Our bi-monthly newsletter highlights important developments related to US civil and criminal securities law.
On February 22, 2023, U.S. District Judge Victor Marrero of the Southern District of New York denied a motion to dismiss a putative class action brought by purchasers of a non-fungible token (NFT) against Dapper Labs, Inc. (Dapper Labs), and its CEO. In the complaint, the plaintiffs claimed that Dapper Labs’ failure to register its NBA Top Shot Moments NFT with the U.S. Securities and Exchange Commission (SEC) violated Sections 5 and 12(a)(1) of the Securities Act of 1933 (Securities Act), and that the CEO was liable as a “control person.” In denying the motion to dismiss, the court rejected the defendants’ argument that the NFTs were not securities, and thus never needed to be registered in the first instance.
Specifically, the court applied the familiar test set forth in SEC v. Howey Co., 328 US 293 (1946), to determine whether the NFTs were “investment contracts,” and therefore securities (as the plaintiffs alleged), or were more akin to cardboard basketball cards that are not regulated under the securities laws (as urged by defendants). The court held that the plaintiffs pleaded facts adequate to establish the prongs of the Howey test: “an investment of money . . . in a common enterprise . . . with the expectation of profit from the essential entrepreneurial or managerial efforts of others.” Defendants conceded that the first prong was satisfied, and on the second prong, failed to persuade the court that the plaintiffs had failed to adequately allege a “common enterprise.” The court credited the plaintiffs’ allegations that the performance of their NFTs was tied to Dapper Labs as a result of its significant control over the primary and secondary markets for the NFTs and the Flow blockchain (a private blockchain created by Dapper Labs as a platform to sell the NFTs), and investors would have no way to sell or transfer their NFTs without the Flow blockchain—allegations that the court concluded supported a claim the NFTs would have no value without Dapper Labs’ efforts. Lastly, the court found that Dapper Labs created an expectation of profit by promoting NFT sales on social media with emojis that the court interpreted as an alleged promise of future profits to purchasers.
Notably, the court cautioned that its ruling that the NFTs were securities was a “close call” and “narrow,” explaining that “[n]ot all NFTs offered or sold by any company will constitute a security,” as this must be decided “on a case-by-case basis.” Notwithstanding this caveat, this and other decisions categorizing NFTs as securities naturally increase exposure to those selling NFTs, and serve as a reminder of the risks facing similar businesses that exercise heavy or complete control over token sales on private platforms.
Delaware Chancery Court Dismisses Caremark Claims Against McDonald’s Directors
On March 1, 2023, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery dismissed derivative claims against directors of McDonald’s Corporation based on their alleged failure to address sexual harassment at the company. The derivative lawsuit alleged that defendants ignored red flags of improper conduct by the company’s former CEO and Global Chief People Officer.
In dismissing the case, the court ruled that the plaintiffs had not met the demanding burden to plead that the directors violated their duties under Caremark, which requires a pleading that the board either (1) utterly failed to implement any reporting or information system or controls, or (2) consciously failed to monitor corporate operations despite the existence of internal controls. Although the court acknowledged and accepted the allegations of sexual harassment red flags, that pleading was not sufficient to overcome the strong business judgment rule presumption that the defendants acted in good faith when responding to them.
The court emphasized the difficulty in pleading Caremark claims, which is a favorable standard for those facing such claims and a reminder of the strong protections provided by the business judgment rule. As a practical matter, boards should remain cognizant of risks facing the company, have a compliance system in place to address risks requiring the board’s attention, and promptly remediate red flags.
For a more thorough discussion of the McDonald’s decision, please see “McDonald’s Part Two: Delaware Court of Chancery Dismisses Caremark Claims Against Directors Arising From Sexual Harassment Issues.”
Delaware Chancery Court Rejects Stockholder Monopoly Suit Against Facebook
On March 1, 2023, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery dismissed an antitrust action brought by stockholders of Facebook’s parent, Meta Platforms, Inc., against the issuer and several directors and officers. The plaintiffs also claimed that the directors and officers breached their fiduciary duty to prevent a “monopolistic buy-or-bury” business strategy that, in turn, squeezed potential social media competitors out of business. These claims largely cut-and-pasted those asserted by the Federal Trade Commission in pending litigation before the U.S. District Court for the District of Columbia.
Vice Chancellor Laster ruled from the bench following oral argument, dismissing the stockholder complaint with prejudice for failing to state a claim. He sharply criticized the plaintiffs for having filed such general and untargeted claims—which the court deemed to be no more than broad accusations that Facebook was a bad actor unsupported by any pleading of specific actionable misconduct.
Vice Chancellor Laster focused in particular on the Caremark aspect of the plaintiffs’ suit, wherein the plaintiffs attempted to use In re Caremark International Inc. Derivative Litigation, which imposes a duty of care and oversight on corporate directors to recognize and act on “red flags” within a company, to argue that Facebook’s directors and management breached their fiduciary duties by implementing a monopolistic business strategy despite knowing it would likely lead to federal antitrust enforcement action. Vice Chancellor Laster was not persuaded, noting that Caremark was not intended as an open-ended license to sue directors under any federal or state law.
Vice Chancellor Laster also criticized the Caremark claims as themselves premature, as the FTC antitrust action is still pending in federal court. Here, Facebook had not yet suffered a loss for which the burden needed to be shifted, and Vice Chancellor Laster noted that the plaintiffs could not rely upon the undecided federal antitrust lawsuit as evidence of a loss to the company that could trigger Caremark duties.
First-Ever Criminal Insider Trading Case Based Solely on 10b5-1 Plans
On February 24, 2023, federal prosecutors brought criminal insider trading charges against Terren Peizer, the founder and executive chairman of healthcare company Ontrak Inc. (Ontrak). According to the indictment, Peizer illegally sold nearly $20 million of his stock through two Rule 10b5-1 plans that he adopted after learning that Ontrak’s largest customer was planning early termination of its $90 million contract.
Rule 10b5-1 plans generally serve as a defense against allegations of improper insider trading, but only if adopted when the owner is not in possession of material nonpublic information about the company. In addition, the SEC has recently adopted rules requiring a mandatory cooling-off period of 120 days after a 10b5-1 plan is adopted before trades can be made pursuant to it. While these requirements were not in effect when Peizer made his trades, the Department of Justice (DOJ) alleged not only that Peizer opened his 10b5-1 plans while in possession of the material nonpublic information about the early termination, but also that when one brokerage firm declined to allow Peizer to open a 10b5-1 plan with it without a cooling-off period, he switched to a second brokerage firm that would allow him to start trading immediately.
Upon unsealing its indictment against Peizer on March 1, the DOJ published a press release calling the case “groundbreaking” as the first criminal indictment based exclusively on an executive’s use of 10b5-1 trading plans, and stated its commitment to identifying executives who attempt to use 10b5-1 trading plans to evade insider trading charges. The DOJ’s criminal indictment is proceeding in parallel to a separate SEC enforcement action filed against Peizer and Acuitas Group Holdings, his wholly owned investment company, in the Central District of California. The SEC has similarly alleged that Peizer, individually and through his investment company, violated federal securities laws by trading on the basis of material nonpublic information about the customer’s intent to end its relationship with Ontrak.
SDNY Allows Bitcoin Tip Case to Proceed Against Stock Promoter
On March 7, 2023, US District Judge Andrew L. Carter of the Southern District of New York denied defendant Gannon Giguiere’s motion to dismiss an insider trading action brought by the SEC. Giguiere is a stock promoter whose website, TheMoneyStreet.com (TMS), promoted penny stocks. In 2017, Giguiere agreed to use TMS to promote the stock of Long Island Iced Tea Corp. (LTEA). In its complaint, the SEC alleged that Giguiere learned via confidential draft announcements provided by a contact connected to LTEA that LTEA planned to shift its business plan from soft drink production to focus on blockchain, and that Giguiere asked and was informed of the date of the announcement in advance of the public release of that information. Following the alleged receipt of this confidential information but prior to the announcement of the pivot to blockchain, Giguiere placed two market orders to buy a total of 35,000 LTEA shares, which he sold less than two hours after the announcement for a profit of $162,500. The SEC subsequently brought an enforcement action against Giguiere, as well as two other individuals involved in the tipping scheme.
In his motion to dismiss, Giguiere argued that he was not subject to tippee liability, as he had not received this information directly from an LTEA employee but instead through a third-party intermediary who had connected him with LTEA, while the SEC argued that the intermediary had informed Giguiere of his insider source. The court agreed with the SEC, holding that the complaint adequately alleged that Giguiere both knew that the source of the information was an insider and knew that there was no business reason for him to learn that insider information.
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