Securities fraud

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The Second Circuit held yesterday that a government agency’s nonpublic, pre-decisional regulatory information does not constitute “property” for purposes of the federal insider-trading and wire-fraud statutes.  The decision in United States v. Blaszczak (2d Cir. Dec. 27, 2022) (“Blaszczak II”) effectively vacated convictions under those statutes for defendants who had traded on nonpublic, market-moving information that had been obtained from a government agency.

The Court of Appeals for the Second Circuit yesterday reversed the dismissal of a securities class action alleging fraud based on the defendants’ failure to disclose an SEC investigation into the company’s disclosed financial-control weaknesses.  The May 24, 2022 ruling in Noto v. 22nd Century Group, Inc. (No. 21-0347) is fact-specific, requiring disclosure of the investigation because the defendants (i) had disclosed the accounting deficiencies that had led to the investigation, (ii) had said they were working on the problem, and (iii) eventually had said they had resolved it, even though the SEC investigation had been pending during that entire period.

The Noto decision could affect disclosure assessments where issuers disclose an underlying accounting problem or other deficiency but are debating whether they must also disclose a pending SEC or other governmental investigation related to that specific problem.  Depending on the facts and circumstances of the particular situation, a court might hold that failure to disclose the governmental investigation makes the disclosure of the underlying problem materially misleading because nondisclosure of the investigation could cause reasonable investors to make “an overly optimistic assessment of the risk” posed by the underlying problem.

On January 28, 2022, the Securities and Exchange Commission filed a complaint in the U.S. District Court for the Northern District of California against HeadSpin, Inc., a Silicon Valley start-up. In the complaint, the SEC alleged that HeadSpin, though its then-CEO Manish Lachwani, engaged in a fraudulent scheme “to propel its valuation to over $1 billion by falsely inflating the company’s key financial metrics and doctoring its internal sales records.”

The Securities and Exchange Commission (“SEC”) filed a settled securities fraud action against App Annie Inc., one of the largest sellers of market data on how apps on mobile devices are performing, and its co-founder and former CEO and Chairman Bertrand Schmitt.  The settlement is the first enforcement action brought…

Thanks to HBO’s documentary, “The Inventor: Out for Blood in Silicon Valley,” and a barrage of media coverage about Elizabeth Holmes and her defunct company, Theranos, it is unmistakable that big misrepresentations can lie in public statements regarding miniscule quantities of blood.

This lesson proved true again last month, when the CEO of Decision Diagnostics, a pharmaceutical testing company, widely publicized that the company could accurately test for COVID-19, providing near-instant results with only a finger-prick of blood. In one press release, the CEO, Keith Berman, went so far as to say the COVID-19 testing would be “commercial ready” by summer of 2020.  The market took note, and the company’s stock soared (by a whopping 1,200%) following Berman’s statements.

The massive data breach of the United States Commerce and Treasury Departments that has roiled the federal government has resulted in federal securities litigation. On January 4, 2021, Plaintiff-Shareholder Timothy Bremer filed a class action complaint against SolarWinds and SolarWinds’ corporate executives in the United States District Court for the Western District of Texas. SolarWinds provides information technology and infrastructure management software products to entities around the globe, including to various U.S. government vendors in the executive branch, military, and intelligence services. According to the complaint, Russian hackers gained access to government email traffic by deceptively interfering with software updates released by SolarWinds. The complaint alleges that SolarWinds violated federal securities law by making false and/or misleading statements and failing to disclose material facts regarding SolarWinds’ cybersecurity practices and protocols, which artificially inflated the market price of SolarWinds’ shares. When news of the hack became public, the value of Solarwinds’ securities dropped, thereby producing an economic loss for investors within the class period of February 24, 2020 through December 15, 2020. The complaint asserts claims for violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 against SolarWinds and its corporate executives, and for violations of Section 20(a) of the Exchange Act against the corporate executives.

The Court of Appeals for the Second Circuit held yesterday that a securities-fraud plaintiff cannot establish corporate scienter without pleading facts showing that employees who allegedly knew of underlying corporate misconduct had some connection to the corporation’s purportedly false or misleading public statements. The decision in Jackson v. Abernathy should prevent securities plaintiffs from establishing “collective” or corporate scienter in the absence of factual allegations showing a corporate speaker’s awareness of the underlying alleged misconduct even if other employees not involved with the corporation’s disclosures purportedly had such knowledge.