Tag: Rule 10b-5
District Court views “shadow trading” to be within the “misappropriation” standard of §10(b)
In August 2021, the SEC filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company, Pfizer. As you know by now, this case has often been viewed as highly unusual: Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, the SEC’s novel theory of the case was that Panuwat engaged in “shadow trading”; he allegedly used the information about the acquisition of his employer to purchase call options on Incyte Corporation, another biopharma that the SEC claimed was comparable to Medivation, based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Panuwat made over $100,000 in profit. The SEC charged that he violated Rule 10b-5 and sought an injunction and civil penalties. (See this PubCo post.) After losing a motion to dismiss, this past September, Panuwat moved for summary judgment, claiming that this was the wrong case to test out the novel shadow-trading theory: “Incyte and Medivation were fundamentally different companies with no economic or business connection, Medivation’s policies did not prohibit Mr. Panuwat’s investment, and Mr. Panuwat’s reasons for making the investment were entirely separate from the Medivation sale process and consistent with his prior investment practices.” The SEC responded that Panuwat’s “actions fit squarely within the misappropriation theory of insider trading” and that his “actions provide strong evidence of his scienter.” The District Court for the Northern District of California has just rendered its decision. Did the Court take issue with the SEC’s application of this novel theory of shadow trading? Not so much. Indeed, the Court appears to treat the case as just another version of “misappropriation” of material nonpublic information. According to the Court, the SEC showed that there were “genuine disputes of material fact concerning (i) whether Panuwat received nonpublic information, (ii) whether that information was material to Incyte, (iii) whether Panuwat breached his duty to Medivation by using its confidential information to personally benefit himself, and (iv) whether Panuwat acted with scienter.” Accordingly, the Court denied Panuwat’s motion for summary judgment. In its Order, the Court reminded the parties to schedule a settlement conference. Will the parties settle? Or will this case go to trial?
Will the SEC’s shadow trading theory fall to SCOTUS’s major questions doctrine?
In August 2021, the SEC filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But it wasn’t your average run-of-the-mill insider trading case. Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he engaged in what has been referred to as “shadow trading”; he used the information about his employer’s acquisition to purchase call options on another biopharma, which the SEC claimed was comparable to Medivation. (See this PubCo post.) Since then, we’ve seen the usual moves on the chess board (discussed briefly below). But what’s particularly interesting, as Alison Frankel pointed out in Reuters, is the amicus brief filed by the Investor Choice Advocates Network, a self-described “nonprofit, public interest organization focused on expanding access to markets by underrepresented investors and entrepreneurs.” In its brief, ICAN contended that the SEC’s invocation of the novel “shadow-trading” theory made this a “major questions” case—a judicial torpedo that we might begin to see fired with some regularity.
Is political corruption securities fraud?
You remember Matt Levine’s mantra in his “Money Stuff” column on Bloomberg: “everything is securities fraud”? “You know the basic idea,” he says, a
“company does something bad, or something bad happens to it. Its stock price goes down, because of the bad thing. Shareholders sue: Doing the bad thing and not immediately telling shareholders about it, the shareholders say, is securities fraud. Even if the company does immediately tell shareholders about the bad thing, which is not particularly common, the shareholders might sue, claiming that the company failed to disclose the conditions and vulnerabilities that allowed the bad thing to happen. And so contributing to global warming is securities fraud, and sexual harassment by executives is securities fraud, and customer data breaches are securities fraud, and mistreating killer whales is securities fraud, and whatever else you’ve got. Securities fraud is a universal regulatory regime; anything bad that is done by or happens to a public company is also securities fraud, and it is often easier to punish the bad thing as securities fraud than it is to regulate it directly.” (Money Stuff, 6/26/19)
(See this PubCo post.) But here’s a new one—bribery and political corruption as securities fraud. As described in this press release, in the fiscal-year-end enforcement crush, the SEC brought settled charges against Exelon Corporation, a utility services holding company, and its subsidiary, electric utility company Commonwealth Edison Company (ComEd), and filed a complaint against ComEd’s former CEO alleging “fraud in connection with a multi-year scheme to corruptly influence and reward the then-Speaker of the Illinois House of Representatives.” Exelon and ComEd agreed to settle the charges, with Exelon paying a civil penalty of $46.2 million. The charges against the CEO are headed for trial. So how is this securities fraud? According to the Chief of the SEC Enforcement Division’s Public Finance Abuse Unit, the CEO’s “remarks to investors about ComEd’s lobbying efforts hid the reality of the long-running political corruption scheme in which they were engaged….When corporate executives speak to investors, they must not mislead by omission.”
SEC charges executives with fraudulent revenue recognition practices
As part of its fiscal-year-end enforcement surge, the SEC filed charges against three former executives of Pareteum Corporation, a telecommunications and cloud software company, for fraudulent revenue recognition practices—a settled action against the former controller and a complaint against the former CFO and former Chief Commercial Officer (also, formerly CEO). As described in the complaint, the SEC charged the former executives with orchestrating a fraudulent scheme to overstate revenue by recording revenue from non-binding purchase orders and concealing the practice from the company’s auditors. From 2018 through mid-2019, the SEC alleged, the defendants’ improper revenue recognition practices resulted in the company’s overstating revenue by “approximately $12 million for fiscal year 2018 (60% of the ultimately restated revenue), and by approximately $30 million for the first and second quarters of 2019 (91% of the ultimately restated revenue).” In addition, the former CFO, the SEC charged, did not establish sufficient internal accounting controls to assess whether revenue should be recognized under GAAP. According to the press release, Pareteum previously settled with the SEC on accounting and disclosure fraud charges in 2021 and filed for bankruptcy in 2022. Notably, the U.S. Attorney’s Office for the SDNY has announced parallel criminal charges against the former CFO and CCO. According to the Associate Director of Enforcement for the SEC’s Philadelphia Regional Office, as the SEC alleged in its complaint, “Pareteum’s executives artificially inflated Pareteum’s revenue numbers to create the illusion of robust revenue growth….Investors should be able to trust public companies to issue truthful and accurate financial statements, and we will hold accountable any executives who abuse that trust and defraud investors.”
The rubber meets the road again—inflated sales, inflated projections charged at electric vehicle manufacturers
Is it Groundhog Day again? Haven’t we heard about this before? An electric vehicle manufacturer that went public through a SPAC transaction is charged by the SEC with fraudulently misrepresenting the status of its products, even posting a misleading video of a truck purportedly operating on hydrogen fuel when it did not. But no, it’s not Nikola Corporation (see this PubCo post). Just this past week, in the rush to beat the shutdown and fortify the SEC’s fiscal year-end statistics, Enforcement announced two settled actions against two manufacturers of electric vehicles for misleading investors. In the first case, Hyzon Motors Inc., a maker of hydrogen fuel cell electric vehicles (FCEVs), was charged with misleading investors about the status of Hyzon’s products, business relationships and vehicle sales, agreeing to pay a civil penalty of $25 million. Two executive officers, also charged, agreed to pay civil penalties of $100,000, and $200,000. Not to mention a restatement to reverse revenue improperly recognized. According to a Regional Director, “[t]ransparency in the form of full, fair, and accurate disclosure is fundamental to the federal securities laws….The defendants allegedly violated this principle by misleading investors about virtually every aspect of Hyzon’s business.” [Emphasis added.] In the second case, the predecessor to Spruce Power Holding Corporation, XL Fleet, which provided fleet hybrid electrical vehicles, was alleged to have misled investors about its sales pipeline and revenue projections. As the successor, Spruce agreed to pay a civil penalty of $11 million. According to the Associate Director of Enforcement, “[i]t goes without saying that investors commonly rely on revenue projections when deciding how and where to invest, and that’s perhaps especially true for investment decisions involving early-stage companies in the SPAC market….By linking its bold revenue projections to misleading claims about the company’s historical performance, XL Fleet misled investors by inhibiting their ability to differentiate between credible facts and mere aspiration.” It’s worth noting here that, in March last year, the SEC proposed new rules regarding SPACs, including rules related to the use of projections in SEC filings “to address concerns about their reliability.” (See this PubCo post.)
You might want to think twice before describing pending litigation as “without merit”
There’s definitely a lesson to be learned from this recent case from the Massachusetts Federal District Court, City of Fort Lauderdale Police & Firefighters’ Ret. Sys. v. Pegasystems Inc.: companies making public statements about pending litigation should be very cautious when characterizing their views on the merits or prospects of that litigation. There may well be occasions when describing litigation as “without merit” may be, well, merited. But companies should keep in mind that claiming that a complaint against the company is “without merit”—as companies often do—may just shake up a whole new hornets’ nest, as it did in this case. (Hat tip to The 10b-5 Daily.)
SEC’s “shadow trading” case survives motion to dismiss
In August last year, the SEC announced that it had filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But this isn’t your run-of-the-mill insider trading case. Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he engaged in what has been referred to as “shadow trading”; he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claimed was comparable to Medivation. According to the SEC, Panuwat made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced. The SEC charged that Panuwat committed fraud against Medivation in connection with the purchase or sale of securities, with scienter, in violation of Rule 10b-5; he had, the SEC charged, breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement. The SEC sought an injunction and civil penalties. (See this PubCo post.) In November, Panuwat filed a motion to dismiss the complaint under Rule 12(b)(6), calling it “an unprecedented expansion” of the Exchange Act. Last week, the Court denied the motion.
SEC imposes $125 million civil penalty on Nikola for alleged material misstatements
Happy New Year!
In July of last year, as discussed in this PubCo post, the SEC and DOJ charged Trevor Milton, the founder, former CEO and executive chair of Nikola Corporation, with securities fraud for disseminating, primarily through social media, false and misleading information about Nikola’s technological achievements. In addition to civil SEC charges, Milton faced two counts of criminal securities fraud and one count of wire fraud, with maximum 20- and 25-year prison terms if convicted. He pleaded not guilty. But, interestingly, there was no word about the company. Was the company completely off the hook for the CEO’s alleged misrepresentations? Now we know that the answer is—far from it. In December, the SEC announced that Nikola had “agreed to pay $125 million to settle charges that it defrauded investors by misleading them about its products, technical advancements, and commercial prospects.” According to Gurbir Grewal, the SEC’s Director of Enforcement, “Nikola Corporation is responsible both for Milton’s allegedly misleading statements and for other alleged deceptions, all of which falsely portrayed the true state of the company’s business and technology.” And in this case, Milton’s alleged misstatements were attributed to the company even though many of the statements were communicated through Milton’s personal account, not the company’s corporate account. Although, according to the SEC, there were plenty of material misrepresentations in Nikola’s registration statements and other standard communications (i.e., not only alleged misstatements through Milton), the case reinforces the point that fraudulent or misleading statements don’t have to be in a prospectus or 10-K to be actionable—social media will do just fine. The case also highlights the need for companies to take social media into consideration in the context of disclosure controls and procedures, potentially including communications, to the extent that they relate to the company, that are made through personal accounts.
Is this insider trading?
On Tuesday, the SEC announced that it had filed a complaint in the U.S. District Court charging a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But it’s not what you might think. The employee didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claims was comparable to Medivation. According to the SEC, the employee made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced. The SEC charged that the employee breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement, in violation of Rule 10b-5. Will the SEC succeed or is the factual basis of the charge just too attenuated?
DOJ and SEC file fraud charges against Nikola CEO
Is there anything topical missing from this case? There’s a SPAC. There’s social media. There’s an unorthodox, charismatic CEO. There are electric vehicles. There are hydrogen trucks with drinking fountains using water produced by the trucks as a by-product of their hydrogen fuel cells—or not. And, there’s a DOJ criminal indictment and an SEC complaint. Yes, I’m talking about the case against Trevor Milton, the founder, former CEO and former executive chairman of Nikola Corporation, who was charged last week with “repeatedly disseminating false and misleading information—typically by speaking directly to investors through social media—about Nikola’s products and technological accomplishments,” according to the SEC press release. What’s more, the DOJ charged, Milton exploited the SPAC structure with a “self-proclaimed media blitz” of false and misleading public statements during a period of time that, in an IPO setting, would have been considered a “quiet period.” In addition to civil SEC charges, Milton faces two counts of criminal securities fraud and one count of wire fraud, with maximum 20- and 25-year prison terms if convicted. He pleaded not guilty. As described by the U.S. Attorney for the SDNY (with an appropriate vehicular metaphor), “[a]s alleged, Trevor Milton brazenly and repeatedly used social media, and appearances and interviews on television, podcasts, and in print, to make false and misleading claims about the status of Nikola’s trucks and technology. But today’s criminal charges against Milton are where the rubber meets the road, and he now will be held accountable for his allegedly false and misleading statements to investors.” The case reinforces the point that fraudulent or misleading statements don’t have to be in a prospectus or 10-K to be actionable—social media will do just fine. According to the Regional Director of the SEC’s Fort Worth Regional Office, “[p]ublic company officials cannot say whatever they want on social media without regard for the federal securities laws. The same rules apply, and the SEC will hold those who make materially false and misleading statements accountable regardless of the communication channel they use.” Notably, this is the second recent case involving SEC charges of misleading claims in connection with a SPAC. (See this PubCo post.)
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