Securities and Derivative Litigation: Quarterly Update - August 2022

Dechert LLP

In this edition of Dechert’s Securities & Derivative Litigation Quarterly Update, we examine (1) a California appellate court decision upholding a federal forum selection provision; (2) a newly emerging Circuit split over the application of a different type of forum selection provision to derivative suits for violations of Section 14(a) of the Securities Exchange Act of 1934; and (3) a Second Circuit decision rejecting the SEC’s expansive interpretation of scheme liability.

California Appellate Court Upholds Federal Forum Provision Applicable to Claims Under the Securities Act of 1933

In a closely watched case, a California appellate court affirmed the dismissal of state court claims alleging violations of the Securities Act of 1933 (“Securities Act”) based on a federal forum provision (“FFP”) in a Delaware corporation’s charter.1 We have reported on the adoption and enforcement of FFPs in prior Dechert OnPoints.2 By way of background, federal and state courts have concurrent jurisdiction over Securities Act claims. In recent years, some Delaware corporations added FFPs to their charters, requiring Securities Act claims to be brought exclusively in federal court. A key benefit of such provisions is avoiding parallel state and federal suits, which needlessly drive up a company’s litigation costs and risk inconsistent adjudications. The enforceability of FFPs took on added importance when the Supreme Court ruled that Securities Act claims filed in state court are not removable to federal court.3 Following the Supreme Court’s decision, state court filings exploded as did the incidence of parallel litigation. In a landmark decision issued in 2020, the Delaware Supreme Court upheld FFPs as facially valid under Delaware corporate law,4 but expressly acknowledged the “‘down the road’ question of whether they will be respected and enforced by our sister states.”5

In Wong v. Restoration Robotics, Inc.,6 the First Appellate District Court of Appeal of the State of California became the first appellate court outside of Delaware to issue a published opinion addressing the enforceability of a FFP in a Delaware corporation’s charter. The case arose out of Restoration Robotics’ initial public offering. The plaintiff-stockholder brought a putative class action in California state court alleging that the company’s offering documents contained materially false and misleading statements in violation of the Securities Act. Relying on a FFP in the company’s certificate of incorporation, the trial court declined jurisdiction and entered a dismissal without prejudice in favor of the company.7

The Court of Appeal affirmed. In enforcing the FFP, the Court of Appeal rejected the plaintiff’s arguments that the FFP (i) contravened Congressional intent embodied in the Securities Act’s removal bar and anti-waiver provision; (ii) violated the Constitution’s Commerce Clause and Supremacy Clause; (iii) was invalid under California contract law; and (iv) was unenforceable because it was both unreasonable and unconscionable. Relying on Supreme Court precedent holding that arbitration provisions do not run afoul of the Securities Act’s jurisdiction and anti-waiver provisions, the Court of Appeal refused to recognize an unwaivable right to a state forum.8 And, applying California law, the Court of Appeal held that neither the plaintiff’s inability to bargain over the FFP nor the provision’s alleged lack of prominence in an exhibit to a lengthy registration statement rendered it unreasonable,9 and that there was nothing unconscionable about the FFP given the plaintiff’s ability to file suit in a local federal forum.10

The Court of Appeal’s decision in Wong is another important step toward solidifying the enforcement of FFPs, particularly in California which has become a hotbed for state court Securities Act claims. This comprehensive and well-reasoned decision should serve as an influential roadmap for courts throughout the country deciding whether to enforce FFPs.

Circuits Split over Validity of a Forum Selection Clause as Applied to Derivative Claims for Violations of Section 14(a) of the Securities Exchange Act of 1934

A different type of forum selection provision generated a Circuit split when the U.S. Court of Appeals for the Ninth Circuit issued a decision in Lee v. Fisher11 affirming the dismissal of a federal court derivative suit under Section 14(a) of the Securities Exchange Act of 1934 (“Exchange Act”). Unlike the federal forum provision discussed above, the forum selection provision at issue in Lee required “‘any derivative action or proceeding brought on behalf of the Corporation’ to be adjudicated in the Delaware Court of Chancery.”12 In enforcing this provision, the Ninth Circuit parted ways with the U.S. Court of Appeals for the Seventh Circuit which, a few months earlier, issued an opinion in Seafarers Pension Plan ex rel. Boeing Co. v. Bradway,13 holding a similar forum selection provision to be invalid in a virtually identical scenario.

Seafarers and Lee were both federal court derivative suits alleging claims under Section 14(a) of the Exchange Act, which prohibits material misstatements or omissions in proxy statements. Section 14(a) may be enforced in private actions by stockholders asserting their own rights and in derivative actions asserting rights of a corporation harmed by a violation. Unlike the Securities Act, which provides for concurrent jurisdiction in state and federal courts, the Exchange Act gives federal courts exclusive jurisdiction over suits filed under the Exchange Act. In both Seafarers and Lee, the company’s bylaws provided that the Delaware Court of Chancery was the exclusive forum for derivative suits. In both cases, the District Courts applied the forum bylaw provision and dismissed the claims over the plaintiff’s objection that doing so would foreclose suit entirely because only federal courts are empowered to hear Section 14(a) claims.14

On appeal, the Seventh and Ninth Circuits reached opposite conclusions—with the Seventh Circuit reversing and the Ninth Circuit affirming. In a split decision, the Seventh Circuit found that the forum provision was invalid as applied to the case because its application would violate Section 115 of the Delaware General Corporation Law. Section 115 provides, in part, that “bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State.”15 The majority reasoned that the forum bylaw provision violated Section 115 because it would “enable corporations to close the courthouse doors entirely on derivative actions asserting federal claims subject to exclusive federal jurisdiction.”16 It further reasoned that federal courts in Delaware are courts “in” that State.17 The majority distinguished prior Delaware cases upholding similar forum bylaw provisions as applied to different circumstances, noting, in part, that the provisions in these cases designated “where” and not “whether” stockholders may file suit.18 And it distinguished the Supreme Court’s decision in Bremen v. Zapata Off-Shore Co.19 favoring the enforcement of contractual forum selection clauses on the grounds that it involved a purely private commercial dispute and did not involve a claim under a federal statute with an anti-waiver provision.20

In contrast, the Ninth Circuit, relying on Bremen and its own precedent construing Bremen, upheld the validity of the forum bylaw provision. It held that neither the anti-waiver nor the exclusive jurisdiction provisions of the Exchange Act demonstrated a “strong public policy” rendering the forum provision unenforceable.21 It further reasoned that the plaintiff failed to prove a lack of “reasonable recourse” in Delaware, i.e., that she could not get any relief in the Delaware Court of Chancery if she could not bring a derivative Section 14(a) claim.22 Finally, the Ninth Circuit declined to follow Seafarers, both because the plaintiff failed to raise and thus waived any arguments under Section 115 of the Delaware General Corporation Law, and because “binding precedent forecloses reliance on the Exchange Act’s antiwaiver provision.”23

Given this newly emerging Circuit split, the application of bylaw provisions like those at issue in Seafarers and Lee to Section 14(a) derivative claims is uncertain. In a late-breaking development, the parties in Seafarers have reached a settlement that, if approved by the federal District Court and the Delaware Court of Chancery, will resolve the federal derivative claims and the follow-on Delaware action. The settlement agreement provides, among other things, for Boeing’s Board of Directors to amend the forum bylaw to allow Boeing’s stockholders to file exclusively federal derivative claims in the federal district courts for the District of Delaware and the Eastern District of Virginia (where Boeing’s headquarters is located). Given the Circuit split and the proposed settlement in Seafarers, it remains to be seen how this issue will ultimately play out in the courts and boardrooms.

Second Circuit Declines to Expand the Scope of “Scheme Liability” in Interlocutory Appeal Taken By SEC

In SEC v. Rio Tinto PLC,24 the U.S Court of Appeals for the Second Circuit affirmed the dismissal of the SEC’s scheme liability claims and rejected the SEC’s argument that alleged misstatements and omissions alone can support scheme liability under Section 10(b) of the Exchange Act, Rule 10b-5(a) and (c) promulgated thereunder,25 and Securities Act Section 17(a)(1) and (3).26 The SEC brought scheme liability claims against Rio Tinto, and its CEO and CFO, alleging that Rio Tinto should have impaired the value of a mine sooner than it did, and that the defendants made various misstatements and omissions about both the mine and its value in financial statements and auditing papers. Relying on the Second Circuit’s decision in Lentell v. Merrill Lynch & Co,27 which held misstatements and omissions cannot form the “sole basis” for liability under the scheme subsections, the District Court dismissed the SEC’s scheme liability claims. Thereafter, the SEC sought reconsideration in light of the Supreme Court’s decision in Lorenzo v. SEC, which held that an individual who disseminated a false statement (but did not make it) could be liable under the scheme subsections.28 The SEC argued that Lorenzo “expanded the scope of scheme liability so that allegations of misstatements and omissions alone are sufficient to state a scheme liability claim.”29 The District Court denied reconsideration, and the Second Circuit granted an interlocutory appeal to “determine whether, post-Lorenzo, misstatements and omissions alone can form the basis for scheme liability.30

The Second Circuit affirmed the dismissal of the SEC’s claims, holding that Lentell remains good law and that “misstatements and omissions can form part of a scheme liability claim, but an actionable scheme liability claim also requires something beyond misstatements and omissions, such as dissemination.”31 The court explained that misstatements or omissions were not the sole basis for scheme liability in Lorenzo; rather, the “dissemination of those misstatements was key.”32 In Lorenzo, the defendant sent two emails to prospective investors, the content of which was supplied by his boss, knowing that the information about asset value was false.33 Accordingly, even though he was the not the “maker” of the statements, his conduct of knowingly disseminating false statements was sufficient for scheme liability. The Second Circuit contrasted these facts with the District Court’s ruling that the complaint against the Rio Tinto defendants alleged “misstatements and omissions only.”34

In rejecting the SEC’s expansive reading of Lorenzo, the Second Circuit reasoned that “[w]ere misstatements and omissions alone sufficient to constitute a scheme, the scheme subsections would swallow the misstatement subsections.”35 The court explained that preserving distinctions between the subsections was important to ensure that private plaintiffs remain subject to the Private Securities Litigation Reform Act’s heightened pleading requirements applicable to claims premised on misstatements or omissions.36 Likewise, the court explained that “overreading Lorenzo would muddle primary and secondary liability,” which is an important substantive limitation on the scope of liability in actions brought by private plaintiffs.37

Rio Tinto is an important decision because it prevents private plaintiffs from being able to repackage misstatement claims as scheme liability claims to evade the protections of the PSLRA and limitations on secondary liability. However, the Second Circuit made clear that the scope of its ruling was “narrow” and that it had no occasion to decide what other actions, in tandem with misstatements or omissions, would be sufficient to demonstrate a scheme.38 The court noted, for instance that it did not consider whether “corruption of an auditing process” or “allegations that a corporate officer concealed information from auditors” are sufficient for scheme liability.39 Thus, while the Second Circuit’s decision in Rio Tinto maintains important distinctions between the misstatement and scheme subsections, the contours of those lines will continue to develop.


  1. Wong v. Restoration Robotics, Inc., 293 Cal. Rptr. 3d 226 (Cal. Ct. App. 2022).
  2. J. Jacobsen, A. Liu, and J. Streeter, Securities and Derivative Litigation: Quarterly Update (Feb. 4, 2022); J. Jacobsen & A. Liu, Securities and Derivative Litigation: Quarterly Update, Dechert LLP (Oct. 21, 2021); J. Jacobsen, A. Liu, and D. Kistenbroker, State Courts Continue to Enforce Federal Forum Provisions (Dec. 8, 2020).
  3. Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund, 138 S.Ct. 1061 (2018).
  4. Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020).
  5. Id. at 133.
  6. 293 Cal. Rptr. 3d 226.
  7. Wong v. Restoration Robotics, Inc., No. 18CIV02609, 2020 WL 6050540, at *1 (Cal. Super. Ct. Sep. 22, 2020).
  8. Wong, 293 Cal. Rptr. 3d at 238-40.
  9. Id. at 248-249.
  10. Id. at 251.
  11. 34 F.4th 777 (9th Cir. 2022).
  12. Id. at 779.
  13. See 23 F.4th 714 (7th Cir. 2022).
  14. Following the District Court’s decision in Seafarers, the plaintiff filed a class action complaint on behalf of Boeing stockholders against Boeing and certain current and former directors and officers of Boeing in the Delaware Court of Chancery seeking a declaratory judgment that Boeing’s forum bylaw violated Delaware General Corporation Law Sections 115 and 109(b) and alleging that the individual defendants breached their fiduciary duties by “maintaining and invoking” the forum bylaw, “failing to correct and/or rescind” the forum bylaw after the passage of Section 115, and “affirmatively asserting” the forum bylaw, including against plaintiff in the federal action. Defendants moved to dismiss the complaint, but the Delaware Court of Chancery stayed the action pending resolution of the Seventh Circuit appeal.
  15. Del. Code Ann. tit. 8, § 115 (West 2015) .
  16. Seafarers, 23 F.4th at 724.
  17. Id. at 720.
  18. Id. at 723 (citation and quotations omitted).
  19. 407 U.S. 1 (1972). The plaintiff has filed a petition for rehearing en banc that has not yet been decided.
  20. Seafarers, 23 F.4th at 725.
  21. Lee, 34 F.4th at 781-82.
  22. Id. at 782.
  23. Id.
  24. No. 21-2042, 2022 WL 2760323 (2d Cir. July 15, 2022).
  25. Rule 10b-5 provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5.
  26. Section 17(a) provides: It shall be unlawful for any person in the offer of sale of securities . . . by use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly—(1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” 15 U.S.C. § 77q.
  27. 396 F.3d 161 (2d Cir. 2005)
  28. 139 S.Ct. 1094 (2019).
  29. Rio Tinto plc, 2022 WL 2760323 at *1 (emphasis in original).
  30. Id. at *5.
  31. Id. at *2 (emphasis in original).
  32. Id. at *5 (emphasis in original).
  33. Lorenzo, 139 S. Ct. at 1096.
  34. Rio Tinto plc, 2022 WL 2760323, at *6.
  35. Id.
  36. Id. at *7.
  37. Id.
  38. Id. at *6.
  39. Id.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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