Central District of California Authorizes Service of John Doe Summons on Cryptocurrency Dealer

On August 15, 2022, the United States District Court for the Central District of California authorized the IRS to serve a “John Doe” summons on Ox Labs Inc., a cryptocurrency prime dealer doing business as SFOX. The John Doe summons calls for Ox Labs to divulge information about U.S. taxpayers who engaged in cryptocurrency transactions of a total value of at least $20,000 in transactions in any given tax year since 2016 – information the IRS told the court would aid in its investigation of the identities and federal income tax liabilities of those individuals.  

John Doe summons do not identify the specific individuals whose information is sought and require court approval. In support of its ex parte motion for leave to serve the summons, the IRS pointed to concerns about the increase in transactions conducted in cryptocurrency which have not been properly reported on tax returns. The IRS noted that one of its agents had conducted an investigation and had identified specific individuals who had held accounts with SFOX and may have failed to comply with tax reporting requirements. These individuals allegedly engaged in cryptocurrency transactions ranging from about $5,000 to about $1 million. As further evidence, the IRS also told the court that, although SFOX does not report to the IRS details of the cryptocurrency transactions that occur on its platform, the IRS has reason to believe that SFOX customers may owe taxes because it is aware of cryptocurrency trading platforms where thousands of users incurred taxes on virtual currency transactions. In connection with John Doe summonses served on the other trading platforms, the IRS reported that it has recovered more than $17.6 million in assessments from these taxpayers.  

In granting the IRS’s ex parte motion, the court held the IRS had met the statutory requirements for issuing an administrative summons to a third party regarding a taxpayer. In particular, (1) the summons was limited to the investigation of an ascertainable class, United States persons who had authority over any combination of SFOX accounts with at least the equivalent of $20,000 of cryptocurrency transactions in any one year between 2016 and 2021; (2) the summons identified a reasonable basis for believing that individuals within that ascertainable class may have failed to comply with internal revenue law, for the reasons stated above; (3) the information sought in the summons was not readily available from other sources; and (4) the summons was narrowly tailored to information pertaining to the failure, or potential failure, of the ascertainable class to comply with the internal revenue laws, as the requests were for identifying information and information about those users’ transactions.

IRS Commissioner Chuck Rettig has stated that the IRS will continue to use this tool on taxpayers who transact with cryptocurrency, and urged these taxpayers to come into compliance with all filing and reporting responsibilities.

Texas District Court Permits Pension Plans to Move Forward with Securities Class Action Against Oil and Gas Company

On August 10, 2022, the United States District Court for the Southern District of Texas issued a second partial dismissal of a securities suit brought by pension plans invested in Cabot Oil & Gas Corp., allowing the investors to proceed with their claims that Cabot and certain executives violated the Securities Exchange Act by allegedly making false statements and material omissions relating to Cabot’s interactions with the Pennsylvania Department of Environmental Protections.

The class action arises out of Cabot’s indictment by a Pennsylvania grand jury in February 2010 for committing more than a dozen environmental crimes in connection with its fracking operations. Cabot had previously signed a Consent Order Agreement in 2010 with the Pennsylvania Department of Environmental Protection to resolve the state’s allegations that the company had caused a residential water well explosion in 2009. In this case, investors allege that Cabot executives made numerous false and misleading statements and omissions from February 2016 through June 2020 as to its compliance with environmental laws, failures to remediate issues, and lack of compliance with the 2010 Consent Order.

U.S. District Judge Lee H. Rosenthal previously dismissed the case in January 2022, but granted investors leave to amend with respect to certain categories of statements and omissions. The plans amended their complaint, adding allegations to bolster their claims that Cabot made materially misleading statements relating to (1) Cabot’s substantial compliance with regulations; (2) Cabot’s remediation efforts concerning various sites for which it had received Notices of Violations, and (3) the status of Cabot’s negotiation of a new Consent Order and Agreement with the Pennsylvania Department of Environmental Protection in 2016.

In the latest ruling, the court evaluated each category of updated allegations for compliance with the pleading requirements of the Private Securities Litigation Reform Act. The court first held that Cabot’s statements in its 2015 annual report that it “believe[d] that it substantially compli[ed] with the Clean Water Act and related federal and state regulations” were nonactionable opinions, rejecting the plans’ argument that Cabot’s 13% noncompliance rate—a figure arrived at through forensic analysis by the plans themselves—rendered those statements materially false or misleading.

The court also analyzed the remediation-related statements that had previously been dismissed for failure to adequately allege scienter. The court found the motive allegations, when considered together with allegations specifically showing that executives were routinely apprised of well-site violations and problems with mediations, were sufficient to meet the pleading requirement. Specifically, the court agreed that allegations regarding (1) the quarterly reports that executives received detailing remediation issues; (2) the grand jury investigation and resulting criminal charges; and (3) Cabot’s presence in a highly regulated industry with a pattern of recurrent violations, when viewed collectively, supported a strong inference of scienter that Cabot executives knew that their statements about remediation were materially false when made.

Finally, the court agreed with the investors’ argument that Cabot’s public disclosure of the new consent Order and Agreement constituted corrective disclosures sufficient to meet loss causation pleading requirements. In one disclosure, Cabot disclosed “disappointing production guidance” preventing the company from being able to drill in a Pennsylvania county, which it said related to the company’s continued work in remediating Notices of Violations received in 2017. In the other disclosure, Cabot disclosed that it received two new proposed Consent Order and Agreements from the Pennsylvania Department of Environmental Protections. The court reasoned that plaintiffs included sufficient information regarding the stock drops that followed each of these disclosures, and eliminated other possible explanations for the price decreased by comparing them against the general market.

The case was thus permitted to proceed as to claims based on categories of statements surrounding the Notices of Violations and the new Consent Order received in 2016.

First Circuit Affirms Dismissal of Securities Fraud Class Action Against CVS Health

On August 18, 2022, the First Circuit affirmed the dismissal of a putative securities class action lawsuit filed by two retirement funds against CVS Health Corporation in the United States District Court for the District of Rhode Island. In the complaint, the plaintiffs alleged that executives of CVS Health and its newly acquired subsidiary, Omnicare, Inc., employed false statements and misleading nondisclosures to conceal Omnicare’s declining customer base from investors.

The investor plaintiffs’ claims arise out of CVS Health’s 2015 acquisition of Omnicare, the leading provider of pharmaceutical services to long-term care facilities. When it first acquired Omnicare in August 2015, the goodwill of the acquisition—or value of anticipated future financial results—was calculated at $8.6 billion. By November 8, 2016, CVS Health reported a reduced goodwill balance of only $6.3 billion in its third quarter 10-Q. By December 2016, investors and analysts were warned in a presentation that revenue growth was predicted to be flat. On November 6, 2017, CVS Health disclosed that the fair value of its long-term care business, including Omnicare, exceeded its carrying value by only approximately 1% and that cash-flow projections for the unit had declined. The goodwill of the long-term care unit continued to decline to $3.9 billion in August 2018 and $2.2 billion in February 2019.

Following the reduction in goodwill value of the long-term care business, the plaintiffs filed a complaint in February 2019 against CVS Health, its CEO Larry Merlo and its former CFO David Denton. In July 2019, the plaintiffs served an amended complaint on those defendants, as well as several additional CVS Health defendants. In the amended complaint, the plaintiffs alleged that between February 2016 and February 2019, CVS Health misleadingly concealed customer losses (and the underlying cause of those losses) so as not to threaten CVS Health’s ability to acquire financing for future acquisitions. The plaintiffs claimed that these false and misleading statements included: (1) CVS Health stated in filings throughout 2016 that its segments benefitted from the Omnicare acquisition; (2) CVS Health executives claimed in 2016 that CVS Health had a leadership position in long-term care with Omnicare, and that Omnicare remained the leader in the market; (3) CVS Health stated in filings throughout 2017 that its pharmacy revenue continued to benefit from its managed care customer base, and that CVS Health had an understanding of the business; (4) CVS Health executives stated that the company was working to improve its technology and processes in support of client relationships; (5) CVS Health claimed that there existed synergies between the CVS Health existing retail pharmacy business and its new long-term care business; and (6) CVS Health made boilerplate statements of future potential risks, where those risks were in fact already occurring.

In response to the complaint, the defendants filed motion to dismiss for failure to state a claim. The district court dismissed the complaint with prejudice on February 11, 2021, finding that the complaint failed to allege any materially false or misleading statements. In March 2021, the plaintiffs moved the court under Rule 59(e) to reconsider its ruling so as to permit plaintiffs to amend the complaint for a second time. The district court denied the motion to reconsider and request for further amendment, and the plaintiffs appealed both the denial of the motion to reconsider and the grant of the motion to dismiss.

The First Circuit affirmed the district court’s decision to dismiss the complaint in its entirety, ruling that the complaint failed to allege the necessary facts about the state of CVS Health’s long-term care business at any particular point in time that would enable the court to reach the conclusion that any of the defendants’ alleged misstatements contradicted the actual state of the business at the time that each alleged misstatement was made. The court also noted that because plaintiff did not include any timeline tying particular statements to customer losses, the allegations instead support the conclusion that these were general customer losses not specifically related to the Omnicare acquisition. Further, the court observed that the complaint provided no information about whether the loss of customers was offset by new business or caused the goodwill write-downs. The court also pointed to the fact that the plaintiffs did not challenge CVS Health’s accounting metrics, and that the plaintiffs’ allegations as to boilerplate risk factors did not provide information necessary to infer that there was any material net loss of customers that was not timely reflected in each write-off. Finally, the court explained that the plaintiffs’ request to amend was properly dismissed, as this requested amendment merely identified new witnesses that could have been identified earlier in time with the exercise of reasonable due diligence.

Twitter v. Musk Update

The battle continues in the Delaware Court of Chancery as Twitter seeks to enforce Elon Musk’s $44 billion buyout. Although discovery was initially ordered to be substantially complete by August 29, that deadline is now imperiled by the predictable discovery disputes. Most recently, on August 11, Twitter asked the court to deny Musk’s motion to add 22 Twitter document custodians (in addition to the 41 custodians Twitter had already offered), which Musk followed with an August 15 motion to compel Twitter to produce several new categories of discovery, including related to (1) Twitter’s monetizable daily active userbase, (2) other metrics such as historical data for the Twitter Firehose and other data feeds, (3) government investigations and litigation, and (4) Twitter’s advertising.

Disputes also continue regarding evidence submitted by the parties in support of their claims. In particular, on August 19, the Court of Chancery denied Musk’s request to exclude an affidavit submitted by Twitter’s general counsel regarding Musk’s August 15 discovery motion, ordering Musk to submit further briefing, and instructing the parties to file a public version of the disputed affidavit by August 24.

Separately, on August 18, Musk filed a motion to dismiss in Crispo v. Musk, a purported stockholder class action suit arising out of the challenged Twitter transaction, which alleges that both Musk and Twitter included terms in the deal that would fundamentally compromise the interests of stockholders. Musk’s argues that the complaint must be dismissed because an individual stockholder lacks standing to insert himself into a breach of contract dispute – i.e., Twitter’s epic lawsuit seeking to compel Musk to close the deal he signed. The motion further argues that the plaintiff’s claim for damages is not ripe, and that Musk owes no fiduciary duties to the plaintiff in his current position as a non-controlling stockholder. The plaintiff has moved for expedited proceedings, but has additionally requested an extension on the opposition to the motion to dismiss. Musk and third-party Twitter have requested a stay until final resolution of the Twitter v. Musk case. The court has not yet ruled on a proposed schedule.

Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

Editorial Board
Jennifer Burns Luz
Meghan K. Spillane
Jonathan Shapiro

Contributing Authors
Anna Wittman