Southern District Of New York Dismisses Claim That Underwriter Of Regulation A+ Offering Was A Seller Of Unregistered Securities, But Allows Securities Fraud Claim To Proceed Past The Pleading Stage
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  • Southern District Of New York Dismisses Claim That Underwriter Of Regulation A+ Offering Was A Seller Of Unregistered Securities, But Allows Securities Fraud Claim To Proceed Past The Pleading Stage
     
    04/23/2019
    On April 11, 2019, Judge Denise Cote of the United States District Court for the Southern District of New York granted in part and denied in part an underwriter’s motion to dismiss a putative class action lawsuit filed against a financial and technological services company (the “Company”), its executives, and the lead underwriter (“Underwriter”) of the Company’s Regulation A+ (“Reg A+”) offering in 2017 (the “Offering”).  In re Longfin Corp. Securities Class Action Litigation, 1:18-cv-02933 (DLC) (S.D.N.Y. Apr. 11, 2019).  Reg A+ was created to exempt certain categories of offerings from registration requirements and is an alternative to a traditional initial public offering.  Plaintiffs alleged that all defendants sold unregistered securities in violation of Section 12(a)(1) of the Securities Act of 1933 (“Securities Act”) in order to list on the NASDAQ, and committed fraud in violation of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder, and that certain of the individual defendants were liable under Section 20(a) of the Exchange Act and/or engaged in insider trading in violation of Section 20A of the Exchange Act.  The gravamen of plaintiffs’ claims is that the Company fraudulently issued more than 400,000 Class A shares to 24 individuals for $0 consideration in order to meet the NASDAQ’s listing requirement that the Company has issued 1,000,000 publicly held shares.  With respect to the Underwriter’s motion to dismiss, the Court dismissed the Securities Act claim, finding that it was not a “seller” of securities, but held that the Exchange Act claim could proceed because plaintiffs’ amended complaint adequately alleged, for the purpose of the motion to dismiss, the Underwriter’s knowledge and participation in a “scheme” under Rule 10b-5.
     
    The Court first considered the Underwriter’s motion to dismiss the Securities Act claim.  Plaintiffs argued that the Underwriter, along with the other defendants, violated Section 12(a)(1) by offering or selling unregistered securities in violation of Section 5 of the Securities Act.  Citing the Supreme Court’s opinion in Pinter v. Dahl, 486 U.S. 622 (1988), the Court noted that a plaintiff may sue a party it did not contract with (in this case, the Underwriter) if that party “successfully solicit[ed] the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.”  Further citing to Pinter, the Court also noted that when a broker acting as an “agent of one of the principals to the transactions successfully solicits a purchase, the agent is a person from whom the buyer purchases within the meaning of [Section 12] and is therefore liable as a statutory seller.”  The Court added that while Pinter did not extend the definition of seller under Section 12(a)(1) to include “participants collateral to the offer or sale,” generally speaking, underwriters may be liable in a firm commitment underwriting if they “[agree] to purchase . . . a percentage of the offering” and as a result bear “the risk if the offering is undersubscribed.”  Plaintiffs alleged that the Underwriter’s role in underwriting the Offering made it a “seller” because it was “instrumental” in allowing the Company to be listed on the NASDAQ, where plaintiffs purchased their shares.  The Court held that such allegations were “insufficient” to state a Section 12(a)(1) violation, finding that the Underwriter’s assistance in both the Offering and the NASDAQ listing process did not make it a seller of the Company’s shares in the open market.  To support this conclusion, the Court noted that there were no alleged facts demonstrating that the Underwriter acted as a broker for plaintiffs’ purchases, owned the shares sold to plaintiffs, or solicited those purchases.  As such, the Court granted the Underwriter’s motion to dismiss the Section 12(a)(1) claim. 
     
    The Court next considered the Underwriter’s motion to dismiss the Exchange Act claim.  Plaintiffs alleged that the Underwriter violated Section 10(b) of the Exchange Act and Rule 10b-5 by participating in the Company’s alleged manipulative scheme.  In its motion to dismiss, the Underwriter argued that the claim against it should be dismissed because the amended complaint failed to allege that it made any false statement.  But the Court disagreed, citing to the Supreme Court’s recent decision in Lorenzo v. SEC to support that there may be liability regardless of whether the Underwriter “made” any misrepresentations or omissions, and also citing to the Second Circuit’s decision in U.S. v. Finnerty, 533 F.3d 143 (2d Cir. 2008) which held that “conduct itself can be deceptive” and liability under Section 10(b) and Rule 10b-5 does not require a “specific oral or written statement.”  The Court added that a critical requirement of the alleged scheme involved getting the Company’s shares listed on the NASDAQ, and therefore the Underwriter may face liability if it “played a significant role” in that process while knowing that much of the Company’s shares were not “validly issued pursuant to a Regulation A+ exemption from securities registration requirements and should not be publicly traded.”
     
    Turning to the issue of scienter, the Court observed that the amended complaint alleged that the Underwriter should have known that certain sales of shares were invalid, thus disqualifying the Company from listing on the NASDAQ.  Specifically, plaintiffs alleged that the Underwriter received bank statements from the Company demonstrating that sales were made to executives and individuals closely related to the Company, and those bank statements did not contain proof that such shares were sold for valid consideration.  Plaintiffs alleged that the Underwriter should have understood such shares transfers were in violation of the NASDAQ’s listing requirements.  While the Underwriter argued that the bank statements it received could have been fabricated, the Court held that for the purpose of evaluating the motion to dismiss, plaintiffs adequately alleged facts giving rising to a “strong inference” that the Underwriter knew or was reckless in ignoring that the purported sales to qualify for listing on the NASDAQ were in fact invalid.  As a result, the Court held that plaintiffs adequately pled scienter under the PSLRA’s heightened pleading requirement and allowed the Exchange Act claim to proceed against the Underwriter. 
     
    Separate and apart from the Underwriter’s motion to dismiss, the Court considered the motions to dismiss for a lack of personal jurisdiction brought by two individual defendants who are domiciled abroad.  Those individual defendants were affiliated with the Company, and plaintiffs alleged that the individuals engaged in insider trading and additionally violated Sections 10(b) and 20(a) of the Exchange Act.  The Court held that while those individuals are not residents of the United States and may have purchased and/or sold Company shares from abroad, the exercise of personal jurisdiction over them was “reasonable” and “appropriate” because of their sufficient minimum contacts with the forum state:  the individual defendants received shares from the Company as part of the alleged manipulation scheme, they sold a portion of their shares through the NASDAQ, and they “knowing[ly] participat[ed] in a securities fraud in the United States.”  The Court further noted that the individual defendants would be appearing in New York before the Court in a related SEC action, so therefore the Court’s exercise of jurisdiction over them in the securities class action would not add any substantial burden.

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