March 22, 2018 Practice Points

District Court Holds Company Not Required to Disclose CEO’s Misconduct at Another Company

Fries illustrates that the duty to disclose is not a requirement to confess all misconduct.

Jennifer Wieboldt

On January 11, 2018, U.S. District Judge Edgardo Ramos granted a motion to dismiss a securities class action complaint, holding that the lead plaintiff’s allegations that a company failed to disclose its CEO’s misconduct at a separate company in its public filings were insufficient. Fries v. Northern Oil & Gas, Inc., 16 Civ. 6543, 2018 WL 388915 (S.D.N.Y. Jan. 11, 2018),illustrates that the duty to disclose is not a requirement to confess all misconduct and provides guidance to counsel representing directors and officers as to when such disclosures may be material.

The Allegations

In Fries, the defendants Northern Oil and Gas Inc. (Northern Oil), its CEO Michael Reger, and its CFO Thomas Stoelk were sued by shareholders for violating section 10(b) of the Securities Exchange Act, one of the federal securities law’s antifraud provisions. The plaintiff contended that Reger improperly exercised control over Dakota Plains Holdings, Inc. (Dakota Plains), a separate public company that Reger cofounded, to improperly obtain financial benefits, including through a stock manipulation scheme. Dakota Plains reported Reger to the SEC, which commenced an investigation, sent Reger a Wells Notice, and ultimately issued a cease-and-desist order that also required him to pay disgorgement and penalties. After Reger informed Northern Oil of the Wells Notice, Northern Oil terminated him, and its stock fell by 6.28 percent that day.

The plaintiff alleged that, in light of Reger’s misconduct at Dakota Plains and his appropriation of Northern Oil’s resources to further his control of Dakota Plains, Northern Oil made fraudulent representations and omissions in its public filings. Specifically, Northern Oil represented that it had adopted a Code of Business Conduct and Ethics, which provided, among other things, that all employees and directors “will comply strictly with all laws governing [Northern Oil’s] operations and to conduct its affairs in keeping with the highest moral, legal and ethical standards.” Fries, 2018 WL 388915, at *3. Northern Oil also represented that it relied on Reger’s knowledge and expertise in the industry to continue to develop its business.

The Holding

Judge Ramos explained that omissions of “corporate mismanagement or uncharged criminal conduct are not actionable unless the non-disclosures render other statements by defendants misleading,” meaning that actionable omissions have to be sufficiently connected to the company’s disclosures. Id. at *8. The court found that Northern Oil’s statements about Reger’s expertise were not rendered inaccurate as a result of Reger’s misconduct at Dakota Plains, nor did they suggest that he was not engaged in the undisclosed improper activity. Furthermore, none of the allegations in the complaint addressed whether Northern Oil was aware that Reger acted illegally at Dakota Plains or violated Northern Oil’s Code of Business Conduct and Ethics. The fact that Northern Oil’s CEO entered into a settlement for violations of the securities laws as a result of his work at another company did not mean that Northern Oil was necessarily required to disclose that unrelated misconduct. In this regard, Fries shows that a motion to dismiss can be successful where the plaintiff does not sufficiently allege that the misconduct was material to the company’s disclosures.

The Fries court also held that a company’s mere adoption of a code of ethics is not rendered misleading by an undisclosed breach of the code. Id. at *7 (citing Villella v. Chem. & Mining Co. of Chile Inc., No. 15 Civ. 2106 (ER), 2017 WL 1169619, at *11 (S.D.N.Y. Mar. 28, 2017)). However, representations regarding a company’s code of ethics may cross the line and become actionable if they are representations of historical compliance or if defendants made guarantees that the code would be followed. Id. The court recognized that the Southern District of New York has found that repeated guarantees of a company’s general integrity and ethical soundness may be actionable. Id. (citing In re Petrobras Sec. Litig., 116 F. Supp. 3d 368, 381 (S.D.N.Y. 2015)). In Fries, however, the court held that the statements in Northern Oil’s Form 10-Ks that the Code of Business Conduct and Ethics was adopted and available for shareholder review did not rise to this level. Finally, the court found that even if the statements were material misrepresentations and omissions, the plaintiff failed to allege the requisite scienter.


It is still an open question as to when guarantees regarding a company’s ethical compliance become material misrepresentations. Although directors and officers often want to assure the market that their companies are ethically sound and comply with securities regulations, they should be mindful of this gray area when deciding what types of representations to include in public filings.


Jennifer Wieboldt is an associate at Arnold & Porter in Washington, D.C.

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