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From Securities Regulation Daily, January 27, 2014

Dismissal of insider trading claims in suit against Xcelera directors was improper

By Rodney F. Tonkovic, J.D.

A Second Circuit panel has found that a district court erred in dismissing Gloria Steginsky's insider trading claims against Xcelera Inc. Steginsky alleged that company insiders bought Xcelera stock by making a tender offer through a shell corporation without disclosing any information about Xcelera's financial situation. The court vacated the dismissal of Steginsky's insider trading claims under Secs. 10(b), 20(a), and 20A of the Exchange Act, but affirmed the dismissal of her market manipulation claims and claims under Sec. 14(e) (Steginsky v. Xcelera Inc, January 27, 2014, Walker, J.).

Background. An in-depth discussion of this case's background may be found in the report on the district court case in the Securities Regulation Daily Wrap-up for March 18, 2013. Briefly, Xcelera, once a successful technology conglomerate, suffered a reversal of fortune when its share price plummeted from a high of $110 to $1 per share in the wake of the technology bubble burst in 2001. None of the defendants have disclosed any information about the company's financial condition since 2005, and they refused to make the required SEC filings between 2004 and 2006. The SEC eventually revoked the registration of all Xcelera securities, and the price dropped to $0.25 a share.

In 2010, siblings Gustav and Alexander Vik, who, along with their father, controlled Xcelera, created OFC Ltd. In December 2010, OFC made a tender offer for Xcelera stock at $0.25 per share; no information about Xcelera's financial condition was disclosed in connection with the tender offer. In April 2011, Steginsky sold her 100,010 shares of Xcelera stock to OFC.

According to the complaint, OFC is a shell company, and the tender offer was orchestrated by the Viks. The ensuing litigation was based on the theory that the Viks had manipulated Xcelera's stock price downward by refusing to make required SEC filings, which caused Xcelera to be delisted, so they could buy back the stock at artificially depressed prices. The district court concluded that Steginsky had failed to state a claim and dismissed both her market manipulation and insider trading claims.

Market manipulation. The panel did not address whether the market manipulation claims were properly pleaded because it found that they were not timely filed. Steginsky argued that she filed within two years of the tender offer. The court, however, found that the alleged manipulation began with the defendants' refusal to make SEC filings from 2004 to 2006, more than five years before the filing of the complaint in 2012. The court accordingly found that the market manipulation claims were properly dismissed, even though the district court dismissed them for the failure to plead scienter.

Insider trading. Next, Steginsky alleged that the Viks, and Hans Erik Orlov, OFC's director, purchased Xcelera shares without disclosing any information about Xcelera's financial state. There was no dispute that these three defendants were insiders and that they failed to provide any information to Steginsky, or any other potential purchasers, before she sold her shares to OFC. The district court held that the defendants had no duty to disclose because the duty does not apply to unregistered shares and because Xcelera is a Cayman Islands corporation, where no such duty exists.

The panel held that the district court was in error. First, the duty of corporate insiders to disclose material information explicitly applies to unregistered securities under Exchange Act Sec. 10(b). Secondly, the duty against insider trading is "imposed and defined by federal common law, not the law of the Cayman Islands." The court added, "Looking to idiosyncratic differences in state law would thwart the goal of promoting national uniformity in securities markets." While the defendants had no affirmative duty to disclose once Xcelera was deregistered, they could not trade in Xcelera shares based on undisclosed material inside information in their possession. The panel vacated the district court's dismissal of the direct and controlling person liability claims under the Exchange Act.

Because the district court did not address the complaint's Sec. 20A claims, the panel vacated their dismissal and remanded for further consideration. The panel then affirmed the dismissal of Steginsky's claims under Sec. 14(e). The panel stated that Rule 14e-3 concerns material information relating to the tender offer. Here, the panel noted, "the allegation is not that someone possessed material nonpublic information about the tender offer—it is that the tender offer itselfwas made by corporate insiders who possessed material nonpublic information." The dismissal of the Section 14(e) claims was thus proper.

The case is No. 13-1327-cv.

Attorneys: Jeffrey S. Abraham (Abraham, Fruchter & Twersky, LLP) for Gloria Steginsky. Peter J. MacDonald (Wilmer Cutler Pickering Hale and Dorr LLP) and Charles W. Pieterse (Whitman Breed Abbott & Morgan LLC) for Xcelera Inc., VBI Corp., Alexander M. Vik, and Gustav M. Vik.

Companies: Xcelera Inc.; VBI Corp.; OFC Ltd.

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