Developments in securities litigation move fast, and not all of them matter equally. Each month, Alto Litigation curates and summarizes the cases, rulings, and regulatory actions most likely to shape risk and strategy in the months ahead.
SEC Rescinds No-Deny Rule for Settlements
On May 18, the SEC formally rescinded its 54-year-old rule requiring defendants or respondents in SEC proceedings, as a condition of any settlement, to agree that while there would be no obligation to admit to the truth of the SEC’s allegations, the defendant could not publicly deny the allegations.
This so-called “no admit/no deny” rule, codified in Section 202.5 of the SEC’s Informal Rules of Practice, was criticized as violating First Amendment free speech rights, although Circuit Courts of Appeal, including the Ninth Circuit, had rejected challenges on those grounds. Notably, the SEC’s rescission release did not assert that the “no deny” policy was unconstitutional, only wrongheaded. Further, the SEC’s rescission release stated that the SEC would not enforce the “no deny” policy in existing settlements, meaning that in the event of a breach of an existing “no deny” policy, the SEC will not seek to vacate a settlement or reopen an adjudicatory proceeding.
Why It Matters: The rescission of the “no deny” policy marks the latest business-friendly action of the SEC in the second Trump Administration, which include a release stating that, with some exceptions, most digital assets are not securities and a recent proposal to rescind the Biden Administration’s climate disclosure regulations (which were held up in court anyway). But the rescission of the longstanding “no deny” policy may have a significant impact on SEC settlements. Will the current or future SEC demand tougher settlement terms if a defendant will publicly deny the SEC’s allegations? Will the ability to publicly deny the SEC’s claims encourage defendants to settle earlier during the investigative or litigation process? Now that the entire “no admit/no deny” policy is rescinded, will the SEC more frequently demand admissions of misconduct as the price of settlement? Will denying the SEC’s allegations subject a defendant to criticism of the decision to settle rather than litigate? Of course, a future SEC may reinstate the policy, but not for the foreseeable future (and administration).
Second Circuit Tightens Standard for Item 303 Omission Claims
On May 28, the Second Circuit Court of Appeals affirmed dismissal of a securities class action against The Gap, Inc., based on allegations that the company had violated the anti-fraud provisions of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder by failing to disclose that an initiative to increase plus-sized clothing options in Old Navy stores would adversely impact financial results by forcing the sale of surplus inventory at deep discounts.
In Smith v. The Gap, Inc., the Second Circuit affirmed the lower court’s dismissal on various grounds. In particular, the Second Circuit panel rejected the plaintiffs’ claim that The Gap violated Item 303 of Regulation S-K, by failing to disclose problems in a Quarterly Report on Form 10-Q. Item 303 requires disclosure of any known trends or uncertainties that could have a material impact on net sales and revenues. The Second Circuit relied on the Supreme Court’s decision in Macquarie Infrastructure Corp. v. Moab Partners, L.P., 601 U.S. 257 (2024), which held that an alleged omission in Item 303 cannot support a Rule 10b-5 claim unless the omission rendered an actual statement misleading. Plaintiffs argued that the disclosure failure made misleading a statement that the clothing program was a “key initiative.” The court held that the alleged omission did not render the statement misleading.
Why It Matters: Plaintiffs in securities class actions had long argued that an alleged omission of information required by Item 303 by itself could support a Rule 10b-5 claim. The Supreme Court in Macquarie rejected the argument and required plaintiffs to show how the alleged omission made an actual statement materially misleading. The decision by the Second Circuit, which is considered prominent in securities law matters, demonstrated that a high bar will be required for plaintiffs to show that an alleged Item 303 omission actually rendered a specific statement misleading.
D. C. Circuit Rejects SEC’s Denial of Whistleblower Claim
The Court of Appeals for the District of Columbia rejected the SEC’s denial of a whistleblower award because the agency failed adequately to explain why it denied the claim of an individual who provided information that led to a successful enforcement action.
In Doe v. SEC, the SEC had asserted that the individual (who was not identified in the proceeding) had not voluntarily provided information to the SEC before the SEC reached out to him after he made disclosures to the media, and therefore he did not qualify for a whistleblower award under the Dodd-Frank Act and SEC rules. While the court rejected the petitioner’s claim concerning the voluntariness of his information, it agreed with his contention that the SEC had not explained why granting an exception was not necessary or appropriate in the public interest. Where the SEC receives an application for an award based on the submission of information leading to a successful and significant enforcement action, and the applicant pointed to the SEC’s past grants of such exceptions, the agency must do more than restate general policy goals. The court remanded the action to the SEC for further consideration.
Why It Matters: The D.C. Circuit remonstrated the SEC for acting in an arbitrary and capricious manner, which is a useful reminder to all government agencies. It is also significant that the ruling cited the Supreme Court’s decision in Loper Bright Enters. v. Raimondo, 603 U.S. 369 (2024), which held that courts need not defer to an agency’s decision and may exercise their own independent judgment concerning whether an agency acted within its authority. Thus, this decision is an example of a court declining to accept the SEC’s own interpretation of the applicable authority.
Delaware Chancery Court Holds That Directors Breached Fiduciary Duties in Financing
In Guilbeau v. Footprint International Holdco, Inc., the Delaware Chancery Court held that plaintiffs sufficiently had alleged that directors had breached their fiduciary duties when they approved a financing that was proposed and largely funded by three institutional investors that were among Footprint’s largest shareholders. The court also held that it was reasonable to infer that the funds may have aided and abetted the directors’ breach.
The financing had been approved by a committee of independent directors and approved by the entire Board. The plaintiffs had alleged that the financing was below market levels; the Board did not consider other financing proposals; there was no disclosure to stockholders concerning special benefits granted to the Funds and another major stockholder; the Funds were provided with control over the Board; and protections for another class of stockholders were eliminated. The court found it reasonable at the pleading stage to impute the knowledge of the Funds’ designees on the Board to the Funds themselves and conclude that the Funds were acting in their own self-interest.
Why It Matters: Although the company was near insolvency, the directors could not ignore their fiduciary duties in approving the financing. The court emphasized that there is “no dilution” of the duty of loyalty when a director holds dual fiduciary roles. When the interests of those to whom the directors owe loyalties conflict, the director faces an inherent conflict of interest. An entire fairness review was required because a majority of the Board was not independent. The court noted that the Delaware Supreme Court in recent decisions had raised the standard for the “knowing participation” element of aiding and abetting, but that those decisions applied to third-party acquirors and possibly not to the Funds with designees on the Board.
Further, the decision did not apply the 2025 amendments to the Delaware General Corporation Code (because the suit was filed before the amendments became effective) and if the amendments had been applicable, the claims against the directors likely would have been dismissed. But the aiding and abetting claims against the Funds may still have survived a motion to dismiss.
Ninth Circuit Sets Evidentiary Bar for Lead Plaintiff Challenges
In re: Crain Walnut Shelling, LP, issued on May 7, concerned a securities class action lawsuit against Super Micro Computer. The district court found that one investor, Crain Walnut, had the largest loss from its investment, and appointed it as the presumptive class plaintiff, a ruling that was challenged by another investor, Universal-Investment. The district court initially held that the standard for challenging a presumptive plaintiff under the Private Securities Litigation Reform Act (PSLRA) was “genuine and serious doubt” about the plaintiff's adequacy, under which it held that Universal had rebutted the presumption of adequacy. Upon a motion for reconsideration, the district court reaffirmed the “genuine and serious doubt” standard but also determined that Crain Walnut was inadequate to be lead plaintiff under a preponderance of the evidence standard.
On a petition for a writ of mandamus, the Ninth Circuit held that the “genuine and serious standard” was improper and misconstrued prior Ninth Circuit rulings. Although the PSLRA is silent on the proper standard, the default standard in civil litigation is preponderance of the evidence based on Supreme Court and Ninth Circuit precedent, and a balancing of the interests analysis. However, the court upheld that district's determination that Crain Walnut was inadequate under a preponderance of the evidence standard, because it had filed inaccurate documents concerning its ownership structure which it failed to correct and its representative testified at a deposition that he would refuse to produce documents even under a court order. Thus, the district court's ruling was not “clear error” that would justify granting the writ of mandamus.
Why It Matters: This case is apparently the first time a Circuit Court of Appeals addressed the standard of proof for rebutting the presumption of adequacy and typicality to a presumptive lead plaintiff under the PSLRA. The court’s decision that the default standard is a “preponderance of the evidence” may influence other Circuit Courts. But the decision also emphasizes that a presumptive lead plaintiff cannot make misleading representations or suggest that it would not obey court orders.