Court Dismisses Post-SPAC Class Action for Lack of Standing

On March 31, 2023, U.S. District Judge Ronnie Abrams of the Southern District of New York dismissed a putative securities class action against CarLotz, Inc. (CarLotz), and certain of its officers and directors on the grounds that plaintiffs lacked standing to sue for losses allegedly arising from false and misleading statements defendants made about CarLotz while it was still a private company.

In 2021, CarLotz became a publicly traded corporation through a de-SPAC transaction whereby it merged with, and assumed the public registration of, the special purpose acquisition company (SPAC) Acamar Partners Acquisition Corporation (Acamar). Plaintiffs had purchased shares of Acamar prior to the de-SPAC transaction and later purchased shares of the post-merger, public CarLotz following the de-SPAC. They asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the Exchange Act) and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the Securities Act), alleging that prior to the de-SPAC transaction, defendants had made false and misleading statements about CartLotz’s then-current business model and inventory. Defendants moved to dismiss on multiple grounds, including that plaintiffs lacked standing to sue.

The court dismissed plaintiffs’ Exchange Act claims for lack of standing, rejecting plaintiffs’ theory that the pre-merger, private CarLotz should be treated as no different than the post-merger, public CarLotz entity. The court ruled that the private right of action under Section 10(b) should be narrowly construed, and for this reason applied the Second Circuit’s “purchaser-seller rule” rigidly such that plaintiffs could have standing only if they were purchasers or sellers of the precise security that was the subject of the alleged fraud. The court also dismissed plaintiffs’ Securities Act claims on standing grounds, rejecting plaintiffs’ argument that the court should treat the de-SPAC transaction as the “real IPO.” The court thus ruled that plaintiffs’ purchases were not traceable to a challenged registration statement (as required for a Section 11 claim) or that they had purchased directly in a public offering (as required for a Section 12(a)(2) claim), again because they either purchased Acamar shares prior to the de-SPAC or purchased CarLotz shares after the de-SPAC transaction.

The question of the proper application of standing requirements — whether the rigid approach favored by this court or the more generous analysis applied elsewhere — is likely to be resolved by the Supreme Court in Slack Technologies, LLC v. Pirani, which was argued on April 17, 2023, and is awaiting ruling.

Southern District of Florida Denies Crypto Firm’s Motion to Dismiss, Holding Cryptocurrency Is a Security

On April 5, 2023, U.S. District Judge Beth Bloom of the Southern District of Florida denied motions to dismiss claims brought by the U.S. Securities and Exchange Commission (SEC) that Arbitrade Ltd., Cryptobontix Inc. (Cryptobontix), SION Trading FZE, and each of those issuers’ control persons for an alleged pump-and-dump scheme involving a Cryptobontix cryptocurrency called Dignity, or DIG, rejecting the now-familiar argument that a crypto asset is not a “security” within the meaning of the Securities Act of 1933 (the Securities Act).

The SEC’s 17-count complaint alleged, inter alia, that the defendants illegally and fraudulently acted, including through the solicitation of investment and by forging purchase agreements and other documentation, to promote DIG as backed by $10 billion in gold bullion, and, therefore, redeemable for gold. As a result, the complaint alleges, defendants were able to offer DIG tokens to investors at artificially inflated prices, which they in turn exploited by selling their own DIG tokens for an allegedly ill-gotten gain of $36.8 million.

In denying motions to dismiss by two individual defendants, the court rejected what has become a frequent, and frequently unsuccessful, argument that the SEC lacked jurisdiction to sue because DIG tokens were not “securities” under the Securities Act. The court reasoned that Congress cast a broad definition of a security, and that the sale of DIG tokens qualified as an “investment contract” under the test set forth in SEC v. W.J. Howey, i.e., that the offering involved (1) an investment of money; (2) a common enterprise; and (3) expectations of profits to be derived from defendants’ efforts. The court also rejected policy-based arguments against broad-brush categorization of all or many digital assets as securities, noting that the complaint at issue alleged that the “entire scheme” of DIG sales constituted an investment contract.

Court Dismisses Stockholder Suit Against Silverback Therapeutics

On April 12, 2023, U.S. District Judge Marsha J. Pechman of the Western District of Washington dismissed with prejudice a stockholder class action against Silverback Therapeutics, Inc. (Silverback), finding that investors failed to allege any actionable misstatements in Silverback’s IPO documents regarding clinical trials of SBT6050, a new drug aimed at treating tumors. The plaintiffs alleged that Silverback misled investors with its offering documents in violation of Section 11 of the Securities Act of 1933 (the Securities Act) and Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act).

According to the complaint, Silverback, a biopharmaceutical company that went public in December 2020, allegedly negligently prepared its offering documents and misled investors by failing to disclose that SBT6050 was neither safe for consumers nor effective. Specifically, plaintiffs alleged that, while Silverback reported that early clinical data showed changes in certain biomarkers associated with tumor regression, it failed to disclose other issues that came to light as the trial unfolded, including negative side effects and limited efficacy, as well as the fact that Silverback would have to discontinue the clinical program for SBT6050—and another, related drug candidate—if certain results were not achieved during Phase 1.

In dismissing these claims, the court found that plaintiffs alleged nothing more than “fraud by hindsight,” because they failed to demonstrate that Silverback knew or had access to data undermining the safety and efficacy of SBT6050 at the time of the IPO. Furthermore, the court held that Silverback’s statements about promising early data “associated” with tumor regression were “a far cry from an absolute statement declaring the drug efficacious.” Reasonable investors would not “mistake correlation for causation” and be misled. Dismissing the claims based on the alleged failure to disclose that another drug depended on SBT6050’s success, the court held that “there is no requirement that a company must draw out all inferences in order to provide a complete and accurate disclosure.”

The court dismissed plaintiffs’ claims with prejudice, having already granted a prior motion to dismiss without prejudice in November 2022, because they once again failed to allege actionable misrepresentations regarding SBT6050’s clinical trials.

Ninth Circuit Reverses Dismissal of Class Action as Time-Barred, Applying More Generous Second Circuit Application of Statute of Limitations

On April 11, 2023, the Ninth Circuit reversed the dismissal of a securities fraud class action brought against HP, Inc. (HP) and certain of its officers under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the Exchange Act). Although the district court had dismissed plaintiffs’ claims as barred by the applicable statute of limitations, the Ninth Circuit reversed and reinstated the case, under a more forgiving application of the two-year statute of limitations applicable to claims under of the Exchange Act. The decision brings Ninth Circuit precedent in line with that of the Second Circuit.

Plaintiffs’ lawsuit followed the settlement in September 2020 of a multi-year investigation by the U.S. Securities and Exchange Commission (SEC) into HP’s disclosures from November 2015 through June 2016, which the SEC claimed failed to disclose the impact of certain sales practices on its quarterly financial reports. Shortly after the announcement of the SEC settlement, plaintiffs filed a class action complaint under Sections 10(b) and 20(a) based largely on challenges to the same 2015 and 2016 public statements. Defendants moved to dismiss because, among other arguments, the claims were barred by the two-year statute of limitations and five-year statute of repose applicable to claims under the Exchange Act. Under the statute of limitations, private actions under Section 10(b) must be filed no later than “two years after the discovery of the facts constituting the violation.” Under the statute of repose, such actions must be brought no more than five years after the alleged securities law violation, without regard to whether or when plaintiffs knew or ever discovered the underlying facts.

The district court granted defendants’ motion, ruling that the claims were time-barred under the two-year statute of limitations because the challenged statements were published, and the company’s declining profits and reductions in channel inventory that were central to the plaintiffs’ fraud theory were disclosed, and therefore were discoverable by a reasonably diligent plaintiff, in 2016 — i.e., more than two years prior to the filing of the operative complaint in April 2021. Having dismissed the case on that basis, the district court declined to address the statute of repose and other alternative arguments that defendants made as alternative bases for dismissal.

In reversing the district court’s ruling, the Ninth Circuit found that the two-year statute of limitations did not begin to run until September 2020, and therefore less than a year before the case was filed. The court reasoned that plaintiffs could not have discovered the necessary facts to sue — namely, facts supporting their scienter allegations — until after the September 2020 SEC order. The Ninth Circuit adopted the Second Circuit’s application of Merck & Co., Inc. v. Reynolds, 559 U.S. 633 (2010) to rule that although the information available to plaintiffs in 2016 was important to the case they later filed, those facts alone were not enough to trigger the two-year filing clock. Applying the two-prong Merck test, the court first identified April 21, 2019, as the “critical date,” which is the date two years prior to the filing of the complaint. Next, the court determined which facts the complaint alleged occurred both before and after that date, and considered whether all of the facts constituting a violation of federal securities law — including materiality, falsity, causation, and scienter — were discoverable prior to the critical date. Under that approach, the Ninth Circuit noted that the SEC announced its settlement in September 2020, which was after the critical date and was, according to the court, the first time there was a public disclosure of the facts and context that the plaintiffs needed to plead scienter. Thus, even though under Merck a “reasonably diligent plaintiff” may have had the wherewithal years earlier to discover many of the other facts necessary to file a complaint “with sufficient detail and particularity to survive a . . . motion to dismiss” with respect to some elements of the Section 10(b) claim, the complaint was timely because it was not until much later that the plaintiffs had the information available to plead the also-necessary scienter prong of their claim.

This decision serves as a warning that the two-year statute of limitations for securities fraud claims does not necessarily begin to run immediately following a “corrective disclosure” or even when an abundance of facts is available that would alert a reasonable plaintiff to a meritorious claim. Instead, the two-year limitations period arguably does not start until enough facts are available that would allow the plaintiff to successfully plead every element of their claim.

SEC Wins Partial Summary Judgment Against Investment Firm for Failing to Disclose Conflicts of Interest

On April 7, 2023, U.S. District Judge Indira Talwani of the District of Massachusetts granted a rare partial summary judgment in favor of the U.S. Securities and Exchange Commission (SEC) as to the liability of an investment adviser, Commonwealth Financial Network (Commonwealth), for failure to disclose conflicts of interest and failure to implement policies and procedures in violation of Section 206 of the Investment Advisers Act of 1940 (the Act).

The SEC charged Commonwealth with failing to disclose a conflict created by its revenue-sharing agreements with the clearing firm, National Financial Services LLC (NFS), a subsidiary of Fidelity Global Brokerage Group, Inc. (Fidelity), whereby Commonwealth shared a portion of NFS’s revenue related to clients invested in certain non-Fidelity funds. The court ruled that there was no dispute from the evidentiary record that Commonwealth knew that its relationship with NFS posed a conflict of interest and knew that lower-cost investment alternatives existed. For this reason, it entered summary judgment because as a matter of law, Commonwealth was required to disclose the conflict and the potential alternatives to investors. The court further held that Commonwealth had failed to adopt and implement written policies preventing those precise violations of the Act.

The court’s ruling is a clear reminder of the need for robust internal controls and policies favoring transparency, and a warning that disclosure of a known conflict of interest is warranted even where investment decisions are unmotivated by that apparent conflict of interest.

Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

Editorial Board

Jennifer Burns Luz
Jonathan Shapiro

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