The SEC is doubling down on potential fraud involving special purpose acquisition company (SPAC) transactions. Cohen Milstein attorneys look at the role inside knowledge of potential fraud can play in protecting investors and say the time is ripe for whistleblowers to come forward.
Market enthusiasm for special purpose acquisition company (SPAC) investments has reached unprecedented heights during the last two years, stoking the concern of the Securities and Exchange Commission as it seeks to protect investors in these transactions.
With stepped up SEC enforcement, the timing is ripe for whistleblowers with knowledge of securities law violations to consider providing the SEC with information about potential SPAC securities law violations. Whistleblower’s can be eligible to receive substantial financial awards for providing useful information to the SEC, but would be well-advised to speak in advance with experienced whistleblower counsel.
The Structure, Purpose of SPAC Transactions
SPACs are publicly-traded shell companies that raise money from investors through an initial public offering with the goal of using that capital to merge with or acquire a private operating company, in a transaction known as a “de-SPAC,” that will result in that target company becoming publicly-traded.
SPACs have bfeen around for years but have only recently come into vogue with retail investors. In 2020, SPACs raised over $80 billion, exceeding the total amount they raised in the prior decade, and raised nearly $100 billion more in just the first three months of 2021.
Whistleblowers Can Profit From Protecting SPAC Investors
Since the creation of its whistleblower program in the wake of the financial crisis of 2007-2008, the SEC has consistently extolled the critical role whistleblowers play in alerting the SEC to fraud that might otherwise go undetected. To provide incentives for individuals to come forward with evidence of securities fraud, the SEC will make financial awards to eligible whistleblowers.
By any measure, the SEC’s whistleblower program has been a success. In the last 10 years, it has awarded a total of more than $1 billion dollars to over 200 individual whistleblowers, with half of that total issued in its last fiscal year.
The agency issued payouts to the highest number of tipsters in fiscal year 2021, and the number of whistleblower tips it receives continues to grow, a strong signal that its pace of issuing whistleblower awards will only increase. In October 2020, the SEC distributed its biggest payout to date, which totaled over $114 million.
Who Are Likely SPAC Whistleblowers?
Likely successful whistleblowers on this issue include individuals with critical information regarding violations of the securities laws such as SPAC or target company insiders, consultants or bankers to SPAC transactions, SPAC investors, and even market observers who use their expertise to identify fraudulent conduct.
The SEC’s investigation and enforcement activity can often take a number of years, and the commission will take all reasonable steps to protect the identity of whistleblowers. Even after an award is issued, and for an added layer of confidentiality, whistleblowers who are represented by counsel can submit their information to the SEC anonymously.
Whistleblowers whose information leads to a monetary recovery of over $1 million and who comply with all eligibility and procedural rules of the SEC’s Whistleblower Program will be eligible for a financial award in the range of 10% to 30% of the SEC’s recovery, depending on factors that include the amount and nature of assistance provided by the whistleblower and her or his counsel.
The Time Is Right
The timing is perfect for whistleblowers with knowledge of securities law violations because the SEC has closely monitored the recent explosion of interest in SPACs, has issued guidance for investors, and brought enforcement actions where appropriate.
Its primary concern, highlighted in investor bulletins and other public statements, is that SPAC investors may not be given full and accurate disclosure of SPAC transactions, particularly as to the terms of those transactions and the financial or operational details of target companies.
Animating the SEC’s concern is the divergence of interests between SPAC investors, who profit only when a deal goes well, and SPAC sponsors, who can profit from fees and other incentives even when a deal doesn’t.
The SEC’s public comments this spring were merely a preview of enforcement activity to come. In July, the SEC brought an action against a SPAC called Stable Road Acquisition Corp., its sponsor, its CEO, the target company Momentus Inc., and the target company’s former CEO. The SEC alleged violations of the securities laws from false or misleading statements about the state of the target company’s outer space propulsion technology.
Only a few weeks later, the SEC brought an action alleging that the former CEO of an automobile company that went public in a de-SPAC transaction, Nikola Corp., made false and misleading statements about his company’s technology on social media. Nikola stands out as a cautionary tale for SPAC investors, as the former CEO has since been indicted for fraud and the company’s share price has fallen from $65 to under $10.
Market trends suggest that the SEC’s enforcement activity regarding SPAC transactions will grow, particularly as the enormous sums raised by SPACs will soon result in a race among sponsors to find target companies or risk losing all opportunity for profit.
As product liability lawyers, we know that one of the goals of every product company should be the safety of its users. Many companies take significant measures to ensure they follow this objective in terms of product design, manufacturing, and notification compliance. Occasionally a company may fall short of design standards and safety measures and/or fails to make it right.
Peloton saw significant growth and success during the COVID-19 pandemic. New work and lifestyle demands have necessitated the adoption of different methods of exercise and stress relief, including the creation of in-home gyms outfitted with Peloton bikes and treadmills. Unfortunately for Peloton, they have also realized that a rise in popularity and product demand can lead to a rise in consumer safety concerns. Since October 2020, Peloton has faced three Consumer Product Safety Commission (CPSC) product recalls for three separate products based on three different types of product liability claims.
As the below three recalls show, Peloton has scored a product liability trifecta.
Manufacturing Defect
In Florida, under strict liability, a product is “unreasonably dangerous because of a manufacturing defect if it is different from its intended design and fails to perform as safely as the intended design would have performed.”1 It appears Peloton’s manufacturing is missing the mark.
In October 2020, the CPSC issued a recall on the PR70P Clip-In Pedals fitted on Peloton bikes (sold between July 2013 and May 2016).2 The CPSC received more than 120 consumer reports of pedal breakages, including 16 reports of leg injuries. Five of those injuries required medical care, such as stitches to the lower leg.
This recall was for approximately 27,000 bikes (54,000 pedals). According to Healthline and Reddit, the complaints go back five months to early 2020, when users describe that the pedal “snapped clean off from the arm while I was standing up riding.” The same user posted a photo, demonstrating that the break occurred where the pedal spindle joins the crankset.
Originally published by Taxpayers Against Fraud on September 30, 2021.
If you are an avid movie watcher – as many of us have become over the last two years – it may seem like whistleblowers are very common. After all, they are heroes of popular films such as The Insider, Erin Brockovich, The Informant, and many others. While they are a popular and constant presence in the media, whistleblowers are not so common in real life.
In the most recent fiscal year, there were only 672 False Claims Act lawsuits filed by whistleblowers (also known as “qui tam” actions”). In a country with over 255 million adults, this means only 1 qui tam lawsuit is filed for every 380,000 adults. This low number is nowhere near what the movies may lead one to believe.
Let’s put that number – 672 – in context. On one hand, fewer people were injured in lightning strikes last year than became FCA whistleblowers. On the other hand, there were more skunk attacks than whistleblower lawsuits filed. Nearly twice as many people are drafted by a major league baseball each year than become whistleblowers. And more than four times as many people were accepted to Harvard as filed a whistleblower lawsuit, although not for lack of trying.
Here’s one more: Guess how many people last year voted for Kanye West for President of the United States. If you guessed 67,906, you are correct. More than 100 times more people voted for Kanye than filed False Claims Act cases.
Although whistleblowers are rare, they make an impact. This is not an opinion. As we have documented throughout the last 30 days, fraud whistleblowing works, and it remains the most effective tool in preventing fraud on the government.
Tomorrow we start a new federal fiscal year knowing the amount and potential for fraud in the country is not media hype or a film creation. So we close out our month of Fraud by the Numbers with one simple question. Do we have too many whistleblowers or not nearly enough?
On September 23, 2021, the Delaware Supreme Court issued a decision in United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Mark Zuckerberg, et al. and Facebook, Inc., C.A. No. 2018-0671-JTL, which set forth a “new” demand futility test designed to supplant the use of the Court’s prior Aronson and Rales tests. Demand futility is a key hurdle in most shareholder derivative cases to establish that the plaintiff has standing to pursue the lawsuit. Failure to establish demand futility results in an early dismissal of the case. The Facebook test, as it will be known, cleans up some confusion about how Aronson and Rales are applied, while ensuring that outcomes will stay consistent with what would have occurred under the prior tests.
The Facebook decision sustained a Court of Chancery ruling, which found that plaintiffs failed to plead demand futility in a case arising from the expenditure of litigation expenses and payment of fees when Facebook abandoned plans to reclassify stock. In the Court of Chancery, Vice Chancellor Laster described the Aronson and Rales demand futility tests and how their interpretation had evolved over time. (Del. Ch. Oct. 26, 2020). Vice Chancellor Laster concluded that the two tests no longer had separate utility in light of subsequent court interpretations and the enactment of a statute by the Delaware legislature designed to protect directors from liability for breaching their duty of care. Instead, his decision boiled them down to a single three-prong test. He explained:
Fundamentally, Aronson and Rales both address the same question of whether the board can exercise its business judgment on the corporat[ion]’s behalf in considering demand. For this reason, the Court of Chancery has recognized that the broader reasoning of Rales encompasses Aronson, and therefore the Aronson test is best understood as a special application of the Rales test. (Citations and quotation marks omitted.)
The Delaware Supreme Court affirmed this approach, and explained from a practical perspective what a plaintiff must establish to show that making a demand would be futile as to a majority of the board. The “new” demand futility test is a three-pronged approach that asks:
- whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
- whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and
- whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.
“If the answer to any of the[se] questions is ‘yes’ for at least half of the members of the demand board, then demand is excused as futile.”
Notably, while the Delaware Supreme Court described this as a new test, it went out of its way to assuage practitioners that this was not a substantive change, explaining that both demand futility tests “‘address the same question of whether the board can exercise its business judgment on the corporat[ion]’s behalf’ in considering demand’; and the refined test does not change the result of demand-futility analysis.” Later in its decision, the Supreme Court reiterated that Aronson, Rales, and their progeny remain good law.
As a practical matter, we expect that Delaware corporations will latch onto some language in the opinion that reminds plaintiffs that pleading demand futility is no easy task, particularly in light of Section 102(b)(7), which exculpates directors for breaches of duty of care, and cannot be used as a path to expose directors to a substantial likelihood of liability or as a basis for finding demand futility.
Yet, despite likely efforts to make this decision seem like a sea change for stockholders, demand futility may still be established based on particularized pleading of non-exculpated breaches of fiduciary duties. Therefore, we do not see the Facebook decision as a significant change to current pleading practices. Plaintiffs have been cognizant of this heightened burden and plead their claims accordingly. Courts, too, understand that whether to apply Aronson or Rales “does not matter” because “under either approach, demand is excused if Plaintiffs’ particularized allegations create a reasonable doubt as to whether a majority of the board of directors faces a substantial likelihood of personal liability for breaching the duty of loyalty.”. Rosenbloom v. Pyott, 765 F.3d 1137, 1150 (9th Cir. 2014).
For example, Cohen Milstein represented stockholders who were able to establish demand futility in the Wynn Resorts litigation and similarly argued that the particular test applied does not matter. That litigation involved allegations that the company’s former CEO and Chairman, Steve Wynn (“Wynn”), had terrorized, sexually harassed, and sexually abused dozens of employees on company property. The incumbent board of directors were made aware of serious allegations against him, yet failed to stop his misconduct or protect company employees. Even more seriously, the directors were personally obligated to report instances of unsuitability to gaming regulators, yet they failed to act which jeopardized existing licenses and future business opportunities. Instead, the directors allowed Wynn to remain at the helm of his namesake company where he continued sexually harassing employees. In Wynn Resorts, the court concluded that plaintiffs had adequately pled demand futility because the “Board had actual knowledge of serious allegations that Steve Wynn was violating the law” and “faces a substantial likelihood of liability for its knowing and conscious inaction.” (Thomas P. DiNapoli. v. Stephen A. Wynn, et al., Case No. A-18-770013-B, (Eighth Jud. Dist. Crt., Clark Cnty., Nev.) Order Denying Defendants’ Motion to Dismiss/Granting Lead Plaintiffs’ Motion to Strike, Sept. 6, 2018).
In this case, the well-known proverb “the more things change, the more they stay the same” seems particularly apt. The two demand futility tests already had culminated in a reasonably consistent application of demand futility. The Delaware Supreme Court is now blessing what already had come to be.
There’s growing recognition of the need to increase gender diversity in corporate America, but progress has been frustratingly slow, says Laura Posner, partner with Cohen Milstein. But, she adds, an unlikely group of players—institutional investors—is finally having some success in forcing corporations to change.
Women, and Black and Latina women in particular, remain hugely underrepresented on U.S. corporate boards. As of 2020, just 20.9% of Fortune 500 board seats were held by White women and 5.7% were held by Black and Latina women. In 2021, S&P 500 companies tripled the share of new directors who are Black and more than doubled the percentage who are Latino. Still, nearly 80% are White, and about 70% are men.
Studies repeatedly show that increasing board diversity is not only the right thing to do for an organization’s culture, but that it leads to better business outcomes, smarter decision-making, and powers innovation, among other benefits. Companies with a market capitalization of more than $10 billion and with women on their boards outperform comparable businesses with all-male boards by 26% worldwide over a period of six years.
Companies with gender-diverse boards have fewer instances of problematic business practices, such as fraud, corruption, bribery, and shareholder battles, and are associated with more transparent disclosure of stock price information and fewer financial reporting mistakes.
There is growing recognition of the need to increase gender diversity in corporate America, but progress has been frustratingly slow. An unlikely group of players, however, are finally having some success in forcing corporations to change—institutional investors.
Changing the Board Game
In September 2018, California Gov. Gavin Newsom (D) signed a bill mandating that corporations with their “principal executive office” in the state with six or more directors have at least three female directors. In the two years since, there was an increase of 66.5% of board seats held by women. At least 11 other states have enacted or are considering board diversity legislation.
In December 2020, Nasdaq proposed a “comply or explain” rule that the SEC approved in August 2021 (over the objection of the Republican-appointed commissioners) that will result in most companies listed on its exchange to have at least one female director and one director who self-identifies as being part of an underrepresented minority group. The rule also requires companies listed on the Nasdaq to disclose uniform diversity information about their boards of directors.
What is, perhaps, less well known are the efforts institutional investors have taken to force companies to diversify their boards. According to TIAA President and CEO Thasunda Brown Duckett, Nuveen, TIAA’s asset manager, encouraged about 325 of the 450 companies in the U.S. that did not have a single woman on their board to add a female director.
State Street announced earlier this year that it will now vote against the chair of the nominating and governance committee at companies in the S&P 500 and FTSE 100 that do not disclose the racial and ethnic composition of their boards; and in 2022, it will vote against them if they do not have at least one director from an underrepresented community.
BlackRock expects to see at least two women as directors on every board. To the extent that it believes a company has not adequately accounted for diversity in its board composition within a reasonable time frame, it may vote against the nominating or governance committee for an apparent lack of commitment to board effectiveness.
Similarly, Goldman Sachs will no longer take a company public without two diverse board members, one of whom must be a woman, and JPMorgan Chase will generally vote against the chair of the nominating committee when the issuer does not disclose the gender or racial and ethnic composition of the board.
The New York City Employees’ Retirement System will generally vote against members of a nominating or governance committee if the board lacks meaningful gender, racial, and ethnic diversity, including, but not limited to, any board on which more than 80% of directors are the same gender. Institutional investors have also increased their focus on diversity data, with ISS, Glass Lewis, Calvert, SSGA, and others pressing for greater DEI-focused disclosure, and demands that the SEC issue regulations mandating unform DEI disclosures.
The Role of Institutional Investors
Institutional investors also have been forcing board change on a case-by-case basis through shareholder derivative litigation alleging toxic workplace cultures due to discrimination, retaliation, and gender and racial bias. Through litigation and ultimately settlement, these companies have been forced to not only completely revamp their DEI initiatives and discrimination, harassment and retaliation policies, procedures and oversight functions, but also to change the composition of their boards.
For example, in the Wynn Resorts derivative action—litigation led by the New York State Common Retirement Fund and the New York City Employees Retirement System—Wynn Resorts agreed to split the CEO and chair position, make a stated commitment to 50% board diversity, and to use a Rooney Rule to require interviews of diverse candidates. (The Rooney Rule is an NFL policy that requires any team with a head coaching vacancy to interview at least one diverse candidate.)
In the wake of shareholder actions led by the state of Oregon arising out of allegations of sexual misconduct at L Brands Inc., the newly spun-off Victoria’s Secret board is now composed of nearly all-women directors (six out of seven directors) and half of the Bath & Body Works Inc. independent directors (the new name of L Brands) are women.
Efforts to diversify boards are long overdue, but the gains we are finally starting to see—however slow—are bound to have a positive impact on company culture and performance across the country. That listing exchanges and institutional investors have become engaged players in the push for such governance reforms is a promising sign of what is to come. Over time, it is likely that these entities will require even higher levels of diversity, bringing more perspectives to boardrooms and greater value to shareholders.
Read Board Diversity Is Critical to Protect Shareholders, Bottom Line
Released on July 26, 2021, Federal Deception Law, Chapter 9, “The Federal False Claims Act and Other Whistleblower Laws,” National Consumer Law Center Digital Library, was updated by Cohen Milstein’s Gary L. Azorsky and Jeanne A. Markey, Co-Chairs of Cohen Milstein’s Whistleblower / False Claims Act practice, with the assistance of Raymond M. Sarola, Of Counsel. The updated chapter addresses federal and state False Claims Act whistleblower protections, as well as whistleblower protections under the SEC, CFTC, IRS and DOT programs, the rights of relators under the FCA, FCA litigation procedure, mandatory arbitration requirements, remedies, and exemplar cases by industry.
9.1.1 Introduction
The federal False Claims Act (FCA) imposes liability on entities and individuals that make false or fraudulent claims to the government for payment for services and products, or that improperly avoid an obligation to repay overpayments to the government. Although FCA cases have traditionally been used to file claims against government defense and health care contractors and suppliers, they arise as well in other areas—such as insurance, housing, government entitlement programs, government loan programs, and environmental and labor laws—that offer potential use by consumer lawyers.
Unlike almost all other fraud statutes or common law causes of action, the FCA, with its unique qui tam provisions, allows private individuals to file and prosecute a lawsuit in the name of the United States. Because FCA cases are brought on behalf of the government, the individual whistleblower plaintiff—or “relator”—need not suffer any personal harm to bring the action. By authorizing suits in these situations, the FCA offers a tremendous opportunity for individuals and organizations to remedy and prevent fraud and other marketplace conduct that harms the government.
The FCA empowers individuals and organizations with knowledge of fraud against the government to file lawsuits to recover damages and penalties for the government. Its express intent is to encourage qui tam suits by giving consumers the tools and incentive to represent the government in actions against those that falsely bill the government for services or goods.
As powerful a tool as the FCA is, the inexperienced practitioner should also recognize its challenges. The Supreme Court has noted that “[t]he False Claims Act’s qui tam provisions present many interpretative challenges,” such that it may not always be possible, even for the Supreme Court itself, “to make them operate together smoothly like a fine tuned machine.”
The outline for Chapter 9 The Federal False Claims Act And Other Whistleblower Laws follows:
9.1 Background
9.2 The Rights of Relators and the Government Under the False Claims Act
9.3 Elements of an FCA Case
9.4 The False Claims Act’s Litigation Procedures
9.5 The False Claims Act Claims on Behalf of the Government Should Not Be Subject to Arbitration Requirements
9.6 Remedies
9.7 Financial Incentives Available to the Relator
9.8 Examples of False Claims Act Cases
9.9 The False Claims Act’s Whistleblower Protection
9.10 State False Claims Acts
9.11 Other Statutes That Give Rewards to Whistleblowers
9.12 The False Claims Act Checklist
The complete treatise, Federal Deception Law, can be accessed here via NCLC’s Digital Library.
About the Authors
Gary L. Azorsky, contributing author, is Co-Chair of Cohen Milstein’s Whistleblower/False Claim Act practice, has recovered nearly $2.5 billion in defrauded funds for federal and state governments, including a $784.6 million settlement in USA, ex re. Kieff v. Wyeth (D. Mass.), the seventh-largest FCA recovery on record and the second-largest recovery in history involving a single class of drugs. Mr. Azorsky has also provided expert FCA guidance in congressional hearings and at the state level and has testified in federal and state courts as an expert witness concerning the False Claims Act.
Jeanne A. Markey, contributing author, is Co-Chair of Cohen Milstein’s Whistleblower/False Claim Act practice, is recognized among the Lawdragon “500 Leading Plaintiff Financial Lawyers” in the United States. Ms. Markey has successfully represented whistleblowers in federal and state cases across the country in some of the highest-profile qui tam litigation in the healthcare, defense, and financial services industries, including USA, ex re. Kieff v. Wyeth (D. Mass.), which resulted in a $784.6 million settlement, the seventh-largest FCA recovery on record and the second-largest recovery in history involving a single class of drugs.
Other Contributors
Raymond M. Sarola is Of Counsel Cohen Milstein’s Whistleblower/False Claims Act and the Ethics and Fiduciary Counseling practice groups. Mr. Sarola represents whistleblowers in qui tam cases brought under the federal and state False Claims Act statutes in industries that conduct business with the government, including health care, defense, and financial services. As a member of the firm’s Ethics and Fiduciary Counseling practice, Mr. Sarola calls on his experience as a trustee on the New York City pension fund boards in counseling public pension funds fiduciary issues.
The law should be modified to require that it be public whether a 10b5-1 plan exists and include the date it was entered into; all 10b5-1 plans be approved by a company’s compensation committee; and most critically, the owner of the plan must be blind to the dates and/or strike prices for purchases and sales set forth in their plan, so that they are not incentivized to improperly keep material news from investors.
By now, the story is familiar: A company announces either good or bad news and its stock price goes up or down, only for investors to later learn that around the same time, corporate insiders sold millions of dollars of their company stock holdings, often for the first time in years. It happened at Eastman Kodak, Moderna Therapeutics, and, more recently, at government contractor Emergent BioSolutions, whose share price fell over 50% from February 2021 to April 2021, coinciding with its announcement of negative financial results and COVID-19 vaccine production problems. Just before that period of bad news, for the first time in over four years, its CEO Robert G. Kramer sold a substantial amount of his company stock for proceeds of over $10 million.
These transactions have something in common besides their fortuitous timing: They were all the result of an SEC rule that was meant to prevent insider trading on the basis of material nonpublic information. The SEC rule, formally known as 10b5-1, covers what are known as “trading plans,” and requires that executives pre-arrange for specific amounts of stock to be sold at specific times according to pre-established criteria. Notably, the rule does not require disclosure of the substance of the plans to investors, and executives can cancel the plans at any time and enter into as many plans as they want.
The theory was that if these plans are adopted when insiders are not in possession of material nonpublic information, they would prevent illegal insider trading. To encourage their use, the Rule provides those who adopt a 10b5-1 plan a “safe harbor” that serves as an affirmative defense to claims of insider selling.
Over the past year, such plans have garnered mounting scrutiny from federal regulators, including SEC Chairman Gensler, and lawmakers. Several recent peer-reviewed studies and hearings in Congress have demonstrated that rather than prevent insider trading, executives use these plans to obtain financial windfalls—the exact opposite of the Rule’s purported intent. The focus thus far has been on whether these plans are being used to promote (not prevent) insider trading on material nonpublic information by encouraging executives to sell before bad news is disclosed, and whether the plans ought to continue to operate as get out of jail free cards when they mask such improper insider selling.
But there is another serious risk that has not garnered enough attention: the risk that 10b5-1 plans create an incentive for company insiders to continue to hide bad news from investors and prop up stock prices by making false and misleading positive statements in advance of planned trades. In addition to corporate insiders’ decisions to sell, there should be heightened scrutiny of corporate insiders’ decisions to speak to investors around the time of planned sales. After all, an executive who knows that they have pre-planned trades on the horizon, or trades that their plan will execute at a certain price, may have an improper motive to reap as much money as possible by keeping the company’s stock price as high as possible.
One way in which investors demonstrate motive in securities fraud cases is by alleging that executives made unusual or suspicious trades based on factors such as their profits, timing, and percentage of holdings sold. But despite the fact that 10b5-1 plans were created as an affirmative defense against allegations of insider trading, courts in these separate securities fraud cases have also routinely allowed company insiders to rely on their 10b5-1 plans to defeat an inference of a motive. As long as an insider has a 10b5-1 plan adopted before the start of a fraudulent scheme, courts almost always find that stock trades pursuant to the plan weigh against an inference that defendants knowingly or recklessly misled investors based on a motivation to inflate the stock price to maximize profits.
Potential changes are on the horizon. The flood of recent massive insider sales has prompted the SEC to call for restrictions on trading plans—for instance, a cooling-off period between when the plan is adopted and when trades can begin—as proposed recently by SEC Chairman Gensler. The House of Representatives also recently passed a bill directing the SEC to carry out a study of potential amendments to Rule 10b5-1, including requiring issuers to adopt a window during which insiders are allowed to trade.
While these proposed changes are a step in the right direction, they fall short of fixing the problems inherent in the 10b5-1 safe harbor. To protect investors, ensure that these plans are not being manipulated for the benefit of insiders, and garner the protection of the safe harbor in litigation, the law should be modified to require that it be public whether a 10b5-1 plan exists and include the date it was entered into; all 10b5-1 plans be approved by a company’s compensation committee; and most critically, the owner of the plan must be blind to the dates and/or strike prices for purchases and sales set forth in their plan, so that they are not incentivized to improperly keep material news from investors.
The Rule’s safe harbor must also be modified to make clear that it is applicable only to claims of insider selling, and does not automatically negate well-pled allegations of motive in securities fraud actions. Although not a panacea, such changes would go a long way to ensuring that 10b5-1 plans are not used by executives to financially benefit themselves at the expense of investors or to hide material information from the market.
# # #
Laura Posner is a partner at Cohen Milstein and a member of the firm’s securities litigation & investor protection and ethics & fiduciary counseling practice groups. She was previously the top securities regulator in New Jersey. Megan Kinsella Kistler, associate at the firm and member of the firm’s securities litigation & investor protection practice, represents institutional and individual shareholders in derivative lawsuits and securities class actions. She is a former federal prosecutor.
For most, summer is synonymous with having fun in the sun. But sometimes products designed to help keep you safe in the sun or better enjoy the summer may actually be dangerous. We all know sunscreen can help reduce the risk of skin cancer, but a recent U.S. Food & Drug Administration (FDA) recall suggests some sunscreens may increase the risk of cancer. Information about that recall and other recent summer product recalls are discussed below.
Johnson & Johnson Sunscreen Recall
On July 14, 2021, the FDA announced that Johnson & Johnson voluntarily recalled specific Neutrogena and Aveeno aerosol sunscreen products due to the presence of Benzene, a known carcinogen. The aerosol sunscreen products being recalled are:
- NEUTROGENA® Beach Defense® aerosol sunscreen,
- NEUTROGENA® Cool Dry Sport aerosol sunscreen,
- NEUTROGENA® Invisible Daily™ defense aerosol sunscreen,
- NEUTROGENA® Ultra Sheer® aerosol sunscreen, and
- AVEENO® Protect + Refresh aerosol sunscreen.
According to the FDA announcement, Johnson & Johnson advises that consumers should stop using these specific products and appropriately discard them.
Umbrosa Pool and Patio Umbrellas Recalled Due to Injury Hazard
On May 27, 2021, the United States Consumer Product Safety Commission (CPSC) announced that Umbrosa has recalled umbrellas equipped with the Umbrosa Evolution Arm/Holder due to an injury hazard from the umbrella arm breaking at the elbow while in use. According to the CPSC announcement, consumers should immediately stop using the recalled umbrellas and contact Umbrosa to receive a free replacement arm/holder. Umbrosa is contacting all known purchasers directly.
Pool Heaters Recalled by Pentair Water Pool and Spa Due to Fire Hazard
On April 18, 2021, the CPSC announced a recall of StaRite and Mastertemp pool heaters due to a fire hazard. According to the CPSC announcement, consumers should stop using the heater immediately if they have one of the specific models cited in the recall. Owners can contact Pentair Water Pool and Spa for a free repair.
Cohen Milstein closely monitors product recalls across industry:
Launched in July 2019, Cohen Milstein’s U.S. Product Recall News Blog tracks product recalls across industry, including consumer products; motor vehicle, tire, and roadway safety products; food, drugs, cosmetics, and medicines; as well as chemicals and environmental products. We monitor the following regulatory agencies and product recall websites:
- Consumer Safety Product Commission (CPSC)
- National Highway Traffic Safety Administration (NHTSA)
- U.S. Food & Drug Administration (FDA)
- Recalls.gov
When safety issues regarding a product are brought to the CPSC, NHTSA or the FDA, these agencies will evaluate and track the issues and will determine whether or not a specific product is not fit or safe for public use. Depending on the product and scope of the problem, either a voluntary recall may be issued by the offending company or a mandatory recall will be issued by the governing agency. The agencies will also work with the offending company on the most appropriate mitigation strategies, including corrective actions.
Cohen Milstein’s Complex Tort Litigation attorneys litigate Unsafe & Defective Products, Wrongful Death & Catastrophic Injury, Environmental Toxic Torts and other matters related to dangerous products, recovering hundreds-of-millions of dollars for consumers who have been harmed by such defective or dangerous products. If you’re interested in learning more about the firm’s Complex Tort Litigation practice, please email us or call us at 877.515.7955.
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On May 11, 2021, in Employees Retirement System of the City of St. Louis v. Jones, No. 2:20-cv-04813, 2021 WL 1890490 (S.D. Ohio May 11, 2021), Chief Judge Algenon L. Marbley of the U.S. District Court for the Southern District of Ohio upheld all claims in a shareholder derivative action seeking to hold certain current and former FirstEnergy Corp. (“FirstEnergy” or the “Company”) directors and officers accountable for their roles in orchestrating one of Ohio’s largest public bribery schemes. Specifically, the Court found Plaintiffs had sufficiently alleged Section 14(a) derivative claims under the Securities Exchange Act of 1934 concerning FirstEnergy’s issuance of false and misleading proxy statements from 2018 through 2020 related to its shareholders’ annual meeting and the re-election of the Company’s directors. This determination allows the Court to exercise supplemental jurisdiction over Plaintiffs’ state law claims, including breach of fiduciary duty and unjust enrichment related to the same criminal scheme. The Court then held that demand was futile on the majority of the FirstEnergy board of directors (the “Board”) under Rule 23.1 of the Federal Rules of Civil Procedure, and that Plaintiffs had standing to assert their state law claims too.
Cohen Milstein Sellers & Toll PLLC represents one of the Plaintiffs in the litigation. This decision represents an important victory for investors because the Court further expanded upon the view that a company’s directors cannot solicit shareholders’ votes using a misleading proxy statement that conceals a company’s illegal activities and the company’s true financial status. The Court held that a misleading proxy statement can provide an “essential link” in causing harm to a company for purposes of establishing Section 14(a) claims in the context of the re-election of directors.
Here, Plaintiffs alleged that between 2017 and 2020, FirstEnergy and its most senior officers paid more than $60 million in illegal contributions to Ohio’s Speaker of the House, Larry Householder, and other Ohio public officials, in exchange for favorable legislation designed to bail out FirstEnergy’s failing nuclear plants. The U.S. Attorney for the Southern District of Ohio described this plot as “likely the largest bribery, money laundering scheme ever perpetrated against the people of the State of Ohio.”
Notably, the bribery scheme began a few days after Householder assumed his office on January 3, 2017, when FirstEnergy flew him to Washington, D.C. on the Company’s private jet to attend President Trump’s inauguration. Within two months of this trip, FirstEnergy and its subsidiaries began making payments to Householder’s secret 501(c) (4) entity. Householder then pushed through House Bill 6 (“HB6”), which according to the FBI, was “essentially created to prevent the shutdown of [FirstEnergy’s] nuclear plants.” Notably, HB6 included a “decoupling” provision that ensured a guaranteed level of income for FirstEnergy, and therefore established a floor for Defendants’ performance-based compensation. Even before charges of misconduct arose, the public strongly opposed HB6, and it was called the “worst energy bill of the 21st century.” In fact, FirstEnergy spent $38 million to defeat a referendum of HB6, while the media publicly questioned the propriety of FirstEnergy’s relationship with Householder. Plaintiffs further alleged that the directors were aware of shareholders’ concerns about the Company’s lobbying efforts and campaign contributions and took affirmative actions to conceal them. None of these material facts were disclosed in the Company’s proxy statements and other public filings.
The bribery scheme was exposed on July 21, 2020, when formal criminal charges were brought against Householder and others, and reports of FirstEnergy’s involvement surfaced soon thereafter. The Company’s stock value fell 45% in the aftermath, eliminating approximately $12 billion of stockholder value. In addition, securities analysts estimate that the Company faces between $500 million and $1 billion in future sanctions. By late April 2021, the Company had disclosed that it was in early discussions with federal prosecutors about a deferred prosecution agreement.
In the May 2021 ruling, Judge Marbley found that Plaintiffs had satisfied all four elements for their Section 14(a) claims related to the Company’s 2018, 2019, and 2020 proxy statements used to solicit FirstEnergy shareholders’ votes for director re-election and executive compensation approval. Judge Marbley explained how Plaintiffs’ allegations meet the heightened pleading requirements of the PSLRA because they alleged that “the Director Defendants caused the Company to issue Proxy Statements that concealed an illegal bribery scheme, its implications for FirstEnergy’s overall business and financial health, and the deficient governance practices at the Company that allowed it to proceed.” The Court then rejected Defendants’ argument that Plaintiffs must plead scienter (intent to deceive) for their level of culpability. Instead, Judge Marbley held that negligence was the appropriate standard to apply for Section 14(a) liability against corporate insiders, like Defendants. The Court further determined that Plaintiffs had alleged that the directors were at least negligent due to the numerous “red flags” that put them on notice of the bribery scandal, including public news reports and concerns raised by the Company’s shareholders.
Next, the Court held that the proxy statements issued by the directors were an “essential link” to causing harm to FirstEnergy. As the Court acknowledged, the Sixth Circuit has yet to define “transaction causation” in the context of the re-election of directors and executive compensation approval and Section 14(a). However, the Court rejected Defendants’ argument that Plaintiffs cannot establish causation because other courts find that injuries caused by “mismanagement or breach of fiduciary duty” are not redressable under proxy rules. Instead, the Court relied on those cases where courts had found causation in similar circumstances to those alleged by Plaintiffs. In fact, Judge Marbley highlighted how “[h]ere, Plaintiffs allege far more than more mismanagement or an isolated bad act. Rather, they have set forth in detail that the Director Defendants perpetrated an illicit bribery scheme and caused substantial risk to the Company that eventually resulted in the loss of nearly half of its stock value.”
After upholding Plaintiffs’ Section 14(a) claims, the Court then determined that those claims shared a common nucleus of operative facts with Plaintiffs’ state law claims because they all related to the same criminal scheme. The Court, therefore, exercised supplemental jurisdiction over the state law claims to determine whether Plaintiffs had adequately alleged demand futility under Rule 23.1 of the Civil Rules of Procedure. Notably, the Court held that Plaintiffs had met their burden to show demand futility in two ways. First, the Court found that Plaintiffs’ allegations were plausible that a majority of the Board was directly overseeing the Company’s most senior officers’ illicit political activities, including the five members of the Corporate Governance Committee. Second, the Court found that the complaint’s allegations were also excused demand because a majority of the Board faces a substantial likelihood of liability, since they acted with reckless disregard for the Company’s best interest. Specifically, Judge Marbley held that Plaintiffs’ “allegations together support the Court’s inference that a majority of the Director Defendants recklessly disregarded their duties to the Company and allowed the criminal scheme to continue unchecked.” The Court then concluded that because Plaintiffs have sufficiently pled demand futility they had standing to bring all their state law claims. The Court, thus, denied Defendants’ motion to dismiss on all counts.
This decision as an important ruling in the area of proxy statement disclosures and solicitation of stockholder votes as the Court found a direct causal link between the misleading proxy statement and issues of voting on director elections and executive compensation—issues of paramount importance in the area of corporate governance.
By Michelle C. Yau, Mary J. Bortscheller, and Julie S. Selesnick
The January 2020 edition of the Shareholder Advocate discussed important fiduciary liability concerns related to the actuarial equivalence requirements of ERISA. This article revisits the subject and provides an overview of court rulings that occurred in the past 18 months.
Actuarial Equivalence Explained
Actuarial equivalence is a computation that means that, all else being equal, all optional forms of benefits offered by a pension plan have the same economic value as each other. Practically speaking, two forms of pension benefits are actuarially equivalent if the present value of all the monthly payments that are likely to be paid to a retiree are equal in value; this calculation is done using two primary actuarial assumptions: an interest rate and a mortality table. The interest rate discounts the value of future payments, while the mortality table provides the anticipated length of time the future payments will be made based on the life expectancy of a person at a given age.
Significantly, ERISA requires the value of all optional forms to be actuarially equivalent to the value of a single life annuity beginning at normal retirement age.1 And whether a plan violates ERISA’s actuarial equivalence rules turn1 Those provisions include ERISA § 204(c)(3), 29 U.S.C. § 1054(c)(3), ERISA § 203(a), 29 U.S.C. § 1053(a), ERISA § 205(a) & (d) (1)(B), 29 U.S.C. § 1055(a) & (d)(1)(B) and § 206(a)(3), 29 U.S.C. § 1056(a)(3).s on whether the actuarial assumptions used to calculate all optional forms of benefits are reasonable. On the question of whether a pension plan’s actuarial assumptions are reasonable, courts have considered whether those assumptions have been updated to reflect current trends in mortality and interest rates.
ERISA Litigation Alleging Non-Actuarially Equivalent Benefits
To date, eleven (11) class action lawsuits have been filed asserting ERISA violations for the failure to pay actuarially equivalent pension benefits. To date, all lawsuits in this area have involved corporate pension plans. The vast majority survived motions to dismiss in jurisdictions around the country, including: Torres v. American Airlines, Inc. (N.D. Tex.); Smith v. U.S. Bancorp (D. Minn.); Cruz v. Raytheon Company (D. Mass.); Belknap v. Partners Healthcare System, Inc. (D. Mass.); Duffy v. Anheuser Bush (E.D. Mo.); Berube v. Rockwell Automation, Inc. (E.D. Wis.); Herndon v. Huntington Ingalls Industries, Inc., et al. (E.D. Va.); Masten v. Met Life (S.D.N.Y) and Scott v. AT&T Inc. (N.D. Cal).
Only two courts have granted motions to dismiss: DuBuske v. PepsiCo, Inc. (S.D.N.Y.) and Brown v. UPS (N.D. Ga.). But both dismissals were based upon procedural rather than substantive issues and in the PepsiCo case, the plaintiffs were given leave to replead.
Torres v. American Airlines and the Smith v. U.S. Bancorp were the first two cases where class certification was contested. In both, the proposed classes were not certified. In U.S. Bancorp, shortly thereafter, the parties announced they had reached an undisclosed settlement in principle.
The first major settlement for the failure to pay actuarially equivalent benefits came in February 2021, in Cruz v. Raytheon Company. In this case, the plaintiffs challenged Raytheon’s use of 1971 mortality tables to calculate JSAs. Raytheon has agreed to pay $59.2 million to more than 10,000 participants and beneficiaries. The settlement followed the district court’s denial of the motion to dismiss.
Recommendations
Because continued litigation in this area is likely, ERISA pension plan trustees should review their plan documents and work with their actuary to consider whether the actuarial assumptions used by the plan are reasonable. It is important to document all steps a plan takes to evaluate the reasonableness of the plan’s actuarial assumptions in the event that litigation ever ensues.
As you consider these issues, Cohen Milstein’s ERISA/employee benefits group is available to assist with a review of the actuarial assumptions in your retirement plan(s).
1 Those provisions include ERISA § 204(c)(3), 29 U.S.C. § 1054(c)(3), ERISA § 203(a), 29 U.S.C. § 1053(a), ERISA § 205(a) & (d) (1)(B), 29 U.S.C. § 1055(a) & (d)(1)(B) and § 206(a)(3), 29 U.S.C. § 1056(a)(3).