration that secondary-market sales of digital assets are not securities, as well as an injunction against the SEC’s bringing an enforcement action against LEJILEX or other CFAT members. LEJILEX v. SEC, No. 24-cv-168, ECF No. 1 at 50, ECF No. 53 at 2 (N.D. Tex. filed Feb. 21, 2024). Plaintiffs argued that digital assets generally are not investment contracts and that the major questions doctrine prevents the SEC from regulating digital assets. ECF No. 35 at 22-31. On June 26, 2024, the SEC sought dismissal or, in the alternative, summary judgment, arguing that the Court lacked jurisdiction and that plaintiffs failed to show that secondary-market digital-asset transactions cannot qualify as securities. ECF No. 38 at 19-25.
In March 2024, Beba, an apparel company that created the “BEBA token,” which is used to redeem an exclusive product from its online store, sought a declaratory judgment that, inter alia, (1) Beba is not engaged in unregistered distribution of securities, and (2) the distribution of BEBA tokens does not constitute an investment contract or securities contract between Beba and token holders. Beba LLC v. SEC, No. 24-cv-153, ECF No. 1 ¶¶ 3, 6, 60, 179-92 (W.D. Tex. filed Mar. 25, 2024). Beba also argued the SEC adopted a “new policy” of alleging that digital assets are investment contracts without going through required notice and comment procedures under the Administrative Procedure Act. Id. ¶¶ 4, 6, 8. After the SEC first moved to dismiss, (ECF No. 22), Plaintiffs filed an amended complaint, (ECF No. 24).
On April 23, 2024, CFAT and the Blockchain Association filed an action challenging the SEC’s Dealer Rule. Crypto Freedom Alliance of Texas v. SEC, No. 24-cv-361, ECF No. 1, ¶¶ 4, 7 (N.D. Tex. filed Apr. 23, 2024). Plaintiffs argued that the SEC exceeded its authority in changing the definition of “dealer” and that the SEC’s failure to address concerns by the digital assets industry was arbitrary and capricious. Id. ¶ 12. On May 17, 2024, plaintiffs moved for summary judgment, arguing that the SEC’s departure from the meaning of the word “dealer” exceeds its statutory authority and that it acted arbitrarily and capriciously in violation of the Administrative Procedure Act. ECF No. 29 at 18-44. The SEC cross-moved for summary judgment, arguing that it acted within its statutory authority, that its rule was reasonable (and reasonably explained), and that it had provided adequate notice its rule would apply to “crypto asset securities.” ECF No. 39 at 14-47. Gibson Dunn represents the plaintiffs in a related lawsuit challenging the same SEC Rule. See National Association of Private Fund Managers v. SEC, No. 24-cv-00250 (N.D. Tex. Mar. 18, 2024).
2. SEC Approves Spot Ethereum Exchange-Traded Funds (ETFs)
On May 23, 2024, the SEC approved eight spot Ethereum ETFs from major financial institutions—including BlackRock, Fidelity, and others. Tim Copeland & Sarah Wynn, SEC Approves 8 Ethereum ETFs including BlackRock and Fidelity, The Block (May 23, 2024). This approval comes four months after the SEC’s first approval of spot Bitcoin ETFs, as discussed in our Securities Litigation 2023 Year-End Update, and shows increased institutional acceptance and regulatory clarity for Ether-based digital assets.
3. SEC May Target Decentralized Exchanges
On April 10, 2024, Uniswap Labs, which created the Uniswap Protocol on a decentralized Ethereum blockchain, shared that it received a Wells notice from the SEC. Uniswap, Fighting for DeFi, Uniswap Labs Blog (Apr. 10, 2024). Uniswap claimed that the SEC lacks authority as the Uniswap Protocol does not meet the legal definitions of securities exchange or broker and that its UNI token is not a security. Id. Uniswap compared Uniswap to Bitcoin and Ethereum, which the CFTC has said are not securities. Id.
4. U.S. House Of Representatives Passes Crypto Bill
On May 22, 2024, the U.S. House of Representatives passed the Financial Innovation and Technology for the 21st Century Act (FIT21), which marks the first time that the House has passed a significant crypto bill. Jesse Hamilton & Nikhilesh De, U.S. House Approves Crypto FIT21 Bill With Wave of Democratic Support, CoinDesk (May 22, 2024). The legislation aims to regulate U.S. crypto markets, makes the CFTC the leading regulator of digital assets, and implements new rules to determine whether an asset is subject to federal securities laws. Id. SEC Chair Gary Gensler fiercely opposed the bill, stating that the bill “would create new regulatory gaps and undermine decades of precedent regarding the oversight of investment contracts, putting investors and capital markets at immeasurable risk.” Statement on the Financial Innovation and Technology for the 21st Century Act, SEC (May 22, 2024).
VII. Lorenzo Disseminator Liability
As previously discussed in our Mid-Year and Year-End Updates, in Lorenzo, the Supreme Court expanded the scope of scheme liability under Rule 10b-5(a) and (c) to individuals who disseminate false or misleading information but are not the “makers” of the misstatement(s). Following Lorenzo, the Second Circuit in Rio Tinto held that defendants must do “something beyond” making material misstatements or omissions to be subject to scheme liability. SEC v. Rio Tinto plc, 41 F.4th 47, 49 (2d Cir. 2022). In other words, the Court in Rio Tinto noted that while those who disseminate false or misleading information may be liable, misstatements alone are not sufficient to trigger scheme liability. Although it has now been five years since Lorenzo was decided, the Supreme Court has yet to clarify the requirements for scheme liability; accordingly, the lower courts are left to shape the contours of scheme liability claims. Since our last update, the Sixth Circuit has implicitly adopted the Second Circuit’s “something beyond” requirement but there is a growing divide among the district courts.
In Teamsters Local 237 Welfare Fund v. ServiceMaster Global Holdings, Inc., the Sixth Circuit embraced the Second Circuit’s test for scheme liability claims and held that “a plaintiff must show: ‘(1) that the defendant committed a deceptive or manipulative act, (2) in furtherance of the alleged scheme to defraud, (3) with scienter, and (4) reliance.’” 83 F.4th 514, 525 (6th Cir. 2023) (quoting Plumber & Steamfitters Local 773 Pension Fund v. Danske Bank A/S, 11 F.4th 90, 105 (2d Cir. 2021)). In ServiceMaster, plaintiff alleged that ServiceMaster violated Section 10(b) “by engaging in a series of misrepresentations and omissions” and “that the Defendants violated Rule 10b-5 (a) and (c) by engaging in a fraudulent scheme to mislead investors about the true nature” of the business. Id. at 522-23. In analyzing plaintiff’s scheme claim, the Sixth Circuit noted that although “[o]ur court has not defined the elements to state a claim for scheme liability . . . the Second Circuit has.” Id. at 525. Relying on the Second Circuit’s articulation of the elements required for a scheme claim, the Sixth Circuit analyzed plaintiff’s scienter allegations because it was “the only disputed element.” Id. The Court held that plaintiff failed to allege a strong inference of scienter. Id. at 529-33. The Court then explained that although a “scheme-liability claim encompasses conduct beyond disclosure violations,” id. at 525 (citing Benzon v. Morgan Stanley Distribs., Inc., 420 F.3d 598, 610 (6th Cir. 2005)), a scheme liability claim is “different and separate from a nondisclosure claim,” id. (citing Rio Tinto, 41 F.4th at 49, 53). Nevertheless, because “the [plaintiff] relie[d] on the same factual circumstances to make out both claims in this case,” plaintiff’s showing of scienter was therefore “no stronger with respect to the scheme-liability claim than it is for the Rule 10b-5 claim.” Id. at 533.
Not all Circuit courts have considered Rio Tinto’s distinction between misstatement and scheme claims. However, certain lower courts outside the Second Circuit have indicated a willingness to adopt the “something beyond” requirement. For example, in SEC v. Westhead, the Southern District of Florida held that the SEC adequately pleaded a scheme liability claim by alleging defendant disseminated the misstatements in the form of private placement memorandums. 2024 WL 3327804, at *10 (S.D. Fla. May 3, 2024). The Court arrived at its decision citing Rio Tinto and SteamMaster, explaining that with “this case law in mind,” dismissal of the SEC’s scheme liability claim was not appropriate because under the “Defendants’ own precedent, [dissemination] is sufficient to survive a motion to dismiss.” Id. (citing Rio Tinto, 41 F.4th at 53). Similarly, in SEC v. Jaitley, the Western District of Texas explained that scheme liability is distinct deceptive conduct from an alleged misstatement. 2023 WL 9105678, at *6-7 (W.D. Tex. Nov. 13, 2023) (holding that defendant furthered a scheme by directing “[c]lients to post fake, favorable reviews” or “posting false reviews herself”).
District courts within the Second Circuit also continue to provide examples of how to apply Rio Tinto’s “something beyond” requirement. In a recent case in the Southern District of New York, SEC v. Rogas, the Court denied a motion to dismiss scheme liability claims against a former executive of NS8, Inc. 2024 WL 1120558 (S.D.N.Y. Mar. 14, 2024). The complaint alleged defendant knew “the revenue numbers used by NS8 and provided to investors were falsified” and continued to solicit numerous potential investors, assisted in a “secondary offering between two NS8 investors,” and devised a scheme to “offload his shares in NS8 in a transaction funded by a third-party investor.” Id. at *1. The Court found that the SEC successfully pled defendant “committed [] manipulative or deceptive act[s]” that were “something beyond misstatements and omissions” as in Rio Tinto. Id. at *5. Specifically, the Court found that (1) initiating six investor transactions while knowing that the revenue numbers were falsified, (2) seeking “additional investors and transactions even after [defendant] became aware” that NS8 had very little money left and only some employees received “real data” about the sales team, and (3) selling shares in a secondary offering after acknowledging revenues were not correct, made out a scheme liability claim. Id. at *5.
In SEC v. City of Rochester, a district court in the Western District of New York, citing positively to Rio Tinto, denied defendants’ motion to dismiss scheme liability claims. 2024 WL 909475 at *9-10 (W.D.N.Y. Mar. 4, 2024). The SEC alleged that defendants made “materially misleading statements and omissions in the offering documents used to sell roughly $119 million in municipal bonds to investors.” Id. at *1. The SEC’s scheme allegations included that the “City Defendants disseminated the false statements in the offering documents sent to investors,” the City’s director of finance “executed separate certifications attesting to the accuracy of the offering documents in furtherance of the scheme,” and “the City Defendants facilitated the sale of the bonds.” Id. at *10. The Court sustained the scheme liability claims noting that statements regarding the reason for the RAN were incomplete and thus misleading. Id.
In the Third Circuit, the District of New Jersey found that the SEC sufficiently alleged scheme liability under Rule 10b-5(a) and (c), citing to Rio Tinto. SEC v. Mintz, 2024 WL 1173096, at *15, 18 (D.N.J. Mar. 18, 2024). Specifically, the SEC alleged that defendants submitted “misleading trade order instructions or false and misleading representations concerning the number of ‘locates.’” Id. at *15. The Court determined that the submission of those transactions and the “repeated circumvention of Regulation SHO and efforts to conceal Defendants’ scheme” were sufficient to constitute “deceptive conduct independent of its allegations that Defendants made false or misleading statements.” Id. at *15.
Certain lower courts within the Ninth Circuit, however, have disagreed with the Second Circuit’s approach and declined to apply the “something beyond” requirement. In SEC v. Prakash, the Northern District of California emphasized that the Ninth Circuit has not adopted the “something beyond” requirement set forth in Rio Tinto. 2024 WL 781037, at *6 (N.D. Cal. Feb. 26, 2024). Rather, the Court found that “to the extent that [defendant] argues that scheme liability claims require conduct beyond misstatements, the Court finds that this argument is foreclosed by Lorenzo and Ninth Circuit precedent.” Id. The Court explained that the Supreme Court in Lorenzo rejected the argument that Rule 10b-5(a) and (c) concern “scheme liability claims ‘that are violated only when conduct other than misstatements are involved.’” Id. Similarly, the Ninth Circuit previously held that its “prior holding that ‘[a] defendant may only be liable as part of a fraudulent scheme based upon misrepresentations and omissions . . . when the scheme also encompasses conduct beyond those misrepresentations or omissions’” was abrogated by Lorenzo. Id. (citing In re Alphabet, Inc. Sec. Litig., 1 F.4th 687, 709 n.10 (9th Cir. 2021)). Thus, the Court read Lorenzo as holding that 10b-5 “covers a broad range of conduct” and its subsections are not “mutually exclusive.” Id.
Similarly, in In re AGS, Inc. Securities Litigation, the District of Nevada explained that “in Lorenzo, the Supreme Court explained that considerable overlap exists.” 2024 WL 581124, at *5 (D. Nev. Feb. 12, 2024) (citing Lorenzo, 139 S. Ct. at 1101-02). “The various subsections thus merely describe subsets of a broader category—fraud.” Id. (emphasis in original). Ultimately, the only difference between a scheme liability claim verses a misrepresentation claim is “not that they proscribe mutually exclusive . . . conduct,” rather, the conduct in scheme claims is made in furtherance of a scheme “while the latter doesn’t involve a scheme.” Id. And because plaintiff’s cause of action could be construed as either a misrepresentation claim or a scheme liability claim, the Court held that plaintiff failed to state a claim under any subsection of Rule 10b-5 because when a scheme claim is based on the same set of facts as a misrepresentation claim, and “those facts do not sufficiently allege fraud . . . [under the] the misrepresentation claim, then the scheme claim necessarily fails.” Id.
VIII. Market Efficiency And “Price Impact” Cases
District courts continue to engage with defendants’ attempts to defeat or limit class certification by rebutting the Basic presumption of reliance with evidence that the alleged misstatements had no impact on the stock price. These developments occur against the backdrop of the Second Circuit’s 2023 decision in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., 77 F.4th 74, 105 (2d Cir. 2023) (ATRS), covered in our 2023 Year-End Update and discussed in more detail in our Client Alert. The Second Circuit continues to be the only circuit court to address substantively the “price impact” issue following the Supreme Court’s guidance in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, 594 U.S. 113 (2021) (Goldman).
To refresh, in Goldman, the Supreme Court held that courts analyzing whether to grant class certification must consider all evidence regarding price impact—even if the evidence overlaps with merits questions such as materiality. 594 U.S. at 121-22. The Court explained that where a plaintiff’s price impact theory is based on “inflation-maintenance,” i.e., where price impact of the challenged statement is shown indirectly by a drop in the company’s stock price following a corrective disclosure on the theory that “price inflation [had been] maintained by an alleged misrepresentation,” a court must consider whether there is a “mismatch” between the alleged corrective disclosure(s) and challenged statement(s). Id. at 123. That is because a “mismatch” between the misrepresentation and the corrective disclosure “starts to break down” the inference of front-end price inflation. Id. In ATRS, the Second Circuit studied the mismatch between the generic challenged statements (e.g., statements about business principles) and more specific alleged corrective disclosures (e.g., reports of government investigations into specified employees and transactions) and held that defendants had “sever[ed] the link” between the challenged statements and the price drop. ATRS, 77 F.4th at 104. In reaching this conclusion, the Court was clear that “all record evidence relevant to price impact” should be considered. Id. at 103 n.15 (internal citations omitted).
Lower courts continue to scrutinize price impact arguments, particularly the potential “mismatch” between the alleged corrective disclosures and the challenged statements. See, e.g., Sjunde AP-Fonden v. Goldman Sachs Grp., Inc., 2024 WL 1497110, at *17 (S.D.N.Y. Apr. 5, 2024) (finding “no match” between 11 out of 13 alleged misstatements and the corrective disclosure); In re Apache Corp. Sec. Litig., 2024 WL 532315, at *6 (S.D. Tex. Feb. 9, 2024) (finding no price impact for 12 out of 13 alleged misrepresentations and limiting the class period accordingly); In re Kirkland Lake Gold Ltd. Sec. Litig., 2024 WL 1342800, at *12 (S.D.N.Y. Mar. 29, 2024) (finding no price impact and declining to certify the class).
For example, in Kirkland Lake, the Court denied class certification, finding that defendants had rebutted the Basic presumption of class-wide reliance with evidence showing that all three alleged misstatements did not impact the stock’s price. 2024 WL 1342800, at *9-12. For the first two alleged misstatements, the Court found them to be “fairly broad and generic statements about the company’s growth strategy,” and that there was a “considerable gap in genericness between the earlier statements and the corrective disclosure.” Id. at *8. In conducting its analysis, the Court considered contemporaneous analyst reports and the opinions of defendants’ mining industry and economics experts. Id.
As to the third statement, which the Court described as “quite specific,” the Court compared the alleged misstatement and corrective disclosure “to determine ‘whether there [was] a basis to infer that the back-end price [drop] equals front-end inflation.’” Id. at *11 (citing ARTS, 77 F.4th at 99 n.11). The Court determined that there was a different kind of substantive mismatch because the challenged statement “referred to future targets” and the corrective disclosure reflected only information at the time of acquisition. Id.
In Sjunde AP-Fonden, the Court declined to find a match between 11 of 13 alleged misstatements and the corrective disclosure. 2024 WL 1497110, at *16. The Court concluded that the corrective disclosure “d[id] not even address” or “d[id] not mention [] at all” the same issues as several of the alleged misstatements, so the Basic presumption was inapplicable to those statements. Id. at *16-17. For other challenged statements, the Court found in defendants’ favor because the corrective disclosure did “not necessarily render false the [challenged] statements.” Id. at *16. For the remaining two statements, the Court held the statements were appropriately specific and were “render[ed] false” by the disclosure. Id. at *15-16.
Recent decisions also emphasize the more basic requirement that a later stock price decline is only evidence of an earlier statement’s price impact, if it, in fact, reveals new information contrary to the challenged statements. See In re FibroGen Sec. Litig., 2024 WL 1064665, at *12-15 (N.D. Cal. Mar. 11, 2024) (“revelations that are not ‘corrective’ cannot form the basis for a corrective disclosure”).
We will continue to monitor developments in this area.
IX. Other Notable Developments
A. Seventh Circuit Determines Procedure For District Courts To Evaluate Suits Resulting In Mootness Fees
In Alcarez v. Akorn Inc., the Seventh Circuit set forth the proper procedure for a district court to evaluate mootness fees paid to shareholder plaintiffs after the voluntary dismissal of an action brought under Section 14(a) of the Securities Exchange Act challenging a public company merger. 99 F.4th 368 (7th Cir. 2024).
After Akorn Inc. announced a merger, shareholders brought six individual and putative class actions against Akorn, asserting its proxy statement was inadequate and in violation of Section 14(a). Alcarez, 99 F.4th at 372. After Akorn amended its proxy statement with additional disclosures, all plaintiffs voluntarily dismissed the complaint and Akorn agreed to pay plaintiffs’ counsel a $322,500 mootness fee. Id. A different Akorn shareholder moved to intervene to force plaintiffs’ counsel to return the mootness fee, arguing that the suits’ only goal was to extract money for counsel. Id. A district court in the Eastern District of Illinois denied the motion to intervene but agreed with the shareholder’s broader argument. Id. at 373. The district court thus exercised its “inherent authority” to reopen the suit, determined the complaints were frivolous, and then abrogated the settlement and ordered plaintiffs’ counsel to return the mootness fee. Id. Plaintiffs appealed, arguing that the district court lacked authority to reopen the case and lacked jurisdiction to review the mootness fee after the voluntary dismissal. Id. at 374.
The Seventh Circuit vacated the opinion and remanded with instructions. It first determined that the district court lacked inherent authority to reopen the voluntarily dismissed case without a motion under Federal Rule of Civil Procedure 60(b). Id. at 374. However, it further held that the shareholder in question should have been allowed to intervene and file a motion to reopen. Id. The Court reasoned that the shareholder had a common claim with the main action since he was “an investor in Akorn whose shares’ value was affected by the merger and the mootness fees” and “class counsel and Akorn [we]re looking out for their own interests rather than those of the class” making intervention “appropriate.” Id. at 375.
The Seventh Circuit further determined that the district court had “inherent authority” to evaluate the suits under 15 U.S.C. § 78u-4(c)(1) and Federal Rule of Civil Procedure 11. Id. at 377. The statute, the Court reasoned, applies to all suits arising under the Exchange Act and mandates that courts assess compliance with Rule 11(b) upon “final adjudication of the action” which includes voluntary dismissal. Id. at 376.
The cases were remanded to the district court with instructions to treat the shareholder as an intervenor, to allow him to make a Rule 60(b) motion, and to decide appropriate relief. Id. at 378.
B. Sixth Circuit Joins Majority Of Circuits In Holding The Bespeaks Caution Doctrine Survived Codification Of The PSLRA
Joining other circuits, the Sixth Circuit held that the bespeaks caution doctrine still applies to statements contained in offering documents outside of the PSLRA’s safe harbor provisions for forward-looking statements. Kolominsky v. Root, Inc., 100 F.4th 675, 687-88 (6th Cir. 2024); see 15 U.S.C. § 78u-5(c).
Root, Inc., an insurance company primarily focused on automobile insurance, purportedly attracted investors with its low customer-acquisition cost (CAC). Plaintiffs alleged that certain statements in Root’s registration statement were misleading or omitted material facts about Root’s CAC because, at the time of Root’s IPO, the CAC was higher than its historic average. Id. at 681. The district court dismissed all claims for failure to state a claim. Plaintiffs appealed three of their dismissed claims: those under Sections 11, 12(a)(2), and 15 of the Securities Act. Id.
The Sixth Circuit affirmed. One of the three allegedly misleading statements implicated the bespeaks caution doctrine. The challenged statement contained in Root’s registration statement provided that “[a]s we grow, we may struggle to maintain cost-effective marketing strategies, and our customer acquisition costs could rise substantially.” Id. at 682, 687. The district court had determined that the “statement was not actionable because it was a forward-looking statement labeled as a risk factor.” Id. at 687. The Sixth Circuit agreed, concluding that the statement fell “squarely within the bespeaks caution doctrine’s protection.” Id. at 689.
The Sixth Circuit determined that Congress did not intend for the safe harbor provisions of the PSLRA to replace the bespeaks caution doctrine, which “shields companies . . . from liability when they make statements that are forward-looking and accompanied by meaningful cautionary language.” Kolominsky, 100 F.4th at 688. The Sixth Circuit therefore joined the majority of circuits—namely the First, Second, Third, Fifth, Eighth, Ninth, Tenth, and Eleventh Circuits—that previously reached a similar conclusion about the doctrine’s post-PSLRA status. Id. at 687-88.
C. Ninth Circuit Provides Additional Guidance On Determining Loss Causation
On April 5, 2024, the Ninth Circuit provided additional guidance on determining loss causation in a securities fraud case, explaining that a plaintiff does not necessarily need to show a stock price increase on the heels of a misstatement but may “plausibly show that the misstatement inflated the stock’s price.” In re Genius Brands Int’l, Inc. Sec. Litig., 97 F.4th 1171, 1185 (9th Cir. 2024) (emphasis added).
In 2019, the price per share of children’s entertainment company Genius Brands International, Inc. fell below the NASDAQ minimum trading requirement. Id. at 1177. Subsequently, a group of shareholders alleged that the company had made certain false statements regarding (1) how frequently its flagship children’s television show would air per week; (2) the possibility of Disney or Netflix acquiring the company; and (3) the company’s rights to the works of comic book author Stan Lee. Id. at 1179. The shareholders alleged that the company and its officers violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5(a)-(c). Id. at 1177, 1179. The district court dismissed the shareholders’ suit with prejudice for failure to adequately plead falsity and loss causation. Id. at 1179-80. The district court dismissed two of the claims for a “failure to allege an initial price increase.” Id.
The Ninth Circuit reversed in part and affirmed in part. On loss causation, the Ninth Circuit’s opinion emphasized that “a price increase is one way of demonstrating that ‘the price was higher than it would have been,’ but it is not the only way.” In re Genius Brands Int’l, Inc., 97 F.4th at 1185 (quoting In re BofI Holding, Inc., 977 F.3d at 789) (emphasis added). Accordingly, it “suffices to plausibly allege that the stock price was higher than it would have been but for the defendant’s statement—whether because the statement increased the stock price, maintained the stock price, or prevented a greater decrease in the stock price.” Id. at 1187. On two of the claims, the Ninth Circuit reasoned that the district court had “impermissibly conflated an initial price increase with initial price inflation.” Id. at 1185. The case was remanded for further proceedings. Id. at 1190.
D. Companies Continue To Litigate Alleged Misrepresentations Related To COVID-19
More than four years removed from the initial COVID-19 outbreak, coronavirus-related securities litigation continues to be active. As we last discussed in our Securities Litigation 2022 Mid-Year Update, a class-action complaint was filed in May 2020 against biopharmaceutical company Sorrento Therapeutics (Sorrento) and its officers on behalf of all shareholders who had purchased Sorrento stock in the week following the company’s May 15, 2020, press release. In re Sorrento Therapeutics, Inc. Sec. Litig., 97 F.4th 634, 637-38 (9th Cir. 2024). Early in the COVID-19 pandemic, Sorrento announced the discovery of an antibody showing “100% inhibition” of COVID-19 infection. Id. at 641. Some Sorrento officers claimed the antibody would “completely prevent infection” and provided a COVID-19 “cure.” Id. at 639 & n.3. As the market responded to this information, Sorrento’s stock more than tripled in value. Id. at 638. Sorrento’s stock value eventually declined, however, as outsiders publicly began to scrutinize and critique Sorrento’s development. Id.
The complaint alleged that Sorrento purposefully misled investors and falsely claimed to have a COVID-19 cure in violation of Sections 10(b) and 20(a) and Rule 10b-5. Id. at 638-39. The district court dismissed the complaint, concluding that plaintiffs failed to plausibly allege falsity because Sorrento had disclosed in the press release that the antibody remained in preclinical stage, the officers’ statements were “corporate optimism” rather than an “actionable material misstatement of fact,” and Sorrento’s need to fundraise did “not give rise to a strong inference of scienter.” Id. at 639-40.
The Ninth Circuit affirmed. On falsity, the Court held that Sorrento’s “overblown” statements did not rise to the level of “materially misleading” investors considering Sorrento’s contemporaneous disclosures about the antibody’s early developmental status. Id. at 641. A reasonable person, knowing that the antibody required further testing after reading the press release, would not understand the press release to mean that Sorrento had “an immediate 100% cure” for COVID-19. Id. The Court rejected the argument that Sorrento could not, in good faith, have believed that it had a cure given the fact that there still is no cure for COVID-19. Id. at 641-42.
On the issue of scienter, the Court concluded that “although Sorrento’s financial situation was clearly helped by the market’s response to the [antibody] announcement,” Sorrento had resorted to other measures to mitigate its “dire financial situation” far in advance of the announcement. Id. at 642-43. A need to fundraise, accordingly, did not adequately establish motive for fraud. Plaintiffs’ argument also failed to “allege any particular improper or inflated sales” and such a “showing of trading history [was] necessary to raise an inference of scienter.” Id. at 643.
E. SEC Adopts Amendments To Regulation S-P, Requiring Covered Firms To Take Additional Customer Data Protection Measures
In May, the SEC adopted amendments to Regulation S-P, which require covered financial firms to provide certain protections for personally identifiable information of customers and consumers. 17 C.F.R. § 248.30; see also Mark T. Uyeda, Comm’r, Sec. & Exch. Comm’n, Statement on the Amendments to Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Customer Information (May 16, 2024) https://www.sec.gov/newsroom/speeches-statements/uyeda-statement-reg-s-p-051624 (“Comm’r Uyeda, Statement on the Amendments to Regulation S-P”). Initially adopted in 2000, Regulation S-P set standard for firms’ treatment of customers’ nonpublic personal information. See id. Due to the evolving nature and impact of data breaches, the amendments require “covered institutions to adopt written policies and procedures that provide for an incident response program to protect customer information from unauthorized access.” Id.
The “incident response program” requires covered firms to “assess the nature and scope” of the incident, take “appropriate steps to contain and control such incidents,” and provide notice to “each affected individual.” 17 C.F.R. § 248.30(a)(3)(i)-(iii). The amendments provide detailed requirements of these notices. For example, notice may not be required if a covered firm determines, after a reasonable investigation, that the “sensitive customer information has not been, and is not reasonably likely to be, used in a manner that would result in substantial harm or inconvenience.” Id. § 248.30(a)(4)(i). Notice may also be required to be sent to non-customers, as the amendments also define “customer information” to include information that (1) is within the covered firm’s possession regardless of whether there is a “customer relationship”; and (2) pertains to “the customers of other financial institutions where such information has been provided to the covered institution.” Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Customer Information, 89 Fed. Reg. 47688, 47714 & n.290 (June 3, 2024) (emphasis added); see also 17 C.F.R. § 248.30(d)(5)(i).
In terms of timing, notice must be sent “as soon as practicable, but generally not later than 30 days after the financial institution becomes aware that there has been an unauthorized breach of customer information.” Comm’r Uyeda, Statement on the Amendments to Regulation S-P. Covered firms are not required to contract with service providers to deliver data breach notices, but remain responsible “regardless of which entity sends the notice.” Id.
Additionally, the amendments extend Regulation S-P’s safeguard and disposal requirements to transfer agents registered with the Commission or another appropriate regulatory agency. Id.
The amendments provide for an 18-month compliance period for larger entities after the date of publication and a 24-month compliance period for smaller entities. Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Customer Information, 89 Fed. Reg. at 47723-24.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Securities Litigation practice group:
Christopher D. Belelieu – New York (+1 212.351.3801, [email protected])
Jefferson Bell – New York (+1 212.351.2395, [email protected])
Michael D. Celio – Palo Alto (+1 650.849.5326, [email protected])
Jonathan D. Fortney – New York (+1 212.351.2386, [email protected])
Monica K. Loseman – Co-Chair, Denver (+1 303.298.5784, [email protected])
Brian M. Lutz – Co-Chair, San Francisco (+1 415.393.8379, [email protected])
Mary Beth Maloney – New York (+1 212.351.2315, [email protected])
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Alex Mircheff – Los Angeles (+1 213.229.7307, [email protected])
Lissa M. Percopo – Washington, D.C. (+1 202.887.3770, [email protected])
Jessica Valenzuela – Palo Alto (+1 650.849.5282, [email protected])
Craig Varnen – Co-Chair, Los Angeles (+1 213.229.7922, [email protected])
Allison K. Kostecka – Denver (+1 303.298.5718, [email protected])
Mark H. Mixon, Jr. – New York (+1 212.351.2394, [email protected])
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