Securities Snapshot
February 22, 2022

District Court Denies Payday Lender's Bid To Dismiss SEC Enforcement Action

District Court Denies Payday Lender's Bid To Dismiss SEC Enforcement Action; Delaware Chancery Court Dismisses Camping World Insider Trading Derivative Suit; California Federal Judge Certifies Class Of Apple Common-Stock Holders Alleging Company Made Misleading Statements About iPhone Sales; BlockFi To Pay $100 Million In Penalties For Failing To Register Its Crypto Lending Product; SEC Proposes Changes To Whistleblower Program Rules

On February 2, 2022, the U.S. District Court for the Southern District of Florida in SEC v. Sky Group USA LLC, et al., denied Sky Group USA LLC (“Sky Group”) and its CEO Efran Betancourt’s motion to dismiss a U.S. Securities and Exchange Commission complaint alleging that the payday lending business fraudulently raised more than $66 million from over 500 investors. The SEC alleged that Sky Group violated both the Securities Act and Exchange Act by selling promissory notes to investors while falsely representing that their investments would be used to fund consumer payday loans, and would be returned over the course of the year with interest. The SEC alleges that Sky Group instead spent significant portions of these investor funds on other business expenses, Betancourt’s personal expenses, and “Ponzi-like” repayments to earlier investors. The defendants moved to dismiss, arguing that the court lacked subject matter jurisdiction because the notes Sky Group sold to investors were not “securities” and therefore were not subject to regulation under the Securities Act.

In Reves v. Ernst & Young, 494 U.S. 56 (1990), the U.S. Supreme Court held that any note with a term of more than nine months is presumptively a security, but that the presumption can be rebutted if a defendant demonstrates that a particular note bears a “strong resemblance” to certain enumerated categories of notes that do not constitute securities because they are issued in a commercial or consumer context, rather than an investment context. The Supreme Court instructed courts deciding whether a particular instrument bears such a “strong resemblance” to one of these excluded categories to consider four factors, including: (1) the motivation for buyers and sellers to enter a transaction, (2) the distribution plan of the instrument, (3) the reasonable expectations of the investing public, and (4) the existence of another regulatory scheme that reduces the risk of the investment.

Applying this test, the Sky Group court denied defendants’ motion to dismiss, finding that the notes sold to investors constituted securities under all four Reves factors. First, the Court noted that Sky Group used proceeds from the notes for general business purposes — even though the notes were nominally intended only to finance payday loans — which supported a finding that the notes were securities. Next, the court found that the notes had a wide scope of distribution, as they were sold to over 500 investors from 18 U.S. states and 19 different countries, which indicated that there was “common trading for speculation or investment,” a key feature of securities. In addition, the court found that Sky Group pitched the notes as a safe income-generating investment, and the investing public would have reasonably considered the notes to be securities based on this marketing. Finally, the court noted that there was no other regulatory scheme besides the Securities Act that could have reduced the risk of the notes, rejecting the defendants’ argument that security provisions of the notes rendered regulation under the Securities Act unnecessary, finding that this protection was “illusory” because notes did not give the investors an enforceable lien or security in any particular Sky Group asset or receivable.

Delaware Chancery Court Dismisses Camping World Insider Trading Derivative Suit

On January 31, 2022, the Delaware Court of Chancery dismissed a derivative suit concerning claims that RV and camping retailer Camping World’s directors profited by more than $530 million by selling their stock on the basis of material, non-public information (“MNPI”) regarding challenges that the company was experiencing with its integration of another outdoor retail chain it had recently acquired. The court found that the plaintiffs had failed to show that making a derivative demand on Camping World’s board would have been futile. 

The derivate suit stems from Camping World’s 2017 acquisition of outdoor sporting goods retailer Gander Mountain Company at a bankruptcy auction. Plaintiffs alleged that Camping World experienced difficulties integrating Gander’s systems with its own and challenges in meeting the publicly-announced timelines to open 70 Gander store locations. Plaintiffs allege that once these challenges were publicly disclosed, it caused Camping World’s stock price to plummet. 

The plaintiffs primarily alleged that five of Camping World’s nine directors breached their fiduciary duties by trading Camping World stock while aware of MNPI regarding the company’s difficulties with the Gander integration. Because plaintiffs did not make a demand upon the Camping World board before filing the derivative action, they were required to show such a demand would be futile by showing that the majority of directors either lacked independence from the directors accused of wrongdoing or faced significant personal liability. Plaintiffs contended that such a demand would be futile because a majority of the directors either faced a substantial likelihood of liability as a result of their own insider trades or lacked independence from the four directors they alleged engaged in insider trading. 

Vice Chancellor Lori Will rejected plaintiffs’ demand futility arguments, concluding that at least five of the six independent directors (out of nine total directors) could have impartially considered a litigation demand. The court found that plaintiffs’ allegations that two independent directors faced a substantial likelihood of liability for insider trading for a series of trades in 2017 were insufficient because plaintiffs could not specifically identify any MNPI known by these directors prior to the trades. The court was unpersuaded by plaintiffs’ reliance on board minutes from several board meetings in 2017 — which plaintiffs claimed indicated that the company never had concrete plans to open 70 Gander stores and was running behind its initially-announced schedule for store openings — finding that the minutes did not indicate that the board had received any material information that was not already known to the market. The court further noted that any inference that these directors had knowingly traded on MNPI was negated by the fact that the challenged trades occurred after the company had already publicly disclosed delays to the store opening timeline and uncertainty about the number of stores.

The court also rejected plaintiffs’ additional allegations that five independent directors that had served on the audit committee faced a substantial likelihood of liability for preparing and reviewing allegedly misleading public statements regarding the Gander integration, similarly finding that plaintiffs failed to allege specific facts indicating that these directors were aware of information that materially contradicted the company’s statements. Having found that plaintiffs failed to establish that at least five of Camping World’s nine directors could not impartially consider a demand, the court dismissed the case and declined to further evaluate plaintiffs’ allegations concerning Camping World CEO and Chairman Marcus Lemonis and the two other non-independent directors.

California Federal Judge Certifies Class Of Apple Common-Stock Holders Alleging Company Made Misleading Statements About iPhone Sales

On February 4, 2022, the U.S. District Court for the Northern District of California granted certification of an investor class that purchased or otherwise acquired publicly-traded Apple Inc. securities from November 2, 2018 to January 2, 2019 and suffered damages due to alleged misrepresentations as to Apple’s financial condition. The court excluded from the class holders of Apple stock options, due to plaintiff’s failure to show that common questions of damages predominated with respect to option holders.

Lead Plaintiff Norfolk County Council brought the securities fraud class action against Apple, Timothy Cook (CEO), and Luca Maestri (CFO) for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. As alleged in the complaint, following an announcement of its financial results for Q4 2018 on November 1, 2018, Apple allegedly represented that business in China had been “very strong” the previous quarter, particularly in iPhone sales. But Apple allegedly knew when making these statements that U.S.-China trade tensions and China’s economic conditions were actually negatively impacting sales and the demand for Apple products, that retail sales were declining, and that the company was already cutting or preparing to cut iPhone production and reduce orders for the current quarter. Thereafter, in Q1 2019 on January 2, 2019, Apple preannounced an earnings shortfall, citing “[l]ower than anticipated iPhone revenue, primarily in Greater China, account[ing] for all of [Apple’s] revenue shortfall.” Apple’s stock price subsequently dropped from $157.92 per share on January 2, 2019, to $142.19 per share on January 3, 2019.

In opposition to plaintiff’s motion for class certification, defendants argued that Norfolk was not an adequate class representative due to certain errors it had made concerning the dates of its stock purchases and the share price used to calculate the sale of stock in a certification filed in support of its motion to be appointed as Lead Plaintiff, which it then corrected two years later without explanation. Defendants further argued that Norfolk’s November 12, 2018 acquisition of Apple shares was not a purchase but rather a transfer between accounts.

Judge Yvonne Gonzalez Rogers disagreed with both arguments, finding that Norfolk had corrected the inadvertent errors, there was no evidence of bad faith or intent to deceive the court, and that the errors did not demonstrate a conflict with the class. Plaintiff had also submitted records showing that it acquired Apple shares on November 12, 2018, in exchange for its investment in a pooled fund, and the court was not persuaded that this was meaningfully indicative of inadequacy.

Defendants also challenged plaintiff’s showing of predominance under Rule 23(b)(3), arguing that the reliance and damages elements of a Section 10(b) fraud claim could not be satisfied on a class-wide basis. The court disagreed, finding plaintiff made a prima facie showing sufficient to invoke a rebuttable presumption of reliance based on the “fraud-on-the-market” theory as to holders of Apple stock, and concluding that defendants failed to rebut this presumption by proving the alleged misrepresentations — particularly the January 2, 2019 disclosure — had no negative price impact.

The court did, however, exclude from the certified class holders of options of Apple stock, finding that plaintiffs had failed to show that common questions of damages predominated as to that category of investors in the putative class. The court reasoned that the 2,282 distinct Apple stock options that were available for trading during the relevant period had varying characteristics.

BlockFi To Pay $100 Million In Penalties For Failing To Register Its Crypto Lending Product

On February 14, 2022, the SEC issued a Cease and Desist Order charging BlockFi Lending LLC (BlockFi) with failing to register the offers and sales of its retail crypto lending product. To settle the SEC’s charges, BlockFi agreed to pay a $50 million penalty, cease its unregistered offers and sales of the lending product, BlockFi Interest Accounts (BIAs), and attempt to bring its business within the provisions of the Investment Company Act within 60 days. BlockFi’s parent company also announced that it intends to register under the Securities Act of 1933 the offer and sale of a new lending product. In parallel actions announced the same day, BlockFi agreed to pay an additional $50 million in fines to 32 states to settle similar charges. 

According to the SEC’s order, since March 4, 2019, BlockFi offered and sold BIAs, by which investors lend digital assets to BlockFi in exchange for monthly interest payments. The SEC found that BIAs are securities under applicable securities law, and the company was therefore required to register its offers and sales of BIAs. The order also found that BlockFi operated for more than 18 months as an unregistered investment company because it issued securities and also held more than 40% of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers. Finally, the order also found that BlockFi made false and misleading statements for more than two years on its website concerning the level of risk in its loan portfolio and lending activity, in particular representations that the loans were “typically” over-collateralized, when statistically they were not.

The SEC charged BlockFi with violations of Sections 5(a) and 5(c) of the Securities Act for offering and selling BIAs, which it found as notes constituted securities, without a registration statement filed or in effect with the SEC and without qualifying for an exemption from registration. The SEC also charged BlockFi with violations of Sections 17(a)(2) and (a)(3) of the Securities Act for allegedly making materially false and misleading statements on its website concerning its collateral practices and risks associated with its lending activity. Additionally, as a “first-of-its-kind” action, the SEC also charged BlockFi with violating Section 3(a)(2) of the Investment Company Act of 1940 for engaging in interstate commerce while failing to register as an investment company with the SEC.

According to SEC Chair Gary Gensler, this is “the first case of its kind with respect to crypto lending platforms” and that the settlement “makes clear that crypto markets must comply with time-tested securities laws... [and] further demonstrates the Commission’s willingness to work with crypto platforms to determine how they can come into compliance with those laws.”

SEC Proposes Changes To Whistleblower Program Rules

On February 10, 2022, the Securities and Exchange Commission proposed two amendments to the rules governing its whistleblower program. If adopted, Exchange Act Rules 21F-3 and 6 will “help ensure that whistleblowers are both incentivized and appropriately rewarded for their efforts in reporting potential violations of law to the Commission.” The first proposed amendment would allow awards for related actions where an alternative award program would provide an award that is meaningfully lower than the SEC’s whistleblower program would allow. This amendment is aimed at alleviating concern that similarly situated whistleblowers could end up with disparate awards, thereby better incentivizing whistleblowers to come forward. The second amendment would eliminate the SEC’s authority to decrease a whistleblower’s potential monetary award, clarifying that the SEC’s discretion will only be used for the purpose of increasing a potential monetary award. These proposed amendments are consistent with the SEC’s efforts to expand its whistleblower program by providing further incentives and to encourage companies to establish appropriate mechanisms to encourage internal reporting of alleged misconduct and processes to investigate and address concerns.

Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

Editorial Board
Kate E. MacLeman
Meghan K. Spillane

Contributing Authors
Jordan Benson
Jessica Huang
Viktors Dindzans