Securities Law Alert
In This Edition:• Second Circuit: Affirms Denial of Leave to Amend a Securities Fraud Complaint, Finding Plaintiffs
Alleged No Material Misrepresentations and Pled Only “Fraud by Hindsight”• Fifth Circuit: (1) Fifth Third Applies to Claims of Excessive Riskiness, and (2) Failure to Disclose
Inside Information or Investigate the Prudence of Investing in Company Stock Does Not
Constitute a “Special Circumstance”• Ninth Circuit: Disclosure of the Alleged Fraud Is Not a Prerequisite for Loss Causation• New York Supreme Court: Rejects Disclosure-Only Settlement That Provided “Worthless”
Supplemental Disclosures, and Holds That Supplemental Disclosures Must “Aid a Reasonable
Shareholder in Deciding Whether to Vote for the Merger”
February 2018

“Simpson Thacher &Bartlett LLP’s litigationgroup is frequently at theforefront of many of thehighest-profile financial
services-related disputes
in the market . . . ”–The Legal 500 2017

Second Circuit: Affirms Denialof Leave to Amend a Securities
Fraud Complaint, Finding
Plaintiffs Alleged No Material
Misrepresentations and Pled
Only “Fraud by Hindsight”
On January 26, 2018, the Second Circuit
affirmed denial of leave to amend a securities
fraud complaint alleging misrepresentations
concerning a consumer finance company’s
underwriting practices. Waterford Twp.
Police & Fire Ret. Sys. v. Reg’l Mgmt. Corp.,
2018 WL 565780 (2d Cir. 2018) (Waterford
III).1 The Second Circuit found the proposed
amended complaint alleged no material
1. Simpson Thacher represents Regional Management Corp.
and certain of its current and former directors, officers andshareholders in this matter.

Simpson Thacher & Bartlett LLP

misrepresentations, and pled only “fraud
by hindsight.”
Plaintiffs’ original complaint challenged
the company’s “characterizations of its
underwriting practices as ‘sound’ or‘targeted,’” among other claims. Waterford
Twp. Police & Fire Ret. Sys. v. Reg’l Mgmt.
Corp., 2016 WL 1261135 (S.D.N.Y. 2016)(Waterford I).2 Plaintiffs “alleged thatlower-level branch staff were skeptical of[the company]’s live check underwriting.”
However, the district court found plaintiffs
pled no facts demonstrating that the company
did not believe its statements of opinion
concerning its underwriting practices at thetime it made those statements, as required
under the Supreme Court’s decision in
Omnicare v. Laborers District Council
2. Please click here to read our prior discussion of the district
court’s decision.

Construction Industry Pension Fund, 135
S. Ct. 1318 (2015).3 The court dismissed
plaintiffs’ complaint in its entirety.
The proposed amended complaint included
new allegations from a supervisor who
oversaw underwriting practices at a numberof the company’s branches. Because these
new allegations did not address underwriting
practices at the company’s headquarters,
which handled the live check loans at issue,
the district court found plaintiffs’ proposed
allegations would be insufficient to survive
a motion to dismiss. Waterford Twp. Police& Fire Ret. Sys. v. Reg’l Mgmt. Corp., 2017
WL 395206 (S.D.N.Y. 2017) (Waterford II).
The Second Circuit agreed, and found thefacts pled were “just as consistent with thepossibility that [the company] believed what
it was saying about its underwriting practices(and that its beliefs were correct) as the
opposite.” Waterford III, 2018 WL 565780.

The proposed amended complaint also
included allegations post-dating the classperiod that concerned the company’s
representations as to the adequacy of staffing
in its loan servicing departments. The district
court found these allegations were “a classic
example of attempting to sustain a cause ofaction based on ‘fraud by hindsight,’ that
is, alleging ‘that defendants should haveanticipated future events and made certain
disclosures earlier than they actually did.’”
Waterford II, 2017 WL 395206 (quoting
Novak v. Kasaks, 216 F.3d 300 (2d Cir.
2000)).
The Second Circuit agreed that these
proposed allegations were insufficient tosuggest that the company did not believe its
staffing was adequate at the time it madethe statements at issue. The court further
determined that plaintiffs did not point to“‘any contemporaneous facts that would
3. The Omnicare Court made it clear that “a sincere statementof pure opinion is not an ‘untrue statement of material fact,’
regardless [of] whether an investor can ultimately prove thebelief wrong.” 135 S. Ct. 1318. Please click here to read ourprior discussion of the Omnicare decision.

have rendered such a belief unfounded.’”Waterford III, 2018 WL 565780 (quoting
Waterford I, 2016 WL 1261135). The Second
Circuit observed that “[i]nvestors frequently
clamor for cutting labor costs to pay out
more in profits.” The court emphasized that it“need[s] something more than hypotheticals
to conclude that such a ho-hum feature ofa capitalist enterprise was in fact a guise to
defraud those it often benefits.”

Fifth Circuit: (1) Fifth Third
Applies to Claims of Excessive
Riskiness, and (2) Failure to
Disclose Inside Information
or Investigate the Prudence ofInvesting in Company Stock
Does Not Constitute a “Special
Circumstance”
On February 6, 2018, the Fifth Circuit
followed the Second Circuit in holding that
the Supreme Court’s decision in Fifth Third
Bancorp v. Dudenhoeffer, 134 S. Ct. 2459
(2014)4 applies to ERISA claims alleging
that company stock was excessively risky
in addition to claims that the stock was
overvalued. Singh v. RadioShack Corp.,
2018 WL 732913 (5th Cir. 2018) (percuriam). The Fifth Circuit further held thatplaintiffs could not satisfy Fifth Third’s“special circumstances” exception for claims
based on publicly available information byalleging that defendants failed to disclose
inside information, or failed to monitor thecontinued prudence of investing in company
stock. The court also ruled that plaintiffs
did not satisfy Fifth Third’s “more harmthan good” standard for claims based on
inside information.

Fifth Third’s Standard Governs
Public Information-Based Claims
Alleging Excessive Risk
The Fifth Circuit rejected plaintiffs’
contention that Fifth Third “addresses only
allegations that public information showed
4. In Fifth Third, the Court outlined the standards for pleading
an ERISA breach of the duty of prudence claim against
the fiduciary of an employee stock ownership plan. Pleaseclick here to read our prior discussion of the Fifth Third
decision.

2that a stock was overvalued, not claims thatthe stock was excessively risky.” The court
found “‘illusory’” the “distinction between
claims that stock is overvalued and claims
that stock is excessively risky.” Singh, 2018
WL 732913 (quoting Rinehart v. Lehman
Bros. Holdings, 817 F.3d 56 (2d Cir. 2016)).5
The Fifth Circuit reasoned that “[i]n an
efficient market, market price accounts
for risk.” The court held that “although[Fifth Third] was primarily framed in termsof overvalued-stock allegations, it applies
equally to [p]laintiffs’ public-information
claims premised on excessive risk.” The
Second, Sixth and D.C. Circuits have reached
the same conclusion.6

Failure to Disclose Inside
Information Does Not Constitute a“Special Circumstance”

Failure to Investigate thePrudence of Continuing toInvest in Company Stock Is Not a“Special Circumstance”
The Fifth Circuit also rejected plaintiffs’
contention that the “special circumstances”
requirement was satisfied because the Planfiduciaries allegedly “failed to investigate thecontinued prudence of investing Plan assets
in [company] stock.”
Because plaintiffs “did not plausibly allege
that the purported lack of investigation had
any effect on the reliability of the market
price,” the Fifth Circuit held that thisfailure to investigate “cannot be a special
circumstance” within the meaning of Fifth
Third.

In Fifth Third, the Court held that “allegations
that a fiduciary should have recognized frompublicly available information alone that themarket was over- or undervaluing the stock
are implausible as a general rule, at leastin the absence of special circumstances.”
134 S. Ct. 2459. The Fifth Circuit notedthat “[t]he Supreme Court has not defined‘special circumstances,’ but has said thatsuch circumstances ‘affect[ ] the reliability ofthe market price as an unbiased assessmentof the security’s value in light of all public
information.’” Singh, 2018 WL 732913(quoting Fifth Third, 134 S. Ct. 2459).

Plaintiffs Did Not Satisfy Fifth
Third’s “More Harm Than Good”
Standard for Claims Based on
Inside Information

Plaintiffs contended that Fifth Third’s“special circumstances” requirement was met
because defendants had “withheld material
information from the market, skewing thestock price.” The Fifth Circuit held that the
failure to disclose inside information does notconstitute a “special circumstance” because
Fifth Third established a separate standard
for analyzing insider-information claims.

“To state a duty of prudence claim basedon nonpublic information, ‘a plaintiff must
plausibly allege an alternative action thatthe defendant could have taken that would
have been consistent with the securities laws
and that a prudent fiduciary in the same
circumstances would not have viewed as more
likely to harm the fund than to help it.’” Id.
(quoting Fifth Third, 134 S. Ct. 2459).

5. Please click here to read our prior discussion of the Second
Circuit’s decision in Rinehart.
6. See Rinehart, 817 F.3d 56 (“Fifth Third foreclose[s] breachof prudence claims based on public information irrespectiveof whether such claims are characterized as based on alleged
overvaluation or alleged riskiness of a stock.”); Pfeil v. State
Street Bank and Trust Co., 806 F.3d 377 (6th Cir. 2015) (“theexcessively risky character of investing ESOP funds in stock of
a company experiencing serious threats to its business . . . isaccounted for in the market price”); and Coburn v. Evercore
Trust Co., 844 F.3d 965 (D.C. Cir. 2016) (“arguing that a stock
is too risky to hold at current market prices is part and parcelof the claim that that stock is overvalued” for Fifth Third
purposes).

In the case before it, the Fifth Circuit foundthat a prudent fiduciary could conclude
that freezing investments in company stock“would signal to the market ‘that insider
fiduciaries viewed the employer’s stock as abad investment,’ causing the Fund’s existingholdings of [company] stock to decline
in value.” Id. (quoting Fifth Third, 134 S.
Ct. 2459).
The Fifth Circuit also found that “a prudent
fiduciary could readily conclude that ‘publicly
disclosing negative information would do
3

more harm than good to the fund by causinga drop in the stock price and a concomitantdrop in the value of the stock already heldby the fund.’” Id. (quoting Fifth Third, 134 S.
Ct. 2459).

Ninth Circuit: Disclosureof the Alleged Fraud Is
Not a Prerequisite for Loss
Causation
On January 31, 2018, the Ninth Circuit heldthat “a general proximate cause test . . . is theproper test” for loss causation under Section
10(b) and Rule 10b-5 and that disclosureof the fraud is not a prerequisite for losscausation. Mineworkers’ Pension Scheme v.
First Solar, 2018 WL 626948 (9th Cir. 2018)(per curiam).
The Ninth Circuit found the district court had
appropriately applied the general proximate
cause test in holding that “[a] plaintiff cansatisfy loss causation by showing that thedefendant misrepresented or omitted the veryfacts that were a substantial factor in causing
the plaintiff’s economic loss.” Id.
The district court read the Ninth Circuit’s
earlier decisions as divided on the appropriate
test for loss causation. In the district court’sview, one line of prior Ninth Circuit opinions
held that “[s]ecurities fraud plaintiffs canrecover only if the market learns of the
defendants’ fraudulent practices. It is notenough that plaintiffs are injured by theconsequences of those practices.” Smilovits
v. First Solar, 119 F. Supp. 3d 978 (D. Ariz.
2015).7 The district court found that anothergroup of Ninth Circuit rulings held that“drawing a causal connection between thefacts misrepresented and the plaintiff’s loss
will satisfy loss causation. A plaintiff need notshow that the fraudulent practices themselves
were revealed.”8
7. The district court found the following Ninth Circuit rulings
took this approach: Oregon Public Employees’ Retirement
Fund v. Apollo Group, 774 F.3d 598 (9th Cir. 2014); Loos v.
Immersion Corporation, 762 F.3d 880 (9th Cir. 2014); In
re Oracle Corp. Securities Litigation, 627 F.3d 376 (9th Cir.
2010); and Metzler Investment GMBH v. Corinthian Colleges,
540 F.3d 1049 (9th Cir. 2008).
8. The district court cited to the following decisions: Nuveen
Municipal High Income Opportunity Fund v. City of
Alameda, 730 F.3d 111 (9th Cir. 2013); Berson v. Applied
Signal Technology, 527 F.3d 982 (9th Cir. 2008); and In re
Daou Systems, 411 F.3d 1006 (9th Cir. 2005).

The district court followed the latterapproach, but certified the following question
for interlocutory appeal:[W]hat is the correct test for losscausation in the Ninth Circuit? Can aplaintiff prove loss causation by showingthat the very facts misrepresented
or omitted by the defendant were asubstantial factor in causing the plaintiff’s
economic loss, even if the fraud itself was
not revealed to the market, or must themarket actually learn that the defendantengaged in fraud and react to thefraud itself?
Id. (internal citations omitted).
On appeal, the Ninth Circuit explained that
the Exchange Act, as modified by the Private
Securities Litigation Reform Act, “defines‘loss causation’ as the plaintiff’s ‘burdenof proving that the act or omission of the
defendant alleged to violate [Section 10(b)]caused the loss for which the plaintiff seeks
to recover damages.’” Mineworkers’ Pension
Scheme, 2018 WL 626948 (quoting 15 U.S.C.
§ 78u-4(b)(4)). The court found “[t]his
inquiry requires no more than the familiar
test for proximate cause.”
The Ninth Circuit stated that in order “[t]oprove loss causation, plaintiffs need only
show a causal connection between the fraud
and the loss, by tracing the loss back to thevery facts about which the defendant lied.”Id. (internal citations omitted). The courtemphasized that “‘[d]isclosure of the fraud is
not a sine qua non of loss causation, which
may be shown even where the alleged fraud is
not necessarily revealed prior to the economic
loss.’” Id. (quoting Nuveen Mun. High Income
Opportunity Fund v. City of Alameda, 730
F.3d 1111 (9th Cir. 2013)).
The Ninth Circuit noted that its recent
decision in Lloyd v. CVB Financial
Corporation, 811 F.3d 1200 (9th Cir.
2016)9—issued after the district court’sorder—“clarifie[d] the applicable rule.” The
Lloyd court observed that “loss causation
is a context-dependent inquiry, as there
are an infinite variety of ways for a tort
to cause a loss.” 811 F.3d 1200 (internal
citations omitted). The Lloyd court statedthat “[b]ecause loss causation is simply a
9. Please click here to read our prior discussion of the Lloyd
decision.
4variant of proximate cause, the ultimate issue
is whether the defendant’s misstatement,
as opposed to some other fact, foreseeably
caused the plaintiff’s loss.”
In Mineworkers’ Pension Scheme, the Ninth
Circuit explained that “[r]evelation of fraud inthe marketplace is simply one of the ‘infinite
variety’ of causation theories a plaintiff
might allege to satisfy proximate cause.”10
2018 WL 626948. The court noted that if “astock price drop comes immediately after
the revelation of fraud,” this “can help to ruleout alternative causes.” However, the Ninth
Circuit emphasized that “[a] plaintiff may also
prove loss causation by showing that the stock
price fell upon the revelation of an earnings
miss, even if the market was unaware at thetime that fraud had concealed the miss.”

New York Supreme Court:
Rejects Disclosure-OnlySettlement That Provided“Worthless” Supplemental
Disclosures, and Holds That
Supplemental Disclosures
Must “Aid a Reasonable
Shareholder in Deciding
Whether to Vote for the
Merger”
On February 8, 2018, the New York Supreme
Court refused to approve a disclosure-only
settlement based on its determination that the
supplemental disclosures were “worthless.”
City Trading Fund v. Nye, 2018 WL 792283(N.Y. Sup. Ct. 2018) (Kornreich, J.) (CityTrading Fund III). The court held that adisclosure-only settlement should not beapproved unless the supplemental disclosures“aid a reasonable shareholder in deciding
whether to vote for the merger.”
The court had previously declined toapprove the settlement at issue because
the supplemental disclosures were “utterly
immaterial.” City Trading Fund v. Nye,
46 Misc.3d 1206(A) (N.Y. Sup. Ct. 2015)(Kornreich, J). On appeal, the First
Department observed that the additional
10. The Ninth Circuit indicated that there was no conflict in
its prior rulings on loss causation. The court stated that its“approval of one theory should not imply [its] rejection ofothers.” Mineworkers’ Pension Scheme, 2018 WL 626948.

disclosures were “arguably beneficial,” andreversed and remanded. City Trading Fundv. Nye, 144 A.D.3d 595 (1st Dept. 2016) (CityTrading Fund II). The First Department
found the trial court’s determination was“premature” because the court had notconducted a fairness hearing before issuing its
decision.

Following its ruling in City Trading Fund II,
the First Department adopted a multi-factor
test for evaluating disclosure-only settlements
in Gordon v. Verizon Communications, 148
A.D.3d 146 (1st Dept. 2017). The Gordon
court instructed that courts must consider thefactors set forth in Matter of Colt Industries
Shareholder Litigation, 155 A.D.2d 154 (1stDept. 1990) for reviewing nonmonetary
settlements of class action suits,11 as wellas “two additional criteria: whether the
proposed settlement is in the best interestsof the putative settlement class as a whole,
and whether the settlement is in the bestinterest of the corporation.” The Gordon
court indicated that the factor concerning thebest interests of the class “is satisfied where
the supplemental disclosures provide ‘some
benefit to the shareholders.’” City Trading
Fund III, 2018 WL 792283 (quoting Gordon,
148 A.D.3d 146).
The City Trading Fund III court recognizedthat “approval under Gordon requires alesser showing than” that required under the
Delaware Chancery Court’s decision in In re
Trulia Stockholder Litigation, 129 A.3d 884(Del. Ch. 2016).12 The Trulia court statedthat a disclosure-only settlement “was likely
to be met with continued disfavor unless the
11. The Colt factors are: “the likelihood of success, the extent
of support from the parties, the judgment of counsel, thepresence of bargaining in good faith, and the nature of theissues of law and fact.” 155 A.D.2d 154.
12. Please click here to read our prior discussion of the Delaware
Chancery Court’s decision in Trulia.
5supplemental disclosures address a plainlymaterial misrepresentation or omission.”
129 A.3d 884. The Trulia court emphasized“that it should not be a close call that the
supplemental information is material as thatterm is defined under Delaware law.”
The City Trading Fund III court thenconsidered what the Gordon court meant
when it stated that the supplemental
disclosures must provide “some benefit” tothe shareholders.13 The City Trading FundIII court concluded that “while the plaintiff
need not (as under Trulia) rule out all doubts
as to the materiality of the supplemental
disclosures, the court must be able toplausibly conclude that the supplemental
disclosures would, in fact, aid a reasonable
shareholder in deciding whether to vote forthe merger.” The court reasoned that “[i]fthe supplemental disclosures would not
do so, then there is no basis to conclude
13. The court noted that it did not read Gordon, which post-dated
the First Department’s decision in City Trading Fund II,“to permit approval if plaintiff merely makes a showing thatthe supplemental disclosures are ‘arguably beneficial.’” City
Trading Fund III, 2018 WL 792283.

that such disclosures were of any benefit to
the shareholders.”
Turning to the disclosure-only settlement
before it, the court found “the supplemental
disclosures were not at all helpful to theshareholders.” The court explained that thedisclosures were “of the ‘tell me more’ sortthat countless courts have recognized are oflittle to no value, and which certainly do notsubstantially alter the total mix of available
information.” For example, the court notedthat the disclosures included “independent,
third-party projections” which “are notconsidered material” as a general rule.
The City Trading Fund III court found it
significant that “shareholders that own sharesworth hundreds of thousands of dollars morethan [plaintiff’s] nominal holding of ten
shares [had] objected” to the settlement. The
court concluded that the corporation and its
shareholders would be “net losers” under theterms of the agreement, and therefore denied
approval of the settlement.

This edition of the
Securities Law Alert was edited by
Susannah S. Geltman
sgeltman@stblaw.com / +1-212-455-2762,
Paul C. Gluckow
pgluckow@stblaw.com / +1-212-455-2653,
Peter E. Kazanoffpkazanoff@stblaw.com / +1-212-455-3525,
and Cheryl J. Scarboro
cscarboro@stblaw.com /+1-202-636-5529.

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