On September 7, 2018, Judge Charles Breyer of the United States District Court for the Northern District of California denied a motion to dismiss a second amended putative class action complaint on behalf of Volkswagen bondholders asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Volkswagen and certain of its former executives alleging that defendants failed to disclose Volkswagen’s use of “defeat device” software to mask emissions in the company’s diesel engines. In re Volkswagen “Clean Diesel” Marketing, Sales Practices, and Products Liability Litigation
, MDL No. 2672 CRB (JSC) (N.D. Cal. Sept. 7, 2018). In its previous July 19, 2017
and March 2, 2018
orders, as discussed in our prior posts, the Court had first dismissed certain claims for failure to adequately plead scienter and then, reconsidering its prior holding that plaintiff was entitled to a presumption of reliance under Affiliated Ute
, dismissed plaintiff’s first amended complaint in its entirety for failure to plead reliance. In considering the second amended complaint, the Court held that scienter and individual, direct reliance were adequately alleged, but raised questions about plaintiff’s ability to prove class-wide reliance.
The Court had previously dismissed claims against Volkswagen Group of America, Inc. (“VWGoA”) and its former President and CEO on the basis that scienter was not adequately alleged because the CEO was not alleged to have been aware of the defeat device issue until the day of the relevant bond offering filing. However, new allegations that the CEO had learned of a study indicating problems with Volkswagen’s emissions nearly two months earlier were held to support a strong inference that he acted with an intent to deceive or with deliberate recklessness when he failed to disclose that there was reason to believe Volkswagen’s “clean diesel” vehicles were significantly out of compliance with U.S. emission standards. In this regard, the Court noted that Volkswagen did not disclose the emissions issue until one-and-a-half years later, after it was “actually caught,” which rendered the inference that the former CEO’s silence at the time of the offering was intended to deceive as “cogent and at least as compelling” as the inference that he was still innocently conducting an investigation at that time. Slip op. at 22.
In its July 19, 2017 order, the Court had held that plaintiff was entitled to the presumption of reliance under Affiliated Ute Citizens of Utah v. United States
, 406 U.S. 128 (1972). But in its March 2, 2018 order, it reconsidered that ruling in light of the Second Circuit’s decision in Waggoner v. Barclays PLC
, 875 F.3d 79 (2d Cir 2017), and held that Affiliated Ute
did not apply because the only omission alleged was that an affirmative statement was misrepresented. The Court also rejected in that order plaintiff’s argument that direct reliance was established based on statements in the Offering Memorandum that “you should rely on the information contained in this Offering Memorandum” and that investors “have relied only on the information contained in this document.” See
March 2, 2018 Order at 12-14. In its most recent order, however, the Court held that additional allegations that plaintiff’s investment advisor had reviewed and relied upon the Offering Memorandum were sufficient to plausibly support direct reliance by plaintiff. Slip op. at 4. However, given that direct reliance would likely be difficult to prove on a class-wide basis, the Court offered some observations about plaintiff’s proffered arguments in favor of a presumption of reliance.
The Court rejected all of plaintiff’s arguments for a market-based presumption of reliance. First, the fraud-on-the-market presumption under Basic Inc. v. Levinson
, 485 U.S. 224 (1988), was inapplicable because the bonds—which plaintiff purchased in a Rule 144A private placement—were not “actively traded” on a “well-developed market.” Slip op at 7. Second, the Court noted that the “fraud-created-the-market” presumption of reliance has not been accepted in the Ninth Circuit, but even if it were available it would not apply because “it is almost inconceivable that, but for the fraud, the credit markets would have completely shut out one of the world’s largest automakers.” Id.
at 8. Third, the Court held that the “fraud on the regulatory process” presumption, first adopted in Arthur Young & Co. v. U.S. District Court
, 549 F.2d 686, 695 (9th Cir. 1977), was of uncertain viability but, in any case would not apply here because the alleged misrepresentations were made to the EPA and the California Air Resources Board; since those agencies were not the gatekeepers for securities offerings, the alleged misrepresentations did not plausibly enable the bond sale to go forward. Id.
The Court then re-engaged on the Affiliated Ute
presumption. Plaintiff argued that the Court’s March 2, 2018 holding—that Affiliated Ute
was inapplicable because the alleged omission was of the truth that certain affirmative statements allegedly misrepresented—effectively rendered the presumption unavailable in any case brought under Rule 10b-5(b), i.e.
, any case predicated on affirmative statements. See Smith v. Ayers
, 845 F.2d 1360, 1363 (5th Cir. 1988) (presumption only available under 10b-5(a) and (c)). According to plaintiff, this would contravene the Ninth Circuit’s decision in Blackie v. Barrack
, 524 F.2d 891 (9th Cir. 1975). The Court noted that, although the matter was not clear, Blackie
appeared to have involved both misstatements and omissions, but the Ninth Circuit held that the presumption was nevertheless available in that case. Slip op. at 18. Although this “g[a]ve the Court some pause,” id.
at 16, the Court declined to finally resolve the matter, noting that the issue would need to be resolved in considering class certification. Potentially of significance in that regard, the Court denied plaintiff’s request to permit a further amendment to add insider trading claims. Although plaintiff contended that insider trading could be committed without affirmative statements and the Affiliate Ute
presumption would apply under a “pure omissions” theory, the Court explained that, under Chiarella v. United States
, “when an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.” 445 U.S. 222, 235 (1980). The Court thus held that, because corporate insiders do not owe fiduciary duties to purchasers of corporate debt, there was no duty to disclose the alleged emissions fraud to the plaintiff-bond purchasers here. Id.
Finally, the Court sustained “control person” claims against VWGoA’s former CEO under Section 20(a). The allegation that he was President and CEO of VWGoA was “indicative of control” as to VWGoA, and allegations that he was personally involved in responding to the emissions study indicated that he exercised “day-to-day oversight” over transactions that contributed to the ultimate fraud. Further, specific allegations that he had been “provided with copies” of the Offering Memoranda prior to or shortly after their issuance and had the ability and/or opportunity to correct them or prevent their issuance demonstrated that he had control over the allegedly misleading statements. Id.
at 24-25. In so holding, the Court rejected the CEO’s arguments that he could not be liable as a control person because he had not signed the Offering Memoranda. Id.