Securities Law Alert
In This Edition:• Second Circuit Finds Janus’s Definition of What It Means “to Make” a Misstatement Under Rule 10b-5 Does
Not Apply to Section 17(a)(2)• Second Circuit Holds SLUSA Only Precludes Claims Based on Allegations of Fraudulent Conduct (1) by the
Defendant (2) That Are Not “Extraneous” to Plaintiffs’ Theory of Liability• Second Circuit Affirms Dismissal of a Securities Fraud Action Against the Royal Bank of Scotland, Finding
Optimistic Statements Concerning the ABN Amro Acquisition to Be Inactionable Puffery• Eleventh Circuit Dismisses Securities Fraud Action Against Jiangbo Pharmaceuticals’ CFO and Auditor on
Scienter Grounds Based on Plaintiffs’ Failure to Allege a Sufficiently Specific Theory of Fraud• Southern District of New York Holds (1) Newman’s “Personal Benefit” Requirement Applies in
Misappropriation Cases; and (2) a Tippee May Be Civilly Liable for Recklessly Disregarding the Tipper’s
Receipt of a Personal Benefit• Delaware Chancery Court Finds Breach of Master Limited Partnership Agreement by General Partner for
Failure to Evaluate Related Party Transaction Properly
April 2015

SimpsonThacher“[d]emonstrates
considerable expertisein the current multitude of
RMBS-related cases, while
also continuing to impress
highly in M&A litigation.”–Chambers USA
2014

Second Circuit Finds Janus’s
Definition of What It Means to“Make” a Misstatement Under
Rule 10b-5 Does Not Apply to
Section 17(a)(2)
In Janus Capital Group v. First Derivative
Traders, 131 S. Ct. 2296 (2011), the Supreme
Court defined what it means to “make”
a statement for purposes of Rule 10b-5.
The Janus Court held that “the maker ofa statement is the person or entity withultimate authority over the statement,
including its content and whether and how tocommunicate it.”1

On April 9, 2015, the Second Circuit held theJanus “Court’s definition of ‘to make’ in Rule10b-5 does not apply to [Section] 17(a)(2)”of the Securities Act of 1933. U.S. Sec. & Exch.
Comm’n v. Big Apple Consulting USA, 2015
WL 1566925 (2d Cir. 2015) (Siler, Jr., J.).
Section 17(a)(2) renders it unlawful “for any
person in the offer or sale of any securities… to obtain money or property by means of
any untrue statement of a material fact or any
omission to state a material fact.” The Second
Circuit found that the phrase “by means of
any untrue statement” in Section 17(a)(2)“encompasses a broader range of conduct
than ‘mak[ing]’ such a statement as defined in
SEC Rule 10b-5(b)” (emphasis added by the
court).

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

1

Background
The SEC brought suit against Big Apple
Consulting and its wholly owned subsidiary,
MJMM (collectively, “defendants”) in
connection with their provision of public
relations and investor relations services to
CyberKey Solutions, a company that soldcustomizable USB drives. CyberKey allegedly
falsely represented in press releases that it
had received a $25 million purchase orderfrom the Department of Homeland Security.
The SEC contended that defendants either“knew, or were severely reckless in notknowing, that CyberKey” had no purchaseorders from the federal government and infact “had very little legitimate revenue at all.”Nevertheless, defendants allegedly “persisted
in promoting CyberKey and selling hundredsof millions of unregistered CyberKey shares tounsuspecting investors.”
Following a trial, a jury found that defendants
had violated Section 17(a). Defendants
appealed. Among other arguments,
defendants asserted that the district court had
erred in submitting the Section 17(a) claims
to the jury in light of the Supreme Court’s
decision in Janus. Defendants argued that“because they did not have ultimate authority
over the content of CyberKey’s press releases,
they could not be considered ‘makers’ of any
material misstatements and thus could not beliable under the provisions of Section 17(a),”which defendants characterized as “largely
coextensive in scope” to the provisions ofRule 10b-5.

Second Circuit Determines Janus’s“Maker” Definition Is Inapplicable
to Section 17(a)(2) Because
Section 17(a)(2) Is Broader Than
Rule 10b-5(b)On appeal, the Second Circuit rejected
defendants’ contention that the Janus Court’s
definition of “make” “extends to claims
brought under [Section] 17(a) of the Securities
Act.”
First, the Second Circuit found “untenable”
defendants’ attempt “to import the [Janus]
Court’s narrow holding to the entirety of[Section 17(a)]” because subsections (1) and(3) of Section 17(a)—like subsections (a) and(c) of Rule 10b-5—“do not use the word ‘make’or even address misstatements.” The Second
Circuit found the Janus Court “did not alter
the potential for liability under Rule 10b-5(a)and (c).” Even after Janus, a defendant “whois not the ‘maker’ of an untrue statement ofmaterial fact” could “nonetheless … be liable
as a primary violator of Rule 10b-5(a) and(c).” The Second Circuit explained it would be“incongruous” to apply Janus “to remove thepotential for liability under” Sections 17(a)(1)and (3) given that “Rule 10b-5(a) and (c)[were] modeled” after those provisions.
The Second Circuit also deemed meritlessdefendants’ contention that “the Court’s
holding in Janus should apply to [Section]17(a)(2)” because “[Section] 17(a)(2) isthe analogue to Rule 10b-5(b).” The court
explained that the text of Rule 10b-5(b) differsfrom “the expansive language of [S]ection
17(a)(2).” Under Rule 10b-5(b), a defendant
may not “make any untrue statement of amaterial fact or [ ] omit to state a materialfact” in connection with the purchase orsale of securities. Section 17(a)(2), however,prohibits defendants from “obtain[ing]money or property” in connection with “theoffer or sale of any securities” “by means of
any untrue statement of a material fact or any
omission to state a material fact” (emphasis
added by the court). While a defendant can
only be held liable under Rule 10b-5(b) for“mak[ing]” a material misstatement, theSecond Circuit found that a defendant may
be liable under Section 17(a)(2) regardless ofwhether the defendant “use[d] his own false
statement or one made by another individual”(quoting SEC v. Tambone, 550 F.3d 106 (1stCir. 2008)). The Second Circuit “decline[d]… defendants’ invitation to supplant thelanguage of [Section] 17(a)(2) with words
taken from” Rule 10b-5(b).
Finally, the Second Circuit found Janus
inapplicable to Section 17(a)(2) for the
additional reason that the Janus Court
addressed the implied private right of action
under Rule 10b-5. The Janus Court statedthat it was “mindful” of the need to “givenarrow dimensions … to a right of action
Congress did not authorize when it firstenacted the statute and did not expand
when it revisited the law” Janus, 131 S. Ct.
2296. The Second Circuit explained that “thesame concern regarding the expansion of a
judicially-created private cause of action”
does not apply with respect to claims under
Section 17(a)(2) because “there is no privateright of action under [Section] 17(a).”2Second Circuit Holds SLUSA
Only Precludes Claims Basedon Allegations of Fraudulent
Conduct (1) by the Defendant(2) That Are Not “Extraneous”
to Plaintiffs’ Theory of
Liability
In its April 23, 2015 decision, the Second
Circuit addressed “the scope of the Securities
Litigation Uniform Standards Act of 1998(‘SLUSA’), … which bars the maintenance of
certain state-law-based class actions alleging
falsity in connection with transactions in …
‘covered securities.’” In re Kingate Mgmt.
Ltd. Litig., 2015 WL 1839874 (2d Cir. 2015)(Leval, J.). The Second Circuit determinedthat “SLUSA requires courts … to inquire
whether an allegation is of [fraudulent]
conduct by the defendant, or by a third party.”
The court held that “claims of false conduct inwhich the defendant is not alleged to have had
any complicity are not” “subject to SLUSA’s
prohibition”(emphasis in the original).
The Second Circuit also held that “[i]f theallegation [of fraudulent conduct by the
defendant] is extraneous to the complaint’s
theory of liability, it cannot be the basis for
SLUSA preclusion.”

Background
Plaintiffs brought suit in the Southern
District of New York alleging a multitudeof state law-based claims against various
defendants affiliated with Kingate Global
Fund and Kingate Euro Fund (the “Funds”),
two “feeder funds” for Bernard L. Madoff
Investment Securities. In March 2011, theSouthern District of New York dismissed
plaintiffs’ claims on SLUSA grounds.
The court “concluded that because someallegations in the complaint involved material
misstatements in connection with thepurchase or sale of a covered security, the[c]omplaint should be dismissed in its
entirety.” Plaintiffs appealed.

Second Circuit Finds Plaintiffs’
Claims Satisfy SLUSA’s “inConnection with” Requirement
The Second Circuit began its analysis bydetermining whether plaintiffs’ claims
satisfied “SLUSA’s requirement that the false

conduct be ‘in connection with’ a transactionin ‘covered securities.’” The court explainedthat in In re Herald, 753 F.3d 110 (2d Cir.
2014), it had previously interpreted theSupreme Court’s decision in Chadbourne &Parke LLP v. Troice, 134 S. Ct. 1058 (2014),2
to find that SLUSA precluded claims broughtby plaintiffs who had invested in offshore
funds based on the expectation that the funds
would then invest the proceeds in S&P 100
stocks. The Herald court distinguished Troice
because there, plaintiffs “were not seeking,directly or indirectly, to purchase covered
securities.” Herald, 753 F.3d 110. The Herald
plaintiffs, however, had made “attempted
investments in covered securities, albeit
through feeder funds.”
The Second Circuit found that the Kingate
plaintiffs, “like the Herald plaintiffs, [had]purchased the uncovered shares of theoffshore Funds, expecting that the Funds
were investing the proceeds in S&P 100
stocks, which are covered securities.” Kingate,2015 WL 1839874. The court therefore
determined that SLUSA’s “in connection
with” requirement was met.

Second Circuit Holds SLUSA
Preclusion Applies Only to
Claims Alleging False Conduct by
the Defendant
The Second Circuit then considered “themeaning of SLUSA’s ambiguous use of theword ‘alleging’” insofar as SLUSA precludes
covered class actions “alleging … [false
conduct] in connection with the purchase orsale of a covered security.” The court foundthat “the history and the purposes of thisprovision all favor interpreting it to apply tostate law claims predicated on conduct by
the defendant that is specified in SLUSA’s
operative provisions referencing the antifalsity proscriptions of the 1933 and 1934
Acts” (emphasis in the original). The court
reasoned that “[s]uch allegations would be
subject to the [Private Securities Litigation
Reform Act (‘PSLRA’)] if pleaded as a private
securities claim,” and therefore “[c]ouching[those claims] as state law claims would
escape the PSLRA’s limitations.” The Second
Circuit explained that “[i]nterpreting SLUSA
to apply” “whenever a falsity in connection
with a transaction in a covered security is anecessary predicate of the plaintiffs’ claim,
2. Please click here to read our prior discussion of the Troice
decision.
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even where the falsity is not chargeable tothe defendant and the claim could not havebeen brought under the federal securities laws
… would bar state law claims in a manner
unrelated to SLUSA’s purposes.”
The Second Circuit clarified that there
were “two caveats and a limitation” toits holding that SLUSA only precludes
claims alleging fraudulent conduct by the
defendant in connection with transactions
in covered securities. First, the court foundthat plaintiffs cannot “evade SLUSA bycamouflaging allegations that satisfy thisstandard in the guise of allegations that donot.” The court explained that “[w]hen the
success of a class action claim depends ona showing that the defendant committedfalse conduct conforming to SLUSA’s
specifications, the claim will be subject to
SLUSA, notwithstanding that the claim
asserts liability on the part of the defendantunder a state law theory that does not include
false conduct as an essential element—such as breach of a contractual right to fairdealing” (emphasis in the original). The court
further stated that “if the success of a claim
depends on conduct specified in SLUSA, andthe defendant was complicit in that conduct,
the claim is covered by SLUSA even though
plaintiffs … artfully avoided using SLUSA’s
terms.”
Second, the court ruled that “SLUSA may
apply even though there is no private claim… for that violation under the 1933 and 1934
Acts.” The court reasoned that while SLUSA“requires an allegation of conduct prohibitedby the anti-falsity provisions of the 1933 and1934 Acts that are referenced in SLUSA,”the statute “does not require an allegationof conduct for which the 1933 and 1934 Acts
authorize a private right of action” (emphasisin the original).
Finally, the court recognized that certain“[s]tate law fraud prohibitions … are notdefined in a manner that refers explicitly
to securities transactions, much less totransactions in ‘covered’ securities.” The
Second Circuit held that “where a state law
class-action claim charges the defendant withliability based on conduct violative of the antifalsity provisions of the 1933 and 1934 Acts as
referenced in SLUSA but does not allege thesupplemental status-based elements specified
in SLUSA, such as the ‘covered’ status of therelevant security, the court may nonethelessascertain those facts independently of [ ]plaintiffs’ allegations and apply SLUSA whenthose facts are present.”

Second Circuit Rules “Peripheral”
Allegations of False Conduct
Cannot Serve as the Basis for
SLUSA Preclusion
The Second Circuit also considered whether“the falsity of the conduct alleged in thecomplaint” must “be essential to the state
law theory of liability” in order for SLUSA
preclusion to apply. The court recognizedthat under “the broadest of interpretations,[the term] ‘alleging’ could mean that SLUSA
applies to any claim that includes any
reference whatsoever to the false conduct
specified in SLUSA, even if the false conduct
is completely irrelevant to the state law theoryof [ ] defendants’ liability.”
Rejecting this approach, the Second Circuit
held that an allegation of fraud “cannot
be the basis for SLUSA preclusion” if it is“extraneous to the complaint’s theory of
liability.” The court explained that“[a]ny factual assertion in a complaint canbe considered an ‘allegation,’ regardlessof whether the asserted fact pertains in
any way to the defendant or has any rolein establishing the defendants’ liability.”
Because “[c]omplaints are drafted not only
to comply with the legal requirements forsetting forth an actionable claim, but also
at times for public relations purposes,” they
may “include assertions intended for the eyesof the press” that are “unrelated to the legal
theory of the complaint.” The Second Circuit
therefore found that “SLUSA requires courts
to inquire whether [an] allegation is necessary
to or extraneous to liability under the state
law claims” before determining whether
that allegation can serve as the basis for
SLUSA preclusion.

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Second Circuit Holds Dismissal of
the Entire Action Is Not Warranted
If SLUSA Precludes Some (But NotAll) of Plaintiffs’ Claims
The Second Circuit determined that the
district court had erred in dismissing
plaintiffs’ entire action after finding that
SLUSA precluded some (but not all) ofplaintiffs’ claims. The court explained that“[t]he district court was required to conduct[its SLUSA] analysis on a claim-by-claim
basis.”
The court found that under longstanding
Second Circuit precedent, “only the claims
covered by SLUSA’s terms should [have]be[en] dismissed” (citing Dabit v. Merrill
Lynch, Pierce, Fenner & Smith, Inc., 395 F.3d
25 (2d Cir. 2005), rev’d on other grounds byDabit, 547 U.S. 71)). The court stated that thisposition is “clearly correct” because “SLUSA
does not say that a class action containing
a claim that falls within the statute’s terms‘must be dismissed.’” Rather, SLUSA “asserts
the very different command—that no coveredclass action based on the law of any state andincluding the necessary allegations ‘may be
maintained in any State or Federal court byany private party’” (emphasis added by the
court). The Second Circuit observed that“[i]f the court dismisses the claims thatcome within SLUSA’s terms and allows theother claims to proceed,” then “the surviving
action which is ‘maintained’ does not include
allegations precluded by SLUSA.”The Second Circuit vacated the district court’s
decision, and remanded the action for further
proceedings consistent with its opinion.

Second Circuit Affirms
Dismissal of a Securities
Fraud Action Against theRoyal Bank of Scotland,
Finding Optimistic Statements
Concerning the ABN Amro
Acquisition to Be Inactionable
Puffery
On April 15, 2015, the Second Circuit affirmed
dismissal of a securities fraud action against
the Royal Bank of Scotland (“RBS”). IBEW
Local Union No. 58 Pension Trust Fund &Annuity Fund v. Royal Bank of Scotland
Grp., 2015 WL 1653788 (2d Cir. 2015) (Chin,J.). The court determined that RBS’s positive
statements concerning its acquisition of
ABN Amro were inactionable expressions of“general corporate optimism.” In addition, thecourt held that RBS’s alleged understatementof its subprime exposure by less than 5%
was immaterial pursuant to the guidance set
forth in the SEC’s Staff Accounting Bulletin(“SAB”) No. 99. Finally, the Second Circuitalso found immaterial RBS’s representationthat the United Kingdom’s Financial Services
Authority (“FSA”) had “encouraged,” rather
than “required,” RBS to raise additional
capital in April 2008.

Second Circuit Holds Optimistic
Statements Concerning the
ABN Amro Acquisition Were
Not Actionable Because Those
Statements Were Not Worded as
Guarantees, Nor Was There Any
Allegation That RBS Did Not Believe
the Statements at the Time They
Were Made
Plaintiffs contended that RBS had “made[a number of] false statements” regarding
its April 2007 acquisition of ABN Amro, aDutch bank. For example, RBS had statedthat “[t]he integration of ABN Amro [was]off to a promising start” and that RBS’s“positive view” of the transaction had “beenconfirmed.” Plaintiffs claimed that thesestatements “were misleading” because, inplaintiffs view, “ABN Amro was sufferingsignificant losses and the acquisition [hadbeen] ‘an unmitigated disaster for RBS.’”The Second Circuit found that RBS’s
positive statements concerning the ABN
Amro acquisition were nothing more than“inactionable puffery.” The court explainedthat “[s]tatements of general corporate
optimism, such as these, do not give rise to
securities violations.” The Second Circuitrecognized that “[s]tatements of corporate
optimism may be actionable if ‘they are
worded as guarantees or are supported by
specific statements of fact, or if the speaker
does not genuinely or reasonably believe
them.” Here, however, the court determinedthat RBS’s statements were “not worded as
guarantees” and “there [were] no allegations
that defendants did not reasonably believe”
the statements at the time they were made.
5Second Circuit Finds RBS’s Alleged
Understatement of Its Subprime
Exposure Immaterial Under SAB
No. 99With respect to plaintiffs’ claims that had“RBS [had] understated its [subprime]
exposure in its December 2007 press release,”
the Second Circuit found that the “allegedly
undisclosed” amount “constitute[d] less than
4% of RBS’s total asset backed securities
exposure, and less than 1% of its total assets.”
The Second Circuit explained that thisalleged understatement was “presumptively
immaterial” under SAB No. 99, which“provides that a misstatement related to lessthan 5% of a financial statement carries apreliminary presumption of immateriality.”
The court further found that the “qualitative
factors” enumerated in SAB No. 99 did“not favor treating [RBS’s] presumptively
immaterial statements as material
statements.” The Second Circuit noted thatplaintiffs did “not allege that the amountof exposure could have been calculated
precisely, mask[ed] a change in earnings,
change[d] a loss into income or vice versa, or
involve[d] an unlawful transaction, or thatthe misstatements resulted in a significant
positive market reaction.”

Second Circuit Determines
RBS’s Representation That
the FSA “Encouraged” Rather
Than “Required” RBS to Raise
Additional Capital Was Not aMaterial Misstatement

CEO “purportedly ‘specifically required’
RBS to conduct a Rights Issue.” Second,the court explained that “critical facts werealready known to the investing market: RBS
needed an infusion of capital; it was taking
additional write-downs; the FSA was closely
monitoring RBS’s situation and encouraging a
Rights Issue; and there was generally a steep
deterioration in market conditions and credit
market outlooks.” Finally, the court found it
significant that there was no determinationthat RBS had “violated [the] FSA’s minimum
capital guidelines.” Given “these contexts,”
the Second Circuit held that “a reasonable
investor would have deemed the difference
between ‘encouraged’ and ‘required’ to beimmaterial.”
Judge Leval issued an opinion concurringin part, but dissenting from the majority’s
decision with respect to RBS’s alleged
misstatements concerning the Rights Issue. In
Judge Leval’s view, “[t]he fact that RBS had
decided to raise capital before being told by
the FSA that it had to do so [did] not change
the fact that it was required to raise capital.”Moreover, Judge Leval disagreed with the
majority’s view that “a reasonable investor
would see no material difference between
the acknowledged fact that RBS had been
‘encouraged’ by the FSA to raise capital and afurther statement that it had been ‘required’by the FSA to do so.” Judge Leval opined that“the difference is substantial” and found thata “reasonable investor would [have] want[ed]to know” that the FSA had “required” RBS toraise capital.

Plaintiffs alleged that RBS had
misrepresented the reasons for its £12 billion
Rights Issue in April 2008. According to
RBS, the FSA had “encouraged” RBS toraise capital. However, RBS made it clearthat RBS had not been “‘asked to raise
capital by anyone,’ including the FSA.”
Plaintiffs claimed that RBS’s “statements
were false” because the FSA’s CEO had infact “‘specifically required’ [RBS] to conduct
a Rights Issue to ‘raise as much capital as
possible.’”Eleventh Circuit Dismisses
Securities Fraud
Action Against Jiangbo
Pharmaceuticals’ Former
CFO and Auditor on Scienter
Grounds Based on Plaintiffs’
Failure to Allege a Sufficiently
Specific Theory of Fraud

Following a review of “[t]he timeline of events
leading up to RBS’s allegedly false statement,”
the Second Circuit determined that plaintiffs
had “fail[ed] to plead the basis for a securities
fraud claim.” First, the court found that
RBS “had already started preparations for
the Rights Issue” five days before the FSA’s

On March 25, 2015, the Eleventh Circuit
affirmed dismissal of a securities fraud
action against Jiango Pharmaceuticals’ CFO
and auditor on scienter grounds. Brophy
v. Jiangbo Pharm., 781 F.3d 1296 (11thCir. 2015) (Pryor, J.). The court found thatplaintiffs had “fail[ed] to allege a theory6

of fraud that [was] specific enough in its
scope or [its] connection to [either thecompany’s CFO or its auditor] to support astrong inference of scienter.” Notably, thecourt rejected plaintiffs’ contention that thecompany’s former CFO “must have known”
of the alleged fraud given her position at
the company.

Background
In May 2011, less than a year after Jiango
Pharmaceuticals became a publicly traded
company, the company disclosed that the
SEC had formally launched an investigation
into the company’s reported cash balances,
and also disclosed that it had defaulted ona debt payment. The company’s share pricequickly plummeted in the days and months
that followed. Plaintiffs subsequently broughta securities fraud action against Jiangbo, its
principal officers, as well as its audit firm,
Frazer LLP.
Plaintiffs alleged that Elsa Sung, Jiangbo’s
former CFO, and Frazer, Jiangbo’s auditor,
had “misrepresented the company’s cash
balances and failed to disclose a material
related-party transaction.” The district court
dismissed plaintiffs’ claims against both Ms.
Sung and Frazer for failure to allege fraudwith the specificity required under the Private
Securities Litigation Reform Act (“PSLRA”).
Plaintiffs appealed.

Eleventh Circuit Rejects Plaintiffs’
Contention That Jiangbo’s Former
CFO “Must Have Known” About theAlleged Fraud Given Her Role at
the Company
On appeal, the Eleventh Circuit rejected
plaintiffs’ attempt to establish scienter byclaiming that “the disparity between Jiangbo’s
actual and reported cash balances” was solarge “that it would have been difficult or
impossible for Ms. Sung not to have known
about it in her capacity as CFO.” The court
noted that plaintiffs’ “fail[ure] to allege any
particular amount or even a range” by which
Jiangbo’s cash balances were overstated“weaken[ed] any inference of scienter to be
drawn from the magnitude of the alleged
overstatements.” The Eleventh Circuit also
found meritless plaintiffs’ claim that “anumber of red flags,” including the SEC
investigation and the company’s allegedly“dysfunctional internal controls,” “shouldhave put Ms. Sung on notice of the fraud.”
The court explained that “the complaint
provide[d] no explanation as to how these redflags should have alerted her to the fraud.”
The court stated that since plaintiffs did notdescribe “how these vaguely defined problems
would have affected financial reporting or
how Ms. Sung would have known about
them,” it could not “rely” on those allegations“to add much weight to an inferenceof scienter.”
The Eleventh Circuit found that plaintiffs
essentially wanted the court to “rely solely on
Ms. Sung’s position as CFO to overlook [the]omissions and ambiguities in the complaint.”
In support of this argument, plaintiffs “cite[d]cases in which courts [have] recognized astrong inference of scienter based in parton a senior financial executive’s oversightof the processes that produce a company’s
financial statements.” The Eleventh Circuit
deemed those cases inapposite because they
all “involve[d] particularized allegations
that the executives knew or were severely
reckless in disregarding how those processes
were distorted by fraud.” Here, however,plaintiffs had “allege[d] no particularizedfacts that directly show[ed] [that] Ms. Sungintended to deceive shareholders or knew
about or was severely reckless with respect
to deficiencies in reporting.” For example,
plaintiffs “offer[ed] no allegations describing
Ms. Sung’s day-to-day practices as CFO or
identifying any specific misconduct apartfrom confirming incorrect cash balances
within filings and on conference calls.”
The Eleventh Circuit held that in the absenceof “more particularized allegations,” plaintiffs’“claim that Jiangbo’s fraud was too large
for Ms. Sung not to have noticed [was]unpersuasive.” The court determined that“[t]he seriousness of Jiangbo’s errors and
Ms. Sung’s proximity to those errors at mostimpl[ied] negligence, which is not enough toestablish scienter.”7

Eleventh Circuit Finds theInference of Scienter as to Jiangbo’s
Auditor Even Weaker Than theInference as to Jiangbo’s Former
CFO Because the Auditor Was “aStep More Removed” From theAlleged Indicators of Fraud
The Eleventh Circuit found that “[i]f theinference of scienter against Ms. Sung [was]tenuous, then the corresponding inference
against Frazer [was] even more attenuated.”
The court explained that “[a]s an external
auditor, Frazer was a step more removed
than Ms. Sung from any alleged indicatorsof the fraud.” Here, plaintiffs did not specify“in what ways Frazer’s audit was deficient,”
nor was there any “allegation that Frazer had
extensive involvement with the company
beyond what was required to conduct a single
audit.”“Ultimately,” the court held that “theinvestors’ allegations against Frazer suffer[ed]from the same overarching deficiency as thoseagainst Ms. Sung: they fail[ed] to articulatea theory of the fraud with any particularity.”
The court observed that “[a]lthough theallegations against Ms. Sung and Frazer
might survive motions to dismiss under a lessburdensome pleading standard, the PSLRA
imposes a high bar.” The Eleventh Circuit
therefore affirmed dismissal of the complaint
as to both Ms. Sung and Frazer.

Southern District of New York
Holds (1) Newman’s “Personal
Benefit” Requirement Appliesin Misappropriation Cases;and (2) a Tippee May Be
Civilly Liable for Recklessly
Disregarding the Tipper’s
Receipt of a Personal Benefit
In United States v. Newman, 773 F.3d 438(2d Cir. 2014), a case brought under the“classical” theory of insider trading, theSecond Circuit held that a tippee can only beliable for insider trading if “the tippee knewof the tipper’s breach, that is, he knew the
information was confidential and divulged
for a personal benefit.” On April 6, 2015,
the Southern District of New York held that
Newman’s “personal benefit” requirement

also applies in cases brought under the“misappropriation” theory of insider trading.
Sec. & Exch. Comm’n v. Payton, 2015 WL
1538454 (S.D.N.Y. 2015) (Rakoff, J.). The
court also held that a tippee “may be civilly
liable” for trading on material nonpublic
information if the tippee either “knew or
recklessly disregarded” the tipper’s receipt
of a personal benefit in exchange for thedisclosure of that information (emphasis
added).

BackgroundAt issue were allegations that Michael
Dallas, a law firm associate, had disclosed
information concerning IBM’s pending
acquisition of SPSS to his roommate, Trent
Martin, who was a registered broker-dealer
at the time. The SEC alleged that Martin
had “tipped inside information about the
SPSS acquisition” to his roommate, Thomas
Conradt, a lawyer affiliated with a New York
broker. According to the SEC, Martin andConradt “shared a close, mutually-dependent
financial relationship, and had a history of
personal favors.” For example, “Conradt took
the lead in organizing and paying sharedexpenses for the apartment,” and assisted
Martin when he ran into legal trouble inconnection with a street altercation. Several
days after the street altercation incident,
Conradt purchased SPSS securities.
Conradt allegedly disclosed information
concerning the SPSS acquisition to two of hiscolleagues. The SEC claimed that Conradt
informed his two colleagues that he had
obtained the information from his roommate.
The two colleagues then purchased SPSS
securities. The SEC subsequently brought civil
insider trading claims against Conradt’s twocolleagues (“defendants”), on the grounds
that defendants knew that Martin had
misappropriated the information concerning
the SPSS acquisition and had inappropriately
disclosed this information to Conradt.

Court Holds Newman’s “Personal
Benefit” Requirement Applies
Even in Misappropriation Cases
Involving Remote Tippees
The SEC contended that Newman’ s “personal
benefit” requirement should not apply incases brought under the “misappropriation”
theory of insider trading, in which “anoutsider (i.e., not part of the company
8

whose stock is to be traded) … embezzles
material nonpublic information … and theneither trades on it or, in return for a benefit,
provides it for trading purposes to a tippee.”
The SEC argued that “a remote tippee’s
knowledge that the inside informationemanated from an act of misappropriation
should be sufficient to charge the remotetippee, for it is the equivalent of knowledge
that the tippee is the knowing recipient ofstolen property.”
The Southern District of New York rejected
the SEC’s contention. The court explainedthat in Newman, the Second Circuit expressly
stated that “[t]he elements of tipping liability
are the same, regardless of whether the
tipper’s duty arises under the ‘classical’ orthe ‘misappropriation’ theory” of insider
trading (quoting Newman, 773 F.3d 438).
While the Second Circuit’s statements “werenot technically necessary to the resolution of
the case,” the Southern District of New York
found that “these statements seem so clearly
intended to give guidance to the lower courtsof this Circuit that” the court “[took] themas binding.”

Court Finds the SEC Sufficiently
Alleged the Tipper’s Receipt of a
Personal Benefit for Disclosure of
the Material Nonpublic Information
The court next considered whether the SEC
had “sufficiently alleged that Martin, thetipper, [had] received a personal benefit fordisclosing material nonpublic information
about the SPSS acquisition to Conradt.” Thecourt explained that in Dirks v. SEC, 463
U.S. 646 (1983), the Supreme Court statedthat a “personal benefit” could be found if
there is “a relationship between the insider
and the recipient that suggests a quid proquo from the latter, or an intention to benefit
the particular recipient.” The Dirks Court
further stated that a personal benefit may“also exist when an insider makes a gift ofconfidential information to a trading relativeor friend.” In Newman, however, “theSecond Circuit held that, to the extent Dirks
suggests that a benefit may be inferred froma personal relationship, ‘such an inference
is impermissible in the absence of proof of ameaningfully close relationship that generates
an exchange that is objective, consequential,
and represents at least a potential gain ofa pecuniary or similarly valuable nature’”(quoting Newman, 773 F.3d 438).

While the court recognized that it may bedifficult “to reconcile the two” decisions,the court found that the SEC’s allegations
satisfied “any definition of ‘benefit’ set forthin either Dirks or Newman.” Here, theSEC contended that Martin and Conradt
were roommates whose “expenses were
‘intertwined.’” The SEC also alleged that
Martin had thanked Conradt for his legal
assistance, and “told Conradt he was
happy that Conradt [had] profited from the
SPSS trading because Conradt had helpedhim.” The court found these allegations“indicative [of] Martin’s intent to benefit
Conradt at the time of the disclosure of theinformation, as well as evidence of a quid pro
quo relationship.”

Court Determines the SEC
Adequately Alleged Defendants
Recklessly Disregarded Whether
the Tipper Had Received a Personal
Benefit for Disclosing the Material
Nonpublic Information
The court next considered the SEC’s
allegations as to whether Conradt’s colleagues(the defendants in this action) knewthat Martin had personally benefited bydisclosing information concerning the SPSS
acquisition to Conradt. The court explainedthat a defendant may be “guilty of criminal
insider trading only if that person committed
the offense ‘willfully,’ i.e., knowingly andpurposely.” However, the court found thata defendant “may be civilly liable if that
person committed the offense recklessly,that is, in heedless disregard of the probableconsequences.” The court stated that incivil cases, it is “inclined to define unlawful
insider trading broadly, so as to effectuate theremedial purposes behind the prohibition ofsuch trading.”
Turning to the case before it, the court heldthat the complaint “more than sufficiently
allege[d] that defendants knew or recklessly
disregarded that Martin [had] received apersonal benefit in disclosing information toConradt, and that Martin in doing so [had]breached a duty of trust and confidence tothe owner of the information.” The court
noted that defendants allegedly “knew that
Martin was the source of the tip to Conradt,”
and “that Conradt and Martin were friends
and roommates.” One of the two defendants
also allegedly knew of “Martin’s assaultarrest.” Moreover, defendants allegedly “took9multiple steps to conceal their own trading
in SPSS securities.” The court determinedthat these allegations were “enough to raise
the reasonable inference that [ ] defendants
knew that Martin’s relationship with Conradt
involved reciprocal benefits.”

Delaware Chancery Court
Finds Breach of Master
Limited Partnership
Agreement by General Partner
for Failure to Evaluate Related
Party Transaction Properly
In an April 20, 2015 memorandum opinion
written by Vice Chancellor Laster, theDelaware Court of Chancery, in In Re El
Paso Pipeline Partners, L.P. Derivative
Litigation, found that the general partnerof El Paso Pipeline Partners, L.P. (the“partnership”), a publicly traded master
limited partnership (“MLP”), breached thepartnership’s limited partnership agreement
and ordered the general partner to pay $171
million in damages.3 The court found that theindependent directors serving on the conflicts
committee of the general partner’s board of
directors failed to form a subjective belief
that a sale of assets from the partnership’s
parent, El Paso Corporation (“parent”) to
the partnership (a transaction commonly
known as a “dropdown”) was in the bestinterests of the partnership, as required by
the limited partnership agreement. Although
the opinion is consistent with previous
MLP cases in that the court evaluated theconflicts committee’s actions under the
express contractual provisions of the limited
partnership agreement rather than traditional
fiduciary duties applicable to directors in thecorporate context, the opinion demonstrates
that even when directors are subject tocontractually limited fiduciary standards,
their conduct will not be immune fromscrutiny by wary Delaware courts in conflictof-interest transactions.

Discussion
In 2010, the partnership was a publicly
traded MLP. Fifty-two percent of thecommon units and the entire general partner
3. The partnership’s existence as a publicly traded MLP ended in2014 when the partnership became a wholly owned subsidiary ofKinder Morgan (which also owns the general partner).

interest of the partnership were owned by
the parent. As owner of the general partner,
the parent controlled the partnership andwas entitled to appoint all of the directors of
the general partner. In the Spring of 2010,
the partnership and the parent engaged
in a dropdown transaction (the “Spring
dropdown”) where the parent sold to thepartnership a fifty-one percent interest in two
subsidiaries that owned a 190-mile natural
gas pipeline and a liquefied natural gas
terminal. In the Fall of 2010, the parent andthe partnership engaged in another dropdown(the “Fall dropdown”) where the parent soldto the partnership the remaining forty-nine
percent interest in the assets transferred in
the Spring dropdown plus a fifteen percent
interest in a separate parent subsidiary that
owned a 7,600 mile natural gas pipeline.
The limited partnership agreement authorized
the general partner to approve interested
party transactions such as dropdowns by
one of four different paths, one of which was“Special Approval,” which required that a
conflicts committee consisting of independent
board members of the general partner
approve a transaction in the good faith belief
that the transaction is in the best interestsof the partnership. Special Approval was thepath taken for both the Spring dropdown andthe Fall dropdown.
Delaware courts have previously held that agood faith standard similar to the one in thelimited partnership agreement requires onlythat the conflicts committee have a subjective
good faith belief that the proposed transaction
is in the best interests of the MLP and does
not impose any objective or reasonablenessstandard with respect to a “belief.” To prevail
on a claim that the conflicts committee
breached its contractual duty of good faith,
the plaintiff cannot merely show that abelief was unreasonable or misguided
but rather must prove either (1) that theconflicts committee acted in subjective badfaith, meaning that the conflicts committee
believed that the dropdowns were not in
the best interests of the MLP, or (2) that theconflicts committee consciously disregarded
its contractual duty to form a subjective belief
that the transaction was in the best interestsof the MLP.4

4. Allen v. Encore Energy Partners, L.P., 72 A.3d 93, 104-106(Del. 2013).
10

The plaintiff filed suits challenging the Spring
dropdown and the Fall dropdown, alleging
that the general partner breached the limited
partnership agreement. The court granted
summary judgment in favor of the defendants
with respect to the Spring dropdown ina separate opinion decided on June 12,20145 and partially denied the defendant’s
motion for summary judgment as to the Fall
dropdown in a separate order issued on June
12, 2014.6
In a post-trial decision, the court concluded
that the general partner had breached thelimited partnership agreement with respect to
the Fall dropdown. The court made a numberof findings which led to its conclusion that theconflicts committee failed to form a subjective
good faith belief that the Fall dropdown
was in the best interests of the partnership.
The court cited communications among
the members of the conflicts committee inwhich they expressed the view that the Fall
dropdown would not be in the best interestsof the partnership as well as communications
discussing their views regarding the values for
the Spring dropdown and the Fall dropdown,
5. In Re El Paso Pipeline Partners, L.P. Derivative Litigation,2014 WL 2768782 (Del. Ch. 2014).
6. In Re El Paso Pipeline Partners, L.P. Derivative Litigation,2014 WL 2641304 (Del. Ch. 2014) (Order).

which were significantly below the amounts
eventually paid in both transactions. The
court also concluded that the committee
members did not view their job as one ofevaluating whether the Fall dropdown wasin the best interests of the partnership but
rather believed they were merely supposed todetermine whether the Fall dropdown would
be accretive, which the court emphasized
is a measure of the short term impact of atransaction on the level of distributions toequity holders rather than an indication of thelong term value created by a transaction. The
court also criticized the conflicts committee
for having fallen into a “comfortable pattern”
in approving dropdowns and failing tonegotiate seriously with the parent.
Finally, the court was critical of the analysis
undertaken by the committee’s financial
advisor. In particular, the court pointed out
a number of inconsistencies between theanalysis prepared by the financial advisor
for the Spring dropdown and the analysis
prepared for the Fall dropdown even though
the transactions involved, in part, the sameassets. The court criticized both the absenceof clearly articulated reasons for the changes
in the financial advisor’s analyses between
the Spring dropdown and the Fall dropdown
and the conflicts committee’s apparent
unawareness of these changes.

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

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