Securities Snapshot February 26, 2019

On Motion For Reconsideration, SEC Granted Preliminary Injunction Against CryptoCurrency Exchange And Its Founder For Acts Of Alleged ICO Fraud

On motion for reconsideration, SEC granted preliminary injunction against cryptocurrency exchange and its founder for acts of alleged ICO fraud; Chancery Court dismisses investor suit against United Airlines over CEO severance pay; Eastern District of Michigan tosses securities class action targeting cholesterol drug developer; shareholder suit against Credit Suisse allowed to proceed.

On February 14, 2019, the Southern District of California entered a preliminary injunction prohibiting Blockvest, LLC (“Blockvest”), a company set up to exchange cryptocurrencies, and its founder, Reginald Buddy Ringgold, III (“Ringgold”), from violating an anti-fraud provision of the federal securities laws. The decision came following the court’s initial denial of a motion for preliminary injunction filed by the U.S. Securities and Exchange Commission (“SEC”) last November, when the SEC sought an injunction freezing Blockvest’s assets and barring it from proceeding with a planned initial coin offering (“ICO”) and any other securities sales.

According to the SEC’s complaint, Blockvest and Ringgold offered and sold unregistered securities in the form of digital assets called “BLVs” through Blockvest’s website, whitepaper, and social media accounts and misrepresented that their ICO was “registered” and “approved” by the SEC despite receiving no approval, authorization, or endorsement from the SEC. The SEC also alleges that defendants falsely claimed their ICO had been approved or endorsed by the Commodity Futures Trading Commission and the National Futures Association, and promoted the ICO with a fictitious regulatory agency they created—the “Blockchain Exchange Commission”—using a seal similar to the SEC’s and the same address as the SEC's headquarters.

Last November, the court denied the SEC’s motion for a preliminary injunction because there were disputed factual issues as to the nature of what was offered to 32 “test investors” who used the Blockvest exchange platform and 17 individuals who loaned or invested money in Rosegold Investments LLP (“Rosegold”), which in turn invested in Blockvest. Specifically, Ringgold’s testimony and declarations from some of the 32 test investors indicated that they did not intend to make an investment and were merely testing the Blockvest exchange platform. Ringgold’s testimony also indicated that the 17 individuals who loaned or invested money in Rosegold were really making personal loans to him and Blockvest’s CFO. At the time, the court did not directly address an alternative argument made by the SEC that the promotional materials on Blockvest’s website, whitepaper, and social media accounts constituted an offer of unregistered securities.

In granting the motion for partial reconsideration, the court reaffirmed its previous ruling regarding the 32 test investors and 17 individuals who loaned or invested money in Rosegold, but credited the SEC’s alternative theory. Applying the definition of an investment contract set forth in the Supreme Court’s decision in SEC v. W.J. Howey Co., the court found that BLVs are securities because Blockvest’s website and whitepaper urged people to pay for tokens with digital or other currency, provided that any funds raised would be pooled together and later divided among investors by a profit sharing formula, and described purchases of BLVs as being a “passive” investment that would generate “passive income.” The court also rejected defendants’ arguments that there was no offer of securities because there was no manifestation of intent to be bound, explaining that there is no requirement that performance be possible or that the issuer be able to legally bind a purchaser.

This decision reinforces that the focus of any analysis of whether digital currencies are securities remains on how those digital currencies were marketed and not on the subjective beliefs of those who acquired them.

Chancery Court Dismisses Investor Suit Against United Airlines Over CEO Severance Pay

On February 12, 2019, the Delaware Court of Chancery dismissed a derivative suit alleging that the directors of United Airlines (“United”) breached their fiduciary duties by giving the former CEO and other executives excessive compensation in separation agreements. While he was under federal investigation for re-instituting a flight route between Newark, New Jersey and Columbia, South Carolina in exchange for the chairman of the Port Authority of New York and New Jersey approving development projects at United’s regional hub, the former CEO and United entered into a separation agreement providing the former CEO with approximately $37 million in benefits. A special committee of outside directors (the “Special Committee”), advised by outside counsel, negotiated and approved the separation agreement and approved separation agreements with two other United executives.

The plaintiff, a purported stockholder, sent a demand letter to United’s board on October 7, 2016 (the “Initial Demand”), demanding that United claw back compensation from the former CEO and other United executives and modify its claw back polices and future employment agreements. The board did not consider the Initial Demand, and instead delegated the issue to the Special Committee. Five of the ten members of the Special Committee had previously negotiated and approved the separation agreements. The Special Committee rejected the Initial Demand, and on May 4, 2017, the plaintiff filed suit, arguing that the board breached its fiduciary duties by delegating consideration of the Initial Demand to the Special Committee because the members of the Special Committee were incapable of acting disinterestedly and independently in considering the Initial Demand. Defendants moved to dismiss the complaint, but the plaintiff sent another demand letter (the “Supplemental Demand”), addressed to the board, repeating the demands in the Initial Demand and adding a request that the board initiate legal proceedings to rescind the former CEO’s separation agreement. The Special Committee then formed a subcommittee (the “Subcommittee”) comprised of five of its members who were not on the Special Committee or the board when the Special Committee approved the separation agreements. The Subcommittee unanimously rejected the Supplemental Demand, and the plaintiff subsequently filed an amended complaint, primarily arguing that the board acted in gross negligence in relying on the Special Committee and Subcommittee because they were conflicted with respect to the Initial and Supplemental Demands.

Under Court of Chancery Rule 23.1, a shareholder who makes a pre-suit demand concedes that the board is disinterested and independent for purposes of responding to the demand. In their renewed motion to dismiss, defendants argued that the concession that the board is disinterested and independent should be extended to the Special Committee and the Subcommittee and that the plaintiff was therefore required to plead with particularity facts sufficient to create a reasonable doubt that the Special Committee and Subcommittee’s demand refusals were valid exercises of their business judgment. The court disagreed, holding that extending that concession would conflict with Delaware Supreme Court’s decision in Scattered Corp. v. Chicago Stock Exchange, Inc. The court explained that the plaintiff’s concession only established that a majority of the board, and not every member of the board, is disinterested and independent. Nevertheless, the court dismissed the complaint because it did not allege particularized facts that the Special Committee or Subcommittee were conflicted.

The court’s decision emphasizes the care that a board must exercise in constituting a demand committee if it chooses to delegate responsibility for investigating and responding to the allegations in a demand letter.

Eastern District Of Michigan Tosses Securities Class Action Targeting Cholesterol Drug Developer

On February 19, 2019, the Eastern District of Michigan dismissed in its entirety and with prejudice a securities fraud case bringing claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 on behalf of a putative class of stockholders of Esperion Therapeutics, Inc. (“Esperion”), a clinical-stage pharmaceutical company developing a low-density lipoprotein cholesterol lowering drug therapy. The complaint alleged that Esperion “trumpet[ed]” the safety and tolerability of its drug, bempedoic acid, after beginning Phase 3 clinical trials despite “several red flags,” including two deaths during Phase 2 clinical trials, changes to Esperion’s Phase 3 protocols to address adverse safety issues, and deaths in the Phase 3 clinical trial. The complaint further alleged that after making statements about the drug’s success between February 2017 and May 2018, Esperion “revealed alarming safety results from the Phase 3 clinical trial,” which caused the share price to drop dramatically.

The Defendants moved to dismiss the complaint, arguing primarily that the plaintiffs failed to allege any specific facts giving rise to a strong inference of scienter and that all of the information regarding the Phase 2 clinical trials had previously been revealed. Examining the complaints’ allegations using the non-exhaustive factors set forth by the Sixth Circuit in Helwig v. Vencor, Inc., the court agreed with the defendants. In particular, the court rejected the plaintiffs’ argument that there was anything suspicious about the timing of sales of Esperion securities by the defendants, noting that the CEO and CFO actually increased their holdings of Esperion stock during the putative class period. The court also rejected the plaintiffs’ argument that the closeness in time of the allegedly false statements to the purported corrective disclosures suggested scienter because the allegedly false statements were made over a period of 15 months. Finally, the court rejected the plaintiffs’ argument that Esperion’s desire for its key product to be successful supported an inference of fraud. Indeed, the plaintiffs could not point to any allegations that the defendants did not reasonably believe their interpretation of prior clinical results, which were publicly released.

This decision emphasizes the importance for life sciences companies of making fulsome disclosures of trial results that support the company’s interpretation of those results. Goodwin represented Esperion and the other defendants in this litigation.

Shareholder Suit Against Credit Suisse Allowed To Proceed

On February 19, 2019, the Southern District of New York partially dismissed a complaint filed by four pension and retirement plans on behalf of a putative class of holders of Credit Suisse Group AG (“Credit Suisse”) ADRs. The complaint alleged that Credit Suisse and its current CEO, current CFO, and former CEO made materially misleading statements and omissions regarding Credit Suisse’s procedures to monitor and control risk, the extent of Credit Suisse’s positions in collateralized loan obligations and distressed debt, and the riskiness of those investments in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Those misstatements purportedly allowed Credit Suisse to amass $4.3 billion of exposure from collateralized loan obligations and distressed debt and ultimately resulted in a $1 billion write-down, which, when disclosed, caused the value of Credit Suisse ADRs to decline 11%, injuring investors.

Although the court held that there was nothing false or misleading about Credit Suisse’s statements regarding the extent of its position in collateralized loan obligations and distressed debt or the riskiness of those investments, it held that plaintiffs had sufficiently alleged that Credit Suisse knowingly made material misstatements or omissions regarding its risk limits and controls. In particular, plaintiffs alleged that statements in Credit Suisse’s 2014 annual report that it had “extensive risk protocols” and that the risk limits were “binding” were false because those limits were not binding and were effectively breached on at least three occasions when Credit Suisse “redefined,” “increased,” or “retired and replaced” them to accommodate its growing risk exposure. The court also held that plaintiffs had adequately alleged scienter because the current CFO and current and former CEOs all sat on the committee that set Credit Suisse’s risk limits. Because the disclosure of Credit Suisse’s $1 billion write-down in connection with its collateralized loan obligations and distressed debt coincided with an 11% decrease in the value of Credit Suisse ADRs, the court held that plaintiffs had alleged that the purported misstatements and omissions regarding Credit Suisse’s risk limits caused investors’ losses and allowed plaintiffs’ claims to proceed, except as to alleged misstatements regarding the extent and risk of Credit Suisse’s distressed portfolio.

The decision highlights many courts’ willingness to look beyond the form of corporate actions and examine their substance to determine whether defendants’ statements are misleading. In particular, statements that a risk limit is “binding” may be found to be false and misleading in the future if the risk limit can be raised without disclosing such changes to investors.