Ninth Circuit Resolves Loss Causation Issue Under Section 10(B)

Attorney: Austin P. Van
Pomerantz Monitor March/April 2018

In Mineworkers’ Pension Scheme v. First Solar, Inc., the Ninth Circuit recently resolved an internal conflict in its case law regarding the loss causation requirement of Sec­tion 10(b) of the Exchange Act. The court held that a plain­tiff may prove loss causation by showing that revelation of the very facts misrepresented or omitted by the defendant caused the plaintiff’s economic loss, even if the fraud itself was not revealed to the market. That is, to satisfy the loss causation requirement, a plaintiff need not point to a revelation that the defendants committed fraud, but rather only to a revelation of the facts concealed by the fraud. This commonsense ruling greatly improves the ability of investors in California and elsewhere in the Ninth Circuit to recover losses that were sustained as a result of fraud before the fraud itself was revealed to the public.

Defendant First Solar, Inc. is a large producer of solar panel modules. Plaintiffs, a putative class of purchasers of First Solar’s stock, alleged that the company discov­ered manufacturing defects in its solar panel modules that caused them to lose power within the first several months of use, as well as design defects in the modules that caused them to lose power faster in hot climates. Plaintiffs alleged that First Solar hid these defects and their cost and scope from the market and misrepresented key data in their financial statements.

First Solar’s stock price declined steeply after these defects and their cost and scope were revealed to the market. First Solar initially disclosed the manufacturing defect and significant additional costs related to curing the defect and, over the next year, the company disclosed consistently disappointing earnings and financial results, additional expenses related to curing the product defects, and the departure of the company’s CEO. However, at no point did the company or any other party reveal that First Solar had known about, and misrepresented or fraudulently concealed, any of these problems in the past.

On their motion for summary judgment, defendants ar­gued that plaintiffs had not satisfied the loss causation requirement of Section 10(b) because plaintiffs’ losses were not caused by the revelation that First Solar had committed fraud. Plaintiffs replied that revelation of the facts allegedly misrepresented and concealed by defendants, namely, the company’s product defects and related financial burdens, was sufficient to satisfy the loss causation requirement.

The district court identified two irreconcilable lines of Ninth Circuit case law on this issue. The first line of cases began with In re Daou Sys., where the Ninth Circuit reversed a district court’s decision dismissing a Section 10(b) action on the ground that the plaintiffs had not alleged any disclosures that defendants were engaging in improper accounting practices. The Ninth Circuit held that where disclosure of “the company’s true financial condition” caused the stock to drop, loss causation was satisfied, even though the company’s fraudulent accounting practices were not revealed to the market. The Ninth Circuit took a similar approach in Berson v. Applied Signal Technology, Inc., and ultimately fashioned a standard for loss causation in Nuveen v. City of Alameda when it held that a plaintiff can establish loss causation “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.”

However, the district court in First Solar recognized that a second line of Ninth Circuit cases had applied a dif­ferent standard. In Metzler v. Corinthian Colleges, Inc., the plaintiff alleged that the defendant, an operator of vocational colleges, had manipulated student enrollment data, and that plaintiff suffered losses when the company issued a press release showing lower earnings than the false data had suggested. The Ninth Circuit affirmed dismissal of the complaint on the ground that plaintiff had failed to allege that the market “learned of and reacted to [the] fraud,” as opposed to merely reacting to reports of the defendant’s newly disclosed poor financial health. In In re Oracle Corp., the Ninth Circuit similarly held that plaintiffs cannot prove loss causation “by showing that the market reacted to the purported ‘impact’ of the alleged fraud . . . rather than to the fraudulent acts themselves.” The Ninth Circuit followed the holdings of Metzler and In re Oracle in Loos v. Immersion Corp. and Oregon Public Employees Retirement Fund v. Apollo Group, Inc., both of which held that loss causation requires a showing that the market reacted to the revelation of fraud, rather than the revelation of the facts concealed by the fraud or the impact of the fraud.

The district court in First Solar ultimately applied the stan­dard from the Daou line of cases and held that plaintiffs did not need to show that the market reacted to the fact that First Solar had committed fraud in order to satisfy the loss causation requirement. However, faced with two irreconcilable lines of cases, the district court requested that the Ninth Circuit resolve the conflict on interlocutory appeal.

In a brief yet unequivocal per curiam opinion, the Ninth Circuit affirmed the district court’s holding, and so upheld its prior rulings in Daou, Berson and Nuveen. The Court announced that “[t]o prove loss causation, plaintiffs need only show a causal connection between the fraud and the loss by tracing the loss back to the very facts about which the defendant lied.” Accordingly, plaintiffs may satisfy the loss causation requirement “even where the alleged fraud is not necessarily revealed prior to the economic loss.”

The Ninth Circuit’s holding in First Solar marks its first definitive resolution of the internal conflict in its case law on loss causation. While the Court did not expressly overrule the Metzler line of cases, it limited those cas­es to their facts. Moreover, the Court made clear that, contrary to Metzler and its progeny, a plaintiff may prove loss causation by showing that defendant’s stock price fell upon revelation of an earnings miss, even if the market was unaware at the time that fraud had concealed the miss.

In recent years, defendants in Section 10(b) actions in the Ninth Circuit have routinely cited to the Metzler line of cases to support an argument that loss causation is absent in any case where losses were sustained prior to the market learning the fact that defendants had committed fraud. This standard from Metzler permitted defendants to escape liability under Section 10(b) if the negative impact of their fraud was revealed to the market prior to revelation of the fraud itself. With First Solar, the Ninth Circuit has closed the door to that argument and, in the process, granted a significant victory for investors seeking to recover for losses due to fraud that occured prior to revelation of the fraud itself.

Dept. Of Treasury Promotes Forced Arbitration For IPO Claims

Attorney: Leigh Handelman Smollar
Pomerantz Monitor March/April 2018

When a company goes public, it seeks to raise money from investors by selling securities through an initial pub­lic offering (“IPO”). To effectuate an IPO, the company must file several documents with the SEC, including a registration statement and a prospectus. In these docu­ments, the company relays its financial statements and other important information about its business, opera­tions and strategy. Investors rely on these documents in determining whether to purchase the company’s securi­ties in the IPO.

Under the securities laws, investors can much more eas­ily recover for misrepresentations in IPO offering docu­ments than misrepresentations in non-IPO public disclo­sures. Section 11 of the Securities Act makes companies automatically liable for any material misstatements or omissions in their registration statements; and all officers and directors who sign the registration statement are also presumptively liable. In order to escape liability, these of­ficers and directors carry the burden of establishing that they did not know, and could not reasonably have known, about the misrepresentations. Investor reliance on these misrepresentations or omissions is also presumed, un­less the company can disprove it.

Of course, most investors cannot practically avail them­ selves of these rights unless they can pursue them in a class action. Except for large institutional investors, which may have large-scale individual damages, most investors’ losses are not great enough to justify bringing an individual securities action. The very threat of class action securities suits helps to keep companies honest, especially in their public filings. Investors are able to seek the full amount of damages from the fraud, whereas a government action typically only seeks disgorgement. Class action securities suits based on false or mislead­ing IPO documents have allowed investors to recover billions of dollars over the years. These investors range from an average citizen holding the security in his/her retirement account, to large pension funds. Private class action securities suits on behalf of investors have been a driving force in holding bad actors accountable. It is well-known that SEC resources are limited and that private enforcement has been more effective in not only holding bad actors accountable, but in deterring wrong­doing as well.

The very effectiveness of these Section 11 remedies has made them a prime target of pro-business groups; and the Trump administration is showing signs that it may well be listening to them, in the guise of promoting more IPOs. The U.S. Dept. of Treasury recently issued a report on ways to reduce the cost of securities litigation, including forced arbitration. Bloomberg News has report­ed that the SEC, under its new chair, Jay Clayton, might be looking for ways to effectively ban securities class actions based on misstatements in IPO documents, in favor of forcing arbitration. Often, class actions are impossible to arbitrate; therefore, requiring arbitration could effectively present an insurmountable barrier to any recovery for all but the minority of investors whose losses are large enough to make an individual action practicable.

While this move may promote more IPOs in the United States, taking away real investor rights has serious implications in the United States securities markets. In general, the SEC has been less successful in recover­ing monies for defrauded investors than private lawsuits. Further, as the Wall Street Journal recently reported, foreign investors purchased over $66 billion in U.S. stocks in 2017, which number is predicted to grow. One of the main reasons foreign investors like to invest in U.S. stocks is that the protections of the U.S. securities laws are stronger than those of other countries. The Petrobras case is a great example. There, investors in a class action who purchased pursuant to U.S. trans-actions were able to recover $3 billion (despite Petrobras bylaws requiring arbitration). However, investors who purchased securities through the Brazilian stock ex­change were required to arbitrate their claims rather than bring a private enforcement action. Those investors recovered nothing.

Aside from individual investors not being able to recover in an arbitration, there is another negative side effect: arbitrations are not matters of public record and, therefore, the deterrent effect is negated. Newly-appointed SEC Commissioner Robert J. Jackson, Jr. has recently stated similar concerns, displaying his skepti­cism for mandatory arbitration of these claims.

While SEC Commissioner Michael S. Piwowar indicat­ed he would be willing to consider such a drastic policy change, SEC Chairman Jay Clayton has told a Senate panel that he is “not anxious” to allow investors to be barred from filing securities class action claims after an IPO. Senator Elizabeth Warren has been vocal about refusing to dilute investor rights in this regard. She told Clayton, “The SEC’s mission is to protect investors, not throw them under the bus.” Further, former SEC Chair­man Harvey Pitt urged Clayton to put this issue on the “back burners,” citing the very limited resources that the SEC is already encountering. Jackson, Jr. also voiced concerns with respect to the limited budget of the SEC. Another critic of the proposed policy change, Rick Flem­ing, Investor Advocate at the SEC, has stated his opinion about mandatory arbitration of shareholder claims this way: “stripping away the right of a shareholder to bring a class action lawsuit seems to me to be draconian, and, with respect to promoting capital formation, counterpro­ductive.”

Chairman Clayton recognizes that the issue is complex, with investor rights pitted against public company rights, each with their own strong advocates. He confirmed that any policy change in this regard would be subject to great debate, reiterating his desire to delay decision on this is­sue: “[This] is not an area that is on my list for where we can do better[.]” In other words, Chairman Clayton does not appear to want to decide this issue anytime soon.

Regulation A+ Earns A D

Attorney: Joshua B. Silverman
Pomerantz Monitor March/April 2018

For more than eight decades, the Securities Act of 1933 has protected investors by requiring full disclosure in initial public offerings. As President Roosevelt explained at the time of its enactment, the statute was intended to restore confidence in public markets by ensuring that important information regarding new issues was not “concealed from the buying public.”

In 2012, the Jumpstart Our Business Startups (JOBS) Act created a new type of offering that largely bypassed these investor protections. Commonly known as a mini- IPO or Regulation A+ offering, the provision allowed small companies to raise $50 million or less with limited regula­tions. Advocates claimed that by bypassing “burdensome” regulations the act would facilitate capital formation, create jobs, and reinvigorate capital markets.

Regulation A+ companies go through only a minimal “qualification” process, avoiding most pre-offering scrutiny from the SEC’s Division of Corporate Finance. Such com­panies are not bound by the “quiet period” rules that restrict advertising of traditional IPOs. As a result, many are promoted by online ads and social media campaigns making aggressive promises. Even worse, Regulation A+ offerings are not subject to the strong private remedy under Section 11 of the Securities Act of 1933.

More than five years after the JOBS Act, none of the promised benefits has materialized. There is no evidence that Regulation A+ has created jobs (except for stock pro­moters) or boosted small business. Peeling back safe-guards, however, definitely hurt investors. Regulation A+ has become a “backdoor” mechanism to facilitate public listings by companies that would not be able to do so by traditional means, and most have resulted in heavy losses. Because most shares in these offerings are foisted on retail investors, they have borne the majority of these losses. But institutions are now getting involved. FAT Brands, for example, claims that institutional inves­tors accounted for 30% of its mini-IPO.

The first company to take advantage of the light-touch regulations, Elio Motors, listed on the OTCQX at $12 after running a heavily-advertised campaign on a crowd­funding site. Shares now languish below $3, less than 25% of their price at the time of listing. Instead of creating jobs, the undercapitalized manufacturer of three-wheeled vehicles has furloughed workers.

More than a dozen other companies have since used Regulation A+ to go public, with many even listing on the NASDAQ or NYSE. A recent study by Barrons magazine confirms that investors lost money in nearly all of these offerings. The fourteen offerings reviewed by Barrons dropped by an average of 40% on a price-weighted basis during their first six months of trading, at a time when the Russell 2000 and S&P SmallCap 600 indexes both registered strong gains.

Predictably, the reduced scrutiny of Regulation A+ has attracted promoters with shady pedigrees. For example, the CEO of Level Brands, Martin Sumichrast, was previously known for bringing low-quality companies public through Stratton Oakmont, the infamous penny-stock brokerage featured in Wolf of Wall Street. Rami El-Batrawi, the CEO and founder of YayYo, a ride-sharing company that filed to go public in 2017, was until recently banned from serving as an officer or director of a public company under a consent judgment settling claims that he manipulated trading of his prior company, Genesis Intermedia.

Although Regulation A+ has been a disaster by any ob-jective measure, lawmakers seem intent to double down. A bill currently pending in the House of Representatives would raise the limit of Regulation A+ offerings to $75 million. Until Congress begins to consider the needs of investors, it truly is “buyer beware.”

Supremes Hold That State Courts Still Have Jurisdiction Over Securities Act Class Actions

Attorney: H. Adam Prussin
Pomerantz Monitor March/April 2018

Since the Securities Act of 1933 (the “Securities Act”) was first enacted, it has provided that state and federal courts have “concurrent” jurisdiction over cases brought under that Act. So Congress passed SLUSA, the Securities Litigation Uniform  Standards Act of 1998, which prevents investors from bringing so-called “covered class actions” under state law which parallel misrepresentation claims under federal securities laws. Generally speaking, section 77p of SLUSA defines “covered class actions” as cases, brought on behalf of fifty or more investors in securities listed on a national exchange, that allege that defendants made misstatements or omissions in connection with initial public offerings, in violation of state law. The intent was to prevent investor plaintiffs from bringing state law cases alleging misrepresentations in securities transactions.

As we reported in the September/October 2017 edition of the Monitor, the Supreme Court had granted certiorari in a case called Cyan. That case poses the question of whether SLUSA deprives state courts of jurisdiction over class actions under the Securities Act.

The Cyan case concerns one of SLUSA’s “conforming” amendments, which added the following phrase to the Securities Act’s provision allowing state court concurrent jurisdiction over Securities Act claims: “except as provided in section 77p of this title with respect to covered class actions.” Since “covered class actions” are defined as actions raising state law claims, not securities laws claims, this “exception clause” seems to be a non sequitur.

So what does SLUSA’s “exception” clause mean? De­fendants said that it means that class actions under the Securities Act can no longer be prosecuted in state courts. Plaintiffs said that section 77p does not actually say that and applies only when a complaint contains claims under both the Securities Act and state law. The government had a third position, which is that such cases could still be brought in state courts, but that defendants could then have them “removed” (transferred) to federal courts.

The Supreme Court has now spoken. In a unanimous opinion, it agreed with the plaintiffs, holding that Securities Act cases can still be brought in state courts, and can­not be removed to federal courts. According to the Court, section 77p “says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule of §77v(a)— under which a state court may hear the Investors’ 1933 Act suit – continues to govern.”

What, then, does the “exception clause” actually remove from state court jurisdiction? In our article last fall, we noted that “the exemption is codified in the jurisdictional provision of the Securities Act, so it must mean that concurrent jurisdiction does not exist for some claims under the Act. What those claims are is a puzzlement that only the Supreme Court can resolve.” As it turns out, the Court could not figure that out either.

The opinion states that the investors might be right that the “exception” clause applies only when the case involves both state law and Securities Act claims. Or it might be there for some other reason. It concluded that “[i]n the end, the uncertainty surround­ing Congress’s reasons for drafting that clause does not matter. Nor does the pos­sibility that the risk Congress addressed (whether specific or inchoate) did not exist. Because irrespective of those points, we have no sound basis for giving the “except” clause a broader reading than its language can bear.”

In cases involving statutory interpretation the Supreme Court has, in recent years, been relying heavily on the “plain meaning” of statutory language, a doctrine that presupposes that Congress, in passing statutes, means exactly what it says and says exactly what it means. Sometimes, though, Congress uses language that makes no sense. That seems to be what happened here.

Defendants in securities cases often believe that state courts will be more favorably disposed towards investor plaintiffs than the federal courts will be. If that is true, the Supreme Court’s decision in Cyan will preserve this tactical advantage for investors.