Securities Litigation Update: Second Circuit Opines On Pleading Standards And Statutory Standing For Claims Under Section 10(b) Of The Securities Exchange Act Of 1934

• Published date: 10 December 2021
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities, Shareholders
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Jason Halper, Ellen V. Holloman, Philip S. Khinda, Jonathan Watkins, Adam Magid and Victor Celis

On November 24, 2021, the U.S. Court of Appeals for the Second Circuit issued a pair of decisions addressing threshold requirements for securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5: (i) pleading a material misstatement or omission, and (ii) demonstrating standing to sue as a "purchaser" or "seller" of a security. In Altimeo Asset Management v. Qihoo 360 Technology Co. Ltd.,¹ the Court reinstated Section 10(b) claims premised on the defendants' alleged failure to disclose in proxy materials a plan to relist the post-merger company on a foreign exchange. In so ruling, the Court parted ways with the district court, which concluded that the proxy materials adequately disclosed the "possibility" of a relisting, and the plaintiffs failed to allege a "concrete" pre-merger relisting plan so as to render the disclosure misleading. In Aiello v. Brown,² the Court clarified that holders of unexercised preemptive rights to acquire securities'absent "irrevocable liability" to acquire a security'lack standing to assert Section 10(b) claims. We discuss these decisions and the implications for securities litigants below.

I. Altimeo Asset Management v. Qihoo: Court Reinstates Section 10(b) Claims Based on Alleged Failure to Disclose Post-Merger Relisting Plan Prior to Shareholder Vote

A. Background

Qihoo 360 Technology Co. Ltd. was an internet security company headquartered in Beijing, China, which, since 2011, had listed American Depositary Shares (ADSs) on the New York Stock Exchange.³ In June 2015, a group of investment funds and Qihoo shareholders, including Honyi Zhou, its chairman and CEO, proposed to take Qihoo private by acquiring all outstanding shares not owned by members of the company's board of directors. In December 2015, the Qihoo board approved the transaction, and the company executed a merger agreement with the buyer group, subject to a vote of the company's shareholders.

In advance of the shareholder vote, Qihoo issued proxy materials stating that, after completion of the merger, the surviving company "will become a private company beneficially owned solely by the Buyer Group," and "the Buyer Group does not have any current plans, proposals or negotiations that relate to or would result in an extraordinary corporate transaction . . . such as a merger." The proxy materials, however, noted that after the transaction the surviving company's management or board "may propose or develop plans and proposals, . . . including the possibility of relisting the Surviving Company . . . on another internationally recognized stock exchange." Qihoo's shareholders ultimately approved the merger with 99.8% of the votes cast, and the transaction closed on July 15, 2016.

On November 2, 2017, SJEC Corporation, an elevator-manufacturing company listed on the Shanghai Stock Exchange, announced that it would be conducting a "backdoor listing"'i.e., a reverse merger'with then-private Qihoo's main business.⁴ The transaction was completed on February 28, 2018, at which time the merged entity'360 Security Technology Inc.'began to trade on the Shanghai Stock Exchange.

In August 2019, two investment companies that traded Qihoo ADSs prior to the 2016 merger filed a putative class action against Qihoo, Zhou, and two directors in the Central District of California, asserting violations of Sections 10(b), 20(a), and 20A of the Exchange Act and Rule 10b-5 thereunder. The complaint alleged that Qihoo's proxy materials were materially misleading because, at the time of the merger, the buyer group intended to relist Qihoo in China at a higher valuation, and defendants' failure to disclose that information caused plaintiffs to sell their shares at artificially deflated prices. To support these allegations, the complaint cited statements by a confidential witness (a former Qihoo employee who worked in its PR department) and contemporaneous news articles from Chinese publications, and contended that the timing of the relisting would not have been feasible unless defendants had conceived of the plan pre-merger. After the case was transferred to the Southern District of New York, the defendants filed a motion to dismiss, which the district court (Engelmayer, J.) granted in full. In the district court's view, the complaint failed to plead the factual premise that underlay its claims: that defendants, pre-merger, had "a concrete plan to relist Qihoo."⁵ Rather, the complaint at most pled that, at the time of the merger, defendants "envision[d] a possible future relisting," and the proxy materials explicitly advised of such "possibility."⁶ The plaintiffs appealed the dismissal order.

B. The Decision

A unanimous three-judge panel of the Second Circuit reversed, holding that plaintiffs adequately alleged that Qihoo's proxy materials contained material misstatements and omissions under Section 10(b) of the Exchange Act and Rule 10b-5.⁷ In contrast to the district court, which focused on whether the complaint adequately pled the premise of its claims (a "concrete plan to re-list Qihoo"), the Second Circuit reframed the question as a two-part inquiry: (1) Did the complaint adequately allege a misstatement or omission? (2) If so, did the complaint adequately allege that the misstatement or omission was "material"?

As to the first question, the Court held that plaintiffs plausibly alleged that the statement in the proxy materials that "the Buyer Group does not have any current plans" to relist Qihoo was not accurate.⁸ In this regard, the Court emphasized allegations that it "typically takes companies at least a full year on the quickest timeline and usually longer, from the time they first start to consider a backdoor listing until...