In Far-Reaching Decision, Delaware Chancery Court Rules that Officers Who Engage in Sexual Harassment Act in Bad Faith and may be Liable for Acts of Disloyalty In a decision with important implications for businesses and stockholders nationwide, a Delaware Chancery Court judge ruled yesterday that corporate officers may be held liable for failing to oversee misconduct that harms a company and for acting in bad faith – the first time a Delaware court has extended duties of oversight beyond the boardroom and into the C-suite. Significantly, the decision by Vice Chancellor Travis Laster involved the former Global Chief People Officer of McDonald’s, who is not only accused of intentionally ignoring a corporate culture of sexual misconduct and harassment, but of acting in bad faith by repeatedly engaging in sexual misconduct himself. The underlying fact pattern is all too familiar: a corporate executive engages in sexual harassment and gets a slap on the wrist and “final warning,” despite the company’s supposed zero-tolerance policy for such misconduct. Vice Chancellor Laster determined that claims against McDonald’s former Global Chief People Officer David Fairhurst could proceed because, “[t]he duty of good faith requires that a fiduciary subjectively act in the best interests of the entity. When engaging in sexual harassment, the harasser engages in reprehensible conduct for selfish reasons. By doing so, the fiduciary acts in bad faith and breaches the duty of loyalty.” It’s a Good Time To Extend Caremark Claims to Corporate Officers Legally, the decision is largely devoted to the logic underlying liability for corporate officers’ acts of bad faith and also their failure to exercise oversight on behalf of the company, also known as a Caremark claim. Caremark established the standards of oversight liability for directors as a two prong test, which requires a plaintiff to either allege facts showing that directors failed to implement a reporting system on matters of critical importance to the company; or, after adopting a necessary reporting system, failed to monitor for potential risks of a corporate trauma that required their attention. Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).  Under the latter portion of the test, a stockholder must allege that directors failed to act, even after the reporting system generated “red flags.” VC Laster concluded that the same fiduciary duty applies to corporate officers, noting that they are responsible for managing the day-to-day affairs of the company and thus better situated to provide relevant, timely information to the board. The decision notes: “officers are far more able to spot problems than part-time directors who meet a handful of times a year.” (at 27). Accordingly, if an officer fails to share information about harm to the company with the board, the directors themselves may want to sue the officer for a breach of duty to the company. And, if the board has a potential claim, so too would a stockholder in derivative litigation, in which the shareholder sues for fiduciary breaches in the company’s stead. Sexual Harassment Claims, A Party Atmosphere, Fear of Retaliation, EEOC Charges, and a 30-City Walkout at McDonald’s VC Laster applied this newly-carved-out oversight theory of officer liability to McDonald’s Fairhurst, who served as the company’s Chief Global People Officer from 2015 until McDonald’s terminated him in 2019. As alleged in the complaint, Fairhurst had “day-to-day responsibility for ensuring” that the company provided a “safe and respectful workplace” for 200,000 people working at its corporate-owned restaurants and two million more employed by McDonald’s franchises – 55% of them women. Instead, he and then-CEO Steve Easterbrook turned the McDonald’s Chicago headquarters into a “boys’ club” where they and other executives sexually harassed female employees and HR officials ignored women’s reports of inappropriate conduct. They behaved this way despite a headline-grabbing 30-city employee walkout in 2016 to bring attention to more than a dozen complaints filed with the Equal Employment Opportunity Commission, a one-day strike by workers in 2018 after another flurry of EEOC complaints, and a letter of inquiry from a U.S. Senator. The opinion concludes that Fairhurst was aware of incidents of sexual harassment and misconduct at the company as early as 2016. In addition, Fairhurst acted in bad faith by consciously ignoring those red flags, thereby acting with scienter. VC Laster highlighted the fact that not only did Fairhurst himself engage in sexual misconduct, but that he did so after receiving a final notice that such behavior was unacceptable. Therefore, VC Laster found it is reasonable to conclude that Fairhurst ignored the sexual misconduct of others and party atmosphere more broadly, particularly since Fairhurst and Easterbrook, who took over as CEO in 2015, actively fostered the culture. The last four pages of the decision are perhaps the most significant for officer liability in the context of sexual harassment. VC Laster axiomatically wrote: “sexual harassment is bad faith conduct. Bad faith conduct is disloyal conduct. Disloyal conduct is actionable.” Thus, he ruled, the stockholders had properly stated a claim that Fairhurst acted in bad faith and disloyally to the company. The decision notes that an officer cannot act in good faith while violating company policy, breaking the law, and exposing the company to liability. These features are hallmarks of sexual harassment and discrimination based derivative lawsuits that Cohen Milstein has worked on across the country, notably against such companies as Wynn Resorts, Alphabet, L Brands, and Pinterest. Going forward, VC Laster’s ruling will be relied upon not only to support the viability of cases where officers and directors materially support toxic, inequitable workplaces, but also where officers fail to protect a company from harm based on their own officer oversight duties. Julie Goldsmith Reiser is a partner at Cohen Milstein and co-chair of the firm’s Securities Litigation & Investor Protection practice, which Law360 named this month as one of its 2022 Securities Groups of the Year.

Employee Stock Ownership Plans (ESOPs) are retirement plans that are set up to invest solely in the stock of the employer.

Among other things, ESOPs offer the company and employee participants various tax benefits, making them “qualified” plans that are regulated by the Employee Retirement Income Security Act (ERISA). If managed properly, and in accordance with ERISA, ESOPs can be help employees save for retirement.

Traditionally used by smaller, privately held companies, ESOPs can be used by larger, publicly held companies and can complement 401(k) retirement plans. Similar to the 401(k)-vesting period, an ESOP participant earns an increased portion of company shares in the plan for every year of service. When an employee retires or resigns, they can “cash out” of the ESOP and claim their nest egg.

ESOPS: Vulnerabilities and Potential for Abuse

Unfortunately, ESOPs are vulnerable to abuse that is difficult for participants to detect. ESOPs provide a mechanism that allows an owner to transfer ownership of a company to its employees. While Congress permits ESOPs to encourage employee ownership of companies, it was aware that owners can use ESOPs to receive more money for their interest in the company than it’s actually worth. To protect employees from these abuses, Congress put stringent requirements on employees that choose to use ESOPs.

ERISA requires that ESOPs be managed prudently and with undivided loyalty to the employee-ESOP participant, and imposes strict “prohibited transaction” restrictions on owners wishing to use an ESOP for their employees.

Employees and ESOP participants suffer the consequences of an ESOP overpaying for a company. Overpayment not only reduces the amount of retirement savings a participant will ultimately earn, but also can put a strain on a company’s financial health that may imperil job security.

Fortunately, ESOP-participants that are harmed by a mismanaged ESOP can seek redress and assert their rights under ERISA.

Real Life Examples

Case in point. We are representing approximately 750 employee ESOP beneficiaries of the Casino Queen Hotel & Casino, the former famed riverboat casino which moved on land in 2007 to East St. Louis, Illinois.

In the complaint, we allege that the owners of Casino Queen tried to sell the casino to third party buyers for years. Unsuccessful, they decided to create their own buyer and established the Casino Queen ESOP for the purpose of buying 100% of the company’s outstanding common stock for $170 million.

The Complaint explains how, employees were told initially that the ESOP was a great opportunity that would lead to the creation of greater wealth, this alluring promise was revealed to be a mere illusion.

The Complaint alleges numerous ERISA violations, including that the ESOP’s trustee concealed that the ESOP had significantly overpaid for the company stock in 2012, and that they engaged in other ERISA violations, including selling all the casino’s real property out from under the ESOP.

The lawsuit names as Defendants several people who profited handsomely from the sale of the casino.

We also represent the employees of the following private companies in ESOP litigation. Plaintiffs’ allegations in those cases are summarized below:

• Western Milling, an agribusiness, specializing in fertilizer, pesticides, seeds, and animal feed formulas, where the Kruse family, among others, formed Western Milling ESOP to buy 100% of outstanding Kruse-Western stock for over $244 million. Just two months after the transaction, Kruse-Western stock was valued at just 10% of what it was previously valued.
• World Travel, a full-service concierge travel management company. In 2017, the founders of the company created the ESOP and then sold 100% of their World Travel stock to the newly created ESOP at an above-market price. Further, despite selling 100% of their stock ownership and touting that the company is 100% employee owned on its website, the founders have retained full control of the company.
• Triad Manufacturing, a vertically integrated design and manufacturing company that builds retail store environments, nationally and globally.  Allegedly the owners of the company and the ESOP’s Trustee, GreatBanc Trust Company, breached their fiduciary duties by selling 100% of the owner’s company stock to the newly created Triad ESOP. Approximately two weeks later, Triad’s stock dropped nearly 97%.
• Envision Radiology, an outpatient radiology company with locations in five states. Allegedly, the original owners and top ex of Envision Management Holding, Inc. as well as Argent Trust Company (which served as the trustee to the ESOP), breached their fiduciary duties to the ESOP and engaged in prohibited transactions in connection with the sale of Envision company stock to the newly created Envision Management Holding, Inc. Employee Stock Ownership Plan in 2017.
• W BBQ Holdings, Inc., the owner of Dallas BBQ, a restaurant and catering chain in New York City that serves low-cost barbeque and beverages. Allegedly, the controlling members and shareholders of W BBQ Holdings and the trustee of the WBBQ ESOP, caused the ESOP to engage in transactions that are prohibited under ERISA and breached their fiduciary duties to the ESOP in connection with the sale of the company to the ESOP at a dramatically inflated price over fair market value.

Early Warning Signs

While early warning signs are hard to detect, there are certain themes these cases have in common.

• An ESOP is quickly created
• No to little information is given to employees about the ESOP and projected benefits
• Employees have no voice, no vote in the creation of the ESOP or the selection of the trustee
• The ESOP overpays, i.e., over fair market value, for shares of the company stock or other company assets
• Employees have no voice, no vote in the ESOP’s transactions

Employees are best served when they understand the risks and rewards of ESOPs. Please contact us if you have concerns about your company’s ESOP.

Michelle C. Yau, Esq. – myau@cohenmilstein.com

Kai Richter, Esq. – krichter@cohenmilstein.com

Daniel R. Sutter, Esq. – dsutter@cohenmilstein.com

Ryan Wheeler, Esq. – rwheeler@cohenmilstein.com

Cohen Milstein Sellers & Toll PLLC
1100 New York Avenue, N.W., Suite 500
Washington, D.C. 20005
Telephone: 888-240-0775 or 202-408-4600

Sharon K. Robertson will moderate a panel at the American Antitrust Institute’s (AAI) annual Private Antitrust Enforcement Conference on November 9. The panel, “Beneficial Coordination: When Public and Private Enforcers Collaborate,” will explore key issues, challenges, and best practices in the coordination of public and private antitrust enforcement.

Now in its 16th year, the Private Antitrust Enforcement Conference features a series of panels on topics relevant to of interest to the antitrust community. Experts and thought leaders in enforcement, advocacy, and academia serve as panelists.

Visit the AAI’s event page for a full agenda and information on registration.

A federal judge in Nevada is allowing most of a putative class action against the hospitality giant MGM Resorts International to move forward, rejecting the company’s bid to escape claims that it mishandled customers’ personal data and essentially let hackers steal that information in 2019.

The ruling on Wednesday, by U.S. District Judge Gloria M. Navarro, will force MGM Resorts to face allegations of negligence and breach of contract, as well as claims that it violated a host of consumer protection statutes, while sparing it from an accusation of negligent misinterpretation.

In a 43-page decision, Judge Navarro rejected the company’s stance that it cannot be accused of negligence since the consumers suffered only financial harm, noting that hackers stole their names, addresses, contact information, dates of birth and, for some, their government-issued ID numbers. That negates MGM’s argument under the so-called economic loss doctrine, the judge held, calling it “difficult to conceive how the dissemination of an individual’s [personally identifiable information] does not necessarily diminish their control over their digital and physical identity.”

. . .

The plaintiffs are represented by Miles N. Clark of the Law Offices of Miles N. Clark LLC, Don Springmeyer of Kemp Jones LLP, E. Michelle Drake, Michael Dell’Angelo, Jon Lambiras and Reginald Streater of Berger Montague PC, Douglas J. McNamara, Andrew N. Friedman, Geoffrey A. Graber and Paul Stephan of Cohen Milstein Sellers & Toll PLLC, David M. Berger and Eric H. Gibbs of Gibbs Law Group LLP, and by John A. Yanchunis, Jean S. Martin and Marcio Valladares of Morgan & Morgan Complex Litigation Group.

Read the complete article on Law360.

By Poorad Razavi

I have frequently written and spoken about the many nuances of advancing a product liability claim, as well as a variety of strategic tactics to employ in order to advance a mature case theory. As a 15-year veteran product defect attorney, these are naturally the topics that appeal to me. However, as a young attorney, or an attorney generally unfamiliar with the intricacies of product liability, discussing these topics is akin to coaching someone to land a plane without ever discussing how to take off in the first place. And as the downtime of the pandemic has granted me the capacity to renew my love of learning about astrophysics, I have come to accept that somewhere in the dimensional multiverse is a version of me who is also new to the field of complex torts and product defects, and he or she needs to have resources containing the fundamentals as well. This article is written for him or her.

What Is Product Liability?

Product liability, in the context of this publication, is a claim rooted in the defectiveness surrounding the design, manufacture, and/or warning of a product that has caused a tortious harm to an individual.

A design defect means that the actual intended iteration of the product is such that its foreseeable use is dangerous to the user and/or public at large. Examples would include Takata airbags or asbestos-lined construction materials, which are (arguably) defective from inception. Florida continues to recognize the “consumer expectations” test as well as the risk/utility test in defining a design defect. Aubin v. Union Carbide Corp., 177 So. 3d 489 (Fla. 2015). “A product is unreasonably dangerous because of its design if [the product fails to perform as safely as an ordinary consumer would expect when used as intended or when used in a manner reasonably foreseeable by the manufacturer] [and] [or] [the risk of danger in the design outweighs the benefits].” Fla. Std. Jury Instr. (Civil) 403.7b.

A manufacturing defect is where an otherwise (presumably) safe product is made unsafe due to errors during the actual manufacturing/construction of the product. An example of this would include the recent recall for specific batches of Similac baby formulas that were found to have harmful contaminants introduced during the manufacturing stage.

A warning defect is where the nonobvious dangers of a product are not adequately conveyed to the user and/or public at large. Examples of this include warnings about pharmaceutical drug contraindications or about the dangers of using an infant car seat as a sleeping device outside of a vehicle.

Read the complete “Back to Basics: A Product Liability Primer” article in the September/October 2022 issue of the Florida Justice Association Journal.

Securities Litigation 101
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Securities fraud costs investors billions of dollars a year and shareholder lawsuits are the best available tool to recover fraud-related losses. The top 100 securities class action settlements alone have returned more than $68.6 billion to defrauded investors since 2001; approximately $10 billion in settlement proceeds awaited distribution as of September 30, 2022, according to ISS Securities Class Action Services.

Potential securities litigation claims are considered assets of the trust fund, giving trustees and staff a fiduciary duty to manage them effectively. For that reason, many pension funds have established portfolio monitoring programs to calculate their losses when new shareholder lawsuits are filed and keep track of settlements in which they are entitled to share. This article reviews the elements of a successful monitoring program.

Adopting and Maintaining a Securities Litigation Policy

A successful monitoring program begins with a comprehensive and up-to-date securities litigation policy. The Board should approve a policy that reflects its thinking about the factors that could tip the balance between remaining an “absent” class member, which is suitable for most shareholder lawsuits, or actively pursuing litigation as a lead or individual plaintiff. Spending time in this area bears dividends because a well-considered policy makes sure that staff will only spend their time on cases that the policy defines as worth the effort.

Tracking Settled Cases

For securities acquired in the United States, trustees should at least take steps to ensure their fund’s custodial bank is filing all class-action settlement claims to which the fund is entitled. Because U.S. class actions function on an “opt in” basis, settlement claims administrators will attempt to contact all class members via their custodian once a settlement receives final approval. At that time, any fund owed a recovery can decide whether to collect its share, opt out of the class to pursue individual litigation, or object to the settlement.

Monitoring New Cases

When a securities class action is filed in U.S. federal court, impacted shareholders have 60 days to ask the judge to appoint them lead plaintiff. For that reason, trustees arguably have a fiduciary duty to monitor newly filed lawsuits to decide if active involvement can boost a fund’s recovery or is otherwise beneficial to fund members. Since custodian banks only concern themselves with settlement claims, investors often select law firms or other third-party providers to track all new cases, calculate a fund’s initial losses, and evaluate the merits of active involvement (something discussed in greater detail below).

A securities litigation policy should list factors the fund wants evaluators to consider before recommending it consider pursuing active litigation. Policies sometimes include a minimum dollar loss threshold to trigger a full case evaluation. They may specify other factors to weigh: the strength of the legal claims at issue; the probability of a meaningful financial recovery; the opportunity for corporate governance improvements; the amount of staff time necessary to oversee counsel; and the egregiousness of the fraud, for example.

Non-U.S. Litigation

Since many non-U.S. cases are litigated in “opt out” jurisdictions, where a fund must register earlier to collect in an eventual settlement and where a “loser pays” regime may expose plaintiffs to financial risk, policies may establish different criteria for U.S. and non-U.S. litigation.

The National Association of Public Pension Attorneys and other organizations have model policies to use as templates.

Selecting Monitoring Firms

If the policy calls for retaining monitoring law firms, staff should manage the process. The quality, selectivity, and number of law firms selected —together with the policy guidelines—will affect the number of cases flagged for consideration. Some funds issue open or targeted RFPs to select firms; others invite a group of reputable firms to submit proposals and select some to make “final” presentations to the board. While there is no magic number of monitoring firms to select, using more than one firm is a best practice; doing so offers checks and balances at no extra cost (since law firms do not charge a fee for monitoring), ensures a single firm won’t be excluded from considering a case due to conflicts of interest, and allows for a mix of law firms with different approaches, strengths, and experiences. You’ll want to consider reducing the number of monitoring firms if your staff feels overwhelmed by too many recommendations.

With a properly designed program, staff involvement will be limited largely to reviewing periodic reports from monitoring law firms and, on occasion, screening case recommendations. Monitoring firms should identify all new cases that impact the fund; investigate and evaluate their merits; properly assess initial losses and complications in collecting damages; and recommend the best course of legal action, focusing on the fund’s policy goals. Most newly filed U.S. securities class actions will not require action before the settlement stage.

Pursuing an Active Role in Litigation

There are cases, however, where a fund may want to become a lead plaintiff. Doing so may boost its recovery and will ensure proper management of a case in which it has a significant financial interest. Typically, the lead plaintiff signs off on major strategic decisions, reviews important filings, and is involved in any settlement discussions. It may be able to pursue corporate governance remedies. It selects lead counsel, negotiates attorneys’ fees, and oversees class counsel. Some lead plaintiffs choose to do more. While there are no out-of-pocket costs—lead counsel reimburses the costs of travel and other expenses—the lead plaintiff should expect to dedicate some hours of staff time to the litigation. If the case is successful, lead counsel may petition the court to authorize compensating staff for time spent carrying out lead plaintiff duties.

Conclusion

Putting a portfolio monitoring program in place to account for securities litigation assets is a best fiduciary practice and enacting a securities litigation policy is the best way to provide a fund with clear, consistent guidelines about protecting its interests in shareholder lawsuits. Just as an investment policy is regularly reviewed to ensure consistency with the fund’s evolving circumstances, a securities litigation policy should be regularly reviewed to ensure it accurately reflects the fund’s evolving attitude toward involvement in securities litigation.

It seems as though Environmental, Social and Governance investing is on the forefront of everyone’s mind these days. News stories on the topic abound, with politicians of every stripe propounding their positions. A recent opinion piece in one national newspaper pronounced that trustees who engaged in Environmental, Social and Governance investing were clearly violating their fiduciary duty, while an op-ed in a competing news outlet claimed that those who ignored Environmental, Social and Governance investing were most certainly in violation of their fiduciary duty. What is a prudent fiduciary supposed to do in these polarized times?

Language Matters—Define the Terms

Critical to the analysis of fiduciary duty and Environmental, Social and Governance investing is an understanding of exactly what Environmental, Social and Governance investing actually means. One of the greatest difficulties in this area is a lack of clarity over Environmental, Social and Governance investing terminology, as Environmental, Social and Governance investing is not clearly defined and can mean different things to different investors. As set forth by State Street Global Advisors, different Environmental, Social and Governance investing strategies include: “exclusionary screening” (excluding certain companies, sectors or countries from the universe of possible investments); “positive screening” (affirmatively tilting the portfolio toward certain companies based on Environmental, Social and Governance investing metrics—note that the appropriateness of the metrics themselves has been hotly debated); “impact investing” (targeting a measurable positive social or governance impact, usually project specific); “active ownership” (engaging with companies on a variety of issues to initiate changes in company policies, practices and behaviors), and “ESG integration” (consideration of factors in order to achieve higher returns and/or mitigate risk). As these strategies differ widely, analyzing the application of fiduciary duty in each of these strategies may likewise be different.

Back to Basics

The fundamental starting point for any prudent pension system fiduciary facing a difficult situation is to return to the fundamental elements that underlie fiduciary duty. Fiduciary duties have been called “the highest known to the law.” Key to beginning an analysis is the exclusive benefit rule, which provides that investments shall be for the exclusive benefit of the participants and beneficiaries of the system and therefore fiduciaries must act solely in the interests of the members and beneficiaries of the system. This common law rule is codified in the enabling legislation that governs most public pension plans. Moreover, the Internal Revenue Code (“IRC”) provides that no part of the corpus or income of the pension trust may be used for or diverted to purposes other than for the exclusive benefit of the employees or their beneficiaries. This is critically important since public pension plans must remain “qualified plans” in order to entitle their members and beneficiaries to tax exemptions.

Closely related to the exclusive benefit rule and central to every statement of fiduciary duty is the fiduciary duty of loyalty, which provides that trustees must act solely in the interest of members and beneficiaries without regard to the interest of any other person. The trustee owes a duty to the beneficiary to administer the trust solely in the interest of the beneficiary and may not be guided by the interests of any other parties or person. The duty of loyalty is strictly construed in law and the U.S. Supreme Court has stated that the duty to trust beneficiaries must overcome any loyalty to the interests of the party that appointed the trustee. This is sometimes called the “one hat rule,” requiring that while trustees may also have a “day job”—as an elected official, an employee of an employer who pays into the system, or an officer of a union whose members belong to the system, for example—when making decisions as a trustee of the retirement system they may only wear their fiduciary trustee “hat.” This means that trustees of public retirement systems are not fiduciaries for appointing authorities, employers who pay into the systems, employees, unions, constituents, taxpayers, the public—or anyone other than the members and beneficiaries.

One Size Does Not Fit All—And May Not Fit Forever

Public pension plans come in a variety of sizes and shapes and each plan is different. Funding levels, for example, may vary dramatically, as may pension obligations. When setting the strategic asset allocation for the pension plan, which is often referred to as one of the most important functions of a trustee, trustees consider the plan’s funding levels and pension obligations and the plan’s risk tolerance and diversification of the investment portfolio. When making investment decisions, the fiduciary duties of prudence and care require consideration of the prevailing circumstances—meaning that investment action that is prudent for one investor may not be prudent for another.

Moreover, since fiduciaries must consider the prevailing circumstances, what is prudent at one time may not be prudent at a later time. This means that fiduciary duty is dynamic—i.e., while the fundamental fiduciary duties are based on legal principles that do not change, the application of those principles cannot be static, since fiduciaries must take into consideration current circumstances.

Conclusion

Applying this analysis, we see that not every type of Environmental, Social and Governance investing may be appropriate in every case. Prudent fiduciaries must keep the interest of the plan participants and beneficiaries paramount, and may not permit the use of the corpus or income of the pension trust in violation of the exclusive benefit rule, thereby risking disqualification under the IRC. They may not sacrifice investment returns and take on additional risk to promote interests unrelated to the portfolio’s objectives.

But prudent fiduciaries cannot ignore Environmental, Social and Governance investing factors that influence the performance of investments and are material to long-term returns and levels of risk. It cannot be impermissible for trustees to consider the state of the world in applying fundamental fiduciary principles to fulfill their obligations to members and beneficiaries, since they are seeking to preserve the assets for future generations of members and beneficiaries. Indeed, that is what trustees do when exercising their fiduciary responsibilities: they gather facts about prevailing circumstances and potential investment vehicles to make well informed decisions. Decisions made in 2022 are not the same as those that might have been made in 1972. The world has changed, and circumstances are different. Factors affecting the long-term considerations that public pension trustees must weigh are different. If responsible, informed decision making were static, there would be little need for trustees or the rules guiding their decision making. Fiduciaries must gather facts, analyze and assess those facts, and make decisions based on all relevant facts. It is impossible to invest prudently, loyally, and carefully without considering the impact of factors—including environmental, social, governance, cultural, economic, and political factors—that influence the performance of investments and are material to long-term risk and return. It’s a classic approach that has served pension funds and their beneficiaries well for a very long time—and should serve them for a very long time to come.

The Fall 2022 issue of the Shareholder Advocate includes:

• Holding Auditors Accountable for Complicity in Corporate Fraud – Laura Posner
• Third Circuit Rejects Bid to Overturn Class Certification in EQT Litigation –  Benjamin Jackson
• Tenth Circuit Revives Investors’ Fraud Suit Against Pluralsight – Carol Gilden
• Securities Litigation 101: Portfolio Monitoring Best Practices – Christopher Lometti and Richard Lorant
• Fiduciary Focus: Between a Rock and a Hard Place: Fiduciary Duty and Investment Concerns – Suzanne Dugan

Click here to download the Fall 2022 edition of the Shareholder Advocate (PDF).

Cohen Milstein and its co-counsel recently scored an important victory in the Third U.S. Circuit Court of Appeals, which refused to allow Defendants to appeal the District Court’s class certification decision in In re EQT Corp. Securities Litigation, a federal securities class action relating to the 2017 merger of major natural gas producers EQT Corporation and Rice Energy. In re EQT is a prime example of how federal securities defendants nowadays nearly always file a Rule 23(f) petition following a decision to certify a class, no matter how long the odds of securing a reversal.

EQT is a major producer of natural gas that drills wells through hydraulic fracturing, or “fracking.” In November 2017, EQT acquired rival gas producer Rice Energy for $6.7 billion. EQT’s senior executives told investors at the time that the merger would create synergies worth between $2.5 billion and $7.5 billion by combining the two companies’ supposedly contiguous drilling acreage, which would allow for longer and more efficient lateral wells, and by enabling EQT to capitalize on best practices and new technologies developed by Rice Energy. Plaintiffs in In re EQT allege that these representations were false and misleading because, among other things, the claimed synergies were based on assumptions Defendants knew or recklessly disregarded were invalid, and because EQT did not in fact intend to adopt Rice Energy’s best practices or technology following the merger. After the acquisition, EQT concealed skyrocketing costs and serious problems drilling long lateral wells, instead telling shareholders it was “ahead of schedule for achieving our capital synergies.” The truth was ultimately revealed through EQT’s financial disclosures and a series of presentations the former Rice Energy executive team made during a proxy contest for control of the company.

On August 11, 2022, the U.S. District Court for the Western District of Pennsylvania issued a thorough 51-page opinion that granted Plaintiffs’ motion for class certification. Defendants then filed a motion for leave to appeal the District Court’s decision to certify the class to the Third Circuit pursuant to Federal Rule of Civil Procedure 23(f).

Defendants raised three principal arguments to support their petition. First, they argued the District Court’s ruling conflicted with the Supreme Court’s decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, 141 S. Ct. 1951 (2021), even though the District Court directly quoted and correctly applied the standard endorsed by that decision. Second, Defendants argued that the District Court had ignored “qualitative” evidence of the lack of price impact in the form of analyst reports, even though the District Court assessed the qualitative evidence of the “economic materiality” of the corrective disclosures at issue. Third, Defendants argued that Plaintiffs’ out-of-pocket damages model is not susceptible of common proof on a classwide basis and violated the requirements of Comcast Corp. v. Behrend, 569 U.S. 27 (2013)— ignoring that Comcast is generally inapplicable in securities litigation, that the out-of-pocket damages model is the accepted standard approach in securities class actions, and that the District Court thoroughly analyzed Plaintiffs’ model and found it to be applicable class-wide.

On September 23, 2022, just nine days after the parties’ briefing on the petition was complete, a Third Circuit panel consisting of Judges McKee, Shwartz, and Bibas denied Defendants’ petition for leave to appeal. The Third Circuit gave no quarter to Defendants’ arguments, dispatching with their petition in a terse, three-sentence order.

In re EQT exemplifies the current trend of defendants filing Rule 23(f) petitions following class certifications as a matter of course. Hopefully, more plaintiff victories like the one in In re EQT will give defendants pause and deter them from filing meritless petitions and imposing unwarranted costs on federal securities plaintiffs.

In a significant holding for plaintiffs arguing scienter in shareholder lawsuits, the Tenth U.S. Circuit Court of Appeals said a lower court had erred when it found that Pluralsight, Inc. Defendants’ use of a predetermined trading plan automatically removed their motive to manipulate the company’s stock price. In its August 23, 2022 opinion reversing the District Court’s dismissal of the shareholder lawsuit¹ , the Tenth Circuit held, among other things, that the existence of a 10b5-1 trading plan does “not per se rebut an inference of scienter where … a defendant was allegedly motivated to misrepresent or withhold material information to affect a stock price.”

Pluralsight is a startup software company that offers a cloud-based technology skills platform and sells subscriptions to its products and services. At the start of the class period in January 2019, the complaint alleged that Defendants misrepresented the size of the company’s salesforce—the primary driver of Pluralsight’s quarter-over-quarter billings growth, which was the key business metric by which Pluralsight attracted investors. In addition, the complaint alleged that the company and its CEO and CFO knew that Pluralsight misrepresented the size of the salesforce and intentionally withheld this pertinent information from investors. The Lead Plaintiffs appealed to the Tenth Circuit after the U.S. District Court for the District of Utah dismissed the amended complaint on August 2, 2021.

The Tenth Circuit reversed the dismissal in part, holding that the two Lead Plaintiffs—the Indiana Public Retirement System and the Public School Teachers’ Pension and Retirement Fund of Chicago—had plausibly alleged that Defendants made a false and misleading statement at the start of the class period. At that time, Pluralsight CFO James Budge had stated that the company had “about 250” quota-bearing sales representatives; however, it was later revealed that Pluralsight actually only had only “about 200” quota-bearing sales representatives at the time. The Tenth Circuit stated that this “strongly suggests Pluralsight could not have had ‘about 250′ quota-bearing sales representatives on January 16, 2019” and found that the information was “objectively verifiable.” The misstatement marked the beginning of the class period and was a key misrepresentation, the falsity of which was revealed in the third quarter of 2019, when the Company reported a dramatically decreased billings rate of growth, shocking analysts and investors alike. The stock price dropped nearly 40 percent.

In ruling for Lead Plaintiffs on the scienter element of a 10b-5 securities fraud claim, the Tenth Circuit found that Lead Plaintiffs had pled a compelling inference that Defendants knew overstating Pluralsight’s number of quotabearing sales representatives was likely to mislead investors. The Tenth Circuit performed a holistic review in reaching this conclusion, looking to multiple allegations. To begin with, the panel cited Defendants’ statements to analysts and investors on July 31, 2019 and in January 2020, which supported the inference that the CFO knew of the capacity gap but failed to admit it. The appellate court’s finding was bolstered by the fact that the CFO had repeatedly emphasized to analysts and investors that Pluralsight carefully monitored the data surrounding Pluralsight’s billing growth and that the size of the sales force was at the core of Defendants business model.

Moreover, the Tenth Circuit held that the CEO’s and CFO’s suspicious trading within the Class Period, both inside and outside of their 10b-5-1 trading plans, supported scienter. Importantly, the Tenth Circuit agreed with Lead Plaintiffs’ argument, supported by an Amici Curiae brief by former SEC Commissioners Robert J. Jackson and Luis A. Aguilar, former SEC Chief Accountant Lynn Turner and Columbia Law Professor Joshua Mitts, along with other prominent academics, that the “text and history of Rule 10b5-1 shows that such plans can be manipulated easily for personal financial gain and thus cannot rebut the inference that personal financial gain was a motive for Defendants’ material misrepresentations.” The Court noted that these plans do not prevent officers from “making false statements to artificially inflate the stock price to trigger those automatic trades—and that is what plaintiffs allege occurred here.” The Court then found that Lead Plaintiffs’ allegations raised a strong inference of scienter because the CEO and CFO allegedly profited from their stock sales, sold a significant portion of their holdings, and the volumes of sales were higher than outside the class period.

The Tenth Circuit also revived Plaintiffs’ claims under Section 20A of the Exchange Act, which provides a private right of action to contemporaneous purchasers against corporate insiders who purchase or sell a security while in possession of material inside information.

This case is an important holding for investors. It demonstrates that affirmatively misrepresenting facts or data that a company and it officers continuously report on and that form a “key metric” in attracting investor interest, presents a danger of misleading investors and will support a finding of scienter. Significantly, the Tenth Circuit’s holding also shows that 10b5-1 trading plans are not an automatic shield to fraud claims, or a “get out of jail free card.” Courts recognize that, regardless of when the plan is created, Defendants with a 10b5-1 plan could be motivated to make material misrepresentations affecting the stock price to their benefit before a scheduled sale or to trigger a sale at a particular price.

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1. Indiana Public Retirement System, et. al. v. Pluralsight, Inc., 45 F.4th 1236 (10th Cir. 2022).