I call your attention this week to Chief Judge Marbley’s opinion in in re FirstEnergy Securities Litigation, 2022 U.S. Dist. LEXIS 39308 (S.D. Ohio Mar. 7, 2022), sustaining the securities fraud complaint against FirstEnergy and various additional defendants.  To some extent, the decision was unsurprising; Chief Judge Marbley sustained similar allegations in a parallel derivative 14(a) claim last year, but there are still some things here I want to highlight.

The basic claim is that FirstEnergy bribed Ohio politicians to secure a public bailout of failing nuclear plants, and lied about it to investors.  When the scandal came to light, the fallout was dramatic, resulting in, among other things, a criminal case against FirstEnergy and a plunge in its stock price.

I’m going to talk about two aspects of the decision.

First, many of the public lies were relatively generic statements to the effect that FirstEnergy’s political donations and lobbying activities complied with all laws, and that the company had a system of internal controls to ensure that this was the case.  (Sidebar: Speaking of generic statements, I assume everyone saw the news that the Second Circuit granted Goldman Sachs’s third 23(f) petition in the Arkansas Teachers case?  I guess the third time wasn’t the charm, for the plaintiffs, anyway).  Anyhoo, these are the kinds of statements that might under other circumstances be dismissed on puffery grounds, but the court focused here on how FirstEnergy’s shareholders cared enough about its lobbying to seek greater disclosure through a Rule 14a-8 proposal.  FirstEnergy, in opposing that proposal, made some of the challenged statements.  As the court put it, “Representations about the Company’s lobbying activities and legal compliance—which in other cases might be bland and innocuous—take on a different character when, as alleged, they were proffered in response to specific shareholder concerns and served to further the scheme through distraction and concealment.”  Later in the opinion, in response to defendants’ challenges to materiality, the court said: “several of these compliance statements were offered as reasons to vote against a shareholder proposal for increased oversight of lobbying policies and payments.  Context changes the meaning of those statements from aspiration to assurance; the speakers are claiming that increased oversight is not necessary because the Company is compliant and has effective controls.  That assurance—which, importantly, helped to shield the scheme from detection—was misleading and more than mere ‘puffery’ or ‘corporate cheerleading.’”

Similarly, the court held that, in this context, the corporate “Code of Conduct and Director Code of Conduct, espousing ‘high ethical standards,’ ‘fair dealing,’ and ‘compliance with the law’” constituted actionable misstatements.

I am fascinated by these holdings.  It’s a relatively novel use of the shareholder proposal mechanism (although I have to draw parallels to the Oracle court’s use of say-on-pay votes as evidence that a director who sat on the compensation committee, and ignored those votes, lacked independence Larry Ellison).  There are so many shareholder proposals on ESG topics; political activities are a fairly routine subset.  It would be fascinating if company opposition to these proposals was regularly treated as more material than ordinary company boilerplate, and thus became a backdoor way to strengthen Section 10(b) as a mechanism for policing ESG-like disclosures.  (I have previously written that under current doctrine, 10(b) does not do a very good job of this).

And frankly, I thought by this point, most courts were treating corporate codes of conduct as immaterial as a matter of law.  Usually, courts say something to the effect that codes of conduct are not promises, but merely “aspirational.”  Here, the court engaged in what I believe is the proper analysis – it held that you can’t call something aspirational if you weren’t even trying to behave in accordance with the code, i.e., as the court put it “The Company’s Code of Conduct and Director Code of Conduct false or misleading in that they were presented to shareholders in proxy statements but allegedly were being disregarded intentionally by the Company and its senior management. The Company later would admit to violations of these policies in a series of executive firings.”

That’s the first thing.

Second is the use of scheme liability to draw in nonspeaking defendants.  After Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), it seemed like nonspeaking defendants were free and clear of potential Section 10(b) liability, but then in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), the Supreme Court held that even nonspeakers might be liable for participation in a fraudulent scheme.  

At the time, it was not obvious if this holding would redound to the benefit of private plaintiffs (as opposed to the SEC) given the constraints imposed by Stoneridge Investment Partners, LLC v. Scientific-Atlanta, 552 U.S. 148 (2008), but since then, some claims have gotten through, and FirstEnergy is the latest example.  The court held that certain officers who participated in the scheme by having discussions with the public officials who were bribed, overseeing media efforts, and coordinating political activities and lobbying, had potentially violated 10(b), and refused to dismiss claims against them.  Relying on West Virginia Pipe Trades Health & Welfare Fund v. Medtronic, 845 F.3d 384 (8th Cir. 2016), the court held that the scheme consisted of producing a “public-facing product” (the bailout and the misleading nature of FirstEnergy’s support), and these behind-the-scenes activities contributed to that product.  Notably, one of the defendants subject to this theory was the corporation’s general counsel and chief legal officer, who, quoting the court:

is alleged to have overseen “the Company’s fulfillment of its legal and ethical obligations, internal control policies and procedures and adherence to internal control, risk management and compliance guidelines,” and to have been terminated for “conduct” in support of the scheme as well as his failure to prevent it.

According to the plaintiffs, this defendant was eventually fired for ““inaction and conduct that the Board determined was influenced by the improper tone at the top.”

So. Let that be a lesson to you.