The U.S. Court of Appeals for the Second Circuit held earlier this week that a company’s accurately reported financial statements are not misleading simply because they do not disclose that alleged misconduct might have contributed to the company’s financial results. The court also ruled that alleged misstatements made three to four years before the plaintiffs purchased the issuer’s securities were not material as a matter of law where an “outpouring of information” about the alleged misconduct followed those purported misstatements and preceded the plaintiffs’ securities purchases.

The decision in Plumber & Steamfitters Local 773 Pension Fund v. Danske Bank A/S (2d Cir. Aug. 25, 2021) squarely aligns the Second Circuit with other courts that have held that accurately reported financial results are not actionable even if undisclosed alleged misconduct purportedly contributed to the financial performance. The decision also highlights the need to consider whether a particular shareholder can be an optimal class representative where the complaint alleges a long class period.

Factual Background

The Danske Bank securities litigation arose out of a money-laundering scandal at Danske’s Estonian branch.  Problems began to emerge in 2009, with additional news coming out in subsequent years. In December 2014, Danske reported a goodwill impairment related to its operations in Estonia (and elsewhere).  In March 2016, the Danish Financial Supervisory Authority publicly reprimanded and fined Danske for failing to identify money-laundering risks at the Estonian branch and for not implementing risk-mitigating measures.  News articles in 2017 and mid-2018 reported additional bad news.  And in September 2018, Danske released the report of an independent investigation showing that the scope of the alleged misconduct was much larger than had originally been anticipated.

The plaintiffs purchased Danske Bank ADRs between March and June 2018, amid the “fallout” from the news of the money laundering, and filed a securities class action in 2019 on behalf of a class of purchasers of Danske ADRs between January 9, 2014 and April 29, 2019. The complaint alleged material misrepresentations and omissions relating to the bank’s financial statements (which had incorporated revenue from the allegedly illegal transactions), the 2014 statements about the goodwill impairment, a 2015 statement about whistleblower reporting, a July 2018 statement about the expected immateriality of pending lawsuits and disputes, and statements about corporate governance.

The District Court dismissed the complaint for failure to plead an actionable misrepresentation or omission and for failure to plead a strong inference of scienter.  The Second Circuit affirmed on the first ground without reaching the scienter ruling.

The Second Circuit’s Decision

Accurately Reported Financial Results Not Actionable

The Second Circuit first held that “accurately reported financial statements do not automatically become misleading by virtue of the company’s nondisclosure of suspected misconduct that may have contributed to the financial results.”  The bank had “no obligation to self-report its growing suspicions regarding” the money-laundering issues in Estonia, so “its disclosure of accurate historical data, standing alone, is not actionable.”

The court also rejected the plaintiffs’ argument that the financial reports were per se misleading by allegedly failing to comply with applicable accounting standards. The plaintiffs had contended that contract revenues are reportable only if the underlying contracts are “enforceable” and that illegal contracts are not enforceable.  But the Second Circuit held that the plaintiffs had “conflate[d] the distinct concepts of illegality and unenforceability” and had not established that the deposit contracts were unenforceable under foreign contract law.

Immateriality of Statements Made Long Before Plaintiffs’ Purchases

The Second Circuit next rejected the argument that alleged misstatements about the 2014 goodwill impairment could have been material in 2018, when the plaintiffs purchased their ADRs.  Although recognizing that materiality “involves a fact-specific inquiry” that “can be decided on a motion to dismiss only if reasonable minds cannot differ on the question of materiality,” the court nevertheless held that “[l]ogic compels the conclusion that time may render statements immaterial.” “Here, almost 39 months intervened between the 2014 announcement of the goodwill impairment and the [plaintiffs’] purchases of Danske ADRs. Over that time, the Estonian Branch was the subject of intervening events and disclosures. . . .  In this case, the outpouring of information about the Estonian Branch between 2016 and 2018 compels the conclusion that the 2014 statements about the goodwill impairment were too remote in time to have assumed actual significance in the deliberations of a purchaser in 2018.”

The court reached the same conclusion about the alleged misstatement in 2015 concerning whistleblower reports.

Immateriality of Statements Made After Plaintiffs’ Purchases

Conversely, the Second Circuit held that alleged misstatements made in July 2018, after the plaintiffs’ last ADR purchases, were not actionable because they “could not have influenced the price of a purchase that had already been made.”

Immateriality of General Statements About Corporate Responsibility

The Second Circuit also held that Danske’s general statements about “striving” to conduct its business in accordance with legal standards, “condemn[ing] money laundering,” and “tak[ing] the steps necessary to comply with internationally recognised standards” were not actionable.  The statements were the type that “almost every bank . . . makes”; “[g]eneral declarations about the importance of acting lawfully and with integrity are inactionable puffery, especially when expressed in aspirational terms.”

The court acknowledged that “[a]ssertions of satisfactory regulatory compliance can be materially misleading if the descriptions of compliance efforts are detailed and specific.”  But here, “[a]lthough Danske averred that it took steps to comply with AML protocols and vaguely recited some AML buzzwords, it claimed no particular acts of compliance.”  Moreover, Danske had made those statements in 2013 and 2014 – more than three years before the plaintiffs purchased their ADRs.  The statements thus were immaterial for that reason as well.

Implications

The Second Circuit’s ruling that accurately reported financial results are not actionable is a welcome published decision from that court and will undoubtedly be used in the many cases where securities plaintiffs contend that a company’s financial performance was infected by underlying alleged misconduct.  The ruling on corporate-governance statements and puffery adds to the growing line of cases rejecting securities claims based on such generalized, aspirational statements.

Perhaps the most interesting aspect of the Danske decision is the holding that alleged misstatements can be immaterial as a matter of law if too much other information has entered the market after those statements and before the plaintiff’s stock purchases.  The ruling does not draw a bright line about materiality’s “half-life,” and its applicability to other fact patterns likely will be heavily litigated in the future.  But the decision frames the issue and provides some guidance to plaintiffs and defendants.

The decision also highlights the question whether a particular plaintiff is an appropriate class representative for a long class period (here, purportedly more than five years). The lead plaintiffs bought their ADRs much too late to challenge the early alleged misstatements – and too early to challenge the last alleged misstatement.  Plaintiffs’ counsel will need to consider how to balance these considerations in proposing lead plaintiffs, and defendants might explore similar issues at the class-certification stage.

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