On February 1, 2023, Judge Paul A. Engelmayer of the Southern District of New York dismissed claims against Coinbase Global Inc. (Coinbase) and its CEO in a case alleging that the crypto exchange sold or solicited unregistered securities and failed to register as a broker-dealer when it offered 79 digital assets of various types on its online trading platform. The lead plaintiffs in the case, individuals who had transacted on the platform, brought claims under (1) Section 12(a)(1) of the Securities Act of 1933 (Securities Act) for sale or solicitation of unregistered securities; (2) Section 29(b) of the Exchange Act for rescission of illegal contracts with Coinbase customers; and (3) New York’s blue sky laws for the sale of unregistered securities and failure to register as a broker-dealer. The opinion marks a significant victory for online trading platforms, and companies seeking to develop online trading platforms and reduce the risk of private-securities litigation would be wise to pay attention to this decision when developing user agreements, marketing, and promotions.
In dismissing the case, the court first held that the plaintiffs failed to show that Coinbase qualified as the “immediate seller” of the alleged securities within the meaning of Section 12 of the Securities Act. The court relied on a user agreement between the company and its users indicating that title remains with users, and users do not directly transact with Coinbase; rather, Coinbase facilitates transactions among Coinbase customers.
Second, the court found that Coinbase did not “solicit” the sale of securities within the meaning of Section 12 of the Securities Act, because Coinbase did not directly and actively participate in the sales. At most, the plaintiffs alleged “collateral” participation through the promotion and marketing of the company’s token. Specifically, the complaint alleged that Coinbase provided users with descriptions of each token and its purported value proposition, participated in direct promotions including “airdrops” of free tokens designed to increase trading volume, and published news regarding price movements. The court found that those “activities of an exchange are of a piece with the marketing efforts, ‘materials,’ and ‘services’ that courts . . . have held insufficient to establish active solicitation by a defendant.”
With respect to the plaintiffs’ Section 29(b) claim for rescission of an illegal contract, the court rejected their theory that each individual transaction constituted a distinct contract capable of rescission. Instead, as framed by the pleadings, the only contract capable of rescission was the user agreement governing all of the transactions. The court held that the user agreement did not “necessitate illegal acts,” but rather could entail transactions in assets that the complaint did not depict as unregistered securities (i.e., Bitcoin and Ethereum); therefore, the contract was not eligible for rescission under Section 29(b).
Critically, the court did not need to address whether the tokens at issue were in fact securities in order to dismiss the claims against Coinbase and its CEO. The court noted that this key issue facing the industry presents questions of fact about the specific tokens and is not a legal question that can be resolved at the motion-to-dismiss stage. This dictum, if found persuasive, may pose a challenge to dismissing future cases that hinge on a resolution of the question of whether a specific token is a security.
Ninth Circuit Upholds Dismissal of Section 14(e) Claim Against Finjan
On January 20, 2023, a three-judge panel of the Ninth Circuit upheld the dismissal of a securities fraud action brought by an investor against cybersecurity company Finjan Holdings Inc. (Finjan), its CEO, and members of its board of directors. The plaintiff alleged that Finjan and its directors violated Section 14(e) of the Securities Exchange Act of 1934 (the Exchange Act) in connection with the sale of the company to Fortress Investment (Fortress), because revenue predictions included in disclosures to investors were false. Section 14(e) prohibits the use of false or misleading statements in connection with a tender offer. According to the plaintiff, Finjan falsely lowered its revenue projections to support a sale of the company to Fortress, while knowing that the lower revenue projections and resulting valuations were unreasonable.
Finjan resolves a pivotal open question following a 2018 decision in which the Ninth Circuit split from other circuits in holding that a claim under Section 14(e) does not require a plaintiff to allege or prove “scienter” (i.e., fraudulent intent) and instead requires only negligence. Left unresolved after that decision was how the Ninth Circuit negligence standard would apply to opinion statements, which generally require plaintiffs to allege both objective and subjective falsity. In Finjan, the court concluded that because Section 14(e) does not require scienter, a plaintiff need only allege a “reasonable inference” of subjective falsity, rather than the more onerous “strong inference” applicable to fraud claims under the Private Securities Litigation Reform Act. Thus, a plaintiff need only allege that the defendants negligently made statements that they did not subjectively believe.
Nonetheless, the Ninth Circuit held that the plaintiff failed to state a claim under Section 14(e) because he could not allege that Finjan management did not actually believe the revenue projections were true, or that the revenue projections did not reflect the company’s likely future performance. The court reasoned that, in light of the impact on the company of the COVID-19 pandemic, which resulted in a 25% decline in revenue from a substantial revenue source, it was not reasonable to infer that Finjan management believed its valuations were too low. In addition, the company’s prior valuations were too remote in time to undermine Finjan’s revised projections. The court also held that several public articles claiming that Finjan shares were worth more than the sale price were irrelevant because there was no allegation that Finjan management knew of the articles or could have reached the same conclusion.
Even though the pleading standard for Section 14(e) claims may be lower in the Ninth Circuit than in other circuits, plaintiffs still must plead facts supporting a reasonable inference that defendants did not subjectively believe the opinions they express. Courts will not green-light shareholder actions simply because a company has revised outdated projections.
Securities Class-Action Settlements Clear $4.7 Billion in Total Value for 2022
Two recent reports analyze significant trends in securities class-action filings and settlements in 2022. First, Institutional Shareholder Services issued a report (the ISS Report) finding that the total value of securities class-action settlements surpassed $4.7 billion in 2022 (an increase of more than one-third over the prior year) and that the 141 settlements reached last year represented the highest annual total since 2017. Second, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse recently released their annual report on securities class-action filings (the Cornerstone Report), which found that despite a 43% drop in new filings compared with the five-year average, defendants did not see a corresponding decrease in the total amount of losses alleged in 2022. Rather, alleged losses reached all-time highs in the most common types of securities class actions, such as those asserting claims under Section 10(b) (dubbed “core” filings in the Cornerstone Report).
Both reports also present noteworthy geographical trends. For example, the ISS Report shows that more than one-third of all federal class actions that resulted in settlement were concentrated in just a handful of federal district courts. With 26 settlements, The US District Court for the Southern District of New York saw the largest number; the US District Courts for the Northern and Central Districts of California tied for second place with 10 each. Meanwhile, the state courts with the most class-action settlements were the Delaware Court of Chancery (17) and the New York State Supreme Court, New York County (six). As for filings, the Cornerstone Report found that 31% of all “core” class actions were filed in the Ninth Circuit, with those cases accounting for a disproportionate 60% of total investor losses under Cornerstone’s approach to comparative loss calculations.
As for this year, 2023 “appears likely . . . to deliver meaningful shareholder recoveries,” according to the ISS Report, including through investor participation in the SEC’s Fair Fund settlements. The ISS Report also predicts that this year may bring more COVID-19-related class-action settlements, as dozens of actions arising out of pandemic-related claims continue to progress through courts nationwide.
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
Ian Q. Rogers
Jennifer Burns LuzPartner
Ian Q. RogersAssociate