Securities class action lawsuits have been an important part of the litigation scene in Australia for many years. But even though the current class action procedural regime has been in place since 1992, no Australian securities class action lawsuit ever went all the way to judgment – that is, no case ever went to judgment until last week. On October 24, 2019, the Federal Court of Australia issued a post-trial Order in the TPT Patrol Pty Ltd as trustee for Amies Superannuation Fund v Myer Holdings Limited. The court’s ruling, a copy of which can be found here, contains a number of interesting points and could have important implications. A detailed October 25, 2019 memo from the Clyde & Co law firm about the judgment can be found here. Background The lawsuit was filed as a representative action by a Myer Holdings Limited shareholder on behalf of all investors who acquired Myer securities between September 11, 2014 and March 19, 2015. The allegations in the lawsuit related to statements made on September 11, 2014 by Myer’s CEO, Bernie Brooks, at a meeting with analysts and journalists. Among other things, Brooks expressed his belief that in the financial year ending in July 2015 Myer would likely have a net profit after tax (NPAT) in excess of Myer’s NPAT in the previous financial year. As it turned out, when the company updated its financial performance in March 2015, the company’s updated NPAT forecast for the fiscal year was stated as significantly below the prior financial year. The company’s share price declined about 10% on this news. The plaintiff shareholder commenced an action against Myer, alleging that the company and Brooks did not have a reasonable basis for the September 2014 forecast. The plaintiff further alleged that the company’s failure to clarify or revise its September 2014 forecast was in violation of the company’s continuous disclosure obligations under the Companies Act of DATE and under the ASX Rules. The plaintiff also alleged that Myer engaged in misleading or deceptive conduct. The case proceeded to trial. The October 24, 2019 Order In a 389-page October 24, 2019 order, Justice Jonathan Beach found that the plaintiff had established that Myer had violated its continuous disclosure obligations under both the Companies Act and the ASX rules. He specifically found that the company should have updated its prior disclosure on several difference occasions. Justice Beach also rejected the company’s attempt to rely on various exceptions to the disclosure obligations, holding that a “reasonable person” would have expected the updated information to be disclosed. However Justice Beach also said that “notwithstanding” the “contraventions” of the continuing disclosure obligations, he was “not convinced that the applicant and the group members have suffered any loss flowing from the contraventions.” In order to reach the loss questions, Justice Beach had to first decide whether loss causation was to be demonstrated on a direct (individual reliance) basis or on an indirect (market) causation basis. Justice Beach addressed the issue on a market basis, and also found that the use of “event studies” were useful in terms of assessing both materiality and share price inflation issues. However, in reliance on these principles, tools, and approaches, Justice Beach concluded that “because the market price for Myer securities at the time the contraventions occurred already factored in an NPAT well south of Mr Brookes’ rosy picture painted on 11 September 2014.” In other words, Justice Beach concluded, “the hard-edged scepticism of market analysts and market makers at the time of the contraventions had already deflated Mr Brookes’ inflated views.” Discussion U.S.-based readers undoubtedly were struck by the key role that Australia’s distinctive continuous disclosure regime played in this case. Whereas in the U.S., public companies are subject only to a periodic reporting requirement, Australian-listed companies are subject to a continuing duty to update and clarify. The distinction between the U.S. periodic reporting approach and the Australian continuous disclosure requirement is one of the very important differences between the public company duties (and potential liability risks) in the two countries’ systems. From my perspective, there are several noteworthy things about his ruling, the first of which is that Myer was found to have violated its continuing disclosure obligation. As Clyde & Co noted in its memo about the ruling, this ruling is “a timely reminder that when a company makes a forecast it has an ongoing obligation to monitor that forecast and change it if, at any time, it is no longer valid.” Another noteworthy thing about this ruling is that notwithstanding Justice Beach’s conclusion that the company did not fulfill its continuing disclosure obligation, he nevertheless concluded that neither the plaintiff nor the class had suffered damages as a result. This conclusion that there were no damages caused by the failure to update and correct the forecast is noteworthy in and of itself, but the reason for Justice Beach’s conclusion is all the more striking – he basically concluded that the market discounted the inflated forecast at the time it was made. As a result of their “hard-edged skepticism,” market observers disregarded the forecast. But the most significant thing about this ruling is that it happened at all. All prior securities class action lawsuits in Australia were either dismissed, withdrawn, or settled. Because there have been no prior judgments, there has been little case law addressing the important issues Justice Beach discussed in his opinion; the “jurisprudence” that this ruling represents is, the Clyde & Co memo notes, “welcome.” However, the rulings is subject to appeal. And as the law firm memo notes, “until there is a body of case law, including authoritative statements from appeal courts and the High Court, we expect uncertainty on central questions in these claims relating to such matters as causation and loss.” One final note of importance from the law firm memo is its message that while this case was the first to proceed to judgment in Australia, “our prediction is that it will not be the last.” Financial Lines Conference in Hamburg: On January 21 and 22, 2019, I will be participating as a International Keynote speaker at the Haftpflicht 2020 conference to be held in Hamburg, Germany. The conference will address a wide-variety of D&O and other financial lines topics, as detailed in the conference brochure, which can be found here. Readers of The D&O Diary are eligible for a €200 discount. To take advantage of the discount, visit the conference registration page here, and enter the VIP-code 77D02530R01. The post Australian Securities Class Action Suit Reaches Judgment for the First Time appeared first on The D&O Diary. Australian Securities Class Action Suit Reaches Judgment for the First Time syndicated from https://888migrationservicesau.wordpress.com via Tumblr Australian Securities Class Action Suit Reaches Judgment for the First Time
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Agency Denies Industry Petition and Publishes Revised Draft GuidanceThe U.S. Food and Drug Administration (FDA) appears set to ramp up enforcement efforts against companies selling homeopathic products. Since 1988, FDA’s enforcement decisions have been made within the framework of Compliance Policy Guide (CPG) § 400.400. Under this policy, the agency generally limited enforcement actions to products that were either inappropriately labeled or manufactured in violation of good manufacturing practice (GMP) regulations. Publication of the new draft guidance document, which officially withdraws CPG 400.400, is the latest signal that the regulatory landscape is changing – perhaps dramatically. The agency first revealed a new attitude toward homeopathic drugs with the issuance of a draft guidance in December 2017, which laid out a new “risk-based” model of enforcement that would guide agency decisions on homeopathic products. As we previously reported, this effectively rolled back the permissive framework of the CPG, although the agency noted that the CPG would not be withdrawn until the draft guidance is finalized. Not surprisingly, the homeopathic industry pushed back. One group (Americans for Homeopathy Choice) filed a petition urging the retention of the Compliance Policy Guide and the preservation of FDA’s pre-guidance homeopathy framework. Industry efforts do not appear to have worked. The FDA denied the petition of Americans for Homeopathy Choice and, over the first half of 2019, issued several Warning Letters to manufacturers and marketers of homeopathic drug products.1 The 2019 draft guidance document on homeopathy enforcement is nearly identical to the 2017 draft. It sets forth six categories of homeopathic products that reflect the agency’s enforcement priorities:
These categories largely track their 2017 predecessors, but FDA’s inclusion of broader categories for products with reports of injuries that raise potential safety concerns (versus products with only reported safety concerns) and for products with significant quality issues (versus adulterated products) underscores the possibility of wider-reaching FDA enforcement actions against manufacturers and marketers. While the FDA is sending a clear message to the homeopathic industry, we wonder whether the implications could reach beyond regulatory enforcement. By explicitly reaffirming that homeopathic drug products do not have any special status under federal law, the agency is essentially saying that all homeopathic drug products that are not marketed under an approved new drug application (i.e., all homeopathic drug products) are unlawful. This could embolden the plaintiff bar to initiate lawsuits against all companies selling homeopathic products – even those that survive the increased scrutiny of this new FDA enforcement policy. This is just another reason why companies manufacturing, marketing, and/or distributing homeopathic products would be wise not only to reevaluate their quality system, ingredients, and claims to mitigate the risk of being the subject of FDA’s next press release, and but also to prepare for the possibility of civil litigation. There is certainly more to come. Please feel free to contact the authors with questions or requests for additional information.
via Tumblr FDA Puts Homeopathic Industry on Notice – No More Lax Enforcement Under Louisiana law, does the operator’s bad faith preclude recovery for the non-operator’s breach of a joint operating agreement if the operator caused the non-operator to breach the JOA but did not itself breach? Apache’s choice In Apache Deepwater, LLC v. W&T Offshore, Inc., (link will come later) the litigants were parties to a JOA for operations on offshore deepwater wells. Apache proposed to use two drilling rigs tor P&A three wells at a much higher cost than a vessel that had been considered for the operation. W&T contended that Apache’s proposal was for the purpose of offloading to W&T half of $1 million per day stacking costs of a bad rig contract. Apache’s AFE for the P&A using the two rigs was $81 to $104 million, which would be cheaper for them (but not in total) than the alternative. Apache’s story was that the federal regulators would not have approved the original vessel for the operation after Deepwater Horizon. W&T declined to approve Apache’s AFE. Apache used the two rigs anyway. The work was successful and Apache billed W&T for its 49% share, or $68 million (Note to self: You can’t afford offshore operations). W&T paid $24 million (its share of the original estimate). Apache sued for breach of contract. The ambiguous JOA Section 6.2 of the JOA prohibited the operator from conducting any operation costing more than $200,000 without an AFE approved by the non-operator. But Section 18.4 directed the operator to conduct abandonments required by governmental authority and the risks and costs would be shared by the participating parties. No AFE was required. The jury With these conflicting provisions, the JOA was deemed ambiguous. After trial the jury found (1) W&T breached the JOA; (2) Apache’s damages were $43 million; (3) Apache was not required to obtain W&T’s approval; (4) Apache engaged in bad faith; thereby causing WMT not to comply with the JOA; and (5) W&T was entitled to an offset of $17 million. The result Overruling the jury, the trial and appellate courts ruled that as a matter of law Apache’s bad faith did not preclude Apache’s recovery for breach of contract. W&T was not entitled to the offset. This was a diversity case, so the court employed Louisiana civil law methodology to reach its decision by first examining primary sources of the law, the codes and statutes, rather than case law, which is secondary in Louisiana, unless the Supreme Court has ruled on the question. The court decided that Lamar Contractors Inc. v. Kacco Inc. was controlling. Civil Code Article 2003 requires a contract to be performed in good faith, but that duty is not to be considered in isolation and is circumscribed by obligations imposed by the contract. The question, then: Must a party seeking to recover for breach of contract demonstrate that the non-breaching party failed to perform its obligations which in turn contributed to the breaching party’s breach. Here Apache’s bad faith did not become relevant until it was determined that Apache failed to perform its contractual obligation that in turn caused W&T’s failure to perform. The court concluded that the good-faith inquiry in Article 2003 is limited to situations where the obligee (Apache here) has breached. The jury did not find that Apache breached the JOA, so article 2003 did not bar Apache’s recovery of its full damages as a matter of law. From a distance, it looks like W&T got the answer it wanted (Apache’s bad faith) to the wrong question (the right one being, did Apache breach?) Listen to the best base player of all time. Louisiana Operator’s Bad Faith Does Not Preclude Recovery syndicated from https://888migrationservicesau.wordpress.com via Tumblr Louisiana Operator’s Bad Faith Does Not Preclude Recovery Once again, wildfires are raging across the length of California, from San Francisco to Los Angeles. Once again, the electricity transmission facilities of PG&E are thought to have caused or contributed to at least some of the wildfires. And once again, in the wake of the wildfires, shareholders have launched a securities class action lawsuit against company executives. As discussed below, the new lawsuit is the latest example of the way in which transformative changes arising from climate change can lead to directors’ and officers’ liability litigation. The Complaint On October 25, 2019, a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against three PG&E executives. (The company itself, which filed for Chapter 11 bankruptcy on January 19, 2019, is not named as a defendant.) The complaint, a copy of which can be found here, purports to be filed on behalf of a class of investors who purchased PG&E securities between December 11, 2018 and October 11, 2019. The complaint alleges that during the class period the defendants made material misrepresentations or omissions, damaging investors. The complaint seeks to recover damages on behalf of the class based on alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint focuses on the remedial efforts and safety measures the company claimed that it was putting in place after the 2018 California wildfires. Among other things, the complaint refers to the company’s various statements community wildfire safety program, which included as a contingency, the provision for rolling electrical blackouts, to cut off electricity in areas in wildfire danger. The complaint also quotes the various company statements about measures the company claimed to have put in place to communicate with utility customers in the event of blackouts. After having described the various measures the company claimed to have put in place, the complaint then quotes from an October 12, 2019 New York Times article (here) that described what happened when the company went to try to implement the planned safety measures, including deployment of blackouts. According to the article, which the complaint quotes at length, the utility’s “communications and computer system faltered” and the company “struggled to tell people what areas would be affected and when.” Roads, businesses, nursing homes, and government facilities “went dark without warning.” The complaint alleges that the company’s share price declined over 4% on this news. According to the complaint, on October 23, 2019, after the company shut off power to 179,000 homes and businesses in 17 northern and central California counties, the company’s share price declined another 12.4%. The complaint alleges that the Defendants made materially misleading misrepresentations or omissions by failing to disclose that “(i) PG&E’s purportedly enhanced wildfire prevention and safety protocols and procedures were inadequate to meet the challenges for which they were ostensibly designed; (ii) as a result PG&E was unprepared for the rolling power cuts the Company implemented to minimize wildfire risk; and (iii) as a result, the Company’s public statements were materially false and misleading at all relevant times.” The Complaint’s Climate Change-Related Allegations In addition to the company’s various statements about its wildfire safety measures, the complaint also quotes at length the company’s statements about why wildfires have in recent years have become both a serious and growing problem. For example, the complaint quotes at length from the company’s December 10, 2018 press release, which, among other things, quote the company’s then-CEO as saying: As Californians, we are all faced with the devastating realities of extreme weather and the growing wildfire threat. In recent years, we’ve made significant changes and additions to our business to combat these weather events, but the climate is changing faster. The complaint also quotes the company’s December 13, 2018 press release, which refers to a company official as saying “As California experiences more frequent and intense wildfires and other extreme weather events, we must take necessary, bold, and urgent steps to protect our customers.” The complaint also quotes a variety of other company statements and disclosures in which the company references “the growing wildfire threat” and “extreme weather events.” The company specifically notes that the company previously has been the subject of extensive litigation (which ultimately triggered the company’s bankruptcy filing) based on “widely publicized and catastrophic wildfire incidents that occurred in California in 2015, 2017, and 2018.” Discussion This new lawsuit against PG&E comes even a trial goes forward in New York state court against the energy giant Exxon Mobil based on the company’s alleged misrepresentations concerning the company’s climate change risks. Indeed, just last week, the Massachusetts Attorney General initiated a separate lawsuit against Exxon Mobil relating to the company’s climate change-related disclosures and omissions. Exxon Mobil is also the target of a separate securities class action lawsuit pending in the Northern District of Texas relating to its climate change-related disclosure. The new lawsuit against PG&E is also just the latest lawsuit to be filed against PG&E as a result of California wildfires taking place due to changed operating conditions arising from global climate change. As I noted at the time, PG&E was hit with a climate change-related securities class action lawsuit in the wake of the 2018 wildfires. The company was also hit with a separate shareholder derivative lawsuit after the 2018 wildfires. PG&E had also previously been the subject of another securities class action lawsuit filed earlier in 2018 relating to the company’s involvement in the 2017 California wildfires. These two sets of litigation provide concrete examples of the ways in which climate change disclosure and changed operating conditions arising from wildfires can result in directors’ and officers’ liability claims. Now, I know that a cynic might say that the various lawsuits in these two groups are in each set basically just the same lawsuit over and over again, and relate more to what is going on with respect to these two companies than to anything more general than that. Disparate problems involving just two companies are, the cynic might say, hardly enough to represent a trend. To the cynic, I might first point out that PG&E is not the only company to have been hit with securities lawsuits based on changed operating conditions brought on by climate change. Following the 2018 California wildfires, another electrical utility, Edison International was also hit with a climate change related securities lawsuit. And it should also be noted that there have been climate change-related disclosure actions outside the U.S. as well. For example, in August 2018, the non-profit legal group Client Earth filed complaints with the U.K. Financial Conduct Authority (FCA) against three different U.K. insurers. The legal group contended that the insurers’ annual reports failed to meet the requirements of the Disclosure Guidance and Transparency Rules due to the absence in the reports of any climate change-related disclosures. A similar action seeking increased climate change-related disclosure was filed in Australia against one of the leading banks. But beyond these other examples of climate change-related litigation, my further response to a cynic seeking to minimize the general significance of the various Exxon Mobil lawsuits and the PG&E wildfire litigation is that the circumstances behind these lawsuits are not necessarily unique or company-specific. Exxon Mobil is only one of many companies making disclosures about the risks arising from climate change. And PG&E is far from the only company that is (or will be) faced with changed operating conditions arising from climate change. Moreover, it is clear that investors are concerned about company disclosure of climate change risk. As noted in an October 9, 2019 Reuters article (here), institutional investors are very focused on corporate disclosure of climate change risk, and in fact are quite concerned with companies’ climate change disclosures, particular with the disclosures of companies in the oil and gas production industry. By the same token, companies whose operations will be affected by the changing physical conditions arising from climate change could find themselves the target of claims from investors and other constituencies for failure to anticipate and guard against climate change-related conditions — not just with respect to wildfires alone, but also, for example, relating to coastal flooding, drought, supply chain disruption, political unrest, and the many other kinds of effects and consequences that climate change may cause. It is true that to date there have only been a small handful of climate change-related cases. But while there have indeed only been a few cases, that does not mean that the prospect of further climate change related D&O litigation is not a serious threat to companies, their executives, and their insurers. As noted in an October 28, 2019 memo from the Freshfields Bruckhaus Deringer law firm entitled “The Tipping Point? Climate Change and Directors’ Duties” (here), “It is only a matter of time before ‘climate compliance’ commands at least the same level of attention as other corporate compliance issues. Companies that fail to adapt may find themselves wrong-footed and exposed to risk.” One final note about the new lawsuit. It has only just been filed and it remains to be seen whether or not it will prove to be successful. That said, I think it is fair to say that the court will struggle to find any allegations of scienter in this complaint. Indeed, the complaint reads much more like a mismanagement claim than a misrepresentation claim – as if often the case with event-driven lawsuits like this one. The post Securities Suit Arising From Climate Change-Caused Conditions Hits Utility appeared first on The D&O Diary. Securities Suit Arising From Climate Change-Caused Conditions Hits Utility syndicated from https://888migrationservicesau.wordpress.com via Tumblr Securities Suit Arising From Climate Change-Caused Conditions Hits Utility Last week, the FTC announced yet another settlement with a company regarding its customer review practices. This case involved a popular cosmetics brand that retailed at Sephora—Sunday Riley. According to the FTC, Sunday Riley’s managers and Chief Executive Officer ordered employees and interns to create fake Sephora accounts and submit reviews for their products. The FTC had obtained multiple company emails showing the lengths Sunday Riley went to drive positive customer reviews, including evading Sephora’s detection by manipulating IP addresses. Sunday Riley and its CEO settled with the FTC. In the settlement, the company and CEO did not admit fault, which is standard in these settlements. Similar to other recent settlements relating to “fake” customer reviews, the parties agreed on a go-forward basis to not make misrepresentations about the status of an endorser or customer review and to disclose material connections in endorsements and reviews. In a dissent filed by Commissioner Rohit Chopra, and joined by Commissioner Rebecca Kelly Slaughter, Commissioner Chopra criticized the settlement for not being harsh enough:
While Commissioner Chopra is right to call out the growing problem of fake reviews and how it can distort markets, his criticism of “no-money, no-fault” orders is overstated. Companies that enter into these orders are subject to strict reporting and recordkeeping obligations. For example, Sunday Riley must maintain for five years all records that “tend to show lack of compliance” with the order and copies of each ad that includes product reviews or social media endorsements, among other records (this obligation will last until the year 2039). The FTC imposes these reporting and recordkeeping requirements because its Division of Enforcement closely monitors companies’ compliance with such consent orders. Under the FTC Act, the FTC has the authority to assess extraordinary penalties if a party violates an order (or violates a rule properly promulgated by the FTC). The FTC Act was deliberately designed that way, and, based on our experience counseling clients in this space, the threat of an enforcement action and steep civil penalties have both a specific and general deterrent effect.
via Tumblr Customer Review Fraud Top of FTC’s Priority List In the wake of the U.S. Supreme Court’s March 2018 Cyan decision, in which the Court affirmed that state court’s retain concurrent jurisdiction for liability action under the ’33 Act, plaintiffs’ lawyers have initiated a number of Section 11 actions in the courts of a number of states. This new wave of state court Securities Act lawsuits is now making its way through the courts. As the cases have progressed, in some instances the state courts have granted the defendants’ motions to dismiss. The latest example of a state court granting a defendants’ motion has now occurred in the Connecticut state court claim alleging ’33 Act violations in connection with Pitney-Bowes September 2017 debt note IPO. The Connecticut court’s October 24, 2019 order granting the defendants’ motion to strike, a copy of which can be found here, raises a number of interesting issues. In March 2017, Pitney Bowes filed a shelf registration statement, intending to offer securities in the future. On September 13, 2017, the company filed a prospectus with the SEC in connection with the sale on that date of $700 million in notes in an IPO. The prospectus incorporated by reference certain of Pitney Bowes prior SEC filings. A plaintiff security holder subsequently brought a liability action in Connecticut state court purportedly on behalf of a class of investors who purchased the Notes in the September 2017 offering. The lawsuit was filed against the company, certain of its directors and officers, and against the company’s offering underwriters. The gist of the complaint is that the company failed to disclose at the time of the offering a number of items that subsequently were disclosed when the company reported its third quarter financial results as of September 30, 3019 quarter end. The company and the individual defendants filed a motion to dismiss, alleging that the plaintiff’s complaint had failed to state claim on which relief could be granted. In his October 24, 2019 opinion, Connecticut Superior Court Judge Charles T. Lee granted the defendants’ motion to strike. In granting the motion, Judge Lee reviewed each of three main alleged misrepresentations and omissions on which the plaintiff sought to rely. Judge Lee first addressed the plaintiff’s allegation that the defendants violated the disclosure obligations under Item 303 of Regulation S-K, requiring the company to disclose “trends” and “uncertainties,” by failing to disclose in the offering documents that lower equipment sales and margins during the in-progress third quarter in Pitney Bowes’ Small and Medium Business Solutions. Judge Lee noted that other courts in implying duty to disclose a trend have required that the development must “take place over a longer period of time that merely one quarter.” Here, by contrast, Judge Lee noted, the plaintiff has simply alleged that equipment sales and margins declined in the third quarter compared to the prior quarter. He said that Nothing in the plaintiff’s complaint suggests that this decline was part of an ongoing pattern, nor that it was caused by a persistent condition affecting Pitney Bowes’ business rather than ordinary, quarter-to-quarter business fluctuations. Accordingly, because neither the duration nor the substance of the alleged declines at issue meet the criteria of a ‘trend’ under Item 303, Pitney Bowes was under no independent duty to disclose the alleged declines in equipment sales and margins during a quarter which had not yet closed, nor their overall impact on company financial performance, prior to or at the time of, the IPO. Judge Lee then addressed the plaintiff’s allegation that the statement in offering documents that the company’s Small and Medium Solutions segment was “characterized by a high level of recurring revenue” was misleading absent additional disclosures concerning the purported third quarter decline in segment revenue. The plaintiff argued that the statement implied that the segment would generate continuously high revenue going forward. Judge Lee said that “a plain reading of the statement makes clear that it did not carry with it the promise that the … segment would generate consistently high levels of overall revenue in the future. Rather, the statement indicates that, irrespective of the total amount of revenue earned with the segment, much of it was derived from recurring sources.” The declines in the third quarter revenue in the segment “did no render the statement … misleading.” Finally Judge Lee addressed the plaintiff’s allegations based on the statements in the offering documents about improvements in equipment sales and margins in the Small and Medium Business Solutions segment during the second quarter. The plaintiff contended that these statements, which the plaintiff alleged presented a “transformative turnaround story,” were misleading in the absence of additional disclosures about the declines in these metrics during the third quarter. Judge Lee said with respect to these statements about second quarter performance that the “are unequivocally in the past tense” and merely describe the quarter’s second quarter performance. The plaintiff’s claim that the statements implied a “transformative turnaround” relies on “a reading of the statements that is completely divorced from the context in which they appear.” Nothing in these statements “suggests, explicitly or implicitly that any of this performance would continue into the future.” To the contrary they were merely “accurate statements of historic fact that cannot form the bases of a securities claim.” Discussion The Connecticut court joins of the courts of a number of other states that have recently granted motions to dismiss (or in this case a motion to strike) in Securities Act liability actions filed in the courts of those states, including Texas (as discussed here) and New York (discussed here). The fact that the courts in these various jurisdictions are granting these dismissal motions is significant, if for no other reason than the plaintiffs’ lawyers clearly sought to pursue these various actions in state court because they believed they would fare better there rather than in federal court. Indeed, in an interesting and useful recent paper (here), Stanford Law School Professor Michael Klausner and his colleagues posited that one of the reasons for the “dramatic increase” in state court Securities Act liability actions in the wake of Cyan is the plaintiffs’ counsel’s belief that state court pleading standards are generally lower than those in federal court, which should make the lawsuits filed in state court less likely to be dismissed. If as a result of the dismissals granted in this and the other state court Securities Act liability action it become clear that the plaintiffs will not actually enjoy — or at least are not a certain to enjoy — an advantage at the pleading stage, some of the plaintiffs’ incentives to pursue the claims in state court may be diminished. At a minimum, it is clear at least in the Pitney Bowes case, the complaint received every bit as much scrutiny as the complaint would face in federal court. While I believe that the ruling in the Pitney Bowles is significant, as it is just the ruling of a state court trial judge – and of a state court trial judge in Connecticut, which is not one of the states in which many of the post-Cyan state court lawsuits are being filed. The states with the most post-Cyan Securities Act lawsuits are California and New York. In that regard, it is important to note that July 2019, the New York state court judge presiding in the Netshoes Securities Litigation did grant the defendants’ motion to dismiss in that Securities Act liability action (as discussed here). These various dismissal motions rulings are of course themselves without precedential value and are subject to appeal. However, one can hope that these rulings may send a message that the plaintiffs should reconsider whatever perceived advantages they may think they have in proceeding in state court rather than federal court. Ultimately, we can hope that Congress will fix the problem that Cyan created; it makes no sense to have a system that permits parallel or duplicative litigation and that has a multitude of state courts enforcing and applying the federal securities laws. However, unless or until Congress gets around to amending the ’33 Act’s jurisdictional provision, plaintiffs’ lawyers will have the option of filing their suits in state court. One can only hope that decisions like Judge Lee’s in the Pitney Bowes case will help persuade the plaintiffs’ lawyers to stick with the federal court forum. One final thing that D&O insurance underwriters will want to note is that this ’33 Act liability lawsuit was brought in state court against Pitney Bowes, a company whose shares were publicly traded prior to the debt offering that was the subject of the lawsuit. D&O Underwriters have tended to consider the Cyan-related state court lawsuit problem as relating primarily to classic IPO companies – that is, companies that have only recently launched their securities to trade for the first time in the public markets. It is a point that I have made before, but companies engaging in follow-on or secondary offerings can also be subject to ’33 liability litigation, and therefore also face the possibility of separate or parallel state court securities class action litigation. This lesson from the Pitney Bowes case could easily be lost as the Connecticut court referred to the company’s notes offering as an IPO (because the debt securities were traded for the first time in the public markets as a result of the offering) but Pitney Bowes undeniably was a public company prior to the note offering that was the subject of the state court lawsuit. The point that should not be lost here is that companies whose securities are already publicly traded could upon completion of subsequent securities offerings face the possibility of state court securities class action litigation, even if the companies are well past their initial IPO. Special thanks to a loyal reader for sending the Connecticut decision to me. The post Connecticut State Court Knocks Out Post-Cyan Securities Act Liability Action appeared first on The D&O Diary. Connecticut State Court Knocks Out Post-Cyan Securities Act Liability Action syndicated from https://888migrationservicesau.wordpress.com via Tumblr Connecticut State Court Knocks Out Post-Cyan Securities Act Liability Action In the latest example of a securities class action lawsuit arising out of data breach or other cybersecurity incident, on October 24, 2019, a plaintiff shareholder filed a securities class action lawsuit against California-based software company Zendesk. The lawsuit follows after the company announced disappointing second quarter financial results in July and then announced in early October that customer account information had been accessed. The lawsuit is most recent in a series of lawsuits in which companies experiencing cybersecurity incidents get hit with securities lawsuits. Background Zendesk is a software and services company that provides a variety of tools that allow the company’s clients to manage their customer interactions. Among other things, the company’s software allows the client companies to communicate with their customers through online customer chats. On July 30, 2019, the company issued a press release and held a conference call to discuss its second quarter 2019 results. The company announced increased net losses and revenue growth at levels below the most immediate preceding quarters. In addition, the company said that its sales growth in Europe, Middle East and Africa, as well as in its Asia Pacific region, fell below the company’s expectations. The company also lowered its guidance for the remainder of the year. According to the subsequent securities complaint, the company’s share price fell by $10 on the disappointing quarterly earnings news (about 11%). Then, in an October 2, 2019 blog post (here, updated on October 4, 2019) Zendesk announced that a third party had alerted the company that its customer support and chat products and customer accounts had been accessed. The blog post, as updated, said that upon learning of the security concern, the company engaged a forensic team; initiated its security incident protocol; and contacted law enforcement officials. The company said that by September 24, 2019, it had “identified approximately 15,000 Zendesk Support and Chat accounts, including expired trial accounts and accounts that are no longer active, whose account information was accessed without authorization prior to November of 2016.” The information accessed “included some personally identifiable information (PII) and other Service Data.” The data accessed included “email addresses, names and phone numbers of agents and end-users of certain Zendesk products, potentially up to November 2016.” The accessed data may have also included “agent” [that is, Zendesk employee] passwords and customer passwords, although the company had found no evidence that the passwords had been used to gain unauthorized access. The company also found that certain account authentication information for about 7,000 accounts had been accessed. According to the subsequently filed securities complaint, the company’s share price declined an additional $2.90 on the news (about 4% from the previous day’s high). The Complaint On October 24, 2019, a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against Zendesk and certain of its directors and officers. The complaint (a copy of which can be found here) purports to be filed on behalf of a class of investors who purchased Zendesk securities between February 6, 2019 and October 1, 2019. The complaint seeks to recover damages on behalf of the plaintiff class for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The plaintiff’s law firm’s October 24, 2019 press release about the lawsuit can be found here. The complaint alleges that the defendants concealed material information and/or failed to disclose that “(a) Zendesk’s clients had been subject to data breaches dating back to 2016; (b) Zendesk was experiencing slowing demand for its SaaS offerings, particularly in Germany, the United Kingdom, and Australia, due in large part to political uncertainty and China trade issues there; and © as a result of the foregoing, Zendesk’s business metrics and financial prospects were not as strong as defendants had led the market to believe during the Class Period. “ In purported support of these allegations, the complaint references both the company’s July 30, 2019 earnings announcement and its October 2, 2019 blog post about the cybersecurity incident. In making allegations with respect to the cybersecurity incident, the complaint references several statements the company allegedly made in its February 14, 2019 filing on SEC form 10-K, in which the company allegedly said, among other things, that “We maintain a comprehensive security program designed to help safeguard the security and integrity of our customers’ data.” The referenced section also stated that the company regularly reviews its security program and obtains third-party security audits and examinations. The complaint alleges the company’s 10-K states further that a data breach “could have an adverse effect” on the company’s financial results and could cause it to lose customers” if the data systems were breached. The complaint alleges that these “purported warnings were themselves materially false and misleading” because the company “had already experienced a data breach dating back to accounts opened before November 2016 that had not yet been disclosed or remedied.” The complaint goes on to make similar allegations relating to the company’s statements about the additional expenses, compliance concerns and regulatory issues that might result from a data breach, saying with respect to these additional statements that they “tacitly and misleadingly stated that the Company’s data was then being maintained in a secure state, when it was not.” In support of its allegations that the defendants acted with scienter, the complaint purports to rely on insider trading allegations, in addition to generalized allegations that the defendants acted with alleged knowledge that the alleged misrepresentations were false when made. The complaint alleges that, with the company’s share price allegedly inflated by the alleged misrepresentations, the individual defendants “cashed in, collectively selling about 409,000 of their personally held Zendesk shares for more than $32.7 million in proceeds.” In support of these supposed insider trading allegations, the complaint alleges with respect to each of the individual defendants the number of shares that each defendants sold and the total amount of proceeds that each individual realized from the sale. The complaint does not say what percentage of each individual’s total Zendesk shareholdings these sales represent. The complaint also does not specify when the alleged sales took place with respect either to the July 31, 2019 earning release or the October 2, 2019 security incident report. The complaint’s cybersecurity-related allegations also include a brief, obscure, and confusing suggestion (made in reliance of a IT media-related blog) that the food-delivery company DoorDash was a pre-November 2016 customer of Zendesk, and that DoorDash’s announced breach of customer data of 4 million of its customers is somehow connected to Zendesk’s data breach. Discussion The Zendesk lawsuit is the latest in a series of securities suits filed this year against companies that had been with hit with cybersecurity incidents. This series of lawsuits includes the lawsuit recently filed against Capital One in the wake of the company’s high-profile data breach. The series of lawsuits this year also includes the securities suit filed in June against FedEx following news that the company’s European operation was struggling to recover from a cyber virus incident. While there have been a number of cybersecurity incident-related securities lawsuits filed this year, and there have been similar lawsuits filed in prior years, the number of these lawsuits filed has never quite amounted to the volume of cases that some commentators predicted we would see. One likely reason why there just have not been that many cybersecurity-related securities suits is that often news of a data breach or other cybersecurity incident typically does not trigger a significant drop in the affected company’s share price. Indeed, you could argue that this case represents a good illustration of the point; in this case, Zendesk’s disclosure of the cybersecurity incident resulted in a decline of less than 4% in the company’s share price. This hardly amounts to the kind of precipitous share price decline on which plaintiffs typically rely in asserting alleged securities law violations. (Given the relatively small share price decline and the apparently modest size of the data breach, you do have to kind of wonder why the plaintiff bothered to file a securities suit in this case. Maybe he is just attempting to use the cybersecurity-related allegations a way to try to boostrap their earnings disappointment lawsuit.) While this new lawsuit is similar in some ways to the earlier cybersecurity-related securities lawsuit, it is different in at least two ways. First, in this latest lawsuit against Zendesk, the cybersecurity-related allegations represent only a portion of the alleged misrepresentations on which the plaintiff seeks to rely; alongside the cybersecurity-related allegations, the complaint also presents that classic earnings miss/stock drop allegations. Second, this latest lawsuit differs from many of the earlier cybersecurity-related securities lawsuits in that it attempts to make specific scienter allegations; here, by contrast to the other cases of this type, the plaintiff has attempted to raise insider trading allegations. The insider trading allegations might well make this complaint likelier than some of the others to survive the initial pleading hurdles; however, if the plaintiff wants to rely on the insider trading allegations in order to try to establish scienter, in his amended complaint he is going to have to specify what percentage of each individual’s holding the individual’s sales represented, and he is going to have to provide a more detailed timetable of when the sales took place relative to the alleged misrepresentations. With respect to the alleged cybersecurity-related misrepresentations, it seems to me that the plaintiff is going to have to do more to establish that the various data security statements in the company’s 10-K were knowingly misleading. Essentially all the plaintiff has done is allege, with the benefit of hindsight information following the disclosure of the breach, that the company’s earlier statements, made before the breach was known, were knowingly false when made. These kinds of fraud by hindsight allegations may or may not be sufficient to meet the initial pleading hurdles, but I have never found these kinds of allegations particularly persuasive. There may or may not be valid mismanagement allegations in there somewhere (the defendants “should have known” or “should have better managed” etc.) but the suggestion of fraudulent misrepresentation based only on the later breach disclosure is, to me, unpersuasive. Massachusetts Files Climate Change-Related Suit Against Exxon: With trial underway in New York’s climate change disclosure-related lawsuit against Exxon, Massachusetts Attorney General Maura Healey has started her own suit against the global energy giant. On October 24, 2019, Healey’s office filed the state’s own lawsuit against Exxon. A copy of the complaint can be found here. The Massachusetts lawsuit, like the New York law suit, alleges that Exxon made material misrepresentations to investors about the company’s climate change-related risks. However, as discussed in an October 25, 2019 Law 360 article about the new lawsuit, the new Massachusetts lawsuit goes further; according to the article, the complaint also alleges that “the company deceived consumers about how its fossil fuel products contribute to climate change and misled consumers about being an environmentally responsible company.” The article also says the new suit is the first climate change-related lawsuit based on state consumer protection laws. The post Zendesk Hit with Data Breach-Related Securities Suit appeared first on The D&O Diary. Zendesk Hit with Data Breach-Related Securities Suit syndicated from https://888migrationservicesau.wordpress.com via Tumblr Zendesk Hit with Data Breach-Related Securities Suit In a series of recent actions, the SEC has demonstrated its aggressive approach toward cryptocurrency regulation and enforcement. In the following guest post, John Reed Stark, President of John Reed Stark Consulting and former Chief of the SEC’s Office of Internet Enforcement, takes a detailed look at the SEC’s recent actions and considers the actions’ implications. A version of this article originally appeared on Securities Docket. I would like to thank John for his willingness to allow me to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is John’s article. **************************** This month the U.S. Securities and Exchange Commission (SEC) initiated three illuminating regulatory and enforcement crypto-related actions, celebrating a virtual Octoberfest of crypto-related initiatives and proclamations. Specifically, the SEC reinforced their cryptocurrency hardline by:
Over the past several years, the SEC has steadily risen to become perhaps the most effective and outspoken crypto-police force in the world. The SEC has brought a broad range of cryptocurrency-related enforcement actions and turned out a number of thoughtful, forward-thinking and comprehensive regulatory pronouncements. Concurrently, SEC Chairman Jay Clayton has launched his own anti-crypto crusade, bravely taking center stage and plainly asserting that cryptocurrency tokens looked and acted like securities and were susceptible to fraud and chicanery by insiders, management and better-informed traders and market participants. Some examples of Chairman Clayton’s more biting cryptoisms over the past three years include:
Clearly, Chairman Clayton has adopted a dogmatic yet commonsensical approach to crypto-regulation. This article discusses the SEC’s three recent October regulatory and enforcement crypto-maneuvers and offers some thoughts going forward for the cryptocurrency marketplace. The Telegram TRO Dating back to as early as 2014, the SEC began bringing enforcement actions relating to cryptocurrency, and with its October 11, 2019 filing of SEC v. Telegram Group, Inc. and Ton Issuer Inc. which sought a temporary restraining order (TRO), the SEC has reached yet another crypto-related milestone. Without alleging any fraud by any of the defendants, the Honorable Judge P. Kevin Pastel of the United States District Court for the Southern District of New York signed the emergency judicially decreed temporary restraining order, and also granted the SEC expedited discovery and other emergency relief. The SEC’s sole allegation in the Telegram matter is that the defendants were in the midst of an alleged unregistered, ongoing digital token offering in the U.S. that needed to be stopped dead in its tracks, before investors experienced any further harm. This was quite a victory; the SEC rarely, if ever, has brought an enforcement action involving such a large amount of money without any allegation of a swindle, scam or other form of deception. Telegram, a popular encrypted messaging app, is used world-wide, including by Hong Kong protesters wishing to cloak themselves against detection and monitoring by authorities. The SEC alleges that both offshore Telegram defendants raised over $1.7 billion from investors, making it one of the largest and most well-known token offerings in crypto-history. According to the SEC’s complaint, Telegram and TON began raising capital in January 2018 to finance the companies’ business, including the development of their own blockchain, the “Telegram Open Network” or “TON Blockchain,” as well as the mobile messaging application Telegram Messenger. Defendants sold approximately 2.9 billion digital tokens called “Grams” at discounted prices to 171 initial purchasers worldwide, including more than 1 billion Grams to 39 U.S. purchasers. Per the SEC, Telegram promised to deliver the Grams to the initial purchasers upon the launch of its blockchain by no later than October 31, 2019, at which time the purchasers and Telegram will be able to sell billions of Grams into U.S. markets. The complaint alleges that defendants failed to register their offers and sales of Grams, which are securities, in violation of the registration provisions of the Securities Act of 1933. Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement stated: “Our emergency action today is intended to prevent Telegram from flooding the U.S. markets with digital tokens that we allege were unlawfully sold … We allege that the defendants have failed to provide investors with information regarding Grams and Telegram’s business operations, financial condition, risk factors, and management that the securities laws require.” Steven Peikin, the other Co-Director of the SEC’s Division of Enforcement stated: “We have repeatedly stated that issuers cannot avoid the federal securities laws just by labeling their product a cryptocurrency or a digital token … Telegram seeks to obtain the benefits of a public offering without complying with the long-established disclosure responsibilities designed to protect the investing public.” Telegram Fights Back, But Loses (Badly) On October 16, 2019, Skadden Arps, Slate, Meagher and Flom, counsel to Telegram, filed a response to the SEC, arguing that the SEC’s emergency injunction was unwarranted, throwing a Hail Mary and asking the court to deny the SEC’s motion to enforce a post-TRO subpoena. Telegram argued that its upcoming Gram token was not a security, and that the SEC should not be able to force the company to produce documents or witnesses about its blockchain project. However, on the same day, in an October 16th, 2019 Declaration executed by Skadden, Telegram consented to the TRO and agreed that they “shall not offer, sell or deliver Grams to any person or entity for a period of five (5) months beginning on the date of this Stipulation, and shall provide thirty (30) calendar days’ notice to the SEC before offering, selling, or delivering Grams to any person or entity following the five month period.” Telegram’s surrender and complete capitulation allowed for the preliminary injunction hearing to be postponed until February 18–19, 2020 (pushed forward from the TRO hearing originally scheduled for October 24, 2020). Meanwhile, expedited discovery continues which will likely become an onerous and costly burden for Telegram — and could reveal further inculpatory or exculpatory evidence. Even though Telegram has now consented to the SEC’s TRO, promising to halt its offering until the February 2020 preliminary injunction hearing, it is still worth reviewing the SEC’s response to Skadden’s original opposition motion, which the SEC filed in the form of an October 17, 2019 letter to the court. The SEC’s letter reveals just how strongly the SEC believes in its position and gives Skadden a preview of things to come. In the detailed letter, the SEC reiterated that Telegram has violated the securities laws by selling Grams, which are “securities” under the Securities Act, to certain investors, including buyers in the U.S., without any applicable exemption from registration. The SEC insists that Telegram has not only violated the U.S. securities laws but also stresses that the company is likely to violate the law again. As an aside, Skadden’s October 16th Declaration also attached email correspondence between the SEC and Skadden, offering a rare glimpse into the desperate flurry of communications from Skadden to the SEC, all occurring amid the harsh reality of the impossible schedule of court ordered expedited discovery facing the defendants: Telegram Contacts its Investors According to several online crypto-publications, since the SEC TRO, Telegram has sent at least two emails to investors. In the first email to investors, reportedly dated October 16, 2019, Telegram explained that the SEC lawsuit has rendered the timing of its token offering unachievable and asked investors to grant the company an extension of time to get its network running. Telegram further offered investors the chance to approve the date change, adding that if the majority of Telegram’s token holders disagree with the delay, they will receive 77 percent of their investment back. In the second email to investors, reportedly dated October 19, 2019, Telegram encouraged investors to view the February 2020 SEC hearing as “a positive step.” Specifically, Telegram reassures investors that the recent rescheduling of hearings until February is actually good news while maintaining that the company will not be distributing Gram tokens until that time. The Telegram team also explained why the February 2020 hearings would resolve the situation more satisfactorily than the originally scheduled October 2019 hearing. According to Cointelegraph, Telegram stated in the letter: “Telegram views this development as a positive step towards resolving this matter through the court system in an expeditious manner, and we and our advisers will be using the time to ensure that Telegram’s position is presented and supported as strongly as possible at the February hearing … The February hearing is different from the one previously scheduled for October 24, because in the February hearing Telegram anticipates asking the court to rule on the core argument that Grams are not securities. The October 24 hearing, in contrast, was only to consider whether a delay should have been mandated, without conclusively resolving the core argument.” Whether Telegram’s questionable spin on the SEC TRO passes the straight face test is beside the point. Clearly, the SEC is digging in on its cryptocurrency crackdown, remaining dogged and engaged. Furthermore, the rigorous requirements of expedited discovery are now underway for Telegram — and could even lead to additional charges. In short, Telegram has a serious fight on its hands. The SEC Bitwise ETF Denial The criminalities associated with cryptocurrency’s use are almost as egregious and disturbing as the criminalities associated with its valuations. Bitcoin and other cryptocurrency’s anarchistic valuations remain generally unregulated and without any meaningful oversight, leaving them easily susceptible to fraud and chicanery by insiders, management and better-informed traders and market participants. For the typical cryptocurrency trading platform, there is no central regulatory authority; no state or federal team of bank auditors and compliance experts scrutinizing transactions and policing for manipulation; and no existing federal licensure – it’s not just the Wild West, it’s global economic anarchy. Along these lines, researchers from the University of Texas found that manipulation in the cryptocurrency market is rampant and much of the run-up in Bitcoin’s price during 2017 was due to manipulation orchestrated by the Hong Kong exchange Bitfinex. In a 66-page paper, the authors found that tether was used to buy bitcoin at key moments when it was declining, which helped “stabilize and manipulate” the cryptocurrency’s price. This is yet another reason for bitcoins wildly fluctuating valuations – which during in the past two years has gone from $19,000 to $3,200 and back up to over $11,000. Similarly, a recently published report by Arcane Research notes bitcoin’s price routinely drops shortly before the Chicago Mercantile Exchange (CME) monthly futures contracts expire. This pattern has existed since January, 2018 and the writers assert that the timing and volume of decline are too significant to be mere coincidence. The report explains a number of scenarios where manipulation may be at work, but does not present any specific, concrete proof. Thus, it should come as no surprise that the SEC yet again rejected an application for a bitcoin exchange-traded fund or so-called ETF. ETF’s are baskets of different types of investments that are pooled together into a single entity, which then offers shares to investors that are subsequently traded on major stock exchanges. Each share of an ETF gives its owner a proportional stake in the total assets of the ETF. ETFs have taken the investing world by storm. All told, investors have put about $3.5 trillion into ETFs as of October 2018 and hundreds of different ETFs are available for purchase. Specifically, on October 9, 2019, the SEC denied Bitwise Asset Management’s bid to launch a bitcoin exchange-traded fund, stating in its order: “The Commission is disapproving this proposed rule change because, as discussed below, NYSE Arca has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of Exchange Act Section 6(b)(5), and, in particular, the requirement that the rules of a national securities exchange be ‘designed to prevent fraudulent and manipulative acts and practices.” In its application, Bitwise claimed to have identified the 5% of platforms that carry “real trading volume” and pledged to ensure that their ETF would track that tranche of the bitcoin spot market. Bitwise also promised to enter into a surveillance agreement with a large enough portion of the regulated bitcoin futures market to meet SEC requirements. But the SEC was not convinced. Had the SEC granted Bitwise’s ETF application, the SEC would have been encouraging and facilitating main street investor trading in the oft-manipulated, federally unregulated, chaotic, secretive and fractured international cryptocurrency marketplace. Clearly, the shadowy world of cryptocurrency would have taken on an air of legitimacy that the SEC is simply not ready to sanction. No Bitcoin ETF Approvals to Date The SEC has yet to approve any bitcoin-related ETFs, although several proposals have been put before the agency. For instance, in July 2018, The SEC denied an application for the Winklevoss brothers and their company, BZX, to launch a bitcoin-based ETF, citing concerns about the lack of oversight in the underlying bitcoin market. One SEC commissioner, Hester Pierce, dubbed the “SEC Crypto-mom” by her supporters, dissented from the BZX denial, asserting that she believed BZX’s proposal met the standard for approval and expressed her concern that the SEC’s approach undermines investor protection by precluding greater institutionalization of the bitcoin market.” Commissioner Pierce stated at the time: “More institutional participation would ameliorate many of the commission’s concerns with the bitcoin market that underlie its disapproval order … More generally, the commission’s interpretation and application of the statutory standard sends a strong signal that innovation is unwelcome in our markets, a signal that may have effects far beyond the fate of bitcoin ETPs.”
Commissioner Pierce’s dissent not only contested the disapproval of what would have been the first exchange-traded vehicle of cryptocurrency, but it also became the rallying cry for bitcoin believers who argue that it’s not the role of regulators to tell investors where they can invest. However, among government officials, Commissioner Pierce may not have many supporters. Even President Trump would disagree with her. When it comes to cryptocurrency, President Trump is surprisingly aligned with Congressional and Senate Democrats, even going so far as to tweet about his disdain and dislike of bitcoin and other cryptocurrencies. Bitwise ETF Epilogue Despite some support on its fringes from Commissioner Pierce, the SEC has remained reluctant to approve any sort of cryptocurrency ETF. Now, after the SEC’s Bitwise rejection, the SEC has only one bitcoin ETF proposal currently sitting before it, filed by Wilshire Phoenix and NYSE Arca. Meanwhile, according to a news release published on October 9, 2019, Bitwise remains surprisingly upbeat about their progress and promisers to re-apply. The Bitwise news release states: “We deeply appreciate the SEC’s careful review. The detailed feedback they have provided in the Order provides critical context and a clear pathway for ETF applicants to continue moving forward on efforts to list a bitcoin ETF. . . We look forward to continuing to productively engage with the SEC to resolve their remaining concerns, and intend to re-file as soon as appropriate.” The SEC, CFTC and FinCen Joint Statement on Activities Involving Digital Assets On October 11, 2019, the SEC, CFTC and FinCen released an unusual and rare Joint Statement urging anyone dealing with digital currencies to ensure they are adhering to obligations under anti-money laundering and countering the financing of terrorism regulations, regardless of what those digital assets are called. The Joint Statement addressed the various labels and terminologies that are used to describe digital currencies, clarifying that their regulatory treatment is determined by the underlying facts, circumstances, uses, and economic realities, and not the label or terminology used to describe them: “Regardless of the label or terminology that market participants may use, or the level or type of technology employed, it is the facts and circumstances underlying an asset, activity or service, including its economic reality and use (whether intended or organically developed or repurposed), that determines the general categorization of an asset, the specific regulatory treatment of the activity involving the asset, and whether the persons involved are ‘financial institutions’ for purposes of the BSA.” The Joint Statement emphasized that all financial firms, under each of the three regulator’s purview, must meet their anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act (BSA). The Joint Statement also explained in particular that AML/CFT requirements for broker-dealers “apply very broadly and without regard to whether the particular transaction at issue involves a ‘security’ or a ‘commodity’ as those terms are defined under federal laws. MSB Requirements By way of background, pursuant to BSA, transactions involving traditional financial firms, such as banks, brokers and dealers, and money service businesses (MSBs), are subject to strict federal and state AML laws and regulations aimed at detecting and reporting suspicious activity, including money laundering and terrorist financing, as well as securities fraud and market manipulation. MSBs are broadly defined, and have historically been recognized by FinCEN to include: (1) currency dealers or exchangers; (2) check cashers; (3) issuers of traveler’s checks, money orders, or stored value; (4) sellers or redeemers of traveler’s checks, money orders, or stored value; and (5) money transmitters. MSBs have been required to register with FinCEN since 1999, when the MSB regulations first went into effect. An entity acting as an MSB that fails to register (by filing a Registration of Money Services Business, and renewing the registration every two years per 31 U.S.C. § 5330 and 31 C.F.R. § 1022.380), is subject to civil money penalties and possible criminal prosecution. The BSA and its implementing regulations require an MSB to develop, implement and maintain an effective written AML program that is reasonably designed to prevent the MSB from being used to facilitate money laundering and the financing of terrorist activities. Since cryptocurrency financial intermediaries provide financial services, they are also mandated by AML regulations to verify their customer’s identity before offering their services, also known as KYC. Financial institutions often blur the lines between KYC processes and AML practice. In KYC, each client is required to provide verifiable and credible identification credentials in order to use a cryptocurrency company’s service. Customer Due Diligence (CDD) is a basic KYC process where customer’s data such as proof of identity and address is gathered and used to evaluate the customer’s risk profile. Enhanced Due Diligence (EDD) is an advanced KYC procedure for high-risk customers, prone to money laundering and financing of terrorism. Transaction monitoring is a key element of EDD. AML programs typically include a system of internal controls to ensure ongoing compliance with the BSA; independent testing of BSA/AML compliance; a designated BSA compliance officer to oversee compliance efforts; training for appropriate personnel; and a customer identification program. Thus, to ensure AML compliance, financial firms start with KYC, by obtaining clearly identifiable information about a prospective client, and identifying any potential risks of association. Cryptocurrency Firms, AML and KYC The Joint Statement is clearly a shot across the bow for cryptocurrency trading “exchanges” and other platforms. Adhering to AML, CFTC, KYC and the rest of the alphabet soup of rigorous financial regulatory requirements, requires among other things, meticulously recording transactions; definitively knowing who customers are; and promptly and efficiently reporting suspicious activity to law enforcement. Yet given the identification and verification challenges associated with the global locations, pseudo-anonymity, encryption, decentralization and historically criminal tendencies of typical cryptocurrency users, cryptocurrency intermediaries face extraordinary challenges meeting AML/CFT/KYC obligations. Along these lines, the New York State Attorney General’s office (NYAG) asked 14 popular crypto trading platforms to respond to answer a detailed questionnaire covering a wide range of topics, from trading fees to anti-money-laundering policies to methods for keeping customer assets secure. Ten chose to comply, and the September, 2018 report of their responses illuminates the shadowy inner workings of cryptocurrency trading platforms, raising serious questions regarding the growing connection between cryptocurrency and money laundering — as well as a range of market manipulation concerns. Not only do cryptocurrency firms typically lack the sophisticated technological compliance infrastructure of traditional U.S. financial institutions, but they are also often misguided when it comes to their AML/KYC and other related BSA compliance responsibilities. For cryptocurrency firms, the Joint Statement is yet another stark reminder that FinCEN’s AML requirements combined with state law MSB licensing and bonding requirements create a hefty, burdensome and onerous federal and state regulatory burden and concern for crypto-intermediaries. Looking Ahead Historically the SEC has successfully kept themselves above the fray when it comes to partisan wrangling and bickering, especially when it comes to investor protection. But in the last several years, political infighting has unfortunately become more common among SEC commissioners. For instance, consider the current fiasco at the Public Company Accounting Oversight Board (PCAOB), which apparently is rooted in a disagreement over regulatory priorities. One board member, Kathleen Hamm, an extraordinarily well-respected and seasoned former legal finance professional, SEC Enforcement division assistant director, U.S. Treasury official and Georgetown Law School adjunct law professor, was not reappointed, after serving barely two years of the tail end of a five year term — despite her willingness to stay on. Normally this sort of term extension is an automatic. Instead, the SEC replaced Hamm with a far less experienced White House aide and former Republican Senate Banking Committee staffer, and then anointed conservative libertarian SEC Commissioner Pierce to serve as the primary supervisor of the PCAOB board members. Yes, the same SEC Commissioner Pierce mentioned above, who in addition to her support for bitcoin ETF’s, is also an outspoken proponent of rolling back compliance with Section 404(b) of the Sarbanes-Oxley Act. Departing PCAOB senior employees (some of whom claim that they were pushed out) were reportedly even bullied into signing non-disparagement agreements in exchange for six months of continued compensation. Unheard of for a government agency, non-disparagement agreements are suspicious to say the least, and perhaps even unenforceable. Meanwhile, the PCAOB has issued 27% fewer audit-inspection reports this year; has not had a permanent general counsel or enforcement director for 16 months; and has around 50 permanent positions currently vacant. This odd PCAOB gerrymandering and slowdown offers a rare glimpse into the political tensions and fractures within the SEC, and seems like an ominous sign for the SEC enforcement program. However, thanks to SEC Chairman Jay Clayton, with respect to issues of cryptocurrency, the SEC has thankfully remained true to its roots as the investor’s advocate. Chairman Clayton’s steady stream of crypto-related enforcement actions; multiple crypto-related public statements, speeches and regulatory pronouncements; and thoughtful collaboration with other regulatory agencies, has been both heroic and relentless. Chairman Clayton clearly understands the dark side of cryptocurrency. Need a fake I.D., a bottle of opiates, a cache of credit card numbers or a thousand social security numbers? Need a way to collect a ransomware payment? Need to fund terrorist-related activities? Need to hire a hitman? Need to finance an election tampering scheme? Cryptocurrencies like bitcoin have become the payment method of choice for these, and a slew of other, criminal enterprises. Moreover, Chairman Clayton has spent the bulk of his entire professional lifetime counseling companies regarding corporate finance and market infrastructure. He therefore undoubtedly also appreciates the virtual driver’s-ed film of possible securities law violations rampant within the cryptocurrency marketplace, raising legal questions and regulatory issues from every angle. My take is that so long as Jay Clayton chairs the SEC, the cryptocurrency market will thankfully remain stuck and temporized by aggressive SEC enforcement. Furthermore, all cryptocurrency market players should take heed, especially the lawyers who serve as counsel for crypto-related transactions. By allowing their crypto-clients to peddle unlawful securities and violate a broad range of securities laws, lawyers are failing in their role as gatekeepers. Just consider the many aggrieved parties involved in the Telegram digital coin offering, who already probably paid millions, or perhaps even tens of millions in legal fees. Now, Telegram is stuck with the massive costs associated with the TRO, which will undoubtedly add even more millions of dollars to their legal bills. By providing the kind of legal advice that can land a client into the SEC’s investigative, regulatory and prosecutorial crosshairs, lawyers risk more than just their reputations and livelihoods. Sooner or later cryptocurrency players who become SEC defendants are going to turn on their lawyers and begin pointing fingers. Not a pretty picture no matter what the crypto-lawyer’s defense and no matter how much the crypto-lawyer’s good faith. ____________________________ John Reed Stark is president of John Reed Stark Consulting LLC, a data breach response and digital compliance firm. Formerly, Mr. Stark served for almost 20 years in the Enforcement Division of the U.S. Securities and Exchange Commission, the last 11 of which as Chief of its Office of Internet Enforcement. He currently teaches a cyber-law course as a Senior Lecturing Fellow at Duke Law School. Mr. Stark also worked for 15 years as an Adjunct Professor of Law at the Georgetown University Law Center, where he taught several courses on the juxtaposition of law, technology and crime, and for five years as managing director of global data breach response firm, Stroz Friedberg, including three years heading its Washington, D.C. office. Mr. Stark is the author of “The Cybersecurity Due Diligence Handbook.”
The post Guest Post: The SEC Triples Down on its Cryptocurrency Crackdown appeared first on The D&O Diary. Guest Post: The SEC Triples Down on its Cryptocurrency Crackdown syndicated from https://888migrationservicesau.wordpress.com via Tumblr Guest Post: The SEC Triples Down on its Cryptocurrency Crackdown Most primary D&O insurance policies are written on a global basis, meaning that the policy’s coverage will respond to claims wherever they arise, anywhere in the world. However, in recent years, as a result of tax, regulatory, indemnification, and currency questions, both insurance buyers and insurers have become concerned about the potential need for companies to have locally admitted policies in place in foreign jurisdictions where the companies have operations. The question about whether or not a company should have a local policy has become a perennial issue. In an October 16, 2019 post on Woodruff Sawyer’s blog entitled “Foreign Subsidiaries and D&O Insurance: Are you Prepared to Place?” (here), Jane Njavro takes an interesting look at the issues surrounding these questions. As discussed below, these questions raise a number of recurring concerns. As Njavro notes in her article, a number of factors recently have increased concerns about the possible need for local policies, notwithstanding the worldwide coverage afforded under most D&O insurance policies. These factors include the increasing susceptibility of multinational companies to cross-border regulatory actions; the increasing awareness of local company officials to their personal liability; and the need to address local tax issues. In addition, there are countries that require the purchase of locally-admitted insurance and the payment of locally applicable taxes in order to have a claim paid in that country. In addition to the factors Njavro notes, another concern has to do with countries (such as, for example, China) where currency controls may limit or prohibit the payment of either insurance or indemnification from outside the country. Njavro notes that there are a number of common reasons why U.S.-based companies will include local polices as part of their global D&O insurance program: A prospective director will not join the local board without a local policy in place; applicable local law may prohibit, or not clearly allow, the corporate parent to indemnify the directors and officers of the local unit; concerns about compliance with local taxes without putting a local policy in place; and the need to provide an insurance solution to address concerns about the possibility that governmental authorities may “freeze” the assets of local officials. As Njavro’s article correctly notes, various companies take a wide variety of approaches to these concerns. At one end of the spectrum, there are the companies that are content simply to rely on the worldwide coverage provided by the parent company’s D&O insurance policy. At the other end of the spectrum, there are the companies (usually global companies in highly regulated industries) that choose to purchase local policies in every country where there is an employee on the ground. This latter approach, as Njavro notes, entails a great deal of complexity and requires a great deal of collaboration with the primary carrier. In between these two categorical approaches are a variety of alternative intermediate approaches. One alternative approach is for the company to purchase locally admitted policies in a few key countries, based on considerations of the local liability environment, applicable indemnification and advancement laws, tax requirements, and currency control considerations. Another alternative is to arrange the global &O insurance program with a structure a master policy a tax schedule and/or with difference in condition/difference in limits policies over a program of local policies. As Njavro correctly notes, while there are a variety of solutions and alternative approaches available, there is no single solution that will serve the needs of every company. Just to further complicate things, in the current disrupted D&O insurance marketplace, where many insurers have changed their underwriting and pricing approaches and many insurance buyers are facing steep increases in the D&O insurance premiums, there may be “added complexity” to trying to put solutions in place to address these foreign insurance questions. Njavro is quite correct that different companies take different approaches to these issues. In my experience (perhaps a reflection of the kinds of companies with which I am usually working), very few companies take the approach that they need a local policy in every jurisdiction where they have an employee or representative on the ground. Again, at least in my experience, most companies simply do not want to deal with the complexity and expense involved in trying to take this approach to this issue. At least in my experience, it is far more common for companies to conclude that they will simply rely on the their primary D&O insurance policy’s worldwide coverage provision, accepting the risk that they could be taking on risks (from their perspective, purely theoretical) in the various jurisdictions where they have employees or representatives on the ground. In my view, even for companies inclined to want to rely on their base policy’s worldwide coverage section, the better approach is that the company still go through a country-by-country analysis in order to determine whether or not there are at least some countries where the company has a local presence where the company may want to consider buying a local policy. When addressing this country-by-country analysis, I usually suggest that companies take a decision-tree type approach. The first question in is whether the local unit is a formal subsidiary organized under the laws of the local jurisdiction or if the unit is just a local sales office or manufacturing facility. If it is a separate subsidiary, the next question is whether the subsidiary has a separate local board. If the answer is yes, I usually suggest that the parent company consider a local policy. If the answer is no, and if the local unit is not a legally separate entity, then the question is whether the local officials have separate decision-making authority or operate autonomously. If the answer is yes, then the parent company may want to consider a local policy. Even if the local unit is not separately organized and the local officials do not operate autonomously, there is still another analytic level on the decision tree, which as to do with the local laws. The question is whether there are considerations arising from the local law that militate in favor of having a local policy for the protection of the local officials. These local legal considerations could relate to local laws relating to the liabilities of local officials (if, for example local executives can be personally liable under the local jurisdiction’s environmental, tax, or criminal laws for corporate activities). Another consideration that might militate in favor of a local policy would be if there are limitations on the corporate parent’s ability to indemnify the local officials or advance their legal costs. The kind of limitations relevant here would include not only local laws relating to indemnification, but also currency controls limiting the ability of non-local insurers or the corporate parent from sending funds into the jurisdiction. While this decision tree approach provides a way to approach these issues analytically, the fact is that these questions always arise in a specific context. The nature and characteristics of the company involved will always play into this – companies in highly regulated industries (oil and gas, health care, casinos, etc.) will always take a different approach than companies that are not as highly regulated. Also, different companies will respond to these questions differently based on varying risk tolerance. For some companies, the key consideration is going to be cost or even a desire to avoid complexity. These kinds of companies – and there are a lot of them out there – when confronted with all of these undeniably subtle and elusive issues will waive the whole thing off as involving too much expense or confusion to bother with. There is another contextual issue here that I can’t ignore, and that has to do with the insurers. The insurers tend to dominate the dialogue on these topics and each of the insurers participating in the dialogue tries to pitch the discussion so that it leads toward the particular solution that that insurer is able to offer. The problem is that the solutions the various insurers are offering are often diametrically opposed or at a minimum inconsistent, when it comes to way to approach particular jurisdictions; the coordination between a master and local policies; dealing with tax issues; dealing with local policy issuance, etc. The result of these conflicting signals is that all too often the discussion of these topics wounds up sounding to the insurance buyer like a lot of static. Because of that and because of the expense and complexity involved, at the end of the day a lot of prospective buyers wind up waiving off the entire issue. Despite the static and occasional complexity, the question of whether or not a company should have local policies in any particular jurisdiction is an important one. I agree with Njavro that given the stakes involved, these issues require a “thoughtful approach,” one that takes into account the needs of both the parent company and the individual executives in each of the local jurisdictions, as well as the legal environment in the local jurisdiction and the overall company context. I know that for many insurance professionals find the whole question of the need for local policies to be fraught and challenging. I encourage readers with views on this topic to add their thoughts to this post using the comment feature below. The post Do D&O Insurance Policyholders Need Local Policies in Foreign Jurisdictions? appeared first on The D&O Diary. Do D&O Insurance Policyholders Need Local Policies in Foreign Jurisdictions? syndicated from https://888migrationservicesau.wordpress.com via Tumblr Do D&O Insurance Policyholders Need Local Policies in Foreign Jurisdictions? Plaintiffs Argue District Court Lacked Authority to Set Aside Their Mootness Fee Settlement10/22/2019 As I have detailed in prior posts, in the latest variant in the merger objection litigation game, the plaintiffs agree to dismiss their lawsuit after the defendant companies make additional disclosures and agree to pay the plaintiffs’ counsel a “mootness fee.” The absence of any court involvement in the case resolution makes this an attractive alternative for the plaintiffs’ lawyers. However, at least one court recently intervened in order to upset this cozy game. As discussed here, in a blistering June 2019 opinion, Northern District of Illinois Judge Thomas Durkin, exercising what he called his “inherent authority,” acted to “abrogate” the parties’ settlement in the litigation arising out of the acquisition of Akorn , Inc. by Frensenius Kabi AG, and ordered the plaintiffs’ lawyers to return to Akorn their $322,000 mootness fee, ruling that the additional disclosures to which the company agreed were “worthless to shareholders” and that the underlying lawsuits should have been “dismissed out of hand.” Now, in the brief to the Seventh Circuit filed on their appeal of Judge Durkin’s order, the plaintiffs argue that Judge Durkin’s order was “void” because Judge Durkin lacked jurisdiction, had “no authority to continue” after the parties’ settlement, and that he “drastically overstepped the bounds of [the court’s] inherent authority.” The plaintiffs brief sets the stage for what may prove to be a very interesting appellate decision. The plaintiff/appellant’s October 18, 2019 brief can be found here. Alison Frankel’s October 21, 2019 brief on her On the Case blog about the brief can be found here. Background The plaintiffs in the underlying lawsuits sued Akorn and its board of directors in connection with the proposed merger, seeking additional disclosure regarding the transaction. After Akorn revised its proxy statement, plaintiffs dismissed their lawsuits in exchange for a mootness fee. Ted Frank, an Akorn shareholder, moved to intervene and object to the fee. Judge Durkin ordered the parties to brief the issue whether he had “inherent authority” to abrogate the settlement in light of the Seventh Circuit’s ruling in the Walgreen case (about which refer here). Judge Durkin concluded he had the authority to review the settlement, in light of the statement of Judge Posner’s opinion in the Walgreen case that “a class action that seeks only worthless benefits for the class should be dismissed out of hand.” In order to determine whether the complaints should have been “dismissed out of hand,” Judge Durkin reviewed each of the additional disclosures that the complaints sought. With respect to each, Judge Durkin concluded that the additional matter sought was “not plainly material” and concluded that the additional disclosures were “worthless to shareholders.” Yet, he noted, the plaintiffs’ attorneys were “rewarded” for suggesting “immaterial changes to the proxy statement.” The company paid the fees “to avoid the nuisance of ultimately frivolous lawsuit” disrupting the transaction. Since it had “failed” to dismiss the plaintiffs’ complaints out of hand, as it “should” have done, the Court “exercises its inherent authority to rectify the injustice that occurred as a result.” Judge Durkin “abrogated” the settlement agreements and order the plaintiff counsel to return the fees paid under the settlement. The plaintiffs appealed to the Seventh Circuit.
The Plaintiffs’/Appellants’ Brief In their recently filed brief, the plaintiffs argue that Judge Durkin’s ruling in the district court is “unprecedented” and “riddled with a series of critical and fundamental errors, and it warrants reversal.” As grounds for reversal, the plaintiffs first argue that the order was “void because it lacked jurisdiction” as it “acted after the controversy was over” and under the Federal Rules of Civil Procedure the court “had no authority to continue.” The court’s decision to “abrogate” the parties’ settlement “is directly at odds with settled law.” The plaintiffs further argue that by litigating the merits of the parties’ settled and dismissed claims, the district court “drastically overstepped the bounds of its inherent authority,” arguing that reliance on inherent authority may not be used to “side-step applicable rules, statutory regimes, and established principles of law.” The plaintiffs also contend that the Walgreen opinion on which the district court placed so much weight gave the court no authority to review the mootness fee. In Walgreen, the plaintiffs argue, the Seventh Circuit was reviewing fees awarded in connection with a settlement on behalf of a shareholder class. In the Akorn case, the district court was not reviewing a class settlement; instead, the court inserted itself to assess a private agreement between the parties in the underlying dispute, an agreement that did not need court approval, and about with respect to which the court had no authority. Finally, the plaintiffs argue that even if the Court had the authority to act, the Court’s review of the settlement was “fundamentally flawed,” as the Court failed to properly apply the judicial standard for reviewing a mootness fee and failed to properly consider the additional disclosures plaintiffs’ complaint prompted. Discussion The merger objection lawsuit phenomenon is a curse on our judicial system that effectively imposes a process tax on the parties to the merger transaction. In recent years, these lawsuits have been filed in connection with the vast majority of claims. As one recent academic study showed, in 2018 alone, over 80% of all merger transactions valued over $100 million were the subject of at least one merger objection lawsuit. Following the Delaware Chancery Court’s January 2016 decision the Trulia case (discussed here), which evinced the Delaware court’s disdain for the type of disclosure-only settlement by which these merger objection suits were resolved, the plaintiffs lawyers began filing the merger objection lawsuits in federal court rather than in state court, and in recent years, began resolving the cases based on mootness fee settlements. These settlements are costly. The academics in the recent study put the low range estimate of the aggregate in mootness fee paid in 2017 alone at $23.32 million. The federal court merger objection lawsuit continue to be filed at a torrid pace; of the 340 2019 YTD federal court securities class action lawsuit filings, 133 (or 39% of all year to date securities suit filings) are merger objection lawsuits. Given the egregiousness of the problems surrounding merger objection litigation, I applauded Judge Durkin’s opinion at the time. I hoped that the opinion might signal the “beginning of the end” of the merger objection lawsuit phenomenon. However, I did also note that in order for Judge Durkin’s ruling to have any impact on the merger objection litigation racket, other courts would have to be persuaded that they had the authority to review mootness fee agreements as Judge Durkin did. The plaintiffs’ brief goes to the heart of the question of whether or not district courts have any authority to review these kinds of agreements. The brief uses rather vivid language to suggest that Judge Durkin overstepped the bounds of his authority in “abrogating” the settlement and setting aside the agreed mootness fee. How the appellate court will rule remains to be seen. Ted Frank, the Akorn shareholder who appeared to object to the mootness fee in the district court, has filed a motion to be allowed to appear as an amicus curiae before the Seventh Circuit, in order to argue in favor of Judge Durkin’s district court rulings. Ultimately, this appeal may require the Seventh Circuit to address some fundamental questions about the reach of the court’s authority. Depending on how it plays out, this appeal could result in some very interesting discussion of the extent of district court’s authority. But while the outcome of this appeal remains to be seen, I am rooting for Judge Durkin’s decision to be affirmed. Not because I have strong views about the inherent authority of district courts but rather because I would like to see his ruling on the mootness fee issue validated. Anything that might help to drive a stake in the heart of the merger objection litigation curse should be encouraged. For my recent discussion of the plaintiffs’ firms who are filing these lawsuits and walking off with the mootness fees, please refer here. The post Plaintiffs Argue District Court Lacked Authority to Set Aside Their Mootness Fee Settlement appeared first on The D&O Diary. Plaintiffs Argue District Court Lacked Authority to Set Aside Their Mootness Fee Settlement syndicated from https://888migrationservicesau.wordpress.com via Tumblr Plaintiffs Argue District Court Lacked Authority to Set Aside Their Mootness Fee Settlement |
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