On February 25, in a case demonstrating courts’ intolerance for unsubstantiated “must-have-known” allegations to allege scienter, the federal district court for the District of New Jersey dismissed with prejudice an amended class action complaint against Cancer Genetics, Inc. and certain current and former Cancer Genetics officers, who were represented by Goodwin Procter. The case related to Cancer Genetics’ April 2, 2018 disclosures regarding a $1.8 million write-off in accounts receivable and $4.4 million bad-debt expense following the company’s acquisition of Response Genetics years earlier in 2015. The amended class action complaint alleged that defendants made material misstatements regarding the acquisition and integration of Response Genetics in violation of Sections 10(b) and 20(a) of the Exchange Act, and focused on several statements made by the individual defendants over a two-year class period, as well as certain Sarbanes-Oxley (“SOX”) certifications submitted by Cancer Genetics in its SEC filings. The Goodwin team obtained complete dismissal of the action with prejudice—i.e., without leave for plaintiff to amend the complaint.
The district court, in an opinion issued shortly after argument on the motion, concluded that the amended complaint had not alleged an actionable misstatement or omission. The court found many of the remaining statements too vague to be actionable, non-actionable “puffery,” or forward-looking statements protected by the Private Securities Litigation Reform Act’s (“PSLRA”) safe harbor. The court also found that the amended complaint did not adequately allege scienter (knowledge of wrongdoing). The court rejected plaintiff’s arguments that defendants “must have known” about issues relating to the Response Genetics acquisition, and instead found that the more plausible inference was that defendants became aware of those issues only after engaging third-party consultants in 2018 to evaluate Cancer Genetics’ accounts receivable. The court noted that plaintiffs had not demonstrated that the issues were so obvious that defendants would had to have known about them before the third-party evaluation. The court also found that allegations from confidential witnesses used in the amended complaint were “at best unreliable,” because they were “generic and conclusory” and “based upon rumor and conjecture.” The district court also rejected all motive allegations raised by the plaintiff, which had included allegations concerning the defendants’ bonuses, money raised by Cancer Genetics during the class period, and allegations concerning certain defendants’ departures. The court further found that the fact alone that some defendants had signed SOX certifications was insufficient to establish liability, faulting the plaintiff for failing to provide any independent basis to believe that the defendants knew the certifications were misleading when made or recklessly disregarded them.
The court dismissed the Section 20(a) claim, because the amended complaint had failed to adequately allege a required predicate violation of the Exchange Act. Finally, the court denied plaintiff leave to amend and dismissed the action with prejudice. The court noted that plaintiff had conceded at oral argument that he had not gathered any additional facts in the fourteen months since filing the amended complaint to bolster his claims, and the court found that defendants’ own statements suggested that the most plausible inference is that defendants realized Cancer Genetics’ collections issue only after engaging third-party consultants.
The court’s opinion highlights the inadequacy of “must-have-known” arguments to make out the strong inference of scienter required under the securities laws.
CDCA NIXES SECURITIES CLASS ACTION ALLEGING EMULEX MISLED SHAREHOLDERS ABOUT TENDER OFFER
On February 25, in Varjabedian v. Emulex Corp. et al., the Central District of California reaffirmed that a summary of a fairness opinion need not be exhaustive, and dismissed with prejudice a securities class action against Emulex Corporation, a telecommunications company, and members of its board, among others, arising from a 2015 merger agreement between Emulex and Avago. Under the agreement, a subsidiary of Avago would initiate a tender offer for Emulex’s outstanding stock at $8.00 per share, which was a 26.4% premium on Emulex’s “undisturbed stock price.” The day before the tender offer was launched, Emulex filed a Recommendation Statement with the Securities Exchange Commission recommending that shareholders tender their shares. The Recommendation Statement provided various descriptions of the fairness opinion issued in connection with the merger, but did not describe a premium analysis in the opinion showing that the 26.4% premium was below average but within the range of comparable transactions. On May 5, 2015, the Emulex tender offer expired with a sufficient number of shares tendered to consummate the merger.
On remand from a Ninth Circuit decision holding that plaintiff’s claims under Section 14(e) of the Exchange Act require only a showing of negligence, rather than scienter, defendants renewed their motion to dismiss, arguing that plaintiff had failed to allege a material and misleading omission and had also failed to state a claim under the Ninth Circuit’s negligence standard. The district court agreed. The court reasoned that the two alleged misstatements in the Recommendation Statement—the omission of the premium analysis and the summary of the fairness opinion—were not materially misleading. Instead, the court found that the Recommendation Statement did not create the impression that the Emulex premium was higher or lower than average. The court further found that the premium analysis did not undermine the Recommendation Statement because the analysis showed that the premium was within the normal range. Finally, the court concluded that Emulex’s summary of the fairness opinion did not need to “include every relevant or meaningful bit of analysis.” On the issue of negligence, the court determined that the PSLRA's heightened pleading requirements do not apply to negligence pleading, but nonetheless rejected plaintiff’s arguments that the challenged statements were made with negligence because those arguments assumed that the purported misstatements were materially misleading. The court concluded that they were not and dismissed the complaint with prejudice.
The court’s opinion affirms that a summary of a fairness opinion is just that—a summary—and need not contain all analysis from the underlying opinion to be materially accurate, particularly where the omitted information is consistent with what is included in the summary.
DELAWARE COURT HOLDS MERGER SUBJECT TO ENTIRE FAIRNESS STANDARD DESPITE INVOLVEMENT OF SPECIAL COMMITTEE
On February 27, in Salladay et al. v. Lev et al., the Delaware Chancery Court issued a significant opinion regarding when procedural safeguards will not “cleanse” a transaction involving an interested board. The case involved a stockholder suit concerning a merger between Intersections, a corporation providing identity-protection software services including Identity Guard, and WC SACD One Inc., a digital security industry joint venture.
The court held, and defendants did not contest, that the operative complaint adequately pleaded that defendants, who were three of Intersections’ six directors, stood on both sides of the merger. Thus, the rigorous “entire fairness” standard presumptively applied, unless defendants could revive the more relaxed “business judgment” standard by arguing the merger included adequate procedural safeguards.
The court, however, held that the procedural safeguards instituted in connection with the merger were insufficient to cleanse the transaction. Delaware law acknowledges that a fully constituted, adequately authorized, and independent special committee can cleanse a conflicted transaction. But the court reasoned that, for the special committee to effectively cleanse the transaction, it must be “sufficiently constituted and authorized ab initio,” meaning that it must be formed “before any substantive economic negotiations begin.” Here, discussions as to the substantive economic conditions of the deal, including a price collar, had already begun by the time the committee was formed.
The court likewise held that the vote of unconflicted shareholders in favor of the merger did not cleanse the transaction. The court identified two deficiencies in the company’s disclosures that prevented disinterested stockholders from making a fully informed vote. First, the disclosures created an impression that if the merger were rejected, there would be a change of control in favor of the acquirer. While a “truly diligent” stockholder would have been able to piece together from the disclosures that this might not be the outcome of rejection of the merger, the court found the disclosures insufficiently clear for such a “fundamental” issue. Second, the disclosures failed to explain the abrupt departure of a financial advisor shortly after being retained to provide a fairness opinion in connection with the merger. Accordingly, the court held that the merger was subject to entire fairness review and denied the defendants’ motion to dismiss.
The case underlines that, where a majority of the board may not be found disinterested with respect to a transaction, a board should establish an independent committee before any substantive negotiations begin for the deal, and a company should ensure that any disclosures to stockholders regarding “fundamental” aspects of the transaction should be as clear as possible.
RAPPER T.I. SHAKES OFF DIGITAL CURRENCY INVESTOR LAWSUIT
In a case that highlights the dangers promoters of digital currency offerings can face, on February 28, in Aurelien Beranger et al., v. Clifford "T.I." Joseph Harris et al., the Northern District of Georgia dismissed with prejudice a lawsuit against Clifford Harris, Jr., also known as the rapper T.I., by investors from across the globe, who alleged that Harris and his co-defendants had solicited and sold FLiK cryptocurrency tokens as part of a “pump and dump” scheme. The suit alleged that Harris and another co-defendant promoted FLiK on their social media accounts, artificially inflating the price of FLiK tokens. Shareholders alleged that the subsequent evaporation of FLiK’s social media campaign and eventual crash of the token’s price was part of T.I.’s scheme to dupe investors. FLiK ultimately failed to launch its internet platform and folded.
Investors alleged violations under the Georgia Uniform Securities Act (“GUSA”) and asserted claims for negligent misrepresentation and unjust enrichment, and sought punitive damages. Dismissing all claims against Harris, the court found that the GUSA claim failed because plaintiffs had not demonstrated a sufficient nexus between Georgia and the transactions at issue. The court rejected the inference that those transactions must have occurred in Georgia simply because Harris and his co-defendants were residents of that state. The court found the “nexus” allegations insufficient because the entity offering the tokens was not located in Georgia, none of the plaintiffs alleged that they had a connection to Georgia, and the online communications giving rise to the transactions were unconnected to Georgia. Further, while Harris is a Georgia resident, it was undisputed that he traveled frequently as a musician, and one of his co-defendants was from California.
In dismissing the negligent misrepresentation claim, the court noted that plaintiffs had failed to plead the necessary element of reasonable reliance. Indeed, the plaintiffs had not alleged direct communications with any of the defendants or specific reliance on the defendants’ statements. The court also found that plaintiffs had failed to plead with the requisite particularity as required under the federal rules, finding this grounds to dismiss both the negligent misrepresentation and unjust enrichment claims. The court refused to grant plaintiffs leave to amend, as they had already amended once before and permitting further amendment would “cause undue delay.”
While the court ultimately dismissed the allegations against Harris as insufficiently pled, the case is a reminder of the potentially significant exposure promoters of digital-currency offerings face generally. It is also significant for its articulation of the high standard for establishing the necessary “nexus” for application of a state’s securities laws, including in the context of cryptocurrency offerings.
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William Evans
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