Saturday, September 13, 2014
The Solicitor General recently filed a brief with the Supreme Court recommending that the Court grant certiorari in the Ninth Circuit case of Moores v. Hildes, No. 13-791. If the Court takes this recommendation (which I’m guessing it will), it will be the third Section 11 case scheduled to be heard this Term. (I’ve blogged about the prior two here and here.)
[More under the cut]
Section 11 of the Securities Act provides a cause of action for investors who purchase a security that was issued pursuant to a registration statement that contains a material false statement.
If the investor buys the security within a certain time period after the registration statement becomes effective, the statute does not require that the investor prove he or she “relied” on the misstatement.
Additionally, the statute does not require that the plaintiff prove that his or her losses were caused by the misstatement; instead, the defendants have the burden of proving that all, or part, of the losses were due to factors other than the misstatement.
The legislative history explains why no reliance is required: Congress adopted something like a fraud-on-the-market theory, whereby it assumed that for the period immediately following the effective date of the registration statement, any material false information in the registration statement would influence the security’s market price. Therefore, all investors would be affected by any misstatements, regardless of whether they personally relied on the false information.
In APA Excelsior III L.P. v. Premiere Techs., 476 F.3d 1261 (11th Cir. 2007), the Eleventh Circuit held that Section 11 should be interpreted not to lack a reliance requirement, but instead to contain a presumption of reliance – one that can be rebutted in the correct circumstances. Those circumstances exist, according to the Eleventh Circuit, when the purchaser “irrevocably” commits to buying the security before the false registration statement is filed.
(When I taught this to my students, I called it Section 11’s invisible rebuttable presumption of reliance.)
Since APA Excelsior, a few district courts have followed the Eleventh Circuit’s lead, although there have been different rationales. Some have agreed that Section 11 contains an invisible rebuttable presumption of reliance; others have simply held that if an investor irrevocably commits to buying a security before the false statement is made, then the false statement is – by law – immaterial (at least as to that investor).
This is a difficult position, however, because in the securities context, materiality is usually an objective inquiry that does not vary by investor. See Amgen Inc. v. Conn. Ret. Plans & Trust Funds (2013).
Other courts have held that if an investor commits to purchase before the false statement issued, then necessarily, the defendants will be able to prove that any losses were not “caused” by the misstatement.
The problem with that is the statutory text, which is very specific about calculating damages based on price paid relative to price drop, and requires defendants to show that the price drop was due to factors other than the misstatement – which, presumably, has nothing to do with when the plaintiff committed to purchase.
In Hildes v. Arthur Andersen LLP, 734 F.3d 854 (9th Cir. 2013), the Ninth Circuit considered the issue, and claimed that it was not creating a circuit split with the Eleventh, but – as the SG points out in his brief – it totally was.
In that case, Peregrine and Harbinger entered into a merger agreement, whereby Harbinger would become a wholly-owned subsidiary of Peregrine, and Harbinger shareholders would receive Peregrine stock in exchange. The merger was subject to the approval of Harbinger’s shareholders, and as part of the arrangement, David Hildes, one of Harbinger’s largest shareholders, signed an agreement granting Peregrine an irrevocable proxy to vote his shares in favor of the deal. Other large shareholders signed similar proxies, amounting to about 15% of the total Harbinger vote.
After the Hildes agreement was signed, Peregrine filed a registration statement to issue the new shares that would be given to Harbinger’s shareholders as merger consideration. The registration statement, as registration statements do, contained information about Peregrine’s financial performance. Harbinger’s shareholders voted in favor of the deal, received their Peregrine shares, and all was rosy until Peregrine admitted that it had massively overstated its revenues for the past several years, and collapsed into bankruptcy.
Hildes filed a lawsuit under Section 11 based on the false registration statement. Now, obviously, Hildes had substantively relied on Peregrine's false financial information when agreeing to the merger - it was part of the information that formed the basis for the deal - but the technical legal question under Section 11 was whether false statements in the registration statement, specifically, were responsible for Hildes's losses.
The district court followed APA Excelsior and dismissed Hildes's claims. In the court's view, because Hildes had irrevocably agreed to the merger before the registration statement was filed, the registration statement could not have caused Hildes’s losses.
The Ninth Circuit reversed. In the Ninth Circuit’s view, the voting proxy that Hildes had signed prior to the registration statement did not count as an irrevocable commitment to purchase Peregrine’s shares, because the merger would never have been consummated if Peregrine’s registration statement had been truthful. Among other things, had Peregrine confessed the truth, Harbinger’s Board would have revoked its agreement to the merger on the ground that Peregrine had previously misrepresented its financial condition during the merger negotations. Or, Harbinger’s remaining shareholders – those who had not signed voting proxies – would have rejected the deal.
The Ninth Circuit distinguished APA Excelsior not on the specific facts – which were quite similar – but on the ground that the Eleventh Circuit had simply never considered whether the plaintiff in that case really was “irrevocably bound” prior to the filing of the registration statement (because the plaintiff had waived that argument by offering it too late in the game).
Not surprisingly, the Peregrine defendants petitioned the Supreme Court for certiorari, arguing that, whatever rationale the Ninth Circuit used, in truth, the Ninth Circuit’s decision represented a split from the Eleventh Circuit.
Hildes initially waived his right to file an opposing brief, but the Supreme Court called for a response. Then, the Supreme Court called for the Solicitor General to offer his views. (These moves are strong signals of Supreme Court interest in a case.)
In his brief, the SG agreed that the Ninth Circuit had created a circuit split, and urged the Supreme Court to grant on that basis. However, and unfortunately for the Peregrine defendants, the SG also argued that the Ninth Circuit’s ruling was substantively correct, because Section 11 does not contain a reliance requirement - even an invisible one.
The case will be considered at the Supreme Court’s September 29th conference, which means we may find out that afternoon, or at least that week, whether it’ll round out a Section 11 hat trick for OT14. Stay tuned.
ETA: My powers of prediction are sterling as ever - despite the SG's recommendation, the Supreme Court turned down the cert petition, and the split remains.