SCOTUS POISED TO RESOLVE CIRCUIT SPLIT REGARDING SECTION 14(E) SCIENTER

On January 4, 2019, the U.S. Supreme Court agreed to hear an appeal of the Ninth Circuit Court of Appeal’s controversial decision in Varjabedian v. Emulex Corp., 888 F.3d 399, 401 (9th Cir. 2018), cert granted, 19-459, 2019 WL 98542 (U.S. Jan. 4, 2019). The outcome of the appeal turns on the Court’s interpretation of Section 14(e) of the Securities Exchange Act. The relevant language reads:

It shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.

15 U.S.C. § 78n(e). The Second, Third, Fifth, Six, and Eleventh Circuits have all determined that Section 14(e) requires proof of scienter—the defendant must be shown to have intended to omit or make an untrue statement of material fact to be held liable. The Ninth Circuit decision is the first to break with this trend.

Contrary to its sister courts, the Ninth Circuit determined that Section 14(e) differs from, and therefore should not be read together with, Exchange Act Rule 10b-5. The Ninth Circuit relied on the Supreme Court’s holding in Ernst & Ernst v. Hochfelder to reason that, despite identical language, Section 14(e) and Rule 10b-5 were promulgated at different times and for distinct purposes and therefore require differing proofs of mental culpability. Unlike Section 14(e)—enacted by statute—the Ninth Circuit recognized that Rule 10b-5 is an SEC Rule derived from the Commission’s powers under § 10(b), powers purposed to control “manipulative or deceptive device[s].” 15 U.S.C. § 78j(b). The court found Section 14(e) governing a “broader array of conduct” and therefore requiring less mental culpability. The Ninth Circuit reasoned that in order to interpret “statutes dealing with similar subjects . . . harmoniously,” Section 14(e) of the Exchange Act ought not require proof of scienter, just as the Supreme Court determined to be the case for the nearly identically worded Section 17(a)(2) of the Securities Act of 1933 in Aaron v. SEC. Finally, the Ninth Circuit concluded that Section 14(e) was never purposed to include a scienter requirement because it was passed as part of the Williams Act of 1968 and was accompanied by a Senate Report stating the purpose of the Williams Act was “to insure that public shareholders . . . will not be required to respond without adequate information,” suggesting “[an] emphasis on the quality of information . . . [not] on the state of mind harbored.” All eyes now turn to the Supreme Court to resolve the Circuit Court split.

SUPREME COURT UNANIMOUSLY RULES THAT SEC SOUGHT DISGORGEMENT IS A “PENALTY” SUBJECT TO A FIVE-YEAR STATUTE OF LIMITATIONS

In Kokesh v. SEC, the Supreme Court determined that the five-year statute of limitations for any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise” in 28 U.S.C. § 2462 applies to claims for disgorgement sought by the SEC as a sanction for violations of the federal securities laws. On October 4, 2009, the SEC brought an enforcement action against Kokesh based on his alleged violations of the securities laws between 1995 and 2009. After a jury found Kokesh liable, the district court imposed a civil penalty based solely on Kokesh’s conduct after October 4, 2004, concluding that the five-year statute of limitations in 28 U.S.C. § 2462 precluded any civil penalty based on Kokesh’s conduct five years before the SEC brought suit. The district court, however, ordered Kokesh to disgorge $34.4 million based on violations going all the way back to 1995—with $29.9 million of that amount resulting from violations before October 4, 2004—because the district court reasoned that disgorgement is not a penalty to which 28 U.S.C. § 2462 applied. The Tenth Circuit affirmed, and the Supreme Court granted certiorari.

Justice Sotomayor, writing for a unanimous court, concluded otherwise. She relied on a 1892 Supreme Court case that defined “penalty” as “punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offen[s]e against its laws.” Huntington v. Attrill, 146 U.S. 657, 667 (1892). From this definition, Justice Sotomayor distilled two principles. First, a penalty redresses a wrong to the public. Second, a penalty is intended to punish and to deter others from committing similar offenses, as opposed to compensating the victim. The Supreme Court reasoned that the disgorgement sought by the SEC is a remedy for violations of public laws against the United States, as opposed to violations against the aggrieved individual. Furthermore, disgorgement is punitive because it is primarily intended to deter violations of the federal securities laws “by depriving violators of their ill-gotten gains.” The Supreme Court noted that in many instances the disgorged funds do not compensate the victims, such as instances when it is not feasible to identify them. Based on the two principles distilled from the definition of penalty, the Supreme Court concluded that SEC sought disgorgement falls within the five-year statute of limitations in 28 U.S.C. § 2462 because disgorgement goes beyond compensation and is intended to punish wrongdoers for violating public laws. Kokesh v. SEC, No. 16-529, 2017 WL 2407471 (2017).

GORSUCH MAY BRING TO SUPREME COURT SKEPTICISM OF PRIVATE SECURITIES LITIGATION AND OF JUDICIAL DEFERENCE TO SEC

Judge Neil Gorsuch’s confirmation hearings do not begin until March 20th, but if he is confirmed to replace the seat vacated by the late Justice Antonin Scalia, Judge Gorsuch could bring some skepticism of securities litigation plaintiffs to the high court. Although Judge Gorsuch has only authored a handful of opinions analyzing securities litigation cases while on the bench for the Tenth Circuit Court of Appeals, two opinions stand out as worth analyzing to give some insight into his views of securities litigation.

In MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P., Judge Gorsuch analyzed the issue of when Section 11 of the Securities Act of 1933 imposes liability on issuers who offer statements of opinions. 761 F.3d 1109, 110 (10th Cir. 2014). Judge Gorsuch thoroughly analyzed the case law and determined that there were three possibilities: (1) an issuer’s opinions about future events can never be actionable, (2) “a plaintiff must show both that the defendant expressed an opinion that wasn’t his real opinion (sometimes called ‘subjective disbelief’) and that the opinion didn’t prove out in the end (sometimes called ‘objective falsity’),” and (3) when a fiduciary or someone who holds himself out to be an expert offers an opinion that lacks an objectively reasonable basis. Id at 1112-15 (emphasis original). Although Judge Gorsuch seemed inclined to go with the second possibility as the correct standard, he concluded that he did not have to select a single approach because in the case at hand, plaintiffs’ complaint failed even under the third, investor-friendly, objectively reasonable basis test. Id. at 1117. Notably, when the Supreme Court looked at the same issue a year later in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, it followed Judge Gorsuch’s inclination. Now, under Section 11, an affirmative statement of opinion is only actionable when it is incorrect and when the speaker did not actually hold the stated belief. 135 S. Ct. 1318, 1326 (2015). This standard is more favorable to issuers than the objectively reasonable basis standard Judge Gorsuch seemed less inclined to adopt.

Even more telling is Judge Gorsuch’s opinion in ACAP Financial, Inc. v. SEC. In that case, the court denied a petition for review of an SEC review of a FINRA decision that imposed a $125,000 fine on a broker-dealer and its registered representative and suspended the registered representative from the securities industry for six months for failing to take sufficient steps to guard against the petitioners’ involvement in trading unregistered shares. 783 F.3d 763, 765 (10th Cir. 2015). Although the Court did not find any reason to overturn the SEC’s punishment based on the grounds raised by the petitioners, Judge Gorsuch noted that the petitioners failed to raise what he considered to be the more substantive arguments. Id. at 767-69. For example, Judge Gorsuch took the time to note that the petitioners did not argue that the SEC used this administrative proceeding to expand the definition of “egregious” and then retroactively applied that expanded definition to petitioners. Id. at 767. Nor did petitioners challenge the SEC’s ability to employ multi-factor balancing tests in deciding what sanctions to issue against petitioners. Id. at 769. As Judge Gorsuch noted somewhat wistfully, “the petitioners before us have repeatedly demurred when presented with the opportunity to challenge the propriety of the SEC’s decisionmaking process.” Id.

This opinion closely echoes Judge Gorsuch’s opinion—and concurrence to his own majority opinion—in Gutierrez-Brizuela v. Lynch. That case was not a securities litigation case but dealt with whether the Bureau of Immigration Affairs could retroactively apply a policy that interpreted an ambiguous statute contrary to a Tenth Circuit opinion. 834 F.3d 1142, 1143 (10th Cir. 2016). Judge Gorsuch determined that the Bureau of Immigration Affairs could not retroactively apply its policy, but he wrote separately in a concurring opinion to criticize the Chevron doctrine, which requires a court to give deference to an executive agency’s interpretation of an ambiguous statute when the agency’s interpretation is reasonable. Id. at 1149-58 (Gorsuch, J., concurring). In Judge Gorsuch’s view, de novo judicial review about what an ambiguous law means should replace the judicial deference given to the executive agency’s interpretation under the Chevron doctrine. Id. at 1158. As alluded to in ACAP Financial, Judge Gorsuch’s view of increasing judicial supervision of an executive agency’s interpretations would include increased judicial supervision of the SEC.

Finally, a handful of other cases in which Judge Gorsuch sat on the panel but did not author the opinion involved what were largely pro-defendant results in private securities litigation cases. See, e.g., Farley v. Stacy, 645 F. App’x 684 (10th Cir. 2016); United Food & Commercial Workers Union Local 880 Pension Fund, 774 F.3d 1229 (10th Cir. 2014); Cook v. Baca, 512 F. App’x 810 (10th Cir. 2013); Thomas v. Metropolitan Life Ins. Co., 631 F.3d 1153 (10th Cir. 2011). Although these cases are not a crystal ball for determining how Judge Gorsuch would come out on the next securities litigation issue facing the Supreme Court, those opinions do give some indication that Judge Gorsuch may take a skeptical view of securities litigation lawsuits, especially cases involving the SEC’s discretion in making and applying policies and rules.