I’ve previously blogged about confusion regarding Section 10(b)’s requirement that a false statement be made “in connection with” a securities trade, when the speaker is a subsidiary of the securities’ issuer.  We have a new entry in the genre in In re Volkswagen AG Sec. Litig., 2023 U.S. Dist. LEXIS 43031 (E.D. Va. Mar. 14, 2023).

This case concerns Volkswagen’s stupid joke from two years ago where it announced that it was changing its name to “Voltswagen,” which roiled the stock for a couple of days until the company admitted that it was just kidding.  An equally stupid securities fraud lawsuit naturally followed, resulting in what is actually a fairly baffling dismissal.  Because whatever one thinks of the claim or its merits, the legal reasoning matters, not just for this case but for future cases. 

The setup:

Volkswagen is a German company, and its stock is not listed on a U.S. exchange.  Its “unsponsored” ADRs trade in the U.S. 

VWGoA is Volkswagen’s American subsidiary.  It is wholly owned by Volkswagen.

The original press release announcing the name change came from VWGoA and its officers, who posted it to the VWGoA website on March 29, 2021.  The press release was taken down, but news media got wind of it, and it popped back up again on March 30, 2021, including quotes from VWGoA’s CEO.  A Volkswagen twitter account – apparently controlled by VWGoA – also announced the change.  VWGoA’s Head of Technology confirmed the story to the Associated Press.  By the close of business on March 30, though, the press release was gone again, and the WSJ was reporting that it was all a joke.

The price of ADRs fell in response, and investors filed a Section 10(b) lawsuit against Volkswagen, VWGoA, VWGoA’s CEO, and VWGoA’s Head of Technology.

In dismissing the complaint, the court actually took the claims seriously, and conducted a thorough analysis of some of the knotty issues concerning Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), but I think its reasoning faltered when it came to the ultimate holding.

The first issue: did plaintiffs allege a “domestic transaction” for Morrison purposes?  In Stoyas v. Toshiba Corp., 896 F.3d 933 (9th Cir. 2018), the Ninth Circuit held that if the ADRs are traded in the U.S., transactions in them are domestic for Morrison purposes.  If they are unsponsored – the subject company truly had no involvement in their creation – there might be a question whether the subject company’s false statements are made in connection with a domestic transaction, but the transaction itself remains domestic and subject to U.S. law.

The Volkswagen court followed this reasoning, and concluded that the plaintiffs’ ADR purchases were domestic.  (Recently, the district court in Toshiba held that even a domestic ADR purchase might be treated as “foreign” if it involved the creation of a new ADR via an overseas purchase of the underlying shares, Stoyas v. Toshiba Corp., 2022 WL 220920 (C.D. Cal. Jan. 25, 2022), but the Volkswagen court questioned that reasoning, see op. at *32 n.8, and in any event, found that such determinations were inappropriate on a motion to dismiss). 

So. Domestic purchase.

Next, the court turned to the potential liability of the Volkswagen parent.  And here, the court employed Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135 (2011) to hold that the plaintiffs had not alleged sufficient facts to show that Volkswagen had exercised “ultimate authority” over the statements issued by VWGoA; therefore, Volkswagen had not “made” a statement for Janus purposes.

I mean, I could go on a riff about the artificiality of treating Volkswagen as distinct from its wholly-owned subsidiary, which the court recognized as being completely under the control of its parent, but the court gave the plaintiffs leave to replead on this and I’ll skip it. 

That left the liability of VWGoA and its officers.  The court agreed that the officers had acted at least recklessly when issuing the press release, their scienter could be attributed to VWGoA, and that plaintiffs had established materiality and loss causation. 

So, the court turned to the defendants’ arguments that, because the ADRs were unsponsored, any statements by VWGoA were not made “in connection with” ADR transactions.

The court first held that, given the relationship between the subsidiary and the parent, the statements by VWGoA were not so attenuated from securities of Volkswagen as to eliminate 10(b) liability.  Op. at *67. 

The court next held that, while it was possible that statements about underlying securities may not be made “in connection with” unsponsored ADRs, in this case, plaintiffs had sufficiently alleged that Volkswagen had had some approval power/involvement with the creation of the ADRs, such that statements about Volkswagen stock would also be “in connection with” its ADRs.  The court thus concluded, “because Plaintiffs have implicated a specific depositary institution, which has publicly confirmed it requires the approval of the foreign issuer prior to launching an unsponsored ADR program, Plaintiffs’ allegations provide a plausible basis that the alleged misstatement ‘touches’ or ‘coincides’ with ‘the purchase or sale of any other security in the United States.’” Op. at *70-71.

Finally, the court held that the statements themselves were distributed in a medium on which investors would rely: “Plaintiffs have adequately averred that VWGoA publicly disseminated a press release on multiple occasions and that such announcement was material. Not only did the announcement itself detail an upcoming significant rebranding effort by the Company across North America, but it also generated a widespread public response.  Given the alleged seriousness with which the market perceived the name change, it is entirely reasonable that investors would have relied upon the press release.” Op. at *71.

But did the claims against the VWGoA defendants survive?

They did not.  The court concluded:

This Court will not contravene Janus by holding that the statements of a non-publicly traded wholly-owned subsidiary and its employees may be actionable upon the parent issuer when the Amended Complaint fails to adequately plead that the alleged material misstatements may be attributed to the parent issuer. Without a plausible theory of liability ascribed to the issuer, Plaintiffs’ purchase or sale of Volkswagen ADRs cannot be said to “touch[]” or “coincide” with the alleged false statements of the Individual Defendants and VWGoA.

In sum, Plaintiffs have sufficiently alleged that Volkswagen continues to play an active role in the unsponsored ADR program and that it was reasonable for investors to rely upon those alleged false statements. But they have not sufficiently pleaded that the alleged false statements by the Individual Defendants and VWGoA “coincide” with or “touch[]” the ADRs purchased by Plaintiffs because the issuer of the underlying securities has not been shown to be liable under § 10(b).

Op. at *72-73.

I … do not follow.  The court seems to be hung up on Volkswagen’s liability, when the question of the liability of VWGoA and its officers is distinct.  Why should VWGoA’s liability for false public statements turn on whether Volkswagen parent is liable?  We have three actors: VWGoA, its CEO, and its head of tech, all of whom, with scienter, made false statements about Volkswagen’s business – about, the court found, Volkswagen’s securities – in a medium on which investors would (and did) rely.  It’s now well-established – the court even says in its opinion, at *65-66 – that actors other than issuers can be liable for issuing fraudulent statements in connection with the issuers’ securities.  Analysts, auditors, brokers, all might lie about a company’s securities; the company may be entirely innocent, but that does not absolve the speaker.  If I adopt some kind of pseudonymous identity and go online and make false statements about a publicly traded security, I would surely expect the SEC to come after me, even if the issuer had nothing to do with it.  

Nonetheless, the court seemed to hold, that logic only extends to actors who are independent of the issuer.  It does not extend to actors who are related to the issuer, such as wholly owned subsidiaries.  Those speakers, uniquely, get a free pass.

In other words, VWGoA and its officers escape liability because there is both too much control by Volkswagen – it would contravene Janus to hold a controlled subsidiary liable for statements it actually made about its parent – and too little, because there was not enough control by Volkswagen to make Volkswagen the legal “maker” of the statements.

Notably, the court’s holding would seem to create an open season for subsidiaries to make false statements about parent companies – which is particularly bizarre because, earlier in its opinion, that’s exactly what the court wanted to avoid:

For purposes of standing, Plaintiffs’ fulsome allegations demonstrate the appropriateness of extending Rule 10b-5’s reach to securities of a parent company, when that parent company exercises substantial involvement over the day-to-day operations of a wholly-owned subsidiary alleged to have violated federal securities laws. If this were not so, issuers exercising such concrete control over their subsidiaries would never be legally responsible for the statements of their non-publicly traded wholly-owned subsidiaries. That would reward issuers with a scapegoat mechanism through their unlisted subsidiaries to avoid§ 10(b)’s remedial scheme.

Op. at *66-67. 

Yes!  I agree!  But still, the court says there’s no liability even for the subsidiary that made the statements, with scienter.

In any event, the plaintiffs have leave to replead (including to replead Volkswagen’s involvement in the whole thing), so we’ll see what happens.

Some word counts that may be of interest to BLPB readers (please check my work and let me know if I’ve gotten any of these wrong):

Compare word counts for “Wachtell Lipton Discusses Larry Fink’s [2023] Annual Letters to Investors“: “ESG” = 0; “stakeholder” = 6; “stakeholder capitalism” = 2.

Addendum: The Wachtell post notes that “[f]or more than ten years, Larry Fink, Chairman and CEO of BlackRock, the world’s largest asset manager, has published separate annual letters — one to CEOs and another to BlackRock’s shareholders. This year, Fink combined the two letters into one.”

Dear BLPB Readers,

Professor Nadav Orian Peer at the University of Colorado Boulder Law School shared that tomorrow, Wednesday March 15th at 2pm ET (noon MT), there will be a “virtual teach-in at Colorado Law about SVB and its significance.”  Interested readers can join the event at:  www.cu.law/svb