Just days after the U.S. Supreme Court agreed to take up the Facebook/Cambridge Analytica securities case concerning risk factor disclosures (as discussed here), the Court has now agreed to take up yet another securities case, this time in a case involving Nvidia and involving the standards for pleading scienter and falsity under the PSLRA. The NVIDIA case involves alleged fraud in connection with the company’s disclosures concerning its sales of graphics processing units (GPU) to cryptocurrency companies as a component of its overall GPU sales. The specific questions the case presents to the Supreme Court concern what and how a plaintiff must plead when pleading scienter and falsity. Because the case involves the PSLRA’s “exacting pleading requirements,” the case potentially could prove to be very significant. A copy of the Court’s June 17, 2024 Order granting the petition for writ of certiorari can be found here.

Continue Reading Supreme Court Agrees to Take Up Nvidia Securities Suit On Pleading Standards Issues
Rua Augusta, in the Baixa district, Lisbon

The D&O Diary is on assignment in Europe, with a first stop in the beautiful Portuguese city of Lisbon (known to the locals as Lisboa). Travel can take you lots of places, but if you are really fortunate, travel will take you to Lisbon, one of the world’s great places and one of The D&O Diary’s all-time favorite destinations.

Continue Reading Bela Lisboa

In a speech last December, as well as in several subsequent statements, SEC Chair Gary Gensler has emphasized the agency’s concerns with companies that are over-hyping their artificial intelligence (AI) capabilities in ways that mislead investors. In March, the agency filed enforcement actions against two investment advisors that allegedly misled investors about the firms’ AI-enabled services.

In the latest example of the agency’s AI-related campaign, earlier this week the agency filed an enforcement action against the CEO and Founder of Joonko Diversity, Inc., an Artificial Intelligence-based employee recruitment startup, alleging among other things that the individual made false AI-related claims about the company’s services. In bringing the action, the agency emphasized the significance of the action’s AI-related allegations. A copy of the agency’s June 11, 2024, press release about the action can be found here. The agency’s complaint in the action can be found here.

Continue Reading SEC Files “AI-Washing” Enforcement Action Against AI-Based Start-Up Founder

The U.S. Supreme Court has agreed to take up a case involving risk factor disclosures in connection with the alleged misuse of Facebook user data by Cambridge Analytica. The case will address a Circuit Court split on the question of what companies must disclose in its risk factors about past instances where risks materialized. As Facebook put it in its petition for writ of certiorari, the question the case presents is whether risk factor disclosures are misleading if they do not disclose past materializations of the risk even if the past event poses no current risk to the company’s ongoing or future business.  The case itself is important because it raises important issues about potential securities law liabilities arising from privacy issues, and the Court’s consideration of the case could address important continuing concerns about corporate risk factor disclosures. A copy of the Court’s June 10, 2024, order in Facebook, Inc. v. Amalgamated Bank granting Facebook’s petition can be found here.

Background

This case arises out of the Facebook-Cambridge Analytica User Data Scandal. Cambridge Analytica allegedly improperly used Facebook user data to target voters in connection with the 2016 U.S. Presidential election. News reports revealed Cambridge Analytica’s use of Facebook user data. However, a subsequent whistleblower-based news report revealed the extent of Cambridge Analytica’s use of the data, and its continued use of the data even after Facebook had become aware of the misuse and had asked Cambridge Analytica to destroy the data.

Facebook investors filed several securities class action lawsuits against Facebook (now known as Meta) and certain of its directors and officers. The lawsuits (later consolidated) raised a number of allegations, including, with greatest relevance to the issues the Supreme Court has agreed to take up, that the company in its risk factor disclosures had referred to the risks to the company of an unauthorized user data disclosure, but had presented the risk as hypothetical when in fact it has already materialized. The district court granted the defendants’ motions to dismiss, and the plaintiff appealed.

As discussed here, in an October 18, 2023, opinion, the Ninth Circuit, with Judge Bumatay partially dissenting, affirmed in part and reversed in part the district court’s dismissal. Of greatest significance, the appellate court reversed the lower court and revived the lawsuit with respect to the plaintiffs’ allegations concerning what Facebook had disclosed about what it knew about Cambridge Analytica’s misuse of user data. Of greatest significance to the Supreme Court’s consideration of the case, the appellate court said that “Because Facebook had presented the prospect of misuse of user data as “purely hypothetical’” when it had already occurred, such a statement “could be misleading even if the magnitude of the ensuing harm was still unknown.”

The Cert Petition

On March 4, 2024, Facebook filed a petition to the Supreme Court for a writ of certiorari. In its petition, Facebook argued that the Ninth Circuit panel’s decision was erroneous, and sought to have the Supreme Court review the following question: “Are risk disclosures false or misleading when they do not disclose that a risk has materialized in the past, even if that past event presents no known risk of ongoing or future business harm?” (Facebook also urged the Court to take up a second question having to do with pleading loss causation, but the Court agreed only to take up the first question.)

In seeking to have the Court take up the case, Facebook argued that the Circuit courts have split on the question of what risk factor disclosures are required with respect to prior events. Facebook argued that prior to this case, the Circuit Courts had developed differing approaches: the Sixth Circuit does not require any risk factors disclosures of past events; and six other circuits require risk factor disclosures only if the company knows the past events will harm the business. In this case, Facebook argued, a two-judge panel adopted, according to Facebook, an “extreme, outlier” position, even if past event poses no known threat of business harm.

In addition to arguing that the Ninth Circuit’s standard makes no sense and would result in risk factor disclosures becoming less useful to investors as it would drown them in irrelevant information about past incidents with no current relevance, and would also encourage “plaintiffs to plead fraud-by-hindsight by attaching significance after a stock drop to events a company had no reason to know were significant at the time of disclosure.”

In their opposition to the petition, the plaintiffs first argued that the question Facebook argues that the case presents is based on a faulty premise that the prior incident involved no known current or future risk. The Ninth Circuit’s opinion, the plaintiffs argue, in to the contrary. The plaintiffs also argued that there is in fact no circuit split, and that in fact the circuit rulings can be reconciled, and that the Ninth Circuit’s holding is also consistent – in each case, the plaintiffs argued, the courts held that a risk cannot be presented as hypothetical if it has already occurred.

Several parties filed amicus briefs in support of Facebook’s petition. For example, the U.S. Chamber of Commerce argued in an amicus brief that the Ninth Circuit’s ruling “all but guarantees that every incident that, with the full benefit of hindsight, can be said to have harmed a public company’s business will spawn securities fraud claims alleging that the company should have disclosed the event sooner.  As the only way to play defense against that outcome, companies will be forced to bloat their future risk disclosures with descriptions of past events—even those that the company does not believe will have any real world impact on its business.”

On June 10, 2024, the U.S. Supreme Court granted the writ of certiorari. The case will be on the Court’s docket for its 2024-2025 term, which begins in October.

Discussion

Any time the U.S. Supreme Court agrees to take up a securities case, it is significant. The Court simply does not take up that many securities cases, and any occasion on which the Court will be called upon to weigh in on the securities laws is noteworthy. Also, any time the U.S. Supreme Court takes up a securities case there is always the possibility that that Court will introduce an approach that shakes up the securities litigation world. (Think, for example, of the Morrison case and its aftermath.)

The fact that the Supreme Court has agreed to take up this case is of particular significance. It is not an uncommon allegation at all in securities complaints that the defendants presented risks as hypothetical that have allegedly already materialized. It will be interesting to see what the Court makes of these kinds of allegations, in the context of a very high profile lawsuit. The Court’s ruling on this case could also have larger significance with respect to risk factor disclosures generally.

There is at least one other reason why the Court’s taking up this case could be significant. That is because at its heart this case is about privacy. The fundamental wrong that Cambridge Analytica (and by extension Facebook) allegedly committed is a violation of Facebook users’ privacy rights. I have long thought that privacy related issues could represent a significant new area of corporate and securities litigation exposure. This case has been one of the most prominent examples of how privacy-related issues can translate into securities litigation. I know, I know, the Supreme Court case is not going to be about privacy issues as such. However, if any portion of the case survives the Supreme Court’s review, it could have important implications about privacy issues as a source of litigation risk.

In any event, this case is now on the Court’s docket for its next term, and it will be interesting to watch.

Napa Valley

The D&O Diary was on assignment last week in Napa Valley in California. Although I have visited Napa several times in the past, it has been a while since I have been there. I had forgotten what a beautiful place it is and how much fun it is to visit.

My primary purpose for traveling to Napa was to participate as a speaker at Inigo’s 2024 Securities Panel Event. The event was held at the beautiful Auberge du Soleil Resort, perched in the hills above Napa Valley. It was a pleasure and an honor to be a part of this excellent event, which first class in every respect. I would like to thank my friends Yera Patel, Ed Whitworth, Tom Ielapi, and all of their Inigo colleagues for inviting me to be a part of this event. It was a great success and a tremendous amount of fun. It was particularly enjoyable to see so many industry friends in such a pleasant setting.

It was an honor to be on this panel with such esteemed fellow speakers. From left to right: Yera Patel of Inigo, who moderated the panel; Boris Feldman of the Freshfields law firm; Stephanie Avakian, former head of the SEC Enforcement Division, now of Wilmer Hale; Jim Harrod of the Bernstein Litowitz law firm; me; and Tom Ielapi of Inigo. It really was an excellent panel and it was great to be a part of it.
After the session, on a terrace at the hotel, with Seth Pfalzer of Woodruff Sawyer and Deidre Finn of Newfront.
With Patricia Ramos and Derek Lakin of Lockton and Nicolai Revin of Marsh.
With Katie Myczek of AON.
With Amy Jeter and Hilarie Gates of Marsh, Larry Bowlus of EPIC, and Jeff Perkins of Marsh.
With Ed Whitworth and Yera Patel of Inigo
With Steve Shappell of Alliant Insurance Services and Laura Markovich of the Skarzynski Marick & Black law firm.
With Erin Stephenson of Woodruff Sawyer.
With Andrew Oldis of the Kaufman Borgeest & Ryan law firm and Millie Baars of Inigo
Such a beautiful venue in such a beautiful setting. A truly memorable event.

In the following guest post, Ed Whitworth, the Head of Financial Lines at Inigo, and Yera Patel, Chief Legal officer and Head of Financial Lines Claims for Inigo, summarize the results of a recent survey Inigo conducted of U.S. securities litigation defense counsel. The original of the survey summary previously was published on Inigo’s blog, here. I would like to thank Ed, Yera, and Inigo for allowing me to publish the report summary on this site. I welcome guest post submissions from responsible authors on topics of interest to the blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article. 

Continue Reading Guest Post: Inigo’s 2024 Defense Counsel Survey

Here at The D&O Diary, our job is to watch for emerging trends in corporate and securities litigation. There is plenty to watch. Because we are always so attentive to what is new, it sometimes surprises us when a development appears that reflects an old or even seemingly played-out trend. That was our reaction to seeing the new COVID-related complaint filed this week against the health Insurer Humana, in which the plaintiff alleges that the company misled investors about the company’s rising costs associated with increased patient utilization rates due to post-pandemic pent-up demand. It is, in fact, a little surprising that even now, more than four years after the coronavirus first emerged in the U.S., COVID-related lawsuits are still being filed. A copy of the Humana complaint can be found here.

Continue Reading Health Insurer Hit with COVID-Related Securities Suit

In several posts (most recently here), I have tried to assess the continuing risks associated with what has been called The Banking Crisis of 2023. In my view, the risks continue, including in particular with respect to banks’ exposure to commercial real estate market. A May 28, 2024, paper by an economist at the Federal Reserve Bank of St. Louis entitled “Commercial Real Estate in Focus” (here) takes a detailed look at the current state of play in Commercial Real Estate (CRE) and examines the implications for banks and thrifts that hold CRE debt. Given the extent of the exposures of banks and thrifts to CRE debt, the author concludes, the CRE sector remains “a challenge for the banking system,” with significant concerns for the banks “if and when losses materialize.”

As the paper details, the CRE asset market is a huge part of the U.S. economy, representing over $22.5 trillion as of the end of 2023. Outstanding CRE debt totaled $5.9 trillion as of the end of 2023, with banks and thrifts holding 50% of that total (government-sponsored entities, insurance companies, and debt securities make up the other half). With such a large share of CRE debt held by banks and thrifts, “the potential weaknesses and risks associated with this sector have become top of mind for banking supervisors.” 

It is worth noting, as the paper shows, that banks’ exposure to CRE debt has grown enormously in the past decade, growing from about $1.2 trillion outstanding as of the first quarter of 2014 to about $3 trillion at the end of 2023. It is perhaps even more noteworthy that, as the paper notes, “a disproportionate share of this growth has occurred at regional and community banks, with roughly two-thirds of all CRE loans held by banks with assets under $100 billion.”

In other words, the health of the CRE market is of critical importance for the banking industry. As the author details in her paper, the CRE sector is currently “navigating several challenges.” The first of these challenges arises from the fact that much of the outstanding CRE debt will soon be maturing and will need to be re-financed at higher interest rates. The second is that these interest rate risks arise while certain market fundamentals continue to deteriorate.

With respect to the maturing debt, the author notes that roughly $1.7 trillion, or nearly 30% of the outstanding CRE debt “is expected to mature from 2024 to 2026.” This prospect is known as the “maturity wall.” The CRE sector has long relied on shorter-term debt durations, in expectation that the debt will be re-financed at maturity. During the many years that interest rates were low and stable, this arrangement made sense. However, in the current interest rate environment, borrowers looking to refinance maturing CRE debt “may face higher debt payments.” While higher debt obligations by themselves weigh on profitability, the weakening of the CRE market’s underlying fundamentals, especially for the office sector, “compounds the issue.”

The three underling fundamentals that are, according to the author, deteriorating are: net operating income (NOI); vacancy rates; and valuations.

The net operating income for the CRE market “has come under pressure of late, especially for office properties.” The office sector faces “not only cyclical headwinds from higher interest rates by also structural challenges from a reduction in office footprints as increased hybrid and remote work has reduced demand for office space.” Higher expenses as a result of sustained economic inflation have also raised operating costs. Overall, the author points out, “any erosion in NOI will have important implications for valuations” (about which see below).

Vacancy rates are obviously important as well, as higher vacancy rates indicate lower tenant demand, “which weighs on rental income and valuations.” U.S. office vacancy rates in the first quarter of 2024 reached 19%, surpassing previous highs reached during the Great Recession and the COVID-19 recession. The vacancy rate may even underestimate the overall level of vacant office space, as space that is leased but not being fully used runs the risk of turning into vacancies as leases expire.

As rates remain elevated, NOI declines, and vacancy rates rise, CRE valuations are under pressure. Because there have been relatively few transactions through early 2024, “price discovery” remains a challenge –meaning it is hard to gauge exactly how much valuations have declined. The reason there have been fewer transactions recently is that “building owners have delayed sales to avoid realizing losses.” By one measure the author cites, the office sector commercial property price index as of the first quarter of 2024 had decline 34% from its peak. The author suggests that “further pressure on valuations could occur as sales volumes return.”

The author concludes that the CRE market remains “a potential headwind for the U.S. economy in 2024,” as weakening fundamentals suggest “lower valuations and potential losses.” Stress in the CRE market is likely to “remain a key risk factor to watch in the near term as loans mature, building appraisals and sales resume, and price discovery occurs,” which will “determine the extent of losses for the market.”

Discussion

Some observers that follow the commercial real estate sector may say there is little new in the economist’s report, but I think the author deserves credit both for the concision of her summary and for marshaling key data to support her analysis and conclusions. The report, which is short, is worth reading in full.

The picture the author paints is indeed troubling. But notwithstanding the concerns, there are some things worth considering. For one thing, and for all of the gloom the author conjures up in her paper, there has still only been one failed bank so far in 2024, and here we are just weeks before the end of the year’s first half. To be sure, it could be that the real trouble is still ahead, as debts mature and as losses are realized. But in that regard, it is reassuring to note that, as the author observes, banks are now “increasing their allowances for loan losses on CRE portfolios,” and “stronger capital positions by U.S. banks provide added cushion against stress.” It is also probably worth noting that the author herself does not raise the specter of further possible bank failures ahead, but rather says only that there are key risk factors to watch in order to “determine the extent of losses for the market.”

There is one note in the author’s paper that is particularly troubling, and that is her observation that a “disproportionate share” of the growth in outstanding CRE debt during the past decade is concentrated at regional and community banks. The author specifically notes that CRE is a challenge to the banking sector overall, but that among banks with high CRE concentrations, “there is a potential for liquidity concerns and capital deterioration if and when losses materialize.”

The challenge that the CRE sector is facing is not helped by the fact that interest rate decreases, which many investors had assumed were on the calendar for later this year, likely will now be delayed. As long as interest rates remain elevated, the concerns surrounding the “maturity wall” will continue, with the likelihood that maturing debt will be rolled over at elevated interest rate levels – which will further weigh on landlords’ operating income and on valuations, which could contribute to and exacerbate losses.

One final note. All of these observations are disturbing enough by themselves, but they are even more alarming when the sheer size of the total CRE debt — $5.9 trillion — is taken into account, especially given that $1.7 trillion is due to mature during the 2024-2026 timeframe. That’s a lot of debt to roll over. It is also a lot of risk for creditors and lenders, particularly if interest rates continue to stay higher longer for longer.