Securities Law Alert
In This Edition:• Seventh Circuit: Respondents in Pending SEC Administrative Proceedings May Not Bypass the Judicial
Review Process Established in 15 U.S.C. § 78y by Bringing Constitutional Challenges to the SEC’s Authority
Directly in Federal Court• Tenth Circuit: Failure to Comply with a Securities Regulation Disclosure Requirement Is Insufficient,Standing Alone, to Raise a Strong Inference of Scienter• Northern District of Texas: Court Applies Halliburton II to Deny Class Certification as to Certain Alleged
Corrective Disclosures Where Halliburton Proved Those Disclosures Had No Price Impact• Southern District of New York: “Adverse Interest” Exception to the General Rule Attributing a Corporate
Executive’s Scienter to the Corporation Does Not Apply If the Corporation Benefited From the Executive’s
Fraud
August 2015

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Seventh Circuit:
Respondents in Pending SEC
Administrative Proceedings
May Not Bypass the Judicial
Review Process Establishedin 15 U.S.C. § 78y by Bringing
Constitutional Challenges to
the SEC’s Authority Directly inFederal Court
On August 24, 2015, the Seventh Circuit
held that a respondent in a pending SEC
administrative enforcement proceeding may
not “skip the administrative and judicial
review process” established in 15 U.S.C.
§ 78y by bringing suit in federal court to“challeng[e] on constitutional grounds
the authority of the SEC to conduct theproceeding.” Bebo v. SEC, 2015 WL 4998489(7th Cir. 2015) (Hamilton, J.) (Bebo II). The
court found it “‘fairly discernible’” from thestatute that Congress intended respondents
in SEC administrative proceedings “‘toproceed exclusively through the statutory

review scheme’ set forth in 15 U.S.C. § 78y”
(quoting Elgin v. Dep’t of Treasury, 132 S. Ct.
2126 (2012)).

BackgroundPursuant to § 929(P) of the Dodd-Frank WallStreet Reform and Consumer Protection
Act of 2010, the SEC has a choice of fora
when seeking monetary penalties against
non-regulated individuals. The SEC may
either “proceed in federal district court or
conduct its own administrative enforcement
proceeding.” There are “proceduralconsequences” to the SEC’s choice of
forum. For instance, the SEC’s Rules ofPractice, rather than the Federal Rules of
Evidence and Civil Procedure, govern SEC
enforcement proceedings. Respondents in
SEC enforcement proceedings therefore
have “fewer rights to discovery” than do
respondents in district court proceedings,
and “no right to a jury trial before the SEC.”
However, respondents in SEC proceedings
do have the right to seek federal appellate
review of final SEC decisions in the circuit
court for the district in which they reside or1

work, or before the District of Columbia Courtof Appeals. See 15 U.S.C. § 78y(a)(1). The
appellate court may then affirm, modify, or
set aside the SEC’s final decision entirely.
In December 2014, the SEC filed anadministrative enforcement action alleging
securities law violations against the former
CEO of Assisted Living Concepts, Inc.,
Laurie Bebo. “Rather than wait[ing] for theadministrative process to end and pursu[ing]judicial review as prescribed by § 78y,”
Bebo brought suit in the Eastern District of
Wisconsin challenging the SEC’s authority
to conduct the administrative proceedingon constitutional grounds. Plaintiff asserted
that “§ 929P(a) of Dodd-Frank [was]facially unconstitutional under the Fifth
Amendment because it provide[d] the SEC[with] ‘unguided’ authority to choose which
respondents [would] and which [would] notreceive the procedural protections of a federal
district court, in violation of equal protection
and due process guarantees.” Plaintiff further“contend[ed] that the SEC’s administrative
proceedings [were] unconstitutional under
Article II because the [administrative law
judges] who preside[d] over SEC enforcement
proceedings [were] protected from removal
by multiple layers of for-cause protection.”
Plaintiff claimed that “[t]his set-up violate[d]Article II … because it interfere[d] with the
President’s obligation to ensure the faithfulexecution of the laws.”

The district court found plaintiff’s claims“compelling and meritorious,” but determinedthat her claims were “subject to the exclusive
remedial scheme” established by the DoddFrank Act governing SEC enforcement
proceedings. Bebo v. SEC, 2015 WL 905349(E.D. Wis. Mar. 3, 2015) (Randa, J.). The
court held that plaintiff was required to“litigate her claims before the SEC and then,if necessary, on appeal to the Court of Appeals
for the Seventh Circuit.” Plaintiff appealed.

Seventh Circuit Holds Respondents
in Pending SEC Administrative
Enforcement Proceedings May Not
Bring Constitutional Challenges
to the SEC’s Authority in Federal
Court Because 15 U.S.C. § 78y
Provides for Meaningful Judicial
Review of Such Challenges
On appeal, the Seventh Circuit explained thatthe question before it was “a jurisdictional
one: whether the statutory judicial review
process under 15 U.S.C. § 78y bars district
court jurisdiction over a constitutional
challenge to the SEC’s authority when theplaintiff is the respondent in a pending
enforcement proceeding.” The court
recognized that, in Free Enterprise Fundv. Public Company Accounting Oversight
Board., 561 U.S. 477 (2010), the Supreme
Court “held that § 78y does not strip district
courts of jurisdiction to hear at least certain
types of constitutional claims.” The Bebo
II court explained that its “focus in thisappeal” was to assess “whether Bebo’s case[was] sufficiently similar to Free Enterprise
Fund to allow her to bypass the [SECadministrative enforcement proceeding] andjudicial review under § 78y.”
In Free Enterprise Fund, plaintiffs broughtsuit in federal district court challenging
the constitutionality of provisions of the
Sarbanes-Oxley Act of 2002 that establisheda special SEC-appointed oversight board
for accounting firms. Final decisions of thespecial oversight board were subject to federal
appellate review pursuant to 15 U.S.C. § 78y.
Significantly, plaintiffs were not subject to any
pending SEC enforcement actions at the timethey brought suit.
The Free Enterprise Fund Court found that“plaintiffs would not [have] be[en] able toreceive meaningful judicial review without
access to the district courts” because § 78y“provides [only] for judicial review of finalorders of the SEC and not every adverse
action by the [special oversight] board wouldbe ‘encapsulated in a final Commission
order or rule.’” To obtain judicial review
under § 78y, plaintiffs would have beenrequired either to (1) seek SEC review of one
or more of the “board’s auditing standards,
registration requirements or other rules”; or(2) “invite a sanction from which to appeal byintentionally violating one of the board’s rules
or by ignoring a request for documents or2

testimony.” The Free Enterprise Fund Court
therefore held that the district court could
exercise jurisdiction over plaintiffs’ claims.
The Bebo II court found that, “[u]nlike in FreeEnterprise Fund, meaningful judicial review[was] available to [plaintiff] under§ 78y.” The court reasoned that since plaintiff
was “already the respondent in a pending
enforcement proceeding,” she would nothave to “select and challenge a Board rule
at random” or “risk incurring a sanction
voluntarily just to bring her constitutional
challenges before a court of competentjurisdiction.” The court explained that “[a]fter
the pending enforcement action ha[d] run its
course, [plaintiff could] raise her objections
in a circuit court of appeals established under
Article III.”
Significantly, the Bebo II court found“no evidence … that Congress intended
for plaintiffs like Bebo who [were]already subject to ongoing administrative
enforcement proceedings to be able tostop those proceedings by challenging theconstitutionality of the enabling legislation or
the structural authority of the SEC.” The court
found it “‘fairly discernible’ that Congress
intended Bebo to proceed exclusively throughthe statutory review scheme establishedby § 78y because that scheme provides formeaningful judicial review in ‘an Article
III court fully competent to adjudicate
petitioners’ claims’” (quoting Elgin v. Dep’t ofTreasury, 132 S. Ct. 2126 (2012)).
The court therefore affirmed dismissalof plaintiffs’ claims for lack of subject
matter jurisdiction.

Tenth Circuit: Failure toComply with a Securities
Regulation Disclosure
Requirement Is Insufficient,Standing Alone, to Raise aStrong Inference of Scienter
On August 18, 2015, the Tenth Circuit
affirmed dismissal of a securities fraud
action alleging that ZAGG, Inc. had failed
to disclose the number of company shares
pledged as collateral in a margin account by
the company’s then-CEO, in violation of Item403(b) of Regulation S-K. In re ZAGG, Inc.
Sec. Litig., 2015 WL 4901893 (10th Cir. 2015)(Tymkovich, J.) (ZAGG II). The court agreed
with defendants that “the bare identificationof a securities regulation violation is notenough,” standing alone, to raise a strong
inference of scienter.

Background
Item 403(b) of Regulation S-K requires
companies to disclose “the amount of sharesthat are pledged as security” in accounts heldby the company’s directors and officers. 17
C.F.R. § 229.403(b). Plaintiffs asserted that
Robert Pedersen, ZAGG’s former CEO andChairman, had “failed to disclose in several
of ZAGG’s SEC filings the fact that he had
pledged nearly half of his ZAGG shares,
amounting to approximately 9 percent of thecompany, as collateral in a margin account.”
ZAGG’s SEC filings during the class period“revealed Pedersen’s total share of ownershipbut did not … indicat[e] the amount of his

3shares pledged as security” as required under
Item 403(b).

with the knowledge that they omitted arequired disclosure.”

Between December 2011 and August 2012,
Pedersen sold ZAGG shares on three separate
occasions in order to meet margin calls. Eachtime, Pedersen filed a Form 4 disclosing thesale. On August 17, 2012, ZAGG announced
that Pedersen was stepping down as CEO andChairman. The company also “filed a Form
8-K with the SEC stating that the company
had implemented a policy prohibiting officers,
directors, and 10 percent shareholders frompledging ZAGG securities on margin.”

The court rejected plaintiffs’ contention that it
was “implausible that Pedersen did not knowof [Item 403(b)’s] requirement to disclose
his pledged shares.” The court explainedthat plaintiffs’ argument “assume[d] that
Pedersen [had] read and prepared thedisclosures, and knew the omission would
mislead investors.” The court found plaintiffs
had alleged no particularized facts showingthat “Pedersen appreciated [this] risk at thetime the disclosures were made.” The court
further found that “Pedersen’s position in
the company [was] also an insufficient basis
from which to impute his knowledge ofthe reporting violation.” Finally, the court
deemed “unpersuasive” the fact that Pedersen
had “executed Sarbanes-Oxley (SOX)
certifications stating that he [had] reviewed
the filings and the information contained
therein was accurate.” The court determinedthat plaintiffs had not alleged any facts
showing that Pedersen knew these “sworn
SOX statements were false at the time they
were made.”

Plaintiffs subsequently brought suit alleging
that “the company’s SEC filings [had] omitted
material information regarding Pedersen’spledged shares,” and that this omission“resulted in the artificial inflation of ZAGG’sshare price.” Defendants moved to dismiss.
On February 7, 2014, the District of Utahdismissed plaintiffs’ complaint on scientergrounds. In re ZAGG Sec. Litig., 2014 WL
505152 (D. Utah. 2014) (Benson, J.). The
court found plaintiffs had neither “allege[d]any facts [showing] that Pedersen knewthat his failure to reveal his pledges would
likely mislead investors,” nor pled “anyparticularized facts that might give rise toa strong inference that the pledged shareswere ‘so obviously material’ that Pedersen
must have been aware that [his] nondisclosure would likely mislead investors.”
Plaintiffs appealed.

Tenth Circuit Finds a Failure
to Comply with a Securities
Regulation Disclosure Obligation
Insufficient to Raise an Inferenceof Scienter Absent Particularized
Allegations Showing Defendant
Knew of or Recklessly Disregarded
the Disclosure Requirement
On appeal, the Tenth Circuit found it“undisputed that ZAGG’s annual reports
and proxy statements filed during theclass period should have disclosed bothPedersen’s total ownership and ‘by footnote
or otherwise, the amount of shares that[were] pledged as security.’” ZAGG II,2015 WL 4901893 (quoting 17 C.F.R.
§ 229.403(b)). The court held, however,that “the fact of [an Item 403(b) disclosure]violation [was] insufficient” to raise aninference of scienter “without some otherfacts evidencing Pedersen signed the filings

Plaintiffs alternatively claimed that Pedersen
had “acted with a reckless disregard of
a substantial likelihood of misleading
investors” in failing to comply with Item403(b)’s disclosure requirements. The Tenth
Circuit explained that “recklessness in [thesecurities fraud] context is a particularly highstandard, … something closer to a state ofmind approximating actual intent.” The court
found that it could not “say that … a failure tocomply with Item 403(b)[ ] … [was] evidenceof conduct that was an extreme departurefrom the standards of ordinary care, … or akinto conscious disregard,” particularly giventhat Pedersen had “personally disclosed themargin account after each margin call.”Tenth Circuit Finds Company’s
Subsequent Margin Account Policy
Changes Did Not Support anInference of Scienter
The Tenth Circuit further determined that“neither Pedersen’s forced resignation nor
ZAGG’s implementation of a new policy
prohibiting officers, directors, and 10 percent
shareholders from pledging company
securities in margin accounts help[ed]to establish an earlier intent to defraud.”
The court found that ZAGG’s margin4

account policy changes and Pedersen’s
forced resignation were “at most an
acknowledgement that the company [had]identified a better way of doing things moving
forward, not an indicator that fraudulent
intent existed at the time the allegedomissions occurred.”
The court found that any inference of
scienter was not “at least as compelling”
as “the plausible, nonculpable inference
that Pedersen did not know Item 403(b)’srequirement and … believed he [had]appropriately disclosed the margin account …
following each margin call.” The Tenth Circuit
therefore affirmed dismissal of plaintiffs’
complaint for failure to allege scienter.

Northern District of Texas:
Court Applies Halliburton II
to Deny Class Certification
as to Certain Alleged
Corrective Disclosures Where
Halliburton Proved Those
Disclosures Had No Price
ImpactIn Halliburton Co. v. Erica P. John Fund,
Inc., 134 S. Ct. 2398 (2014) (HalliburtonII), the Supreme Court held that defendants
are entitled to rebut the presumption ofreliance set forth in Basic Inc. v. Levinson,
485 U.S. 224 (1988) at the class certification
stage by presenting evidence that the alleged
misrepresentation or corrective disclosure
had no price impact.1 The Halliburton
II Court vacated the district court’s classcertification order in a long-running securities
fraud action against Halliburton Company,
and remanded the action for further
proceedings consistent with its opinion.
On July 25, 2015, the Northern Districtof Texas applied the Court’s guidance inHalliburton II to deny plaintiffs’ motion
for class certification in the Halliburton
action as to claims involving five of thesix alleged corrective disclosures at issue.
Erica P. John Fund, Inc. v. Halliburton Co.,2015 WL 4522863 (N.D. Tex. 2015) (Lynn,
J.) (Halliburton III). The court found that
1. Click here to read our prior discussion of the Halliburton II
decision.

Halliburton had successfully rebutted the
Basic presumption by proving that these fivealleged corrective disclosures had no impact
on the company’s stock price. However, thecourt determined that Halliburton had failed
to prove a lack of price impact as to one of thealleged corrective disclosures, and granted
plaintiffs’ motion for class certification withrespect to claims concerning that disclosure.

Background
The Northern District of Texas firstconsidered plaintiffs’ motion for classcertification in 2008. The court declined tocertify the class on the ground that plaintiffs
had not proved loss causation, as required
under applicable Fifth Circuit precedent.
Archdiocese of Milwaukee Supporting
Fund, Inc. v. Halliburton Co., 2008 WL
4791492 (N.D. Tex. Nov. 4, 2008). The Fifth
Circuit affirmed. Archdiocese of Milwaukee
Supporting Fund, Inc. v. Halliburton Co.,
597 F.3d 330 (5th Cir. 2010). The Supreme
Court subsequently vacated the Fifth Circuit’s
decision, holding that plaintiffs “need not”
“prove loss causation in order to obtainclass certification.” Erica P. John Fund, Inc.
v. Halliburton Co., 131 S. Ct. 2179 (2011)(Halliburton I).2 The Court remanded theaction for further proceedings consistent with
its opinion.
On remand, Halliburton sought to overcome
the Basic presumption by presenting evidence
that the alleged misrepresentations had no
price impact. The Northern District of Texas
found that consideration of price-impact
evidence was not appropriate at the classcertification stage, and granted plaintiffs’
motion for class certification. Archdioceseof Milwaukee Supporting Fund, Inc. v.
Halliburton Co., 2012 WL 565997 (N.D. Tex.
Jan. 27, 2012). The Fifth Circuit affirmed.
Erica P. John Fund, Inc. v. Halliburton Co.,
718 F.3d 423 (5th Cir. 2013). Once again, theSupreme Court granted certiorari.
In Halliburton II, the Supreme Court
held that “defendants must be afforded an
opportunity before class certification todefeat the [Basic] presumption throughevidence that an alleged misrepresentation
did not actually affect the market priceof the stock.” 134 S. Ct. 2398. The Court
explained that under Basic, “‘[a]ny showing
2. Click here to read our prior discussion of the Halliburton I
decision.
5that severs the link between the alleged
misrepresentation and … the price received(or paid) by the plaintiff … will be sufficient
to rebut the presumption of reliance’ because‘the basis for finding that the fraud had beentransmitted through market price would begone’” (quoting Basic, 485 U.S. 224). The
Halliburton II Court found that“[p]rice impact is thus an essential
precondition for any Rule 10b-5 class action.”
The Court determined that, “[w]hile Basic
allows plaintiffs to establish that precondition
indirectly, it does not require courts to ignore
a defendant’s direct, more salient evidence
showing that the alleged misrepresentation
did not actually affect the stock’s market
price and, consequently, that the Basicpresumption does not apply.”
The Supreme Court vacated the classcertification order in the Halliburton case andremanded the action for further proceedings
consistent with its opinion in Halliburton
II. Plaintiffs subsequently moved for classcertification as to claims in connection
with six allegedly corrective disclosures.
Prior to ruling on plaintiffs’ motion forclass certification, the Northern District ofTexas held an evidentiary hearing in which
both parties presented expert testimony onwhether the alleged corrective disclosures
impacted Halliburton’s stock price.

Court Finds Defendants Havethe Burden of Both Production
and Persuasion on the Issueof Price Impact at the Class
Certification StageAs an initial matter, the Northern District ofTexas noted that “[t]he Supreme Court did
not state expressly in Halliburton II whether
plaintiffs or defendants must carry the burdenof persuasion to show price impact or lackthereof.” Halliburton III, 2015 WL 4522863.
Based on its “analysis of … Halliburton II,
and decisions by other district courts since
Halliburton II,” the court determined thatHalliburton bore “the burdens of production
and persuasion to show lack of price impact.”
The court held that it was up to Halliburton
to “persuade the [c]ourt that its expert’s event
studies [were] more probative of price impact
than [plaintiffs’] expert’s event studies.” Thecourt reasoned that if it required “plaintiffs tocarry the burden of persuasion to show priceimpact at the class certification stage,” then it“would, in effect, be requiring [plaintiffs] toprove price impact directly, a proposition theSupreme Court [in Halliburton II] refused toadopt.”
The court also rejected Halliburton’s attempt
to rely on Rule 301 of the Federal Rules of
Evidence to claim “that it should bear only
the burden of production” on the issue of
price impact. Rule 301 provides that “unlessa federal statute or [the Federal Rules of
Evidence] provide otherwise, the party
against whom a presumption is directed
has the burden of producing evidence torebut the presumption.” Rule 301 further
provides that it “does not shift the burdenof persuasion, which remains on the party
who had it originally.” The court found that“the fraud-on-the-market presumption is
atypical, and as a result, does not neatly fit
into the Rule 301 framework.” Halliburton
III, 2015 WL 4522863. The court explainedthat “a literal application of Rule 301 to thefraud-on-the-market presumption in a classcertification hearing would allow defendants
to preclude class certification by merely
putting on a reputable expert … [who could]
opine with 95% confidence that a corrective
disclosure had no effect on price.” Pursuant
to “Halliburton’s position on Rule 301,”
plaintiffs “would then be forced to move
forward and prove reliance without the aidof the presumption, which would doom
the class on predominance grounds.” Thecourt determined that “the Supreme Court
would not have modified the fraud-on-themarket presumption so substantially without
explicitly saying so.”Court Finds Class Certification Is
Not the Proper Stage at Which to
Determine Whether Disclosures
Are Corrective
The court declined to address Halliburton’scontention that “each of the alleged corrective
disclosures were not, in fact[,] corrective.”
The court found that the Supreme Court’s
decisions in Halliburton I, Halliburton II,
and Amgen Inc. v. Connecticut Retirement
Plans and Trust Funds, 133 S. Ct. 1184
(2013)3 “strongly suggest that the issue of
whether disclosures are corrective is not a
3. The court noted that, in Amgen, “the Supreme Court held that
securities fraud plaintiffs need not prove materiality at the classcertification stage” because materiality is “an element of a Rule10b-5 cause of action,” any challenge to “which is more properly
dealt with at trial or on a motion for summary judgment.” Pleaseclick here to read our prior discussion of the Amgen decision.
6

proper inquiry at the certification stage.”
The court explained that “Basic presupposesthat a misrepresentation is reflected in themarket price at the time of the transaction.”
For purposes of class certification, thecourt therefore “conclude[d] that theasserted misrepresentations were, in fact,
misrepresentations, and assume[d] that theasserted corrective disclosures were correctiveof the alleged misrepresentations.” The court
reasoned that “hold[ing] otherwise would
require the [c]ourt to pass judgment on the
merits of the allegations after the dismissal
stage and before summary judgment—ineffect, giving a third bite at the apple toHalliburton.”
The court further found that “Halliburton’sarguments regarding whether the disclosures
were corrective [were], in effect, a veiled
attempt to assert the ‘truth on the market’
defense, which pertain[ed] to materiality and[was] not properly before the [c]ourt” at theclass certification stage. The court explained
that, if it determined that a particular
disclosure was not corrective, such a finding
would not “cause[ ] individual questions oflaw and fact to predominate over common
questions.” Rather, “it would end [the]controversy altogether.”

Court Holds Five of the Six Alleged
Corrective Disclosures Had No
Price Impact
The court then turned to whether Halliburton
had proved that the alleged corrective
disclosures had no price impact. The court
explained that in order “[t]o show that acorrective disclosure had a negative impact
on a company’s share price, courts generally
require a party’s expert to testify based on an
event study that meets the 95% confidence
standard, which means ‘one can reject with
95% confidence the null hypothesis thatthe corrective disclosure had no impact on
price.’” The court further noted that “[a]nevent study is generally comprised of twoparts: (1) a calculation of the market-adjusted
price change in the issuer’s share price at thetime the corrective disclosure became public… ; and (2) a determination of whether thecorrective disclosure is among the [companyrelated] news that affected the price on thedate the disclosure became public.”
In the case before it, Halliburton’s expert
determined that there were 35 separate

dates on which plaintiffs alleged either amisrepresentation or a corrective disclosure.
Halliburton’s expert found that none of thealleged misrepresentations or corrective
disclosures had any price impact except for
Halliburton’s December 7, 2001 disclosureof an adverse asbestos-related verdict
against the company. As to that particular
disclosure, Halliburton’s expert opinedthat “there was no price reaction as to thealleged misrepresentation, which the [c]ourt
interpret[ed] to mean that the price reaction
was caused by [other] factors.” Plaintiffs’
expert conducted an event study only withrespect to the six alleged corrective disclosures
at issue, and found that “the market
responded significantly to each of these six
events.”Court Finds a Multiple-Comparison Adjustment
Was Warranted to Correct for the Possibility ofFalse Positives

Halliburton’s expert contended that a
multiple-comparison adjustment was
warranted where, as here, “a large numberof price reactions are tested for statisticalsignificance, because the more price reactions
tested, the greater the odds are of finding
statistical significance simply due to chance.”
While the court recognized that “multiple
comparison adjustments are rarely utilized
in event studies for securities litigation,”the court found that “the use of a multiple
comparison adjustment [was] proper inthis case because of the substantial numberof comparisons, thirty-five comparisons,being tested for statistical significance in[Halliburton’s expert’s] analysis.” However,the court determined that the particularmultiple-comparison adjustment thatHalliburton’s expert applied (the “Bonferroni
adjustment”) “generate[d] a relatively highincidence of … false negatives.” The court
therefore applied a different adjustment (the“Holm-Bonferroni adjustment”), which, inthe court’s view, “addresse[d] the multiple
comparison problem [of false positives]…
while also guarding against the prospect of
unacceptably high levels of [false negatives].”
Court Finds Plaintiffs’ Expert’s Peer Index
Should Be Used to Evaluate Price Impact

As to the relevant indices against which
to measure Halliburton’s stock pricemovement, Halliburton’s expert “selected
an index for each of Halliburton’s two mainlines of business—(1) energy services, and7

(2) engineering and construction (E&C).”
Halliburton’s expert used the S&P 500 Energy
Index and a Fortune E&C index. Plaintiffs’
expert, on the other hand, “constructed a peerindex composed of companies identified byanalysts as being Halliburton’s peers (‘Analyst
Index’).” The court determined that thisAnalyst Index “increase[d] the explanatory
power of [Halliburton’s expert’s model],” andfound that “it should be utilized in measuring
the statistical significance of the price reaction
on the six dates in question.”
Court Holds a Two-Day Window Cannot
Be Used to Measure Price Impact in an
Efficient Market

The court also considered whether thequestion of price impact should be analyzed
over a one- or two-day window following thealleged corrective disclosure. Significantly, thecourt held that, “in this case, the use of a twoday window [was] inappropriate to measure
price impact in an efficient market.” Thecourt reasoned that “[a]n efficient market issaid to digest or impound news into the stock
price in a matter of minutes.” As a result, thecourt determined that “an alleged corrective
disclosure released to the market at the startof Day 1, … followed by a price impact on Day
2, will not show price impact as to the alleged
corrective disclosure.”
Court Finds Halliburton Successfully Rebutted
the Basic Presumption of Reliance with Respect
to Five of the Six Alleged Corrective Disclosures

The court next assessed the evidence of
price impact as to each of the six corrective
disclosures alleged. The court found thatHalliburton had succeeded in rebutting the
Basic presumption of reliance by proving
a lack of price impact as to five of these
corrective disclosures.
With respect to Halliburton’s December 21,
2000 announcement of a $120 million aftertax charge in connection with restructuring
and charges on the company’s fixed-priceengineering and construction contracts,
the court found plaintiffs’ expert’s “use ofa two-day window [was] inconsistent with
an efficient market, especially where therelevant disclosure was made before themarket opened on Day 1.” As to Halliburton’sAugust 9, 2001 announcement concerning
an “upward trend” in new asbestos claims
and an increase in the company’s grossasbestos liability, the court found that thisinformation “both [was] already disclosed
and caused no statistically significant pricereaction.” The court similarly found thatHalliburton’s October 30, 2001 disclosureof an adverse asbestos-related jury verdict
had no price impact because “[p]ublicannouncements [of the jury verdict] preceded
Halliburton’s press release” and there was no
statistically significant price reaction to thoseannouncements. The court likewise foundthat Halliburton had proved a lack of priceimpact as to asbestos-related disclosures onJune 28, 2001 and December 4, 2001.
However, the court found that Halliburton
had failed to prove a lack of price impact
with respect to its December 7, 2001
announcement of an adverse asbestosrelated jury verdict finding Dresser, aHalliburton subsidiary, liable for $30
million in damages. On the date of theannouncement, Halliburton’s stock pricedropped by 40%. Halliburton contended
that the announcement had no price impact
by pointing to a stock price rebound on
December 10th, the second day of trading
following the announcement. The court
held that Halliburton could not rely on thisDay 2 price rebound to show an absenceof price impact “because to do so would beinconsistent with an efficient market, which issaid to digest or impound news into the stock
price in a matter of minutes.”
While the court found that “at least someof Halliburton’s stock price decline … [was]likely attributable to uncertainty in theasbestos environment that also impacted
other companies with asbestos exposure,” thecourt held that Halliburton had failed to provethat this “uncertainty caused the entirety ofHalliburton’s substantial price decline” on
December 7, 2001. The court determinedthat “the price impact on December 7 likely
reflected the market’s view of Halliburton’s
prior representations regarding its asbestos
liability and increased uncertainty in theasbestos environment.”
The court therefore granted plaintiffs’ motion
for class certification “only with respect to thealleged corrective disclosure of December 7,
2001.”

8

Southern District of New
York: “Adverse Interest”
Exception to the General
Rule Attributing a Corporate
Executive’s Scienter to the
Corporation Does Not Apply
If the Corporation Benefited
From the Executive’s Fraud
Under the “adverse interest” exception, a
corporate executive’s scienter will not be
imputed to the corporation if the executive
acted purely self-interestedly and against
the corporation’s interests. On July 30,
2015, the Southern District of New York heldthat the adverse interest exception did not
apply in a securities fraud action broughtin connection with an alleged bribery andkickback scheme involving Petróleo Brasileiro
S.A. (“Petrobras”). In re Petrobras Sec. Litig.,2015 WL 4557364 (S.D.N.Y. 2015) (Rakoff,J.).4 The court found that the allegations did
not “conclusively establish” that Petrobras
had “received no benefit from the [c]orrupt[e]xecutives’ actions, as required to render theadverse interest exception applicable.”
The court further held that it could not“conclude that … alleged misrepresentationsin Petrobras’ financial statements wereimmaterial as a matter of law” even though
the alleged misstatements did not necessarily“reach[ ] the five percent” threshold ofpresumptive materiality set forth in the SEC’s
Staff Accounting Bulletin (“SAB”) No. 99.
The court found that the qualitative factors
discussed in SAB No. 99 “strongly favor[ed]a finding of materiality” because the alleged
misstatements concerned the company’s corebusiness and its corporate integrity.

Background
Plaintiffs contended that Petrobras, its
subsidiaries, and certain former officers anddirectors of the company and its subsidiaries
had “made two categories of false andmisleading statements” in connection withan alleged “multi-year, multi-billion dollar
bribery and kickback scheme.” First, plaintiffs
alleged that “the corruption scheme rendered
the [c]ompany’s financial statements
4. The court’s July 30, 2015 opinion explained the reasoning
for its July 9, 2015 order granting in part and denying in part
defendants’ motion to dismiss plaintiffs’ claims.

materially false and misleading.” Specifically,
plaintiffs claimed that the reported value ofPetrobras’ property, plant, and equipment(“PP&E”) was “inflated by … bribe payments
and overcharges from [a construction]
cartel,” which were incorporated into theprice of Petrobras’ construction contracts.
Second, plaintiffs alleged that “Petrobras[had] made false and misleading statements
regarding the integrity of its management
and the effectiveness of its financial controls.”
Plaintiffs asserted claims under Section 10(b)and Rule 10b-5, among other claims.

Court Finds the Adverse Interest
Exception Inapplicable Because
Petrobras Allegedly Benefited
from the Corrupt Executives’
Alleged Fraud
With respect to the complaint’s allegations,defendants did not dispute that plaintiffs had
adequately pled scienter as to the company
executives who had allegedly “carried out thebribery scheme” (the “Corrupt Executives”).
However, defendants contended that “theadverse interest exception applie[d]” toshield the Petrobras entities from any
imputation of corporate scienter based on the
Corporate Executives’ knowledge “because theCorrupt Executives acted entirely to benefit
themselves and their political patrons, at the[c]ompany’s expense.”
The court explained that the “so-called‘adverse interest’ exception to the generalrule that a corporate executive’s scienter is
attributable to the corporation … applies[only] where ‘an officer acts entirely in his
own interests and adversely to the interests ofthe corporation’” (quoting Kirschner v. Grant
Thornton LLP, 2009 WL 1286326 (S.D.N.Y.
Apr. 14, 2009), aff’d sub nom. Kirschner v
KPMG LLP, 626 F. 3d 673 (2d Cir. 2010)).
The court underscored that a corporation’s“agents cannot be said to have ‘totallyabandoned’ the interests of the corporation”
for purposes of the adverse interest exception
if the “corporation benefit[ed] to any extent
from the fraudulent acts of its agents.”
Here, the court found the complaint plausibly
alleged that the bribery scheme caused thevalue of Petrobras’ PP&E to appear higher
than it actually was, “which in turn inflated
the value of Petrobras’ securities.” The court
determined that “the inflation of the[c]ompany’s PP & E operated as a fraud on
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the investing public, not on Petrobras itself.”
The court further found that the Corrupt
Executives’ alleged “failure to correct” thecompany’s compliance and internal controlrelated statements “clearly benefited the[c]ompany, which was able to continue toattract investment and to complete its largescale expansion plans.” Finally, the court
found that Petrobras allegedly “benefited
from” the corruption scheme by “remaining infavor with its political patrons.”
The court held that the allegations did “notconclusively establish that the [c]ompany
received no benefit from the Corrupt
Executives’ actions, as required to render theadverse interest exception applicable.” Thecourt therefore determined that the Corrupt
Executives’ alleged scienter could be imputed
to the corporation.5

Court Applies the Qualitative
Factors in SAB No. 99 to Find That
Alleged Misstatements Concerning
the Value of Petrobras’ Assets Were
Not Presumptively ImmaterialWith respect to alleged overstatements ofthe value of Petrobras’ assets, defendants
claimed that the company [had] “paid only
three percent more on the cartel contracts
than it would have under an honest bidding
system.” Defendants contended that “thethree percent bribe payment built into thecartel contracts did not materially affect theaccuracy of Petrobras’ financial statements”
under SAB No. 99, which “establishes a‘rule of thumb’ that changes of less than
five percent to financial statements arepresumptively immaterial.”
As an initial matter, the court found that the
public documents on which the complaint
relied “permit[ted] the inference that thecontracts were inflated by much more than
three percent.” The court determined that
5. The Southern District of New York recently reached thesame conclusion with respect to the adverse interest exception
in a different case that also involved an alleged bribery andkickback scheme. See In re PetroChina Co. Sec. Litig., 2015 WL
4619797 (S.D.N.Y. Aug. 3, 2015). In the PetroChina case, thecourt emphasized that the adverse interest exception is “narrow”
and does not apply when “insiders defraud third parties forthe corporation.” PetroChina, 2015 WL 4619797. The court
found that the adverse interest exception did not apply in the
PetroChina case because “[p]resumably, it was in PetroChina’s
interest for any corruption occurring within the [c]ompany
to remain undisclosed in order to preserve its shareholders’confidence.” The court explained that cases applying the adverse
interest exception have “involved corporate actors that weredeemed to have acted to the company’s detriment,” and foundthat the PetroChina case “present[ed] no such scenario.”

it was “not clear whether Petrobras’ alleged
misstatement[s] reach[ed] the five percent‘rule of thumb,’” but found that “there [was] aplausible possibility that [they] might.”“In any event,” the court stated that this“quantitative analysis [was] not dispositiveof materiality.” The court found that“[h]ere, the qualitative factors [set forth in
SAB No. 99] strongly favor[ed] a finding ofmateriality.”6 The court explained that“[t]he errors in Petrobras’ financial statements
were directly related to its concealment of
the unlawful bribery scheme, revelation ofwhich would [have] ‘call[ed] into question
the integrity of the company as a whole.’”The court also deemed it significant that thealleged “misstatements related to the valueof Petrobras’ oil-producing infrastructure,
which [was] the core of its business.”
Finally, because Petrobras’ share price“dropped dramatically when news of thecorruption scheme emerged,” the court
found that investors did, in fact, consider the
information material.
The court therefore determined thatit could not “conclude that the alleged
misrepresentations in Petrobras’ financial
statements were immaterial as a matterof law.”

Court Finds Alleged Misstatementsof Opinion Actionable Under
the Supreme Court’s Decision in
Omnicare Because Defendants
Allegedly Disbelieved theStatements at the Time They
Were Made
Defendants contended that “many of their
allegedly false and misleading statements
were statements of opinion,” and claimed thatplaintiffs had not “plausibly alleged that those
opinions were not honestly held” as required
under the Supreme Court’s decision in
Omnicare, Inc. v. Laborers District Council
Construction Industry Pension Fund, 135 S.
Ct. 1318 (2015).7
6. In SAB No. 99, the SEC stated that “[q]ualitative factors may
cause misstatements of quantitatively small amounts to bematerial.” 1999 WL 1123073. Qualitative factors that the SEC
may consider include “whether the misstatement concerns asegment or other portion of the registrant’s business that has
been identified as playing a significant role in the registrant’s
operations or profitability,” and “whether the misstatement
involves concealment of an unlawful transaction.”
7. Please click here to read our prior discussion of the Omnicare
decision.
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The court explained that under Omnicare,“[a] statement of opinion is not materiallyfalse just because it is incorrect unless it isnot ‘honestly held’ or omits facts about the
speaker’s basis for holding that view, andthose facts conflict with what a reasonable
investor would understand from thestatement itself.” Here, the court foundthat plaintiffs had adequately alleged that
defendants did not believe their statements ofopinion concerning the company’s business
operations at the time those statements were
made. For example, “plaintiffs allege[d] thatat the time the [c]ompany’s management wasprofessing its opinion that the company’s
internal controls were effective, that same
management was well aware of the extensive
corruption in the [c]ompany’s procurement

activities.” The court therefore determinedthat the alleged statements of opinion wereactionable under Omnicare.
The court also found that the alleged
misstatements were not inactionable puffery.
“[W]hen, (as here alleged) the statements
were made repeatedly in an effort to reassure
the investing public about the [c]ompany’s
integrity,” the court found that “a reasonable
investor could rely on [those statements] asreflective of the true state of affairs at the[c]ompany.”
The court therefore denied defendants’
motion to dismiss plaintiffs’ Section 10(b)and Rule 10b-5 claims for failure to pleadmateriality and scienter.

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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