District Of New Jersey Dismisses Putative Class Action Against Blockchain Company For Failure To Adequately Allege Misstatements Or “Scheme” Liability
On April 30, 2020, Chief Judge Freda L. Wolfson of the United States District Court for the District of New Jersey dismissed a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against a company that supports and operates blockchain technologies and certain of its executives and investors. Takata v. Riot Blockchain, Inc., No. 18-02293 (FLW), slip op. (D. N.J. Apr. 30, 2020). Plaintiff alleged that defendants engaged in a “pump-and-dump” scheme to inflate the price of the company’s stock before selling to unsuspecting retail investors. Id. The Court held that plaintiff failed to adequately allege any actionable misrepresentations and otherwise failed to establish “scheme” liability, and dismissed the action without prejudice.
The crux of plaintiff’s allegations was that the company, at the urging of an investor group that allegedly had perpetrated similar schemes at other companies, transitioned from being a biomedical company under a different name to operating a blockchain and cryptocurrency company in an effort to inflate the price of the company’s shares so that certain investors could cash out a profit. Plaintiff also alleged that statements in the company’s S-3 filings denying the existence of “material relationships” with selling shareholders, statements in proxy statements concerning the absence of “related-party transactions,” as well as press releases and public statements touting the company’s investments in blockchain technologies and cryptocurrency, were false and misleading. Id. at 15.
With respect to the alleged misstatements, plaintiff argued that the company’s Form S-3 disclosure misstated that none of the selling stockholders had a “material relationship, with us or any of our subsidiaries . . . other than as a result of the ownership of our shares or other securities.” In fact, plaintiff alleged, certain selling stockholders allegedly maintained ties to an officer and director of the company. Id. at 17. The Court, however, rejected that argument, holding that the statement in the context of the Form S-3 unambiguously referred to relationships with the company and not relationships with officers or directors of the company. Id. at 18.
The Court also rejected plaintiff’s argument that the company’s proxy statement falsely stated that “none” of the company’s directors, officers, or any person holding 5% or more of its common stock had “any material interest, direct or indirect, in any transaction, or in any proposed transaction.” Id. at 19. Plaintiff argued that those statements were false or misleading because two holders of 5% or more of the company’s stock had material interests in target companies, and the proxy failed to disclose that one of the company’s directors was also an investor in a target company. Id. The Court held, however, that the disclosure in the proxy statement referred to transactions “during the last fiscal year,” which ended nine months before the transactions in question, and emphasized that plaintiff had failed to allege any affirmative duty requiring further disclosure. Moreover, the Court noted defendants’ argument—which plaintiff did not rebut—that the director only became a director after the transaction in question was completed, and therefore, there was nothing to disclose at the time of the proxy statement. Id. at 19.
Plaintiff further alleged that statements in the company’s press release misleadingly exaggerated the company’s investments in cryptocurrency products, when in fact the company’s investments were limited, and the company allegedly did not have a meaningful cryptocurrency business plan. Id. at 23. The Court held that many of the challenged statements, however, were general statements of optimism that amounted to non-actionable puffery, and were too “soft” to be capable of “duping” the market. This included, for example, statements that the company’s cryptocurrency investment was “strategic” or that it was “poised to take advantage” of the blockchain “revolution.” Id. at 25. Moreover, while the Court noted that some challenged statements were closer to “concrete and verifiable facts” that might be actionable, the Court concluded that the complaint failed to allege that these statements were false or misleading. For example, plaintiff argued that statements that the company was experiencing “explosive growth” and “steady growth” were false when made, but the complaint did not allege that the company was not experiencing growth at the time. Id. at 26–27.
Separate and apart from the challenged public statements, plaintiff also alleged that defendants engaged in an unlawful “scheme,” which the Court explained required particularized allegations establishing that defendants “committed a deceptive or manipulative act,” in addition to the other requirements of Section 10(b) such as scienter and loss causation. Id. at 29. The Court determined that plaintiff sufficiently alleged that one investor engaged in a “deceptive or manipulative act” by failing to “promptly” file an amended ownership schedule when his holdings decreased from 11.2% of the company to 1.5%, which the Court concluded was “not necessarily deceptive by itself” but became deceptive in the context of plaintiff’s allegations that the investor concealed his sales as part of a pump-and-dump scheme. Id. at 34. The Court further concluded, however, that the complaint failed to allege any such deceptive or manipulative acts by other defendants, and disregarded plaintiff’s attempts to add such allegations in his opposition papers. Id.
The Court further held that plaintiff adequately alleged scienter with respect to the one investor, by alleging that the investor and other members of his organization had been “implicated in multiple pump-and-dump schemes at other companies,” that the investor was the “primary strategist” in those schemes, and that he encouraged other individuals to engage in activity that furthered those schemes. Id. at 36. While noting that those allegations did not independently support an inference of scienter, the Court determined that they “suggest[ed] a pattern of fraud” that supported an inference that the investor knew, or was reckless in not knowing, that concealing stock sales was deceptive. Id. at 36–37.
However, the Court further determined that, with respect to this investor, the complaint failed to allege loss causation. Specifically, the complaint contained no allegation as to how the alleged corrective disclosure—namely, that the investor’s stake had fallen to 1.5% of the company—was a “substantial cause” of any decline in the company’s stock price. Id. at 39. While the complaint contained such allegations with respect to other media reports and other disclosures, there was no causal link alleged between the disclosure of the investor’s stock sales and any economic loss to plaintiff.