On September 21, 2022, U.S. District Judge George B. Daniels of the Southern District of New York dismissed with prejudice a putative securities class action against BELLUS Health, Inc. and certain of its officers, who were represented by Goodwin in the litigation. Plaintiff had challenged the veracity of public statements regarding an ongoing clinical trial and the future prospects of the company’s drug candidate for treatment of chronic cough, alleging that those statements were false and misleading under Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934 (the “Exchange Act”) and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. The court flatly rejected those claims, ruling that plaintiffs did “not identify a single false statement or omission that makes any statement misleading,” and further ruled that the complaint also “fail[ed] to plausibly allege any of the other elements of securities fraud.” This case continues a well-established body of case law supporting life sciences companies providing accurate disclosures to the market, even in the face of significant development and other business risks.
Specifically, the court rejected plaintiff’s core theory that because the company’s Phase 2 clinical trial did not meet its primary endpoint, the company misled investors in its disclosures concerning the study’s design that plaintiff alleged contributed to that outcome. The court instead ruled that, even on the face of the complaint, it was clear that the company had truthfully disclosed the specifics of the clinical trial, warned investors of the risks that the trial may not be successful, and that forward looking corporate statements were appropriately qualified opinions of the sort that could not support a claim. As for the plaintiff’s allegations that the company designed its trial differently than that of certain competitors, the court concluded that “[i]nvestors had the information to discern the differences between the trials and determine whether investing in BELLUS was prudent.” Overall, the Court rejected the lawsuit as an attempt to use “hindsight and securities law as tools to second guess how clinical trials were designed and managed.”
As a separate, an alternative basis for dismissal, the court ruled that the plaintiff failed to plausibly allege that any defendant acted with fraudulent intent (or “scienter”), which was independently fatal to the claims brought under Section 10(b) and Rule 10b-5 of the Exchange Act.
Further, the court denied Plaintiff’s attempt to amend the complaint, concluding that plaintiff’s proposed amendments “d[id] not add a single representation that change[d] the analysis” nor did they “support any plausible scienter allegations” — i.e., the additional allegations would be “futile.”
Wall Street Firms Hit With Nearly $2 Billion in Fines for Failing to Maintain Business Communications Exchanged on Employees’ Personal Devices
On September 27, 2022, the SEC and the Commodity Futures Trading Commission (“CFTC”) announced charges — and collectively, $1.8 billion in fines and other penalties — against sixteen Wall Street firms for failing to maintain and preserve electronic communications conducted on employees’ personal devices as required by the Exchange Act, the Investment Advisers Act of 1940, and CFTC recordkeeping requirements.
The SEC claimed that personnel routinely conducted business via text and messaging apps on their personal devices — such as WhatsApp — despite company policies against doing so. The firms admitted to wrongdoing and agreed to retain compliance consultants to improve their recordkeeping policies and procedures into the future.
Although these were all negotiated regulatory settlements — as opposed to litigated judgments where a judge or jury concluded that any or all of the regulatory charges were correct — they send a dark message to registered financial services firms that it may no longer be enough to simply prohibit the business use of personal devices, no matter how explicit the policy. Instead, regulated firms would be well advised to take a fresh look at their recordkeeping policies and procedures and monitor business communications to ensure that the use of personal devices does not run afoul of regulatory requirements.
SEC Settles Claims With Executives for Insider Trading
On September 21, 2022, the SEC announced a settlement with the CEO and also a former president/CTO of Cheetah Mobile Inc. related to alleged insider trading. According to the settlement order, the SEC claimed that the current CEO and former president violated federal securities laws by selling Cheetah Mobile’s securities pursuant to a joint Rule 10b5-1 trading plan because, although on its face the plan was appropriate, it was not entitled to the protection of the rule because at the time it was adopted the charged officers were already in possession of material nonpublic information, specifically, non-public information regarding a significant negative revenue trend involving a large business partner. Without admitting or denying the allegations, CEO Sheng Fu and former President/CTO Ming Xu agreed to pay civil penalties of $556,580 and $200,254, respectively, and agree to extensive five-year undertakings, primarily concerning their securities trading and Rule 10b5-1 activity.
The SEC’s settlements are an important reminder that, even more than 20 years after corporate insiders began adopting Rule 10b5-1 trading plans to allow them to sell down their positions over time without fear that future corporate events will “close the window,” those plans will provide none of the promised protection if the window is not “open” at the time the plan was adopted in the first instance. That is, just like corporate insiders in possession of MNPI are prohibited from trading in company securities, they are also prohibited from adopting plans to sell in the future pursuant to Rule 10b5-1.
SEC Settles Claims Against Four Investment Advisers for Violations of the Pay-to-play Rule Over Dissent by SEC Commissioner Peirce
On September 15, 2022, the U.S. Securities and Exchange Commission (“SEC”) announced separate settlements with four investment advisory firms related to alleged violations of the SEC’s pay-to-play rule as set forth in Section 206(4) and Rule 206(4)-5 thereunder of the Investment Advisers Act of 1940, which prohibits investment advisory firms from providing services to government clients for two years following a campaign contribution over $350 made by the firm or its employees. Specifically, the SEC alleged that the four investment advisers provided compensatory services to government clients within two years of making campaign contributions of between $1,000 to $1,400 to elected officials or candidates for elected office. Those employee campaign contributions were, without question, very small relative to the scope of services that the advisors were providing to the government clients — the management of funds of tens of millions of dollars—and there were no allegations that the elected officials who received the contributions did anything whatsoever to tip the scale in favor of any individual contributors or their employers. Without admitting or denying the SEC’s allegations, the investment advisers each consented to a cease-and-desist order, a censure, and a civil money penalty of between $45,000 and $95,000.
In a public statement, SEC Commissioner Hester M. Peirce sharply criticized these enforcement proceedings and urged the SEC to revisit the pay-to-play rule, which she argued “does not require any evidence of an actual quid pro quo, or even evidence that the adviser was seeking a quid pro quo” and also “does not require any assessment of whether the official receiving the contribution realistically could influence the decision to hire an investment adviser, or whether the contribution itself reasonably could be expected to influence the official.” Peirce asserted that the rule is an “exceedingly blunt instrument” and puts investment advisers in the uncomfortable position of having to seek — and job candidates having to provide — a list of prior campaign contributions during the interview process, which may dissuade individuals from engaging in the political process altogether. According to Peirce, these enforcement actions “do more harm than good,” and it is “past time” to consider how to improve the pay-to-play rule to address these shortcomings.
Court Axes Investors’ Claims Over Canceled Cannabis Company Shares
On September 15, 2022, U.S. District Judge Raymond P. Moore of the District of Colorado granted summary judgment in favor of GreenLink International Inc., a cannabis real estate and equipment leasing company (“Greenlink”), against a conversion claim brought by its former investors Fred Sebastian and Duke Capital S.A. Plaintiffs claimed that Greenlink had wrongfully converted 56 million Company shares by repurchasing and cancelling them. The court found, however, that Greenlink’s conduct could not amount to conversion as a matter of law because the repurchase was authorized by and made pursuant to a loan agreement executed by Plaintiffs, also ruling that the deadline had passed for plaintiffs to disclose an expert to contest signatures on the agreement.
The court’s ruling resolved plaintiffs’ last remaining claim, as it previously had dismissed federal and state securities claims, and common law fraud and negligence claims. The case will proceed to trial on Greenlink’s counterclaim against Plaintiffs for having breached the loan agreement.
SEC Settles Multiple Claims Related to Alleged Unregistered Offerings and Promotion of Cryptocurrency
On September 19, 2022, the SEC announced a settlement with cryptocurrency company Sparkster Ltd. and its CEO Sajjad Daya related to allegations that the company conducted a sale of unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933.
According to the settlement order, Sparkster circulated a whitepaper in April 2018 detailing an upcoming offering of SPRK tokens, which could be traded in Sparkster’s own marketplace or on other platforms. The SEC alleged that Sparkster raised $30 million from nearly 4,000 investors in the United States and abroad during a “presale” offering in May 2018 and a “crowdsource” offering in July 2018. Sparkster and Daya promoted the offering broadly to crypto token investors and enthusiasts on YouTube, social media, and Sparkster’s website and blog, specifically representing that SPRK tokens would increase in value, that management would continue to improve Sparkster, and that the goal was to list the tokens on third-party trading platforms.
On this basis, the SEC claimed that the SPRK tokens were unregistered securities. For its part — and without admitting or denying the allegations — Sparkster settled by destroying all SPRK tokens in its possession, publishing a notice of the settlement, requesting that SPRK tokens be removed from any third-party trading platforms, and paying nearly $35 million in disgorgement and prejudgment interest as well as a civil money penalty of $500,000. Also, without admitting or denying the allegations, Daya agreed to not participate in digital asset offerings for five years and to pay a civil money penalty of $250,000.
In a related and pending proceeding in the United States District Court for the Western District of Texas, the SEC has sued crypto influencer Ian Balina for (1) failure to publicly disclose that Sparkster had agreed to provide him a 30% bonus for promoting the tokens on social media for 90 days in 2018; and (2) reselling his tokens through his own investing pool without first registering the sale with the SEC. Critically, for the SEC to prevail in its federal court action, it will need to prove that the SPRK tokens were, in fact, “securities” that required registration in the first instance — a significant burden that the SEC has struggled to meet in the pending Ripple litigation and that it avoided altogether in the settled actions involving SPRK (where again, defendants elected to settle to avoid dealing with any threatened claims, and do so without “admitting or denying” the SEC’s views on the matter).
On October 3, 2022, the SEC announced a settlement with Kim Kardashian related to allegations that she failed to disclose that she was paid $250,000 for promoting crypto tokens sold by EthereumMax on her Instagram page in June 2021. Without admitting or denying liability, Kardashian agreed to pay $1.26 million in disgorgement, prejudgment interest, and civil money penalties and agreed to not promote any crypto asset securities for a period of three years. In announcing the settlement, SEC Chair Gary Gensler stated that “Ms. Kardashian’s case . . . serves as a reminder to celebrities and others that the law requires them to disclose to the public when and how much they are paid to promote investing in securities.”
Twitter V. Musk Update: Musk Allowed to Amend Counter Claims Again, Parties Continue to Spar Over Withheld Documents
The Delaware Court of Chancery allowed Elon Musk to again amend his counterclaims against Twitter by adding still more allegations related to former security chief turned whistleblower, Peiter “Mudge” Zatko, this time regarding his $7.75 million severance package. According to Musk, these additional allegations buttress his theory that Twitter violated a deal covenant to operate the business in the ordinary course of business, and that the “multi-million dollar payout to a terminated executive” is just one more example of why Musk and his investment group “were sold a different company than the Twitter that actually exists.”
Meanwhile, the parties continue their epic discovery battle. On September 20, 2022, the court denied Musk’s motion to relitigate an earlier ruling limiting his discovery of Twitter’s internal “Slack chats,” chastising Musk’s team that “a motion for reargument is not a vehicle for renegotiation.” And three days later, on September 23, the court rejected Musk’s argument that Twitter had made a “wholesale waiver” of attorney client privilege that otherwise protected against disclosure of 7,220 corporate documents. There remain still other open discovery disputes awaiting a court ruling, including Musk’s challenge to nearly 3,000 entries on Twitter’s privilege log and Twitter’s motion to compel Musk’s financial adviser and one of the lenders to produce documents that Twitter argues were also improperly withheld as privileged.
On October 6, 2022, after reports emerged that Musk and Twitter were in negotiations to resolve the litigation and move forward with Musk’s acquisition of the company, the court postponed the trial from mid-October until November and gave the parties until October 28, 2022 to reach an agreement and close the transaction.
 See also “SEC Enforcement Against Cheetah Mobile Execs Reflects Heightened Scrutiny of 10b5-1 Plans” (Sept. 29, 2022), https://www.goodwinlaw.com/publications/2022/09/09_29-sec-enforcement-against-cheetah-mobile-execs.
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.
Jennifer Burns Luz
Jennifer Burns LuzPartner