We all know that the federal securities laws prohibit insider trading, “pumping and dumping”, Ponzi schemes and market manipulation. But public shareholders and their lawyers have been working hard to expand this ignoble list. Capitalising on the #MeToo movement, motivated investors have been bringing compliance-related, securities fraud cases against unsuspecting corporations and their officers and directors. The stakes are high.

The plaintiffs in these under-the-radar litigations are not victims of sexual harassment or employment discrimination but corporate shareholders. These litigants contend that certain public companies’ written compliance policies contain material misrepresentations in their anti-discrimination and anti-harassment policies, and that shareholders consequently have been injured.

The companies’ codes of ethics and other compliance documentation certainly were not drafted for their investors, but the publicly available nature of these materials has opened the door to disgruntled shareholders seeking to recoup losses if a company’s stock price falls. Armed with a securities fraud lawsuit and a changing social landscape, these litigants shine yet another spotlight on the corporate world’s efforts to root out discrimination, combat sexual harassment and prevent employment retaliation. For this, the plaintiffs ask for reimbursement of their substantial investment losses in a bear market and other compensatory damages, maybe some injunctive relief and definitely a hefty attorneys’ fees award.

Usually suing for hundreds of millions of dollars, these securities fraud plaintiffs have increased the potential liability of public companies and their executives, slowly but steadily. Officers and directors at public companies—to avoid being on the receiving end of the next shareholder suit—should understand these growing litigation risks and how they intersect with corporations’ ever-developing compliance culture.

Inactionable ‘puffery’

The federal securities laws prohibit public companies and their personnel, in connection with the purchase or sale of any security, from employing “any device, scheme, or artifice to defraud”, making “any untrue statement of a material fact [or omission]” or engaging in “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person”. Relying on these laws, shareholders recently have alleged in different ways that companies and their officers misleadingly touted the companies’ cultures and compliance efforts, disclosure procedures and internal controls in compliance materials and elsewhere, while at the same time permitting or actively concealing sexual harassment and other misconduct in the workplace.

In response, however, New York federal courts, along with courts elsewhere, have repeatedly tossed a number of these plaintiffs’ fraud lawsuits this year. The judges have characterised most of the representations as legally insignificant “generic assertion[s]” and “puffery”. The highest federal appeals court in New York even stated pointedly that “general statements about reputation, integrity, and compliance with ethical norms are inactionable ‘puffery’”, and that they are “too general to cause a reasonable investor to rely upon them”.

The dismissal of these pretty novel securities fraud claims shows that corporations’ compliance materials usually contain aspirational declarations and should not form the basis of a federal securities law claims willy-nilly.

The exceptions

Public shareholders evidently know that if at first you don’t succeed, try, try again. Litigious investors have continued to bring compliance-related securities fraud lawsuits and have done so successfully in Construction Laborers Pension Trust for Southern California v. CBS Corporation and In re Signet Jewelers Ltd. Securities Litigation, not deterred by the series of recent dismissals.

A Manhattan federal court in CBS Corporation recently bucked the trend and allowed a securities fraud claim, brought by a pension fund and other public shareholders, to proceed. The court explained that while rare, a fraud claim will survive a motion to dismiss if the company was “wielding its code of conduct” to reassure investors there were no internal problems, or if the representations are “sufficiently concrete” for a reasonable investor to rely on them.

Consistent with this explanation, the court ruled that the plaintiffs asserted an actionable claim arising out of the chief executive officer’s public statement, made not in a code of conduct but at a Variety Magazine event, that “[#MeToo] is a watershed moment… It’s important that a company’s culture will not allow for this. And that’s the thing that’s far-reaching. There’s a lot we’re learning. There’s a lot we didn’t know.”

The court made clear that the CEO’s statement was material and misleading because it implied that the officer had not known about sexual harassment reports within CBS when he was “actively seeking to conceal his own past sexual misconduct from CBS and the public”.

Shareholders of Signet Jewelers sued the company and certain executives for securities fraud based on Signet’s alleged misrepresentations that it made employment decisions “solely” on the basis of merit and had “confidential and anonymous mechanisms for reporting concerns.” Earlier this year, the court denied defendants’ motion to dismiss, ruling that the representations were “directly contravened” by the plaintiffs’ allegations that the company conditioned employment decisions on whether female employees acceded to sexual misconduct and harassment.

The court observed that in the face of accusations of “rampant sexual harassment,” the company denied the accusations in SEC filings and “point[ed] to their corporate policies” to “reassure the investing public that Signet did not, in fact, have a toxic workplace[,]” and that a reasonable investor would rely on those statements. In March 2020, the defendants threw in the towel and the parties reached a settlement in the amount of $240m.

Unintended consequences

New York’s courts are beginning to allow securities fraud claims predicated on corporations’ false, compliance-related representations intended to reassure investors about the lack of sexual harassment or discrimination at the company. Since a lot of money is at stake, companies may reflexively start to scour their internal policies in order to water down their over-promises and bold expressions of cultural commitment, if they haven’t done so yet. Chief executives and other insiders certainly may be losing sleep, trying to determine what they did and didn’t utter at the most recent cocktail party. Besides these efforts to minimise risk (and sleepless nights), there may be pitfalls here for well-meaning corporate citizens.

The corporate ranks, to varying extents, have responded to the #MeToo movement, the zeitgeist of our era, attempting to augment the corporate culture of compliance and accountability. Yet there is a meaningful risk that this new and improved culture may get somewhat diluted if companies parse the nuances of their compliance verbiage in order to qualify or limit their commitments to broad, ethical principles. Of course, investors are entitled to complete and accurate information from corporations and to try to mitigate or avoid investment losses. But make no mistake: this shareholder litigation model very well may have a boomerang effect and hurt corporations’ cultural commitments and leave employees worse off.

There are important take-aways for corporate boards despite the outcomes in CBS Corporation and Signet Jewelers (besides “don’t commit or conceal sexual harassment”). Well-intentioned corporations should do the following:

• Take the prospect of these securities fraud claims seriously and recognise that they may subject your company and its executives to significant, potential liability.
• Conduct fulsome due diligence and ascertain your company’s potential exposure to these fraud claims and other potential lawsuits, including review, with counsel, of all codes of conduct, internal procedures and other compliance programmes.
• Implement and enforce corporate policies to proactively avoid sexual harassment, discrimination and other misconduct (and most employers in New York State are required to adopt a sexual harassment prevention policy including certain specified content).
• Encourage all executives to exercise care with public statements including any statements in public filings, and also those made at social events, on social media accounts, in articles, on websites and the like.
• Foster a culture of compliance and respect in the workplace—the best panacea to compliance-related securities fraud claims and a lot of other problems too.

The developing case law suggests that general declarations of corporate ethics and morality are usually aspirational and not legally actionable. However, the wave of securities fraud lawsuits and the recent judicial decisions and settlements, in this #MeToo age, cannot be ignored. Corporations and their management, the potential targets of these claims, should be thoughtful and circumspect in formulating and executing compliance policy in order to minimise risk, liability, and litigation headaches down the road.

Marc Rosen chairs the litigation & risk management department at law firm Kleinberg Kaplan.