Are Crypto Tokens Securities? SDNY Judges Reach Different Conclusions

For years, the Securities Exchange Commision (SEC) has been adamant that, according to SEC chair Gary Gensler, the “vast majority” or cryptocurrency tokens are securities and that offers and sales of such tokens are covered by the securities laws. As the SEC ramps up efforts to regulate the cryptocurrency industry in accordance with that position, courts have begun weighing in on the issue—and the results are mixed.

SEC v. Ripple: Tokens Sold Over Exchanges to the General Public are Not Securities

In SEC v. Ripple Labs, Inc, a case we addressed in a previous post, Judge Analisa Torres in the United States District Court for the Southern District of New York held that sales of XRP to institutional investors involved securities under the test articulated by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). 

However, the court ruled that so-called Programmatic Sales on crypto exchanges to the general did not involve securities because the purchasers were not buying directly from Ripple, and therefore could not reasonably expect a profit derived from Ripple's efforts (the third prong of the Howey test).

The Court in SEC v. Terraform Labs Pte. Ltd. Reaches a Different Conclusion

On July 31, 2023, Judge Jed S. Rakoff in the United States District Court for the Southern District of New York reached a conclusion at odds with Judge Torres’ ruling in an opinion denying Terraform Labs’ motion to dismiss a case brought by the SEC. 

In this case, the SEC alleges, among other things, that Terraform Labs and its CEO, Do Hyeong Kwon, failed to register the offer and sale of Terraform’s crypto-assets and committed fraud in connection with those transactions. Judge Rakoff denied Terraform Labs’ motion to dismiss, ruling that the SEC adequately pled that Terraform’s crypto-assets qualified as securities under the Supreme Court’s Howey test. 

Judge Rakoff explicitly addressed—and rejected—the distinction Judge Torres drew between sales to institutional and retail investors, respectively, when evaluating whether the securities laws are implicated. According to Judge Rakoff, “It may also be mentioned that the Court declines to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not.”

Moving Forward

So where does this leave us? While the Ripple and Terraform decisions add additional data points to the discussion, there is still no consensus as to whether crypto-assets are securities. While Judge Torres’ ruling briefly raised hopes in the crypto industry that selling tokens on digital asset exchanges to retail investors could allow such transactions to escape SEC enforcement, Judge Rakoff’s rejection of her reasoning highlights the ongoing uncertainty about this important legal issue.

Are crypto tokens securities? Unless Congress intervenes, it will likely be up to the courts of appeal to answer that question. On August 9, 2023, the SEC announced its intention to appeal the Ripple decision. We will continue to keep you apprised of further developments in these and other cases at the intersection of the cryptocurrency industry and the securities laws.

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.

Board Diversity Requirements in the Wake of Weber

In 2020, California passed Assembly Bill 979, which required California-headquartered public companies to appoint a minimum number of individuals from underrepresented communities to their boards.  This bill followed on the heels of a 2018 Senate Bill that required publicly listed corporations headquartered in California to have two or three female board members, depending on the size of the board.  

Following a recent trial-court decision out of the Eastern District of California as well as two earlier state court decisions, both board requirements have been found to violate equal protection.  That creates significant compliance uncertainty for corporations while these decisions wind through the appellate courts.  At the same time, the benchmarks set out in both bills reflect an interest that many institutional investors have publicly prioritized.  Furthermore, certain publicly listed companies are required to disclose the diversity metrics of their boards.  As a result, even though these bills are currently enjoined, their diversity frameworks will likely continue to be important considerations for boards as they seek to respond to the real expectations of their constituents in a merits-based and non-discriminatory way.   

Trial Courts Find California’s Board Diversity Statutes to be Unconstitutional

In 2020, California passed Assembly Bill 979, which required California-headquartered public companies to appoint a minimum number of individuals (dependent on the size of the corporation) from underrepresented communities to their boards. This law has been challenged, and the U.S. District Court for the Eastern District of California (the “District Court”) became the latest court to rule it unconstitutional.

California Assembly Bill 979

CAB 979 defines “underrepresented communities” as individuals who identify as “Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender.” One to three persons from underrepresented groups must be members of a corporation’s board (again, based on the corporation’s size). Fines for noncompliance are $100,000 for an initial violation and $300,000 for subsequent violations.

Alliance for Fair Board Recruitment v. Weber

The Alliance for Fair Board Recruitment (the “Alliance”) challenged the constitutionality of CAB 979 in a lawsuit in the District Court. On May 15, 2023, the District Court, in Alliance for Fair Board Recruitment v. Weber, ruled that CAB 979 violates the Equal Protection Clause of the U.S. Constitution’s Fourteenth Amendment, as well as 42 U.S.C. §1981.

The Alliance argued that CAB 979’s imposition of board requirements based on select racial and ethnic classifications constitutes an impermissible race-based quota in violation of the Equal Protection Clause of the Fourteenth Amendment to the U.S. Constitution and federal statute 42 U.S.C. §1981, which prohibits racial discrimination on the basis of race in the making and enforcing of contracts. 

The District Court granted Alliance’s motion for summary judgment, ruling that CAB 979’s racial and ethnic quotas are “facially invalid” based on relevant U.S. Supreme Court precedent, including its ruling in the affirmative action case Grutter v. Bollinger.

The District Court is not the only court to consider the constitutionality of California’s board diversity requirements. In two cases, Crest v. Padilla I and II, filed in California state courts, the courts ruled in favor of the plaintiffs and entered injunctions against the implementation and enforcement of CAB 979 and California Senate Bill 826, which requires gender diversity on boards. The courts found that the statutes violated the equal protection provisions of the California Constitution. 

Crest v. Padilla I and II were both appealed and the appeals remain pending. Alliance for Fair Board Recruitment v. Weber was also recently appealed.

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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The U.S. Supreme Court Expands Corporate Personal Jurisdiction via Mallory v. Norfolk Southern Railway Co. Ruling

The U.S. Supreme Court recently issued an opinion in Mallory v. Norfolk Southern Railway Co. that will likely have a significant impact on where litigation is initiated in the United States, particularly if more states follow Pennsylvania’s lead in passing legislation requiring companies who do business locally to consent to personal jurisdiction. 

The Underlying Case

In Mallory v. Norfolk Southern Railway Co., No. 21-1168 (U.S. June 27, 2023), plaintiff Robert Mallory, a resident of Virginia, sued Virginia-based Norfolk Southern, his former employer, in Pennsylvania. The lawsuit alleged that Mallory suffered damages related to exposure to toxic chemicals while working for Norfolk Southern in Virginia and Ohio. The alleged basis for jurisdiction in Pennsylvania was that Norfolk Southern consented to it by registering to do business there.

All out-of-state corporations that desire to do business in Pennsylvania must register as foreign corporations. Pennsylvania law provides that “qualification as a foreign corporation” allows state courts to “exercise general personal jurisdiction” over the corporation.

Norfolk Southern argued that Pennsylvania’s law tying registration to jurisdiction violated the U.S. Constitution’s Due Process Clause.  Pennsylvania’s own courts agreed.

The Supreme Court’s Decision

On June 27, 2023, the U.S. Supreme Court, in a 5-4 decision, reversed the Pennsylvania courts and ruled that the Due Process Clause does not prohibit a state from requiring an out-of-state corporation to consent to personal jurisdiction. Justice Gorsuch, writing for the majority, explained:  “If having to defend this suit in Pennsylvania seems unfair to Norfolk Southern, it is only because it is hard to see Mallory’s decision to sue in Philadelphia as anything other than the selection of a venue that is reputed to be especially favorable to tort plaintiffs. But we have never held that the Due Process Clause protects against forum shopping.”

The dissent argued that the majority’s ruling permits states to bypass due process requirements and manufacture consent to jurisdiction. Moreover, the dissent asserted that Pennsylvania’s registration process does not explicitly explain that registration results in consent.

Implications

The Mallory decision will almost certainly increase forum shopping, particularly if more states adopt foreign corporation registration requirements similar to those in Pennsylvania. Corporations who do business in multiple states should carefully review, and continue to monitor, statutory developments that could impact whether they may be subject to jurisdiction in states in which they’re not headquartered, and in which they have what they might consider—in business (if not legal) terms—a relatively minor presence.

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.

Eleventh Circuit Case Examines Loss Causation Allegations Where Lead Plaintiff Sold Shares Between Company Disclosures Regarding the Existence and Results of an Investigation

“Loss causation”—the notion that a plaintiff generally must plead and prove that the defendant’s action (or inaction) caused their loss—is one of the most fundamental concepts in all of law.  But while the basic concept is easily explained, the devil of its application is in the details.  Nowhere is this more true than in securities fraud cases, where thousands of individuals and entities trade stock based on company and third-party statements alike.

A perennial question in securities fraud cases is whether a given corporate announcement regarding an investigation constitutes a “corrective disclosure,” such that supports a loss causation argument.  For instance, the Ninth Circuit Court of Appeals has held that merely alleging that a company has announced an SEC investigation does not adequately plead loss causation in a securities fraud case.  However, the announcement of an investigation, when coupled with a subsequent confirmation of wrongdoing, can constitute a corrective disclosure.

What about a situation involving both an announcement of an investigation and a subsequent confirmation of wrongdoing, where the plaintiff sells their stock before the final announcements?

That is the fact pattern that the Eleventh Circuit Court of Appeals recently faced.  In MacPhee v. MiMedx Group, Inc., the plaintiffs alleged that MiMedx, the “leading global supplier of amniotic tissue products,” reported “explosive” growth between 2012 and 2017 that was, in fact, predicated on improper sales and distribution practices, as well as a “massive accounting fraud.”  The plaintiffs alleged that the truth regarding the misconduct “leaked into the market through a series of partial corrective disclosures” that included, among other things:  (a) a December 2014 press release that the company was under government investigation; (b) September 2017 and February 2018 press releases regarding audit committee investigations; and (c) a July 2018 announcement of the results of the final audit committee investigation, and related resignations.

The wrinkle?  The lead plaintiff sold its stock after the announcement of the final internal investigation, but before the announcement of the results of that investigation.  Per the Supreme Court’s decision in Dura Pharms., Inc. v. Broudo, there is no loss causation where a shareholder sells their stock “before the relevant truth begins to leak out.”  Accordingly, the MacPhee court held that because the lead plaintiff sold its stock in February 2018, before the announcement of the results of the investigation:  “the announcement of an internal investigation, a government investigation, and a whistleblower lawsuit” “did not qualify as corrective disclosures.”

While it remains unclear how the Ninth Circuit Court of Appeals would rule on such a fact pattern, California practitioners should keep MacPhee in mind, should they find themselves faced with similar circumstances.

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.

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Does a Director of a California Non-Profit Lose Derivative Standing If They Lose Reelection to the Board During Litigation?

A director of a California nonprofit corporation has standing to bring derivative lawsuits on behalf of the nonprofit in appropriate circumstances. Corp. Code § 5710. But what happens when a director who began the litigation with standing loses their bid for re-election to the board?  In 2021, the California Supreme Court granted certiorari to resolve a split of authority on that very question. Given the Court’s two-year average for civil cases, we expect a ruling on this issue in the coming months.  

The case on review is Turner v. Victoria, (2021), 67 Cal. App. 5th 1099, where the California Court of Appeal, Fourth Appellate District, ruled that standing is lost in such circumstances. In reaching its conclusion, the court analogized to cases involving for-profit corporations, which have held that California law “generally requires a plaintiff in a shareholder derivative suit to maintain continuous stock ownership throughout the pendency of the litigation.” Grosset v. Wenaas, 42 Cal. 4th 1100 (2008). The court found no indication that the legislature intended to depart from the ordinary principles requiring a plaintiff to maintain standing throughout litigation.  

However, Turner acknowledged that its decision was at odds with Summers v. Colette, 34 Cal. App. 5th 361 (2019), a decision by the California Court of Appeal, Second Appellate District, which held that a director who brought a derivative action against another director alleging self-dealing and misconduct did not lose standing when removed from such position. And there is some sense in that position, as one can imagine a circumstance where a director is removed precisely to defeat standing in the pending derivative action (purportedly brought for the benefit of the non-profit). That might be more likely to happen in the non-profit context than in the context of a publicly traded corporation. For these reasons, it will be fascinating to see what the California Supreme Court decides.  

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 v. Ripple Labs Split-Decision Makes Waves in the Crypto Industry

In a closely watched case, a federal judge in New York has granted partial victories to both the Securities and Exchange Commission and Ripple Labs Inc. in ruling on cross-motions for summary judgment regarding whether sales of Ripple's digital token XRP violated the federal securities laws. 

On the one hand, Judge Analisa Torres in the United States District Court for the Southern District of New York held that sales of XRP to institutional investors involved securities under the test articulated by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).  The sale of securities that are not registered with the SEC violates Section 5 of the Securities Act of 1933 unless there is an applicable exemption.  To determine if the sale of an asset constituted a securities transaction, courts look at the underlying economic reality and the totality of the circumstances.  In Ripple, the court held that the institutional XRP sales satisfied the three prongs of the Howey test:  there was the investment of money, in a common enterprise, with the reasonable expectation of profit derived from the entrepreneurial or managerial efforts of others.

However, the court ruled that so-called Programmatic Sales on crypto exchanges did not involve securities because the purchasers were not buying directly from Ripple, and therefore could not reasonably expect a profit derived from Ripple's efforts (the third prong of the Howey test).  The court also held that Ripple’s other distributions of XRP to employees and third parties were not securities because there was no payment of money (the first prong of Howey), and there was no illegal underwriting of the tokens.  Further, XRP sales allegedly totaling $600 million by two officer-defendants did not meet the Howey test because they were Programmatic Sales on digital asset exchanges in "blind" bid/ask transactions where the buyers did not know who they were purchasing from, and therefore could not have expected profits derived from Ripple's efforts.  The court also held that a genuine dispute of material facts precluded summary judgment for the SEC on whether the officer-defendants aided and abetted the company's Section 5 violations.  The court rejected the defendants' argument that the SEC violated their due process rights because they lacked fair notice that XRP sales may violate the securities laws.

The court’s ruling in the SEC’s action against Ripple, filed in late 2020, was widely anticipated by the crypto community as a significant test of the SEC’s position that most sales of digital assets constitute securities transactions.  It will be interesting to see whether either side appeals the decision, given that both the SEC and Ripple can claim some measure of victory.

It may seem odd that the determination of whether an asset is a security depends on the nature of the transaction in the asset.  It would be as if GM stock were a security if purchased directly from GM, but not a security if purchased on the New York Stock Exchange.  In either case, the purchaser presumably would be relying on the managerial and entrepreneurial efforts of GM to make a profit.  But the Ripple court stated that the purchasers of XRP on crypto exchanges were less sophisticated than institutional investors; likely did not see the representations and statements of Ripple; may not even had known of Ripple's existence; and likely were expecting a profit based on cryptocurrency trends rather than any action by Ripple.  Therefore, the economic reality and the totality of the circumstances meant that the Programmatic Sales did not constitute the offer and sale of investment contracts.  While the court stated that a Programmatic Buyer stood in the same shoes as a secondary market purchaser, it also noted that it was not addressing whether secondary market sales of XRP constituted investment contracts, because the question was not properly before the court.

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 Holds that District Court Proceedings are Automatically Stayed Pending Appeal of the Denial of a Motion to Compel Arbitration

On June 23, 2023, the U.S. Supreme Court (the “Court”), in the case of Coinbase, Inc. v. Bielski, ruled that litigation in federal district court is automatically stayed when a party appeals the denial of a motion to compel arbitration. The Court reversed the U.S. Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) and resolved a circuit split with a ruling that has important tactical consideration for litigants, as explained below.

The Underlying Case

In this case, Coinbase moved to compel arbitration in a class action filed against it, and the U.S. District Court denied the motion. Coinbase then filed an interlocutory appeal to the Ninth Circuit and moved to stay district court proceedings to allow the arbitrability issue to be addressed on appeal. The district court refused to stay the proceedings, as did the Ninth Circuit. The Ninth Circuit, along with the Second and Fifth Circuits, held the minority position that the denial of a motion to compel arbitration does not automatically stay district court proceedings.

The Supreme Court Ruling

In a 5-4 decision, the Court reversed the Ninth Circuit and held that appealing the denial of a motion to compel arbitration automatically stays district court proceedings pending resolution of the appeal.

Justice Kavanaugh, writing for the majority, noted that while the Federal Arbitration Act grants the losing party a statutory right to an interlocutory appeal when a district court denies a motion to compel arbitration, it does not address whether district court proceedings must be stayed. 9 U. S. C. §16(a). However, the Court explained that the Federal Arbitration Act was enacted “against a clear background principle prescribed by this Court’s precedents” set forth in the Court’s Griggs v. Provident Consumer Discount Co. decision: an appeal “divests the district court of its control over those aspects of the case involved in the appeal.”

In this case, “Because the question on appeal is whether the case belongs in arbitration or instead in the district court, the entire case is essentially ‘involved in the appeal.’” Therefore, district courts must stay proceedings while an interlocutory appeal on arbitrability is ongoing. This is a practice that, according to Justice Kavanaugh, “reflects common sense,” because proceeding with a case while issues of arbitrability are on appeal would reduce the benefits of arbitration, such as efficiency and cost-savings.

Implications

This decision is clearly a victory for defendants who appeal the denial of a motion to compel arbitration. But it also has important tactical considerations for plaintiffs who take a chance by filing in court when they know the dispute may be subject to arbitration.  Even if the plaintiff persuades the relevant court that it has jurisdiction over the dispute, it must now wait out an appeal, which could materially impact the underlying goals of the litigation.  This will impact a plaintiff’s cost/benefit analysis of the optimal forum for initiating a dispute in a case that involves multiple agreements with conflicting forum selection provisions. 

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.

The Ninth Circuit Enforces Forum-Selection Clause, Dismisses Derivative Securities Claim

In an en banc decision in Lee v. Fisher, No. 21-15923, the U.S. Court of Appeals for the Ninth Circuit recently ruled that a shareholder derivative action against The Gap filed in federal court had to be dismissed because a forum-selection provision in the company's bylaws requires all derivative actions to be filed in Delaware Chancery Court. This ruling is notable, as it effectively precludes shareholders from asserting derivative claims on behalf of the company for alleged violations of the Securities and Exchange Act of 1934 (the “Exchange Act”).

The Ninth Circuit Decision

The lawsuit against Gap stemmed from allegations that the company's proxy statements contained materially false and misleading statements concerning the company’s commitment to diversity in nominating directors and hiring executives. Plaintiff brought a derivative action on behalf of the company against former and current directors that alleged the company’s proxy statements violated Section 14(a) of the Exchange Act and SEC Rule 14a-9. The Ninth Circuit’s ruling did not delve into the merits of the case. Instead, the focus was on the procedural question: Can this case be litigated in federal court or must it be removed to Delaware Chancery Court pursuant to the bylaws?

In its decision, the Ninth Circuit noted that the complaint was consistent with the “modern trend in which plaintiffs frame corporate mismanagement claims that normally arise under state law (including challenges to corporate policies relating to ‘ESG [environmental, social, and governance] issues … such as environmentalism, racial and gender equity, and economic inequality’) as proxy nondisclosure claims under § 14(a), in order to invoke exclusive federal jurisdiction and avoid any forum-selection.”

The plaintiff asserted that because the complaint alleged a claim under the Exchange Act, the forum-selection clause violated that antiwaiver provision in Section 29(a) of the Exchange Act. But in a 6-5 decision, the Ninth Circuit held that the antiwaiver provision was not violated because the plaintiff could still enforce the substantive obligations under Section 14(a) and Rule 14a-9 by bringing a direct stockholder claim in federal court. Indeed, the court indicated that the alleged claim should have been brought as a direct action under Delaware law. Further, citing recent Supreme Court jurisprudence, the court stated that the forum-selection clause did not violate a strong public policy of permitting a shareholder to bring a Section 14(a) derivative claim in federal court. The court also held that the forum-selection provision did not violate Delaware law. 

The dissent argued the forum-selection clause conflicts with the plain text of the Exchange Act and eliminates plaintiff's federal claims because Delaware did not have jurisdiction over them.

Conflict with the Seventh Circuit

The court acknowledged that it was disagreeing with a decision of the U.S. Court of Appeals for the Seventh Circuit that held that companies making claims under the federal securities laws could not use forum-selection clauses to avoid federal courts. In January 2022, the Seventh Circuit decided in favor of shareholders of The Boeing Company, allowing them to continue litigating derivative claims in federal court, despite Boeing’s forum-selection clause directing such cases to Delaware Chancery Court.

The circuit split may result in the U.S. Supreme Court weighing in on the enforceability of such forum-selection provisions.

Broader Implications 

This case highlights the importance of provisions in corporate bylaws and commercial contracts that address jurisdictional and choice-of-law issues, which can have a significant impact on the outcome of litigation. There are also strategic considerations related to jurisdiction that must be taken into account, such as whether a federal or state court would be a better forum for a particular case, and whether, in the absence of federal question jurisdiction, there is a basis for diversity jurisdiction to bring a case in federal court. 

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.

Trade Secrecy – The Last Refuge for A.I. Creations?

The dramatic rise in artificial intelligence systems and software has led to an explosion in AI-generated information. Much of that information has commercial value, whether it be in the form of creative content or elaborate machine-learning algorithms and their resulting data streams. But how should that valuable information best be protected?

Traditional intellectual property regimes have been relatively inhospitable to AI-generated content. In the patent world, the Supreme Court’s seminal decision in Alice Corp. v. CLS Bank held that a mere instruction to a computer to implement an abstract idea (for example, an algorithm or prompt) could not be patented.¹ And the U.S. Copyright Office recently issued guidance confirming that AI-generated content without any element of human creative contribution is not copyrightable.²

Fortunately, federal and state trade secrecy laws provide a ready alternative for valuable AI-generated information by expressly recognizing that trade secret rights “protect items which would not be proper subjects for consideration for patent [or copyright] protection.”³ All that is required is that information be competitively valuable and secret. No application, registration, or disclosure is needed and there is no statutory expiration date for a trade secret. Furthermore, there is no requirement that the creator of a trade secret be a natural person (i.e., a human), as is required to secure a patent.

All of this is welcome news to the many companies founded on the promise of machine learning systems. Their algorithmic inputs, training data, neural network designs and implementation, and systems output data all must be protected as trade secrets if they are to be protected at all. But, in practice, maintaining secrecy can be challenging for companies that must partner with other business organizations or release their technology into the wild. Indeed, lawful reverse engineering as well as independent development can provide viable defenses to a trade secret misappropriation lawsuit. Therefore, companies would be wise to implement the following steps to protect their AI-generated data as trade secrets:

1. Ensure non-disclosure agreements are entered into with all partner companies, independent contractors, and employees/officers/directors;

2. When releasing software, ensure that it is designed and implemented in ways that cannot be reverse engineered; and

3. Maintain strict cyber-security and monitoring protocols that are designed to prevent and detect data theft.

By taking these steps, companies will be in a stronger position to bring a lawsuit, obtain a restraining order, and collect damages if a trade secret is misappropriated.

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.

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1. Alice Corp. v. CLS Bank Int’l, 134 S.Ct. 2347, 2355 (2014). 
2.  Copyright Registration Guidance: Works Containing Material Generated By Artificial Intelligence, U.S. Copyright Office (Mar. 16, 2023), available at https://www.federalregister.gov/documents/2023/03/16/2023-05321/copyright-registration-guidance-works-containing-material-generated-by-artificial-intelligence
3. Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470, 482-83 (1974).  

Bahram Seyedin-Noor is Once Again Ranked by Chambers and Partners

Alto Litigation Founder and CEO Bahram Seyedin-Noor has been recognized in the 2023 edition of Chambers USA, the third straight year he has been included in the rankings for his practice in securities litigation in California. 

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 researchers, whose analysis includes interviews of thousands of lawyers and clients each year. Individuals and firms must demonstrate sustained excellence to be considered for the publication. 

Among the feedback provided in support of Bahram’s recognition is that, “He is the right mix of legal grounding, commercial awareness and assertiveness.” It was also noted that, “Bahram is extremely professional, knowledgeable and offers excellent advice.”

Responding to the recognition, Bahram stated “Litigation is a team sport. I am grateful to be surrounded by such a talented and dedicated legal team. This recognition is as much for their work as it is for my contribution to our client successes.”

Alto Partner Bahram Seyedin-Noor Contributes to New Edition of “Litigating and Judging California Business Entity Governance Disputes”

As the nature of business evolves, so does the law pertaining to business entity governance disputes. This week, LexisNexis released the latest edition of “Litigating and Judging California Business Entity Governance Disputes” – a seminal treatise that guides practitioners through a variety of complex business matters involving management, ownership and control of California corporations, LLCs, and general and limited partnerships.

Alto Litigation’s Bahram Seyedin-Noor is the author of Chapter 2 of “Litigating and Judging California Business Entity Governance Disputes,” covering disputes between and among a corporation’s shareholders and its managers relating to the management of the corporation itself.  Alto partners Bryan Ketroser and Josh Korr also contributed to the chapter which provides relevant citations to statutes and court decisions, together with insights, helpful tips and creative solutions for arbitrators, attorneys and judges, who are dealing with disputes regarding the management of a corporation. 

Bahram Seyedin-Noor is the Founder and Managing Partner of Alto Litigation. He is a graduate of Harvard Law School and is admitted to practice in California before all federal district courts and the Ninth Circuit Court of Appeals. He is a noted litigator in complex civil litigation, business litigation and counseling, SEC enforcement matters, and private securities. He is regularly recognized for his thoughtful strategy and adept litigation skills by The California Daily Journal, Benchmark Litigation, and Chambers USA. 

For more information and to purchase the new edition visit LexisNexis.

Retirement Accounts and Personal Liability in California

For lawyers who defend corporate directors and officers against breach of fiduciary duty or fraud claims, the specter of a client’s personal liability may loom large.  Insurance may not cover liability for a breach of fiduciary duty claim (often an intentional tort), and bankruptcy protection similarly may not apply.  Nonetheless, some solace may be found in California’s forgiving debtor exemption laws: judgment creditors are barred from reaching qualified retirement accounts.

These retirement account protections are grounded in California Code of Civil Procedure section 704.115.  The statute can fully exempt ERISA retirement assets from judgement creditors, regardless of the nature of the liability.  McMullen v. Haycock, 147 Cal. App. 4th 753, 755, (2007).  So long as the judgment debtor proves an actual intention to use the ERISA account for retirement purposes, the law will exempt the account from creditor reach.  O'Brien v. AMBS Diagnostics, LLC, 38 Cal. App. 5th 553, 561, (2019).  If, however, the debtor has shown an intention inconsistent with using the ERISA account for retirement purposes—for example, using some of the funds to finance a home long before retirement—then the exemption may be lost.  

Funds held in individual retirement accounts (“IRA”) also enjoy some, albeit lesser, protection.  McMullen, 147 Cal. App. at 755.  For IRA accounts, the protection extends “only to the extent necessary to provide for the support of the judgment debtor.”  To determine the extent of the exemption, the Court will examine how much is needed to satisfy the debtor’s “common necessaries of life” based on his or her personal financial situation.  J. J. MacIntyre Co. v. Duren, 118 Cal. App. 3d Supp. 16, 18, 173 Cal. Rptr. 715, 716 (App. Dep't Super Ct. 1981).  Recreation, music lessons, and insurance expenses may justify exemption in the appropriate context.  Importantly, the debtor may use tracing to claim the exemption over eligible ERISA funds transferred to another account type.  McMullen, 147 Cal. App. at 758.

What happens when an account holder rolls ERISA assets into an IRA account that otherwise would receive only limited protection?  Does the original source of the ERISA funds control to give full protection, or does the IRA roll-over destroy the fully-exempt status?

The caselaw is split on this issue.  The more debtor-friendly cases hold that the rolled-over funds should retain their former, fully-exempt status.  McMullen, 147 Cal. App. at 755.  In McMullen itself, the debtor claimed a full exemption over funds in his IRA account, which he had rolled over from his fully-exempt ERISA retirement plan.  No other assets were added to the rollover IRA.  Opposing the full exemption, the creditor argued that the IRA rollover extinguished the full exemption as IRAs are only partially exempt under the statute’s express language.  

Agreeing with the debtor, McMullen held that full exemption should apply.  In doing so, McMullen relied on Section 703.080, which expressly allows tracing of exempt funds that are distributed to deposit accounts or in the form of cash or its equivalent.  McMullen also noted California’s policy that exemption statutes should be construed (as far as practicable) to the judgment creditor’s benefit.  The liberal tracing application honored the policy goal of allowing a debtor to best protect his or her assets.  

McMullen expressly disagreed with a California bankruptcy court that came to the opposite conclusion.  In re Mooney held that an IRA rollover should extinguish the fully-exempt status.  248 B.R. 391, 397 (Bankr. C.D. Cal. 2000).  While the Mooney court did not dispute that tracing is sometimes appropriate, it used the express statutory language giving IRA accounts only partial protection to override the tracing allowance.  Noting that the legislature never expressly stated an intention to treat rolled-over IRAs different from other IRAs, the Mooney court refused to infer such an intention either.  The Mooney court also noted that pre-retirement access to an IRA is generally easier than for an ERISA employer-sponsored plan.  The Court thus declined to give the rolled-over IRA complete exemption from the judgment creditor.    

In the years since McMullen and Mooney were decided, a third opinion has agreed with McMullen.  O'Brien v. AMBS Diagnostics LLC, 38 Cal. App. 5th 553, 564, 251 Cal. Rptr. 3d 41, 49 (2019) (holding that Mooney was wrongfully decided and agreeing with McMullen that no policy reason existed to extinguish the full exemption simply because the assets are deposited in an IRA rather than “a safe deposit box” or “under a mattress.”).  

Defendants confronted with an adverse judgment that may push them into bankruptcy can take solace in the fact that these protections apply even if the claims include fraud and other torts otherwise not dischargeable in bankruptcy.  See In re Phillips, 206 B.R. 196, 203 (Bankr. N.D. Cal. 1997), as corrected (Mar. 17, 1997), aff'd, 218 B.R. 520 (N.D. Cal. 1998).  Clients and practitioners alike who face (or assert) fiduciary duty claims can benefit from being familiar with the foregoing rules and exceptions.

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 Choice-of-Law: Panacea or Puzzle?

Delaware law enjoys a well-earned reputation for certainty and predictability.  This reputation leads many contracting parties to choose Delaware law as governing should a dispute arise.  But interpreting these choice-of-law provisions often gives rise to tricky legal questions.  Does the choice-of-law provision only encompass contract claims, or does it cover tort claims as well?  How does the language of the provision affect the analysis?  And what happens when Delaware law conflicts with another state’s strong public policy?  Ironically, Delaware courts themselves often disagree on the answers to these fundamental questions, injecting the very type of uncertainty into the litigation that the parties sought to avoid by selecting the law of the “First State.” 

A common threshold question is whether a contract’s choice-of-law provision encompasses tort claims or just contract claims.  The seminal case of Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1048 (Del. Ch. 2006) (J. Strine) holds that choice-of-law provisions generally do encompass tort claims, at least where the tort implicates the contract itself, e.g., fraud or misrepresentation.  In so ruling, the Abry court declined to consider the breadth or narrowness of the provision.  Instead, the court endorsed a strong preference for applying a single body of law to a dispute, in the name of business certainty:

Parties operating in interstate and international commerce seek, by a choice of law provision, certainty as to the rules that govern their relationship. To hold that their choice is only effective as to the determination of contract claims, but not as to tort claims seeking to rescind the contract on grounds of misrepresentation, would create uncertainty of precisely the kind that the parties’ choice of law provision sought to avoid. 

Not all Delaware courts have agreed with the Abry court’s decision to look past the choice-of-law provision’s language in the name of certainty.  Some have drilled down on choice-of-law language in deciding whether tort claims should fall within such a clause’s scope.  For example, Delaware courts have sometimes drawn a distinction between provisions that simply govern the “agreement” on the one hand, and provisions that govern all claims “arising out of” or “relating to” the contract on the other hand.  In Huffington v. T.C. Group, LLC, the Delaware Superior Court found that a “choice of law provision, without language such as ‘arising out of or relates to,’ only requires the Court to apply Delaware law to claims challenging the terms and provisions of the agreement.”  2012 WL 1415930 at *1 (Del. Super.).   Similarly, Gloucester Holding Corp. v. U.S. Tape and Sticky Prods., LLC, found that a provision that “[did] not claim to cover litigation that arises out of or relates to the Asset Purchase Agreement” was “not sufficiently broad enough to cover tort claims such as fraud in the inducement.”  832 A.2d 116 (Del. Ch. 2003).  

Even where a choice of law provision encompasses some torts, Delaware courts may disagree on which torts it encompasses.  For example, one recent decision held that the Delaware choice-of-law provision allows only Delaware securities fraud claims, while barring securities law claims based on the laws of other states.  Anschutz Corp. v. Brown Robin Cap., LLC, No. CV 2019-0710-JRS, 2020 WL 3096744, at *7 (Del. Ch. June 11, 2020) (dismissing Colorado and Texas securities law claims).  In contrast, another case refused to dismiss sister-state securities law claims, noting that a Delaware choice of law provision is not “a mechanism for the wholesale importation of every provision of Delaware statutory law into the commercial relationship of contracting parties.” Wind Point Partners VII-A, L.P. v. Insight Equity A.P. X Co., LLC, No. CV-19C08260, 2020 WL 5054791, at *21 (Del. Super. Ct. Aug. 17, 2020).

Delaware courts may be particularly reluctant to apply a Delaware choice-of-law provision in a way that would frustrate another state’s strong public policy.   For example, the Court of Chancery in Swipe Acquisition Corp. v. Krauss refused to apply a Delaware choice-of-law provision to bar California “blue sky” protections, which offered more expansive protections than Delaware law.  No. CV 2019-0509-PAF, 2021 WL 282642, at *3 (Del. Ch. Jan. 28, 2021).  In doing so, the Court of Chancery relied on California’s strong public policy in applying the protections to the California-based transaction, involving both a California plaintiff and misrepresentations made in California.

Our takeaway from these cases is that a Delaware choice-of-law provision may not always offer the contracting parties the litigation certainty that they hope to achieve.  To lessen the chance of unbargained-for legal risk from other jurisdictions, parties would be wise to make any Delaware choice-of-law provision as concrete as possible.  This may include drafting the contract with the specific examples of the claim types (e.g., contract, fraud, securities, business torts, etc.) that Delaware law should control.  And parties should be aware that, even with the perfect Delaware choice-of-law provision, Delaware courts may decline to bar statutory protections that the laws of other states deem essential. 

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.

Drawing the Line Between Harmless Puffing and Securities Fraud

There is sometimes a fine line between the Silicon Valley entrepreneur who “fakes it till they make it” by engaging in fraud, and the disruptive visionary taking on the established order with unwavering optimism.  Legally speaking, one of the fault lines separating the two is the difference between garden-variety optimism that no reasonable person would use to guide an investment—often called “puffery” in applicable case law – and knowingly false statements. But when do rosy statements cross the line from immaterial puffery to actionable securities fraud under the law?  

In the Ninth Circuit, staying onsides between “puffing” and “fraud” involves “expressing an opinion” that is not “capable of objective verification.”  Macomb Cnty. Employees' Ret. Sys. v. Align Tech., Inc., 39 F.4th 1092, 1097–99 (9th Cir. 2022).  Non-actionable puffery is usually found based on vague statements of optimism such as “good,” “well-regarded,” or other “feel good monikers;” professional (and often amateur) investors know how to devalue the optimism of corporate executives.  But when even generalized optimism overreaches by contradicting known facts, they may ripen from puffery to fraud.  

Two recent Ninth Circuit decisions stake out helpful guideposts.  The first case is Macomb County, where the Ninth Circuit agreed that misstatements about the growth potential in the Chinese market were non-actionable puffery.  Macomb County.  39 F.4th 1092, 1099 (9th Cir. 2022).  There, the defendant was accused of securities fraud for wrongly describing China as “a great growth market,” “a huge market opportunity,” “a market that’s growing significantly for us,” and possessing “really good” “dynamics,” and describing its performance as “tremendous” and “great.”  Since these characterizations were not “objectively verifiable,” the Ninth Circuit held that they were not the “kind of precise information on which investors rely when valuing corporations.”  Significantly, the company’s sales were still growing in China (albeit at a diminished rate), so the descriptions did not “affirmatively create an impression of a state of affairs that differed in a material way from the one that actually existed.”  

But our second case shows that even “general statements of optimism, when taken in context, may form a basis for a securities fraud claim.”  Glazer Cap. Mgmt., L.P. v. Forescout Techs., Inc., --- F.4th ----, 2023 WL 2532061 (9th Cir. 2023).   In Glazer Capital Management, a cybersecurity firm allegedly made false statements in response to sensitive questions about sales performance on an earnings call.  In particular, the cybersecurity firm said that (1) its sales representative numbers were “tracking very well against our sales productivity”; and (2) it had “a very large pipeline” of potential deals that would likely close by the end of the year.  While these statements may have been general, they contradicted the allegedly true facts that (1) the number of experienced sales representatives was shrinking below acceptable levels; and (2) the company pressured sales representatives to inflate the number of deals in the pipeline that were likely to close. The context of these statements also mattered: they were made on earning calls in response to specific questions by financial analysis about disappointing financial results.  These contradictions elevated the statements from harmless puffery to actionable fraud.

Illustrating that even federal judges may differ in distinguishing between securities fraud and puffery, Glazer Capital includes a dissenting opinion.  Disagreeing that the alleged puffery amounted to fraud, the dissenting judge saw the Complaint as rather reflecting “business judgments and opinions about the timing of deals and the underlying causes of missing second quarter forecasts.”  Id. at 25.  The complaint only “reflect[ed] a difference of opinion between the [witnesses] and upper management as to when to characterize a deal as a ‘tech win’ or ‘committed,’ and how much time to allot to closing such deals when including them in earnings forecasts.”  Id.  

One final lesson to take from both Macomb and Glazer Capital is that courts considering the puffery defense do not analyze the alleged statements in a vacuum.  Regardless of how anodyne a statement may seem on its face, courts may turn to the objective truth or falsity of the statement as framed in the complaint when dismissing or upholding the securities fraud claims.  This should put management notice to take extreme care when communicating with investors about business performance and other objectively verifiable metrics. 

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.

Diversity Jurisdiction for Limited Liability Corporations and Partnerships

Defendants in business disputes often wish to have their cases heard in federal rather than state court.  The Federal Rules of Civil Procedure are standardized and may be more streamlined than their state-law counterparts.  Furthermore, Plaintiffs in federal civil cases must obtain a unanimous verdict, whereas many states simply require a majority or supermajority.  There also is a prevailing perception that the federal bench is more likely to grant a defendant’s motion to dismiss or motion for summary judgment, though it is less pronounced in jurisdictions like California, which have specialized complex litigation courts that themselves are sometimes more receptive to such motions.  

Regardless of the reason for knocking, the gates of federal court are not open to all comers.  Where federal question jurisdiction is lacking, parties must navigate the corridors of diversity jurisdiction under 28 U.S.C. § 1332.  The requirements are well known; the amount in controversy must exceed $75,000 and there must be complete diversity of citizenship between all plaintiffs and defendants.  But determining whether diversity exists in cases featuring limited liability corporations and partnerships presents unique complications:  

1. Courts Consider the Residency of All Members or Partners:   While the general rule for corporations is that they are citizens of the state in which they are incorporated, the Supreme Court has erected a “doctrinal wall,” whereby this rule does not apply to other types of entities.  See, e.g., Carden v. Arkoma Assocs., 494 U.S. 185, 189 (1990).  For unincorporated entities, diversity jurisdiction depends on the citizenship of “all the members.”  Id.  It does not matter if certain members are general or limited partners or hold greater or lesser rights.  All of their citizenships are considered.  

2. Courts May Trace Through Multiple Entity Levels:  A court’s diversity analysis is not superficial – if one member of an LLC is itself an LLC or partnership, then the members or partners of that entity must also be considered.  See, e.g., Mut. Assignment & Indem. Co. v. Lind-Waldock & Co., LLC, 364 F.3d 858, 861 (7th Cir. 2004) (“Lind-Waldock is a limited liability company, which means that it is a citizen of every state of which any member is a citizen; this may need to be traced through multiple levels if any of its members is itself a partnership or LLC.”).

3. Courts Split on Pleading Requirements and Jurisdictional Discovery:  A party seeking to invoke diversity jurisdiction bears the burden of pleading facts that demonstrate diversity exists.  Therefore, to properly allege diversity against an LLC or partnership, one must allege the citizenship of each of its members.  However, that information may not be publicly available, because most states do not require the identity and citizenship of partners or members of an unincorporated entity to be publicly disclosed.  This conundrum has led to divergent rulings on several related issues: 

   • Cases are currently split on whether a party invoking diversity jurisdiction may (1) allege the citizenship of an LLC or partnership based on information and belief, or (2) seek jurisdictional discovery into that issue in federal court.  See, e.g., Lincoln Ben. Life Co. v. AEI Life, LLC, 800 F.3d 99 (3d Cir. 2015) (proper to plead citizenship on information and belief and seek jurisdictional discovery); Charles Alan Wright et al., Federal Practice and Procedure: Federal Rules of Civil Procedure § 1224 (3d ed. 2013) (pleading on the basis of information and belief “is a practical necessity.”); but see, e.g., MCP Trucking, LLC v. Speedy Heavy Hauling, Inc., 2014 WL 5002116 (D. Colo. Oct. 6, 2014) (denying jurisdictional discovery and remanding to state court while noting that further discovery in state court could demonstrate that diversity exists); Lake v. Hezebicks, 2014 WL 1874853 (N.D. Ind. May 9, 2014) (collecting cases).

   • Furthermore, there is a circuit split concerning whether negative statements of citizenship, i.e. a bare allegation that the counter-party is not a citizen of the plaintiff’s state of citizenship, are sufficient.  Compare Lewis v. Rego, Co., 757 F.2d 66 (3d Cir. 1985) (negative citizenship pleading is sufficient) with D.B. Zwirn Special Opportunities Fund, LP v. Mehrotra, 661 F.3d 124 (1st Cir. 2011) (negative citizenship pleading is not sufficient).  

   • Note, some of these issues may be obviated due to recent amendments to FRCP 7.1, which now requires parties in an action in which federal court jurisdiction is based on diversity to file a disclosure statement “naming or identifying the citizenship of every individual or entity whose citizenship is attributed to that party or intervenor.”  

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.

California’s Unjust Treatment of Unjust Enrichment

With ancient roots, the unjust enrichment claim has long allowed recovery for money paid by mistake or when contract formation fails.  Indeed, the Roman jurist Pomponious once dictated the operating principle behind unjust enrichment: “This by nature is equitable, that no one be made richer through another’s loss.”  John P. Dawson, Unjust Enrichment: A Comparative Analysis at 42-63 (1951).  Withstanding the test of time, unjust enrichment became enshrined in the English common law in 1760, when Lord Mansfield said, “this kind of equitable action, to recover back money, which ought not in justice to be kept, is very beneficial, and therefore much encouraged.” (1760) 2 Bur 1005.  And our legal system has largely followed suit.  As summarized by the America Law Institute, “a person who is unjustly enriched at the expense of another is subject to liability in restitution.” Restatement (Third) of Restitution and Unjust Enrichment § 1 cmt. B (2011).

Despite this august history, the unjust enrichment claim has not found eternal acceptance in California courts.  To the contrary, a recent published decision has flatly stated: “California does not recognize a cause of action for unjust enrichment.”  Hooked Media Grp., Inc. v. Apple Inc., 55 Cal. App. 5th 323, 336 (2020).  According to this strain of caselaw, the phrase “‘unjust enrichment’ does not describe a theory of recovery, but an effect: the result of a failure to make restitution under circumstances where it is equitable to do so.”  Melchior v. New Line Prods., Inc., 106 Cal. App. 4th 779, 793, 131 Cal. Rptr. 2d 347, 357 (2003).  In other words, a party may recover for unjust enrichment only if it establishes an independent—and inevitably narrower—legal claim, such as quasi-contract.  See id; Rutherford Holdings, LLC v. Plaza Del Rey, 223 Cal. App. 4th 221, 231, 166 Cal. Rptr. 3d 864, 872 (2014) (construing unjust enrichment claim as “a quasi-contract claim seeking restitution”).  Pleading unjust enrichment alone may not suffice.  Id.    

To be sure, California’s disdain for the unjust enrichment claim is not universal; some caselaw does approve of it.  For example, an unjust enrichment claim was upheld as enforceable in Elder v. Pac. Bell Tel. Co., 205 Cal. App. 4th 841, 857 (2012).  The Elder plaintiff alleged that telephone public utilities overcharged him for unauthorized premium content charges.  Id. With the elements described simply as “receipt of a benefit and [the] unjust retention of the benefit at the expense of another,” the unjust enrichment pleading survived demurrer.  Id.  

Elder does not stand alone; a laundry list of older California precedent respects the unjust enrichment claim as a viable one.  See, e.g., Peterson v. Cellco P’ship, 164 Cal. App. 4th 1583, 1593 (2008) (stating elements of unjust enrichment); Lectrodryer v. SeoulBank, 77 Cal. App. 4th 723, 726 (2000) (“Lectrodryer satisfied the elements for a claim of unjust enrichment: receipt of a benefit and unjust retention of the benefit at the expense of another.”); Ghirardo v. Antonioli, 14 Cal. 4th 39, 50, 54 (1996) (party was entitled to “seek relief under traditional equitable principles of unjust enrichment”; claim for “payment of money” based on unjust enrichment theory was “adequately pleaded and proved”); First Nationwide Sav. v. Perry, 11 Cal. App. 4th 1657, 1662 (1992) (“[plaintiff’s] complaint can be amended to state a cause of action for unjust enrichment.”).

Despite the stubborn split of authority, the California Supreme Court has yet to weigh in on either restoring the unjust enrichment claim to its historical status or relegating it to the dustbin of history.  In the meantime, a wise plaintiff will plead at least one other theory, quasi-contract or otherwise, that is universally accepted under California law.

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.

Daily Journal Publishes Jared Kopel Article on Supreme Court Case that Could Relax the Barriers to Securities Suits

The Supreme Court will soon consider whether a direct listing on an exchange eliminates the need for a claim under the Securities Act of 1933 to prove that the plaintiff bought stock issued pursuant to the registration statement that allegedly contained misrepresentations. The case, Slack Technologies, LLC v. Pirani, is significant given that the Court’s decisions could relax the barriers to private securities lawsuits against companies going public.

Jared Kopel, a senior counsel at Alto Litigation, recently wrote an article in the Daily Journal breaking down what’s at stake and the key issues the Court will be considering in the Slack Technologies case. Click here to access the article (subscription required).

For more information regarding securities litigation, please contact one of Alto Litigation’s partners Bahram Seyedin-Noor, Bryan Ketroser or Joshua Korr, or senior counsel Jared Kopel.

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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’s Continued Focus on Insider Trading Plans: New Rulemaking and Enforcement Action

In the past week the SEC has demonstrated its continued focus on insider trading and Rule 10b5-1 trading plans under Chairman Gary Gensler’s watch.

First, the SEC’s December 2022 amendments to Rule 10b5-1 of the Securities Exchange Act took effect. These amendments increase the requirements on company insiders who adopt 10b5-1 trading plans in the following ways:

• Mandatory Cooling Off Periods: The amendments require corporate officers or directors who enter into Rule 10b5-1 trading arrangements to observe a cooling-off period of up to 120 days before any trading may commence. The new amendments also mandate a cooling-off period of 30 days for trading arrangements for people other than issuers, directors or officers.

• Good Faith Certification Re: Material Non-Public Information: Directors and managers adopting or modifying a 10b5-1 plan must now certify that they are not aware of any material nonpublic information about a company or its securities and that they are adopting the plan in good faith.

• Prohibition on Overlapping Plans: 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 per twelve-month period for all persons other than issuers.

• Enhanced Disclosure Requirements: The amendments require more comprehensive disclosure about issuers’ policies and procedures related to insider trading, including quarterly disclosure regarding the use of Rule 10b5-1 plans; the timing of options grants and the release of material nonpublic information; and a requirement to report any option awards beginning four business days before the filing of a periodic report or a Form 8-K that discloses material nonpublic information. Furthermore, insiders that report on Forms 4 or 5 will be required to indicate that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) and to disclose the date of adoption of the trading plan.

Second, the SEC announced an enforcement action for insider trading with respect to trades made pursuant to a 10b5-1 plan. The SEC brought this enforcement action against the Executive Chairman of Ontrak, a health care company based in Santa Monica, for selling more than $20 million in stock while he was aware of the company's deteriorating relationship with a major customer. The defendant, Terrence Peizer, allegedly sold his stock after he had entered into Rule 10b5-1 trading plans. The SEC alleged that Peizer entered into those plans while in possession of material nonpublic information. Parallel criminal charges also were brought against Peizer.

For more information regarding insider trading, and SEC-related issues in general, 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 Cracks Down On Crypto

Gary Gensler, the chair of the Securities and Exchange Commission, keeps his promises, at least when it comes to cracking down on crypto trading.  And not everyone is happy about it.

In recent weeks, the SEC has:

• Brought charges against Hall of Famer former NBA star Paul Pierce for touting EMAX tokens, a crypto asset offered and sold by Ethereum, on social media without disclosing that he received more than $244,000 in tokens for his promotional effort. The SEC also alleged that Pierce misrepresented the size of his personal holdings of the tokens. Without admitting or denying the allegations, Pierce agreed to pay a $1.115 million penalty and make approximately $240,000 in disgorgement.

• Accused Singapore-based Terraform Labs PTE Ltd. and its CEO and majority stockholder, Do Hyeong Kwon, of a four-year scheme that raised billions of dollars from investors by selling various crypto assets that the SEC alleged were securities in fraudulent unregistered transactions that resulted in significant losses for U.S. investors. The complaint asserted, among other things, that defendants misled investors about the stability of Terraform’s algorithmic “stablecoin,” called Terra USD (UST), that purportedly was pegged to the value of the U.S. dollar. The SEC charged that UST’s value was propped only by billions of dollars from investors, and then that after cash disappeared, the value of UST and Terraform’s other crypto assets fell to zero.

• Charged Payward Ventures, Inc. and Payward Trading Ltd., both commonly known as Kraken, with failing to register the offer and sale of their crypto asset staking-as-a-service program, whereby Kraken pooled crypto assets provided by investors and stakes them on behalf of investors. Staking involves locking up tokens in exchange for new tokens when the staked crypto becomes part of the process for validating data on a blockchain.  The SEC’s complaint filed in federal court in San Francisco alleged that although Kraken promised 21% annual investment returns, investors did not receive necessary disclosure, including disclosures surrounding the business and financial condition of defendants, fees, and the risk that investors might lose protection of their tokens.  The Kraken entities settled by agreeing to shut down the staking program and pay $30 million in disgorgement, prejudgment interest and penalties.  However, SEC Commissioner Hester Peirce, a longtime defender of crypto, objected to the enforcement action, arguing that staking services provide a benefit to investors.

• Charged Genesis Global Capital and Gemini Trust Company (controlled by the Winkelvoss Brothers) with the unregistered offer and sale of securities through the Gemini Earn crypto asset lending program.

• Brought settled charges against Nexo Capital, Inc. for failing to register the offer and sale of its retail crypto asset lending product, Earn Interest Product (EIP). Nexo agreed to halt the sale of EIP and pay a $22.5 million penalty, as well as pay an identical amount to settle state regulatory actions.

• Voted 4-1 to amend federal custody requirements to include crypto assets, which would likely require crypto exchanges to obtain further regulatory approval. Commissioner Peirce again objected, opposing the rule because of its timing, workability and breadth.  But she also stated that she hoped to support a final rule after public comment and possible amendments. Commissioner Peirce was not alone in her criticism. The chief policy officer of the Blockchain Association, an industry group, accused the SEC of engaging in “regulation by enforcement.” And Coinbase’s CEO, Brian Armstrong, accused the SEC of “sketchy behavior” while Tyler Winkelvoss called the SEC’s charges against Genesis and Gemini as “totally counterproductive.” 

For more information regarding strategy involving interactions with the SEC, 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.

Alto Litigation Attorneys Giving Back

Serving our community through pro bono work is part of Alto Litigation’s core values. In this season of giving, we are even more grateful for the opportunities to give back to the local community. 

In 2022, Alto attorney Monica Mucchetti Eno took on a pro bono engagement for a client of the Legal Aid Society of San Mateo. The Legal Aid Society is a vital voice for underserved populations that provides free, quality legal services to low-income residents in San Mateo County.

Legal Aid Society of San Mateo provides a myriad of legal services including domestic violence support, guardianship, housing clinics, conservatorship, and other needs as they arise. In her pro bono work, Ms. Eno represented the mother of an 18-year-old child with severe developmental and cognitive disabilities, to secure conservatorship over her son. 

As a result of Ms. Eno’s efforts, the client obtained a Court Order in August appointing her as her son’s limited conservator. As her son’s conservator, the client may now provide for her son’s needs associated with daily life, including making arrangements for his housing, health care, meals, personal care and education.