Arizona Federal Court Upholds Rule 10b-5(b) Claims Against Renewable Energy Company And Its Executives, But Dismisses 10b-5(a) And (c) Claims
On April 8, 2020, Chief Judge G. Murray Snow of the United States District Court for the District of Arizona granted in part and denied in part a motion to dismiss a putative securities class action filed against a renewable energy company (“Company”) and its executives, alleging violations of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5. Zhu v. Taronis Techs. Inc., 2020 WL 1703680 (D. Ariz. Apr. 8, 2020). Plaintiffs alleged defendants misled investors about the existence of a contract with the City of San Diego. The Court denied defendants’ motion to dismiss as to plaintiffs’ claims under Rule 10b-5(b) but granted the motion as to claims asserted under Rule 10b-5(a) and (c).
The Company focuses on technology solutions to create, process, and produce hydrogen-based fuel. To maintain its listing, the Company was required to maintain a stock price above $1.00 for ten consecutive business days. On January 28, 2019, the Company announced in a press release that San Diego elected to use the Company’s MagneGas2 as its metal cutting fuel of choice, which caused the stock price to increase. The next day, San Diego asked the Company to withdraw the press release because the parties did not have a contract. Although the press release was removed, the Company did not file a correction until February 12, 2019, when it filed a Form 8-K/A acknowledging it did not have a formal contract with San Diego.
Plaintiffs alleged defendants knew the press release was false but released it to inflate the stock price and then waited until February 12, 2019 to file a clarification to keep the Company’s stock price over $1.00. While the Court denied defendants’ motion to dismiss claims asserted against the Company and two individual defendants under Rule 10b-5(b), concluding the Complaint adequately alleged a misrepresentation, scienter, and loss causation, the Court dismissed claims against the individual defendants asserted under Rules 10b-5(a) and (c).
While Rule 10b-5(b) makes it unlawful to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading,” Rule 10b-5(a) makes it unlawful to “employ any device, scheme, or artifice to defraud” and Rule 10b-5(c) makes it unlawful to “engage in any act, practice, or course of business which operates or would operate as a fraud or deceit.” Under the Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), a defendant must have “made” the alleged misrepresentation or omission to be held liable under Rule 10b-5(b). This is referred to as the “maker” requirement.
Because several of the individual defendants did not make the alleged misrepresentations, plaintiffs attempted to plead what they described as “scheme liability” claims under 10b-5(a) and (c). Specifically, relying on the Supreme Court’s 2019 decision in Lorenzo v. SEC, 139 S. Ct. 1094, plaintiffs argued that claims under Rules 10b-5(a) and (c) can be based on schemes to disseminate false or misleading statements. Plaintiffs argued their complaint pleaded such claims based on allegations that the individual defendants engaged in a scheme to misrepresent the contract with the City of San Diego, to disseminate false information, and to delay the release of corrective information. The Court rejected plaintiffs’ argument, however, reasoning that “participating in the issuance of the Press Release and in the decision to delay issuing a corrective disclosure…. is not enough.” Accordingly, because plaintiffs failed to allege “conduct beyond” the alleged misstatements, the Court dismissed the claims under Rules 10b-5(a) and (c).
The Court’s decision is an important reminder in the wake of Lorenzo that plaintiffs cannot evade the “maker” requirement of Rule 10b-5(b) imposed by Janus by simply characterizing their claims as “scheme liability” for the dissemination of false statements.