Securities Litigation Update: Courts Of Appeal Address The Exchange Act's Exclusive-Jurisdiction And Non-Waiver Provisions, The Duty To Disclose, And Scienter

• Published date: 18 April 2022
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Financial Services, Commodities/Derivatives/Stock Exchanges, Corporate and Company Law, Securities, Shareholders
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Jason Halper, Ellen V. Holloman, Philip S. Khinda, Jonathan Watkins and Adam Magid

In the first quarter of 2022, federal appellate courts issued a number of thought-provoking (albeit not monumental) decisions addressing the reach of the federal securities laws and, in some cases, highlighting potentially powerful defenses for litigants. In this memorandum, we discuss the following developments:

The Exchange Act's exclusive-jurisdiction and non-waiver provisions. In Seafarers Pension Plan v. Bradway,¹ a divided panel of the U.S. Court of Appeals for the Seventh Circuit reinstated a claim brought in federal court under Section 14(a) of the Securities Exchange Act of 1934 (the 'Exchange Act'), asserted derivatively by a stockholder of the Boeing Company, based on allegedly false and misleading statements in proxy solicitation materials. The Court declined to enforce a Boeing bylaw that, on its face, would have restricted all derivative claims (including those based on alleged violations of Section 14(a)) to the Delaware Court of Chancery. Because federal courts have exclusive jurisdiction over Exchange Act claims like those asserted under Section 14(a), the practical import of a contrary decision would have been to preclude the assertion of any Exchange Act claims via a derivative action. The majority based its ruling on interpretations of Delaware law and the Exchange Act, holding that the former did not permit a corporate bylaw that would 'foreclose suit in a federal court based on federal jurisdiction,' and that the latter disallowed 'waiver' of federal exclusive jurisdiction so as to 'close all courthouse doors' to a derivative Section 14(a) claim. The decision prompted a vigorous dissent from Judge Frank Easterbrook. Judge Easterbrook would have enforced the bylaw because (i) it did not prevent a plaintiff from bringing 'direct' Section 14(a) claims (as to which the bylaw would not have applied), (ii) it did not preclude adjudication of procedural aspects of a Section 14(a) derivative claim in state court (that is, whether, under applicable state law, a pre-suit demand is required, and the plaintiff may properly prosecute derivative claims on the corporation's behalf), and (iii) the bylaw should be viewed as an ordinary contractual forum-selection clause that permissibly waived exclusive federal jurisdiction.

Seafarers forecloses a particular application of an exclusive-forum bylaw, i.e., one that, by limiting federal claims to state court, deprives the litigant of the right to assert the claim in any forum. The decision, however, leaves intact the holdings of the majority of courts that, otherwise, exclusive-forum bylaws are (at least under Delaware law) a permissible and effective way to limit multi-forum litigation and prevent inconsistent judgments. While the question is resolved for now in the Seventh Circuit, Seafarers rests on interpretations of state and federal law that could be upended by future Delaware and/or federal decisions, and leaves room for courts outside the Seventh Circuit to reach different conclusions.

Limits on issuers' disclosure obligations under Section 10(b). The U.S. Courts of Appeal for the Ninth and Second Circuits recently affirmed dismissal of putative class actions asserting claims under Section 10(b) of the Exchange Act and Rule 10b-5, in both cases invoking the principle that, under Section 10(b), issuers do not have a generalized duty to disclose any and all information concerning their business or prospects, even if the information could be deemed material to investors. Rather, absent an independent duty to disclose (such as by statute or regulation), an issuer typically is required to disclose information that is only 'necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.'² Applying this concept, in Weston Family Partnership LLLP v. Twitter, Inc.,³ the Ninth Circuit affirmed dismissal of Section 10(b) claims against Twitter, Inc. based on its alleged failure to disclose software bugs in public statements about an advertising program, reasoning that, by not specifically addressing the existence or non-existence of the software bugs in other statements, it had no independent duty to make such disclosure. Likewise, in Arkansas Public Employees Retirement System v. Bristol-Myers Squibb Co.,⁴ the Second Circuit rejected claims against Bristol-Meyers Squibb Co., holding that it did not mislead investors by failing to publicly disclose a key metric used in a cancer drug trial, since it explicitly informed the public that it was withholding the information throughout the course of its trial.

Twitter and Bristol-Myers are apt illustrations of how issuers can minimize the risk of Section 10(b) liability through careful decision-making regarding subjects that the issuer chooses to address, and being upfront with investors about what they are'and are not'choosing to disclose. Nonetheless, issuers should exercise caution in reading too much into the decisions. Whether or not the omission of a fact renders other statements materially 'misleading' is highly fact-dependent, and often a judgment call for the court at the motion stage. Still, the decisions may deter plaintiff overreach in borderline cases, and should serve as a valuable precedent for defendants in cases where the issuer has never affirmatively addressed the allegedly omitted information, and there is no independent duty to disclose.

Pleading a 'strong inference' of scienter. The U.S. Court of Appeals for the Second Circuit issued two other decisions'Malik v. Network 1 Financial Services, Inc.⁵ and KBC Asset Management NV v. Metlife, Inc.⁶'both affirming dismissal of putative class actions under Section 10(b) based on plaintiffs' failure to plead a 'strong inference' of 'scienter' (an intent to deceive or defraud). Any assessment of scienter is inherently fact-dependent and will vary on a case-by-case basis. These decisions, however, show that the Second Circuit continues to take the high bar set in the Private Securities Litigation Reform Act to plead scienter seriously, and will not hesitate to short-circuit a claim where the inference of fraudulent intent is not 'cogent and at least as compelling' as a non-fraudulent inference.

I. Seafarers Pension Plan v. Bradway: Seventh Circuit Permits Derivative Section 14(a) Claim to Proceed in Federal Court, Declines to Enforce Delaware Exclusive-Forum Bylaw

A. Background

SEC Rule 14a-9, promulgated under Section 14(a),⁷ prohibits solicitation of proxies by means of materially false or misleading statements.⁸ Almost 60 years ago, in J.I. Case Co. v. Borak, the Supreme Court recognized an implied private right of action for violations of Rule 14a-9 (which the statutory text does not explicitly provide for), based on the 'congressional belief that '(f)air corporate suffrage is an important right that should attach to every equity security bought on a public exchange.'⁹ The Court found a private right of action implicit because 'among [the statute's] chief purposes is 'the protection of investors,' which certainly implies the availability of judicial relief where necessary to achieve that result.'¹⁰ Borak held that, under Section 14(a), a 'right of action exists as to both derivative and direct causes'i.e., on behalf of the corporation (for 'damage done the corporation') and on behalf of the individual stockholder (for 'damage inflicted directly upon the stockholder'), respectively.¹¹

The distinction between a direct and derivative Section 14(a) claim was at the forefront of Seafarers. The case arose out of the tragic events surrounding the 2018 and 2019 fatal crashes of two Boeing 737 MAX airliners in Indonesia and Ethiopia. All 737 MAX airliners around the world were thereafter grounded until November 2020, when the Federal Aviation Administration approved the aircraft for flight. In December 2019, Seafarers Pension Plan, a Boeing stockholder, filed a complaint in the U.S. District Court for the Northern District of Illinois (where Boeing is headquartered), asserting violations of Section 14(a) and Rule 14a-9 thereunder, derivatively on behalf of Boeing, against Boeing officers and directors for allegedly false and misleading statements about the development and operation of the 737 MAX in Boeing's 2017, 2018, and 2019 proxy materials.

The defendants moved to dismiss on forum non conveniens grounds, arguing that the suit was precluded by a bylaw adopted by Boeing (which is incorporated in Delaware) providing that all derivative claims must be asserted in the Delaware Court of Chancery. In relevant part, the bylaw provided:

[U]nless [Boeing] consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for . . . any derivative action or proceeding brought on behalf of the Corporation[.]

The district court (Hon. Harry D. Leinenweber) enforced the bylaw and dismissed the case. The district court was unmoved by the plaintiff's argument that, in light of federal courts' exclusive jurisdiction over Exchange Act claims, the bylaw effectively would preclude the plaintiff from bringing its derivative claim in any forum. The district court did not agree that there was a curtailment of plaintiff's rights because Delaware offers a claim that is 'precisely' the same as a Section 14(a) claim, albeit under Delaware law, for failing 'to disclose fully and fairly all material information within the board's control when it seeks shareholder action.'¹² Given the availability of a state-law equivalent, the district court reasoned, it would not 'thwart[]' public policy to compel plaintiff to bring its claim in state court.¹³ There were 'good reasons,' the court believed, for a corporation to limit stockholder claims against its officers and directors to one forum, under a 'single law,' including avoidance of multi-forum litigation and 'inconsistent verdicts.'¹⁴ The plaintiff appealed to the Seventh Circuit.

B. The...