We have been following defendants’ motions to dismiss in the In re Lending Club Securities Litigation class action, No 3:16-cv-02627-WHA, in the United States District Court for the Northern District of California (“the Lending Club Litigation”). Plaintiffs brought claims under both Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, alleging that Lending Club misled shareholders about (1) the company’s internal controls over financial reporting, (2) its relationship with Cirrix—a company formed for the sole purpose of purchasing loans from lending club, (3) its data integrity and security, and (4) its loan approval process. The Court’s decision on defendants’ motions to dismiss provides a roadmap for plaintiffs’ bringing Section 11 claims based on failure to disclose weaknesses in internal controls.
Peter Saparoff is a Member in the firm’s Boston office and co-chairs the firm’s Securities Litigation Practice. He is one of the nation’s leading securities litigators and he has represented clients in well over 100 cases, investigations, and proceedings throughout the country. He has successfully defended SEC investigations, class actions, derivative suits, stock exchange proceedings, and state securities investigations, and has handled numerous FINRA arbitrations, among other matters.
On May 9, 2017, the U.S. Court of Appeals for the Federal Circuit (“Federal Circuit”) affirmed in part and reversed in part an earlier decision from the U.S. Court of Federal Claims, which had held that aspects of the Government’s bailout of AIG constituted an illegal exaction. This case stems from two steps the Government took as part of its bailout of AIG. First, the Government issued a loan to AIG in exchange for preferred shares that were convertible to common shares representing an 80% equity interest in AIG. Second, AIG executed a 1:20 reverse stock split that enabled AIG to have enough unissued and authorized common shares to enable the Government to convert its preferred shares, without the need for AIG shareholder to vote in favor of authorizing enough common shares to allow for the Government’s conversion. This case proceeded as an “opt-in” class action, and many institutional investors opted in to the class.
Briefly stated, AIG’s largest shareholder, Starr International Co. (“Starr”) asserted claims based on the Government’s acquisition AIG equity (the “Equity Claims”) and claims based on the reverse stock split (the “Stock Split Claims”). With respect to the Equity Claims, Starr alleged that the Government’s acquisition of AIG equity was an illegal exaction because Section 13 of the Federal Reserve Act did not authorize the Government to take equity as consideration for its bailout loan. Additionally, through the Stock Split Claims, Starr maintained that the Government engineered a reverse stock split to enable it to convert the preferred shares it obtained as consideration for the bailout loan into common shares without a shareholder vote, depriving Starr of its ability to block the resulting dilution. In sum, the Federal Circuit (a) reversed the Court of Federal Claims decision that Starr had standing to pursue its Equity Claims, holding those claims were solely derivative; and (b) affirmed the Court of Federal Claims decision that denied relief for the Stock Split Claims, holding the court did not clearly err in finding that the primary purpose of the stock split was to prevent delisting by the NYSE, not to avoid a shareholder vote.
We have been keeping up with the In re LendingClub Securities Litigation class action, No. 3:16-cv-02627-WHA in the Northern District of California (“LendingClub”), in regard to Judge William Alsup’s unusual decision to require additional briefing from the class plaintiff before agreeing to the class plaintiff’s choice of class counsel. Now, as the LendingClub Plaintiffs oppose the Defendants’ motions to dismiss, Plaintiffs’ counsel is highlighting a recurring trend in motion to dismiss practice: defendants arguing facts at the motion to dismiss stage, particularly in complex cases.
As we have previously noted (here and here), Dutch Foundations (or Stichtings) have been considered a useful tool in seeking recovery for losses on foreign securities. After the Morrison decision closed U.S. courts to claims for purchases of shares of foreign issuers on non-U.S. exchanges, investor advocates sought to use Dutch Foundation effectuate a recovery. Under the Dutch Civil Code, Foundations may negotiate global settlements of investor claims and/or bring suit in the Netherlands to recover for alleged securities fraud. Last year, for example, a foundation negotiated a €1.2 billion settlement with Ageas, the successor-in-interest to Fortis Holdings, over claims that Fortis misled investors. Prior to that, a Dutch Foundation had also forged $58.4 million settlement with Converium covering claims that Converium misstated its financial condition, and a $340 million settlement with Royal Dutch Shell covering transactions on non-U.S. exchanges. Currently, an investor Foundation has asserted claims in the Dutch courts against Volkswagen relating to the Dieselgate scandal.
Recent developments, however, have put the continued viability of Dutch Foundation actions into question. As we wrote here, in June of 2016, a Dutch court dismissed a foundation’s claims because, in the court’s view, the foundation failed to sufficiently safeguard the interests of its members from the foundation president’s potential conflict of interest. Then, the Court of Justice of the European Union (“CJEU”) issued a decision in Universal Music International Holding BV v Schilling that limited the jurisdiction of courts in EU countries, such as the Netherlands. The Universal Music decision addressed Regulation 44/2001, under which defendants must be sued in courts of the member state where they are headquartered, or, for tort-based claims, the place where the harmful event occurred. The CJEU concluded that pure financial damage to a bank account cannot by itself give rise to jurisdiction in the member state where the bank account sits. The CJEU thus held ““It is only where the other circumstances specific to the case also contribute to attributing jurisdiction to the courts for the place where a purely financial damage occurred, that such damage could, justifiably, entitle the applicant to bring the proceedings before the courts for that place” (par. 39).
More recently, the Dutch court has applied the Universal Music case to limit the ability of a foundation to bring suit against BP p.l.c. in the Dutch courts. After settlement negotiations apparently failed, a Foundation representing the interests of BP retail shareholders filed an action against BP in Amsterdam, relating to BP’s alleged misstatement concerning its safety protocols leading up to the Deepwater Horizon oil spill and its alleged misstatement concerning the spill flow-rate. The Foundation sought recovery for investors who had invested in BP shares through a Dutch financial intermediary or account.
On November 4, 2016, Judge Keith Ellison of the United States District Court for the Southern District of Texas granted preliminary approval of a $175 million settlement in the federal securities class action In re: BP p.l.c. Securities Litigation between BP and Lead Plaintiffs for the “post-explosion” class. While the settlement is still subject to final approval, it resolves allegations that BP misrepresented the seriousness of the Deepwater Horizon explosion and its aftermath—covering investors who purchased BP shares between the date of the first alleged misrepresentation about the amount of oil being released as a result of the explosion (April 26, 2010) and the date on which it was revealed that BP initially misrepresented the spill’s severity (May 28, 2010). In granting preliminary approval of the settlement, Judge Ellison also: (1) rejected 135 institutional investors’ request for exemption from opt-out procedures; and (2) allowed some plaintiffs who timely requested exclusion from the class to withdraw their requests and opt back into the settlement. Continue Reading Court in the BP p.l.c. Securities Litigation Upholds Opt-Out Procedures But Then Allows Individual Action Plaintiffs to Opt Back Into $175 Million Settlement
Angela DiIenno contributed to this article.
Recently, the United States District Court for the Northern District of California (the “Court”) dismissed claims against Yahoo, Inc., holding that a 16-year old exemption granted to Yahoo by the Securities and Exchange Commission (“SEC”) barred the plaintiff’s claims alleging that Yahoo was operating as an unregistered investment company in violation of the Investment Company Act of 1940 (“ICA”). UFCW Local 1500 Pension Fund v. Mayer, et al., No. 16-cv-00478 (N.D. Cal. Oct. 19, 2016).
This litigation relates to a 2000 SEC order granting Yahoo an exemption from registering as an investment company. The SEC granted the exemption because it found that Yahoo was “primarily engaged in a business other than that of investing, reinvesting, owning, holding, or trading securities . . . .” The exemption was predicated on two conditions: “1. Yahoo! [would] continue to allocate and utilize its accumulated cash and Cash Management Investments for bona fide business purpose; and 2. Yahoo! [would] refrain from investing or trading in securities for short-term speculative purposes.”
According to the plaintiff’s complaint, Yahoo’s business has changed substantially since the exemption was issued. The complaint alleges that “in 2000 approximately 57 percent of Yahoo’s income came from its operating business, while approximately 44 percent came from investments.” According to the plaintiff, however, by 2014 operations were responsible for only 1.2 percent of Yahoo’s income, and in 2015, “all of its net income was attributable to its investments.” Additionally, the complaint asserts that “[i]n 2013, Yahoo began considering spinning-off its Alibaba holdings” and registering the spin-off company itself as an investment company.
Due to these “fundamental changes to Yahoo’s business” the plaintiff, UFCW Local 1500 Pension Fund (“UFCW”), filed derivative and direct claims against Yahoo and its directors and officers for the alleged failure to register Yahoo as an investment company in violation of the ICA. UFCW argued that Yahoo had lost the protection of its registration exemption such that Yahoo was required to register as an investment company under the ICA. It further argued that because Yahoo had never so registered, “it had been operating illegally as an unregistered investment company.” Continue Reading Court Dismisses Claims Alleging that Yahoo Is Illegally Acting as an Unregistered Investment Company
Recent doubts have been raised as to the effectiveness of Dutch Foundations, which have become an important vehicle in foreign recoveries. While Dutch Foundations have negotiated settlements in some situations, some foreign commentators have begun to question their utility.
A Dutch Foundation, also known as a “stichting,” can be established in the Netherlands to represent the interests of victims. It is capable of resolving claims against a defendant in the form of a collective settlement or by instituting a legal proceeding. The Foundation has an independent Board of Directors that guides its activities.
An investor can join a Foundation without becoming a party plaintiff. A Foundation can begin a legal proceeding in its own name in a Dutch court on behalf of its members. Institutional investors in the U.S. and elsewhere are often solicited to join a Foundation because, in order to establish its “representation,” the Foundation must demonstrate that it has many members from various jurisdictions. The Foundation can either bring a collective action for a determination of liability or it can begin a collective settlement proceeding. Under said settlement proceeding, a settlement can bar everyone from suing the defendant except those who opt out.
With investors facing uncertainty as to the risks of becoming party plaintiffs in foreign securities cases, the Foundation has become, in some instances, an excellent practical alternative. Foundations have achieved some notable settlements in Shell Netherlands, EADS, and Converium, for example. However, some foreign commentators have raised issues about the Foundation’s effectiveness – especially as to non-Dutch defendants (even though we understand Converium was not a Dutch entity). The commentators raise such issues as jurisdiction, damages, and the statutes of limitations.
While these are understandable concerns, a non-Dutch defendant faced with numerous suits in various foreign jurisdictions might well look at the Foundation as a way to practically resolve all disputes. Because of the Morrison decision, discussions as to viability of litigation vehicles in foreign courts will certainly increase as investors continue to search for ways to recover losses, which recovery (pre-Morrison) could have been achieved in the United States.
Our recent and extensive experience with foreign securities litigation leads us to conclude that Foundations can be effective vehicles for recovery.
Section 18 of the Securities Exchange Act, while seldom used in the past, has been increasingly used by institutional investors in suits against banks and other entities. The advantages of Section 18 are as follows:
- Plaintiff need not allege scienter.
- Unlike Section 12(a)(2) of the Securities Act, plaintiffs need not allege privity. Section 18 attributes liability to “[a]ny person who shall make or cause to be made” a material misstatement.
- Although a plaintiff must allege “eyeball reliance” on the SEC filings covered by the statute, this is not a difficult task for an institutional investor. Indeed, the ways in which the specific statements are misleading or fail to state material facts can be persuasively enunciated by investment professionals who are, in effect, experts. The allegations can present defense counsel with unique arguments they had not anticipated and give the case momentum. Accordingly, the investor can present to the court a compelling case of how someone was misled by the disclosures, rather than a case based on anonymous reliance pursuant to the “fraud-on-the-market” doctrine.
- There is a right to a jury trial.
- There is some authority that investment advisors can sue on behalf of clients.
With the increasing barriers to successfully prosecuting a securities fraud case in the United States, including the jurisdictional limitations caused by the Morrison decision, institutional investors are sometimes now looking to other jurisdictions to sometime recover their losses. One such jurisdiction is Australia.
While we are not Australian attorneys, our observations from dealing with many Australian cases are as follows:
- Plaintiffs’ attorneys in Australia frequently announce new investigations and/or “class actions” relating to what they see as fraudulent conduct. “Class Actions” or “Representative Proceedings” in Australia differ from U.S. class actions in that one usually has to “opt in” to be assured of participating in the settlement. (There are exceptions – a few actions are filed as “open” class actions which cover all investors. Others – initially filed as “closed” class actions sometimes are opened to all investors during the settlement process, presumably because of the defendants’ insistence for complete protection.)
In the context of our representation of institutional investors, our experience reveals that they have been confronting an increasingly difficult process in recovering their losses from alleged violations of securities laws. These are among the developments:
- The Morrison decision has insulated many large companies in which investors have sustained losses from Federal Securities Laws claims. While certain avenues to seek redress in foreign jurisdictions have improved, there are still obstacles in many foreign jurisdictions. Alternatively, filing a separate action in U.S. courts – without the benefit of Federal securities claims – has its own set of issues.
- The claims process itself has become more adversarial. Electronic filing has enabled claims administrators to be more diligent in rejecting claims or challenging claims for deficiencies. Deadlines have become tighter. Failure to cure deficiencies can substantially reduce the value of a claim if not eliminate it. In addition, counsel for defendants are sometimes participating in the claims process with the intent to reduce valid claims to the smallest number possible.
- Institutions are solicited to opt out of various class actions. Opt out proposals require careful analysis not only of the merits of the proposed complaint but also of the institutions’ own transactions. While the solicitation may be characterized as a “prudent way” to “maximize recovery,” following some of these proposals could place an institution at risk.
- Institutions should also be aware of the various objections to settlements in which they may be class members. Some objections – if allowed – would enhance shareholder recovery. Others are without merit and drain the settlement fund.
Accordingly, we trust that this new “Class Action Recovery – Institutional Investors” blog will alert institutions to events in this developing landscape.