Delaware District Court Rules Against AI Company in Legal Research Copyright Case

In an important artificial intelligence ruling for both the legal technology and publishing industries, the U.S. District Court for the District of Delaware has largely sided with Thomson Reuters in its copyright infringement lawsuit against ROSS Intelligence.  The court held that ROSS's use of Westlaw headnotes to train its AI legal research platform infringed Westlaw’s copyrights and was not protected by fair use.

The February 11, 2025 opinion by District Judge Bibas revises his earlier 2023 summary judgment ruling and provides important guidance on how courts may analyze copyright claims involving AI training data.

Key Holdings

The court granted partial summary judgment to Thomson Reuters, finding that ROSS had infringed copyrights in 2,243 Westlaw headnotes. The court found that Westlaw's headnotes contained sufficient creativity to merit copyright protection, comparing the editorial process of creating headnotes to sculpture - choosing which parts of an opinion to highlight demonstrates creative expression.

Notably, the court rejected ROSS's fair use defense after analyzing the four traditional fair use factors. While acknowledging that ROSS's use was "intermediate" - converting headnotes into training data rather than displaying them to users - the court found this use was still primarily commercial and non-transformative since ROSS aimed to compete directly with Westlaw.

The court particularly emphasized market harm, noting that both the current legal research market and potential future market for AI training data could be impacted. The opinion distinguished this case from Google v. Oracle, where copying was permitted in part because programmers relied heavily on the specific programming interface at issue. Here, in contrast, ROSS could have created its own original legal summaries without needing to copy Westlaw's existing content, as there was no similar technical or practical necessity to use its specific expression.

Implications for AI Development

This ruling suggests companies developing AI systems should carefully evaluate their training data sources and may need to:

1. Obtain licenses for copyrighted training materials rather than assuming fair use will apply

2. Develop original training data rather than copying existing protected content

3. Consider whether their use truly transforms the copyrighted material in a way that serves a different purpose from the original

The court noted it was only addressing non-generative AI in this case, leaving open questions about how copyright law might apply to generative AI systems.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Arbitration & Injunctive Relief: Practice Pointers for Judicial Relief in California Superior Court

As more and more commercial agreements incorporate arbitration provisions, it is increasingly common for business disputes to be subject to arbitration.  However, sophisticated parties often want seasoned judges to decide their right to injunctive relief even though they want the efficiencies that arbitration has to offer.  For that reason, it is fairly typical for an arbitration provision to include a “carve out” that allows the contracting parties to seek injunctive relief in Court.  For example, an arbitration agreement might provide: 

“Any dispute arising out of or in connection with this Agreement shall be referred to and finally resolved by arbitration before a single arbitrator.  The foregoing, however, shall not preclude the parties from applying to a court for any preliminary or injunctive relief to preserve the status quo.”

When a party to such an agreement wants to have its substantive dispute heard in arbitration but seek injunctive or other provisional relief from a California state court, there are a few practical considerations to keep in mind.

First, a complaint is not required if a party filed an arbitration demand first.  The California Arbitration Act (“CAA”), codified at Code of Civil Procedure (“CCP”) §§ 1280-1294.4, allows a party to an arbitration agreement to file a complaint in state court or an arbitration demand and then seek a provisional remedy from the Court.  If the party chooses to file its arbitration demand first, it need only file an application for provisional relief in the court in the county in which the arbitration proceeding is pending.  See CCP § 1281.8(b).  The application must be accompanied by a copy of the arbitration demand and any response to it.  Id.  

Second, guard against the risk of waiver of the right to arbitrate.  If a party decides to file a complaint along with their application for provisional relief, they should take several safeguards to ensure they do not waive their right to arbitration.  These include:

• File a statement pursuant to CCP § 1281.8(b) that indicates they are reserving their right to arbitrate.

• File a motion to stay all other proceedings in the action (other than the application for provisional relief) pending the arbitration of any “issue, question, or dispute which is claimed to be arbitrable” and which is “relevant to the action pursuant to which the provisional remedy is sought.”  See CCP § 1281.8(d).  Failure to file a motion to stay contemporaneously with the complaint and application for provisional relief is not a waiver on its own, but it is a factor a court can consider in finding waiver if prejudice to the other party has occurred because the court action was not stayed.  See Simms v. NPCK Enterprises, Inc., 109 Cal.App.4th 233, 240-241 (2003) (no waiver despite parties’ failure to include a request for stay with their application for provisional relief). 

• If you are certain you can arbitrate all of the substantive claims in the dispute, be careful how you approach your request for a jury trial both in the complaint and in your case management statement.  Consider using conditional language that requests a jury trial as to any claims or issues not subject to arbitration.

• Only plead causes of action that are necessary to the request for injunctive relief.  Adding claims beyond the limited set you wish the court to adjudicate may cause further confusion regarding whether your client intends to arbitrate those claims or litigate them in court.  

Third, confidentiality must be safeguarded.  keep in mind that arbitration proceedings are, by their nature, confidential.   Confidential information can be included in an arbitration demand without the need to seek special protection.  But a party who files a copy of a confidential arbitration demand concurrently with their application for provisional relief, should evaluate the need to file under seal any confidential portions of the arbitration demand. 

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Noteworthy Limitations on Claims for Stolen Property Under Penal Code Section 496

Civil litigators typically assert civil claims based on civil statutes.  But in Siry Investment, L.P. v. Farkhondehpour, 13 Cal.5th 333 (2022) (“Siry”), the California Supreme Court held that the fraudulent diversion of funds can sometimes give rise to a claim for stolen property under Penal Code Section 496 (“Section 496”).  Since then, there has been a marked increase in civil plaintiffs asserting Section 496 claims alongside civil fraud claims.  More recent cases, however, have pared back the statute’s reach in important ways.

Section 496 Explained

Section 496(a) makes the receipt, concealment, or withholding of stolen property a criminal offense.  Specifically, the statute imposes criminal liability on 

“[e]very person who buys or receives any property that has been stolen or that has been obtained in any manner constituting theft or extortion, knowing the property to be so stolen or obtained, or who conceals, sells, withholds, or aids in concealing, selling, or withholding any property from the owner, knowing the property to be so stolen or obtained …”

To establish a claim for receipt of stolen property under Section 496, a plaintiff must prove: “(1) the property was stolen; (2) the defendant knew it was stolen; and (3) the defendant had possession of it.”  In re Anthony J., 117 Cal.App.4th 718, 728 (2004).  “Although it is not a specific intent crime, a necessary element of the offense of receiving stolen property is actual knowledge of the stolen character of the property.”  People v. Rodriguez, 177 Cal.App.3rd 174, 179 (1986).   

The kicker?  Subsection (c) of the statute allows any person injured by a violation of Section 496(a) to bring an action for three times the amount of actual damages, costs of suit, and reasonable attorney’s fees.

Plaintiff Must Both Plead and Prove Defendant’s Knowledge that the Funds Were Stolen

Two post-Siry cases emphasize that a Section 496 plaintiff must plead and prove the defendant’s knowledge that the property they received was stolen.  

LA Tech and Consulting, LLC v. American Express Company involved a dispute over money that was withdrawn from the plaintiff’s account by third-party Doe Defendants without plaintiff’s approval.  Case No. SA CV 22-01213-DOC-KES, 2022 WL 17350939 (C.D. Cal. Nov. 28, 2022), at *1, aff’d on this issue by LA Tech and Consulting, LLC v. American Express Company, No. 22-56221, 2023 WL 8166780 (9th Cir. Nov. 24, 2023).  Allegedly, AMEX’s online payment system improperly allowed the Does to transfer money from plaintiff’s account to the Does’ AMEX credit line.  Id. at *1.  AMEX moved to dismiss the Section 496 claim, arguing that the operative pleading insufficiently alleged that AMEX “knowingly received, withheld, or concealed stolen property.”  Id. at *2.  

Plaintiff countered that it need not plead knowledge that the funds were stolen, as that issue is best left to the jury to decide, and in any event, it had sufficiently pled AMEX’s knowledge that it received stolen funds because it alleged that (1) AMEX designed a system that only require a cardholder to obtain someone’s check to link their checking account and authorize payment, and (2) AMEX falsely represented that it was authorized by plaintiff to transfer funds to itself in plaintiff’s name.  Id. at *3. 

The court rejected both of plaintiff’s arguments, noting first that “failure to plead facts sufficient to establish requisite knowledge under Section 496 is fatal at the pleading stage.”  Id. at *4 (citing Freeney v. Bank of Am. Corp., No. CV 15-2376-JGB-PJWX, 2016 WL 5897773, at *12 (C.D. Cal. Aug. 4, 2016), judgment entered sub nom. Freeney v. Bank of Am. [C]orp., No. EDCV152376JGBPJWX, 2017 WL 382228 (C.D. Cal. Jan. 25, 2017) (dismissing Section 496 claim because plaintiffs did not plausibly allege that defendant had actual knowledge that the transfers associated with the accounts involved stolen money).  The court further recognized that the fact AMEX had allegedly designed a system that made third-party fraud a “mere possibility” – without more – was not sufficient to meet the knowledge requirement.  Id.

Similarly, in Tu Le v. Prestige Community Credit Union, defendant credit union Prestige moved for summary judgment on a Section 496 claim, arguing that plaintiffs had failed to present facts suggesting that Prestige knew a non-profit church account holder (“Church”) was stealing investor funds.  Case No. 8:22-cv-00259-JVS, 2023 WL 9689133 (C.D. Cal. Nov. 6, 2023).  Plaintiffs argued that Prestige knew, or should have known, about the Church President’s financial fraud convictions.  Id. at *11.  The court found otherwise as plaintiffs had failed to show how knowledge of that conviction resulted in Prestige’s knowledge that the Church obtained its money by false pretenses.  Id.

One-Year Statute of Limitations Applies to Recovery of Treble Damages Under Section 496

Want to take advantage of treble damages under Section 496?  Better move fast.

In both the Tu Le case discussed above, and May v. Google LLC, the plaintiffs argued that the three-year statute of limitations set forth in CCP § 338(a) should apply to a Section 496 treble damages claim.  2023 WL 9689133 at *9; Case No. 24-cv-01314-BLF, 2024 WL 4681604, *8 (N.D. Cal. Nov. 4, 2024).  In both cases, the plaintiff lost, and the courts applied a one-year statute of limitations instead.

As the Tu Le court explained: “[T]he settled rule in California is that statutes which provide for recovery of damages additional to actual losses incurred, such as double or treble damages, are considered penal in nature[], and thus governed by one-year period of limitations stated in [CCP] § 340[a].”  2023 WL 9689133 at *9.  See also May, 2024 WL 4681604 at *8 (same).  The May court was unpersuaded by dicta in Siry because the Siry court did not address the statute of limitations for treble-damages claims under Section 496.  

The Presumption Against Extraterritoriality May Bar a Section 496 Claim

A pair of post-Siry decisions lay the groundwork for dismissal of a Section 496 claim where the receipt, withholding or concealment of stolen property occurs outside of California.  

Penal Code § 27(a)(1) restricts criminal liability in California to those “persons who commit, in whole or in part, any crime within th[e] state.”  California has a presumption against extraterritoriality, under which a state statute is considered inapplicable to “occurrences outside the state, ... unless such intention [of the statute’s extraterritoriality] is clearly expressed or reasonably to be inferred from the language of the act or from its purpose, subject matter or history.”  Sullivan v. Oracle Corp., 51 Cal.4th 1191, 1207 (2011).

The court in Dfinity USA Rsch. LLC v. Bravick, expressly considered the extraterritorial reach of Section 496 and held that “the state legislature did not intend for [Section 496(a)] to broadly reach other conduct in other states.”  No. 22-cv-03732-EJD, 2023 WL 2717252, at *4 (N.D. Cal. Mar. 29, 2023).  Accordingly, the Dfinity court dismissed plaintiff’s Section 496 against a Michigan resident defendant who failed to return equipment belonging to his employer Dfinity (a Delaware company based in California) that he was originally given while working for the company in California.  Id. at *5.  Similarly, in Scosche Industries, Inc. v. S & T Montgomery Distributing, Inc., the Court considered whether defendants’ preparation of fraudulent bills in Alabama that were sent to a corporation located in California could serve as the basis for a Section 496 Claim.  Case No. 2:22-cv-09030-SVW-MAA, 2024 WL 4003894 (C.D. Cal. June 5, 2024).  Because the alleged fraudulent act itself occurred outside the state, the Court reasoned that Section 496 could only apply if defendants’ direction of fraudulent bills created out of state to a corporation located in California could be “considered a more than de minimis preparatory act which occurred in California.”   Id. at *4.  

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Four Alto Attorneys Write Chapter for Chambers and Partners’ 2025 Litigation Global Practice Guide

We are thrilled to announce that four Alto Litigation attorneys contributed a chapter on trends in California litigation for Chambers and Partners’ prestigious 2025 Litigation Global Practice Guide. The contributing attorneys, whose insights on trends in California securities litigation are featured, are Bahram Seyedin-Noor, Joshua Korr, Jared Kopel, and Monica Eno.

The 2025 Litigation Global Practice Guide features 70 jurisdictions. It provides the latest legal information on litigation trends, funding, initiating a lawsuit, pre-trial proceedings, discovery, injunctive relief, trials and hearings, settlement, damages and judgment, appeals, costs, and alternative dispute resolution (ADR), including arbitration.

The topics that Bahram, Josh, Jared, and Monica address and analyze include: 

1. California courts’ adoption of Delaware’s Caremark standard of liability for directors asleep at the wheel

2. How “down rounds” are precipitating shareholder actions

3. Plaintiffs include state securities fraud claims in federal complaints

4. California continues to be a hotbed of litigation concerning cybersecurity breaches

5. “AI Washing” and securities claims

6. The SEC continues to go after California crypto-companies

If you’re looking to stay abreast of trends and developments in California securities litigation, we encourage you to read this chapter, which can be found here. Many of the insights shared are based on real-world experience and expertise gained by our attorneys working at the forefront of important securities litigation cases in California. 

We appreciate Chambers and Partners calling upon us to address these important issues!

Alto Litigation Elevates Kevin O'Brien to Partner

Alto Litigation is pleased to announce the elevation of Kevin O'Brien to Partner. A skilled litigator with extensive experience in complex commercial and intellectual property matters, Kevin has successfully represented clients across multiple industries including biotechnology, clean energy, financial services, and telecommunications.

Since joining Alto Litigation, Kevin has established himself as a key member of the firm's litigation practice, handling high-stakes disputes for the firm’s sophisticated clients. His expertise spans trade secret litigation, patent disputes, unfair competition, and complex commercial litigation, where he has consistently demonstrated his ability to navigate cases from initial filing through trial.

"I've had the privilege of working closely with Kevin, and his elevation to Partner is a testament to both his exceptional legal talent and his unwavering commitment to our clients," said Bahram Seyedin-Noor, founder and managing partner of Alto Litigation. "He embodies the hard-working, innovative and client-focused approach that defines our firm."

Prior to joining Alto Litigation, Kevin served as Counsel at WilmerHale LLP in Palo Alto and clerked for the Honorable Richard G. Andrews of the United States District Court for the District of Delaware. He earned his J.D., summa cum laude, from the University of California, Hastings College of the Law, where he served as Symposium Editor of the Hastings Law Journal. He received his B.A. in English Literature from the University of California, Santa Barbara.

D.C. Circuit Upholds SEC’s Denial of Whistleblower Award to Attorney Who Reported Client Misconduct

Corporate in-house and outside counsel routinely handle their clients’ most sensitive and confidential information, so the idea that a “trusted advisor” would turn whistleblower—particularly given the potential for substantial monetary awards for blowing the whistle—is a concern for companies. But can lawyers be paid whistleblower awards? In a recent decision addressing the intersection of attorney ethics and whistleblower incentives, the U.S. Court of Appeals for the D.C. Circuit, in Doe v. SEC, 114 F.4th 687 (D.C. 2024), upheld the Securities and Exchange Commission’s denial of a whistleblower award to an in-house attorney who reported suspected misconduct by his client.

Legal Framework

The SEC’s whistleblower program, established by the Dodd-Frank Act of 2010, permits the Commission to provide monetary awards to whistleblowers who voluntarily provide original information leading to successful enforcement actions with monetary sanctions exceeding $1 million. However, SEC Rule 21F-4(b)(4)(ii) limits attorneys’ eligibility for such awards when the information was obtained through client representation. Under this rule, attorneys may only receive awards if their disclosure was permitted by applicable state attorney conduct rules or SEC attorney conduct regulations.

The SEC’s adoption of Rule 21F-4(b)(4)(ii) reflected a careful balancing of competing policy interests. On the one hand, the SEC recognized that attorneys, particularly those serving in-house roles, are uniquely positioned to detect securities law violations due to their access to sensitive corporate information. On the other hand, the SEC sought to preserve the sanctity of attorney-client communications and avoid creating incentives that might undermine clients' ability to seek candid legal advice. The rule attempts to strike this balance by allowing attorney whistleblowers to receive awards only when their disclosures would be permitted under existing ethical frameworks.

Case Background

In Doe v. SEC, an unidentified in-house counsel ("John Doe”) discovered information suggesting that funds from his employer's securities offering were being misappropriated. Doe submitted a tip to the SEC, stating that an individual was misappropriating investors' funds and requesting that the SEC act to protect investors. The SEC’s subsequent investigation resulted in judgments against multiple parties, including Doe’s client company.

When Doe applied for a whistleblower award, he primarily relied on two Florida Rules of Professional Conduct: Rule 4-1.6(b), which requires attorneys to reveal confidential information necessary to prevent a client from committing a crime, and Rule 4-1.6(c)(1), which permits disclosure of confidential information necessary to serve the client’s interests. Doe argued his disclosure served his client’s interests by preventing further misappropriation and potentially enabling completion of the project the offering was meant to fund.

The Arguments and Analysis

Doe’s primary argument rested on Florida Rule 4-1.6(c)(1), contending that his disclosure served his client’s interests in multiple ways. He asserted that preventing further misappropriation of funds would benefit the company by preserving its assets and that completing the intended project would fulfill the company’s obligations to investors. He also initially attempted to characterize his client as a potential victim of the misappropriation rather than a perpetrator.

However, Doe's own subsequent statements to the SEC undermined these arguments. In a sworn declaration, he acknowledged that when making his tip, he "fully expected” and "intended" to trigger an SEC investigation of his client. He admitted that his "goal" was to prevent his client "from committing a crime" and that he intended for the Commission to investigate the entire securities offering, including his client’s role.

The SEC denied Doe’s application, finding that his disclosure was not authorized by either Florida rule. The Commission emphasized that Doe’s own statements indicated he suspected his client was already implicated in wrongdoing when he made the tip, rather than seeking to prevent future crimes. Moreover, the SEC found that subjecting one’s client to an SEC investigation could not reasonably be viewed as serving the client's interests.

The D.C. Circuit agreed with the SEC’s analysis. Writing for the court, Judge Wilkins emphasized that while preventing misappropriation might have provided some benefit to the company, Florida Rule 4-1.6(c)(1) requires that disclosure be "necessary" to serve the client’s interests. Given that Doe’s tip foreseeably subjected his client to an investigation and enforcement action, the court found it could not have been "necessary" to serve the client’s interests.

The court also rejected Doe’s argument that only his contemporaneous tip, which he claimed portrayed his client as a victim, should be considered in evaluating his motives. Instead, the court found the SEC properly considered Doe’s subsequent statements, including his sworn declaration acknowledging that he "fully expected" and "intended" his tip to trigger an investigation of his client.

Conclusion

The court’s ruling reinforces that attorneys’ ability to profit from whistleblower awards remains sharply limited when the disclosure involves client information. It suggests that attorneys cannot receive whistleblower awards when they report suspected client misconduct, even if they attempt to characterize their disclosure as serving the client’s interests. The case also establishes that the SEC and courts may look beyond the content of the initial whistleblower tip to evaluate an attorney's true motives and intentions in making the disclosure.

The case underscores that while the SEC’s whistleblower program has become an important tool for detecting securities violations, attorneys’ fundamental duties to their clients remain paramount and cannot be overcome by the prospect of monetary awards.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Benchmark Litigation 2025 Rankings Recognize Alto Litigation and Three of its Attorneys Among the Top in California

Benchmark Litigation, described as “the definitive guide to the market’s leading firms and lawyers,” recently released its 2025 rankings, and Alto Litigation and its attorneys received several honors.

Alto Litigation was ranked a Recommended Firm in California. Benchmark also recognized both founding partner Bahram Seyedin-Noor and partner Bryan Ketroser as a “Litigation Star,” and partner Joshua Korr as a “Future Star” (40 and under). 

Rankings are based on extensive interviews with clients and peers. Benchmark’s analysis noted that Alto Litigation is known as “a powerhouse litigation boutique based in San Francisco representing some of Silicon Valley’s most coveted companies and entrepreneurs in high-stakes litigation and regulatory matters, ranging from securities litigation, investment disputes, and SEC investigations to trade secrets and general commercial disputes.” 

Bahram, a graduate of Harvard Law School, has tried cases before judges and juries in California and Delaware, and was a law clerk to Judge James Ware in the U.S. District Court for the Northern District of California. Over the last twenty-five years, Bahram has achieved dozens of victories in securities class actions, derivative lawsuits, arbitrations, trade secrets, and fiduciary duty disputes. In 2021 and 2019, Benchmark Litigation named Bahram the “San Francisco Attorney of the Year” and nominated him for “California Securities Litigation Attorney of the Year” alongside only three other attorneys in the State in multiple years. Chambers & Partners ranks Bahram among California’s top securities litigation practitioners. During Benchmark’s evaluation, a peer noted, “Bahram has it all – the drive, the hunger, the right amount of aggression – but he also knows when to play it cool and sit back and pay attention, turning observations into his advantage.”

Bryan, a graduate of Yale Law School, concentrates his practice on securities litigation, complex commercial litigation, and SEC investigations. He represents technology companies, entrepreneurs, officers, directors, employees and shareholders in high-stakes matters in California, Delaware, and other courts throughout the United States. Benchmark Litigation has recognized Bryan as a Litigation Star since 2021 and, before that, repeatedly included him in its “40 & Under Hot List.”

Josh is an experienced attorney, well-practiced in litigating a broad range of business disputes in California state and federal courts, and in arbitrations with JAMS and AAA. His areas of expertise include securities litigation, general business disputes, internal and government investigations, trade secrets, high-net-worth family law and Marvin actions, and appellate litigation. He graduated in the top of his class at the University of California, Hastings College of the Law. “He’s [Josh’s] a real ‘right-and-left brain’ person. He’s a brilliant writer – he writes these pithy and sometimes funny complaints,” a peer said in Benchmark’s assessment. 

Benchmark’s full analysis of Alto Litigation can be found here.

SEC: Separation Agreements Cannot Require Waiver of Whistleblower Awards

The Securities and Exchange Commission (SEC) just delivered a message to corporations: don’t interfere with whistleblowing, even indirectly.

Whistleblowers are an extremely valuable tool in enabling the SEC and other government agencies to combat corporate fraud.  Accordingly, the Dodd-Frank Reform and Consumer Protection Act of 2010 (Dodd-Frank) created financial awards as an incentive to encourage whistleblowers to report violations of the federal securities laws. Dodd-Frank also authorized the SEC to issue rules protecting whistleblowers.  Thus, the SEC adopted Rule 21F-17, providing in relevant part that “No person may take an action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce a confidentiality agreement” that would prohibit such a communication.

Prior SEC actions were directed at companies that required current or departing employees to sign confidentiality agreements that expressly prohibited the employee from reporting possible violations to the government.  See In the Matter of CBRE, Inc., (Admin. Proc. File No. 3-21675, Sept. 19, 2023) (company required departing employee to represent that the employee had not filed a complaint or charges against the company with a court or government agency); In the Matter of D.E. Shaw & Co., L.P. (Admin. Proc. File No. 3-21775, Sept. 29, 2023) (company required new employees to sign agreement stating that they would not voluntarily provide confidential information to government agencies and departing employees to sign releases before they could receive payments when such releases required representation that no complaints had been made to a government agency).  The SEC has brought more than 20 such actions for violations of Rule 21F-17 based on a company’s use of a restrictive confidentiality agreement.

Now, the SEC has gone further.  On September 9, 2024, the SEC brought settled administrative proceedings against seven companies whose agreements required employees to waive any claim to the whistleblower bounties awarded by the SEC. (Several of the affected companies also forced contractors to sign agreements prohibiting them from reporting violations, which the SEC made clear violated Rule 21F-17.)  Although the SEC stated that it was unaware of any instance in which the companies sought to enforce these agreements, their existence constituted an “impediment” to whistleblowing and thus violated Rule 21F-17—because the provisions obviously eliminated the major incentive for would-be whistleblowers to report violations in the first place.  Each of the companies agreed to entry of a cease-and-desist order barring them from committing or causing future violations of Rule 21F-17, and to pay a civil monetary penalties of amounts ranging from $19,500 to $1.386 million. The SEC’s Orders noted that the companies cooperated with the SEC and agreed to take remedial action. 1

The lesson is clear, and arguably extends even beyond the whistleblower context:  Think twice before trying to get cute with the SEC by doing indirectly that which you clearly cannot do directly.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

1  In the Matter of a.k.a. Brands Holding Company, (Admin. Proc. File No. 3-22078, Sept. 9, 2024); In the Matter of Acadia Healthcare Company, Inc., (Admin. Proc. File No. 3-22079, Sept. 9, 2024); In the Matter of App.Folio, Inc., (Admin. Proc. File No. 3-22080, Sept. 9, 2024); In the Matter of Idex Corporation, (Admin. Proc. File No. 3-22081, Sept. 9, 2024); In the Matter of LSB Industries, Inc., (Admin. Proc. File No. 3-22082, Sept. 9, 2024); In the Matter of Smart Life, Inc., (Admin. Proc. File No., 3-22083, Sept. 9, 2024); In the Matter of TransUnion, (Admin. Proc. File No. 3-22084, Sept. 9, 2024).

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Josh Korr and Jared Kopel Named to 2025 Best Lawyers in America

Alto Litigation, a sophisticated boutique law firm that represents clients in complex litigation, is pleased to announce Josh Korr and Jared Kopel’s inclusion in the 2025 Best Lawyers in America® list. 

Josh was recognized for his expertise in commercial litigation, as well as litigation - intellectual property. Jared was recognized in the litigation-securities category.

The Best Lawyers in America® is a national listing of outstanding attorneys. This annual guide is derived from peer-review surveys in which thousands of leading lawyers confidentially evaluate their professional peers.

Court Rules Ripple’s XRP Is a Security While Dismissing Most Securities Claims

In 280 and 279 BC, King Pyrrhus of Epirus defeated the Romans in the Battles of Heracles and Asculum but suffered insurmountable casualties that resulted in the eventual loss of the military campaign. Hence the reference to a Pyrrhic Victory in which the battle was won but the war was lost.

That fate may befall Ripple Labs, Inc. and the larger crypto community after a decision by the U.S. District Court for the Northern District of California throwing out federal and state law class claims but declining to follow another federal court that held that Ripple’s digital asset, XRP, was not a security under federal law. The ruling at summary judgment by Judge Phyllis Hamilton in In re Ripple Labs, Inc. Litigation, No. 18-cv-06753-PJH (N.D. Cal. June 20, 2024), allowed a single claim under California law concerning one statement by Ripple CEO Brad Garlinghouse to go to trial. However, Judge Hamilton’s decision undermines the determination by a court in the Southern District of New York that a certain category of XRP sales did not satisfy the definition of a security under federal law.

Background

Ripple, based in San Francisco, promotes a global payment protocol and exchange system. Ripple developed the XRP digital asset that could be used as a “bridge asset” to make a bridge transfer between two fiat currencies. Ripple asserts that the XRP functions as a currency and therefore is not a security that needs to be registered with the Securities and Exchange Commission. The SEC, however, begs to differ and filed an action, pending in the Southern District of New York, arguing that XRP is a security.

In the Ripple securities litigation, plaintiff Bradley Sostack brought a class action under federal and state law on behalf of all purchasers of XRP from May 3, 2017, to the present and who either retained the XRP and/or sold XRP at a loss. The plaintiff alleged that defendants Ripple Labs, XRP II (a subsidiary of Ripple), and Bradley Garlinghouse, Ripple’s CEO, violated Section 12(1) of the Securities Act of 1933 by the offer and sale of unregistered securities and California Corporations Code Section25503 for the primary violation of Code Section 25110’s restriction on the offer and sale of unregistered securities. The plaintiff also brought control person liability claims against Ripple and Garlinghouse under Section 15 of the Securities Act and California Corporations Code Section 25504.

Further, Sostack brought a claim only in his individual capacity (and not as a class claim) for a violation of California Corporations Code Section 25501 against Ripple and XRP II, and a parallel material assistance claim under Code Section 25504.1 against Ripple and Garlinghouse. These allegations arose out of a single allegedly misleading statement by Garlinghouse in a December 14, 2017, televised interview in which he asserted that he was “very, very, very long [on] XRP” when he supposedly sold millions of XRP during 2017.

Dismissal of Class Claims

Defendants asserted that the federal claims had to be dismissed under the statute of repose in Section 13 of the Securities Act, which bars claims brought “more than three years after the security was bona fide offered to the public.” The court held that the evidence showed that XRP was offered to the public before July 3, 2015, more than three years before the lawsuit was filed. Thus, summary judgment had to be granted on the federal class claims.

Defendants asserted that the claims under California Corporations Code Section 25503 for failing to register a security required the plaintiff to prove that he was in privity with the defendant – i.e., that they had a direct contractual relationship with each other – concerning the purchase of XRP. The court agreed that privity was required and that the plaintiff had failed to raise a triable issue that he or any class members were in privity with defendants or their agents in connection with the purchases of XRP, mandating summary judgment on the state law class claims.

Remaining Claim and the Definition of a Security

The dismissal of the class claims left only the allegation concerning the single alleged misleading statement by Garlinghouse brought by the plaintiff in his individual capacity. Whether summary judgment was granted on that claim turned on whether the XRP satisfied the definition of a security under federal law.

The U.S. Supreme Court established the definition of a security in SEC v. W. J. Howey Co., 328 U.S. 293 (1946). The Ninth Circuit defines the “Howey” test as 1) an investment of money; 2) in a common enterprise; 3) with an expectation of profits produced by the efforts of others. Warfield v. Alaniz, 569 F. 3d 1015 (2009). Judge Hamilton found that the XRP plainly satisfied the first two prongs of the Howey test.

But defendants argued that Judge Hamilton should follow the analysis of the court in the SEC’s action against Ripple, where Judge Analisa Torres distinguished between institutional buyers of XRP under a written contract and so-called programmatic buyers of XRP on digital asset exchanges. SEC v. Ripple Labs, Inc., 682 F. Supp. 3d 308 (S.D.N.Y. 2023). Judge Torres held that the institutional purchasers relied on Ripple’s managerial and entrepreneurial efforts for an expectation of profit, while the programmatic purchasers relied more on cryptocurrency market trends given that such buyers presumably were not aware of the company’s promises and representations.

But Judge Hamilton disagreed with this analysis (as did another court in the Southern District of New York; see SEC v. Terraform Labs Pte. Ltd., 684 F. Supp. 3d 170 (S.D. N.Y. 2023)). Judge Hamilton found that defendants had numerous publicly-disseminated statements concerning Ripple’s efforts with regard to the cross-border payments industry, which defendants acknowledged that they had targeted. Further, Ripple worked with a marketing agency to answer questions directly by XRP purchasers. The court stated that: “[G]iven the relative novelty of cryptocurrency, and given the lack of any controlling law regarding the motivation of a reasonable cryptocurrency investor, the court declines to find as a matter of law that a reasonable investor would have derived any expectation of profit from general cryptocurrency market trends, as opposed to Ripple’s efforts to facilitate XRP’s use in cross-border payments.” The court therefore denied summary judgment and permitted the individual claim to proceed to trial.

While Ripple understandably hailed the dismissal of the class claims, Judge Hamilton’s decision is a defeat in the efforts by Ripple and the crypto industry to argue that crypto assets are not a security under the Howey standard. The resolution of this dispute must come from the appellate courts and/or Congress.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

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Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

SEC Cracks Down on "AI Washing" and Private Causes of Action Will Surely Follow

As artificial intelligence (AI) continues to dominate headlines, become integrated into more technology products, and attract massive amounts of new capital, claims of "AI washing" brought by the Securities and Exchange Commission (SEC) and private plaintiffs will almost certainly become more prevalent. Similar to "greenwashing," where companies make false or misleading claims about the environmental benefits of their products or practices, AI washing involves making exaggerated or untrue statements about a company's AI capabilities to attract investors and customers. The SEC has recently issued settled enforcement actions against two investment advisers, Delphia (USA) Inc. and Global Predictions Inc., for making false and misleading statements about their use of AI.

Delphia (USA) Inc. 

According to the SEC's Order Instituting Administrative and Cease-and-Desist Proceedings in the Matter of Delphia (USA) Inc. (the Delphia Order), from 2019 to 2023, Delphia, a Toronto-based firm, made false and misleading statements in its SEC filings, press releases, and website regarding its purported use of AI and machine learning that incorporated client data in its investment process. According to the Delphia Order, Delphia claimed that it “put[s] collective data to work to make our artificial intelligence smarter so it can predict which companies and trends are about to make it big and invest in them before everyone else.” However, the SEC found that these statements were false and misleading because Delphia did not actually possess the AI and machine learning capabilities that it claimed to possess. Additionally, the firm was charged with violating the SEC’s Marketing Rule, which prohibits registered investment advisers from disseminating advertisements that include untrue statements of material fact.

Global Predictions Inc. 

The SEC, in the Order Instituting Administrative and Cease-and-Desist Proceedings in the Matter of Global Predictions, Inc. (the Global Predictions Order), found that Global Predictions, a San Francisco-based firm, made false and misleading claims in 2023 on its website and social media about its use of AI. According to the SEC, the firm falsely claimed to be the "first regulated AI financial advisor" and misrepresented that its platform provided "[e]xpert AI-driven forecasts." Global Predictions also violated the Marketing Rule by falsely claiming that it offered tax-loss harvesting services and including an impermissible liability hedge clause (a type of clause that, generally, allows a party to limit their potential exposure to liabilities and losses) in its advisory contract, among other securities law violations.

Without admitting or denying the SEC’s allegations, both Delphia and Global Predictions consented to entry of the Delphia Order and the Global Predictions Order, respectively, finding that they violated the Investment Advisers Act and ordering them to be censured and imposing a cease-and-desist order from violating the charged provisions. Delphia agreed to pay a civil penalty of $225,000 and Global Predictions agreed to pay a civil penalty of $175,000.

Potential Causes of Action for Private Plaintiffs

In addition to SEC enforcement actions, companies engaging in AI washing should also be concerned about potential private lawsuits brought by investors or consumers. Private plaintiffs may seek to bring claims under various federal and state laws, including:

A. Securities Claims

1. Securities Act of 1933: Plaintiffs could bring claims under Sections 11, 12(a)(2), and 15 for material misstatements or omissions in registration statements, prospectuses, or oral communications related to public offerings.

2. Securities Exchange Act: Plaintiffs may bring claims under Sections 10(b), 14(a), 14(e), 18, and 20(a) for false or misleading statements in various contexts, including in connection with the purchase or sale of securities, proxy statements, and tender offers.

B. State Law Claims

1. Breach of fiduciary duty: Plaintiffs could bring direct or derivative claims under Delaware or California law, arguing that misstatements concerning AI capabilities exposed the company to liability.

2. California Corporations Code violations: Plaintiffs could bring claims under various sections of the California Corporations Code based on allegations of materially misleading statements.

C. Advertising and Consumer Protection Claims

1. California laws: Claims could be brought under the California Unfair Competition Law, False Advertising Law, and Consumers Legal Remedies Act.

2. New York law: New York's General Business Law §§ 349-50 prohibits deceptive acts or practices and false advertising in the conduct of business.

These private causes of action underscore the importance of ensuring accuracy and transparency in AI-related claims, as companies may face significant legal risks beyond SEC enforcement actions.

Conclusion

The rise of AI washing claims poses risks to companies. As the SEC's recent enforcement actions against Delphia and Global Predictions demonstrate, regulators are taking a proactive approach to combat false and misleading claims about AI capabilities. Companies that engage in AI washing not only face potential SEC penalties but also may expose themselves to private lawsuits from investors and consumers under a range of federal and state laws.

To avoid the consequences of AI washing, companies should prioritize accuracy and transparency in their AI-related claims. This requires a commitment to truthful and precise communication, robust internal controls and oversight, and staying informed about regulatory developments and best practices. By adopting these measures, companies can harness the power of AI while maintaining the trust and confidence of their stakeholders.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Bahram Seyedin-Noor is Ranked by Chambers and Partners for Fourth Year in a Row

Alto Litigation Founder and CEO Bahram Seyedin-Noor has been recognized as a top securities litigator in California in the 2024 edition of Chambers USA. This is the fourth straight year he has been included in the rankings. He is also the only ranked lawyer in his category at a securities litigation defense firm that is outside of the 125 largest firms (by revenue) according to The American Lawyer's 2024 Am Law 200 ranking.

Chambers and Partners’ annual rankings are a well-respected publication that recognizes firms and lawyers for excellence in their chosen practice areas. Chambers rankings are thoroughly vetted by hundreds of researcher analysis, and includes interviews of thousands of lawyers and clients each year. Individuals and firms demonstrate sustained excellence to be considered for the publication. 

Among the feedback provided in support of Bahram’s recognition is that, “Bahram is a very commercially minded litigator. He is professional, knowledgeable, and resourceful. He is assertive while preserving the ability to settle, a balance which many litigators struggle to master.”

Responding to the recognition, Bahram stated, “Achieving success in litigation requires a true team effort. We’ve assembled the largest and most talented team we’ve ever had at Alto Litigation, and this recognition is as much about their work as it is for my contribution to our client successes.”

Two Alto Litigation Attorneys Contribute Chapter to Chambers and Partners’ Prestigious 2024 Litigation Global Practice Guide

We are pleased to announce that two Alto Litigation attorneys contributed a chapter on trends and developments in the United States for Chambers and Partners’ prestigious “International Fraud & Asset Tracing 2024 Global Practice Guide.” The contributing attorneys are Bahram Seyedin-Noor and Jared Kopel.

The International Fraud & Asset Tracing 2024 Guide covers 18 jurisdictions, and provides the latest legal information on fraud claims, disclosure of assets, shareholders’ claims against fraudulent directors, overseas parties in fraud claims, rules for claiming punitive or exemplary damages and laws to protect banking secrecy.

Bahram and Jared focus, in particular, on trends in U.S. enforcement involving cryptocurrency, including developments in prominent cases involving FTX, Coinbase, and BitConnect.

As they say, knowledge is power, so if you’re looking to stay abreast of trends and developments in fraud and asset tracing, we encourage you to read this chapter, which can be found here (Please Note: once on the page click “Trends and Developments” tab near the top of the page to view Bahram and Jared’s contribution). 

We appreciate Chambers and Partners calling upon us to address these important issues!

Navigating the Landscape of Securities Litigation Claims Based on Risk Factor Disclosures

Public companies are required to disclose in Securities and Exchange Commission (SEC) filings potential risks that could adversely impact their business, financial condition, or operational results. However, when these disclosures are deemed inadequate, misleading, or false, investors may pursue securities litigation claims. Recent decisions by the Ninth Circuit Court of Appeals have shown a trend favoring plaintiffs in such cases, as exemplified by the notable case of In re Facebook, Inc. Sec. Litig., 87 F.4th 924 (9th Cir. 2023) and In re Alphabet, Inc. Sec. Litig., No. 20-15638, 2021 WL 2448223 (9th Cir. 2021).

Understanding Risk Factor Disclosures

Risk factor disclosures are an essential component of a company’s SEC filings, providing investors with vital information about potential vulnerabilities. These disclosures encompass a wide array of topics, including market competition, regulatory changes, economic conditions, cybersecurity threats, and litigation risks. The purpose of these disclosures is to enable investors to make well-informed decisions based on a comprehensive understanding of the company’s risk profile.

Securities litigation claims can arise when investors allege that a company’s risk factor disclosures were inadequate, misleading, or false. Plaintiffs may argue that the company failed to disclose material risks, understated the significance of known risks, or made false or misleading statements about the company’s risk profile. Such claims are often brought under federal securities laws, such as Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5; and Section 11 of the Securities Act of 1933 for registered public offerings.

To succeed in a securities litigation claim based on risk factor disclosures, plaintiffs generally must demonstrate that:

1. The company’s risk factor disclosures were materially false or misleading;

2. The company acted with scienter (i.e., knowledge or reckless disregard for the truth);

3. The plaintiffs relied on the false or misleading statements; and

4. The plaintiffs suffered economic losses as a result.

Securities litigation claims based on risk factor disclosures are often complex and highly fact-specific, requiring extensive analysis of the company’s SEC filings, public statements, and internal documents. Defendants typically defend these claims by arguing, among other things, that the risk disclosures were accurate; were forward-looking information protected by the “safe harbor” in the securities laws; or were non-actionable opinions or puffery.

Ninth Circuit Rulings

Recent rulings in cases involving Facebook and Alphabet by the Ninth Circuit Court of Appeals have emphasized the importance of transparency and accuracy in corporate disclosures, underscoring the legal consequences of misleading or inadequate risk statements in SEC filings.

The Ninth Circuit’s decision in In re Facebook, Inc. Sec. Litig., 87 F.4th 924 (9th Cir. 2023), is a case in which the court upheld allegations of securities fraud against a public company based on misleading risk disclosure statements by omission. The case centers around the alleged improper harvesting of personal data from millions of Facebook users by Cambridge Analytica. Facebook shareholders filed a securities class action against Facebook and certain of its officers, alleging that Facebook’s risk factor disclosures were materially misleading by failing to disclose the data harvesting incident.

Facebook's 10-K filings warned about potential risks such as “failure to prevent or mitigate security breaches” and the possibility of third parties improperly accessing user data. However, the plaintiffs argued that these warnings were misleading because they presented the risks as hypothetical, even though the data breach had already occurred. 

The district court dismissed the claims. However, the Ninth Circuit reversed, finding that Facebook’s risk statements were misleading because they portrayed the risk of data breaches as purely hypothetical, despite the fact that such breaches had already happened. A reasonable investor, the court concluded, would have understood the risk as conjectural when it had, in fact, already transpired.

In a similar vein, In re Alphabet, Inc. Sec. Litig., No. 20-15638, 2021 WL 2448223 (9th Cir. 2021), revolved around cybersecurity disclosures. In February 2018, Alphabet filed its 10-K for FY 2017, listing potential consequences of third-party breaches of Google’s cybersecurity measures. However, the company did not disclose a known data breach that had exposed user data for three years, which the CEO had allegedly become aware of in April 2018.

Alphabet’s subsequent 10-Q filings in April and July 2018 stated that there had been “no material changes” to the risk factors outlined in the 2017 10-K—but they did not disclose the breach. When the breach was revealed by the Wall Street Journal in October 2018, Alphabet’s stock price dropped, prompting securities fraud actions against the company and its executives.

The district court dismissed the plaintiffs’ complaint. However, the Ninth Circuit reversed on the basis that a reasonable investor would have been misled by Alphabet’s representation that there had been no material changes in risk factors, suggesting that no data breach had been discovered.

Implications for Public Companies

The Facebook and Alphabet cases underscore the importance of accurate and comprehensive risk factor disclosures in SEC filings. Public companies must be diligent in disclosing known risks and avoiding the portrayal of risks as hypothetical when they have already materialized.

Conclusion

The landscape of securities litigation claims based on risk factor disclosures continues to evolve. As the legal framework surrounding these claims develops, companies must remain vigilant in their disclosure practices to mitigate the risk of securities litigation. 

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

SEC Prevails (For Now) in Controversial “Shadow Trading” Case

In a first of its kind trial, the Securities and Exchange Commission (SEC) has convinced a federal jury in San Francisco to find a former executive of a pharmaceutical company liable for illegal insider trading for purchasing stock options in another pharmaceutical company after he allegedly learned that his own company would be acquired, in an example of what has become known as the SEC’s controversial “shadow trading” theory.  Shadow trading is typically defined as when an employee uses confidential information about his own company to purchase stock in another company that is not involved in any transaction with the employee’s company.  

In SEC v. Panuwat, No. 21-cv-06322-WHO, pending before Judge William Orrick III, in the U.S. District Court for the Northern District of California, the SEC alleged that Matthew Panuwat, a senior director of business development at Medivation, Inc., a mid-sized oncology-focused pharmaceutical company headquartered in San Francisco, purchased 578 call option contracts in another mid-sized pharmaceutical company, Incyte Corporation, minutes after Panuwat received an email from Medivation’s CEO stating that Pfizer, Inc. was likely to acquire Medivation.  The SEC asserted that Panuwat made $107,00 in trading profits after Medivation’s acquisition became public.  The jury took only several hours on April 5 to find that the SEC had proved by a preponderance of the evidence that Panuwat had violated the federal securities laws by misappropriating material, nonpublic information in violation of a duty owed to his employer to not profit by the use of confidential information.

Panuwat argued that the SEC had failed to plead and prove that the information at issue was material and nonpublic; that Panuwat breached any duty owed to Medivation; and that he acted with an intent to defraud, or scienter.  But he also contended (supported by many in the defense bar) that the SEC was employing a novel application of the misappropriation theory that improperly expanded the law and violated his rights.  According to Panuwat, information that may have been material to Medivation could not have been material to Incyte. The SEC, by contrast, argued that the action concerned the standard application of the misappropriation theory of insider trading, upheld by the Supreme Court in U.S. v. O’Hagan, 521 U.S. 642 (1997). The SEC asserted that information about the potential acquisition of Medivation was material to both Medivation and Incyte because the information would be viewed by a reasonable investor as significantly altering the total mix of information concerning both companies. Prior to the trial, Judge Orrick denied Panuwat’s motion to dismiss and for summary judgment.  Panuwat may ask Judge Orrick to set aside the verdict.  If such a motion does not succeed and there is no settlement, it is likely that the Ninth Circuit Court of Appeals and even the Supreme Court will be asked to evaluate the outer limits of insider trading liability.

The verdict should alert companies to update their insider trading policies to make clear that employees may not use confidential information to trade in the securities of another company if the information is material to that company’s securities.

There is no provision in the federal securities laws that defines or expressly prohibits insider trading.  Rather, the SEC brings actions under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, the basic antifraud provisions of the securities laws.  To support a Section 10(b) claim, the SEC must show by a preponderance of the evidence that the person traded while in possession of material, nonpublic information and that the person acted with scienter.

Insider trading generally is divided into two categories.  The so-called “classical” theory occurs when an employee trades in his own company’s stock while in possession of material nonpublic information.  The “misappropriation” theory, sustained in the O’Hagan decision, applies when a person trades in the securities of another company while in possession of material, nonpublic information obtained from a person or entity to whom the person owed a duty of trust and confidentiality. A securities trader is liable if he “knowingly misappropriated confidential, material, and nonpublic information for securities trading purposes, in breach of a duty arising from a relationship of trust and confidence owed to the source of the information.” SEC v. Talbot, 530 F.3d 1085, 1092 (9th Cir. 2008).

The misappropriation theory typically has been used, for example, to charge employees of a company making an acquisition who used confidential information to purchase stock of the target company, or individuals  who misused confidential information obtained from their spouse. SEC Rule 10b5-2 also sets forth when a duty of trust or confidence exists for purposes of the misappropriation theory.  

The SEC alleged that Panuwat was responsible for finding, evaluating and pursuing acquisition possibilities for Medivation, and therefore was aware of developments in the pharmaceutical industry.  In March 2016, Medivation was approached by an unsolicited offer to purchase the company, which resulted in a months-long sales process.  Panuwat purportedly was aware that Incyte was a comparable, mid-sized oncology-focused company.  Panuwat was privy to confidential information about the sales process, and having signed the company’s insider trading policy, knew he could not trade in the securities of another company based on confidential corporate information. On August 18, 2016, Medivation’s CEO sent an email to company executives, including Panuwat, indicating that Pfizer had “overwhelming interest” in acquiring Medivation and would shortly resolve final details concerning the acquisition.  According to the SEC, seven minutes after receiving the email, Panuwat purchased the Incyte call options with a short expiration date, although he never previously had traded in Incyte stock or options. The jury presumably concluded that Panuwat’s actions showed that he believed that the information was material to Incyte; Panuwat testified that he wasn’t even sure that he saw the CEO’s email.  Panuwat profited by selling his stock after Incyte’s stock price rose by 7.7% when the Medivation acquisition was publicly disclosed.

Panuwat argued that information about the Pfizer-Medivation was not material to Incyte and that he had no material nonpublic information concerning Incyte. He also contended that he did not breach any duty owed to Medivation because the insider trading policy did not prohibit him from trading in Incyte securities.  Panuwat also asserted that he did not act with scienter because he did not actually use any material nonpublic information in deciding to purchase Incyte options.  These arguments were rejected by the court and presumably by the jury.

Judge Orrick, in rejecting Panuwat’s motion for summary judgment, held that the SEC’s theory of liability fell within the general framework of insider trading, as well as the “expansive language” of Section 10(b) and corresponding regulations. The court stated that:

“Whether information about an acquisition of Company A is material to Company B (or Company C, D, or E) will depend on any number of factors, as established in [the case law]. If those factors are not met, the information will not be material and the trader will not be liable. And if the information is material, the trader will not be liable unless he acted with the requisite intent to defraud. An ordinary trader understands that buying or selling securities with such an intent is prohibited by law. So long as the trader does not act with scienter, he will not be liable for insider trading.”

Having triumphed in this action, the SEC will be eager to pursue the shadow trading theory in other cases. It remains to be seen whether the result in Panuwat will be sustained by appellate courts and/or followed by other district courts.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Supreme Court Rejects Securities Claims Based on “Pure Omissions”

A unanimous Supreme Court has rejected private stockholder claims based on the antifraud provisions of the federal securities laws for a company’s failure to comply with SEC disclosure requirements, in the absence of an affirmative statement that was rendered materially misleading by the omission.  Reversing and remanding a lower court’s decision, the Court, also resolving a split among the Circuit Courts of Appeal, ruled that a “pure omission” of information – even disclosure mandated by SEC regulations - does not violate SEC Rule 10b-5(b) because the Rule prohibits only affirmative misstatements and omissions that create “half-truths”.  In colorful, if not necessarily illuminating language, the Court observed that the difference between a pure omission and a half-truth “is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.” 

In Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 (April 12, 2024), Macquarie owned and operated infrastructure-related businesses, including a subsidiary that operated bulk liquid storage terminals, including No. 6 fuel oil, a high-sulfur byproduct of the refining process. In 2016, the United Nations International Maritime Organization formally adopted IMO 2020, a regulation that in four years would limit the sulfur content of fuel oil used in shipping at 0.5% compared to the 3% sulfur content in No. 6 fuel oil.  Macquarie did not discuss the potential impact of IMO 2020 in its public filings. In 2018, however, Macquarie’s disclosure that the amount of storage capacity contracted for by a subsidiary’s customers had sharply declined due to changes in the No. 6 fuel oil market resulted in a 41% stock price drop.

Moab Partners, a stockholder, filed an action alleging that Macquarie and certain officer defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by failing to satisfy the disclosure requirements under Item 303 of SEC Regulation S-K, which sets forth the disclosure obligations of public companies in periodic reports filed with the SEC.  Item 303 requires a public company to provide its Management Discussion and Analysis, which, among other things, requires disclosure of any “known trends . . .  or uncertainties” that were known to or reasonably likely to have material effects on the company’s financial condition and operations. Moab alleged that defendants’ failure to disclose the potential financial impact of IM0 2020 violated Item 303 which in turn provided a basis for the Rule 10b-5 claim.  The district court dismissed the complaint, but the Second Circuit Court of Appeals reversed, citing binding precedent in holding that a violation of Item 303 alone could sustain a Rule 10b-5 claim. By contrast, other Circuit Courts, including the Ninth Circuit, have held that Item 303 by itself does not create a duty of disclosure for purposes of Rule 10b-5.

Justice Sotomayor, writing for the Court, observed that Rule 10b-5(b) makes it unlawful to make any untrue statement of a material fact “or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” The Rule prohibits false statements, lies, and half-truths, but not “pure omissions.”

A pure omission occurs “when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.”  For example, if a company failed entirely to file an MD&A, the omission has no particular significance because nothing was disclosed. Half-truths, however, are representations “that state the truth only so far as it goes, while omitting critical qualifying information.” A classic example would be a seller who discloses that there may be two new roads near a property he is selling but fails to disclose that a third potential road might bisect the property. Or, as noted above, the child who tells his parents only that he had dessert but fails to disclose that he ate the whole cake.

Rule 10b-5(b) by its very text prohibits half-truths, but not pure omissions.  By contrast, Section 11(a) of the Securities Act of 1933 prohibits any registration statement for a public offering that, among other things, omits “to state a material fact required to be stated therein.” Thus, Section 11 creates liability for failure to speak on a subject while Rule 10b-5(b) lacks similar language.  “Silence, absent a duty to disclose, is not misleading under Rule 10b-5.” Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988).  But, the Court held, even a duty to disclose does not automatically render silence misleading under Rule 10b-5(b).  “Today, this Court confirms that the failure to disclose information required by Item 303 can support a Rule 10b-5(b) claim only if the omission renders affirmative statements made misleading.”

The Court swatted away the argument by Moab and the U.S. Solicitor General that a plaintiff need not plead any misleading statements rendered misleading by a pure omission because reasonable investors know that Item 303 requires disclosure of all known trends and uncertainties.  Such an interpretation would read the “statements made” language out of Rule 10b-5(b) and shift the focus of the Rule and Section 10(b) from fraud to disclosure, while rendering superfluous Section 11(a)’s pure omission clause.  Nor would eliminating private liability for pure omissions create broad immunity for a company’s fraudulent failure to satisfy Congressional and SEC disclosure requirements. A plaintiff can always bring claims based on violations that create half-truths and the SEC still has the ability to prosecute violations of its own regulations.

One final note: the Court’s analysis centers on the text of Rule 10b-5(b). It remains to be seen whether a pure omission of a material fact still might support liability under the “scheme liability” provisions of Rule 10b-5(a) and (c).  It also remains to be seen whether the identical analysis applies to disclosure requirements for proxies and tender offer filings.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Delaware Chancery Court Examines Special Litigation Committee

The creation of a Special Litigation Committee (“SLC”) is a useful device for a corporation to address and dispose of litigation accusing the corporation and/or corporate insiders of misconduct.  A recent decision by the Delaware Chancery Court provides significant guidance on the requirements for an SLC’s recommendation to dismiss litigation to pass muster with the court.  In particular, the Chancery Court emphasized that an SLC’s investigation and decision-making must be reasonable, not perfect. 

The Chancery Court’s decision in In re Carvana Co. Stockholders Litigation, No. 2020-0415-KSJM (Del. Ch. Mar. 27, 2024), arose from a direct stock offering by Carvana, an online used car retailer, in March 2020. The two controlling stockholders, Ernest Garcia II and Ernest Garcia III, participated in the offering and Garcia II later sold over $1 billion of his shares.  The plaintiff-stockholder filed a derivative action on behalf of the company against the Garcias for breach of fiduciary duty, alleging that they enriched themselves through the offering by acquiring shares at a depressed price. 

After Chancellor Kathaleen St. J. McCormick denied the defendants’ motion to dismiss, the Board of Directors formed a two-person SLC, which conducted a seven-month investigation, reviewing over 100,000 documents and interviewing 16 witnesses. The SLC retained outside counsel and an investment banker to assist the investigation. The SLC concluded in a 170-page report that no wrongdoing occurred and that terminating the lawsuit was in the company’s best interests.  The SLC then moved to dismiss the lawsuit. 

The Court evaluated the SLC’s motion to dismiss under Zapata v. Maldonado, 430 A. 2d 779 (Del. 1981). Under Zapata, the SLC first has the burden of proving its independence and that it acted in good faith in conducting an investigation of reasonable scope that provided a reasonable basis for its conclusion. The court then applies its own business judgment in determining whether the SLC’s recommendation falls within a range of reasonable outcomes that a disinterested and independent decision maker for the corporation could reasonably accept. 

Independence of SLC Members 

Plaintiffs’ opposition to the SLC’s motion to dismiss challenged the independence of the SLC members, Michael Maroone and Neha Parikh.  Plaintiffs asserted that these directors were not independent because they voted to approve the direct offering transaction and discussed the motion to dismiss the underlying lawsuit.  But a director’s approval of a transaction does not establish the director’s inability to impartially consider the merits of the transaction at a later time.  And because the Board did not vote on filing the motion to dismiss, the SLC members did not participate in a substantive manner in the decision to file the motion.  Nor was their independence compromised because they considered management’s recommendation on the choice for outside counsel or because they were named as defendants in lawsuits filed after the direct offering transaction. 

Investigation Was Reasonable and Good Faith 

The  SLC bears the burden of proving that it acted in good faith and conducted a reasonable investigation.  First, plaintiffs argued that the SLC relied too much on the work of outside counsel.  But the court held that reliance on independent, competent outside counsel was typical and reasonable.  A key fact for the court was that the SLC members met formally nine times and informally many times; participated in decisions regarding document collection and other matters; and attended critical witness interviews.  The SLC members’  lack of memory concerning details of the investigation was not relevant because “that is why humans write things down.”  The SLC’s report was exhaustive, well-documented and included the relevant facts.  Although Maroone expressed a lack of enthusiasm about serving on the SLC and described it as a “part-time responsibility,” there was no evidence that such views compromised his diligence.  The failure to collect text messages from some individuals paled in comparison to the extensive document collection.  In summary, the record amply demonstrated the SLC’s good faith efforts to thoroughly investigate the allegations through a reasonable interview process. 

Scope 

The court rejected plaintiffs’ contention that the SLC failed sufficiently to consider Garcia II’s stock sales.  The SLC found that there was no basis for knowing that Carvana’s stock price would increase after the stock offering and the stock that Garcia II sold was not purchased in the offering but came from stock he had owned since Carvana’s initial public offering.  The investment bank retained by the SLC found that there was sufficient liquidity and volume to allow non-participating Carvana stockholders to purchase shares.  The investment bank concluded that the economic dilution suffered by the Garcias far outweighed any benefit they received from the offering and in fact they were diluted more than any other stockholder on an absolute dollar basis.  The SLC investigated the conduct of two directors and found that although neither were independent as a matter of law, they acted properly with respect to the stock offering. Other flaws alleged by plaintiffs were minimal and did not affect the SLC’s conclusions. 

In short, the SLC met its burden and established that its conclusions were the product of a good faith, reasonable investigation.  Plaintiffs failed to raise a genuine question of material fact as to the thoroughness of the investigation, the reasonableness of the scope or the reasonableness of the SLC’s conclusions. 

The Court’s Examination 

The court’s task in exercising its own business judgment was “to determine whether the SLC’s recommended result falls within a range of reasonable outcomes that a disinterested and independent decision maker for the corporation, not acting under any compulsion and with the benefit of the information then available, could reasonably accept.”  The court concluded that based on that standard, it accepted the SLC’s recommendation to dismiss the derivative action.  

Conclusion 

The Carvana decision illustrates how an SLC, if utilized properly, provides a basis for dismissing a derivative action. But it is essential that certain fundamental principles be followed: the SLC members must be independent; competent outside counsel (and an investment bank, if needed) should be retained; the SLC members should actively participate in the investigation; all important issues should be investigated; the findings and conclusions should be well-documented; and the SLC’s conclusions must have a reasonable basis. 

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

S.D. Cal. Refuses to Dismiss First Prosecution of Insider Trades Pursuant to a 10b5-1 Plan

SEC Rule 10b5-1 provides an affirmative defense to corporate officers, directors, and companies for trading in their company’s stock. To be eligible for the defense, the officer, director or company must establish a public trading plan that sets forth predetermined dates, prices and amounts for buying, selling or hedging stock. Once the plan is created, stock transactions will occur automatically based on the details of the plan, and the plan will provide a defense against accusations of illegal insider trading.   

But there is a catch. The 10b5-1 plan must be adopted at a time when the insider does not have possession of material nonpublic information about the company. The failure to adhere to this essential legal requirement resulted in the first criminal prosecution for insider trading based on the allegedly corrupt use of a 10b5-1 plan – charges that a federal judge recently refused to dismiss. 

In March 2023, the U.S. Department of Justice brought criminal charges against Terren Peizer, the former Chief Executive Officer and Chairman of Ontrak, Inc., a Los Angeles-based company that uses artificial intelligence and telehealth to treat behavioral health conditions. The first-of-its kind indictment charged Peizer with entering into two 10b5-1 plans and then selling 600,000 shares of stock while knowing that Cigna Group, Ontrak’s leading customer, planned to terminate a major contract to provide health care for chronically ill patients. Peizer’s stock sales allegedly enabled him to avoid $12.7 million in market losses after the stock price fell by 44% after the announcement of the contract termination. In bringing the indictment, Assistant Attorney General Kenneth A. Polite, Jr., stated that “Today’s groundbreaking insider trading indictment demonstrates that the Department of Justice, together with our law enforcement partners, will not allow corrupt executives to misuse 10b5-1 plans as a shield for insider trading.”  

After a superseding indictment was filed in January 2024, Peizer moved to dismiss, asserting that the government had not sufficiently alleged that he possessed and used nonpublic information. But U.S. District Judge Dale S. Fischer in Los Angeles held in a March 7, 2024, ruling that the indictment specified numerous nonpublic facts that a “reasonable investor would consider important in deciding whether or not to trade in Ontrak securities.” 

The prosecution charged that in March 2021, Peizer stepped down as CEO of Ontrak and became the Executive Chairman and Chairman of the Board of Directors. But despite the change in title, Peizer still received nonpublic information about customer relationships, including the fact that Cigna was raising numerous issues concerning its relationship with Ontrak and that the Cigna contract was at serious risk of being terminated. Peizer allegedly knew that losing Cigna would seriously affect Ontrak’s stock price, particularly after the price plummeted by 46% in February 2021 when Ontrak announced the loss of Aetna, its then-largest customer. At a May 18, 2021meeting, Cigna informed Ontrak of its intent to terminate its contract by year-end. 

On May 4, 2021, eight days before the meeting with Cigna, and when he allegedly had been expressing concern to Ontrak’s CEO and a consultant that the Cigna contract would be terminated, Peizer contacted a broker to establish a 10b5-1 plan to sell $19 million in stock, although he had sold stock only twice since 2003. After learning that the broker would require a “cooling-off period” before he could sell stock, Peizer allegedly went to a different broker, who although not requiring a cooling-off period, recommended that Peizer refrain from selling stock for 30 days, a proposal that Peizer rejected.  

To enter into the 10b5-1 plan, Peizer allegedly falsely certified that he did not possess material nonpublic information. After the 10b5-1 plan was adopted on May 11, 2021, Peizer exercised 686,000 stock warrants and began selling those shares. 

On August 13, 2021, Peizer allegedly learned from a senior executive that Cigna appeared ready to terminate its contract. One hour after this call, Peizer allegedly entered into a second 10b5-1 plan, again falsely stating that he did not possess material nonpublic information. Peizer sold approximately 45,000 shares of Ontrak stock over the next three days before Ontrak announced on August 19, 2021, that Cigna had terminated its contract, resulting in the steep stock price decline. 

Peizer’s motion to dismiss argued that he did not enter into the 10b5-1 plans while possessing material nonpublic information about Cigna. He asserted that on May 6, 2021, and on August 5, 2021, prior to the implementation of his trading plans, Ontrak made filings with the SEC that disclosed all material information about the Cigna relationship. Peizer argued that these filings – a quarterly report and a Form 8-K report – publicly disclosed that Ontrak might not be able to keep key customers, that losing these customers would materially harm the company, and that it expected a smaller budget and more limited expansion. The August disclosure, Peizer argued, disclosed a reduced forecasted gross margin because the company had made a revised proposal to Cigna that would negatively impact Ontrak’s margins. Peizer also argued that Ontrak’s compliance professionals reviewed and approved his 10b5-1 plans. 

Judge Fischer rejected these arguments. First, the court held that it could not take judicial notice of SEC filings and that only the face of the indictment could be considered (unlike in a civil case, where SEC filings might be incorporated by reference into the complaint). Second, the court held that the indictment “clearly and directly” alleged an intent to defraud, despite Peizer’s argument that intent was inadequately pled. Finally, in response to Peizer’s argument that the government had not showed how he “used” any nonpublic information, the court that “[T]his is obviously not true, as the [indictment] provided extensive detail regarding Defendant’s trades that were allegedly made based on his knowledge of nonpublic information.” 

Peizer contended that the government had not clearly stated its theory of liability because its description of the material nonpublic information that he allegedly possessed was “ambiguous.” But the court held that “it should go without saying that [the information] is not ambiguous in context” and the government’s theory of liability was based on the specific information described in the indictment. 

In December 2022, the SEC adopted amendments to Rule 10b5-1 that could have prevented Peizer’s trading. The most important amendment was to require a cooling-off period for officers and directors of the later of 90 days following the modification or adoption of the 10b5-1 plan or two days following disclosure in periodic reports for the quarter in which the plan was adopted or modified. Under the revised rule, if Peizer filed his 10b5-1 plan on May 11, 2021, he would have been able to sell stock prior to the August 19, 2021 announcement of the Cigna contract termination—but not until August 9, 2021, after the cooling-off period. In addition, because a cooling-off period would still be in place, he would not have been able to sell immediately after filing his August 13, 2021 10b5-1 plan. Of course, he could have still sold stock outside of a 10b5-1 plan, but that still would have been illegal insider trading if he was aware of Cigna’s plans.  Also, the amendments restrict the use of multiple overlapping trading plans and limit the ability to rely on the affirmative defense for a single-trade plan to one single trade plan for all persons other than the company.  

The SEC’s revised rule was intended to prevent the kind of abuse of 10b5-1 plans for which Peizer is being prosecuted. Nonetheless, officers and directors, and a company’s inside and outside counsel, must carefully monitor trading under 10b5-1 plans to ensure compliance with legal requirements and to avoid potential liability. 

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

Negligent Misrepresentation Claims Can’t Be Based on Opinions – Or Can They?

We all “know” that statements of opinion are not actionable … right?

Not so fast.  It is true that claims for defamation and intentional misrepresentation require misstatements of fact, and an opinion need not be supported by facts.  But not all opinions are equal, and certain classes of speakers must exercise due care to prevent their conclusions from harming to reasonably foreseeable audiences.    

California’s Negligent Misrepresentation Law

In California, negligent misrepresentation is a form of deceit: “The assertion, as a fact, of that which is not true, by one who has no reasonable ground for believing it to be true.”  Cal. Civ. Code § 1710(2).

Generally, an actionable statement must be an assertion of fact.  “A representation is an opinion “‘if it expresses only (a) the belief of the maker, without certainty, as to the existence of a fact; or (b) his judgment as to quality, value … or other matters of judgment.’” “ Graham v. Bank of America, N.A., 226 Cal. App. 4th 594, 606-607 (2014) (internal citations omitted).  An opinion of property value, for example, is “quintessentially a matter of opinion, not a statement of fact.”  Neu-Visions Sports, Inc. v. Soren/McAdam/Bartells, 86 Cal. App. 4th 303, 310 (2000).  

Opinions may be actionable misstatements of fact in three circumstances: “(1) where a party holds himself out to be specially qualified and the other party is so situated that he may reasonably rely upon the former’s superior knowledge; (2) where the opinion is by a fiduciary or other trusted person; (3) where a party states his opinion as an existing fact or as implying facts which justify a belief in the truth of the opinion.’” Borba v. Thomas, 70 Cal. App. 3d 144, 152 (1977) (internal citations omitted).  

“Whether a statement is nonactionable opinion or actionable misrepresentation of a fact is a question of fact for the jury.”  Furla v. Jon Douglas Co., 65 Cal. App. 4th 1069, 1080-1081 (1998).  

The Speaker’s Superior Knowledge

In Cohen v. S & S Construction Co., 151 Cal. App. 3d 941 (1983), plaintiffs paid a premium to purchase their property lots upon the sales agent’s assurances that the applicable Declaration of Covenants, Conditions and Restrictions protected the view and prevented the neighbors from building obstructions of plaintiffs’ view (spoiler alert: it did not).  The tract developer authored the Declaration, controlled the governing Association’s board of directors, and employed the sales agent who made the misrepresentation to plaintiffs.  

Although the defendants argued the sales agent’s statements were nonactionable opinion, the Court of Appeal for the Fourth District reversed the trial court’s dismissal of plaintiffs’ cause of action for negligent misrepresentation for two reasons relating to the first Borba factor: (1) the developer held themselves out to the public as “experts in establishing and administering homeowner associations and maintaining the aesthetic integrity of their developments,” and (2) the sales agent who worked for the developer was in a position to know facts accessible only to him or his principal.  151 Cal. App. 3d at 946.

The Negligence in Negligent Misrepresentation

A corporation commissioned its attorneys and an accounting firm to prepare confidential offering memoranda (COM) to share with prospective investors in the corporation’s limited partnerships.  The COMs included financial forecasts and projected a return of 16 to 19 percent over a six-year period.  The reports summarized the assumptions and accounting policies supporting the forecasts and warned that the investment “involved a high degree of risk and should be made only by investors who could afford a total loss of their contributions.”  Anderson v. Deloitte & Touche, 56 Cal. App. 4th 1468, 1472 (1997).  

Plaintiffs brought suit after the limited partnerships filed chapter 11 bankruptcy petitions.  Plaintiffs’ expert opined that the accounting firm failed to conduct its examination of the corporation’s forecasts according to applicable accounting guidelines.  Anderson, 56 Cal. App. at 1475.  The trial court granted summary judgment in favor of the defendant accounting firm.  

In reversing the trial court, the Court of Appeal for the First District  emphasized that ostensible statements of opinion may be actionable assertions of fact where the speaker does not speak with due care: “If the acts or conduct of a professional accountant performed in preparation for an audit or representation fall below the applicable standard of care for the profession, in that the accountant failed to examine or acquire the necessary information required to support the accountant's professional opinion disseminated to potential investors, the opinion is made without a reasonable ground for believing it to be true … When a statement, although in the form of an opinion, constitutes “ ‘a deliberate affirmation of the matters stated’ ” … as occurred here, “it may be regarded as a positive assertion of fact.”  Anderson v. Deloitte & Touche 56 Cal.App.4th 1468, 1477 (1997) (internal citations omitted).  

Know Your (Foreseeable) Audience

Accountants are regularly hired by clients to prepare independent audits and reports on the client’s businesses.  But who is the intended audience of those reports: the clients who commissioned them, or third parties who may rely on the reports to their detriment?  As to the third parties: It Depends.

In Bily v. Arthur Young & Co., 3 Cal. 4th 370 (1992) the California Supreme Court affirmed that “Under certain circumstances, expressions of professional opinion are treated as representations of fact.  When a statement, although in the form of an opinion, is ‘not a casual expression of belief’ but ‘a deliberate affirmation of the matters stated,’ it may be regarded as a positive assertion of fact.”  Bily, 3 Cal. 4th at 408, quoting Gagne v. Bertran, 43 Cal. 2d 481, 489 (1954).  

The Bily court next considered whether third parties may rely on such opinions, and whether the speaker could be liable to those third parties.  The “‘class of persons entitled to reply upon the representation is restricted to those to whom or for whom the misrepresentations were made.  Even though the defendant should have anticipated that the misinformation might reach others, he is not liable to them.’”  Bily v. Arthur Young & Co., 3 Cal. 4th 370, 408 (1992) (internal citations omitted).  The Court endorsed the approach of Restatement Second of Torts section 552(b), which “creates an objective standard that looks to the specific circumstances…to ascertain whether a supplier has undertaken to inform and guide a third party with respect to an identified transaction or type of transaction.”  Bily, 3 Cal. 4th at 410.  “If such a specific undertaking has been made, liability is imposed on the supplier.  If, on the other hand, the supplier ‘merely knows of the ever-present possibility of repetition to anyone, and the possibility of action in reliance upon [the information] on the part of anyone to whom it may be repeated,’ the supplier bears no legal responsibility.”  Id. (internal citations omitted).

Conclusion

Opinions can be complicated things – a combination of beliefs, impressions, judgments … and a suggestion of the facts that support these.  While an opinion may not expose its speaker to liability for intentional fraud, speakers should exercise due care to ensure their audience is not harmed by their statements, even if couched as an opinion.  And this care should extend not only to the immediate audience, but also to those who will foreseeably rely on the speaker’s representation.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.

New Developments in Crypto Litigation

In the unpredictable world of cryptocurrency, there is one thing you can almost certainly count on: new and notable developments in crypto litigation and SEC enforcement.

Coinbase and the SEC Continue to Slug it Out in Court

In June 2023, the Securities Exchange Commission (“SEC”) filed a lawsuit in the U.S. District Court for the Southern District of New York alleging that Coinbase evaded securities regulations by failing to register with the SEC as an exchange, clearing agency, or broker.

The parties in January 2024 had oral argument over the central issue in the case: are crypto assets securities?

The SEC contends that they are and therefore that there are securities transactions that are taking place on Coinbase. As a result, the SEC argues, Coinbase is operating as an unregistered exchange. 

During oral argument, Coinbase countered with an argument by analogy, stating that buying cryptocurrency is akin to buying collectibles like Beanie Babies, as opposed to a stake in a company.

The judge’s ruling on this issue is pending. As we have stated previously, the question of whether crypto tokens are securities has divided courts, with a ruling this past summer that exchange sales of Ripple Labs XRP token weren’t subject to SEC jurisdiction, while another judge reached the opposite conclusion in a case against Terraform Labs Pte.

Crypto Company Goes on Offense to Make an “Impact”

A crypto trading platform called Lejilex is attempting to turn the tables on the SEC by filing its own lawsuit against the agency. The lawsuit, with the Crypto Freedom Alliance of Texas as a co-plaintiff, contends that the sale of digital assets on secondary markets does not qualify as securities transactions, thereby exempting them from the regulatory purview of the SEC. In other words, they’re fighting the same battle as Coinbase, but doing so as a plaintiff versus as a defendant.

This sort of litigation is often called “impact litigation” (or “strategic litigation”), which refers to the practice of using legal action to bring about significant changes in the law, practice, or public awareness through precedent-setting court cases. These lawsuits are typically aimed at creating broad changes affecting large groups of people rather than just resolving the specific legal issues faced by the plaintiffs involved in the case.

New York Seeks Billions from Digital Currency Group

It’s not just the federal government that is cracking down on crypto. 

In October, New York Attorney General Letitia James filed a lawsuit alleging that Digital Currency Group, Genesis Global Capital, and Gemini Trust (run by Cameron and Tyler Winklevoss), defrauded investors out of more than $1 billion. The allegations focus on the Gemini Earn program, through which customers lend crypto assets to Genesis Global Capital in exchange for a high rate of return. The attorney general alleges that Gemini lied to investors by assuring them that investing with Genesis through their Gemini Earn program was a low-risk investment. In February, the lawsuit was expanded, and now alleges that damages stemming from fraud exceed $3 billion.

Conclusion

There is still considerable uncertainty about how the securities laws apply to the cryptocurrency industry. One thing that seems certain is that litigation, initiated by governments as well as between private parties, will continue to rage in the crypto domain. We will keep you updated with new developments.

For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.

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Disclaimer: Materials on this website are for informational purposes only and do not constitute legal advice. Transmission of materials and information on this website is not intended to create, and their receipt does not constitute, an attorney-client relationship. Although you may send us email or call us, we cannot represent you until we have determined that doing so will not create a conflict of interests. Accordingly, if you choose to communicate with us in connection with a matter in which we do not already represent you, you should not send us confidential or sensitive information, because such communication will not be treated as privileged or confidential. We can only serve as your attorney if both you and we agree, in writing, that we will do so.

The materials on this website are not intended to constitute advertising or solicitation. However, portions of this website may be considered attorney advertising in some states.

Unless otherwise specified, the attorneys listed on this website are admitted to practice in the State of California.