The securities litigation and regulatory landscape in 2017 defies simple categorization. Plaintiffs filed 226 new federal class actions in the first half of 2017, more than double the average rate over the last 20 years,1 and an additional 99 federal class actions in the third quarter of 2017.2 In contrast, new SEC enforcement proceedings declined. After staying on pace with the prior two years with 45 new enforcement actions against public company-related defendants in the first half of fiscal year 2017, the SEC filed only 17 new enforcement actions against public company-related defendants in the second half of the year.3 The apparent decrease in initiation of enforcement proceedings coincides with the arrival at the SEC of Chairman Walter J. Clayton, who has expressed the view that enforcement actions against issuers rather than individual wrongdoers too often punish the very investors they seek to protect.4
Amidst this activity, there were a number of important legal and regulatory developments, including in the following areas:
- Statutes of Limitations and Repose: The Supreme Court held that the SEC's disgorgement remedy is subject to a five-year statute of limitations, and that a pending class action does not toll the three-year statute of repose under the Securities Act of 1933 (the "Securities Act") for opt-out plaintiffs.
- Class Actions: The Second Circuit held that questions regarding whether activity in the U.S. warrants application of the federal securities laws under Morrison may constitute individual issues that defeat the "predominance" requirement for class certification. The Second Circuit also approved the use of indirect evidence of market efficiency in evaluating whether the fraud-on-the-market presumption applies for purposes of certifying a class action asserting a claim under Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"). The Supreme Court granted certiorari in a case that will require it to decide whether state courts retain concurrent jurisdiction over securities claims covered by the Securities Litigation Uniform Standards Act of 1998 ("SLUSA").
- Securities Fraud: The Second Circuit confirmed the operative test to determine the materiality of an omission of interim financial information, and also held that national securities exchanges may face liability in private securities litigation. The Ninth Circuit extended the Omnicare test for determining when statements of opinion are actionable to Section 10(b) claims. The United States District Court for the District of Utah held that, in actions brought by the SEC, Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act should be applied to extraterritorial transactions to the extent that the "conduct and effects" test can be satisfied.
- Insider Trading: Following the Supreme Court's decision in Salman v. United States, the Second Circuit held that a gift of insider information may be illegal even if the tipper lacks a meaningfully close relationship with the tippee.
- Indemnification: The United States District Court for the Southern District of New York held that public policy prohibits an underwriter from seeking contractual indemnification of settlement costs from an issuer unless the underwriter has demonstrated that it was without fault.
- Whistleblower Actions: The Supreme Court granted certiorari to consider whether whistleblowers who report securities law violations to their internal managers, not to the SEC, are entitled to utilize the anti-retaliation protections in the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act").
- Securities Regulation and Enforcement: The SEC determined that certain applications of distributed ledger or blockchain technology, such as bitcoin and similar "coins," can be securities subject to regulation under the federal securities laws. The new leadership focused the SEC's enforcement priorities on cybersecurity, protecting retail investors, and pursuing individual violators, and attempted to cure doubts about the authority of its Administrative Law Judges. The House of Representatives passed the Financial CHOICE Act, which would require changes to many aspects of SEC enforcement practices.
I. Statutes of Limitations and Repose
A. SEC Disgorgement Remedy Subject to Five-Year Statute of Limitations
In Kokesh v. SEC,5 the Supreme Court held that the SEC's ability to seek disgorgement as a remedy in an enforcement action is subject to a five-year statute of limitations under 28 U.S.C. § 2462, which provides that "an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued."6 In 2009, the SEC brought an enforcement action against Charles Kokesh in the United States District Court for the District of New Mexico, alleging that Kokesh misappropriated $34.9 million from two investment firms that he operated. Following a jury verdict in favor of the SEC, the District Court entered a permanent injunction enjoining Kokesh from violating certain provisions of the federal securities laws, imposed a civil penalty, and ordered disgorgement of profits. Although the District Court limited recovery of the civil penalty to funds Kokesh received within five years of the SEC's filing of its complaint, the Court ordered full disgorgement of $34.9 million in ill-gotten gains, holding that the five-year statute of limitations under 28 U.S.C. § 2462 does not apply to disgorgement because it is not a "civil fine, penalty, or forfeiture."7 The Tenth Circuit affirmed the District Court's judgment with respect to disgorgement.
The Supreme Court reversed in an unanimous decision, holding that disgorgement is a "penalty" under 28 U.S.C. § 462. The Court explained that the purpose of disgorgement, to deter future violations by requiring the forfeiture of profits from securities violations, is "inherently punitive."8 The remedy is not compensatory in nature because, when it seeks disgorgement, the SEC does so on behalf of the public at large, rather than on behalf of "an aggrieved individual,"9 and profits are paid to the district court," not to victims.10 Thus, the Court ruled that the SEC may not seek disgorgement for misappropriation that occurred more than five years before the SEC filed its complaint.11
Kokesh further limits the remedies available to the SEC outside the five-year limitations period set forth in 28 U.S.C. § 462, which the Supreme Court previously held applies to statutory monetary penalties.12 Kokesh likely will have several important effects in SEC enforcement actions, including potentially reducing the SEC's leverage in settlement negotiations, limiting investigations involving older conduct, and motivating the SEC to seek tolling agreements to extend the limitations period as much as possible. Steve Peikin, Co-Director of the Division of Enforcement, remarked that, in light of Kokesh, the SEC "[has] no choice but to respond by redoubling our efforts to bring cases as quickly as possible."13 The SEC also may attempt to seek remedies other than disgorgement in order to avoid the potential preclusive effect of the five-year limitations period. For example, post-Kokesh, the Eighth Circuit held that a permanent injunction enjoining the defendant from future violations of the securities laws was not a "penalty" under 28 U.S.C. § 462 because "[t]he historic injunctive process was designed to deter, not to punish."14
B. Statute of Repose Not Tolled Under American Pipe
In California Public Employees Retirement System v. ANZ Securities, Inc.,15 the Supreme Court held that the American Pipe doctrine does not toll the three-year statute of repose under Section 13 of the Securities Act.
In 2008, investors brought a putative class action asserting claims under Section 11 of the Securities Act against Lehman Brothers Holdings Inc. in the United States District Court for the Southern District of New York. The plaintiffs alleged that the Lehman Brothers' registration statement for certain securities offerings contained material misstatements and omissions. California Public Employees Retirement System ("CalPERS") opted out of a subsequent class settlement and in 2011 filed an individual action against Lehman Brothers in the Northern District of California. Lehman Brothers moved to dismiss the individual action, arguing that the claims were untimely under the three-year statute of repose since the registration statements containing the alleged misstatements were filed in 2007 and 2008. CalPERS countered that the three-year time bar was tolled under American Pipe, in which the Supreme Court ruled that the statute of limitations for individual claims of absent class members may be tolled on equitable grounds while a timely-filed class action is pending.16 The District Court rejected the tolling argument and dismissed CalPERS' individual action as untimely. The Second Circuit affirmed.
The Supreme Court granted certiorari and affirmed. The Supreme Court distinguished American Pipe, explaining that the equitable justifications for tolling a statute of limitations are not applicable to statutes of repose such as Section 13. Unlike a statute of limitations, which "[is] designed to encourage plaintiffs to pursue diligent prosecution of known claims,"17 the "object of a statute of repose, to grant complete peace to defendants, supersedes the application of a tolling rule based in equity."18 "[T]he text, purpose, structure, and history of [Section 13] all disclose the congressional purpose to offer defendants full and final security after three years."19 As a statute of repose, Section 13 "displaces the traditional power of courts to modify statutory time limits in the name of equity."20
ANZ should incentivize larger stockholders to file individual actions under Section 11 relatively soon after a class action complaint is filed. The impact of ANZ may be limited, however, given that several circuits (including the Second Circuit, Sixth Circuit, and Eleventh Circuit) previously had held that the three-year statute of repose is not tolled under American Pipe.21 For average investors, moreover, the costs of filing individual actions will continue to far outweigh the benefits, muting concerns that ANZ will open the "floodgates" to individual securities fraud actions.
1 Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, Securities Class Action Filings: 2017 Midyear Assessment, https://www.cornerstone.com/Publications/Reports/Securities-Class-Action-Filings-2017-Midyear-Assessment.
2 Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, Securities Class Action Filings: 2017 Q3, https://www.cornerstone.com/Publications/Research/Securities-Class-Action-Filings-2017-Q3.
3 Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, Sec Enforcement Activity: Public Companies and Subsidiaries, https://www.cornerstone.com/Publications/Reports/SEC-Enforcement-Activity-2017-Update.
4 See Hearing Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Nomination of Jay Clayton, S. Hrg. 115-9 (Mar. 23, 2017) ("There should be deterrence at the company level [but] shareholders do bear those costs . . . . I firmly believe that individual accountability drives behavior more than corporate accountability.").
5 137 S. Ct. 1635, 1638-44.
6 28 U.S.C. § 2462
7 137 S. Ct. at 1643-44.
8 Id. at 1641.
9 Id. at 1643.
10 Id. at 1644.
12 See Gabelli v. SEC, 568 U.S. 442, 454 (2013).
13 Steven R. Peikin, Co-Director, Enforcement Division, "Reflections on the Past, Present, and Future of the SEC's Enforcement of Foreign Corrupt Practices Act," https://www.sec.gov/news/speech/speech-peikin-2017-11-09.
14 SEC v. Collyard, 861 F.3d 760, 764 (8th Cir. 2017) (citation omitted).
15 137 S. Ct. 2042, 2049-55 (2017).
1 American Pipe & Constr. Co. v. Utah, 414 U.S. 538, 556 (1974).
17 137 S. Ct. at 2049.
18 Id. at 2052.
20 Id. at 2055.
21 See Police & Fire Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013); Stein v. Regions Morgan Keegan Select High Income Fund, Inc., 821 F.3d 780 (6th Cir. 2016); Dusek v. JPMorgan Chase & Co., 832 F.3d 1243, 1249 (11th Cir. 2016).
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