Securities fraud claims fail but plaintiff succeeds with related corporate transaction claims

In AJZN, Inc v. Yu, et al (2015 U.S. Dist. LEXIS 8407) the plaintiff brought various claims relating to corporate transactions after he transferred intellectual property rights to the defendants who subsequently failed to honor the terms of their agreements. AJZN held numerous patents, trademarks, and copyrights relating to wireless audio and internet radio technology.  In 2007, AJZN entered into a senior secured note purchase agreement with defendant Great American Life Insurance Company (“GALIC”) securing AJZN’s assets for a debt obligation.  When AJZN received a $1.5 million settlement of a patent lawsuit, GALIC demanded to be paid the proceeds, and insisted that AJZN appoint defendant Yu as CEO of AJZN.  In 2009, GALIC formed Aerielle with Yu acting as CEO.  In the following year, AJZN entered into an asset purchase agreement with Aerielle and sold all of its assets and its ownership of Aerielle subsidiary ATI for the assumption of certain debt and a warrant.  The warrant gave AJZN an option to acquire membership units of Aerielle and was to further compensate AJZN for its assets.  As part of the agreement, AJZN also entered into a confidential mutual release and settlement agreement. Problems began when AJZN attempted to exercise its rights under the warrant.  Aerielle initially failed to respond to AJZN’s request, but subsequently offered to terminate the warrant in exchange for an earnout agreement.  The earnout agreement would provide AJZN a percentage of the gross revenues generated by ATI if ATI merged with Aerielle.  AJZN rejected the offer, which went through, but ultimately failed to generate any revenue for AJZN. The plaintiff then brought suit for violations of the Securities Exchange Act, Cal. Corp. Code §25401 and §25501, breach of warranty, promissory fraud, recission of release, breach of fiduciary duty, civil conspiracy, tortious interference with contractual relations, fraudulent transfers, unjust enrichment, and successor liability. For the securities fraud, AJZN alleged that the defendants knew the warrant was worthless, would never be honored, and was used to induce AJZN to transfer its assets and eliminate its interest in Aerielle.  The Court however, held that AJZN failed to allege any misrepresentation or omission by the defendants, and dismissed the securities fraud, state corporate fraud claims under §§25401 and 25501, promissory fraud, and recission of release claims.  The Court also dismissed the civil conspiracy claim, finding the violation alleged only by one defendant, and dismissed the claims for unjust enrichment in part against Aerielle. The Court sustained the claims for breach of fiduciary duty, tortious interference with contractual relations, fraudulent transfers, and successor liability.  Breach of fiduciary duty was upheld against Yu for compensation increases and personal expenses he approved to himself.  Yu argued that the release removed any liability from him, but the release specifically excluded intentional fraud.  AJZN alleged tortious interference sufficiently, claiming that GALIC instructed Yu to withhold payments to Aerielle to prevent earned payments to AJZN.  The Court also accepted AJZN’s claim for fraudulent transfers, as it was purported that the transfer rendered Aerielle insolvent, Aerielle received no value for the transfer, and the subsequent company was controlled by GALIC and Yu.  Finally, the Court upheld successor liability because AJZN alleged that Aerielle’s transfer of assets resulted in the successor conducting the same business as Aerielle, using the same assets, and being controlled by the same defendants. The Court granted and denied the motion as described above.

Pleading Particularity for All Elements of Securities Fraud in 9th Circuit

In OPERF v. Apollo Group, Inc. (2014 U.S. App. LEXIS 23677) the Ninth Circuit affirmed dismissal of a securities fraud class action for multiple pleading deficiencies.  The Court also held that the heightened pleading standard under Fed. R. Civ. P. 9(b) and the PSLRA, applies to all securities fraud elements, including loss causation. Defendant Apollo Group is a private education provider who owns the University of Phoenix - an online, for-profit, higher education institution.  During the class period, the plaintiffs alleged that the defendants made false and misleading statements regarding Apollo’s enrollment, revenue growth, business model, and student recruitment.  In Form 10-K filings, Apollo made statements expressing their belief for growth and describing enrollment and revenue growth as “significant events.”  The plaintiffs also claimed Apollo failed to disclose its recruitment of students unable to pay – a fraudulent omission according to the plaintiffs.  In addition to the Section 10(b) and Rule 10b-5 claims, Plaintiffs alleged claims for insider trading and control person liability.

The Court set out the elements for securities fraud and noted the variance of pleading standards in the federal circuits, particularly toward loss causation.  After explaining the connection to common law fraud, Rule 9(b) language, and need for consistency, the Ninth Circuit held that pleading particularity applies to all elements of securities fraud.

Here the plaintiff’s claims failed under both standards.  Apollo’s statements were puffery, subjective optimism that would not induce a reasonable investor’s reliance.   In regards to the omission claim, Apollo disclosed information material to negate any fraud.  The plaintiffs also failed to allege scienter.  Finally, the allegedly fraudulent statements were neither untrue nor called into question by subsequent disclosures - they failed to demonstrate loss causation completely.  Because the remaining claims rested on the same facts, the Court also dismissed them.

Investor's Securities Fraud suit survives Morrison Claim by "Chinese" Company

In Starr Investments Caymen II, Inc. v. China MediaExpress Holdings, Inc., (2014 WL 4180331), plaintiff stockholder Starr Investments brought numerous claims based in securities fraud, state law fraud and corporate governance, against CMEH, previous directors, an independent accounting firm, investment companies and their control persons, and a Hong Kong audit firm and partner employed by the plaintiff.  Starr moved for default judgment against CMEH and all other defendants moved to dismiss pursuant to Fed. R. Civ. P. 12(b)(6). Starr had purchased CMEH stock in 2010.  In 2011, analysts alleged CMEH was engaged in an illegal pump and dump scheme to inflate stock prices.  The company’s auditor confirmed the inflated status, resigned, and the SEC deregistered the company.  Starr brought suit soon after in U.S. District Court in Delaware.

Although most claims were fact-based against each defendant, almost all were subject to the application of Morrison v. Nat’l Australia Bank Ltd. (561 U.S. 247).  The defendants argued that the transactions at issue were public sales, not sales through the listed stock exchange, and not subject to the §10(b) claims.  The Court rejected the argument, explaining Morrison’s holding, that §10(b) claims apply to sales of securities listed on an American stock exchange, not solely sales that occur via the stock exchange.  The defendants also attempted to characterize CMEH as a Chinese company, but the company was incorporated in Delaware and never listed stock on a foreign exchange.  The motions to dismiss based on Morrison were denied.

As to the remaining motions, the Court examined the allegations under the heightened pleading standards of both Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act.  Most allegations were for violations of §10(b), Rule 10b-5, and §20(a), but also included claims for negligent misrepresentation, common law fraud, aiding and abetting fraud and breach of fiduciary duties, and conspiracy to commit fraud.

The Court dismissed the §10(a), Rule 10b-5, and §20(a) claims against the former directors for insufficient pleadings, but the state law claims survived lower pleading standards.  The Court found the pleadings sufficient against the accounting firm, based on allegations of GAAS violations and ignorance of fraud red flags, but dismissed the claims for negligent misrepresentation and aiding and abetting.  The §10(b) claim against the investment companies and their directors were dismissed because Starr failed to plead any misrepresentation made by those defendants.  Finally, the Court found the pleadings against the Hong Kong audit firm superior to those implicating the accounting firm.  The allegations for negligent misrepresentation were sufficient, as the defendant must have intended that Starr rely on the information they sought by employing the defendant.  However, the claims against the individual partner were dismissed. The Court explained that a partner is not considered a “maker” of a false statement issued by the firm, unless he signs the statement personally.

The Court granted the Plaintiff’s motion for Entry of Default Judgment and granted in part and denied in part all other motions as stated above.

Securities Fraud remanded in light of Halliburton II

After the district court certified the class in Local 703 v. Regions Financial Corp. (762 F.3d 1248), Regions appealed the order.  The Eleventh Circuit found the certification well-reasoned but remanded to reconsider in regards to the recently decided Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II, 134 S.Ct. 2398). According to the allegations, Regions’ issued misrepresentations in analyst statements and financial disclosures beginning in 2008.  In 2009, the company made a substantial corrective disclosure that caused the stock price to plummet.  The plaintiffs brought a class action suit for all investors who purchased stock during the applicable period and the district court certified the class under Fed. R. Civ. P. 23(a) and 23(b)(3).  Regions appealed, arguing that the plaintiffs did not prove common questions of reliance, Regions’ offered sufficient rebuttal evidence of class-wide reliance, the name representatives were atypical, and the period for class certification was unjustified.

The defendant claimed that the plaintiffs failed to establish that the stock was traded on an efficient market to invoke Basic v. Levinson's (485 U.S. 224) “fraud on the market” presumption.  Regions argued the court should have applied an analytical examination to determine market efficiency, should have required evidence of an immediate change in stock price, and that these errors contributed to the application of a per se rule that every market is efficient.

The Eleventh Circuit found the trial judge properly applied the Basic presumption and rejected Regions' arguments.  The Court refused to adopt a mandatory analytical framework in order to maintain the flexibility of examining market efficiency on a case-by-case fact intensive inquiry.  This did not mean, however, that district court’s approached the issue blindly - the Eleventh Circuit stated that high-volume trading activity facilitated by people who analyze stock information or who make trades based upon that information defined an efficient market.   These features might not apply to every case though, because stocks traded on a smaller scale, or not widely followed, could still be traded on an efficient market.  Regions suggested that the Court adopt the factors from Cammer v. Bloom (711 F.Supp 1264), but the Court thought it unwise to require such an analysis in every case.

The Court also rejected the argument for proof of an immediate effect on stock price as it would defeat the Basic presumption.  The disclosures made by Regions were also intended to prevent any effect on stock price, not cause a significant decline.  Finally, the Eleventh Circuit agreed against the application of a per se rule of market efficiency, but did not find such applied by the district court.

However, the Court agreed with Regions, on the argument that Defendants may introduce evidence of price impact, or lack thereof, to rebut the Basic presumption as established in Hallibuton II.  Because the district court relied on the law before Halliburton II, the issue had to be remanded for reconsideration.

Regions’ arguments for atypical class representatives were also rejected.  The Court agreed with Regions regarding the class period however, because the district court applied the wrong dates.  The plaintiffs requested the class period encompass the date of the initial disclosure to the date of the corrective disclosure, but the district court extended the class period by one extra day.  The Court remanded the issue to be corrected.

The Court affirmed the Basic presumption application, the typicality of class representatives, and the start date of the class period, but vacated and remanded the other issues.

Narrow Liability Under Section 11 for Opinion Statements

In MHC Mut. Conversion Fund, L.P. v. Sandler O'Neill & Partners, L.P. (2014 WL 3765717) the Tenth Circuit maintained narrow liability under section 11 (15 U.S.C. 77k) of the Securities Act, for opinion statements concerning future events by a securities issuer. This case arose after the 2008 financial crisis. Bancorp issued a statement, reporting significant losses in mortgage-backed securities, but that it expected losses to level off and for the market to rebound shortly. The company did warn more losses were expected if the market did not improve. Bancorp issued the statement after both internal and independent expert analysis. Unfortunately, the market did not rebound, more losses resulted and the plaintiffs filed suit for violations of §11 of the Securities Act and Rule 10(b).

A cause of action exists under Section 11 if a registration statement contains an untrue statement of material fact or omits a material fact necessary to make a statement not misleading. Because Bancorp offered an opinion and the statute focuses on facts, the court addressed actionable opinions. Usually, opinions are not actionable; under this view, the plaintiffs’ claim fails. An opinion can be actionable if it is a false opinion, but the plaintiffs could not show the defendant subjectively disbelieved the opinion it published -- even though that opinion turned out to be very wrong. The court rejected the plaintiff's theory that Bancorp was liable because it provided an expert opinion with no objectively reasonable foundation was actionable, again requiring no sincere belief in the statement by the defendant.

The Court held that an objectively reasonable basis test applied, but the action would have failed under any test. The plaintiffs alleged no evidence that relying upon the statement would mislead an investor. The statement by Bancorp was definite, qualified, and provided notice that the speaker might be wrong – factors used to classify a statement as an non-actionable opinion in prior cases. The plaintiffs attempted to argue that the statement was not opinion, but actually a fact, but the court rejected this also.

The court also dismissed the plaintiff’s 10(b) claim for failing to demonstrate scienter. The complaint at most alleged motive and opportunity to mislead, not the particular facts required to demonstrate an intent to defraud or reckless disregard of the truth.

The Tenth Circuit affirmed the District Court’s decision, dismissing the complaint with prejudice.