Securities Law Alert
In This Edition:• Supreme Court: Courts Must Apply the ERISA Pleading Standards of Fifth Third Bancorp v.
Dudenhoeffer• Eighth Circuit: (1) Cautionary Statements Must Provide “a Realistic Description of the Risks Applicableto the Particular Circumstances,” and (2) Not All Bad Corporate News Is “Corrective” for Loss Causation
Purposes• Ninth Circuit: Announcement of a Government Investigation Can Serve as a Corrective Disclosure for
Loss Causation Purposes If the Inaccuracy of the Misstatement at Issue Is Subsequently Confirmed• Southern District of New York: (1) Defendants Do Not Have a Generalized Duty to Disclose SEC
Investigations and Wells Notices, and (2) Defendants Have No Duty to Update Statements Made Prior to
the Class Period• Southern District of New York: Adverse Interest Exception to the General Rule Imputing an Executive’s
Scienter to the Corporation Does Not Apply If the Corporation Benefited From the Executive’s Fraud
February 2016

Supreme Court: Courts Must
Apply the ERISA PleadingStandards of Fifth Third
Bancorp v. Dudenhoeffer
SimpsonThacher’s “marketleading securities litigation
practice” is “known for handlinghighly-publicized disputes
in defense of major financial
institutions and international
corporations.”– Chambers USA
2015

On January 25, 2016, the Supreme Court
reversed for the second time the decision of
the Ninth Circuit not to dismiss an ERISA
complaint. Amgen v. Harris, 136 S. Ct. 758(2016) (per curiam) (Amgen III) (reversing
Harris v. Amgen, 788 F.3d 916 (9th Cir.
2014) (Amgen II)). Reiterating that Fifth
Third Bancorp v. Dudenhoeffer, 134 S. Ct.
2459 (2014),1 “set[s] forth the standards
for stating a claim for breach of the duty ofprudence against fiduciaries who manage
employee stock ownership plans (ESOPs),”
the Supreme Court held the Ninth Circuit
had failed to properly apply those standards
1. Please click here to read our prior discussion of the Supreme
Court’s decision in Fifth Third.

Simpson Thacher & Bartlett LLP

in evaluating the Amgen complaint. After
conducting its own review, the Supreme Court
concluded the complaint lacked “sufficient
facts and allegations to state a claim.”

BackgroundIn 2007, participants in Amgen-sponsoredpension plans (the “Amgen Plans” or the“plans”) brought suit in the Central District ofCalifornia alleging that the plans’ fiduciaries
had breached their duties under ERISA bycontinuing to offer the Amgen Common StockFund as an investment option, even though
the fiduciaries allegedly knew or should have
known that the price of Amgen stock was
artificially inflated.
On March 2, 2010, the district court
dismissed plaintiffs’ claims for failure to rebut
the presumption of prudence established in
Moench v. Robertson, 62 F.3d 553 (3d Cir.
1995). Harris v. Amgen, 2010 WL 744123
1

(C.D. Cal. 2010). Several years later, in
October 2013, the Ninth Circuit reinstatedplaintiffs’ ERISA claims. Harris v. Amgen,
738 F.3d 1026 (9th Cir. 2013) (Fletcher, J.)(Amgen I). The Ninth Circuit held that thefiduciaries of the Amgen Plans were “notentitled to a presumption of prudence”
because they “were neither required nor
encouraged by the terms of the Plans to invest
in Amgen stock.” Applying ERISA’s “normal
prudent man” standard of care, the Ninth
Circuit determined that plaintiffs’ allegations
were sufficient to state a claim.

or should have known,” based on inside
information, “that the stock was being sold at
an artificially inflated price.”

On June 25, 2014, the Supreme Court vacatedthe Ninth Circuit’s decision in Amgen I andremanded for reconsideration in light of its
opinion issued the same day in Fifth Third.
In Fifth Third, the Supreme Court held that
ESOP fiduciaries are not entitled to any“special presumption” of prudence but are
instead “subject to the same duty of prudence
that applies to ERISA fiduciaries in general,
except that they need not diversify the fund’s
assets.” Simultaneously, however, the Court
provided pleading guidance to help courts“divide the plausible sheep from the meritlessgoats.” As relevant here, the Court held that“[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.”

In its per curiam decision, the Supreme
Court explained that Fifth Third recognizedthat “ESOP fiduciaries confront uniquechallenges given ‘the potential for conflict’that arises when fiduciaries are alleged tohave imprudently ‘fail[ed] to act on inside
information they had about the value of theemployer’s stock.’” Amgen III, 136 S. Ct. 758(quoting Fifth Third, 134 S. Ct. 2459). In
light of these challenges, the Supreme Court
explained, courts must “consider whether
the complaint has plausibly alleged that a
prudent fiduciary in the defendant’s position
could not have concluded that stopping
purchases—which the market might take asa sign that insider fiduciaries viewed that
employer’s stock as a bad investment—or
publicly disclosing negative information
would do more harm than good to the fundby causing a drop in the stock price and aconcomitant drop in the value of the stockalready held by the fund” (quoting Fifth
Third, 134 S. Ct. 2459).

On remand, the Ninth Circuit once again
deemed plaintiffs’ allegations sufficient tostate breach of fiduciary duty claims under
ERISA. Amgen II, 788 F.3d 916. The Ninth
Circuit acknowledged that the Supreme
Court in Fifth Third had “articulated certain
standards for ERISA liability,” but stated thatit had “already assumed those standards” inAmgen I. Applying those standards, the Ninth
Circuit determined it was “quite plausible”
that defendants could have removed theAmgen Common Stock Fund “from the listof investment options” available throughthe Amgen Plans “without causing undue
harm to plan participants.” Accordingly, theNinth Circuit held, the Amgen complaintplausibly alleged that the fiduciary defendants
had violated their ERISA duty of care “bycontinuing to provide Amgen common stock
as an investment alternative when they knew

Defendants petitioned the Supreme Court forcertiorari of the Ninth Circuit’s decision in
Amgen II. The Court granted certiorari andreversed.

Supreme Court Reverses the Ninth
Circuit for Failure to Properly
Apply the Pleading Standard in
Fifth Third

Applying this standard, the Supreme Court
held the Ninth Circuit had “failed to properly
evaluate the complaint.” The Ninth Circuit
had found it “quite plausible” that removing
the Amgen Common Stock Fund as aninvestment option under the Amgen Plans
would not have resulted in “undue harm toplan participants” (quoting Amgen II, 788
F.3d 916). However, the Ninth Circuit did not“assess whether the complaint . . . ‘plausibly
alleged’ that a prudent fiduciary in the same
position ‘could not have concluded’” thatremoving the Amgen Common Stock Fund as
an investment option under the plans would
have done “more harm than good” (quoting
Fifth Third, 134 S. Ct. 2459).
The Supreme Court conducted its own reviewof the Amgen complaint and determinedthe complaint lacked “sufficient facts
2and allegations” to support “[t]he Ninth
Circuit’s proposition that removing theAmgen Common Stock Fund from the listof investment options was an alternative
action that could plausibly have satisfied
Fifth Third’s standards.” The Court therefore
reversed the Ninth Circuit’s decision andremanded the action for further proceedings
consistent with its opinion. The Court left
it to the discretion of the district court todecide whether to permit plaintiffs to amend
their complaint “in order to adequately
plead a claim for breach of the duty ofprudence guided by the standards provided in
Fifth Third.”

Eighth Circuit: (1) Cautionary
Statements Must Provide“a Realistic Description of
the Risks Applicable to theParticular Circumstances,”and (2) Not All Bad Corporate
News Is “Corrective” for Loss
Causation Purposes
On February 10, 2016, the Eighth Circuit
revived a securities fraud action alleging that
The Dolan Company (“Dolan”) had madematerial misrepresentations and omissions
concerning the financial stability of its
subsidiary, DiscoverReady. Rand-Heart of
New York v. Dolan, 2016 WL 521075 (8thCir. 2016) (Rand-Heart II) (Benton, J.).
The Eighth Circuit held that the warnings
accompanying the alleged misstatements
were not “meaningfully cautionary” because
defendants did not provide “a realistic

description of the risks applicable to theparticular circumstances.” However, the court
also found that plaintiffs had not adequately
alleged loss causation as to a certain segmentof the class period because one of the alleged“corrective disclosures” did not actuallycorrect any prior misrepresentations.

Background
DiscoverReady was a litigation support
business. The company’s biggest customer
was Bank of America, which accounted for
20% to 30% of DiscoverReady’s revenues.
In late June or early July 2013, Bank ofAmerica expressed concern regarding Dolan’sfinancial stability, and informed Dolan that it“would need to solve its financial problems”“in order for Bank of America to continue tosend work to DiscoverReady.” Rand-Heartof New York v. Dolan, 2015 WL 1396984(D. Minn. Mar. 25, 2015) (Magnuson, J.).
In July 2013, Dolan’s board of directors“authorized [the company’s COO] to begin toseek buyers for the DiscoverReady business.”
On August 1, 2013, Dolan’s CEO stated during
an analyst call that the company “expect[ed]”DiscoverReady “to grow at double-digit
rates over the prior year.” However, heacknowledged that DiscoverReady’s third
quarter revenues would likely be below theprior year’s. Dolan’s CEO stated that he did
not want “to dampen enthusiasm about . . .
growth prospects for DiscoverReady” butexplained that the company wanted “to set
proper expectations for a business that may
experience lumpiness on a quarter-to-quarter
basis.” Plaintiffs contended that the August
1, 2013 statements were “materially false andmisleadingly incomplete, because none of thestatements informed the public about ‘thedeterioration of the [c]ompany’s relationshipwith Bank of America.’”
On November 12, 2013, Dolan’s CEO statedin a press release that “DiscoverReady’s
third quarter revenues were affected not
only by the quarterly lumpiness that isinherent to the e-discovery business, but also
decreased primarily as the result of a periodof reduced work from DiscoverReady’s largest
customer.” Dolan’s share price fell by nearly
50% following this announcement. Plaintiffs
nonetheless contended that “the company’s
stock price ‘remained artificially inflated to amaterial degree’ until” January 2, 2014, when
Dolan “announced that it had appointed a3‘Chief Restructuring Officer’ to attempt to
restructure the company’s indebtedness.”
Dolan’s share price fell by almost 21% after
the January 2 announcement.
On March 26, 2015, the District of Minnesota
dismissed plaintiffs’ claims. While the court
found that plaintiffs had adequately allegedthat the August 1, 2013 statements werematerially misleading, the court determinedthat plaintiffs had failed to allege scienter.
The court further held that plaintiffs had
failed to establish loss causation for the period
between November 12, 2013 (the date Dolandisclosed DiscoverReady’s “reduced work”
from its “largest customer”) and January 2,
2014 (the end of the class period).

Eighth Circuit Finds Dolan
Must Have Known That the
Decline in Bank of America’s
Business Significantly Impacted
DiscoverReady’s Financial Stability
On appeal, the Eighth Circuit explained that“[s]cienter can be established by a deceitfulor manipulative state of mind, severe
recklessness, or motive and opportunity.”
Rand-Heart II, 2016 WL 521075. The
Eighth Circuit noted that the district court
had “found no motive” for defendants tomisrepresent DiscoverReady’s financial
stability. The district court also deemed it
significant that Dolan’s CEO had “never soldhis shares of the company stock.” However,the Eighth Circuit underscored that theabsence of motive “does not end the [scienter]inquiry.”
Here, plaintiffs alleged that Dolan had been
“severely reckless” “in failing to disclose that
Bank of America had stopped sending newwork to DiscoverReady” during the August 1,
2013 conference call. Plaintiffs claimed thatthe loss of Bank of America’s business was so
significant that it “prompted [Dolan’s][b]oard in June 2013 to ‘authorize themarketing of DiscoverReady for sale.’” Basedon these allegations, the Eighth Circuit foundthat “DiscoverReady’s financial instability
caused by the decline in Bank ofAmerica[‘s business] was, at the least, ‘soobvious that [defendants] must have beenaware of it.’” The court therefore held thatplaintiffs had adequately pled scienter as to
the August 1, 2013 statements.

Eighth Circuit Finds Dolan’sStatements Regarding
DiscoverReady’s Financial
Prospects Were Not Protected
Forward-Looking Statements
The Eighth Circuit rejected defendants’contention that the August 1, 2013 statements
regarding DiscoverReady’s “double-digit”
growth and the possible “lumpiness” in
DiscoverReady’s quarter-to-quarter revenues
were protected forward-looking statements
under the Private Securities Litigation Reform
Act’s (“PSLRA”) safe-harbor provision.
Defendants stated that the August 1, 2013statements were inactionable because they
were accompanied by cautionary language
from the company’s SEC filings. Specifically,
the company warned that “DiscoverReady’s
business revenues have traditionally been
concentrated among a few customers andif these large repeat customers choose to
manage their discovery with their own staff
or with another provider and if we are unable
to develop new customer relationships, ouroperating results and the ability to execute
our growth strategy at DiscoverReady may be
adversely affected.”
The Eighth Circuit found that these warnings,“[e]ven if cautionary,” were “not meaningfully
cautionary.” The court explained that thewarnings were not “based on a realistic
description of the risks applicable tothe particular circumstances” affecting
DiscoverReady but were instead “a boilerplate
litany of generally applicable risk factors.”

Eighth Circuit Finds Plaintiffs
Failed to Allege Loss Causation
Between November 12, 2013 andJanuary 2, 2014
With respect to loss causation, the Eighth
Circuit found that defendants had “fully
disclosed on November 12, 2013” that
Bank of America was no longer sending
DiscoverReady any new litigation support
work. The court found meritless plaintiffs’
claim that the alleged fraud was “not fully
revealed” until the company’s January 2, 2014
announcement of a new restructuring officer.
The Eighth Circuit determined that theJanuary 2 press release was not a corrective
disclosure for loss causation purposes because“[n]othing in the January 2 press releasecorrect[ed] previous misrepresentations.”4

Rather, the announcement merely“elaborate[d] on [Dolan’]s previously
disclosed plan to restructure.”
The Eighth Circuit underscored that “[i]nthe financial markets, not every bit of bad
news that has a negative effect on the priceof a security necessarily has a corrective
effect for purposes of loss causation.” Thecourt explained that “[a] drop in stock
price is not necessarily caused by an earlier
misrepresentation.” Rather, a lower stock
price “may reflect . . . changed economic
circumstances, changed investor expectations,
new industry-specific or firm-specific facts,
conditions, or other events, which taken
separately or together account for someor all of that lower price” (quoting Dura
Pharmaceuticals v. Brodo, 544 U.S. 336(2005)).
In order to allege loss causation based on
the drop in Dolan’s stock price following theJanuary 2 press release, the Eighth Circuit
found that plaintiffs had to allege “thatDolan’s fraud—and not other events—caused
the price to fall.” Because plaintiffs failed to
do so, the Eighth Circuit held that the district
court “did not err in finding no loss-causation
for the period between November 12 andJanuary 2.”

Ninth Circuit: Announcementof a Government Investigation
Can Serve as a Corrective
Disclosure for Loss Causation
Purposes If the Inaccuracy of
the Misstatement at Issue Is
Subsequently Confirmed
On February 1st, 2016, the Ninth Circuit
revived in part a securities fraud action
against CVB Financial Corporation (“CVB”)
alleging that the company had made material
misrepresentations concerning the likelihoodthat its largest borrower would default on its
loans. Lloyd v. CVB Financial Corp., 2016
WL 384773 (9th Cir. 2016) (Hurwitz, J.). The
Ninth Circuit held that “the announcementof an SEC investigation related to an alleged
misrepresentation, coupled with a subsequentrevelation of the inaccuracy of thatmisrepresentation, can serve as a corrective
disclosure for the purpose of loss causation.”In the case before it, the Ninth Circuit
found that the announcement of an SEC
investigation into CVB’s “loan underwriting
methodology and allowance for credit losses”
could be deemed a corrective disclosure
because CVB later wrote down certain of theloans in question and designated other loans
as non-performing.

Court Finds Plaintiffs Adequately
Alleged Falsity and Scienter as to
Two Alleged Misrepresentations
Plaintiffs challenged as materially misleading
a statement in CVB’s 2009 Form 10-K,
filed in March 2010, representing that thecompany was “not aware of any . . . loans asof December 31, 2009 for which known credit
problems of the borrower would cause serious
doubts as to the ability of such borrowers tocomply with their loan repayment terms.”
Plaintiffs also asserted claims in connection
with CVB’s “nearly identical ‘no serious
doubts’ statement in a 10-Q filed on May
10, 2010” that “differed from the previous‘no serious doubts’ statement[] only in that
it was ‘as of March 10, 2010.’” According toplaintiffs, both statements were misleading
because Garrett Group, CVB’s largest
borrower had “told CVB in early January 2010that unless modifications to loan terms were
made, Garrett could not meet its obligations
and might file for bankruptcy.”
The Ninth Circuit acknowledged that the
representation in CVB’s 2009 Form 10-K
may have been “[t]echnically . . . true, giventhat the critical meeting with Garrett did nottake place until January 2010.” However,the court found that “the statement was
plainly misleading when made.” The Ninth
Circuit explained that by the time CVB filed
its 2009 Form 10-K in March 2010, “CVB
had known for two months that there was abasis for serious doubts about the ability of
Garrett, CVB’s largest borrower, to repay.”
The court determined that “[t]he omissionof that fact, combined with the reassurance
that everything was fine as of December
31, 2009, [met] the pleading standard for amaterial omission.” The court found CVB’s
May 2010 “no serious doubts” statement
similarly misleading, and determined thatplaintiffs had adequately alleged scienter as toboth statements.
Notably, the Ninth Circuit concluded
that the district court had erroneously5“discounted” plaintiffs’ confidential witness
allegations regarding when CVB learnedof Garrett’s repayment challenges because
those allegations were based on hearsay.
The Ninth Circuit stated that “the fact thata confidential witness reports hearsay does
not automatically disqualify his statementfrom consideration in the scienter calculus.”
Rather, courts must “examine a confidential
witness’s hearsay report to determine if it issufficiently reliable, plausible, or coherent.”
Here, the Ninth Circuit determined thatthe confidential witness allegations were
“sufficiently reliable for pleading purposes”
because they were “specific in time, context,
and details, and involved important
communications from a chief executive officer
to his [b]oard.”

Court Holds CVB’s Announcementof an SEC Investigation into theCompany’s Loan Underwriting
Methodology and Allowance
for Credit Losses Constituted a
Corrective Disclosure
Turning to the question of loss causation, theNinth Circuit explained that “investors must
demonstrate that the defendant’s deceptive
conduct caused their claimed economic
loss.” The court noted that plaintiffs insecurities fraud actions “typically” satisfy thisrequirement by alleging “that the defendantrevealed the truth through corrective
disclosures which caused the company’s stock
price to drop and investors to lose money.”In the case at hand, “[t]he only significant
fall in CVB’s share price occurred after[the company’s] announcement” of an
SEC investigation into CVB’s underwriting
methodology and its allowance for credit
losses. The district court had found that thisannouncement did not qualify as a corrective
disclosure for loss causation purposes.
On appeal, the Ninth Circuit reversed the
district court’s ruling. The Ninth Circuit notedthat in Loos v. Immersion Corp., 762 F.3d
880 (9th Cir. 2014),2 it had previously heldthat “the announcement of an investigation,
standing alone and without any subsequent
disclosure of actual wrongdoing, does notreveal to the market the pertinent truth ofanything, and therefore does not qualify
as a corrective disclosure” (quoting Loos,
2. Please click here to read our prior discussion of the Loos
decision.

762 F.3d 880). However, the Ninth Circuit
explained that it had “left open [the questionof] whether the announcement of aninvestigation can ‘form the basis for a viable
loss causation theory’ if the complaint also
alleges a subsequent corrective disclosure by
the defendant” (quoting Loos, 762 F.3d 880).
In CVB, the Ninth Circuit “answer[ed] thatquestion in the affirmative.”
The Ninth Circuit observed that plaintiffs in
the instant action alleged “much more” thansimply the announcement of a government
investigation. Plaintiffs asserted that CVB’sshare price “dropped over 20% the day after
the announcement” of the SEC investigation,
but claimed that “the market hardly reacted
at all” a month later when “CVB disclosedthat it was charging off millions in Garrett
loans.” The Ninth Circuit found that themarket’s response “confirm[ed] that investors
understood [the announcement of the SEC
investigation] as at least a partial disclosureof the inaccuracy of the previous ‘no serious
doubts’ statements.” The court concluded
that plaintiffs had adequately alleged losscausation, and reasoned that “any other rulewould allow a defendant to escape liability by
first announcing a government investigationand then waiting until the market reacted
before revealing that prior representations
under investigation were false.”

The Ninth Circuit noted that its decision was“consistent” with the Fifth Circuit’s decisionin Public Employees’ Retirement System ofMississippi v. Amedisys, 769 F.3d 313 (5thCir. 2014).3 In that case, the Fifth Circuit
held that announcements of government
investigations into a company’s Medicare
billing practices could serve as corrective
disclosures for loss causation purposes “when‘viewed together with the totality of theother alleged partial disclosures’” (quoting
Amedisys, 769 F.3d 313).
3. Please click here to read our prior discussion of the Amedisys
decision.
6

Southern District of New
York: (1) Defendants Do Not
Have a Generalized Duty toDisclose SEC Investigationsand Wells Notices, and(2) Defendants Have No Duty
to Update Statements Made
Prior to the Class Period
On January 22, 2016, the Southern Districtof New York dismissed a securities fraud
action against Lions Gate Entertainment
Corporation alleging that the company had
a duty to disclose an SEC investigation andthe issuance of Wells Notices concerning
certain transactions designed to prevent a
minority stockholder from gaining control of
the company. In re Lions Gate Entertainment
Corp. Sec. Litig., 2016 WL 297722 (S.D.N.Y.
2016) (Koeltl, J.). The court held that there
is no “generalized duty to disclose” SEC
investigations and Wells Notices because,
among other reasons, “the securities laws
do not impose an obligation on a company
to predict the outcome of investigations.”
The court further ruled that defendants haveno duty to update or correct statements
made prior to the class period because there
would otherwise be a “never-ending duty of
disclosure.”

BackgroundIn the summer of 2010, Lions Gate andseveral of its executives (collectively,“defendants”) entered into a series oftransactions allegedly designed to prevent
Carl Icahn, a minority investor, from gaining
control of the company. Several months later,
the SEC initiated a formal investigation into
these transactions. In July 2012, the SEC’s
Enforcement Division issued several Wells
Notices 4 indicating that it was considering
recommending that the SEC file a civil action
against defendants.
In February 2014, Lions Gate signed
a settlement agreement with the SEC
pursuant to which the company agreed to
pay a civil penalty of $7.5 million and admit
4. As the court explained, “[a] Wells Notice informs therecipient that the SEC Enforcement Division staff has decided
to recommend that the [SEC] bring an enforcement proceeding,identifies alleged violations of securities law, and provides
potential defendants the opportunity to make a responsive
submission.”

wrongdoing under Sections 13(a) and 14(d)of the Securities Exchange Act. On March 13,
2014, the SEC both commenced and resolved
administrative proceedings against Lions
Gate. That same day, Lions Gate filed a Form
8-K disclosing the SEC investigation and theterms of its settlement with the SEC. Notably,
the SEC did not bring any action against Lions
Gate’s executives.
Shareholders subsequently brought suitalleging that “the SEC staff investigationand Wells Notices from the Enforcement
Division triggered a duty of disclosure.”
Plaintiffs contended that the failure todisclose the investigation and the Wells
Notices “rendered misleading statements
about the potential adverse effect of pending
litigation” in the company’s SEC filings
between February 2013 and March 2014.
Specifically, plaintiffs challenged Lions Gate’s
representation that it did “not believe thatthe outcome of any currently pending claims
or legal proceedings [would] have a material
adverse effect on the [c]ompany’s financial
statements.” Defendants moved to dismiss
plaintiffs’ claims.

Court Finds Defendants Had No
Duty to Disclose Either the SEC
Investigation or the Wells Notices
The court explained that “[s]ilence, absent
a duty to disclose, is not misleading under
Rule 10b-5.” Here, the court found that
“defendants did not have a duty to disclose
the SEC investigation and Wells Notices
because the securities laws do not impose
an obligation on a company to predict theoutcome of investigations.” The court further
explained that “[t]here is no duty to disclose
litigation that is not substantially certain tooccur.”
The court emphasized that the issuance of a
Wells Notice “does not necessarily indicatethat charges will be filed.” The court observedthat “the Enforcement Division may notproceed with a recommendation to commence
an action and the SEC may not authorize thefiling of an action even if the Enforcement
Division recommends it.” In the instantaction, the court noted that “the SEC neverproceeded with a charge that Lions Gate [had]violated Section 10(b) and Rule 10b-5 andnever proceeded with any litigation against
individual defendants, despite the issuance7

of Wells Notices discussing their potential
liability.”
The court found that the cases cited byplaintiffs purporting to support the existenceof a duty to disclose Wells Notices and SEC
investigations were “inapposite because(1) the defendants in those cases were subject
to a preexisting duty of disclosure under the
securities laws or [had] made express priordisclosures related to the investigation whichwere rendered materially misleading byomitting information about the investigation,and (2) the investigation itself was material.”
The court explained that those “cases standfor the proposition that when a company
speaks on a subject, it cannot omit material
facts about that subject, and cannot makea material misrepresentation about theexistence of an investigation.”
Here, plaintiffs did not allege that defendants
had made any statements during the classperiod about the transactions in question or
the SEC investigation of those transactions.
As to Lions Gate’s representation in its SEC
filings that it did not believe that pending
claims or legal proceedings would have amaterial adverse effect on the company’s
financial statements, the court found thatplaintiffs did not allege that “defendants’opinions were not supported by the facts
known to them at the time” as required under
the Supreme Court’s decision in Omnicare v.
Laborers Dist. Council Constr. Indus. Pension
Fund, 135 S. Ct. 1318 (2015).5
The court further determined that plaintiffs
had “failed to allege that the investigation
itself was material” given that the final SEC
penalty “was less than one percent of Lions
Gate’s consolidated revenue . . . for thethird quarter of 2014.” The court noted that
this was “much lower than the five percent
numerical threshold that the . . . Second
Circuit has determined is a ‘good starting
place for assessing the materiality of[an] alleged misstatement’” (quoting ECA,
Local 134 IBEW Joint Pension Tr. Of Chicago
v. JP Morgan Chase, 553 F.3d 187 (2dCir. 2009)).
The court rejected plaintiffs’ contention that
defendants had a duty to disclose the SEC
investigation because there was a “reasonable
likelihood that the [SEC] penalty could havematerially affected” Lions Gate’s financials.”
5. Please click here to read our prior discussion of the Omnicare
decision.

The court found that “[t]he securities laws
do not require a company to hypothesize
the worst results of an investigation whenthose results do not materialize and when
the company chooses not to speak about
the investigation.”

Court Holds Defendants Have No
Duty to Correct Statements Made
Prior to the Class Period
The court found meritless plaintiffs’ claimthat defendants had a “duty to correct”
statements they had made before the start ofthe class period concerning the transactions at
issue. The court explained that under Second
Circuit precedent, there is no “duty to correct
previous misstatements” if “defendants madethe original statements before the [c]lass[p]eriod and became aware of the errors inthose statements before the [c]lass [p]eriod”(citing Lattanzio v. Deloitte & Touche, 476
F.3d 147 (2d Cir. 2007)). The court reasoned
that “[a]ny other rule would undercut themeaning of the [c]lass [p]eriod and eviscerate
the statute of limitations” because “[i]tcould always be argued that allegedly false
statements made long before the [c]lass[p]eriod and outside the statute of limitations
should be corrected by a statement within
the [c]lass [p]eriod.” The court foundthat “impos[ing] a never-ending duty of
disclosure would circumvent the general rulethat pre[-][c]lass [p]eriod statements are
not actionable.”

Court Finds Defendants Have
No Duty to Disclose Government
Investigations and Wells Notices
Under Regulation S-K
The court also rejected plaintiffs’ argumentthat defendants were required to disclose the
SEC investigation and Wells Notices under
Regulation S-K. First, the court explainedthat “a failure to make a required disclosure
under Item 303 [of Regulation S-K] in a Form
10-Q filing is an omission that can serve as
the basis for a Section 10(b) securities fraudclaim” only “if it satisfies the materiality
requirement under Basic.” Here, the court
determined that the investigation at issue was
not material under either the Basic test or
Item 303’s “distinct materiality test,” which
provides that “[n]o information need be given
with respect to any proceeding that involves
primarily a claim for damages if the amount8

involved, exclusive of interest and costs, does
not exceed 10 percent of the current assetsof the registrant and its subsidiaries on aconsolidated basis” (quoting Item 303 ofRegulation S-K).
Second, the court found that “an investigation
alone is not a ‘pending legal proceeding’ ora ‘proceeding [ ] known to be contemplated
by governmental authorities’” within themeaning of Item 303 of Regulation S-K.
The court reasoned that when the SEC
conducted its investigation in the instantaction, “the SEC had not yet decided
whether it would charge Lions Gate andthe individual defendants with securities
violations.” Similarly, the court found that“the issuances of the Wells Notices did
not mark the beginning of a ‘pending legal
proceeding’” because “[a] Wells Notice only
informs an individual or company that the
SEC Enforcement Division staff is considering
recommending that the SEC file an action.”
Finally, the court found that “[a]n SEC
investigation [cannot] be characterized asa ‘known trend’ or ‘uncertainty’ under Item303,” or as a “risk factor” under Item 503(c)of Regulation S-K. The court explained thatthe complaint did “not plausibly allege” thatthe civil penalty assessed “put Lions Gate’s
profits at risk or made the stock ‘risky’ as aresult of Lions Gate’s ongoing operations.”

Court Finds GAAP Does
Not Mandate Disclosure of
SEC Investigations
The court further determined that defendants
were not required to disclose the SEC
investigation and the Wells Notices underAccounting Standards Certification Topic 450(“ASC 450”), which addresses the disclosureof certain loss contingencies. First, the court
found that the investigation was not a loss
contingency for ASC 450 purposes because
it “was not pending or threatened litigation.”
Second, the court determined that there was“no plausible allegation that the amount of
the loss could have been estimated” until after
Lions Gate had reached a potential settlementwith the SEC.

Court Holds Plaintiffs Failed toAllege Scienter
Finding “no clear case law that would require
the disclosure of the SEC investigation andthe Wells Notices in the absence of a preexisting duty to disclose,” the court held thatplaintiffs could not “show that the defendants[had] acted in reckless disregard of the
securities laws.” The court further found that“an inference against scienter” was supported
by numerous factors, “including . . . the small
civil penalty the SEC imposed relative to the[c]ompany’s net assets, the uncertainty ofwhether the Commission would move forwardwith the proceedings against Lions Gate,and the fact [that] the Commission neverbrought charges against individual officers ordirectors.” The court concluded that “[t]hemore cogent inference [was] that Lions Gate
did not specifically disclose the investigation
until the settlement had been concluded
because it did not believe that there was arequirement to do so.”Southern District of New York:Adverse Interest Exception
to the General Rule Imputing
an Executive’s Scienter to the
Corporation Does Not Apply
If the Corporation Benefited
From the Executive’s Fraud
On February 3, 2016, the Southern Districtof New York held that a corporate executive’s
scienter could be imputed to the corporationeven though the executive had personallyprofited from undisclosed related party
transactions with the corporation. Dragon
State Int’l v. Keyuan Petrochemicals, 2016
WL 439022 (S.D.N.Y. 2016) (Crotty, J.).
The court determined that plaintiffs had
adequately pled corporate scienter because
the executive’s misconduct allegedly benefited
the corporation.

Court Finds Plaintiffs Adequately
Alleged Scienter as to theCompany’s CEO, and DeterminedThat the CEO’s Scienter Could Be
Imputed to the Company
Plaintiffs alleged that Keyuan International
had falsely represented both in public
filings and the company’s stock purchaseagreement (“SPA”) that it “had not engaged
in undisclosed related party transactions.”
The company later acknowledged that it hadin fact engaged in “hundreds of millions of9

dollars in previously undisclosed related
party transactions” with entities connected to
Keyuan’s CEO, Chungfeng Tao.
The court found that the allegations were
sufficient to raise a strong inference of
scienter as to Tao. The court explained that
because Tao signed Keyuan’s SPA and its
public filings, “Tao constituted a ‘maker’of statements contained therein and wasbound to disclose all required information.”
Moreover, “Tao was [allegedly] closely
tied to sizeable undisclosed related party
transactions that substantially impacted
Keyuan’s sales.” The court found that a strong
inference of scienter arises where, as here,“the complaint alleges that defendant ‘knew
facts or had access to information suggestingthat their public statements were notaccurate’” (quoting Novak v. Kasaks, 216 F.3d
300 (2d Cir. 2000)).
The court further held that these same
allegations were also sufficient to establish

Keyuan’s corporate scienter. The court
explained that in order to plead corporate
scienter under Second Circuit precedent,“the pleaded facts must create a strong
inference that someone whose intent could
be imputed to the corporation acted withthe requisite scienter” (quoting Teamsters
Local 445 Freight Div. Pension Fundv. Dynex Capital, 531 F.3d 190 (2d Cir.
2008)). Notably, the court rejected Keyuan’scontention that its CEO’s “alleged misconduct[could not] be imputed to the company since
Tao was motivated by self-interest, and to
Kenyan’s detriment.” The court found thatthe complaint “allege[d] a possible motive(quoting Keyuan’s own public filings) for
Tao’s misconduct that would benefit Keyuan:
the company [had] engaged in related party
transactions ‘to overcome the restrictions
regarding the use of certain bank loans or
to satisfy the banks’ internal requirements
to demonstrate the usage of the loans.” Thecourt therefore held that Keyuan’s CEO’s
scienter could “be imputed to Keyuan.”

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).

10

New York

Los Angeles

Mark G. Cunha+1-212-455-3475
mcunha@stblaw.com

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

Michael D. Kibler+1-310-407-7515
mkibler@stblaw.com

Paul C. Curnin+1-212-455-2519
pcurnin@stblaw.com

Thomas C. Rice
+1-212-455-3040
trice@stblaw.com

Chet A. Kronenberg+1-310-407-7557
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Susannah S. Geltman+1-212-455-2762
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Mary Kay Vyskocil+1-212-455-3093
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Nicholas S. Goldin+1-212-455-3685
ngoldin@stblaw.com

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

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David J. Woll
+1-212-455-3136
dwoll@stblaw.com

Joseph M. McLaughlin+1-212-455-3242
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Jonathan K. Youngwood+1-212-455-3539
jyoungwood@stblaw.com

Alexis S. Coll-Very+1-650-251-5201
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James G. Kreissman+1-650-251-5080
jkreissman@stblaw.com

Washington, D.C.
Peter H. Bresnan+1-202-636-5569
pbresnan@stblaw.com
Jeffrey H. Knox
+1-202-636-5532
jeffrey.knox@stblaw.com
Cheryl J. Scarboro+1-202-636-5529
cscarboro@stblaw.com
Peter C. Thomas+1-202-636-5535
pthomas@stblaw.com

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