FEDERAL COURT ASSESSES WHETHER A NOTE IS A SECURITY UNDER THE TEXAS SECURITIES ACT

Is a promissory note a security under the Texas Securities Act? (“TSA”). For starters, the TSA defines “security” to include a “note.” But as a recent Western District of Texas opinion shows, the test is hardly so simple. Vodicka v. Barlin stems from three loans made by the plaintiffs to the defendants, purportedly for a real estate development. No. 1:10-CV-00076-DAE, 2016 U.S. Dist. LEXIS 11283 (W.D. Tex. Feb. 1, 2016). Instead, according to the plaintiffs, the defendants pocketed the money as part of a Ponzi scheme.

At issue in the court’s most-recent opinion was whether the notes issued to the plaintiffs were securities under the TSA. Despite the TSA’s straightforward definition, it only creates a presumption of a security. The presumption can be rebutted by showing the notes are similar to specific types of notes that are not securities. For example, a note securing a home mortgage or a note delivered in consumer financing is typically not a security.

The decision turned on four factors laid out by the United States Supreme Court in Reves v. Ernst & Young, which has been labeled the “family resemblance test.” First, what were the motivations of a reasonable buyer and seller? Because these investors sought a high-interest return, it suggested “an investment rather than a pure commercial or consumer transaction,” and weighed towards a security. Second, was the note subject to common trading for speculation or investment? Since the notes were not commonly traded, and there was no apparent secondary market, that factor weighed against a security. Third, what was the reasonable expectation of the investing public? Based on alleged representations by the defendants, the court determined the notes’ “fundamental character” was that of an investment, and therefore a security. Fourth, were there risk-reducing factors, such as a regulatory scheme, collateral, or insurance? The court found Texas’s limited protections for creditors and debtors were not a regulatory scheme. The notes were not insured, but they were collateralized. Therefore, the court found this factor was neutral.

The court concluded the presumption from the TSA’s definition of a security, coupled with the factors discussed above, established these notes were securities. But the opinion stressed that determining whether a note is a security under the TSA typically requires a detailed analysis.

DALLAS COURT OF APPEALS REVERSES JUDGMENT AGAINST BROKER-DEALER—AN OFFER TO DO CUSTOMIZED SECURITIES TRADE “SUBJECT TO DOCUMENTATION” DOES NOT CREATE AN UNCONDITIONAL CONTRACT

The Dallas Court of Appeals has reversed a $21.5 million judgment awarded to Highland Capital Management, L.P. against RBC Capital Markets, LLC in the trial court, and rendered a take-nothing judgment.

The case stemmed from events in 2000, when RBC marketed a set of subordinated promissory notes offered for sale by the note holders. Highland Capital offered to buy some of the notes for roughly half their face value, subject to “docs and reps,” including a customized written trade confirmation and representations by both the note holders and the payor. The note holders later refused to sell, but Highland claimed RBC was contractually bound to deliver the notes, even though the conditions were not satisfied. Arguing its stated conditions were not material to the deal, Highland sued RBC for breach of contract, and the jury awarded Highland $21.5 million plus pre-judgment interest. RBC appealed.

The appeal turned on whether oral communications between RBC and Highland created an enforceable agreement. Under New York law, as in Texas, contract formation requires a meeting of the minds on the essential terms. Here, Highland’s bid was subject to numerous conditions, including a written trade confirmation and certain representations from the note holders. The Court held RBC did not, and could not, accept those conditions because they required agreement by the note holders. And because material terms remained to be negotiated, the Court found no contract was formed.

The Court rejected Highland’s position, supported by expert testimony, that according to industry custom a securities trade occurs whenever parties agree to price and principal and that “docs and reps” were just a formality. The Court stressed that industry custom cannot alone create an intent to be bound or vary the parties’ express agreement. Nor can an expert witness “usurp the court’s function by giving an opinion as to the legal effect of an industry custom” or by opining “on the ultimate legal issue in the case.” From its own examination of the record, the court found the parties had not reached an agreement, reversed the jury’s verdict, and rendered a take-nothing judgment.

Carrington Coleman and Enoch Kever, PLLC represented RBC. The full opinion is available here.

TEXAS SUPREME COURT WILL WEIGH IN ON THE ALLEN STANFORD LITIGATION AND THE TEXAS UNIFORM FRAUDULENT TRANSFER ACT

The Texas Supreme Court is poised to consider a significant fraudulent transfer case stemming from the Allen Stanford Ponzi scheme. The origins of Janvey v. Golf Channel date back to 2009. In the wake of Stanford’s $7 billion Ponzi scheme, the Northern District of Texas appointed a receiver for Stanford and his related entities. The receiver sued the Golf Channel (among others), claiming the nearly $6 million Stanford paid for advertising was a fraudulent transfer under the Texas Uniform Fraudulent Transfer Act (“TUFTA”).

The case turns on whether the Golf Channel could prove an affirmative defense—that its advertising services were something of “reasonably equivalent value” in return for the transfer. Not so, according to the Fifth Circuit’s original opinion in March 2015. Value is measured from these particular creditors’ perspective, not the general marketplace, under the court’s original reasoning. And so while advertising “may have been quite valuable to the creditors of a legitimate business,” it had “no value to the creditors of a Ponzi scheme.”

But on a motion for rehearing three months later, the Fifth Circuit changed course and vacated its original opinion. The court acknowledged that “precisely where TUFTA draws the line between the various interested parties is the difficult question that Texas courts have yet to answer.” On that basis, the Fifth Circuit certified a question to the Texas Supreme Court, asking what showing of value is sufficient to prove an affirmative defense to a fraudulent transfer claim.

Last Friday, the Texas Supreme Court set the case for oral argument on January 12, 2016. Apart from its significance in the Stanford litigation, the court’s ruling is expected to clarify the contours of defenses available to innocent trade creditors who deal with businesses that were engaged in fraudulent conduct. The briefing and up-to-date case events are available here.

FEDERAL DISTRICT COURT CERTIFIES SECURITIES CLASS ACTION UNDER THE SUPREME COURT’S HALLIBURTON CASES

Bryan Erman and Parker Graham

After thirteen years and two trips to the Supreme Court, Halliburton investors won class certification to pursue certain securities-fraud claims in a Dallas district court, signaling the first significant application of the Supreme Court’s companion cases in this circuit. Halliburton, according to the plaintiffs, had initially misrepresented its potential liability in asbestos litigation and its expected revenue from various contracts, which caused the company’s stock to drop when it later made corrective disclosures.

The case’s complex history hinged on several procedural issues: Judge Barbara Lynn initially denied class certification because the plaintiffs had not proved loss causation (a link between misrepresentations and loss). The Supreme Court reversed, holding plaintiffs are not required to show loss causation at the class-certification stage. On remand, Judge Lynn certified the class and declined to consider Halliburton’s argument that it could negate a necessary element (the presumption of reliance) by showing any misrepresentations had not impacted its stock price. The Supreme Court reversed again, holding defendants are entitled to introduce price impact evidence at the class-certification stage.

Judge Lynn’s most-recent opinion, therefore, considered Halliburton’s price impact evidence for the first time. By parsing through dueling experts, the court found no reliable evidence that Halliburton’s corrective disclosures about construction contracts, its swelling asbestos liability exposure, and two adverse jury verdicts—information that had already been reported by the media or partially disclosed by Halliburton—had any impact on its stock price. But the court did find a convincing price impact based on Halliburton’s disclosure of one particular $30 million asbestos verdict and the 40% stock price plunge that day. Judge Lynn therefore certified the class with respect to that disclosure alone. More broadly, the court’s 53-page opinion provides the most thorough roadmap yet for class certification issues under the Supreme Court’s Halliburton rulings.

A KBR UPDATE: CONFIDENTIALITY AGREEMENTS KEEP DRAWING SEC SCRUTINY

Parker Graham

We recently wrote about an SEC enforcement action targeting KBR, Inc.’s confidentiality agreements. By preventing employees from discussing internal investigations without the legal department’s approval, KBR ran afoul of Dodd-Frank Rule 21F-17 prohibiting “any action to impede” contacting the SEC.

Since then, SEC Office of the Whistleblower Chief Sean McKessy shared more insight regarding the SEC’s enforcement of this rule. According to McKessy, the Commission is continuing to scrutinize agreements potentially implicating the rule, even going so far as reviewing executive separation agreements and asking employees to provide agreements for review. He stressed that the SEC considers Rule 21F-17’s whistleblower protections “very broad.” And while the language in KBR’s amended agreement (quoted in our post below) is still useful guidance, McKessy cautioned that wording is not necessarily a “safe harbor.” The SEC will likely review language in context with an employer’s overall policies and practices. Without taking an official position, McKessy also suggested scrutiny might stretch beyond publicly traded companies to include private employers who contract with public companies.

If there were any doubt before, now is the best time for employers to review their confidentiality policies, severance agreements, and other similar documents to ensure compliance with Dodd-Frank. While KBR’s amended language is a good start, compliance will also require a careful look at overall practices and procedures with whistleblowers in mind.

TEXAS CONSIDERING A NEW CHANCERY COURT

With its sophisticated and business-savvy court system, Delaware attracts more than half of America’s corporate charters. Now Texas, hoping to create a similar draw, is considering creating its own chancery court to handle complex business disputes.

If enacted, House Bill 1603 would create a new Texas chancery court with concurrent jurisdiction over securities claims, shareholder-derivative actions, internal-governance disputes, and other complex corporate cases. Seven chancery judges, appointed by the governor and drawn from both political parties, would sit on the trial court. Another seven judges would form the chancery court of appeals, with the Texas Supreme Court still ultimately deciding any civil appeals. Chancery judges would have business backgrounds (at least ten years in “complex business transaction law” or “complex civil business litigation”) beyond the basic requirements for elected district judges (four years of legal practice).

The bill’s supporters say that a chancery court much like Delaware’s would resolve complex business litigation more quickly and before judges with specialized experience in the field. And if so, we may see an uptick in businesses choosing to incorporate in Texas. The full bill is available here and updates on its progress through the legislature are available here.

COURT RULES SECURITIES CLAIMS AGAINST BP ARE NOT TIME BARRED

In a recent opinion, Judge Keith Ellison refused to dismiss securities claims against BP stemming from the gulf-coast oil spill. In re Bp P.L.C., No. 4:13-cv-1393, 2014 U.S. Dist. LEXIS 138920 (S.D. Tex. Sept. 30, 2014). This subset of plaintiffs alleges BP and its officers misstated the company’s readiness for an oil spill, which “slowly emerged” when the Deepwater Horizon rig exploded and BP’s stock plunged in 2010. The defendants moved to dismiss, arguing a two-year statute of limitations and five-year statute of repose barred the securities claims.

In response to both arguments, the plaintiffs raised American Pipe, which tolls limitations for putative class-action members until class certification is decided. Although these plaintiffs were originally putative class members, they “opt[ed] out of the putative class” by suing individually in April 2013, before Judge Ellison denied class certification months later. Thus, according to the defendants, the plaintiffs forfeited tolling by opting out of the putative class without “wait[ing] until class certification [was] denied.” But the court rejected that argument, holding that tolling applies until plaintiffs leave a putative class either because certification is denied or because they sue individually. Echoing the Second Circuit, Judge Ellison stressed that tolling exists “to protect class members from being forced to file individual suits in order to preserve their claims” not to “induce class members to forgo” individual suits.

Likewise, American Pipe tolled the five-year statute of repose. By joining the initial class action, the plaintiffs functionally “prefiled” their later individual lawsuits. “So long as the defendant has fair notice of the type and number of claims that could be asserted against it,” the court concluded, “then there is no unfair surprise when a class member assumes responsibility for its own individual claim during the course of the class action, or after class status has been denied.” On that basis, apart from dismissing claims against one individual defendant, the court denied the motion to dismiss.