As readers will recall, in March 2018, the U.S. Supreme Court held in the Cyan case that state courts retain concurrent jurisdiction for liability actions under the Securities Act of 1933. Commentators have correctly identified this decision as primarily of concern to IPO companies. However, one question I regularly get is whether Cyan could mean that companies conducting secondary offerings could also face state court class action securities litigation. I have usually answered this question by saying that while it is theoretically possible, for a number of reasons I thought it was relatively unlikely. Besides, I usually have added, I am not aware of any class action lawsuits in which claimants have filed ’33 Act claims relating to a secondary offering in state court. That is, I was not aware – until now.
The Secondary Offering
Endo Pharmaceuticals plc is a generic drug company organized under the laws of Ireland with its principal place of business in Pennsylvania. On May 18, 2015 Endo announced that it would be acquiring Par Pharmaceutical, another generic drug company for over $8 billion. In order to finance the acquisition, in part, the company announced that it would be conducting a secondary public offering. On June 5, 2015, the company issued a prospectus in connection with the secondary offering, in which it sold over 27 million shares at a price of $83.25 per share.
In a February 28, 2017 complaint filed against Endo, certain of its directors and officers, and its offering underwriters, in Common Pleas Court in Chester County, Pennsylvania, an institutional shareholder alleged that the secondary offering prospectus contained numerous material omissions relating deteriorating performance in several Endo operating divisions. The complaint alleges that following a series of disclosures in early 2016 in which the deteriorating conditions came to light, the company’s share price declined to $16.17 per share. The Pennsylvania complaint was filed on behalf of all investors who purchased shares in the June 5, 2015 offering. The complaint alleges that the defendants violated Sections 11, 12(a)(2), and 15 of the Securities Act of 1933.
On March 31, 2017, the defendants (acting before the U.S. Supreme Court issued its Cyan decision) removed the state court action to the Eastern District of Pennsylvania. However, in an August 27, 2017 opinion in which the Court expressly noted the pendency of the Cyan action before the Supreme Court, Eastern District of Pennsylvania Judge Paul S. Diamond remanded the case to the Chester County Court of Common Pleas.
According the Endo’s May 9, 2019 SEC filing on Form 10-Q (here, see page 29), in April 2019 the parties reached a settlement in principle of the Pennsylvania state court action. According to the filing, the settlement in principle “would provide the investor class $50 million in exchange for a release of their claims; the settlement is subject to court approval. As a result, during the first quarter of 2019, the Company recorded an increase of approximately $50 million to its accrual for loss contingencies. As the Company’s insurers have agreed to fund the foregoing settlement, the Company also recorded a corresponding insurance receivable of approximately $50 million during the first quarter of 2019, which is included in Prepaid expenses and other current assets in the Condensed Consolidated Balance Sheets.”
As I noted at the outset, in my prior comments about the possibility of state court Section 11 claims against companies conducting secondary offerings, I was careful to say I was not aware of any cases where that had happened. I was well aware of the possibility that there might be state court secondary offering securities suits out there that I just didn’t know about. As this case shows, there was in fact at least one case out there. For all I know, there may be others as well.
Some observers may say that my observations here about the possibility of secondary offering-related state court securities class action lawsuits cases are hardly news. There is certainly nothing about state courts’ concurrent jurisdiction under Section 22 of the ’33 Act that limits state courts’ jurisdiction to cases involving IPO companies. The state courts’ jurisdiction extends to all ’33 Act liability actions. Indeed, as my good friend Priya Cherian Huskins noted in a guest post on this site (here), there have already been a number of post-Cyan merger objection lawsuits filed in state court and alleging ’33 Act violations. (Priya might well point out that this Endo case is really nothing more than another example of the phenomenon she described in her guest post.)
Just the same, there are a number of interesting things about the Endo state court secondary offering lawsuit.
The first is that it was filed pre-Cyan, suggesting a willingness even then by at least some members of the plaintiffs’ bar to seek to pursue this types of claim in state court, even at a time when it wasn’t clear that the state court would in fact retain jurisdiction. Now that it state court jurisdiction is clear, the possibility of filing secondary offering state court securities suits may be that much more appealing to at least some claimants’ attorneys.
The second interesting thing about the Endo lawsuit is that it was filed in Pennsylvania state court (where Endo has its principal place of business), and not in either California or New York state court. The fact that this lawsuit was filed and successfully pursued to settlement in a state other than California or New York is a reminder that post-Cyan companies and their insurers face the prospect of getting hauled into the courts of any of 50 states.
Another interesting thing about the Endo state court lawsuit is that there does not appear to be a parallel federal court action. To be sure, there is a securities class action pending against Endo and certain of its directors and officers in the Eastern District of Pennsylvania that contains some of the allegations raised in the Pennsylvania state court action (as well as a number of other allegations), but the federal court class action does not focus specifically on the misrepresentations in the June 2015 offering. And, more to the point, the federal court lawsuit alleges violations of Section 10(b) and 20 of the ’34 Act; it does not allege violations of the ’33 Act. (As detailed in the company’s recent 10-Q to which I linked above, the company has in fact been the target of a number of federal court securities class action lawsuits over the last several years, also including a separate lawsuit filed in Superior Court of Justice in Ontario, Canada; while there have been several different securities suits against the company, none as far as I can tell contain ’33 Act allegations in connection with the June 2015 secondary offering.)
The fact that the Endo secondary offering state court securities suit settled for $50 million dollars is a reminder that the threat of state court securities litigation is not merely a complicating factor; it represents a substantial liability exposure. The fact that, according to Endo’s 10-Q, the settlement of the state court suit is to be funded by the company’s insurers is reminder that the threat of state court securities litigation represents a substantial risk exposure not just for companies, but for their insurers as well.
Which brings me to the final and most important thing about the Endo lawsuit, and that is that the state court securities class action lawsuit related not to an IPO but to a secondary offering. After Cyan, most D&O insurers have recognized that the possibility of state court securities class action litigation represented a potentially significant increase in the claim exposure of IPO companies. The D&O insurance market, although adjusting somewhat haphazardly, has changed to take into account the risk of state court securities litigation that IPO companies face. However, as far as I can tell, there has been relatively little adjustment to take into account the possibility of secondary offering-related state court class action securities litigation.
In fairness, in the grand scheme of things, we are really still just in the early days of adjusting to Cyan. It has only been about 14 months or so since the Supreme Court issued its opinion. Companies, their advisors, and their insurers are still adjusting as they try to determine what the practical consequences of the decision will be.
The one thing for sure is that Cyan certainly does make for a chaotic mess. In recent months there have been calls by business groups for another round of securities class action litigation legal reform. A wide variety of proposals are under discussion. However, if these business groups wanted to focus on one modification that would make an immediate difference, they would target their efforts on trying to convince Congress to fix the Cyan problem by modifying Section 22 of the ’33 Act to eliminate concurrent state court jurisdiction for ’33 Act liability claims.
Special thanks to a loyal reader for sending me information about the Pennsylvania lawsuit and settlement.