Securities Law Alert
In This Edition:• Supreme Court: Considers the Scope of Tipper/Tippee Liability Under the Securities Exchange Act of 1934
• First Circuit: Affirms Dismissal of Securities Fraud Action Against Vertex Pharmaceuticals, Finding No
Basis to Infer the Company Knowingly or Recklessly Published Erroneous Interim Clinical Study Results• Fifth Circuit: Supreme Court’s Fifth Third Decision Mandates a “More Harm Than Good” Standard for
ERISA Breach of Duty of Prudence Claims Based on Inside Information, Not a “More Good Than Harm”
Standard• Southern District of New York: Dismisses Securities Fraud Action Against MDC Partners, Holding
Plaintiffs’ Disagreements with Defendants’ Accounting Judgments and EBITDA Formulas Could Not
Support a Claim
October 2016

Supreme Court: Considers
the Scope of Tipper/Tippee
Liability Under the Securities
Exchange Act of 1934

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The Supreme Court heard oral arguments
on October 5, 2016, in Salman v. UnitedStates, No. 15-628, a case in which the Court
will consider a question at the center ofmany insider trading prosecutions: whether
the personal benefit necessary to establish
liability under Dirks v. SEC, 463 U.S. 646(1983) requires proof of “an exchange thatis objective, consequential, and represents
at least a potential gain of a pecuniary orsimilarly valuable nature,” as the Second
Circuit held in United States v. Newman,
773 F.3d 438 (2d Cir. 2014), cert. denied, No.
15-137 (U.S. Oct. 5, 2015),1 or only that theinsider and the tippee shared a close family
relationship, as the Ninth Circuit held UnitedStates v. Salman, 792 F.3d 1087 (9th Cir.
2015), cert. granted, 84 U.S.L.W. 3401 (U.S.
Jan. 19, 2016) (No. 15-628).2

Although no federal statute or regulation
expressly prohibits insider trading, courts
have construed Section 10(b)—a “catch-allclause” in the Securities Exchange Act of 1934
(the “1934 Act”)—to prohibit insider trading
as a type of securities fraud. Today, underDirks, determining whether trades executedby someone who has received material
nonpublic information (a “tippee”) qualifies
as a type of fraud prohibited by the 1934
Act “depends in large part on the purpose of
the [insider’s] disclosure.” 463 U.S. at 662.
Dirks held that liability can only attach where
the insider personally benefited directly
or indirectly from the disclosure. Id. If theinsider received no personal benefit from thedisclosure, then there has been no breachof duty to stockholders, and no derivative
breach can be attributed to tippees who tradeon the information. Id. Thus, showing thatthe disclosing insider personally benefited
from the tip is critical to establishing insider
trading liability in this context.

1. Please click here to read our prior discussion of the Newman
decision.
2. Please click here to read our prior discussion of the Salmandecision.
Simpson Thacher & Bartlett LLP

1

Oral Argument Highlights
The oral argument focused on each party’s
test for determining when a tipper received
a “personal benefit” in exchange for material
nonpublic information. Petitioner contended
that the insider must receive a concrete
benefit. In particular, the insider must receive
either a pecuniary benefit, or something that
may translate into a financial benefit (e.g., areputational benefit with monetary value).
Petitioner offered two primary defenses forthis formulation. First, criminal statutes
are generally construed narrowly, and theelements ought to clearly demarcate what is
and is not illegal. According to Petitioner, abroader formulation would be ambiguous,and thus would subject market participants
to unpredictable prosecutions. Second,
it is well-accepted that not all trading onmaterial nonpublic information is unlawful.
Petitioner reasoned that if the satisfaction
one experiences from sharing informationand helping another were sufficient, then the“personal benefit” element would always besatisfied when information is intentionallyshared. All information sharing would ipso
facto be illegal. But Petitioner cautioned that
his rule would not permit all information
sharing among family members. For example,
because family members are often financiallyinter-dependent, benefiting a family member
could, in some instances, financially benefit
the tipping insider.
The government took a different view, arguingthat the 1934 Act broadly prohibits giving
information to another—whether a relative,
friend, or even a casual acquaintance—“forthat person to be able to profit on it.”Responding to questions from the bench, thegovernment conceded that the tipping insider
must know that the tippee will trade upon theinformation for criminal liability to attach.
In support of its position, the government
asserted that the obligation giving rise to
the cause of action for insider trading tracks
the common law duty of “loyalty,” which isbreached when one uses information for a
personal reason. In addition, the government
argued that a broad construction is necessary
as a policy matter to prevent insiders fromfreely sharing information with friends andfamily, which could disrupt markets.
During oral argument, the Justices posedseveral hypotheticals to evaluate how theparties’ competing frameworks would assign
liability in different scenarios. For example,

responding to Petitioner’s contention thatan insider must receive some tangible gain
in order to satisfy the personal benefit
requirement, Justice Kagan asked about
an insider who planned to give a friend
money, but decided to provide valuable
nonpublic information instead. By contrast,
in a hypothetical posed to the government,
Chief Justice Roberts underscored that not
all information sharing is done for personal
gain: suppose an individual asks a friend
to join him for a weekend retreat, and thefriend declines, explaining that he has to workon an important transaction for Google. In
Chief Justice Roberts’ hypothetical, even if
the tippee trades on the material nonpublic
information, the insider did not offer the
information as a gift or otherwise benefit
from the disclosure. Throughout the oral
argument, it was clear that the Justices were
trying to reconcile two competing concerns.
The Justices appeared to support the notionthat an insider need not receive a tangible,
immediate financial benefit in exchange fordisclosing material nonpublic information.
But certain Justices appeared wary of a test
that could expose all sharing of material
nonpublic information to potential liability.
If the personal benefit element is to serve asa limiting principle, it must be given a more
precise and workable definition.
The Justices also appeared to grapple with anumber of other issues. In Dirks, the Supreme
Court expressly stated the “elements offiduciary duty and exploitation of nonpublic
information . . . exist when an insider
makes a gift of confidential information toa trading relative or friend” because the “tipand trade resemble trading by the insider
himself followed by a gift of the profits to
the recipient.” 463 U.S. at 664. Although
this clear pronouncement would appear
to foreclose Petitioner’s narrow framing,
it was not central to the Dirks holding andthus could be considered non-binding dicta.
Additionally, Justice Breyer engaged in a lineof questioning aimed at resolving whether
information-sharing with a relative ought tobe treated differently. He posited that helping
a relative may be analogous to helping one’s
self, thus creating a special rule inapplicable
to a scenario where an insider assists a friendor casual acquaintance. Given the number
of issues in play, and the varied questions
from the Justices, whether a clear majority
exists in support of a particular formulation
remains uncertain.
2

First Circuit: Affirms
Dismissal of Securities
Fraud Action Against Vertex
Pharmaceuticals, Finding No
Basis to Infer the Company
Knowingly or Recklessly
Published Erroneous Interim
Clinical Study Results
On October 3, 2016, the First Circuit affirmed
dismissal of a securities fraud action alleging
that Vertex Pharmaceuticals and several of
its executives “turned a blind eye” to “study
results that seemed too good to be true” inorder to reap “a windfall on the sale of theirstock.” Local No. 8 IBEW Ret. Plan & Trust v.
Vertex Pharmaceuticals, 2016 WL 5682548(1st Cir. 2016) (Kayatta, J.). The First Circuit
found no allegations to support plaintiffs’
contention that defendants knowingly
or recklessly “announced interim resultsthat overstated the improvement in lungfunction” of patients taking an experimental
drug combination for the treatment of
cystic fibrosis.

Plaintiffs’ Allegations Failed toRaise a Strong Inference of Scienter
The First Circuit noted that “Vertex’s public
description” of its interim clinical study
results allegedly “contained an error thatmade unexpectedly good results look evenbetter than they were.” However, the court
found the inference that Vertex knowingly
or recklessly published the inaccurate study
results was not “strong enough to equal
the alternative inference that Vertex was
negligent in viewing very good results as
being even better than they in fact were.”Interim Study Results Were Neither Implausible
Nor Obviously WrongWith respect to plaintiffs’ contention that
Vertex itself described the study results as“unexpected,” the First Circuit explainedthat “many studies of new pharmaceuticalproducts result in surprises, both good andbad.” The court reasoned that “Vertex madethe investment necessary to design andperform a study testing” the experimental
drug combination because the company“must have thought that positive results werepossible, even if not probable.”

As to plaintiffs’ claim that “it was obviousthat there was something wrong with the[interim] results,” the First Circuit found noallegations “that scientists in general, muchless those at Vertex, regarded the interim
results as implausible.” The court also notedthat plaintiffs did “not allege that anybody at
Vertex responsible for receiving, reviewing,
and reporting the results had actually spotted
the error in the interpretation of the results
before the discovery that led to” Vertex’s
announcement of corrected study results.
The First Circuit rejected plaintiffs’ argumentthat it would be “‘absurd’ to suggest that[d]efendants were not aware of the suspectnature of the results” given the importanceof the study to the company. The court statedthat “the importance of a particular item
can support an inference that the defendantis paying close attention to that item.”
However, the court explained that “[s]uch aninference . . . is only helpful in establishingscienter if that close attention would haverevealed an incongruity so glaring as tomake the need for further inquiry obvious.”
Here, the court found no allegation of“such an obvious incongruity” between the
expected interim results and the reported
interim results.
The First Circuit found similarly meritlessplaintiffs’ contention that defendants shouldhave cross-checked the interim results against
the raw data, which allegedly would haveuncovered the error in question. The court
found the complaint’s allegations “insufficientto establish that the erroneously interpretedend results . . . were themselves so obviously
suspect that [the court could] draw a strong
inference that the defendants were recklessin failing to consult the raw data themselves
for verification.” The court further noted thatplaintiffs pointed to no “legal requirement, or
any undertaking by Vertex, that obligated thecompany to double-check the interim results
before announcing them.”
Defendants Had No Financial Motive to Report
Overstated Interim Results

The First Circuit also “considered” andrejected plaintiffs’ theory that “defendants
had a financial motive to ‘turn[] a blind eye’to the erroneous interpretation of the interim
results because of the stock price spike
precipitated by the error.” First, the court
observed that Vertex’s CEO did not sell any
stock during the class period, and found the3CEO had “no motive to ignore an error thatwas obvious and that would therefore soon
become known.” The court explained that“[a]nnouncing good results on such a study
would have been clearly better for Vertex thanannouncing great results only to reduce themto good by shortly thereafter confessing error,
thereby harming the company’s credibility
and its reputation for competence.”
As to the allegation that five Vertex employees“sold almost $32 million worth of stock
following release of the overstated interim
results,” the First Circuit stated that “insider
trading in suspicious amounts or at suspicious
times may be probative of scienter.” In thiscase, however, the court observed that neither
the current CEO nor the company’s former
CEO who now serves on the board of directors
allegedly “engage[d] in any inconsistent
trading behavior during the class period.”
The court found that in order “to regard thestock sales as either motive for the fraud
or evidence of the defendants’ knowledge
that the interim study results had been
misinterpreted,” it would have to “hypothesize
either that the error was obvious only to those
defendants who made unprecedented sales,or that it was obvious to all, yet the company’s
current and former CEOs neverthelesswent along with announcing obviously
flawed results.” The court explained that thecomplaint “offers no fact suggesting that thesellers knew more than the nonsellers.”
The First Circuit found that there was “asimple alternative explanation” for theinsiders’ stock sales. Following announcementof the interim results, Vertex’s stock price“suddenly jumped a large amount” following“a long period of steady or dropping stock
prices.” The court reasoned that “[s]uch anincrease—no matter what its cause—creates a
substantial incentive for holders to sell unlessthey believe the price will continue to rise andare willing to wait.”
The court concluded that plaintiffs’
allegations did “not paint the required strong
inference of scienter,” and affirmed dismissalof plaintiffs’ complaint.

Fifth Circuit: Supreme Court’s
Fifth Third Decision Mandatesa “More Harm Than Good”
Standard for ERISA Breachof Duty of Prudence Claims
Based on Inside Information,
Not a “More Good ThanHarm” Standard
On September 26, 2016, the Fifth Circuit
held the Southern District of Texas applied
the wrong pleading standard in determining
whether an amended ERISA complaint
brought by the beneficiaries of BP’s employee
stock ownership plan passed muster under
the Supreme Court’s decision in Fifth Third
Bancorp v. Dudenhoeffer, 134 S. Ct. 2459
(2014).3 Whitley v. BP, 2016 WL 5387678(5th Cir. 2016) (Clement, J.). In Whitley, theFifth Circuit stated that “[u]nder the Supreme
Court’s formulation,” a plaintiff assertingan ERISA breach of the duty of prudence
claim based on inside information “bears thesignificant burden of proposing an alternative
course of action so clearly beneficial that a
prudent fiduciary could not conclude that it
would be more likely to harm the fund thanto help it.” The Fifth Circuit determinedthe district court had instead erroneously
considered whether “no prudent fiduciary
would have concluded that” the alternative
actions “would do more good than harm.”

The District Court Erred in
Considering Whether No Prudent
Fiduciary Would Have Concluded
the Alternative Actions Would Have
Done “More Good Than Harm”
The Fifth Circuit explained that in Fifth
Third, the Supreme Court held that in order“[t]o state a claim for breach of the duty ofprudence on the basis of inside information,a plaintiff must plausibly allege an alternative
action that the defendant could have takenthat would have been consistent with thesecurities laws and that a prudent fiduciaryin the same circumstances would not haveviewed as more likely to harm the fund thanto help it.” Id. (quoting Fifth Third, 134 S. Ct.
2459).
3. Please click here to read our prior discussion of the Fifth Third
decision.
4

The Fifth Circuit also noted that in Amgen v.
Harris, 136 S. Ct. 758 (2016),4 the Supreme
Court “confirmed” that plaintiffs asserting an
ERISA breach of the duty of prudence claim
based on inside information must “plausibly
allege that no prudent fiduciary could haveconcluded that the proposed alternative
action would do more harm than good.”
In the case on appeal before the Fifth
Circuit, however, the Southern District ofTexas had evaluated plaintiffs’ proposed
amended complaint by considering whether“on the basis of the pleadings alone, . . . noprudent fiduciary would have concluded that[the alternatives] would do more good thanharm.” The Fifth Circuit determined that thisformulation was “not equivalent” to the Fifth
Third standard, and found the district court
had “erred” by “alter[ing] the language ofFifth Third to reach its holding.”

Plaintiffs’ Amended Allegations Did
Not Meet the Fifth Third Standard
Turning to the allegations of plaintiffs’
amended complaint, the Fifth Circuit
explained that plaintiffs “theorize[d] that BP
stock was overpriced because BP had a greaterrisk exposure to potential accidents than
was known to the market.” The Fifth Circuit
found that it did “not seem reasonable to saythat a prudent fiduciary at that time could
not have concluded that (1) disclosure ofsuch information to the public or (2) freezing
trades of BP stock—both of which would likely
lower the stock price—would do more harmthan good.” To the contrary, the Fifth Circuit
determined that “a prudent fiduciary could
very easily conclude that such actions would
do more harm than good.”
The Fifth Circuit deemed plaintiffs’ amended
complaint insufficient to meet the Fifth
Third standard, and held “the district court[had] erred in granting [plaintiffs’] motion
to amend.”
4. Please click here to read our prior discussion of the Amgendecision.

Southern District of New
York: Dismisses Securities
Fraud Action Against
MDC Partners, Holding
Plaintiffs’ Disagreementswith Defendants’ Accounting
Judgments and EBITDA
Formulas Could Not Support
a Claim
On September 30, 2016, the Southern Districtof New York dismissed with prejudice asecurities fraud action against MDC Partners
and certain of its officers and directors for
failure to allege either material misstatements
or scienter. North Collier Fire Control and
Rescue Dist. Firefighter Pension Plan v.
MDC Partners, 2016 WL 5794774 (S.D.N.Y.
2016) (Sullivan, J.).5 The court held plaintiffs’
goodwill-related allegations were insufficient
to meet the standard for pleading a securities
fraud claim based on a misstatement of
opinion. As to plaintiffs’ claim that defendants
used a “misleading version of EBITDA,”
the court found that companies are free tocalculate EBITDA as they deem appropriate,
provided they disclose their methodology.
With respect to plaintiffs’ contention that thecompany failed to disclose the full amountof compensation paid to its CEO, the court
found the allegedly underreported amount
was neither quantitatively nor qualitatively
material. Finally, the court held plaintiffs’
allegations of insider stock sales did notsupport an inference of scienter “because thevast majority [of those] trades occurred ayear or more before the alleged revelation of
the fraud.”

Plaintiffs Failed to State a Securities
Fraud Claim as to Alleged GoodwillRelated Misstatements
Plaintiffs contended that MDC Partners
had “overstated its goodwill balance” inviolation of Generally Accepted Accounting
Principles (“GAAP”) by failing to record a
goodwill impairment for a poorly performing
subsidiary that was ultimately merged intoanother one of the company’s subsidiaries.
The court held plaintiffs “failed to plead that[d]efendants made any false or misleading
5. Simpson Thacher represents MDC Partners and two of theindividual defendants in this action.
5

statements in connection with MDC’s
goodwill reporting” for several reasons.
First, the court noted that “the law in theSecond Circuit is clear that allegations of
GAAP violations or accounting irregularities,
standing alone, are insufficient to state asecurities fraud claim.” The court explainedthat “GAAP provisions are subject tointerpretation and tolerate a range ofreasonable treatments, leaving the choiceamong alternatives to management.”
Second, the court observed that under“well-settled” Second Circuit law, “goodwill
estimates are opinion statements because
they depend on management’s determinationof the ‘fair value’ of the assets acquired andliabilities assumed, which are not mattersof objective fact and will vary depending on
the particular methodology and assumptions
used.” To plead a securities fraud claim basedon an alleged misstatement of opinion, suchas an estimate of goodwill, plaintiffs must
allege that (1) “the speaker did not hold thebelief she professed,” (2) “the supporting
fact[s] she supplied were untrue,” or (3) “thestated opinion, although sincerely held andotherwise true as a matter of fact, omitted
information whose omission made the statedopinion misleading to a reasonable investor.”
Here, the court held the complaint did “notsatisfy these pleading requirements.” Thecourt found plaintiffs “allege[d] nothing
more than disagreement with MDC’s
accounting judgments, which cannot support
a fraud claim.”

Plaintiffs Failed to State a Securities
Fraud Claim Based on Allegedly“Nonstandard” Formulas for
Calculating EBITDA
Plaintiffs further claimed defendants“misleadingly” used “the common term
EBITDA” in MDC’s public filings when infact defendants calculated EBITDA basedon formulas that allegedly did not comportwith “the industry standard definition.” Thecourt held plaintiffs “failed to plead that[d]efendants made any false or misleadingstatements in connection with MDC’s
disclosures relating to EBITDA.”
The court explained that MDC’s Form
10-Qs did not “tout” or even use the phrase“industry standard” in describing thecompany’s use of EBITDA as one factor

in measuring its performance. Moreover,the court found that MDC’s class period
earnings releases “specifically explained how
MDC had calculated the ‘EBITDA’ amounts
reported in those releases.” The court heldthat “[n]o reasonable investor would ignore
these definitions, much less assume thatthe reported EBITDA [was] governed by” ageneric industry standard definition.
The court also rejected plaintiffs’ contention
that “MDC misled investors by changing its‘nonstandard’ calculation of EBITDA fromquarter to quarter.” The court held “thisargument misses the mark” because “EBITDA
is a non-GAAP metric for which there is noright formula.” The court found “[t]he factthat a plaintiff may take issue with the way acompany chooses to calculate these metrics
is of no moment because it is not fraudulent
for a reporting entity to calculate metrics that,like EBITDA, are not defined under GAAP.”
The court explained that “[u]nless [p]laintiffs
can show that MDC somehow misledinvestors about how it actually calculated
EBITDA, which they have not, there can be no
claim for fraud.”

Allegedly Underreported CEO
Income Was Neither Qualitatively
Nor Quantitatively Material
Plaintiffs claimed that “MDC failed todisclose the true amount of compensationpaid” to its CEO, both by “underreporting[his] perquisites,” such as the CEO’s useof a corporate apartment, and by allegedly“improperly reimbursing” certain of his
expenses. The court found the allegedly
underreported income was neither
quantitatively nor qualitatively material under
the factors set forth in Litwin v. BlackstoneGroup, 634 F. 3d 706 (2d Cir. 2011).
The court explained that in Litwin, theSecond Circuit “made clear that courts may
evaluate materiality at the pleading stage,”and courts that do so must consider bothquantitative and qualitative factors. The court
observed that the Second Circuit has heldthat “a five percent numerical threshold—i.e.,
at least a five percent difference between
an inaccurate versus accurate financial
disclosure—is a good starting place forassessing the materiality of the alleged
misstatement.” The court further statedthat “useful ‘qualitative factors’ include(1) concealment of an unlawful transaction,6

(2) significance of the misstatement inrelation to the company’s operations, and(3) management’s expectation that the
misstatement will result in a significant
market reaction.”
Applying this standard to plaintiffs’
allegations concerning the CEO’s perquisites,
the court found the amount at issue was “wellbelow the Second Circuit’s 5% threshold.” Thecourt held this category of compensation “wasnot materially misstated” given “its minuscule
impact on [the CEO’s] overall compensation”
and plaintiffs’ “failure to identify any
qualitative factors that would otherwise
support materiality.”
With respect to plaintiffs’ allegations
concerning expense reimbursements, thecourt found that if compared against thecompany’s total expenses for the year, theallegedly underreported reimbursements“would amount to a paltry 0.18%—wellbelow the Second Circuit’s 5% threshold andclearly immaterial.” The court observed that
if the underreported income was measured
against the CEO’s compensation for the year,
however, “the percentage lands above thethreshold at 10.2%.”
The court determined that even if theappropriate benchmark was the CEO’scompensation for the year (rather than thecompany’s total expenses), the court could not
end its analysis without “also consider[ing]qualitative factors of materiality.” Thecourt found the amount of the allegedly
underreported reimbursements would“hardly register[ ]” to a reasonable investor.
The court deemed it “not substantially likelythat a reasonable shareholder” would haveconsidered this additional compensation“important” “in deciding whether to purchase
MDC securities.” The court concluded that theallegedly underreported reimbursements did
not amount to a material misstatement.

Allegations of Insider Stock Sales
Failed to Raise a Strong Inferenceof Scienter
Finally, the court rejected plaintiffs’ effort toplead scienter based on insider stock sales
because most of the “trades occurred nearlya year or more before the end of the [c]lass[p]eriod.” The court explained that it has“consistently held that stock sales occurring
even a few months before the alleged
revelation of the fraud do not raise a strong
inference of scienter.” In this case, “[b]ecause
the vast majority of the [i]ndividual[d]efendants’ trades occurred a year or more
before the alleged revelation of the fraud,”
the court held the insider stock sales did “notsupport an inference of fraudulent motive.”

The Securities Law Alertis edited by Paul C. Gluckow
pgluckow@stblaw.com /+1-212-455-2653, Peter E. Kazanoffpkazanoff@stblaw.com /+1-212-4553525 and Jonathan K. Youngwood
jyoungwood@stblaw.com /+1-212-455-3539.

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