Securities Law Alert
In This Edition:• Third Circuit: A District Court Must Impose “Some Form” of Rule 11 Sanctions When It
Finds Rule 11 Violations in Proceedings Governed by the PSLRA• Ninth Circuit: Complaint Timely Where Plaintiff Could Not Have Discovered Necessary
Facts Until an SEC Order Revealed That a Company’s Statements Were Misleading• Southern District of New York: Interprets the Purchaser-Seller Rule in the Context of a
De-SPAC Transaction
May 2023

Third Circuit: A District Court
Must Impose “Some Form”
of Rule 11 Sanctions When It
Finds Rule 11 Violations inProceedings Governed by the
PSLRA“Recognized for its‘world class lawyering,’
Simpson Thacher & Bartlett
LLP has a leading litigation
practice with wide-ranging
capabilities.”– The Legal 500

Simpson Thacher & Bartlett LLPOn April 5, 2023, the Third Circuit resolved
whether a district court erred in failing toaward attorneys’ fees or impose any othersanctions in connection with determiningthat plaintiffs violated Rule 11 in bringing
certain federal securities claims following
their purchase of unregistered securities in
a company’s stock offering. Scott v. Vantage
Corp., 64 F.4th 462 (3d Cir. 2023) (Smith, J.).
The Third Circuit affirmed the district court’s
determination that certain of plaintiffs’ claims
violated Rule 11 and that the company’s
founder (the only defendant party to theappeal) was not entitled to attorneys’ fees.
The court held, however, that the PSLRA“mandates the imposition of some form ofsanctions when parties violate Rule 11 inbringing federal securities claims.”

Background and Procedural History
Plaintiffs brought federal securities claims
against the defendant company, its president,
and the company’s founder after theypurchased stock in the company’s 2016
stock offering under SEC Rule 506(b).1
Plaintiffs became concerned about thecompany’s financial condition shortly after
they invested their funds but, having no rightto rescind based on their stock agreements,
plaintiffs sued, asserting ten counts against
defendants, including three federal securities
claims (an unregistered securities claim, amisrepresentation claim, and a Rule 10b-5
securities fraud claim). In 2019, the district
court granted summary judgment for thecompany’s founder and the company’s
president on the three federal securities law
claims, which the Third Circuit affirmed.
Before the district court’s summary judgment
ruling, the company entered bankruptcy
proceedings.
1. Securities offerings under Rule 506(b) are exempt fromregistration. An issuer must still meet certain requirements,
however, including that an issuer cannot engage in generalsolicitation or advertising, securities cannot be sold to morethan 35 non-accredited investors, and that non-accredited
investors must have sufficient knowledge and experience toevaluate potential risks.

After performing the PSLRA-mandated Rule
11 inquiry, the district court concluded thatplaintiffs had violated Rule 11 with respect
to their unregistered securities claim andtheir misrepresentation claim against thecompany’s founder, but had not violated
Rule 11 as to their 10b-5 securities fraudclaim. Notably, the district court declined toaward the company’s founder attorneys’ fees
or impose any other sanction based on its
conclusion that plaintiffs’ Rule 11 violations
against him “were not a substantial violation
under the PSLRA” because plaintiffs had areasonable basis to believe they had factual
support for their securities fraud claim,
which it considered to be “the heart of thecomplaint.” By contrast, the district court
awarded attorneys’ fees to the company’s
president after determining that plaintiffs
violated Rule 11 in their claims against
him. The district court concluded that theclaims against the company’s president were
“tenuous, and that his only connection to
Plaintiffs’ claims was his ‘mere status’ as acontrol person.” As to the company, it enteredbankruptcy proceedings before the district
court conducted its Rule 11 analysis.

Certain of Plaintiffs’ Federal
Securities Claims Violated Rule 11
On appeal, the Third Circuit affirmed the
district court’s determination that plaintiffs’
unregistered securities claim2 and their
2. In their unregistered securities claim, plaintiffs allegedthat defendants failed to meet registration exemption
requirements and that the offering violated federal securities
law because the founder sold securities to allegedly
unsophisticated and unaccredited investors without providing
sufficient disclosures. The district court concluded that thefounder reasonably believed that both investors in question
were accredited at the time of their security purchases.

misrepresentation claim3 against thecompany’s founder violated Rule 11. The
Third Circuit also held that the district court
did not abuse its discretion in determiningthat these claims lacked factual support
in violation of Rule 11(b)(3). Noting that,
under Mary Ann Pensiero, Inc. v. Lingle,
847 F.2d 90 (3d Cir. 1988), courts should
assess Rule 11 compliance by assessing aparty’s or attorneys’ conduct based on what
was reasonable to believe at the time of thecomplaint, the Third Circuit stated thatplaintiffs made only general unregisteredsecurities allegations in the complaint andfailed to identify any specific individuals as
unaccredited investors. Similarly, as to themisrepresentation claim, the Third Circuit
pointed to the district court’s determinationthat plaintiffs’ pre-filing investigation shouldhave revealed the lack of factual support for
their allegation that the offering was public.
The Third Circuit also affirmed the district
court’s determination that plaintiffs’ 10b-5
securities fraud claim did not violate Rule 11.
The Third Circuit concluded that there wasno abuse of discretion in the district court’s
determination that plaintiffs had a reasonablebasis to allege securities fraud. The Third
Circuit also noted that while the district
court did summarily dismiss the 10b-5 claim,“courts must ensure that Rule 11 ‘not be used
as an automatic penalty against an attorney
or a party advocating the losing side of adispute.’” (quoting Gaiardo v. Ethyl Corp.,
835 F.2d 479 (3d Cir. 1987)).
3. Plaintiffs alleged that the founder violated 15 U.S.C. § 771(a)(2)by making misrepresentations while selling company stock(for example, by misrepresenting the company’s resources).
The district court found that the documentation provided toprospective investors clearly identified the offering as privateand for accredited investors only and concluded that suchmisrepresentation claims did not apply to the private sale ofsecurities.

2

It Was an Abuse of Discretion Not
to Impose Any Sanctions
Ultimately, the Third Circuit concluded thatthe district court abused its discretion in
declining to impose any form of sanctions andvacated the portion of the order that declined
to impose sanctions because the text of the
PSLRA makes the imposition of sanctions
mandatory after a court determines that a
party has violated Rule 11. On remand, theThird Circuit instructed the district court
to impose “some form of sanction” against
plaintiffs in accordance with Rule 11, but
took no position on what sanction to impose
acknowledging that the district court was
better situated to make that determination.

Ninth Circuit: Complaint
Timely Where Plaintiff
Could Not Have Discovered
Necessary Facts Until an
SEC Order Revealed That a
Company’s Statements Were
Misleading
On April 11, 2023, the Ninth Circuit reversed
and remanded a district court’s dismissal ofa securities fraud class action on the groundthat it was untimely. York Cnty. v. HP, Inc.,
65 F.4th 459 (9th Cir. 2023) (Bybee, J.). The
Ninth Circuit determined that the defendantprinting supply company’s “allegedly
fraudulent statements, on their own, wereinsufficient to start the clock on the statuteof limitations.” The Ninth Circuit held thatthe complaint was timely, concluding thatplaintiff could not have discovered the facts
necessary to plead an adequate complaint
until after the issuance of an SEC orderthat revealed the misleading nature ofdefendants’ statements.

Background and Procedural History
During investor calls between November 2015
and June 2016, the defendant company madestatements about whether it was meeting
its inventory target ranges. The company
allegedly failed, however, to disclose its
complete inventory information or that itengaged in sales practices that led to shortterm gains but harmed overall profits.4
Following an investigation, the SEC allegedly
uncovered these practices and issued anorder in 2020 (“SEC Order”) instituting
cease-and-desist proceedings. The company
agreed to pay a fine but did not admit or deny
the allegations. The SEC Order alleged thatthe company’s disclosures omitted material
information causing them to be incomplete
and misleading.
Within weeks of the SEC Order, plaintiff
filed a complaint alleging that the company
violated Section 10(b) and Rule 10b-5. The
company moved to dismiss on the basisthat plaintiff’s claims were time-barred by
the two-year statute of limitations in 28
U.S.C. § 1658(b)(1), which provides “thatprivate actions alleging securities fraud
must be brought no more than ‘2 years after
the discovery of the facts constituting theviolation’ of securities laws.”5 The district
court dismissed the complaint as time-barred,finding that the public statements, loss in
profits, and reductions in channel inventory
had all taken place by 2016 and reasoningthat a reasonably diligent plaintiff would havediscovered the operative facts of its complaintin 2016, more than four years before thecomplaint was filed.

4. One of these practices was gray marketing, which involves
selling supplies to a distributor who would then sell them at
a discount outside of its assigned territory. These sales would
force local distributors to lower their prices to compete withmarked-down goods from other territories. The company
also used pull-ins, which are discounts offered to encourage
distributors to take additional shipments in a given quarter
that would leave distributors with a full inventory at the
beginning of the following quarter leading to lower sales.
5. The company also moved to dismiss on the basis thatplaintiff’s claims were time-barred by the five-year statuteof repose in 28 U.S.C. § 1658(b)(2), which the district court
did not address in view of its conclusion that the claims
were barred by the statute of limitations. The Ninth Circuit
expressed no opinion on the statute of repose issue.
3Facts Not Deemed Discovered Until
Plaintiff Has Sufficient Detail andParticularity to Survive a Motion toDismiss
Relying on Merck & Co. v. Reynolds, 559
U.S. 633 (2010), the Ninth Circuit held that“a defendant establishes that a complaint
is time-barred under § 1658(b)(1) if itconclusively shows that either (1) the plaintiff
could have pleaded an adequate complaint
based on facts discovered prior to the critical
date and failed to do so, or (2) the complaint
does not include any facts necessary to plead
an adequate complaint that were discovered
following the critical date.” Under Merck, “thecritical date” is defined as the date “two years
before the complaint was filed.” Adopting
the reasoning of City of Pontiac General
Employees’ Retirement System v. MBIA,
Inc., 637 F.3d 169 (2d Cir. 2011), the Ninth
Circuit further held that a “reasonably diligent
plaintiff has not ‘discovered’ one of the facts
constituting a securities fraud violation until
he can plead that fact with sufficient detailand particularity to survive a 12(b)(6) motion
to dismiss.”
In this case, the critical date was April 21,
2019—two years before the complaint was
filed on April 21, 2021. Separating the facts
alleged to have occurred before the critical
date from those alleged to have occurred after
it, the Ninth Circuit noted the allegation thatthe false statements and misrepresentations
were made approximately three years before
the critical date. The court then pointed out
plaintiff’s assertion that it did not “discover
the facts constituting the violation” until after
the critical date because “the SEC Order put[the company’s] prior statements in a newcontext, revealing that ostensibly innocuous
statements were actually intentionalmisrepresentations.” In other words, plaintiff
argued that the issuance of the SEC Orderprovided sufficient evidence of scienter.
Because plaintiff pleaded facts that post-dated
the critical date, the court explained that thecompany could show the claim was timebarred by either showing that: (i) plaintiff“could have pleaded its claim based solely
on things that it knew or should have known
prior to the critical date”; or (ii) “the SEC
Order provided no information necessary”
to plaintiff’s claim. The court stated thatthe company did not explain how plaintiff
could have known of the allegedly fraudulent
practices prior to the critical date or havepleaded scienter without discovering thesepractices. For the same reasons, the court
also concluded that the company failed toshow that the SEC Order did not provide
information necessary for plaintiff to plead an
adequate complaint.

Southern District of New York:Interprets the PurchaserSeller Rule in the Context of a
De-SPAC Transaction
On March 31, 2023, the Southern Districtof New York dismissed6 a securities fraudclass action against a post de-SPAC company
alleging that the pre-merger privately held
6. In its order, the court dismissed the class action without
prejudice and granted plaintiffs one opportunity to amend thesecond amended complaint. However, plaintiffs failed to filean amended complaint within the 30-day timeframe.

4company had made false and misleadingstatements before the merger in violationof Section 10(b). In re CarLotz Sec. Litig.,
2023 WL 2744064 (S.D.N.Y. 2023) (Abrams,J.).7 The court held that plaintiffs—whopurchased shares of the SPAC and the postmerger public company, not the privately
held pre-merger company—lacked standing
and that their challenge to any statements
the pre-merger private company made about
itself was foreclosed by Menora Mivtachim
Insurance v. Frutarom Industries, 54 F.4th
82 (2d Cir. 2022).8

BackgroundThe defendant company is an online used carmarketplace that went public in January 2021
following a de-SPAC transaction. Plaintiffs
brought this securities class action against
the company, and various related entities andindividuals. Plaintiffs alleged that officersof the pre-merger private company madematerially false and misleading statements
concerning their business model prior to theshareholder vote approving the de-SPAC
transaction. Following the merger, the7. Simpson Thacher represents the following defendants in thisaction: Acamar Partners Sponsor I LLC, James E. Skinner,
Domenico De Sole, Luis Ignacio Solorzano Aizpuru, Juan
Carlos Torres Carretero and Teck H. Wong.
8. Please click here to read our discussion of Frutarom.

post-merger public company’s stock dropped.
All defendants moved to dismiss on the basisthat plaintiffs lacked standing under Section
10(b) to challenge any statements made by
the pre-merger private company or its officers
about the pre-merger private company.

The Court Looks to the PurchaserSeller Rule as Interpreted
in Frutarom
In Blue Chip Stamps v. Manor DrugStores, 421 U.S. 723 (1975), the Supreme
Court endorsed the “purchaser-seller rule”
established in Birnbaum v. Newport Steel,
193 F.2d 461 (2d Cir. 1952), which limited
plaintiffs under Section 10(b) to “actual
purchasers or sellers of securities.” In Ontario
Public Service Employees Union Pension
Trust Fund v. Nortel Networks, 369 F.3d 27(2d Cir. 2004), the Second Circuit addressed
the purchaser-seller rule, and held thatplaintiff stockholders lacked standing fortheir Section 10(b) claim because while thestock of the company that they did purchasewas negatively impacted by the material
misstatement of another company (which
had been involved in a number of business
relationships with the company they owned
stock in), they did not purchase the stockof the company that allegedly made themisstatement. Noting that a potential merger
might require a different outcome, the court
declined to decide how the purchaser-seller
rule would apply to a potential merger.
Subsequently, in Frutarom, the Second
Circuit answered that question and held that“purchasers of a security of an acquiring
company do not have standing under Section
10(b) to sue the target company for alleged
misstatements the target company madeabout itself prior to the merger between thetwo companies.”9
Determining that Frutarom foreclosed
plaintiffs’ challenge, the court pointed
out that in this case neither of the named
plaintiffs purchased shares of the pre-merger
private company and that the only pre-merger
shares purchased were those of the publicly
9. In Frutarom, plaintiff purchasers of a U.S. corporation’s
securities alleged that before a merger between thecorporation and a non-U.S. firm—in which the firm became awholly-owned subsidiary of the corporation—the firm madematerially misleading statements. The Southern District of
New York concluded that plaintiffs lacked standing to sue thenon-U.S. firm defendants for statements relating to the firm
because plaintiffs never purchased or sold its securities. A
panel majority of the Second Circuit affirmed.
5

traded SPAC. The court further noted that thechallenged statements were made by the premerger private company about itself, not the
SPAC. The court rejected plaintiffs’ attempt toequate the pre-merger private company withthe post-merger public company, finding that“[p]laintiffs provide no explanation as to why,
as a legal matter, the post-merger entity canbe considered interchangeable with the premerger, privately held company.”

In response to plaintiffs’ concern that
Frutarom allows parties to makemisstatements before a de-SPAC transaction
with impunity, the court pointed out that the
Frutarom majority considered similar policy
arguments and rejected them, reasoning thatplaintiffs could still bring claims alleging
material misstatements against target
companies through SEC enforcement
actions, shareholder derivative suits, orunder state law.

This edition of the
Securities Law Alert was edited by
Bo Bryan Jin / +1-650-251-5068
bryan.jin@stblaw.com
Meaghan A. Kelly / +1-202-636-5542
mkelly@stblaw.com andRachel S. Sparks Bradley / +1-212-455-2421
rachel.sparksbradley@stblaw.com

This will be the last edition of the Securities Law Alert distributed on a monthly basis. Beginning in June,
we will distribute updates shortly after developments occur, in addition to periodic summaries.

6New York

Los Angeles

Martin S. Bell
Partner+1-212-455-2542
martin.bell@stblaw.com

Michael J. Osnato, Jr.
Partner+1-212-455-3252
michael.osnato@stblaw.com

Chet A. Kronenberg
Partner+1-310-407-7557
ckronenberg@stblaw.com

Marc P. Berger
Partner+1-212-455-2197
marc.berger@stblaw.com

Joshua Polster
Partner+1-212-455-2266
joshua.polster@stblaw.com

Palo Alto

Michael J. Garvey
Partner+1-212-455-7358
mgarvey@stblaw.com

Rachel S. Sparks Bradley
Partner+1-212-455-2421

Nicholas S. Goldin
Partner+1-212-455-3685
ngoldin@stblaw.com

Alan C. TurnerPartner+1-212-455-2472
aturner@stblaw.com

Meredith Karp
Partner+1-212-455-3074
meredith.karp@stblaw.com

Craig S. Waldman
Partner+1-212-455-2881
cwaldman@stblaw.com

Peter E. Kazanoff
Partner+1-212-455-3525
pkazanoff@stblaw.com

George S. Wang
Partner+1-212-455-2228
gwang@stblaw.com

Joshua A. Levine
Partner+1-212-455-7694
jlevine@stblaw.com

Alicia N. Washington
Partner+1-212-455-6074
alicia.washington@stblaw.com

Meaghan A. Kelly
Partner+1-202-636-5542
mkelly@stblaw.com

Linton Mann III
Partner+1-212-455-2654
lmann@stblaw.com

Jonathan K. Youngwood
Partner+1-212-455-3539
jyoungwood@stblaw.com

Jeffrey H. Knox
Partner+1-202-636-5532
jeffrey.knox@stblaw.com

Joseph M. McLaughlin
Partner+1-212-455-3242
jmclaughlin@stblaw.com

David Elbaum
Senior Counsel+1-212-455-2861
david.elbaum@stblaw.com

Karen Porter
Partner+1-202-636-5539
karen.porter@stblaw.com

Lynn K. Neuner
Partner+1-212-455-2696
lneuner@stblaw.com

Janet A. Gochman
Senior Counsel+1-212-455-2815
jgochman@stblaw.com

Cheryl J. Scarboro
Partner+1-202-636-5529
cscarboro@stblaw.com

rachel.sparksbradley@stblaw.com

Stephen P. Blake
Partner+1-650-251-5153
sblake@stblaw.com
Bo Bryan Jin
Partner+1-650-251-5068
bryan.jin@stblaw.com
Laura Lin
Partner+1-650-251-5160
laura.lin@stblaw.com
Simona G. Strauss
Senior Counsel+1-650-251-5203
sstrauss@stblaw.com

Washington, D.C.

The contents of this publication are for informational purposes only. Neither this publication nor the lawyers
who authored it are rendering legal or other professional advice or opinions on specific facts or matters,
nor does the distribution of this publication to any person constitute the establishment of an attorney-client
relationship. Simpson Thacher & Bartlett LLP assumes no liability in connection with the use of this publication.
Please contact your relationship partner if we can be of assistance regarding these important developments. The
names and office locations of all of our partners, as well as our recent memoranda, can be obtained from our
website, www.simpsonthacher.com.
7SimpsonThacherWorldwide

UNITED STATESEUROPEASIANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

Brussels
Square de Meeus 1, Floor 7
B-1000 Brussels
Belgium+32-472-99-42-26

Beijing
3901 China World Tower A
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
2475 Hanover Street
Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

LondonCityPoint
One Ropemaker Street
London EC2Y 9HUEngland+44-(0)20-7275-6500

Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Tokyo
Ark Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200

SOUTH AMERICA

São Paulo
Av. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

8