Securities Regulation Daily CEO’s questionable ethics not enough to assert securities violations
Thursday, January 19, 2017

CEO’s questionable ethics not enough to assert securities violations

Addressing the narrow issue of whether shareholders may bring a claim for securities fraud when a CEO and Chairman violates the corporate code of ethics after publicly touting the business’s high standards for ethics and compliance, the Ninth Circuit has affirmed the lower court’s holding that Hewlett Packard (HP) shareholders failed to plead fraud against the company and its former CEO (Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co., January 19, 2017, Christensen, D.).

Scandal. In 2010, HP’s then-CEO was caught in a scandal with an independent contractor after the contractor made claims of sexual harassment. An investigation by HP’s Board revealed that the CEO had misrepresented the amount of time he spent with the contractor and that he doctored expense reports on several occasions and even provided the contractor with confidential inside information about an impending merger. The investigating law firm did not find evidence of sexual harassment or insider trading, but it concluded that the CEO falsified expense reports and lied about his relationship with the contractor.

The CEO resigned from HP shortly after the investigation concluded and HP’s share price dropped, resulting in an alleged loss of $10 billion.

District court. In August of 2013, the Northern District of California granted leave to cure deficiencies in a shareholders complaint which asserted that the company was recovering from a 2006 scandal and that the CEO’s commitment to ethical conduct was key to success of the company and that both he and HP made false and misleading statements when they issued and updated HP’s Standards of Business Conduct Brochure (SBC) in 2006, 2008, and 2010, as well as in HP’s 10-K and 10-Q, throughout the class period.

On June 30, 2014, the Northern District of California again granted HP’s motion to dismiss but this time it was addressing plaintiff’s second amended complaint and it did so with prejudice, explaining that the plaintiffs failed to state a claim for relief under Exchange Act Section 10(b). The plaintiff’s Section 20(a) claim failed because it was not predicated upon an adequately pleaded Exchange Act violation.

Ninth Circuit. The Ninth Circuit agreed with the lower court’s holding that the plaintiff’s second amended complaint failed to allege materiality and falsity, explaining that the statements made by HP and the CEO regarding the SBC were aspirational in nature and emphasized a desire to commit to certain shared values.

Despite the CEO’s actions running contrary to HP’s SBC, the court simply could not agree with the shareholders’ assertions that affirmative statements made by the CEO and HP regarding HP’s SBC created an impression of full compliance with the SBC; thus, neither HP or the CEO had a duty to disclose the CEO’s misuse of his authority and misbehavior in violating the company’s SBC.

The Ninth Circuit’s panel determined that there were no material misrepresentations or actionable material omissions and held that the shareholders failed to state a claim for securities fraud because they failed to sufficiently allege that the defendants made a material misrepresentation or misleadingly omitted a material fact.

The case is No. 14-16433.

Attorneys: Lionel Z. Glancy (Glancy Binkow & Goldberg LLP) and Ira M. Press (Kirby McInerney LLP) for Retail Wholesale & Department Store Union Local 338 Retirement Fund. Joseph Edward Floren (Morgan, Lewis & Bockius LLP) for Hewlett-Packard Co.

Companies: Retail Wholesale & Department Store Union Local 338 Retirement Fund; Hewlett-Packard Co.

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