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Looking back, 2022 was light on groundbreaking appellate-level securities decisions. The U.S. Court of Appeals for the Second Circuit, however, closed out the year with a notable decision in Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd.,1 articulating a new, restrictive conception of the purchaser-seller rule that limits the class of plaintiffs with standing to recover under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Rejecting a test that would require only a “direct relationship” between the alleged misrepresentation and the price of a security bought or sold, the Second Circuit limited Section 10(b) standing to plaintiffs “who purchased or sold the securities about which a material misstatement was made.”2 The decision closes the door, at least in the Second Circuit, on claims by purchasers or sellers of the securities of one company, based on alleged misstatements about another, even if the two companies are merging and their prospects (and share prices) are inherently linked. The influence of the decision in other circuits, where case law on the purchaser-seller rule is sparse, remains to be seen.
Endorsed by the Supreme Court nearly 50 years ago in Blue Chip Stamps v. Manor Drug Stores, the purchaser-seller rule limits “the plaintiff class for purposes of a private damage action under § 10(b) and Rule 10b-5 . . . to actual purchasers and sellers of securities.”3 The Supreme Court found support for the rule in the text of the Securities Exchange Act of 1934 and the Securities Act of 1933, widespread acceptance of the rule in lower courts, and Congress’s repeated rejection of attempts to expand the scope of the judicially created cause of action under Section 10(b) and Rule 10b-5.4 The Court also expressed concern about “the danger of vexatious litigation which could result from a widely expanded class of plaintiffs under Rule 10b-5.”5 Applying the rule, the Court denied Section 10(b) standing to plaintiffs who allegedly refrained from buying a company’s stock, and thus missed the opportunity to profit from a rise in share price, due to defendants’ unduly pessimistic statements about the company’s prospects.6
While Blue Chip Stamps clearly required a purchase or sale of a security for Section 10(b) standing, it did not define precisely what that security must be, other than the statement that plaintiffs must “at least [have] dealt in the security to which the prospectus, representation, or omission relates.”7 That was the issue in Frutarom. There, the plaintiffs were a putative class of investors who acquired shares of International Flavors & Fragrances Inc. (IFF), a publicly traded U.S.-based seller of flavoring and fragrance products, between May 2018 and August 2019. In May 2018, IFF announced its agreement to acquire Frutarom Industries Ltd., an Israel-based company in the same industry. Plaintiffs alleged that following the announcement, Frutarom made materially misleading statements about its compliance with anti-bribery laws and the sources of its business growth, which IFF incorporated into its public filings. The merger closed in October 2018, and Frutarom became a wholly owned subsidiary of IFF. Almost a year later, IFF publicly acknowledged that in advance of the merger, Frutarom had made “improper payments”—i.e., bribes—“to representatives of a number of customers.” IFF’s share price dropped by nearly 16% after the announcement.
Plaintiffs filed suit in the Southern District of New York, asserting violations of Section 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against two sets of defendants: IFF and two of its officers, and Frutarom and five of its officers. The district court (Hon. Naomi Reice Buchwald) dismissed all of plaintiffs’ claims, ruling that plaintiffs did not adequately allege that Frutarom’s misconduct continued into the class period, and that the alleged misrepresentations were neither actionable nor material.8 The district court also held that “plaintiffs lack[ed] statutory standing under Section 10(b) to bring claims against the Frutarom defendants for statements made about Frutarom.”9 Plaintiffs appealed the dismissal order to the Second Circuit, but only with respect to their claims against Frutarom and its officers.
The Second Circuit’s Decision
A Second Circuit panel affirmed, with the majority holding that plaintiffs lacked standing to sue “based on alleged misstatements about Frutarom because they never bought or sold shares of Frutarom.”10 The majority opinion authored by Judge Michael H. Park cited “the advantages of limitations” to a Section 10(b) cause of action recognized in Blue Chip Stamps, including “the danger of vexatious litigation that could result from a widely expanded class of plaintiffs.”11 The majority interpreted Blue Chip Stamps—in particular, the statement that plaintiffs must have “at least dealt in the security to which the prospectus, representation, or omission relates”—as creating a bright-line rule limiting Section 10(b) standing to plaintiffs “who purchased or sold the securities about which a material misstatement was made.”12 Plaintiffs—purchasers of IFF shares only—lacked standing because the alleged misstatements, pertaining only to Frutarom’s compliance with anti-bribery laws and the source of its business growth, were “about Frutarom,” not about IFF.13
The majority also quashed plaintiffs’ advocacy for a “direct relationship” test that would confer standing based on the linkage between Frutarom’s misstatements and the price of the IFF shares. Construing “narrowly” the judge-made cause of action under Section 10(b), the majority explained that contrary to Blue Chip Stamps, a “direct relationship” test would lead to a “case-by-case erosion” of the purchaser-seller rule, and require a “shifting and highly fact-oriented inquiry” to determine standing.14 The majority disagreed that the Second Circuit had adopted a “direct relationship” test in its 2004 decision Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp.15 Rather, Nortel denied standing for claims by purchasers of shares of one company, JDS Uniphase Corporation, against another company, Nortel Networks Corporation, which had acquired a business unit of JDS. To the extent Nortel left open whether a “potential merger,” as opposed to the sale of a business unit, “might require a different outcome,” the Frutarom majority explicitly held that “purchasers of a security of an acquiring company do not have standing under Section 10(b) to sue the target company for alleged misstatements the target company made about itself prior to the merger between the two companies.”16
Although concurring in judgment, Judge Myrna Pérez criticized the majority’s rejection of a “direct relationship” test. According to Judge Pérez, the Second Circuit, in Nortel and subsequent decisions, had focused on “the significance of the relationship between alleged misstatements and plaintiff’s purchase of the securities” in assessing Section 10(b) standing.17 In Judge Pérez’s view, the majority’s test—which limits standing to purchasers or sellers “of securities about which a misstatement was made”—not only conflicted with Second Circuit precedent, but may be confusing to litigants and difficult to apply in different factual scenarios.18 The “formalism” of the majority’s new test, Judge Pérez worried, could lead to “undesirable” consequences, “exclud[ing] plaintiffs who have in fact been damaged by violations of Rule 10b-5.”19 Judge Pérez believed that the Frutarom case could be disposed of simply by applying Nortel (the relationship between IFF and Frutarom was no more “direct” than between JDS and Nortel), and she would have stopped there.
1 54 F.4th 82 (2d Cir. 2022).
2 Id. at 85, 88.
3 421 U.S. 723, 730-31 (1975).
4 Id. at 731-35.
5 Id. at 740.
6 Id. at 754-55.
7 Id. at 747 (emphasis added).
8 Menora Mivtachim Ins. Ltd. v. Int’l Flavors & Fragrances Inc., 19 Civ. 7536 (NRB), 2021 WL 1199035, at *9-23 (S.D.N.Y. Mar. 30, 2021).
9 Id. at *29.
10 Frutarom, 54 F.4th at 84. Judge William J. Nardini joined Judge Park in the majority opinion. Judge Myrna Pérez filed a concurring opinion.
11 Id. at 85-86 (quoting Blue Chip Stamps, 421 U.S. at 740).
12 Id. at 85 (emphases added).
13 Id. at 86.
14 Id. at 86-87 (quoting Blue Chip Stamps, 421 U.S. at 755).
15 369 F.3d 27 (2d Cir. 2004).
16 Frutarom, 54 F.4th at 88 (quoting Nortel, 368 F.3d at 34).
17 Id. at 90-91 (Pérez, J., concurring).
18 Id. at 91.
19 Id. at 94-95 (quoting Blue Chip Stamps, 421 U.S. at 743).
20 Id. at 88.
22 Id. (quoting In re NYSE Specialists Sec. Litig., 503 F.3d 89, 102 (2d Cir. 2007)).
23 IFF, 2021 WL 1199035, at *31 (citing Semerenko v. Cendant Corp., 223 F.3d 165, 169 (3d Cir. 2000), and Griggs v. Pace Am. Grp., Inc., 170 F.3d 877, 878-80 (9th Cir. 1999)).
24 Id. (citing Zelman v. JDS Uniphase Corp., 376 F. Supp. 2d 956 (N.D. Cal. 2005), and In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2004 WL 1435356 (S.D.N.Y. June 28, 2004)).
26 Id. at *32.
27 Griggs, 170 F.3d at 878-80.
28 Cendant Corp., 223 F.3d at 169.
29 Blue Chip Stamps, 421 U.S. at 737-38.