Securities Law Alert
In This Edition:• Supreme Court Clarifies Pleading Requirements for Claims Premised on Statements of Opinion Under
Section 11 of the Securities Act of 1933
• Fourth Circuit Finds District Court Erred by Taking Judicial Notice of SEC Filings That Were Not “Integral”
to the Complaint at the Motion to Dismiss Stage• Southern District of New York Finds That “Maintaining or Furthering a Friendship” Can Constitute a“Personal Benefit” to the Tipper Notwithstanding the Second Circuit’s Decision in United States v. Newman• Southern District of New York Declines to Exercise Section 1331 Jurisdiction Over a Derivative Suit
Concerning FCPA Violations on the Grounds That Doing So Would Be Tantamount to Recognizing a Private
Right of Action Under the FCPA
• Southern District of New York Dismisses Securities Fraud Action Against Molycorp, Finding That the Case
Was a “Classic Example of ‘Fraud by Hindsight’”
March 2015

Supreme Court Clarifies
Pleading Requirements
for Claims Premised on
Statements of Opinion Under
Section 11 of the Securities
Act of 1933

Simpson Thacher
offers a “[m]arketleading practice in generalcommercial andsecurities litigation.”–Chambers USA 2014

Simpson Thacher & Bartlett LLP

On March 24, 2013, the Supreme Court
issued an opinion in Omnicare, Inc. v.
Laborers District Council Construction
Industry Pension Fund, which clarified thepleading requirements for claims basedon statements of opinion under § 11 of the
Securities Act of 1933. The Court held thatan opinion can be “an untrue statement ofa material fact” under the first clause of § 11
only if subjectively disbelieved at the time it
is made. However, the Court also held thatan opinion can form the basis for omissions
liability under the second clause of § 11 if aplaintiff can plead particular material facts
underlying the opinion, the omission of which

made the opinion misleading “to a reasonable
person reading the statement fairly and incontext.” While clarifying that sincerely heldstatements of opinion cannot be challenged
as untrue statements of fact under the firstclause of § 11, the Court’s decision exposes
defendants to potential liability under thesecond clause of § 11 with respect to omissions
claims for certain statements of opinion.

BackgroundOmnicare concerned the pleading
requirements under § 11, which provides
a private right of action for any investor
who purchases a security pursuant to aregistration statement which “contained an
untrue statement of a material fact or omitted
to state a material fact … necessary to makethe statements therein not misleading.” 15
U.S.C. § 77k. The issue presented to the Court
was whether a plaintiff must plead subjective
falsity or only objective falsity of a statementof opinion to plead a cause of action under§ 11.
1Petitioners are Omnicare, Inc., the country’s
largest provider of pharmacy-related services
for the elderly and other residents of longterm care facilities, and individuals who
were officers or directors of Omnicare at therelevant time. Respondents are pension funds
which purchased shares of Omnicare stockin Omnicare’s December 2005 public stock
offering. The pension funds originally broughtsuit in 2006, alleging that statements in theregistration statement were materially false
or misleading at the time they were made,entitling respondents to relief under § 11.
Specifically, Omnicare’s registration
statement included statements of opinion as
to legal compliance, such as “[w]e believe ourcontract arrangements with other healthcare
providers, our pharmaceutical suppliers andour pharmacy practices are in compliancewith applicable federal and state laws.” Thepension funds alleged that because someof Omnicare’s contractual arrangements
amounted to illegal kick-backs, thisstatement and others like it were materiallyfalse or misleading in violation of§ 11. In order to avoid the heightened pleading
burden triggered by an allegation of intent,
respondents specifically disclaimed any
allegation of fraud or intentional wrongdoing.
The district court dismissed the complaint
for failure to state a claim, following the leadof the Second, Third, and Ninth Circuits inholding that a pleading of subjective falsity
is required to make out a § 11 claim basedon a statement of opinion. The Sixth Circuit
reversed, holding that it was inappropriate forthe district court to require the pension fundrespondents to plead subjective knowledge
to make out a claim because § 11 is a strict
liability statute that does not require any
allegation of scienter. In so doing, the court
recognized its disagreement with its fellow
circuits. The Supreme Court granted certiorariand heard oral argument in November 2014.

Summary of the Decision
Justice Kagan wrote the majority opinion,
which was joined in full by Chief Justice
Roberts and Justices Alito, Breyer, Ginsburg,
Kennedy, and Sotomayor. The Court first
explained that while the lower courts had
addressed the issue of false and misleadingstatements of opinion as one question, § 11
is properly read as two separate clauses—thefirst clause prohibits any “untrue statementof a material fact,” and the second prohibits
the omission of “a material fact … necessary
to make the statements … not misleading.”
In addressing the first clause of § 11, theCourt held that “every such statement [ofopinion] explicitly affirms one fact: that the
speaker actually holds the stated belief.”
Because the first clause of § 11 only prohibits
untrue statements of material fact, JusticeKagan reasoned that a statement of opinion
can generally be the basis for liability under
this clause only if the speaker subjectively
disbelieved the opinion at the time thestatement was made. Justice Kagan flatly
rejected the view of both the Sixth Circuit andthe respondents that Omnicare could be held
liable under § 11 merely because its opinion
ultimately proved to be wrong, holding that“a sincere statement of pure opinion is not an‘untrue statement of material fact,’ regardlesswhether an investor can ultimately prove thebelief wrong.”
Thus, to plead a violation of the first clause of§ 11, plaintiffs must plead that the defendantsubjectively disbelieved the opinion at thetime it was made. The Court also recognizedthat opinion statements may give rise toliability under the first clause of § 11 where
they contain “embedded statements of[untrue] fact.”
The greater portion of the Court’s opinion,
however, is devoted to parsing the applicationof the omissions clause of § 11 to statementsof opinion. The Court rejected Omnicare’scontention that “no reasonable person, in any
context, can understand a pure statementof opinion to convey anything more than
the speaker’s own mindset,” holding insteadthat a reasonable investor may understanda statement of opinion to convey more thanthat, depending on the context. Specifically,a reasonable investor could understand astatement of opinion to convey “facts about
how the speaker has formed the opinion” or“about the speaker’s basis for holding thatview.” The Court went on to explain that “ifa registration statement omits material facts
about the issuer’s inquiry into or knowledge
concerning a statement of opinion, and if
those facts conflict with what a reasonable
investor would take from the statement itself,then § 11’s omissions clause creates liability.”
The Court cautioned that the facts which canbe inferred are inherently contextual, andthe reasonable inferences that can be madeare dependent on the type of opinion being
2

given, the specificity of the statement, andthe context of the opinion in the registration
statement as a whole.
Justice Kagan looked to the common law
for guidance on how a reasonable person
understands statements of opinion. The
common law tort of misrepresentation
provided for liability for the omission offacts known to the speaker where thosefacts rebut the recipient’s predictable
inference based on a statement of opinion.
Justice Kagan further expounded that thecommon law provided for greater liability
for those who were understood “as having
special knowledge of the matter which is notavailable” to the listener, which, in the case of
the securities laws, applies to issuers, which
are understood to have special knowledge
about the information in their registration
statements. Moreover, Justice Kagan foundsupport for imposing liability for misleading
opinions under § 11’s second clause in theCongressional purpose in enacting the statute,which was meant to ensure that issuers tell
the whole truth to investors: “An issuer must
as well desist from misleading investors bysaying one thing and holding back another”
in addition to achieving literal accuracy inregistration statements.
Finally, the Court rejected concerns about
unpredictable standards for issuers,
maintaining that such policy arguments areproperly addressed to Congress and would
be mitigated by the heightened pleading
standard under Iqbal v. Ashcroft. Indeed,
Justice Kagan cast doubt on the sufficiencyof the instant complaint, describing
respondents’ “recitation of the statutory
language” as “not sufficient” and “conclusory,”
and asserting that respondents “cannot
proceed without identifying one or more facts
left out of Omnicare’s registration statement.”
The Court also rejected Omnicare’s policy
arguments about chilling the flow of
information to investors, indicating that“market-based forces push back against
any inclination to under disclose” and that
“Congress worked to ensure better, not just
more, information.” The Court vacated thedecision below and remanded the case forapplication of this new standard to the facts ofthe matter.
Justice Scalia concurred in part and in the
judgment, agreeing with the majority’s
analysis of the first clause of § 11 but

disagreeing with its analysis of the second
clause. Justice Scalia disputed the majority’s
account of the common law, arguing thatthe “effect of the Court’s rule is to adopt
a presumption of expertise on all topics
volunteered within a registration statement,”
which Justice Scalia argued was appropriate
only for those disclosures specifically requiredby law to be set forth in the statement.
Justice Scalia further opined that even ifthat presumption was appropriate, thecommon law standard would focus not on the
expectations of the listener but rather on theadequacy of the basis of the statement fromthe expert speaker’s point of view, because
a person receiving an expert opinion does
not assess the adequacy of the basis of that
opinion, but rather relies on the expertise of
the speaker.
Justice Thomas concurred only in the
judgment, agreeing only that the statementsof opinion at issue in the case do notconstitute an untrue statement of material
fact. Unlike the majority, however, JusticeThomas opined that the issue of whether thestatements constitute an actionable omission
was not properly before the Court, having notbeen squarely addressed by the courts below.

Implications
While the Court’s opinion clarifies thatsincerely held statements of opinion cannot
be challenged as untrue statements of fact
under the first clause of § 11, this decision
nevertheless exposes defendants to potential
liability under the second clause of § 11with respect to omissions claims for certain
statements of opinion. While this risk is
mitigated by the Court’s requirement thatany alleged omissions be pled with specificity,
issuers should be aware that phrasing astatement as one of opinion rather than offact does not immunize the statement frompotential § 11 liability. Such statements ofopinion should be included only when there
is underlying support both for making thestatement and concluding that the opinion is
not misleading to investors. The Omnicare
decision creates a context and fact-specifictest that, depending on the application bylower courts, could make it more difficult toobtain dismissal of § 11 claims at the pleading
stage in certain cases.

3Fourth Circuit Finds District
Court Erred by Taking Judicial
Notice of SEC Filings That
Were Not “Integral” to theComplaint at the Motion toDismiss Stage

motion to dismiss.” In “weighing thecompeting inferences regarding scienter,”the court relied on Chelsea’s SEC filings tofind that “none of the individual defendants[had] sold stock during the class period.” Thecourt determined that “the lack of stock sales‘tip[ped] the scales in favor of defendant[s’]motion’ to dismiss.” Plaintiffs appealed.

On March 16, 2015, the Fourth Circuit foundthat the district court had “erred in taking
judicial notice” of SEC filings submitted insupport of defendants’ motion to dismissa securities fraud action because the SEC
filings “did not relate to the contents of thecomplaint.” Zak v. Chelsea Therapeutics
International, 2015 WL 1137142 (4th Cir.
2015) (Keenan, J.). The Fourth Circuit further
held that the district court’s “error was notharmless, because the court [had] incorrectly
construed these [SEC filings] as supporting
its holding that the plaintiffs’ allegationsof scienter were legally insufficient.” The
Fourth Circuit therefore reversed dismissal ofplaintiffs’ suit.

Fourth Circuit Holds That theDistrict Court Should Not Have
Considered Defendants’ SEC Filingsin Evaluating Plaintiffs’ Allegations
Because the Complaint Did Not
Explicitly Reference Those Filings

Background
Plaintiffs contended that Chelsea
Therapeutics International (“Chelsea”) andseveral of its corporate officers had made“dozens of allegedly misleading statements
or material omissions” concerning the
likelihood of FDA approval for Northera, apharmaceutical treatment for a certain typeof hypertension. The complaint stated “ingeneral terms that, in investigating the case,plaintiffs’ counsel had reviewed the public
filings submitted [by Chelsea] to the SEC.”
Beyond this assertion, “the complaint did
not otherwise refer to any SEC filings, orthe contents of such filings, to support [ ]plaintiffs’ allegations.”
Defendants moved to dismiss plaintiffs’
complaint under Rule 12(b)(6). Defendants
asked the court to take judicial notice ofseveral exhibits, including SEC filings,
attached to their motion. According to
defendants, the company’s SEC filings
demonstrated that “none of the Chelsea
officers had sold any shares of Chelsea stockduring the class period.” Defendants asserted“that the absence of such sales undermined
any inference of scienter.”
The district court “took judicial notice of the
SEC documents, and granted [ ] defendants’

On appeal, the Fourth Circuit stated that“when a defendant moves to dismiss acomplaint under Rule 12(b)(6), courts arelimited to considering the sufficiency ofallegations set forth in the complaint and the
documents attached or incorporated into thecomplaint.” The Fourth Circuit stated that“[c]onsideration of a document attached toa motion to dismiss ordinarily is permitted
only when the document is integral to andexplicitly relied on in the complaint andwhen the plaintiffs do not challenge [thedocument’s] authenticity.”
Here, the Fourth Circuit found that
defendants’ SEC filings “were not explicitly
referenced in, or an integral part of, [ ]plaintiffs’ complaint.” Moreover, “thecomplaint did not contain any allegationsuggesting that the individual defendants[had] made any sales or purchases of Chelsea
stock during the class period,” nor were“such allegations … required to demonstrate
a strong inference of scienter.” The Fourth
Circuit therefore ruled that “the district
court should not have considered [Chelsea’s
SEC filings] in reviewing the sufficiency of …
plaintiffs’ allegations.”

Fourth Circuit Finds That Even If
It Had Been Proper for the District
Court to Take Judicial Noticeof Defendants’ SEC Filings, theDistrict Court Had “IncorrectlyConstrued” Those Filings
The Fourth Circuit stated that there is a“narrow exception” pursuant to which courts
may, at the motion to dismiss stage, consider“facts and documents” that are not “integral
to” or “explicitly relied on” in the complaint.
4

Pursuant to Federal Rule of Evidence 201,
“courts at any stage of a proceeding may‘judicially notice a fact that is not subject toreasonable dispute,’ provided that the fact is‘generally known within the court’s territorial
jurisdiction’ or ‘can be accurately and readily
determined from sources whose accuracy
cannot reasonably be questioned’” (quoting
F.R.E. 201). The Fourth Circuit stated that“when a court considers relevant facts fromthe public record at the pleading stage” under
Rule 201, “the court must construe such facts
in the light most favorable to the plaintiffs.”
In the case before it, the Fourth Circuit
determined that even if it had been proper
for the district court to take judicial noticeof Chelsea’s SEC filings pursuant to Rule
201, the district court had “incorrectly
construed the information contained in[those] documents.” The Fourth Circuit
found that Chelsea’s SEC filings “did notprovide a factual basis for the [district] court’s
conclusion that no individual defendant [had]sold Chelsea stock during the class period.”
Moreover, the Fourth Circuit held that thiserror “was not harmless” because the court
had placed great weight on “defendants’purported failure to sell Chelsea stock during
the class period” when evaluating plaintiffs’scienter allegations.

Fourth Circuit Determines
Plaintiffs Had Adequately Pled
Scienter Based on Defendants’Alleged Failure to Disclose Adverse
FDA Guidance
Following a “de novo review” of plaintiffs’scienter allegations, the Fourth Circuit foundthat “plaintiffs’ allegations … permit[ted]a strong inference that … defendants [had]either knowingly or recklessly misledinvestors by failing to disclose criticalinformation received from the FDA during
the new drug application process, while
releasing less damaging information thatthey knew was incomplete.” The court
concluded that plaintiffs had adequately pledscienter by alleging a “conflict[ ]” between
the “material, non-public information known
to [ ] defendants about the status of” thecompany’s application for FDA approval ofNorthera and “defendants’ public statementson those subjects.”

that a strong inference of scienter can arise
merely based on a defendant’s failure todisclose information.” The court recognizedthat “Chelsea and its corporate officers may
have lacked an independent, affirmative duty
to disclose” adverse information received
from the FDA in connection with thecompany’s application for FDA approval ofNorthera. However, the Fourth Circuit statedthat “defendants’ failure” to disclose “must be
viewed … in the context of the statements thatthey affirmatively elected to make” regarding
the likelihood that the FDA would approveNorthera. The Fourth Circuit noted that
under Matrixx Initiatives, Inc. v. Siracusano,
131 S. Ct. 1309 (2011), “companies can control
what they have to disclose under [Section
10(b) and Rule 10b-5(b)] by controlling what
they say to the market” (quoting Matrixx, 131
S. Ct. 1309).

Judge Thacker, Dissenting, Finds
That the Majority Applied Too
Lenient of a Standard to Plaintiffs’
Scienter Allegations
Judge Thacker dissented from the Fourth
Circuit’s majority opinion, finding thatthe majority had applied an overly lenient
standard in evaluating plaintiffs’ scienter
allegations. Judge Thacker stated that the
Fourth Circuit’s decision in Cozzarelli v.
Inspire Pharmaceuticals, Inc., 549 F.3d 618(2008) “makes clear that pleading scienter—
whether in the form of fraudulent intent orsevere recklessness—requires a showing of‘wrongful intent.’” She explained that“[t]his understanding of scienter …
necessarily entails a ‘culpable state of mind.’”Judge Thacker emphasized that courts in the
Fourth Circuit may “not infer scienter ‘fromevery bullish statement by a pharmaceuticalcompany … trying to raise funds’” (quoting
Cozzarelli, 549 F.3d 618). Judge Thacker
stated that she would have affirmed the
district court’s decision.

The Fourth Circuit “emphasize[d] that [its]conclusion [did] not stand for the proposition5

Southern District of New York
Finds That “Maintaining or
Furthering a Friendship” Can
Constitute a “Personal Benefit”
to the Tipper Notwithstanding
the Second Circuit’s Decisionin United States v. Newman

trial court’s “instruction to the jury regarding
the personal benefit element of securities
fraud was erroneous in light of Newman.”

To sustain an insider trading conviction
against a tipper, the government must
establish that the tipper “personally …
benefit[ed], directly or indirectly, from his
disclosure” of confidential information to an
outsider. Dirks v. S.E.C., 463 U.S. 646 (1983).
In United States v. Newman, 773 F.3d 438(2d Cir. 2014) (Parker, J.), the Second Circuit
held that the government may not “prove
the receipt of a personal benefit by the merefact of a friendship, particularly of a casual orsocial nature.”1

The Southern District of New Yorkacknowledged that under Newman, “‘themere fact of a friendship, particularly of acasual or social nature,’ between the tipper
and the tippee is not sufficient evidence
that a personal benefit inured to the tipper”(quoting Newman, 774 F.3d 438). The court
observed that here, however, the trial court’s“instruction to the jury did not permit it toconvict just because Teeple and Riley werefriends.” Rather, the trial court’s charge“required that the tip be given to ‘maintain[ ]or further[ ] a friendship.” The Southern
District of New York determined that “[i]f a
tip maintains or furthers a friendship, and is
not simply incidental to the friendship, thatis circumstantial evidence that the friendshipis a quid pro quo relationship.” The courtemphasized that “[t]he existence of some quid
pro quo is the sine qua non of tipper liability
for insider trading.”

On March 3, 2015, the Southern District of
New York ruled that a “personal benefit”
could be found under Newman “[i]f a tip
maintains or furthers a friendship, and is not
simply incidental to the friendship” because
this may be “circumstantial evidence that thefriendship is a quid pro quo relationship.”United States v. Riley, 2015 WL 891675(S.D.N.Y. 2015) (Caproni, J.).

BackgroundThe case before the Southern District of New
York concerned the insider trading convictionof David Riley, Foundry Network’s former
Chief Information Officer. Riley had allegedly
disclosed material, nonpublic information(“MNPI”) with respect to Foundry’s sales
data and acquisition prospects to Matthew
Teeple, a hedge fund analyst. The trial court’s“charge permitted the jury to find that Riley
had obtained a personal benefit in exchange
for the MNPI … if he [had] provided theinformation for the purpose of ‘maintaining
or furthering a friendship.’” The jury
convicted Riley on two counts of securities
fraud and one count of conspiracy to commit
securities fraud.
When the Second Circuit issued its decision
in Newman, 774 F.3d 438, Riley moved fora new trial or, alternatively, a judgment ofacquittal. Riley contended, inter alia, that the
1. Please click here to read our discussion of the Newman decisionin the December 2014 edition of the Alert.

Southern District of New York
Finds That Information-Sharing to
Maintain or Further a Friendship
Suggests a Quid Pro Quo
RelationshipThe court found that Newman does notpreclude a finding of “personal benefit”
based on the maintenance or furtherance of afriendship, as distinguished from the “mere”
existence of a friendship. In Newman, theSecond Circuit recognized that a “personal
benefit” could be found if there was “proof ofa meaningfully close personal relationshipthat generate[d] an exchange that [was]objective, consequential, and represent[ed]at least a potential gain of a pecuniary orsimilarly valuable nature” (quoting Newman,
773 F.3d 438). The court explained that
under Newman, “[t]he tipper’s gain does
not have to be ‘immediately pecuniary,’ but‘the personal benefit received in exchange
for confidential information must be of someconsequence’” (quoting Newman, 773 F.3d
438 (emphasis in original)). The Newman
court “acknowledge[d] … that a tipper hasreceived a personal benefit when there is‘a relationship between the insider and therecipient that suggests a quid pro quo fromthe latter, or an intention to benefit thelatter’” (quoting Newman, 773 F.3d 438).

6Based on this analysis, the Southern Districtof New York concluded that the trial court’s
jury instruction was not “plain error” under
Newman. Although the Second Circuit might
eventually “rule that merely maintaining
or furthering a friendship is not a sufficientpersonal benefit” for purposes of an insider
trading conviction, the court found that it was“not ‘plain’ that the Second Circuit ha[d] done
so already” in Newman.

Southern District of New York
Determines That Any Rational Jury
Would Have Found That Riley Had
Obtained a “Personal Benefit” fromthe Disclosure at Issue
The Southern District of New York foundthat even if the trial court’s charge to thejury had been erroneous, the error had
no impact on Riley’s “substantial rights”
because “any rational jury would have found,beyond a reasonable doubt, that Riley [had]obtained a personal benefit from providing
MNPI to Teeple.” The court determinedthat “[a]t a minimum, Riley [had] obtained
three concrete personal benefits that were
‘objective, consequential, and represent[ed]at least a potential gain of a pecuniary orsimilarly valuable nature’” (quoting Newman,
773 F.3d 438). First, “Teeple provided Riley
with access to his many contacts,” including
in connection with Riley’s “side business” and“his job search.” Second, Teeple gave Riley“investment advice (which Teeple provided
to others, but not for free).” And third, Teeple
offered “insight into the companies withwhom Riley was pursuing opportunities.”
The court held that “[t]he relationshipbetween Riley and Teeple was clearly a quid
pro quo relationship in which each wastrying to help the other; Riley’s quid wasFoundry’s MNPI.” The court therefore denied
Riley’s motion for both a new trial and for a
judgment of acquittal.

Southern District of New
York Declines to Exercise
Section 1331 Jurisdiction
Over a Derivative Suit
Concerning FCPA Violations
on the Grounds That Doing
So Would Be Tantamount to
Recognizing a Private Right of
Action Under the FCPA
Pursuant to 28 U.S.C.A. § 1331, federal courts“have original jurisdiction of all civil actions
arising under the … laws … of the UnitedStates” (emphasis added). On March 16, 2015,
the Southern District of New York held that
Section 1331’s “arising under” requirement
was not met in a shareholder derivative suitconcerning Avon Products’ alleged failure tocomply with the Foreign Corrupt Practices
Act (“FCPA”). Pritika v. Moore, 2015 WL
1190157 (S.D.N.Y. 2015) (Gardephe, J.). The
court found that “exercising subject matter
jurisdiction over [p]laintiff’s state law claims
would be tantamount to recognizing a privateright of action under the FCPA.”Southern District of New York
Explains that Section 1331 Confers
Jurisdiction Over State Law Claims
Only In “Exceptional” Cases
The Southern District of New Yorkobserved that “[f]ederal courts may exercise
jurisdiction over state [law-based] claims”
pursuant to Section 1331 “where it appears
that some substantial, disputed questionof federal law is a necessary element of oneof the well-pleaded state [law] claims.” Indetermining whether jurisdiction under
Section 1331 is proper, courts must consider
whether the state law claim “(1) necessarilyraise[s] a stated federal issue” that is “(2)actually disputed and (3) substantial,
which (4) a federal forum may entertain
without disturbing any congressionallyapproved balance of federal and state judicial
responsibilities” (quoting Grable & Sons
Metal Products, Inc. v. Darue Engineering& Manufacturing, 545 U.S. 308 (2005)). The
court underscored that state law-based claims
that warrant Section 1331 jurisdiction are“extremely rare exceptions to the general rulethat a suit arises under the law that createsthe cause of action.”7

Southern District of New York
Determines That Plaintiff’s
Derivative Suit Does Not
Satisfy Grable’s Substantiality
Requirement Because It Does Not
Implicate the FCPA’s Validity or
Its Requirements
The court found that plaintiff’s state lawbased derivative action, brought on behalfof nominal defendant Avon, did not satisfy
Grable’s substantiality requirement. Whilethe court recognized that “Avon’s compliancewith the FCPA [would] be one of the criticalissues in this litigation,” the court determinedthat the “case [did] not implicate the validityof the FCPA or the requirements that the
Act imposes.” Rather, the case “involve[d],at best, the application of a federal legal
standard to private litigants’ state law claims.”
The court rejected plaintiff’s contention thatit should exercise Section 1331 jurisdiction
over plaintiff’s claims because “a court may
be required to interpret certain provisionsof the [FCPA]” “in determining whether[d]efendants’ conduct [violated] FCPA
standards.” The court explained that the same
argument could be made “for every case thatinvolves state law claims invoking a federal
standard.” The court also found meritlessplaintiff’s assertion that Section 1331
jurisdiction was warranted because “the FCPA
is not commonly the subject of litigation.”
The court explained that in Merrell Dow
Pharmaceuticals, Inc. v. Thompson, 478 U.S.
804 (1986), the Supreme Court “explicitly
rejected the argument that the novelty of [an]issue” can justify the exercise of Section 1331
jurisdiction.

Southern District of New York
Finds That Exercising Section 1331
Jurisdiction Over Plaintiff’s Claims
Would Disturb a “Congressionally
Approved Balance of Federal andState Judicial Responsibilities” with
Respect to FCPA Enforcement
The court further determined that it “could
not exercise subject matter jurisdiction here‘without disturbing [the] congressionallyapproved balance of federal and state judicial
responsibilities” with respect to FCPA
enforcement (quoting Grable, 545 U.S. 308).
The court explained that “Congress intended
that federal court litigation under the FCPA
would proceed by way of SEC and DOJ

enforcement actions, … and not via private
suit.”
The court found that “exercising subject
matter jurisdiction over [p]laintiff’s state law
claims would be tantamount to recognizing
a private right of action under the FCPA.”Taking “[s]uch an approach would ‘open thefloodgates’ to federal court litigation of private
disputes raising issues under the FCPA, an
outcome directly contrary to Congress’s
apparent intent.” The court therefore
dismissed plaintiff’s derivative suit for lack ofsubject matter jurisdiction.

Southern District of New York
Dismisses Securities Fraud
Action Against Molycorp,
Finding That the Case Was a“Classic Example of ‘Fraud byHindsight’”
On March 12, 2015, the Southern Districtof New York dismissed a securities fraud
action against Molycorp Inc. for failure toallege scienter with respect to the progressof a mining project and the commercial
potential of one of the company’s products.
In re Molycorp, Inc. Sec. Litig., 2015 WL
1097355 (S.D.N.Y. 2015) (Crotty, J.). The
court found that that the case was a “classic
example of fraud by hindsight” in whichplaintiffs attempted to plead scienter basedon company statements that later turned out
to be inaccurate.

Southern District of New York
Determines That Defendants’Alleged Misstatements Concerning
the Progress of Project Phoenix
Were at Most Erroneous, Rather
Than Reckless
The court found that plaintiffs had failed toallege scienter with respect to defendants’
alleged misstatements concerning the
progress and anticipated completion dateof Phase 1 of Project Phoenix, an effort tomodernize Molycorp’s rare earths mine.
Plaintiffs attempted to plead scienter bydemonstrating “circumstantial evidenceof conscious misbehavior or recklessness,”rather than “motive and opportunity to8commit the alleged fraud.” The court
explained that a “stricter standard” applies
to scienter allegations based on “a conscious
misbehavior or recklessness theory.” Althougha plaintiff can “plead scienter by identifying
conscious misbehavior by the defendant, …
the strength of circumstantial allegations
must be correspondingly greater” than the
allegations sufficient to plead scienter undera motive and opportunity theory. “A findingof recklessness requires a showing of conduct
which is highly unreasonable and which
represents an extreme departure from thestandards of ordinary care … to the extent
that the danger was either known to thedefendant or so obvious the defendant musthave been aware of it.” The court held that“[p]laintiffs’ allegations fail[ed] to meet thishigh burden” for a number of reasons.
First, the court found that “a close analysisof the allegations of confidential witnesses”
relied on by plaintiffs “reveal[ed] that the[c]omplaint d[id] not actually come close toalleging [d]efendants’ knowledge of delays
at the [Project Phoenix] mine until, at theearliest, June 2012.” The court determinedthat “this dearth of scienter allegations
mean[t] that a large portion of the statements
which [p]laintiffs allege[d] [were] actionable,
made during February and May [2012],[were] patently not actionable.” The court
found the remaining confidential witness
allegations “devoid of facts demonstratingthat [d]efendants knew they would failto meet the announced schedule [forcompleting Phase 1 of Project Phoenix] when
the statements were made.” At best, theallegations “may show that [ ] defendantsshould have been more alert and more
skeptical, but nothing alleged indicates thatmanagement was promoting a fraud.”
Second, the court rejected plaintiffs’ efforts
to allege scienter based on defendants’knowledge of “serious problems in work
performed by a [Project Phoenix] contractor,
M & K Chemical Engineering.” Even though“poor work was done and … the damages weresignificant enough for Molycorp to sue M &K,” the court determined that this was not
sufficient to establish “that Molycorp knew its
proposed schedule [for completing Phase 1 ofProject Phoenix] was no longer viable.” Thecourt found it “equally as likely, and indeed
more compelling, that Molycorp believed it
could remedy this damage within the existingtime frame.”

Third, the court determined that there was nobasis for plaintiffs’ assertion that defendants“must have known of the delay in completionof Phase 1 [of Project Phoenix] prior to thecompany’s January 10, 2013 announcementthat the project would take six months longer
than expected. The court explained that“[m]anagers … are entitled to investigate fora reasonable time, until they have a full story
to reveal.” Moreover, even if defendants had
relied on timelines that “were not realistic,”
the court emphasized that “recklessness
and erroneousness are not equivalent” forpurposes of alleging securities fraud. The
court stated that “[j]ust because something iswrong or incorrect as a matter of fact does notmean it was reckless.”
Fourth, the court found that plaintiffs had
not alleged scienter based on “the facts thatthe financials were SOX-certified; that
Project Phoenix was a ‘core operation’ of
Molycorp; and that certain [i]ndividual[d]efendants were ‘forced’ to resign during
the class period.” The court explained that“in the absence of more particularized
allegations of scienter,” the fact “thatcertain [d]efendants signed or certified SEC
disclosures is insufficient to support a findingof scienter.” Moreover, “without factual
allegations linking [d]efendants’ resignations
to the alleged fraud, the mere fact of theresignations provides no support for a findingof scienter.” Finally, with respect to plaintiffs’
attempt to rely on the “core operations”
theory, the court explained that “the majority
approach” in the Second Circuit “has been to
consider such allegations as a supplementary
but not independently sufficient means to
plead scienter.”
The court concluded that “[p]laintiffs’
allegations regarding Project Phoenix readas a classic example of ‘fraud by hindsight.’”
Given that defendants “eventually disclosed
the delay” in anticipated Phase 1 completionof Project Phoenix, the court found that
permitting plaintiffs’ claims to go forward“would impose too high a burden ofclairvoyance and continuous disclosure on
corporate officials.”9Southern District of New York
Holds Plaintiffs’ Scienter
Allegations Concerning theCommercial Viability of SorbX
Inadequate Under the Heightened
Scienter Standard Applicable to
Forward-Looking Statements
The court determined that plaintiffs had also
failed to allege scienter with respect to alleged
misstatements concerning “Molycorp’s
progress in building commercial potential for
SorbX, Molycorp’s proprietary water filtration
product.” The court found that “[t]he majorityof statements regarding SorbX identified in
the complaint [were] classically forwardlooking—they address[ed] what defendants
expected to occur in the future.” The court
explained that “[t]he scienter requirement
for forward-looking statements—actual

knowledge—is stricter than [the standard
applicable to] statements of current fact.”
Here, the court found “[p]laintiffs’ allegationsof [d]efendants’ knowledge … both
speculative and conclusory.” For example,
plaintiffs cited a confidential witness whostated that “if anyone in management was‘paying attention,’ they would [have] know[n]by late 2012 that SorbX had no short termcommercial potential.” The court explainedthat these types of allegations do “not meetth[e] [actual knowledge] standard” forforward-looking statements.
The court also found insufficient plaintiffs’
attempt to allege scienter based on Molycorp’s
August 8, 2013 announcement that it would
restate its financials for the first quarter of2013, and therefore dismissed the complaint
in its entirety.

The Securities Law Alertis edited by Paul C. Gluckow(pgluckow@stblaw.com/212455-2653), Peter E. Kazanoff(pkazanoff@stblaw.com/212-4553525) and Jonathan K. Youngwood(jyoungwood@ stblaw.
com/212-455-3539).

10

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Washington, D.C.
Peter H. Bresnan+1-202-636-5569
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+1-202-636-5532
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cscarboro@stblaw.com
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pthomas@stblaw.com

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

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