On March 7, 2022, Judge Algenon L. Marbley of the Southern District of Ohio largely denied a motion to dismiss a putative class action asserting claims under the Securities Exchange Act of 1934 (“Exchange Act”) and the Securities Act of 1933 (“Securities Act”) against an energy company, certain of its executives and directors, and certain underwriters of its bond offerings.
In re FirstEnergy Corp. Sec. Litig., No. 2:20-cv-3785 (S.D. Ohio Mar. 7, 2022). Plaintiffs alleged that the company engaged in an anti-competitive scheme that included bribing state officials in exchange for a government bailout of its nuclear power facilities. The lawsuit relates to the Ohio House Bill 6 scandal, in connection with which Ohio’s former Speaker of the House and others have been arrested on racketeering charges, political strategists and lobbyists have pleaded guilty to a racketeering conspiracy; the company fired certain executives for violating company policies and its code of conduct, and the company entered into a deferred prosecution agreement under which it paid a $230 million penalty and acknowledged having “conspired with public officials and other individuals and entities to pay millions of dollars to and for the benefit of public officials in exchange for specific official action” for the company’s benefit. The Court held that plaintiffs had sufficiently alleged the various elements of their claims and declined to dismiss any defendant from the case, although the Court dismissed certain claims with respect to certain individual defendants.
With respect to their Exchange Act claims, plaintiffs asserted two separate theories of liability, both of which rested on similar underlying facts. One theory was based on defendants allegedly having made misstatements and omissions; the other was based on the company allegedly having engaged in a “scheme …to defraud.”
First, plaintiffs alleged that the failure to disclose the alleged scheme rendered numerous statements misleading, including risk factors in SEC filings, statements regarding the company’s commitment to ethical standards and compliance efforts, statements regarding lobbying activity, and statements regarding the legislation in question. Slip op. at 17-18. Although defendants argued that the challenged statements amounted to non-actionable opinions, the Court observed that the same SEC filings had already been determined in a prior shareholder derivative action to contain material misrepresentations or omissions.
Id. at 18-19. Further, the Court explained, if the alleged scheme were (as plaintiffs alleged) fundamental to the company’s business model, then those statements “either were not honestly held or were not based on the diligence a reasonable investor would expect them to convey.”
Id. at 19. The Court also rejected defendants’ argument that they had no duty to disclose the alleged scheme in connection with “loosely optimistic statements,” explaining that once the company “chooses to volunteer such information,” the “disclosure must be full and fair” and “provide complete and non-misleading information with respect to the subjects on which [it] undertakes to speak.”
Id. at 20. The Court also noted that, in encouraging shareholders to vote against a proposal to increase oversight of lobbying activities, the company made several compliance-related statements, the context of which “change[d] the meaning of those statements from aspiration to assurance,” which was “more than mere ‘puffery’ or “corporate cheerleading.”
Id. at 21.
Based on essentially the same factual allegations as the misrepresentation theory, the Court also found that plaintiffs adequately alleged Exchange Act claims under a theory of “scheme liability.” The Court rejected the company’s argument that the alleged scheme was not illegal and was protected under the First Amendment, explaining that the alleged bribery was “illegal, deceptive, and offensive to democracy.”
Id. at 25. The Court also observed that, contrary to defendants’ suggestion, plaintiffs had, in fact, alleged what laws were violated because they referenced “specific criminal charges actually brought against [d]efendants’ alleged co-conspirators.”
Id. Further, the Court emphasized that plaintiffs alleged an “explicit
quid pro quo agreement,” identifying “specific actors, dollar amounts, phone contacts, meetings, and methods of concealment,” which, in combination with the guilty pleas by alleged co-conspirators, were “more than sufficient to support a plausible and cogent inference that a bribery scheme occurred.”
Id. at 26. The Court for similar reasons rejected defendants’ argument that the scheme allegations were not made with sufficient particularity as to various individual defendants.
Id. at 28-32.
With respect to scienter, the Court first determined as a threshold matter that misstatement claims concerning “present or historical fact” may be based on either a knowledge or recklessness theory of scienter, while for misstatement claims based on optimistic “soft information” and alleged scheme liability, recklessness alone does not suffice and plaintiffs must raise an inference of actual knowledge.
Id. at 33. Moreover, while defendants argued that plaintiffs should not be permitted to avoid individualized allegations by using the “group pleading doctrine”—the validity of which has not yet been addressed by the Sixth Circuit—the Court clarified that this was a “sideshow” because plaintiffs did not claim to rely on group pleading and made specific scienter allegations for each Exchange Act defendant.
Id. at 33-34. Similarly, defendants argued that scienter should not be “presumed” for executives based solely on their position, but the Court held that plaintiffs were not relying solely on defendants’ titles and positions but “rather on the intersection between the executive’s responsibilities and the scheme’s critical aspects.”
Id. at 34-35.
The Court then engaged in an individualized evaluation of the scienter allegations with respect to each of the Exchange Act defendants, including consideration of allegations of insider trading, the timing of the alleged misrepresentations, evidence of bribery, ancillary lawsuits concerning the same subject matter and their quick settlement, the company’s disregard of current factual information in making the challenged statements, defendants’ motivation to save their salaries or jobs, and a series of executive terminations after the alleged scheme became the subject of a criminal complaint—all of which factors the Court concluded favored plaintiffs’ theory of scienter.
Id. at 39-41. The Court rejected defendants’ argument that the motivation to save salaries and jobs was “common to corporations and executives generally,” observing that plaintiffs alleged that defendants “had unusually strong incentives” in that the vast majority of their compensation was performance-based and that the company’s nuclear plants were among “the [c]ompany’s most pressing operational challenges,” presenting a “unique confluence of need and greed” that weighed in favor of scienter.
Id. at 40.
The Court further emphasized that these factors were not a mechanical checklist, but rather must be viewed “in the context of an alleged scheme that reached the core of [the company’s] business model,” concluding that “[i]t is difficult to imagine such a scheme emerging without scienter.”
Id. at 42. Moreover, the Court stated that the scienter factors considered by the Court “fit [plaintiffs’] overarching narrative by adding motive …, cover-up …, and corroboration,” such that a “reasonable person,” taking the allegations “collectively,” would “deem the inference of scienter at least as strong as any opposing inference,” adding that the “competing inference of innocent political participation pales in comparison.”
Id. at 42. The Court also evaluated plaintiffs’ allegations as to each of the Exchange Act defendants, concluding that the allegations, viewed “collectively and holistically,” supported for each such defendant an inference of scienter that was “at least as compelling as any opposing inference.”
Id. at 42-47. While the strength of that inference varied depending on the particular defendant, the Court observed that this “would be expected for non-omniscient parties at an early stage of litigation” and plaintiffs’ allegations were sufficient to warrant discovery.
Id. at 47.
The Court also considered and rejected defendants’ arguments regarding other elements of the Exchange Act claims. While defendants argued that the alleged scheme did not involve “market activity” and therefore was too attenuated to satisfy the “in connection with the purchase or sale of a security” requirement under Section 10(b) of the Exchange Act, the Court rejected “such a constrained view of market activity” and held that plaintiffs had sufficiently alleged how the scheme, and the company’s nuclear liabilities that were the subject of the scheme, “related directly to investors’ valuations and purchases of securities.”
Id. at 47-48.
The Court also held that the reliance element was satisfied with respect to all defendants. For those defendants who were alleged to have made misrepresentations or omissions as part of the alleged scheme, the Court determined that plaintiffs’ allegations were sufficient to establish a presumption of reliance under
Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972) and
Basic Inc. v. Levinson, 485 U.S. 224 (1988).
Id. at 50-52. With respect to defendants who were not alleged to have made misrepresentations or omissions, the Court nevertheless rejected their argument that there can be no reliance absent public disclosure.
Id. at 52. To the contrary, the Court explained that, “for the scheme to succeed, it had to be concealed from the shareholders; otherwise, it would have unraveled,” and investors then would not have purchased securities at allegedly inflated prices.
Id. The Court concluded that plaintiffs adequately alleged that the remaining defendants “created misleading information about the nature and propriety of the [c]ompany’s political activity” that was “publicized by the [c]ompany and factored efficiently into share prices,” which the Court determined constituted a “direct causal chain” supporting reliance.
Id. at 55.
Regarding loss causation, the Court noted that the main argument against loss causation was brought by one executive, who challenged that element as to the disclosure of an alleged illicit payment four months after the putative class period ended.
Id. at 55-56. The Court rejected the argument that this disclosure could not “retroactively cause class period losses,” emphasizing that details of this payment were not the “inflection point at which the market first learned of [d]efendants’ fraudulent scheme” but rather emerged later in the course of ensuing investigations.
Id. at 56. Due to the breadth of the alleged scheme, the Court found it unremarkable that it would emerge in a “series of disclosing events” and declined to examine the disclosure of the alleged payment “in a vacuum.”
Id.
Turning to plaintiffs’ claims under Section 11 of the Securities Act, the Court observed that defendants had “implicitly concede[d] that their arguments rise or fall with the Court’s determination” of the Exchange Act claims and rejected defendants’ arguments largely for the same reasons.
Id. at 64. The Court emphasized that, regardless of the pleading standard, plaintiffs had adequately alleged actionable misstatements and omissions.
Id. at 66. However, the Court also clarified that a heightened pleading standard applied for the company and executives serving in management roles—who plaintiffs alleged engaged in fraudulent activity—but not for non-management director defendants and underwriter defendants, who plaintiffs did not allege “knew of or participated in the scheme in a way that would be fraudulent, as opposed to reckless or negligent.”
Id. at 65-66.
In addition, the Court addressed plaintiffs’ claims under Section 12(a)(2) of the Securities Act, for which the underwriter defendants brought a standing challenge and certain individual defendants argued they were not “statutory sellers” as required under Section 12(a)(2). Regarding standing, the underwriters argued that Section 12(a)(2) applied only to purchases in initial offerings, not aftermarket trading, and plaintiffs had failed to allege that they purchased securities in initial offerings. The Court, however, found that plaintiffs’ allegations that they purchased the company’s notes “directly in and traceable to” the offerings, that defendants “issued, promoted and sold [the company’s] notes to [p]laintiffs,” and referencing plaintiffs’ “purchases of the [company’s] notes issued in the [o]fferings” were sufficient at the pleading stage and the Court explained that it would not “draw reasonable inferences
against [p]laintiffs, which is backwards on a motion to dismiss.”
Id. at 68. Regarding the statutory seller argument, the Court dismissed plaintiffs’ claims under Section 12(a)(2) against the non-management director defendants, for which the Court noted plaintiffs made no “specific allegations of solicitation” but rather appeared to “rest on the [directors’] signatures” on the offering documents, which was insufficient.
Id. at 72-73.
Finally, the Court addressed defendants’ argument that plaintiffs’ claims should be dismissed based on the recent decision in
Nickerson v. American Electric Power Co., No. 2:20-cv-4243-SDM-EPD, 2021 WL 5998536 (Dec. 20, 2021 S.D. Ohio) (“
AEP”). In
AEP, as discussed in our
prior post, the Southern District of Ohio dismissed claims under the Exchange Act involving a similar bribery scheme alleged against an Ohio public utility. The Court, however, distinguished the
AEP case, noting that the
AEP plaintiffs “presented no coherent scheme theory” in their complaint and did not allege misrepresentations in the context of a shareholder proposal regarding lobbying transparency.
FirstEnergy, slip op
. at 74. Moreover, the Court emphasized that the energy company here was alleged to have contributed far more to the alleged bribery scheme than the public utility in
AEP; “undoubtedly played the dominant role in passing” the legislation in question and “stood to gain the bulk of the benefits;” had been charged with criminal wrongdoing; and allegedly experienced a far more substantial decline in share price when the alleged scheme was disclosed.
Id.
