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Obasi Investment Ltd v. Tibet Pharmaceuticals, Inc.

United States Court of Appeals, Third Circuit

July 23, 2019

OBASI INVESTMENT LTD; JINGLI SHAO; ROBIN JOACHIM DARTELL; LIXIN WU; JASON HELTON; SEAN CARITHERS, individually and on behalf of all others similarly situated

          Argued February 12, 2019

          On Appeal from the United States District Court for the District of New Jersey (D.C. No. 2-14-cv-03620) District Judge: Hon. John M. Vazquez

          A. Neil Hartzell [Argued] Freeman Mathis & Gary Attorney for Appellant L. McCarthy Downs, III

          Michael P. Tremonte [Argued] Justin J. Gunnell Sher Tremonte Attorneys for Appellant Hayden Zou

          Laurence M. Rosen [Argued] Rosen Law Firm Keith R. Lorenze Rosen Law Firm Attorneys for Appellees

          Before: HARDIMAN, SCIRICA, and COWEN, Circuit Judges.



         This case comes to the Court as a certified interlocutory appeal. The sole question presented is whether, under Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k, a nonvoting board observer affiliated with an issuer's placement agent is a "person who, with his consent, is named in the registration statement as being or about to become a director[ ] [or] person performing similar functions . . . ." Id. § 77k(a)(3).

         We think not. As required by the text of § 77k(a)(3), our inquiry begins and ends with the registration statement's description of the Defendants. We hold as a matter of law that the Defendants' functions are not "similar" to those that board directors perform, so we will reverse the District Court's order and direct the entry of summary judgment for the Defendants.


         Tibet Pharmaceuticals, Inc. is a holding company. Through an array of parent-subsidiary relationships and contractual rights, Tibet "effectively control[led]" Yunnan Shangri-La Tibetan Pharmaceutical Group Limited (Yunnan), an operating company that manufactured and sold traditional Tibetan medicines. Dartell v. Tibet Pharm., Inc., 2017 WL 1944106, at *2 (D.N.J. May 10, 2017). This case involves Tibet's attempt to raise capital for those operations through an initial public offering (IPO).

         Hayden Zou was an early investor in Tibet and the sole director of China Tibetan Pharmaceuticals Limited, a wholly owned subsidiary of Tibet. Tibet's ability to control Yunnan flowed through China Tibetan. In late 2009, Zou told L. McCarthy Downs, III, a managing director at the investment bank Anderson & Strudwick, Inc. (A&S), about Tibet. The two discussed the prospect of a Tibet IPO, and A&S later agreed to serve as Tibet's placement agent. Zou and Downs then worked together to bring Tibet public. Tibet's IPO registration statement became effective in late 2010.

         Zou and Downs were neither signatories to the registration statement nor named in it as directors of Tibet. Instead, they were listed as nonvoting board observers chosen by A&S. Though Zou and Downs would have no formal powers or duties, the registration statement explained "they may nevertheless significantly influence the outcome of matters submitted to the Board of Directors for approval." App. 178.

         As it turned out, the registration statement[2] omitted material negative information about Yunnan's finances. Yunnan had defaulted on a loan from the Chinese government a few months before Tibet's registration statement became effective and that default led to a judgment that required repayment within 60 days. Though the registration statement described a "long term loan," it said nothing about the default judgment.

         Just before Tibet filed its amended final prospectus, the Chinese government froze all of Yunnan's assets. Tibet did not disclose that either. The IPO closed soon thereafter, and Tibet and its underwriters offered 3 million shares to the public at $5.50 per share. But Yunnan still hadn't paid what it owed, so the Agricultural Bank of China auctioned off the company's assets. This prompted the NASDAQ to halt trading in Tibet's stock, and its price plummeted.

         Plaintiffs sued Zou, Downs, Tibet, A&S, the IPO's auditor, and several other Defendants on behalf of a class of stock purchasers. As relevant to this certified interlocutory appeal, Plaintiffs alleged Zou and Downs violated Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k(a).


         Section 11 imposes near-strict liability for untruths and omissions made in a registration statement. See In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 269 (3d Cir. 2006). Unlike antifraud cases, a § 11 plaintiff need not allege scienter, reliance, [3] or loss causation. See In re Constar Int'l Inc. Sec. Litig., 585 F.3d 774, 782-783 (3d Cir. 2009); In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir. 2010). Congress imposed this in terrorem liability on those best positioned to ensure accurate disclosure. In re Lehman Bros. Mortg.-Backed Sec. Litig., 650 F.3d 167, 181 (2d Cir. 2011) (citing Herman & MacLean v. Huddleston, 459 U.S. 375, 381- 82 & n.13 (1983)).

         Because § 11 is such strong medicine, and to meet its purpose of enforcing accurate registration statement disclosure, it applies only to limited and enumerated categories of defendants. See Herman & MacLean, 459 U.S. at 381-82; Lehman Bros., 650 F.3d at 185 ("It is precisely because § 11 'gives rise to liability more readily,' however, that it is [sic] applies 'more narrowly' than § 10(b)." (quoting Morgan Stanley, 592 F.3d at 359-60)). Among those defendants is "every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner." 15 U.S.C. § 77k(a)(3).

         The District Court, finding there were material issues of fact about whether Zou and Downs had been named as people "performing similar functions to a director," Dartell, 2017 WL 1944106, at *12, denied summary judgment. At the outset, the Court held that only the Defendants' description in the registration statement itself is relevant to the inquiry. Turning to the merits, the Court observed Zou and Downs were named in the registration statement as about to become "board observers" appointed by Tibet's placement agent. In a section titled "Relationship with our Placement Agent," the registration statement describes their role:

         We will have an ongoing relationship with our Placement Agent that may impact our shareholders' ability to impact decisions related to our operations.

In connection with this offering, we have agreed to allow our Placement Agent to designate two non-voting observers to our Board of Directors until the earlier of the date that: (i) the investors that purchase shares in this offering beneficially own less than five percent (5%) of our outstanding shares; or (ii) the trading price per share is at least [$24 per share] for any consecutive 15 trading day period. Although our Placement Agent's observers will not be able to vote, they may nevertheless significantly influence the outcome of matters submitted to the Board of Directors for approval.

App. 178; see App. 230.

         After acknowledging that Zou and Downs would not be able to vote, the District Court observed "they may nevertheless significantly influence the outcome of matters submitted to the Board of Directors for approval." Dartell, 2017 WL 1944106, at *10. In the Court's view, because Zou and Downs had the power to "influence," this meant they "arguably had more influence than any individual board member, who could only cast a single vote." Id. "The Court's only hesitation" in denying summary judgment was that the registration statement used the word "may" rather than "shall" or "will." Id. at *11. That meant it "was not necessarily mandatory that the Board Observers exercise their 'significant influence.'" Id. Still, the Court determined that whether Zou and Downs were covered by § 11 was a jury question. Id.

         Zou and Downs moved for certification of that order under 28 U.S.C. § 1292(b). The District Court granted the motion, finding the underlying legal question-whether Zou and Downs could be liable under § 11-met the requirements of § 1292(b). First, the District Court found the question was a controlling question of law, because its conclusion would create reversible error if we disagreed on appeal. Second, the District Court found there was substantial ground for difference of opinion, despite the question being one of first impression in the courts of appeals, because "Section 11 is narrowly construed" and reasonable jurists could therefore disagree with its conclusion. Dartell v. Tibet Pharm., Inc., 2018 WL 994896, at *5 (D.N.J. Feb. 21, 2018). Finally, the Court thought an interlocutory appeal would materially advance the ultimate termination of the litigation, because it had already granted summary judgment for Zou and Downs on all counts save the one alleging § 11 liability. If we disagreed with the District Court, the litigation would thus be at an end. So the District Court certified the following question:

Can Defendants be potentially liable under Section 11 of the Securities Act of 1933, each as a "person performing similar functions" to a director, in light of Defendants' role as board observers who could (but did not necessarily have to) significantly influence the outcome of matters submitted to the board of directors for approval?

Order at 2, No. 2-14-cv-03620 (D.N.J. Feb. 21, 2018), ECF No. 313. We granted Zou and Downs's timely Petition for Permission to Appeal and now reverse.[4]


         The Securities Act does not define "director," so we turn to dictionary definitions from the time Congress enacted the statute. See New Prime Inc. v. Oliveira, 139 S.Ct. 532, 539 (2019). "Director" could mean "[o]ne who . . . directs, rules, or guides; a guide, a conductor; 'one that has authority over others; a superintendent; [or] one that has the general management of design or work.'" Director, Oxford English Dictionary 392 (1st ed. 1933). Or, in a more specialized sense related to business organizations, it could mean "[a] member of a board appointed to direct or manage the affairs of a commercial corporation or company." Id.; see Directors, Black's Law Dictionary 581 (3d ed. 1933) (defining "director" as a "person[ ] appointed or elected according to law, authorized to manage and direct the affairs of a corporation or company").

         Because § 77k(a)(3) also lists "partner[s]" (in context, another business organization title) and because § 77k(a) lists other statutory defendants by technical titles ("underwriters" for example), it seems clear enough Congress meant "director" in the second, specialized sense. See Yates v. United States, 135 S.Ct. 1074, 1085 (2015) ("[A] word is known by the company it keeps."); Bradley v. United States, 410 U.S. 605, 609 (1973) ("[T]he law uses familiar legal expressions in their familiar legal sense." (quoting Henry v. United States, 251 U.S. 393, 395 (1920))).

         Beyond the text of the Securities Act, the Exchange Act definition of director-which uses the phrase "director of a corporation"-reinforces our conclusion. See 15 U.S.C. § 78c(a)(7) ("The term 'director' means any director of a corporation or any person performing similar functions with respect to any organization, whether incorporated or unincorporated."). So does Securities Act Regulation C, which defines "director" the same way. 17 C.F.R. § 230.405.[5]

         What functions, then, typify directorship? "The whole of the directors collectively form the board of directors." Directors, Black's Law Dictionary 581 (3d ed. 1933). Acting as a board, directors are the corporation's agents. 2 Fletcher Cyc. Corp. § 507 (Sept. 2018 update); 4 Fletcher Cyc. Corp. § 2261 (1918). The board manages the corporation's affairs by: (1) selecting senior officers; (2) controlling executive compensation; (3) delegating administrative authority to officers; (4) making high level corporate policy; (5) deciding financing and capital allocation; and (6) supervising the "welfare of the whole enterprise." 2 Fletcher Cyc. Corp. § 505 (Sept. 2018 update); see 4 Fletcher Cyc. Corp. §§ 1729, 1961, 1966 (1918); Blasband v. Rales, 971 F.2d 1034, 1044 (3d Cir. 1992). Directors owe duties of reasonable care and loyalty. 3 Fletcher Cyc. Corp. § 990 (Sept. 2018 update); see 4 Fletcher Cyc. Corp. § 2261 (1918) ("[W]hether or not directors and other corporate officers are strictly trustees, there can be no doubt that their character is that of a fiduciary so far as the corporation and the stockholders as a body are concerned."). And if shareholders are unhappy with directors, they can vote them out for any reason (or no reason). 3 Fletcher Cyc. Corp. § 357.20 (Sept. 2018 update). At the most basic level, directors are thus defined by their formal power to direct and manage a corporation, and the responsibilities and duties that accompany those powers.[6]

         "Similar," as the term is used in § 77k(a)(3), is most aptly defined as "[h]aving a marked resemblance or likeness; of a like nature or kind." Similar, Oxford English Dictionary 59 (1st ed. 1933). True, there are varying degrees of likeness that might be described as "similar." See In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411, 419 (2d Cir. 2014) ("In ordinary usage, the word 'similar' means 'having characteristics in common,' or 'alike in substance or essentials.'" (quoting Webster's New Int'l Dictionary 2120 (3d ed. 1993))); Ayes v. U.S. Dep't of Veterans Affairs, 473 F.3d 104, 108 (4th Cir. 2006) ("Although the term 'grant' is not defined in the statute, the use of the word 'similar' limits the universe of 'grants' to . . . only grants bearing a family ...

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