The SEC has announced settled charges against Zymergen, which, prior to its recent bankruptcy and ultimate liquidation, was a biotech “focused on the manufacture of novel materials, including optical films used in electronic screens.” The SEC charged that, in its $530 million IPO in 2021, Zymergen misled “IPO investors about its overall market potential, revenue prospects, and customer pipeline for its only commercially available product, an electronics film named Hyaline.” According to the Director of the SEC’s San Francisco Regional Office, “[p]re-revenue and early-stage companies that seek to tap the capital markets must do so with reasonable estimates of their market potential….Today’s order finds that Zymergen failed to satisfy this obligation when it misled investors with what amounted to unsupported hype.” The company agreed to pay a civil penalty of $30 million. In the meantime, Bloomberg reports that a federal district court has recently allowed claims by Zymergen investors to proceed against several VC funds (along with the company, the board, the underwriters, etc). The investors contended that, among other things, the levers provided in the company’s governing documents allowed the VC funds to “control[] the company in the lead-up to its initial public offering” and claimed that they were “responsible for misleading IPO papers before the biological manufacturing company imploded.”
According to the Order, Zymergen was “founded in 2013 for the purpose of replacing petroleum-based products with biobased products, chemicals, and materials.” But to develop and manufacture these materials, Zymergen needed to raise hundreds of millions of dollars; through the fall of 2020, Zymergen raised over $800 million through private offerings. In the fall of 2020, the SEC alleged, after its last private capital raise, the company was “rapidly burning through cash.” At the time, the company had only one commercially available product, Hyaline, an “optical film specifically designed for the flexible electronic device market, including foldable devices with touch screens,” and had previously planned to conduct an IPO after Hyaline generated substantial revenue. But the company needed fresh capital and thought that public market conditions seemed propitious. So instead of conducting another private round, as previously planned, the company decided to undertake an IPO.
According to the Order, Zymergen closed its IPO in April 2021, raising proceeds of approximately $530 million. In its registration statement, the SEC charged, the company misrepresented the market opportunity for Hyaline and, in various analysts’ meetings, provided misleading revenue projections. After its IPO, the SEC alleged, the company also made misrepresentations on its first earnings call. In effect, the SEC alleged, in making claims about its market opportunity, the company failed to have a reasonable basis for those claims, used an unreasonable process in developing its revenue projections, and failed to employ an internal disclosure review process for those claims and other public statements that took into account internal contrary or adverse information known to the company.
According to the Order, because Hyaline was the company’s only commercially available product and the first created by Zymergen’s “biofacturing” platform, information about its market potential was an important datapoint for investors. Although Hyaline had not yet generated any sales, Zymergen estimated in its S-1 that “the display market alone for Hyaline was over $1 billion in 2020 . . . .” But, the SEC alleged, the information included in the S-1 about this $1 billion market opportunity was “materially misleading and lacked a reasonable basis,” information that Zymergen knew or should have known. The market opportunity estimate was developed by Zymergen’s finance team, but the finance team “had no role in the marketing or sales of Hyaline and had no firsthand knowledge or expertise about Hyaline’s markets or appropriate pricing.” As alleged, in preparing its estimate, the finance team “included product markets that the sales team was not targeting and/or that were poor fits for Hyaline’s technical characteristics”—in particular, two markets (aggregating 99% of the market opportunity) that the sales team had previously attempted but failed to penetrate “after customers found Hyaline was either too expensive, unnecessary, or both.” But the sales team did not review the assumptions made by the finance team, the SEC maintained, “nor did the information provided by the sales team support the inclusion of these markets.”
Similarly, the $1billion market opportunity estimate developed by the finance team “relied on product pricing assumptions that were unreasonable and at odds with the company’s own internal sales analyses”—a premium price that was three to five times higher than the price for similar products in those markets at the time. The sales team, however, knew that that premium price would apply only in a few small specialty markets.
When the sales team prepared its own internal analyses “that reflected actual pricing realities and excluded the two markets…that were deemed not likely to be a good fit for Hyaline,” the sales team calculated “the total display market opportunity for Hyaline in 2021 [as] approximately $42 million to $100 million—or approximately 5 to 10 percent of the $1 billion market opportunity for 2020 presented in the Form S-1.”
According to the Order, notwithstanding the material differences in the analyses of market opportunity provided by the two teams, “Zymergen failed to implement a reasonable process to reconcile the two figures. Likewise, between the time Zymergen initially developed its estimates in early January 2021 and the publication of the Form S-1 in March 2021, Zymergen failed to assess whether the $1 billion market opportunity estimate remained accurate.”
The Order also alleged that, in meeting with analysts prior to its IPO, Zymergen provided the analysts with an “internal financial model that included revenue projections for Zymergen’s products for 2021 through 2025.” Zymergen, the SEC contended, expected the analysts would convey the information to investors after the IPO and during Zymergen’s roadshow. The SEC charged that the revenue projections were materially misleading. According to the Order, “Zymergen’s finance team requested that the sales team provide its highest-confidence revenue projections based on a detailed, customer-by-customer analysis and assessment of potential market share. In response, the sales team provided projections indicating that revenues for 2021, 2022, and 2023 were approximately 60–70% lower than management’s prior projections in September 2020.” The finance team reduced its numbers for 2021, but, not pleased with those projections, sent the sales team back to the drawing board to come up with significantly higher projections for 2022 and 2023. And the sales team complied, the SEC charged, and “significantly increased (in some instances, more than doubled) its previous highest-confidence projections for 2022 through 2025, increasing total revenues for those years by approximately $740 million. The finance team subsequently increased these figures even further before providing the final numbers to analysts.” Zymergen then described these projections to analysts as “conservative,” suggesting in analyst meetings that there were “multiple ways the company could exceed the projections.” The SEC alleged that Zymergen did not advise analysts that these projections were well in excess of those originally provided by the sales team. “In light of the unreasonable process used to develop these projections,” the SEC charged, “ Zymergen knew or should have known that the financial model and revenue numbers that it provided to analysts and characterized as ‘conservative’ were misleading.”
In addition, the SEC charged that the company made misleading statements in its first quarter post-IPO earnings call. When analysts asked for updates on the status of Zymergen’s sales pipeline, the company responded that the feedback had been positive and that it “continue[d] to strengthen the pipeline” of customers. The SEC characterized these statements as “materially misleading. Leading up to the earnings call, the company’s internal reports and communications reflected growing concern and materially adverse information regarding the sales pipeline, customer qualification process, and overall revenue prospects and market for Hyaline.” The company’s internal documentation showed that several customers were delaying purchases or dropping out of the process and that the current market for Hyaline “was very small.” The SEC alleged that “Zymergen’s disclosure review process leading up to the earnings call did not reasonably reflect or address this adverse information available to the company. Nor did the company’s public statements appropriately reflect the steady stream of negative information. As a result, the company’s statements during the May 24, 2021 earnings call misled investors and created a misleading, positive impression of the state of Hyaline’s customer pipeline and overall prospects.”
Finally, in August 2021, Zymergen issued a press release and filed a Form 8-K “disclosing adverse facts concerning Hyaline’s deteriorating pipeline and technical issues with the product,” noting in particular that it no longer expected any product revenue in 2021 and only immaterial amounts in 2022. The CEO resigned and the stock price fell 76%. In November, the company announced that it was discontinuing “all but one of its products, including Hyaline.” In July 2022, Zymergen agreed to be acquired by a competitor at a price that was about 10% of its IPO valuation. That acquisition was completed in October, but a year later, Zymergen filed a voluntary petition for bankruptcy under Chapter 11.
The SEC charged that Zymergen violated Sections 17(a)(2) and 17(a)(3) of the Securities Act, which proscribe, in the offer or sale of a security, untrue statements and material omissions, as well as engaging “in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” Neither provision requires a show of scienter. Zymergen agreed to provide cooperation and to pay a civil penalty of $30 million.
