April 2019 – Page 2

No mechanism to probe plaints against CJIpic.twitter.com/O7FB9gVjAn

No mechanism to probe plaints against CJI pic.twitter.com/O7FB9gVjAn

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D&O Insurance: Warranty Exclusion Precludes Coverage Due to Application Misrepresentation

A federal district court has held that because of an insured company’s application misrepresentation about possible M&A activity, a D&O insurance policy’s Warranty Exclusion precludes coverage for the policyholder’s costs incurred in defending claims arising out of the insured company’s acquisition. The court’s opinion raises interesting questions about how the meaning of application questions is to be determined. Central District of California Judge Phillip Gutierrez’s February 4, 2019 opinion in the case can be found here. An April 15, 2019 post on the Wiley Rein law firm’s Executive Summary Blog can be found here.

Background

ServiceMesh was a start-up technology company providing cloud computing services. As early as January 2013, ServiceMesh’s Chief Technology Officer, at the request of the company’s CEO, reached out to several business partners, including Computer Sciences, in communications that involved at least in part the discussion of a possible acquisition of ServiceMesh. In the subsequent insurance coverage litigation, the company argued that in all of the various conversations in which a possible acquisition was discussed, a variety of alternative business arrangements were also discussed, including a licensing arrangement or other forms of business partnership.

In February 2013, Computer Sciences and ServiceMesh began conducting due diligence. In late February, a Computer Sciences representative sent ServiceMesh an email to set up a meeting, the purpose of which was, among other things, “exploring the possibility and setting the stage for a potential acquisition.” In an email after the subsequent meeting, ServiceMesh’s CEO sent a Computer Sciences representative looking forward to further discussions “on both partnership and M&A potential.” At a March 2013 meeting in Las Vegas, a Computer Sciences representative told Service Mesh representatives “We want to acquire you.” After that meeting, the two companies had a number of communications surrounding the exchange of information in support of a possible acquisition or other business arrangement.

On June 26, 2013, Tamara Brandt, the company’s General Counsel, completed a D&O insurance application. Among other things, the application asked in Question 8 “Does the Company contemplate transacting any mergers or acquisitions in the next 12 months where such merger or acquisition would involve more than 50% of the total assets of the company?” Brandt answered the question “No.” The insurer subsequently issued a policy to ServiceMesh for the policy period August 24, 2013 to August 24, 2013.

In July 2013, there were further communications between ServiceMesh and Computer Sciences relating to the exchange of information, as well as communications within ServiceMesh about the need for a term sheet from Computer Sciences. On September 9, 2013, Computer Sciences provided ServiceMesh a written term sheet. The deal closed in November 2013 and ServiceMesh became a unit of Computer Sciences known as CSC Agility Platform.

In May 2015, Computer Sciences sued ServiceMesh’s former CEO in Delaware Chancery Court, alleging that the former CEO had intentionally made misrepresentations to induce Computer Sciences to acquire ServiceMesh. The U.S. Department of Justice and the SEC also because investigating the CEO in connection with the merger.

CSC Agility Platform submitted the Delaware lawsuit and the government investigations to ServiceMesh’s D&O insurer (whose policy went into runoff after the acquisition). The insurer advanced defense expenses under a reservation of rights. The insurer wound up paying its entire $5 million limit. The insurer then filed an action against CSC Agility Platform and related entities to recoup the amounts it had advanced, contending that the Warranty Exclusion precluded coverage under the policy because, the insurer contended, there had been a misrepresentation in the insurance application in response to the question about merger activity. The parties filed cross-motions for summary judgment.

The Warranty Exclusion

The Policy’s Warranty Exclusion provides as follows:

By acceptance of this policy, the Insureds agree that:

the statements in the Application are their representations, that such representation shall be deemed material to the acceptance of the risk or the hazard assumed by Insurer under this Policy, and that this Policy and each Coverage Section are issued in reliance upon the truth of such representations; and
in the event the Application, including materials submitted or required to be submitted therewith, contains any misrepresentation or omission made with the intent to deceive, or contains any misrepresentation or omission which materially affects either the acceptance of the risk or the hazard assumed by Insurer under this Policy, this Policy, including each and all Coverage Sections, shall be void ab initio with respect to any Insureds who had knowledge of such misrepresentation or omission.

Application Question 8, to which ServiceMesh answered “No,” asked “Does the company contemplate transacting any merger or acquisitions in the next 12 months, where such merger would involve more than 50% of the total assets of the company?”

The February 4, 2019 Opinion

In a February 4, 2019 opinion, Judge Gutierrez, applying California law, granted the insurer’s motion for summary judgment, holding that the warranty exclusion operated to preclude coverage based on the answer in the insurance application to Question 8.

In order to reach his decision, Judge Gutierrez had to determine the meaning of Question 8, a question about which the parties disagreed. The insurer contended, in reliance on the dictionary definition of the term, that the word “contemplate” means to think about or to have in view as a possible intention. The defendants in the case argued that Question 8 could only be interpreted as referring to a formal acquisition offer. Under this definition, the answer “No” was not a misrepresentation because the company was not at the time of the insurance application considering a formal offer from Computer Science.

Judge Gutierrez determined that the “ordinary meaning of ‘contemplate’ suggests something more considered and intentional than a stray thought but nonetheless can encompass thinking about something that has not yet been formed into a definite plan.” This “plain-meaning definition,” Judge Gutierrez said, “clearly encompasses ServiceMesh’s actions with regard to a potential acquisition by Computer Sciences.”

Judge Gutierrez rejected extrinsic evidence on which the defendants had sought to rely to argue that the term was ambiguous. Among other evidence he rejected was statements in the declaration of Tamara Brandt, the person who completed the insurance application for ServiceMesh, about what she thought the application question meant.

Brandt stated that she understood Question 8 as asking “whether an offer of a merger or acquisition was being considered by ServiceMesh’s Board of Directors.” Judge Gutierrez said this interpretation represented “merely her own subjective reading of the contract’s language. The mere fact that parties read a contract differently does not create ambiguity.” Brandt’s declaration “does nothing more than show Defendants interpreted the contract differently” than the insurer. Accordingly, Judge Gutierrez said, it has “little relevance to the question before the Court.”

The question before the court, Judge Gutierrez said, is whether the language in Question 8 is “reasonably susceptible of the meaning Defendants seek to ascribe to it.” After considering, among other things, the declaration of the defendants’ expert witness about the application question, Judge Gutierrez concluded that it was not. “The Court,” Judge Gutierrez said, “can see no reason why [the insurer] would only care about a final offer but not about serious discussions that meaningfully increased ServiceMesh’s takeover risk.” Ultimately, he concluded that the defendants had not “convinced the Court” that its interpretation of Question 8 is reasonable. Rather, he concluded that Question 8 “clearly contemplated being acquired by Computer Sciences,” and therefore the answer to Question 8 was inaccurate.

Judge Gutierrez also determined that the insurer had not waived its right to rely on the Warranty Exclusion and that the insurer was not estopped from relying on the Exclusion.

Discussion

At one level, the outcome of this case arguably is no surprise. The company had been in discussions about a possible acquisition by Computer Sciences for months before the insurance application was completed; the discussions continued after the application was completed; and shortly thereafter the discussions resulted in an acquisition. There is the definite sense that ServiceMesh was in the middle of the process that led to its acquisition when the application was completed.

And yet, there is still something about the entry of summary judgment for the insurer here that troubles me. For starters, I have a lingering sense that the Court’s interpretation of the meaning of Question 8 relies on the Court’s silent substitution of an alternative wording for the Question’s actual wording.

Question 8 asked “Does the company contemplate transacting,” not, as the Court’s interpretation seems to suggest, “Is the company contemplating transacting….” Even though these two formulations both use a form of the word “contemplate,” the meaning of the word as used shifts slightly between the two formulations. The actual wording of Question 8 could, and I think arguably does, represent an inquiry about a formed, actual, current existing intent, rather than the consideration of a contingent future possibility. It is the difference between “planning on” (which is what Question 8 asked) and “thinking about” (which is the interpretation the Court gave Question 8).

Viewed in this light, the interpretation of Question 8 by Tamara Brandt, the person that actually completed the application, is easier to understand. If, as I think it can reasonably be argued, Question 8 asks about a formed, current, and actual intent, she arguably was justified in interpreting the question as asking about the consideration of an actual present offer, and not about a possible future offer.

Viewed in this light, it is not accurate to say that Question 8 is only susceptible to one meaning. Viewed in this light, there is a legitimate argument that Question 8 is ambiguous, and therefore that the question of whether or not the company’s answer to the application question was a misrepresentation should have been left to the jury after trial and not decided by the court on summary judgment.

There is another thing about the Court’s rejection of Brandt’s understanding of the meaning of the question that bothers me. Assume that what she said about her interpretation of the meaning of the question is a truthful and accurate statement of what she actually believed the question meant. After all, the only thing anyone filling out an application can do is to try to answer the questions as they understand them. The Court’s brusque declaration that her statement of what she thought the question meant is irrelevant to understanding the question’s meaning would be an alarming suggestion to anyone charged with the responsibility for completing an insurance application. If you can’t rely on what you think the questions mean, how in the world are you supposed to answer the questions at all?

All of that said, there is no doubt that at the time Brandt completed the insurance application for ServiceMesh, the company had for several months been in discussions with Computer Science about a possible acquisition. Did the company mislead the insurer by failing to disclose these discussions? That depends on how you interpret Question 8. It may well be, as the Court concluded, that the information about the acquisition discussions should have been communicated to the insurer. However, in my view, the question of whether or not Question 8 called for the provision of information about the acquisition discussions is an issue that should be decided by a jury, rather than by the Court.

If nothing else, this case represents a sharp, and indeed arguably harsh, reminder of the importance of care in completing an insurance application. Making a mistaken assumption about what an application question means can create potential future coverage problems. It is important for companies’ insurance advisers to make sure they are well aware of these kinds of potential pitfalls, and it is also important that the advisers go through the applications with their clients to try to ensure to the greatest extent possible that the applicant has not inadvertently failed to answer the questions that were actually being asked.

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Well, That Didn’t Take Long: Lyft Hit with IPO-Related Securities Suit

On March 28, 2019, amidst much fanfare, the rideshare company Lyft went public at $72 a share, raising more than $2.2 billion. In the first trading day following the offering, the company’s share price rose 8.7 percent. However, despite the initial euphoria, Lyft’s share price then began to slump. Lyft shares closed at $58.36 on Thursday afternoon (April 18), representing a decline of nearly 20% from the company’s IPO share price. Apparently, at least one investor who purchased shares is fighting mad about the decline. On April 16, 2019 – just 13 trading days after the IPO– the shareholder filed a securities class action lawsuit against the company in California state court. A copy of the plaintiff’s complaint can be found here. An April 17, 2019 Bloomberg article about the lawsuit can be found here.

The Lawsuit

The complaint was filed in California (San Francisco) Superior Court by Lyft shareholder Bryan Hinson, who claims to have purchased Lyft shares traceable to the offering. The complaint names as defendants the company itself; certain of its directors and officers who signed the company’s Registration Statement; and the offering underwriters. The complaint, which purports to be filed on behalf of all investors who purchased shares in or traceable to the offering, alleges that the defendants violated Sections 11, 12(a)(2), and 15 of the Securities Act of 1933.

The complaint alleges that “in what appeared to be a race against” competitor ride share company Uber to be “first to list its shares on a public exchange,” the company went public in late March. The complaint alleges that among the “key selling points to IPO investors” was the company’s “focus on its market share and position.” The complaint also alleges that in the months leading up to the offering, the company acquired a bikeshare company, Motivate, to offer new transportation options to Lyft customers.

The complaint alleges that the Registration statements contained misleading statements about both the company’s market share and the company’s bikeshare initiative. The complaint alleges that the Registration Statement’s representations was “materially inaccurate, misleading and/or incomplete because they failed to disclose, inter alia, that (1) more than 1,000 bicycles in Lyft’s rideshare program suffered from safety issues that would lead to their recall; and (2) Lyft’s ridesharing market position was overstated.”

Interestingly, the complaint’s allegations that the company overstated its market share in the Registration Statement appears to be based in part on the statements that rival Uber made in its draft S-1 filed with the SEC on April 11, 2019. The complaint alleges that “Uber’s S-1 claimed a market share of greater than 65% in the United States and Canada, a claim that further undermined Lyft’s purported claim of 39% market share.”

Discussion

There is some irony in the complaint’s attempt to suggest that because Lyft was in a race with Uber to be the first to go public, the company may have been a little overly hasty. Whatever else one might say about this complaint, there is no doubt that it was filed hastily.

The plaintiff is going to have an uphill battle establishing that the bikeshare and market share concerns were the cause of the decline in Lyft’s share price. For example, in an April 15, 2019 article about the post-IPO decline in Lyft’s share price, the Wall Street Journal attributed the decline to “a surprise 12% fall its second day of trading, a handful of downbeat analyst reports and rumors of high short-selling interest in the company.” (The Journal article does, however, mention the problems with the bikeshare program.)

The plaintiff may also have challenges validating that the company did in fact misrepresent its market share. The allegations of market share misrepresentations rely exclusively on two allegations: a statement that after the offering, Lyft’s share price began to decline “as investors raised concerns that Lyft’s reported market share may have been overstated,” and the statement noted above that the market share Uber claimed in its offering documents conflicted with the market share Lyft has claimed in its offering documents. Perhaps in a later amended complaint the plaintiff will add more substance to these allegations, but that allegations of market share misrepresentations as they currently stand are not exactly overwhelming.

There is of course nothing unusual about an IPO company getting hit with a securities class action lawsuit. According to Cornerstone Research’s latest securities litigation report (page 25), since the global financial crisis, around 12% of IPO companies are hit with securities suits in the first year after the offering, and within six years of the offering nearly 25% of IPO companies get sued. (The percentage of IPO companies getting sued has gone up materially since the late 90s.) What is unusual about this lawsuit is the fact that it was filed just 13 trading days after the IPO.

One reason IPO companies are susceptible to securities lawsuits is that IPO companies sometimes stumble out of the blocks. However, the stumble drawing the lawsuit usually takes the form of a disappointing first earnings release. Nothing like that happened here. What did happen is that the company’s post-IPO share price declined in the trading days following the offering. The suggestion that share price declined because investors discovered the true facts about Lyft’s bikeshare initiative or its market share seems, well, speculative at best.

It is interesting to note that the plaintiffs’ lawyers chose to file the plaintiff’s complaint in state court rather than in federal court. Readers will of course recall that in March 2018, the U.S. Supreme Court held in the Cyan case that state courts retain concurrent jurisdiction over liability actions under the ’33 Act. The Cornerstone Research report noted that there were 30 securities class actions filed in state courts in 2018 (of which 17 also had parallel federal court class action suits as well). While this plaintiff has launched his action in state court, other claimants may yet file in federal court; other plaintiffs’ firms have published “trolling” press releases seeking to find a Lyft shareholder on whose behalf these other firms could file their own Lyft IPO lawsuit. As a number of plaintiffs’ firms have published press releases, it seems likely there will be other lawsuits, raising the possibility of the kind of multiforum litigation about which observers have been worried since the Cyan decision.

The quick arrival of a securities class action lawsuit does put the current wave of Unicorn company IPOs in an interesting context. Pinterest and Zoom completed their IPOs earlier this week and Uber‘s IPO is coming up. These high-profile offerings clearly garner a lot of attention. As the sequence of events involving Lyft shows, the high-profile nature of these offering can also attract the unwanted attention of the plaintiffs’ lawyers as well.

Special thanks to a loyal reader for sending me a copy of the complaint.

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Wait – So There Is No “Viagra for the Brain?” FTC Yet Again Bars Dietary Supplement Sellers from Making Unsupported Cognitive Claims

Consumers over 50 are on an endless quest for things that make us feel, look, or perform like younger versions of ourselves. Marketers aware of how aging demographics are tuned into this quest. The FTC has been especially vigilant in policing claims that dietary supplements, especially in the cognitive and memory space, can turn back the clock (for additional reading on the FTC’s history with unsubstantiated cognitive claims, check out our previous blog posts on Prevagen, 5-Hour ENERGY®, Brain Training, Lumosity, Word Smart, and Your Baby Can Read). Last week, the FTC reached a $25 million settlement with four individuals and their companies that sold supplements touted as “Viagra for the Brain” and promising to increase users’ cognitive abilities (see the settlement orders here and here). The case provides a guide of what not to do in selling dietary supplements.

In its complaint, the FTC argued that the defendants falsely claimed that their supplements Geniux, Xcel, EVO, and Ion-Z could enhance users’ focus by as much as 300 percent; concentration, memory recall, and IQ by as much as 100 percent; and brainpower by as much as 89.2 percent. The advertisements claimed that scientists were declaring the defendants’ “Smart Pill” to be “Viagra for the Brain,” and that the supplements should be “taken as directed for extreme IQ effects.” The supplements were sold for between $47 and $57 per bottle.

To coax consumers to their websites where the supplements could be purchased, defendants created web pages that were deceptively formatted to look like real news outlets, also known as advertorials. In the advertorials the defendants made references to sham endorsements from consumers and celebrities. For example, fictitious consumer testimonials included statements such as, “[a]fter I started taking Geniux I got a promotion at work after just 3 weeks. Three months later I’m CEO and have surpassed all my colleagues,” and “I saw this … a lot on the news about that student who took it and got blamed for cheating [because] it gave him an edge over everyone else… . I tried [Geniux] and I’ll admit, it’s the best thing I’ve had for focus and clarity… .” And in regards to sham endorsements, the defendants tried to ride the coattails of Bill Gates, Elon Musk and Stephen Hawking in claiming these folks achieved dramatic results from one of the defendants’ supplements. The defendants claimed—with no support—that one of their products had been tested in more than 2,000 clinical trials.

Unsurprisingly, the proposed orders ban the defendants from making misleading, false, or unsupported claims and require competent and reliable scientific evidence to substantiate health efficacy claims going forward. Concerning endorsements, defendants cannot claim that: (1) any person is an objective news reporter regarding the endorsement message provided; (2) purported consumers or celebrities who appear in their advertising achieved a reported result due to using any of the covered products; and (3) anyone depicted in advertisements is providing objective and independent opinions about the products. The defendants are required to monitor their affiliate networks, websites, and advertisers to ensure that the affiliates advertising complies with the terms of the settlement. The orders also prevent the defendants from failing to honor refund requests and from refusing to allow returns or order cancellations.

You don’t need to be a genius (or take Geniux) to remember what not to do in marketing supplements. Don’t fake the science, don’t fake the endorsements and testimonials, and don’t fake the refund policy. In short, fake news is bad news.

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Cornerstone Research: Accounting-Related Securities Suit Filings and Settlements Increased in 2018

Driven by a general overall increase in the number of securities class action lawsuit filings, as well as by an increase in the number of M&A-related lawsuits involving accounting allegations, the total number of securities class action lawsuits involving accounting allegations filed in 2018 was well above historical levels, according to a newly released Cornerstone Research report. Also consistent with overall securities suit settlement patterns during the year, the value of settlements of securities suits with accounting allegations during 2018 was at second-highest level in in the last ten years. The Cornerstone Research report, entitled “Accounting Class Action Filings and Settlements: 2018 Review and Analysis,” can be found here. Cornerstone Research’s April 17, 2019 press release about the report can be found here.

Background: Cornerstone Research’s latest is the third of three reports Cornerstone Research has issued regarding 2018 securities suit developments. The first of the three, discussed here, reported that when both state and federal securities class action lawsuit filings are taken into account, the 2018 securities suit filings were at highest-ever levels. The second report, discussed here, showed that aggregate, average, and median securities suit settlements increased in 2018. The latest report, focused on the 2018 filings and settlements in cases involving accounting allegations, is consistent with the two prior reports and show that accounting case filings and settlements in 2018 were at levels above those of recent years.

Meaning of Terms Used: The report examines “accounting filings,” which it defines as securities class action lawsuit filings involving allegations related to Generally Accepted Accounting Principles (GAAP) violations, violations of other reporting standards, auditing violations, or weaknesses in internal controls over financial reporting. The report examines the total number of accounting filings, the number of accounting filings as percentage of all securities suit filings, and the number and percentage of “core” securities suits involving accounting allegations. “Core” filings are the securities lawsuits that do not involve merger objection allegations.

The report also uses the term Disclosure Dollar Loss (DDL) to describe the loss of market capitalization alleged in securities suit filings. DDL describes the dollar value change in a defendant company’s market capitalization between the last trading day before the end of the class period and the trading day immediately following the end of the class period.

Total Number and Proportion of Accounting Filings: There were 143 total accounting filings in 2018, the second highest number on record, behind only the 165 total accounting filings in 2017. The decrease in 2018 relative to 2017 represents a decline of about 13%. The 143 accounting filings in 2018 was 86 percent higher than the 2009-2017 annual average number of accounting filings of 77. While the total number of accounting filings was at record high levels in 2017 and 2018 (consistent with the overall increase in the number of securities class action lawsuits in those years), the proportion of accounting cases to total cases (35%) remained consistent with the historical average proportion (36%).

Number and Proportion of “Core” Accounting Filings: There were 64 core accounting filings in 2018, representing a 10% increase over the 58 core accounting filings in 2017. The 64 core accounting filings in 2018 were slightly higher than the 2009-2017 average number of core accounting filings of 61. The core accounting filings represented 29% of all core securities suit filings, the lowest percentage in the last ten years, other than the 28% percentage in 2017. The lower percentage of core accounting filings in 2017 and 2018 as a proportion of all core filings suggests that as the number of core securities suit filings increased during those two years, the proportion of cases involving accounting allegations has declined.

The fact that the number of core accounting filings in 2018 was roughly the same as the number of annual core accounting filings over the last ten years suggests that the overall increase in the total number of accounting filings described in the preceding paragraph is largely due to an increase in the number of non-core (that is, M&A-related) securities suit filings.

Accounting Cases Involving Restatements: There were 13 accounting filings in 2018 involving restatements, the same number as in 2017, but down from the 2009-2017 annual average number of accounting cases involving restatements (19). The 2018 restatement cases as a percentage of all core accounting filings (20%) was the lowest level in the last ten years. Both the number (14) and the percentage (34%) of accounting case settlement in 2018 were the lowest since 2013, consistent with the general overall decline in the number of accounting restatements. However, three of the five largest securities class action lawsuit settlements in 2018 involved financial restatements.

Market Cap Size of Core Accounting Case Defendants: The median market capitalization of core accounting case defendants in 2018 filings was roughly $1.5 billion, the highest level in the last ten years more than double the 2009-2017 average annual median market capitalization of $652 million. Over the past five years, accounting cases have been filed against larger issuer defendants than in prior years. Larger issuer defendants firms are generally associated with higher accounting case settlement amounts.

Market Capitalization Losses in 2018 Core Accounting Case Filings: The core accounting filings in 2018 represent an aggregate total of $53.9 billion in DDL, which is 68 percent greater than the average annual DDL for all accounting cases during the period 2009-2017 ($32 billion), and in fact the highest annual level in ten years. The increase in DDL is consistent with the increase in the size of the issuer defendants as measured by market capitalization.

Number and Proportion of Accounting Case Settlements: The number of accounting case settlements in 2018 (41) declined relative to the number of accounting case settlements in 2017 (49), and relative to the 2009-2017 annual average number of accounting case settlements (48). The proportion of 2018 accounting case settlements as a percentage of all securities suit settlements (53%) was at the second lowest level in the last ten years. The proportion of accounting case settlements as percentage of all settlements is higher than the proportion of accounting cases among all securities suit filings, suggesting that accounting cases are less likely to be dismissed and thus more likely to settle. The report notes that accounting allegations are often added as cases progress, including even with respect to event-drive securities litigation.

The Value of Accounting Case Settlements: The total value of accounting case settlements in 2018 was $4.48 billion, representing 88% of all securities suit settlement value during the year, and also representing the second highest total over the last ten year. The increase during 2018 was largely attributable to a number of very large settlements during the year; all five of the settlements of over $100 million during the year involved accounting allegations.

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To Be an Ad or Not to Be an Ad: That is the Question

You want to start taking supplements, so you turn to a guide containing consumer reviews. Is the guide just a collection of advertisements? Last month, the Southern District of California again confronted this question, and also took into consideration whether the reviews should be afforded First Amendment protection. The court reiterated its prior finding that the Lanham Act does not apply to a nutritional supplement guide that faced a false advertising challenge.

In the fifth edition of the NutriSearch Comparative Guide to Nutritional Supplements (the “Guide”), NutriSearch recognized four companies—but not Ariix—with the Gold Medal of Achievement, even though NutriSearch allegedly acknowledged Ariix met the standards for the distinction. For its part, NutriSearch explained that it was reworking its awards recognition program for the sixth edition of the Guide, and that the fifth edition Gold Medal winners were merely prior winners who were grandfathered in. Ariix filed suit against NutriSearch and the Guide’s author, Lyle MacWilliam, claiming that the failure to award the Gold Medal amounted to a false representation that Ariix or its products are not as good as its main competitor, Usana, or Usana’s products. Ariix also alleged that the Guide claims to be objective and neutral, but is actually a shill for Usana, because of a previously undisclosed business relationship between MacWilliam and Usana.

In dismissing Ariix’s first complaint in 2018, the district court drew a distinction between commercial advertising or promotions, which the Lanham Act governs, and consumer reports or reviews, which the Lanham Act does not. The latter category is entitled to First Amendment protection. The court explained that “[i]f a plaintiff could get around First Amendment protections simply by arguing that a reviewer is biased, the First Amendment protection accorded to product reviews would not mean much.” The court cautioned that not “any publication calling itself a consumer product review actually is one … [b]ut if a publication that appears to be a consumer product review is in fact a consumer product review, it falls outside the scope of the Lanham Act’s false advertising provision.” This is true even if the consumer product reviews “are alleged to be biased, inaccurate, or tainted by favoritism.” The court allowed Ariix to file an amended complaint to address deficiencies in its pleadings.

Ariix’s amended complaint failed to cure its pleading deficiencies. At the outset, the amended complaint “treat[ed] the Guide as a whole as commercial advertising,” a premise the district court rejected the first time around. Even if the award recognitions were to constitute commercial advertising, the district court held it would not be enough to subject the entire Guide to the false advertising provision of the Lanham Act. This is because the Guide is comprised of two main sections: a set of ratings of 1,500 different nutritional supplements sold by different companies, and general information about supplementation. The Guide also aggregates consumer reviews. The fact that so many different products were reviewed rendered implausible Ariix’s claim that the purpose of the Guide is to push consumers towards Usana’s products. Further, Ariix failed to allege that in bestowing the awards, NutriSearch and MacWilliam were expressing false or misleading facts rather than mere opinions or value judgments, as the Lanham Act would require.

In the end, the court found that the amended complaint failed to plead facts showing that the Guide was commercial advertising within the meaning of the Lanham Act. Further, it failed to plausibly allege false statements about Ariix’s products. Because it had already been given leave to address these pleading deficiencies, the court inferred Ariix could not successfully amend if given another opportunity to do so. Thus, Ariix’s amended complaint was dismissed with prejudice for failure to state a claim.

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Coverage Complications for Prior Acts Under Claims Made Insurance Policies

Theoretically, claims made insurance coverage applies to claims made during the policy period regardless of when the underlying acts took place. The claims made arrangement contrasts with the framework under an occurrence policy, where coverage applies according to when the underlying acts took place, regardless of when the claim is made. But even though claims made coverage is intended to apply to claims made during the policy period, there are sometimes claims made policy provisions that can preclude coverage for some or all of the past acts alleged. These coverage limiting provisions can under certain circumstances substantially limit the past acts coverage available under a claims made policy.

In an April 12, 2019 memo entitled “How Insurance Companies Try to Use Past Events to Defeat Coverage of New Claims” (here), the Barnes and Thornburgh law firm takes a look at claim made policy provisions that can limit or preclude coverage for prior acts. The memo identifies four specific ways that claims made insurers may seek to use to try avoid coverage for past events.

First, claims made policies may contain a prior knowledge exclusion. These exclusions provide that if anyone within the group of persons described in the exclusion was aware before a specified date of events that the person or persons knew could form the basis of a claim, coverage under the policy for a subsequent claim based on those events is precluded. For discussion of a claim in which a policy’s prior knowledge exclusion operated to preclude coverage, refer here. Obviously, the definition of the group whose awareness precludes coverage and the specification of the prior knowledge date can significantly affect the scope of this exclusion’s preclusive effect.

In addition, depending on the exclusion’s wording, the prior knowledge requirement may include both a subjective component (that is, actual awareness) and an objective component (that is, reasonable awareness of the possibility of future claims). The actual policy wording here matters; some versions of the exclusion preclude coverage for known facts that “could” or “might” lead to a claim, while other versions require that the known facts be “likely” to lead to a claim. As the memo notes, under the “likely” to lead to a claim formulation, “the insurance company has a heavier burden of showing that the exclusion applies because it would have to demonstrate that the potential for a claim was relatively clear based on the individual’s knowledge.”

Second, claim made coverage for prior acts can be affected by policy retroactive dates. A retroactive date provision specifies that the policy’s coverage applies only to acts taking place after a certain date. Retroactive date provisions are sometimes referred to as continuity date provisions. These provisions can restrict the retroactive reach of the policies coverage for past events. These kinds of provisions can create complications when claims assert a continuing pattern of alleged misconduct taking place over a protracted period of time.

Further complications can emerge when different layers in a multilayer insurance program have different retroactive date. The situation can arise when a policyholder adds additional layers of excess insurance over the course of several policy periods. Often, in order to protect themselves from the possibility that the policyholder is buying more insurance because of the possibility of incoming claims, the excess insurers will agree to provide the additional limits of liability subject to a past acts date that coincides with the policy inception date. These different retroactive dates can mean that in the event of a future claim alleging prior acts, the excess coverage may not be available to provide coverage for some or all of the loss attributable to the prior acts.

Third, coverage under claims made insurance policies for prior acts can be limited by a prior and pending litigation exclusion. These exclusions preclude coverage for claims pending at the time of the policy inception. For discussion of an example of a case in which a prior and pending litigation exclusion operated to preclude coverage, refer here. Complications can sometimes arise under these exclusions in the event of subsequent claims. These exclusions often are written with broad preambles (“based upon, arising out of, in any way relating to”), raising the possibility for a fight over the extent of the relationship between the prior claim and the subsequent claim and whether the connection is sufficient to trigger the preclusive effect of the prior and pending claim exclusion.

Another prior and pending claim exclusion complication that can arise has to do with previously pending claims of which the policyholder was unaware. An example of a situation in which this complication might arise is in the event of a qui tam action or False Claim Act claim. These kinds of claims often are filed under seal with the court, in order to allow the government an opportunity to investigate the claim and determine whether or not it wants to assert the claim itself. While the complaint remains under seal, the defendant may be unaware of the action’s existence. As the memo notes, at least one court has held that a qui tam action filed prior to a policy’s specified prior and pending litigation date can trigger the exclusion, because the exclusion does not require that the policyholder have knowledge of the exclusion. For that reason, it is in the policyholder’s interest for the prior and pending litigation exclusion’s preclusive effect to be limited to litigation of which the policyholder has notice.

Finally, a claims made insurer may seek to evade coverage for prior acts by seeking to rescind the policy based upon alleged omissions or misrepresentations in the policy application. Absent restrictive policy provisions, the rescission of an insurance policy can entirely void coverage, for all claims and for all persons. In more recent times, many management liability insurance policies are entirely non-rescindable except for premium non-payment. Other policies contain severability provisions limiting a coverage rescission – or the preclusion of coverage—based on an application misrepresentation solely to those persons with knowledge of the misrepresentation, with a further provision the knowledge of one person will not be imputed to any other person. These kinds of rescission restrictive provisions can substantially limit the extent to which the insurer can avoid coverage based upon supposed application misrepresentations.

If nothing else, a review of these various policy provisions show that a claims made policy’s specific terms and conditions can substantially affect the availability of coverage for a particular claim, particularly as pertains to allegations based on past events. These examples also show that the wording of the various exclusions and provisions can substantially affect these exclusions’ and provisions’ preclusive effects. The analysis of these provisions also underscores the importance for all insurance buyers of enlisting the assistance of a knowledgeable and experienced insurance advisor who can ensure either that these provisions are removed from the policy altogether or wording in a way to restrict their preclusive effect to the maximum extent possible.

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Despite short ban imposed on Adityanath and Mayawati, Model Code of Conduct isn’t working well https://timesofindia.indiatimes.com/blogs/ronojay-sens-blog/despite-short-ban-imposed-on-adityanath-and-mayawati-model-code-of-conduct-isnt-working-well/ …

Despite short ban imposed on Adityanath and Mayawati, Model Code of Conduct isn’t working well https://timesofindia.indiatimes.com/blogs/ronojay-sens-blog/despite-short-ban-imposed-on-adityanath-and-mayawati-model-code-of-conduct-isnt-working-well/ …

Say It Again: Private Companies Are Subject to the Federal Securities Laws

It is a point I have made before but it is worth saying again – private companies are not immune from scrutiny under the federal securities laws. In a series of recent enforcement actions – most notably the SEC’s March 2018 enforcement action against Theranos and two of its executives – the SEC has made of point of emphasizing that its regulatory reach extends to private companies. Last week, the SEC announced the resolution of another enforcement action against private company executives. The latest action, involving a failed Silicon Valley start-up, underscores the SEC’s readiness to pursue securities law violations by private company executives.

Background

On April 2, 2019, the SEC announced that it has settled an enforcement action the agency brought against the founder and chief executive of Jumio, Inc., a private mobile payments company. In its complaint against the former CEO, Daniel Mattes, the SEC alleged that Mattes “defrauded investors by providing them with materially misstated financial statements that purported to show that Jumio had earned significantly more revenue and profits than it actually did.”

The complaint alleges that Mattes sought to sell some of his personal holdings in Jumio stock on the secondary market in privately negotiated transactions. The complaint alleges that in order to facilitate these sales, Mattes provided investors with financial statements that, among other things, “overstated Jumio’s revenue by more than ten times through the inclusion of revenue that Jumio did not earn as well as revenue from a round-trip transaction that had no economic substance.” Mattes also allegedly made a number of misleading statements to investors, for example that he was not selling his shares because “there was lots of great stuff coming up” for Jumio and “he’d be stupid to sell at this point.”

The complaint also alleges that Mattes hid the stock sales from Jumio’s board of directors and made false statements to Jumio’s lawyers, who signed off on the sales. In making the sales, Mattes made personal profits of $14 million. Jumio restated its financial statements in 2015. In 2016, Jumio filed for bankruptcy and the investors who purchased the shares from Mattes lost their entire investment.

Without admitting or denying the allegations, Mattes agreed to be enjoined from future similar violations and barred from being an officer or director of a publicly traded company in the U.S., and will pay more than $16 million in disgorgement and prejudgment interest plus a $640,000 penalty.

The SEC also filed a separate proceeding against Jumio’s former CFO Chad Starkey for “failing to exercise reasonable care concerning Jumio’s financial statements” and signing stock transfer agreements that falsely implied that Jumio’s board had approved Mattes’ sales. Starkey entered a cooperation agreement with the SEC and also to pay approximately $420,000 in disgorgement (from Starkey’s own stock sales) and prejudgment interest.

Discussion

The SEC’s actions against the two former Jumio executives serves as yet another reminder that the SEC will pursue company executives for securities law violations, even if the executives work for a private company. Indeed, in its press release announcing the negotiated resolution of the Jumio enforcement actions, the SEC included a statement from the regional director of the SEC’s San Francisco office as saying “Company executives must provide investors with accurate information irrespective of whether their companies are publicly or privately traded.”

In an April 11, 2019 memo about the SEC’s enforcement actions against the Jumio executives, the Proskauer law firm noted that the actions are “a reminder that privately negotiated securities transactions and private, VC-funded companies are not exempt from regulatory scrutiny.”

The SEC’s latest actions against the Jumio executives and its earlier enforcement actions involving other private companies clearly have important risk management implications for private companies. It is critically important that private companies and their executives recognize that they face potential liability exposure under the federal securities laws for alleged misrepresentations to prospective investors and others.

As I have emphasized before in commenting on SEC actions involving private companies, the potential federal securities law liability exposures for private company executives has important D&O insurance implications, as well. However these implications may not always be taken into account. The D&O community tends to divide the world between public and private companies and to proceed on the assumption that potential liability under the federal securities laws is strictly a concern for public companies. As this case highlights, this division between public and private companies when it comes to liabilities under the federal securities laws is not nearly as strict as the common presumption typically assumes.

A private company executive caught up in an SEC enforcement proceeding clearly would want to look to their company’s D&O insurance to provide their defense. However, whether or not the private company’s D&O insurance policy would respond will depend significantly on the policy’s actual wording, including, among other things, the wording of the policy’s securities exclusion. This exclusion is intended to preclude coverage under the private company policy for liabilities incurred in connection with taking the company public – the insurer did not undertake to insure a public company and so excludes public company liabilities under the policy.

The wordings of these exclusions vary widely, and in some versions the exclusion is written sufficiently broadly that the insurer might seek to rely on the exclusion to preclude coverage for the kinds of actions that were brought here against private company executives. Ideally, the exclusion would not even go into effect unless the insured company has completed a public offering; however, not all exclusions are so limited.

The bottom line is that it is important in connection with the placement even of private company D&O insurance for the possibility of an SEC enforcement action against the company or its executives is taken into account. In particular, it will be important for private company executives worried about the availability of policy coverage in the event of an SEC enforcement action to review their policy with their insurance advisor to ensure that the policy’s securities exclusion would not preclude coverage in the event of an SEC proceeding.

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