Bounty programs originated in the digital gaming world where “free items or other perks have traditionally been offered to gamers for their help in game development, usually in the form of bug hunting.” (Steve Walters, CoinBureau). Ventures seeking to raise money through ICO’s have adopted bounty programs as “an efficient and cheap way to spread the word about the ICO by outsourcing marketing to regular people.” (Hira Saeed, CoinSchedule). Ventures reward tokens for the new ICO to “Bounty Hunters” for completing specified tasks which help promote the ICO. The "bounty hunters" gain tokens by making posts on social media (e.g. YouTube, Twitter, and Facebook), while developers receive tokens as payment for coding (Investopedia). These programs are classified as either pre-ICO bounty programs or post-ICO programs respectively. Pre-ICO programs generally “focus on social media platforms, and are designed to create awareness about the project and the upcoming ICO.” (Steve Walters, CoinBureau). Post-ICO programs usually involve either translations campaigns, which help broaden the global reach of the project by making documents available in foreign languages, or bug reporting programs. (Id.)

Given how important and commonplace bounty programs are in ICO’s, the SEC’s decision to pursue an ICO which, although fraudulent, failed to raise money shows the  agency’s commitment to enforcing its regulatory oversight of these assets. (SEC Press Release). This order is consistent with the SEC’s ongoing effort to regulate a class of assets which are securities—in all but name—and to protect potential investors. The SEC’s order gives a clear warning to main street investors: “be alert to the risk of old-school frauds, like oil and gas schemes, masquerading as innovative blockchain-based ICOs.” (Id.)

Beyond the warning to investors and potential fraudsters, there are two key takeaways from the SEC’s order. First, consistent with previous SEC statements, simply using words such as “token” or “decentralized network” in a white paper does not magically transform the coin from a security into something else beyond the reach of the SEC. Second, granting tokens as part of a pre or post-ICO “bounty program” qualifies as issuing securities, even if the ICO is never completed. Therefore, promoters looking to raise money through an ICO must be aware of the SEC’s position as ICO’s continue to move into the regulatory mainstream.

Despite only fourteen cryptocurrencies being available in June 2013, CoinMarketCap now reflects over 1,900 available cryptocurrencies. Although certain currencies are only available on select exchanges and many exchanges are only available within certain countries, there were over five hundred crypto exchanges in operation as of April 2018. (Kai Sedgwick, Bitcoin). Crypto exchanges establish currency rates, which are largely based on the cryptocurrency's trading volume and demand present on the exchange itself. This unregulated, exchange-specific pricing structure—in addition to other minor factors—commonly results in price variances ranging from one to five percent between exchanges (Kira Egorova, Cointelegraph). The lack of regulation in crypto exchanges also makes them vulnerable to a variety of “black swan” events, such as hackers, bugs, and rogue employees. Due to this vulnerability, cautious traders often store their holdings in offline wallets and move funds to an exchange just long enough to place trades (William Peaster, Blockonomi). While a multitude of investors appear undeterred by this extreme volatility and absence of regulation, many institutional investors, among others, remain apprehensive (Jordan French, TheStreet).

When deciding how best to regulate the world of cryptocurrencies, there is no shortage of ideas or competing philosophies. But several noteworthy ideas seek to establish a united front, which focus on adapting current financial regulations instead of trying to reinvent the wheel. For example, the Jibrel Network proffers that integrating the current financial industry with blockchain technology could “usher in an era of smart regulation” in which people could place their “trust in code rather than in institutions.” (Id.) A single agency, however, may lack the authority and resources necessary to effectively regulate a financial sector which prides itself on decentralization. Accordingly, regulators from the SEC, FINRA, and the CFTC have begun coordinating their investigations and increasing interagency cooperation as it relates to regulatory action (Michael del Casillo, Forbes).

Some crypto exchanges also have banded together to self-regulate and bring order to what is currently referred to as “a Wild West for market manipulation, fraud, and money laundering” (Lydia Beyoud, Bloomberg BNA). One such coalition is the Virtual Commodity Association (VCA). Currently comprised of four larger exchanges, with Gemini taking the lead, the VCA seeks to develop and strengthen regulations throughout the digital asset industry, including reducing volatility and increasing market transparency. In line with these objectives, their sights for the future are set on obtaining approval from the SEC to establish a bitcoin-based exchange-traded fund (ETF). (Id.)

With multiple institutions and exchanges, such as NASDAQ, anxious to embrace the cryptocurrency market, the question regarding future regulation appears more a matter of when rather than if (Kate Rooney, CNBC). Larger groups, such as Germany’s Central Bank, believe a movement towards global regulations of both cryptocurrencies and their exchanges is the only way to effectively regulate this recent financial phenomenon. Despite the potential wisdom in this approach, many countries have drastically different opinions on how the crypto market should be dealt with. For example, while Japan is among its largest supporters and has even given Bitcoin currency status, other countries, such as China, are in active opposition and have started banning ICOs and crypto exchanges. Ultimately, while the future will almost certainly see increased regulations within individual countries, the existence of such wildly divergent views surrounding the crypto market will make developing and implementing globally accepted regulations difficult, if not impossible (Darryn Pollock, Cointelegraph).

 The PCAOB is comprised of a five-member board (the "Board") appointed by the SEC (with input from the Secretary of the Treasury and Chair of the Board of Governors of the Federal Reserve System) and each Board member is appointed to a staggered five-year term (About the PCAOB). In addition to appointing the Board members, the SEC provides oversight of the PCAOB through the approval of its rules, standards, and budget (About the PCAOB).

Two advisory groups act as a support and advice mechanism to the Board, the Investor Advisory Group and the Standing Advisory Group. The Investor Advisory Group provides the Board members with their views and advice regarding PCAOB matters that affect investors (Investor Advisory Group). The Standing Advisory Group provides the Board members with advice regarding the development of audit and audit-related standards (Standing Advisory Group).

The PCAOB has a number of on-going obligations. One of its primary responsibilities is to establish auditing and professional standards, which the public accounting firms registered with the PCAOB must follow in their role of preparing and issuing audit reports of public companies or broker-dealers (Standards). The PCAOB also undertakes periodic inspections of registered accounting firms to determine whether a firm is in compliance with the Sarbanes-Oxley Act, the PCAOB's rules, the SEC's rules, and relevant professional standards (Inspections). In conjunction with its authority to inspect, the PCAOB can also investigate and discipline registered accounting firms and their employees who have been found to be in non-compliance with rules and standards. (Enforcement). 

As a result of its role and responsibilities, the PCAOB has broad authority in regard to accounting firms that audit public companies and broker-dealers. Through its oversight of registered accounting firms, the PCAOB plays an important role in investor protection.

On August 8, the day after the Tweet, the Securities and Exchange Commission (SEC) began investigating whether Mr. Musk’s statements were truthful or misleading in order to determine if he had violated SEC Rule 10b-5, a securities law violation. (Mark Matousek, Business Insider). After the investigation commenced, Mr. Musk blogged about his actions; specifically, his personal beliefs on why he considered taking the company private and his reasoning for making the initial announcement on Twitter. The blog post could be construed as Mr. Musk’s attempt to dissuade the SEC from believing that he had engaged in deceptive practices. Nevertheless, the SEC began a formal investigation.  Subsequently, on August 24th, Mr. Musk addressed shareholder concerns and announced that Tesla would be “staying public” in another blog post.

Under SEC Rule 10b-5, it is “unlawful for any person … by the use of any means or instrumentality of interstate commerce … [t]o employ any device, scheme, or artifice to defraud, 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, or to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

To prove a fraud under Rule 10b–5, six elements must be established: (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation and the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) loss causation.

The SEC could establish that Mr. Musk made a material misrepresentation that caused an economic loss due to the rapid spike and later decline in Tesla’s stock from the day of his initial Tweet. (Peter J. Henning, The New York Times). The high stock price could mean that he misled investors who either bought in because they thought Tesla would go private or those that sold their shares because they did not want to own shares of Tesla stock if it went private. Scienter could be established by either showing that Mr. Musk had both motive and opportunity to commit fraud or by establishing facts that constitute circumstantial evidence of recklessness or conscious behavior. Connection and reliance could be shown by a potential buyer who was dissuaded from purchasing as a result of the fraudulent statement, or by an investor who held a security and, in reliance on the alleged misstatement, sold the security. (See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 79–80 (2006). Loss causation could be shown when the misrepresented or concealed information negatively affected the stock price. (See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). According to Bloomberg, some investors have already filed suit against Mr. Musk and Tesla for manipulating Tesla’s stock prices.

Scienter (or an intent to defraud) may be more difficult to prove, as Tesla’s Board of Directors acknowledged the talks of “going private” had been previously discussed with Saudi Arabia's sovereign wealth fund, which could show that Mr. Musk did not act with the required knowledge to defraud investors but was being truthful about his negotiations; however, his conduct could also be considered reckless since he failed to consider the consequences of his Tweet and how it could affect Tesla and its shareholders. (Aisha Al-Muslim, The Wall Street Journal). His state of mind at the time of making the Tweet would be crucial in the SEC’s determination of whether he acted with scienter and thus whether he violated Rule 10b5. (Ben Bain and Matt Robinson, Bloomberg).

The implications of the investigation could result in a formal charge from the SEC, which could result in millions of dollars in fines for Tesla. Certain professionals believe that the SEC has moved away from enforcing huge monetary penalties against corporations for these types of violations, which could result in Tesla playing a significantly lower fine than those imposed by the SEC in the past.” These professionals believe that this trend is due in part to the SEC wanting to punish individual wrongdoers as opposed to holding companies liable for their employees’ wrongdoings. “Even if the commission ultimately concludes Musk’s tweet was unfounded, the Tesla CEO’s potential penalty would probably be less than $200,000, according to two securities law professors and a defense lawyer who tracks SEC enforcement”. (Alison Frankel, Reuters)

At this time, the SEC has declined to comment over the extent of the investigation or whether it will decide to formally charge Elon Musk with violating securities laws.

Following requests for information from hedge funds about their digital assessment pricing, the SEC put the Office of Compliance and Examinations (OCIE) in charge of current review of smaller brokerage firms dealing virtual tokens. (Benjamin Bain, Bloomberg). OCIE conducts examinations aimed to protect investors and ensure market integrity. If OCIE’s examinations show signs of misconduct, it refers the findings to SEC’s enforcement division for further formal investigations. (Benjamin Bain, Bloomberg). Industry self-regulators, such as Financial Industry Regulatory Authority (FIRA) and the National Futures Associations (NFA), also are questioning companies about their cryptocurrency dealings. As governmental and non-governmental (self-regulating) regulatory authorities attempt to understand the entire cryptocurrency ecosystem to ensure an efficient marketplace, this line of questioning will likely continue. 

Regulatory agencies heightened scrutiny of cryptocurrency comes directly from the top—as SEC Chairman Jay Clayton believes the ICO market is “rife with fraud.” (Benjamin Bain, Bloomberg). Protecting retail investors from cryptocurrency risk is a primary focus of OCIE’s investigations. Retail investors are individual investors that buy and sell securities for their own personal investment. (SeeInvestorguide.com). Specifically, the OCIE wants financial professionals to maintain safeguards and controls to protect retail investors’ assets against fraud and misappropriation. (Benjamin Bain, Bloomberg). For guidance in complying with the law, some brokers and money managers have openly reported their cryptocurrency involvement to regulators, while others are less willing to volunteer information. This kind of self-reporting is difficult because there is a debate in the regulatory landscape about what crypto assets should be considered securities and thus under the SEC’s jurisdiction. 

The NFA notified the Commodity Futures Trading Commission that in the future they plan to require firms dealing in cryptocurrency derivatives and cash markets to make additional disclosures. (Benjamin Bain, Bloomberg). Whether or not regulators will request additional information or turn over findings to enforcement divisions remains uncertain. An important question the SEC must answer is if cryptocurrency, like bitcoin, will be considered a security for regulatory purposes. Chairman Clayton previously stated bitcoin-type cryptocurrency will be considered a commodity like other sovereign currency, but tokens or coins sold in ICO’s do classify as securities. (Nick Marinoff, Bitcoin Magazine; Josephine Wolff, Slate).

Regardless of the decision, the more guidance regulators provide for cryptocurrency, the more informed investors and institutions can be in their dealings with cryptocurrency. The push for information in this area reminds us that the cryptocurrency world is still relatively unknown, and regulators cannot fully act without a sufficient understanding of the market.  JJ Kinahan, chief market strategist for TD Ameritrade, summed up the uncertainty in the landscape by stating, “[n]o one is quite sure what the rules are.” (Bob Pisani,CNBC). As information from recent inquiries come in, regulators may be able to contribute more guidance to investors regarding their conduct with cryptocurrency.

Rule 15c2–12 prohibits a “Participating Underwriter”—a broker, dealer, or municipal securities dealer acting as an underwriter—from purchasing a primary offering of municipal securities with an aggregate principal amount of $1 million or more unless certain requirements are met. 17 C.F.R. § 240.15c2–12(a). One such requirement is the existence of the agreement between the securities issuer and the MSRB described above, which further requires the issuer to provide timely notice to the MSRB when any of fourteen listed events occurs. 17 C.F.R. § 240.15c2–12(b)(5)(i)(C)(1)–(14). These events include rating changes, bankruptcy, or material modifications to rights of security holders. The recent SEC amendments increase the total number of events requiring notice to the MSRB from fourteen to sixteen by adding paragraphs (15) and (16) to Section (b)(5)(i)(C) of Rule 15c2-12. The new paragraphs are reproduced here in full:

(15) Incurrence of a financial obligation of the obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material; and 

(16) Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties. 

(SEC, Final Rule). The amendment also includes a definition of “financial obligation.”

The SEC believes the amendments will increase transparency by expanding the amount of information publicly disclosed about municipal securities and better inform investors and other market participants about the financial condition of issuers of municipal securities. (SEC, Press Release).

While these amendments do not dramatically modify the requirements of Rule 15c2–12, issuers, borrowers, and underwriters ought to adopt new policies and procedures to ensure compliance with the additional provisions. (Graham Beck et al., Nixon Peabody LLP). Large issuers and borrowers with multiple departments responsible for debt obligations should be especially cautious. Tracking and reporting may be more complex when multiple departments are involved, and those issuers and borrowers will likely need to update procedures in order to ensure consistent reporting of incurrence or default of financial obligations and their materiality under the new Section (15).

S&N was formed in 1992 by Stoddard and Donald Newman. In 1994 Defendants distributed 25% equity to Plaintiff, with the rest of the shares distributed to Donald Newman. Plaintiff assigned his stock shares to the Roy B. Stoddard Revocable Living Trust (“Stoddard Trust”). Plaintiff was charged with a federal crime and borrowed money from Defendants to pay for legal fees. According to the allegations, Plaintiff moved to safeguard his assets held within the Stoddard Trust, mainly his 25% interest in the S&N after Defendants declined a second loan to Stoddard. The complaint asserts that Stoddard transferred his 25% to Newman. Plaintiff, however, asserted that he kept his trust’s interest in S&N. Defendant changed the name of S&N to Newman Logging, Inc. No notice was given to Defendants that Plaintiff still considered himself a shareholder of the company. Defendants obtained a certificate from the Washington Secretary of State confirming the dissolution of Newman Logging Inc. The complaint alleged Plaintiff sent a letter on behalf of the Stoddard Trust demanding a review of corporate records to which Defendants refused. Plaintiff filed suit against Defendants alleging breach of a fiduciary duty to the corporation by failing to maintain S&N and Newman Logging, Inc.’s corporate status and for distributing corporate assets to Donald Newman. Plaintiff sought accounting of the Defendants’ financial affairs, a declaratory judgment acknowledging Plaintiff’s 25% interest in Defendants, and the distribution of leftover corporate assets to Plaintiff. Defendants filed a motion to dismiss which was granted by the trial court.

RCW 23B.14.340 provides for the possibility of recovery from a corporation after its dissolution for a wrong incurred before its dissolution. However, an action pursuing a remedy must commence within three years of the corporation’s effective date of dissolution. RCW 23B.14.350 addresses the conduct and affairs of a corporation after it is dissolved. For example, under the statute a dissolved corporation must cease all normal business activity except those concerning the process of dissolving the company and liquidating its assets to pay off any debts.

Stoddard argues that RCW 23B.14.350 creates ambiguity and does not apply to his shareholder suit for a corporate accounting and other remedies. The court disagreed, holding that the statute of limitations of three years provided in RCW 23B.14.340 is “sweeping” and applies to any action commenced against a dissolved company. The court concludes that the certificate of the dissolution of the Newman, Inc. provided by the Washington Secretary of State in 2010 started the three-year timeframe for when a suit could be brought. Stoddard’s 2016 action was thus outside of that three-year timeframe.

Accordingly, the court granted Defendant’s motion to dismiss.

The primary materials for this case may be found on the DU Corporate Governance website.

Kitov, an Israeli biopharmaceutical company, developed a drug candidate, KIT-302, for the treatment of hypertension and osteoporosis. The company hired an independent Data Monitoring Committee (“DMC”) to evaluate the likelihood of KIT-302’s approval by the Food and Drug Administration before it could be marketed. Kitov provided data related to the drug’s efficacy to the DMC. Subsequently, the DMC’s review and analysis revealed no additional tests were necessary and classified the drug as viable. According to the complaint, however, Kitov provided falsified data in a report to improve the likelihood of a favorable review by the DMC. On February 6, 2017, an Israeli newspaper article about defendant Israel’s arrest concerning the allegedly falsified report prompted a 30% decline in value of Kitov stock.

To adequately state a claim under Section 10(b) of the Exchange Act and successfully implement Rule 10b-5, a plaintiff must allege facts sufficient to show: (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.

With regard to the first element above, a statement or omission qualifies as material when a substantial likelihood exists that a reasonable investor would view the disclosure as significantly altering the 'total mix' of information made available. To properly allege scienter, the second element, a complaint must allege the defendant made false or misleading statements either intentionally or with deliberate recklessness, or that facts give rise to a strong inference of such. To meet the loss causation element, a plaintiff must show that the subject of the fraudulent statement or omission actually caused the loss. A plaintiff does not need to prove the fraudulent behavior emerged as the only possible cause of the stock price decline, but rather that the actions serve as one plausible explanation for the stock’s decline.

Additionally, according to Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (“PSLRA”), fraud assertions must meet a heightened pleading standard stating the “who, what, when, where, and how” the fraud occurred.

Finally, to properly allege a violation of Section 20(a), a plaintiff must allege both a primary violation of the Act and control over the primary violator.

In granting Plaintiffs’ motion in part, the court held that the complaint adequately pleaded material omissions with regard to Defendants Kitov and Israel. The court reasoned Defendants Kitov and Israel’s statements regarding the validity and results of the KIT-302 study qualified as material and misleading because information appeared falsified to create the impression that the drug was likely to receive FDA approval. The court also found the presence of the loss causation element evidenced by Kitov’s stock prices steeply declining immediately after the news reports of an investigation into Kitov’s statements came out. Finally, the court held Plaintiffs met the scienter element with respect to CEO Israel and Kitov, but not CFO Rock. Witness testimony revealed that Israel directed those conducting the study to falsify results to improve the drug’s market viability. Further, the evidence revealed that both Kitov and Israel appeared consciously aware the statements were misleading. Conversely, the court found that defendant Rock did not satisfy the scienter requirement because the allegations did not create a strong inference that he knew about the fraud or had access to information about it. Finally, the court ruled that Plaintiffs adequately alleged control person liability under their Section 20(a) claim, so Defendants Kitov and Israel’s motion to dismiss that claim was denied.

For the above reasons, the court denied defendants Kitov and Israel’s motion to dismiss and granted Rock’s motion to dismiss in full.

The primary materials for this case may be found on the DU Corporate Governance Website.

According to the amended complaint, in December 2016, Rory Cowan, acting on behalf of Lionbridge Technologies, Inc. as the CEO, signed a plan of merger agreement to combine his company with HIG Capital LLC. HIG offered $5.75 per Lionbridge share to merge the latter into two HIG affiliates: LBT Acquisition, Inc. and LBT Merger Sub, Inc. Lionbridge retained Union Square Advisors LLC to evaluate HIG’s offer for fairness as well as prepare projections based on Lionbridge’s current finances, should Lionbridge desire to accept the offer. Union Square concluded HIG’s offer was fair and produced financial projections for Lionbridge through 2020; Lionbridge then sent these projections in a proxy statement to its shareholders, including Plaintiffs, seeking their approval for the proposed merger. Lionbridge stated the financial projections arose “under the assumption of continued standalone operation as a publicly-traded company and did not give effect to any changes or expenses as a result of the merger or any effects of the merger.”

Plaintiffs are Lionbridge shareholders who allege this proxy statement contained certain “nondisclosures,” specifically “materially false and misleading statements and omissions,” in violation of Section 14(a) of the Exchange Act. Additionally, Plaintiffs claim that HIG, its affiliates, and Lionbridge’s board are “controlling persons” who should face liability for such alleged misleading statements and omissions under Section 20(a) of the Exchange Act. 

In order to successfully state a claim under Section 14(a) of the Exchange Act, Plaintiffs must allege that: (1) a proxy statement contained a material misrepresentation or omission; and (2) this misrepresentation or omission caused injury. Finally, Plaintiffs must show that “The proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link in the accomplishment of the transaction.” Section 20(a) imposes liability on every person who controls anyone liable under any provision of the Exchange Act; therefore, to sustain their Section 20(a) claim, Plaintiffs must first show Defendants violated Section 14(a) of the Exchange Act.

Here, however, the court determined Plaintiffs’ allegations mandated an even stricter pleading standard because the amended complaint indicates fraud. Plaintiffs alleged Lionbridge gave false statements to Union Square to ensure approval of HIG’s offer in order to convince shareholders to vote for the planned merger. Plaintiffs alleged Lionbridge’s management team was so motivated because HIG offered it continued employment and specifically offered Mr. Cowan the opportunity to rollover part of his Lionbridge stock into the surviving company’s stock. The court noted that, according to OFI Asset Mgmt. v. Cooper Tire & Rubber, 834 F.3d 481 (3d Cir. 2016), when a 14(a) claim sounds in fraud it is subjected to the heightened pleading standards of the Private Securities Litigation Reform Act (“PSLRA”). The PSLRA requires a complaint to “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.”

First, the court found the projections qualified for the PSLRA’s safe harbor protecting forward-looking statements because they contained “a lengthy and specific disclaimer.” Lionbridge explained the financial projections “[were] not included…to influence a Lionbridge stockholder’s decision whether to vote for the merger agreement or for any other purpose.” The statement cautions shareholders “not to place undue, if any, reliance on the [financial] forecasts.” The court concluded, based on this disclaimer, nothing in the proxy statement rose to the level of a statement of fact other than the assertion that Lionbridge provided the same projections to its shareholders as it did to HIG et al. and Union Square.

Next, the court found Plaintiffs’ 14(a) claim did not qualify as actionable because the filings failed to allege the projections provided to shareholders contained different information from those provided to other parties. The court concluded the only relevant fact was whether the projections provided to shareholders read the same as those provided to other relevant parties. Here, Plaintiffs did not allege the projections in the proxy statement differed from those provided to the other parties involved; therefore, Plaintiffs failed to state a 14(a) claim based on the projections contained in the proxy.

The court proceeded to conclude, without further analysis, that Plaintiffs’ Section 20(a) claim also failed because the court found that Plaintiffs did not adequately plead a Section 14(a) violation and a Section 20(a) claim requires an underlying Exchange Act violation.

For the above reasons, the court granted Cowan’s motion to dismiss Plaintiffs’ Section 14(a) and 20(a) Securities Exchange Act of 1934 claims.

The primary materials for this case may be found at DU Corporate Governance Website.

According to the court’s factual background, SolarCity is an energy company that sells and leases solar energy systems. The costs associated with leases and sales are accounted for differently in SolarCity’s financials. While installation and overhead costs in each lease are amortized across the entire duration of the lease’s standard twenty-year term, the same costs in each direct sale are realized at the time of sale. SolarCity uses a formula, which divides the indirect overhead costs by the prior and current period direct costs to allocate the appropriate amount of overhead costs between the lease and direct sales systems. 

Plaintiffs alleged between 2012 and 2014 (the “Class Period”), SolarCity erroneously omitted the prior period’s direct costs from the denominator, causing its direct sale costs to be amortized with the costs associated with leases. The error created an artificial increase in SolarCity’s sales margins, though the company still reported net losses. Plaintiff claimed the error intentionally misrepresented SolarCity’s profitability just before its IPO in 2012, violating both § 10(b) of the Act and Rule 10b-5 of the Code of Federal Regulations.

To adequately state a claim under § 10(b) and Rule 10b-5, plaintiffs must prove six elements: (1) a material misrepresentation or omission by defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation. Here, the court only addressed the second element. Under 15 U.S.C. § 78u-4(b)(2)(A), scienter can be established when a complaint states facts “giving rise to a strong inference that the defendant acted with the required state of mind.”

The court held the alleged facts did not establish scienter. Plaintiff alleged there was a motive for fraud because SolarCity needed its sales division to appear profitable in order for its IPO to be successful. As additional evidence, Plaintiff proposed the leadership reorganization that occurred at SolarCity shortly before the announcement of the accounting error implied the existence of the scienter element. Plaintiff then noted Defendants’ Sarbanes-Oxley certifications indicated they were knowledgeable about the gross margins of the sales and lease systems. Lastly, Plaintiff contended the record revealed the core operations doctrine allowed an inference that “facts critical to a business’s ‘core operations’ . . . are known to a company’s key officers.”

The court noted that despite Plaintiff’s evidence, the actual conduct of Defendants was inconsistent with scienter. The facts suggested that Defendants took a hands-on approach to managing SolarCity’s sales division, and as a result they became aware of the company’s general unprofitability. Nevertheless, they did not sell any of their stock in SolarCity during the Class Period. Further, Defendants proactively disclosed the error to the public when it was discovered. The court also found Defendants’ actions allegedly indicating motive spoke only about routine corporate objectives rather than a particular fraudulent action. Finally, the court found the incorrect statements only misstated the degree of the company’s unprofitability instead of creating a “facade of profitability.” Resultantly, it was fair to note that the error was not immediately obvious to the Defendants.

For the above reasons, the court concluded that Plaintiff’s narrative of fraud was not more plausible than a non-fraudulent alternative and therefore affirmed the dismissal of Plaintiff’s TAC. 

The primary materials for this may be found on the DU Corporate Governance Website.

The Shareholder submitted a proposal providing that:

RESOLVED, that shareholders of Pfizer Inc. (“Pfizer”) ask the Board of Directors to report to shareholders by December 31, 2018, at reasonable cost and omitting confidential or proprietary information, on the risks to Pfizer from rising pressure to contain U.S. prescription drug prices, including the likelihood and potential impact of those risks as applied to Pfizer, the steps Pfizer is taking to mitigate or manage those risks and the Board’s oversight role. The report should address risks created by payer cost-effectiveness analysis, patient access concerns, outcomes-based pricing, and price sensitivity of prescribers, payers and patients.

Pfizer sought to exclude the proposal under subsections (i)(7) and (i)(10) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to include a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholder, however, must meet certain procedural and ownership requirements. Moreover, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirement of the Rule, see The Shareholder Proposal Rule and the SEC and The Shareholder Proposal Rule and the SEC (Part II).

Rule 14a-8(i)(10) allows the exclusion of a shareholder proposal from the company's proxy material “if the company has already substantially implemented the proposal.” For a proposal to be substantially implemented, the actions of the company must compare favorably to the guidelines and essential purposes of the proposal. For additional discussion of the exclusion, see Aren Sharifi, Rule 14a-8(I)(10): How Substantial is “Substantially” Implemented in The Context of Social Policy Proposals?, 93 DU L. Rev. Online 301 (2016).

Additionally, Rule 14a-8(i)(7) permits exclusion of a shareholder proposal from its proxy materials if it deals with "a matter relating to the company’s ordinary business operations.” However, when a proposal relates to the company’s operations but also raises important issues of public policy, the SEC will reject the requested no action relief. For additional explanation of this exclusion, see Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8(i)(7), 93 DU Law Rev. Online 183 (216), and Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, 93 DU L. Rev. Online 263 (2016).

Pfizer argued for omission of the proposal under Rule 14-a-8(i)(7) because the SEC has allowed exclusions under this subsection when the proposal related to product pricing decisions or requesting a report on how the company plans to respond to regulatory, legislative and public pressures relating to pricing policies or price increases. Specifically, Pfizer asserted that the proposal "delves much more deeply into the day-to-day affairs of Pfizer" beyond requesting information regarding general business strategy with the goal of providing affordable access to prescription drugs. While Pfizer acknowledged that a proposal might not be excluded under this rule if it focuses on a significant policy issue, it alleged the proposal focused on ordinary business matters.

Pfizer also argued for omission under Rule 14-a-8(i)(10) because it had already substantially implemented the proposal. Pfizer contended that its Regulatory and Compliance Committee is tasked with "overseeing current and emerging risks and regulatory and enforcement trends that may affect Pfizer’s business operations, performance, or strategy,” and this meets the objective of the proposal requesting Pfizer assess risks relating to pricing decisions. The public disclosures from the committee appear in its annual report on Form 10-K for 2016, quarterly report for the quarter ending on Oct. 1, 2017, and in the 2017 proxy statement.

In response, Proponents argued drug-pricing decisions do not fall within the protection of section (i)(7) because drug pricing is a significant policy issue that constitutes more than an ordinary business decision. Proponents also asserted that the (i)(10) exclusion does not apply because the disclosed materials do not address the concerns related to the risks of payer cost effectiveness, patient access, or price sensitivity of prescribers.

The SEC agreed that Pfizer substantially implemented the proposal and decided it would not recommend enforcement action if Pfizer omitted the proposal from its proxy materials in reliance on Rule 14a-8(i)(10).

The primary materials for this post may be found on the SEC website.

Shareholder submitted a proposal providing that:

RESOLVED, That the stockholders of General Electric, assembled in Annual Meeting in person and by proxy, hereby request the Board of Directors to take the necessary steps to provide for cumulative voting in the election of directors, which means each stockholder shall be entitled to as many votes as shall equal the number of shares he or she owns multiplied by the number of directors to be elected, and he or she may cast all of such votes for a single candidate, or any two or more of them as he or she may see fit. 

In the cover letter of the proposal, Shareholder stated, “Please include my attached proposal and images in the GE 2018 Proxy”. Attached to the proposal is a full-page image including a chart, text, equations, and emoji’s (collectively, the “Images”). 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company's proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the Rule indicates thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC & The Shareholder Proposal Rule and the SEC (Part II).  

Rule 14a-8(i)(3) permits the exclusion of a shareholder proposal if the proposal or supporting statement is contrary to any of the SEC’s proxy rules or regulations, including Rule 14a-5(a), which requires information in a proxy statement to be clearly presented, and Rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials. Rule 14a-8(i)(4) permits the exclusion of a shareholder proposal if the proposal relates to the redress of a personal claim or grievance against the company or any other person, or if it is designated to result in a benefit to the proponent of the proposal, or to further a personal interest not shared by the other shareholders at large. For additional discussion of exclusion 14a-8(i)(4), see Jon Wagner, Finding the Grievance in the Personal Grievance Exclusion, 94 Denv. L. Rev. Online 394 (2017). 

GE argued the proposal should be excluded under 14a-8(i)(3) because the Images are irrelevant to the subject matter of the proposal.  The Images, GE contended, were “nonsensical,” alluding to two stock transactions by the GE’s former CEO.  The Images show a line of text next two transactions alluding to a “2,700%” gain in initial investment. Another line of text adds “during the same time” (without referring to a specific time frame) a shareholder investment that was “down” 46%. Without any further explanation, the image adds a sentence stating cumulating voting would better align shareholder and CEO performance. GE further contended there is no clear connection to how alleged historical securities transactions could be distributed and used by shareholders through adoption of cumulative voting. GE argued the remainder of supporting statements were also vague and misleading. GE believed these statements would make the entire proposal vague and indefinite—leaving shareholders unable to determine with reasonable certainty what the actions or measures of the proposal require. Finally, GE asserted that the Images and the supporting statements would personally benefit Shareholder.  

Shareholder did not respond to the exclusion request by GE but was included in the correspondence between the SEC and GE. In his proposal, Shareholder argued that “[m]any states have mandatory cumulative voting, so do National Banks.”  Further, Shareholder generally stated many corporations have adopted cumulative voting. Finally, Shareholder explained that the increase in shareholder voice as represented by cumulative voting may serve to “better align shareholder performance to CEO performance.” 

The SEC was unable to agree with GE that the entire proposal could be excluded from its proxy materials in reliance on Rule 14a-8(i)(4) because the proposal does not relate to the redress of a personal claim or grievance against GE. Further, the SEC was unable to agree with GE that the proposal was designed to benefit Shareholder, or to further a personal interest not shared by other shareholders at large.  The SEC, however, did find a basis to exclude the Images under rule 14a-8(i)(3) because the Images were irrelevant to a consideration of the subject matter of the proposal and a reasonable shareholder would be uncertain as to the matter on which her or she is being asked to vote.  Accordingly, the SEC indicated it would not recommend enforcement if GE excluded the Images from its proxy materials, but recommended enforcement if GE excluded the entire proposal from its proxy materials.

The primary materials for this post can be found on the SEC website.

Shareholder submitted a proposal providing that:

This proposal recommends that Ford prepare a report, following all applicable laws, at reasonable expense, outlining the costs and benefits of feeding its employees, with the intention to promote health, productivity, and profitability.

Ford argued the proposal may be excluded from the company’s proxy materials under Rule 14a-8(i)(7). 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC and The Shareholder Proposal Rule and the SEC (Part II).

Rule 14a-8(i)(7) allows for the exclusion of a proposal if it “deals with a matter relating to the company’s ordinary business operations.” When a company cites this exclusion, the SEC must determine whether the proposal implicates the normal operations of the company. The SEC, however, will generally weigh a proposal implicating business operations against potential social policy implications. For additional explanation of the exclusion, see Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8?, 93 DU Law Rev. Online 183 (2016), and Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, 93 DU L. Rev. Online 263 (2016).

Ford argued Shareholder’s proposal should be excluded under Rule 14a-8(i)(7) because the proposal would allow shareholders to circumscribe whether and how Ford should feed its employees. Ford contended the decision whether or not to feed its employees is a clear business decision. Ford stated that because providing free food to employees would involve complex decision-making processes regarding employee compensation and Ford facility operations, it would relate to the ordinary business operations of the company. The SEC agreed with Ford’s basis for exclusion, concluding that the staff would not recommend enforcement action if Ford omitted Shareholder’s proposal from its proxy materials. The staff agreed the subject matter of the proposal related to the company’s ordinary business operations.

The primary materials for this case may be found on the SEC website.

Endo develops, manufactures, and distributes branded and generic pharmaceutical products worldwide. Endo acquired Par Pharmaceuticals (“Par”) in 2015. Between May 2015 and May 2016, Defendants publically stated Endo was “making progress” toward strategic priorities resulting from the acquisition of Par. In January 2016, Endo announced $118.46 million in losses for the fourth quarter of 2015, stock prices fell 21 percent after the announcement. In March 2016 and May 2016, Endo revised its 2016 revenue expectations downward, stock prices fell 11 percent and 39 percent, respecivelly, after each revision. Additionally, in May 2016, Defendants released a series of statements indicating trouble with the integration of Par. Plaintiffs allege Defendants made material misrepresentations to investors when they intentionally misled investors with public comments about the company’s sales outlook and the integration of the Par acquisition. Plaintiffs, additionally allege Defendants attempted to defraud investors by unlawfully boosting sales when the company engaged in “improper and illegal sales practices” by offering deep discounts on two of its drugs to secure relationships with Pharmaceutical Benefit Managers. 

Section 10(b) and Rule 10b-5 of the Exchange Act prohibit any misstatements or omissions of material fact in connection with the sale or purchase of a security. Securities fraud claims are subject to the heightened pleading standards of the Private Securities Litigation Reform Act (“PSLRA”) which requires plaintiffs to plead with particularity facts establishing fraud and an inference of scienter. Plaintiffs must specify each statement alleged to be false, the reason the statement is misleading, and that defendants had both the intent and opportunity to commit fraud. Scienter can be established by alleging strong circumstantial evidence of conscious misbehavior or recklessness. Additionally, a plaintiff must establish he suffered a loss because of defendant’s actions. Finally, Section 20(a) holds control persons liable for the fraud of the entities they control.

The court determined Plaintiffs did not meet the heightened pleading standard under the PSLRA. The court noted Plaintiffs’ allegation that Defendants engaged in illegal sales practices was both conclusory and lacked substantial evidence to prove the practice was illegal. Further, the Plaintiffs’ argument rested solely on the fact that individual Defendants held executive positions at Endo, which, on its own, failed to give rise to a strong inference of scienter. Regarding the allegations of material misrepresentation, the court determined the statements made by Defendants were not actionable because they were expressions of opinion or expectation, rather than intentional misstatements or omissions. Finally, the court concluded Plaintiffs were unable to establish a primary violation under Section 10(b),  therefore, the Section 20(a) claim also failed. 

Accordingly, the court granted Defendant’s motion to dismiss without leave to amend. 

The primary materials for this case may be found on the DU Corporate Governance website.

Plaintiffs purchased Higher One stock between August 7, 2012 and August 6, 2014. Higher One provides financial management and banking products and services to higher education institutions and their students. According to the complaint, on August 7, 2012, Higher One agreed to a consent order (“2012 Order”) issued by the Federal Deposit Insurance Corporation (“FDIC”) alleging violations of the Federal Trade Commission Act (“FTC Act”). Under the 2012 Order, Higher One was required to revise its compliance management system. According to the allegations, Defendants did not make the necessary changes to their policies, but claimed they had undertaken the requisite changes in various public statements. Higher One was again found in violation of the same provisions of the FTC Act under a FDIC Consent Order issued in 2015, and a Federal Reserve Cease and Desist Order. Plaintiffs further allege Cole Taylor Bank (“CTB”), one of Higher One’s banking partners, terminated its relationship with Higher One,in 2013,out of fear it would be subject to regulatory penalties related to Higher One’s conduct. According to the allegations, Defendants, in their public statements, stated the decision to end the relationship was mutual,and did not disclose the true reason for the termination when discussing Higher One’s relationships with other banks. Plaintiffs’ complaint alleged Defendants made statements that were materially false and misleading regarding: (1) Higher One’s compliance with the 2012 Order, (2) the dissolution of Higher One’s relationship with CTB, (3) the transparency of Higher One’s products, (4) required changes to practices due to a class action settlement, and (5) Higher One’s financial and operating results. 

Section 10(b) and Rule 10b-5 of the Exchange Act prohibit any misstatements or omissions of material fact in connection with the sale or purchase of a security. Securities fraud claims are subject to the heightened pleading standards of the Private Securities Litigation Reform Act (“PSLRA”) which requires plaintiffs to plead with particularity facts establishing fraud and an inference of scienter. Plaintiffs must specify each statement alleged to be false and the reason the statement is misleading. Scienter can be established by alleging strong circumstantial evidence of conscious misbehavior or recklessness. Additionally, a plaintiff must establish he suffered a loss as a result of defendant’s actions. Finally, Section 20(a) holds control persons liable for the fraud of the entities they control.

The court determined Plaintiffs sufficiently met the heightened pleading standard under the PSLRA for the majority of their allegations. The court held the complaint properly identified the false statements and identified the reasons they were misleading with regard to statements made about: (1) the termination of Higher One’s relationship with CTB, (2) the transparency of Higher One’s products, (3) the changes required due to a class action lawsuit, and (4) Higher One’s financial and operating results. Furthermore, the court found the complaint established a sufficient nexus between the conduct cited in the 2012 Order and ongoing violations to establish Defendants could not have reasonably believed their own statements regarding legal compliance. However, the court determined statements about Higher One’s relationships with other banks, which made no mention of the reason for the termination of its relationship with CTB, were not actionable because Defendants had no general duty to disclose managerial misconduct or uncharged criminal conduct. The court held Plaintiffs allegations sufficiently established the knowledge or recklessness required for scienter, and found Plaintiffs established loss causation. Finally, because Plaintiffs established a primary violation of Section 10(b), the court declined to dismiss the Section 20(a) claim.  

Accordingly, the court denied in part and granted in part Defendants’ motion to dismiss. 

The primary materials for this case may be found on the DU Corporate Governance website.