Regular readers of this blog know that the filing of a shareholder lawsuit following the disclosure of a bribery investigation is a well-established phenomenon (as discussed, for example, here). Readers will also recall that in March 2015 when the U.S. Supreme Court issued its Omnicare decision (about which refer here), there was significant discussion whether the Court’s ruling that omitted facts could make a statement of opinion misleading and support liability under the securities laws could prove helpful to plaintiffs and even lead to more securities lawsuits premised on alleged omissions.
The trend lines for both of these issues came together in a recent dismissal motion ruling in the Southern District of New York in the securities class action lawsuit involving Och-Ziff Capital Management Group. In a February 17, 2016 opinion (here), Southern District of New York Judge J. Paul Oetken ruled that the defendants’ alleged failure to disclosure alleged but uncharged violations of the FCPA and sanctions laws was not actionable. However, he also held that the defendants’ failure to disclose the existence of the DoJ and SEC investigations was actionable, in light of the statements the company did make about its exposure to regulatory investigations. As discussed below, the Court’s conclusion that these alleged omissions were actionable was made with express reference to and reliance on the Supreme Court’s Omnicare decision.
This securities suit arising out of investigations in which Och-Ziff is involved relating to the company’s alleged participation in transactions in Zimbabwe, Congo and Libya that allegedly were in violation of the FCPA and various U.S. trade sanction prohibitions. According the plaintiff’s complaint, the SEC and the DoJ began to investigate Och-Ziff’s Africa investments in 2011, when the company received subpoenas from the SEC and requests for information from the DoJ. To date, the details of the investigation have not been made public and neither agency has initiated an enforcement action against Och-Ziff.
Between February 2012 and November 2013, the company made a series of statements in its SEC filing to the effect that it is involved in litigation and subject to regulatory scrutiny, but that it is “not currently subject to any pending judicial, administrative or arbitration proceedings that are expected to have a material impact on the Company’s consolidated financial statements.”
On February 2, 2014, the Wall Street Journal reported that the DoJ was investigating Och-Ziff regarding possible violations of the FCPA. On March 14, 2014, Och-Ziff made an SEC filing on Form 8-K in which is announced that “some of its previously issued financial statements should be restated and should not be relied upon.” Four days later, the company filed a restated Form 10-K amending its 2013 annual report. Among other things, the company also disclosed for the first time the existence of the SEC subpoenas and the DOJ requests for information, involving “the FCPA and related laws” and concerning investments in a number of companies in Africa. The restated 10-K also said that while the company is unable to determine who the investigation will be resolved, “an adverse outcome could have a material effect on our business.”
As discussed here, the plaintiff filed a securities class action lawsuit on May 5, 2014. The defendants moved to dismiss.
The February 17, 2016 Opinion
In a February 17, 2016 opinion and order, Judge Oetkin granted in part and denied in part the defendants’ motion to dismiss.
Judge Oetkin granted the defendants’ motion with respect to the plaintiffs’ allegations that the defendants violated the securities laws by failing to disclose the company’s uncharged illegal conduct. In order to state a claim of this type, Judge Oetkin said, the plaintiff would have to state a plausible claim that the underlying conduct actually occurred. However, he concluded that the plaintiffs had not stated a plausible claim that Och-Ziff violated any law. He also concluded that the plaintiff had failed to plead facts establishing that Och-Ziff had a duty to disclose any uncharged illegal conduct – as, for example, if disclosure were necessary to avoid rendering existing statements misleading. Accordingly, Judge Oetkin concluded that the complaint failed to state a claim based on the defendants’ alleged failure to disclosure their alleged violations of the law.
However, Judge Oektkin reached a different conclusion with respect to the plaintiffs’ allegation that the defendants violated the securities laws by failing to disclose the existence of the investigations. In analyzing this issue, Judge Oetkin expressly referred to the U.S. Supreme Court’s statement in the Omnicare decision that statements of opinion are actionable if they omit material facts about the basis for the speaker’s opinion that, if disclosed, would likely “conflict with what a reasonable investor would take from the statement itself.”
In analyzing the plaintiff’s allegation about the failure to disclose the existence of the investigations, Judge Oetkin referred to the company’s statement in its SEC filings that “We are not currently subject to any pending regulatory, administrative or arbitration proceeding that we expect to have a material impact on our results of operations or financial condition.”
Judge Oetkin concluded that the plaintiff had adequately alleged that Och-Ziff made actionable misstatements about the existence and risks of regulator proceedings. The plaintiffs have “plausibly alleged that Och-Ziff misled investors by suggesting that the company was not facing an investigation that could have a material impact on its business, when, in fact, it was facing such an investigation.”
The question, Judge Oetkin said, is not whether the company had a duty to announce the investigation; rather, it is whether “in light of that Investigation, the statements Och-Ziff chose to make were materially misleading.” Give the company’s “explicit acknowledgement” in its restated annual report that the investigation could have a material effect on its business, the plaintiffs have “plausibly pleaded” that the earlier statements, in which the company opted to speak on the subject of investigations, the company “did not speak in an accurate and complete manner.” The omitted facts, if disclosed, would have conflicted with what a reasonable investor would have taken from the statement the company did make.
Finally, Judge Oetkin also concluded that the plaintiffs had adequately pled scienter with respect to the alleged omissions. He noted that the company had known about the investigation since 2011, but waited to disclose the investigation and its potential impact until after the Wall Street Journal article appeared. Accordingly, Judge Oetkin concluded that “Plaintiffs plausibly alleged that the Management Defendants were reckless in opting to misrepresent their exposure to civil and criminal liability.”
The question of whether or not a public company has an affirmative duty to disclose the existence of an investigation is a perennial issue (as discussed recently discussed, for example, here). However, the outcome of this dismissal motion turned not on the question of whether or not Och-Ziff has a duty to disclose the existence of the investigation; rather, the outcome turned on what the company said, given that there was an investigation pending.
The obvious lesson for a company is that if, as Och-Ziff did here, a company chooses not to disclose the existence of an investigation, what the company does say in the interim becomes very important. In addition there is the practical consideration that, as happened here, the news about the information might leak out anyway, in ways that potentially are more damaging to the company than if it had disclosed the existence of the information.
The problem for reporting companies is that if they go ahead and disclose the existence of an investigation, they may have problems to deal with anyway, just different ones. As I have noted frequently on this blog, the filing of a follow-on civil lawsuit is a frequent accompaniment of the disclosure of the existence of an FCPA investigation. Of course, the type of lawsuit that ensued might be different as well; rather than a disclosure or misrepresentation lawsuit, the type of lawsuit involved would more likely be in the form of a mismanagement lawsuit. (To be sure, another plaintiff shareholder filed a New York state court mismanagement lawsuit against Och-Ziff’s senior officials following the disclosure of the FCPA investigation, as discussed here, in addition to this misrepresentation and omission lawsuit.) Of course, the disclosure of the existence of an SEC investigation can also lead to a securities class action lawsuit, as discussed here.
These kinds of issues are a problem for any company facing an SEC or DoJ investigation, but they present a particularly difficult set of issues for a company facing an FCPA investigation, because of the significant reputational issues involved with the disclosure of an FCPA investigation and because of the well-recognized costs associated with the investigation and resolution of FCPA enforcement actions. However, while it is, as noted above, nothing new that civil litigation follow-on in the wake of the disclosure of an FCPA investigation, this case is unusual in that the investigation has not yet resulted in an enforcement action.
Judge Oetken’s reliance on the Omnicare decision in making his ruling here is interesting in its own way. The fact is that the Omnicare case itself involved — and the U.S. Supreme Court addressed only – questions involving potential liability under Section 11 of the ’33 Act. The Supreme Court did not address whether or not its analysis was equally applicable to liability questions under Section 10 of the ’34 Act. As I discussed in a recent blog post, some have argued that Omnicare’s logic applies equally in the ’34 Act context as well as in the ’33 Act context. Interestingly, Judge Oetken did not get hung up on or even acknowledge the possibility of this issue. Essentially, he just assumed that Omnicare applied here to this plaintiff’s claims, which were based exclusively on the ’34 Act.
Judge Oetken’s reference to and reliance on Omnicare is interesting in another respect. That is, it underscores the fact that the omissions portion of the U.S. Supreme Court’s opinion in Omnicare may prove to be useful to plaintiffs. There was a point earlier on after the Omnicare decision came down at which it seemed that the plaintiffs were struggling to take advantage of the omissions discussion in Omnicare. The outcome of this dismissal motion, and in particular Judge Oetken’s use of the Omnicare opinion in his dismissal motion rulings, shows that the Omnicare opinion is proving to be useful to plaintiffs after all.
Special thanks to a loyal reader for sending along a copy of the Judge Oetken’s opinion.