On July 29, 2019, Judge Denise Cote of the United States
District Court for the Southern District of New York granted
reconsideration of her prior decision and dismissed securities
fraud claims brought against an underwriter in a putative
securities class action. In re Longfin Corp. Securities
Class Action Litigation, 1:18-cv-02933 (DLC) (S.D.N.Y. July
29, 2019).
As discussed in our prior post, plaintiffs filed securities law
claims 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”). On April 11, 2019, the Court granted
the Underwriter’s motion to dismiss claims brought under the
Securities Act of 1933, but denied its motion to dismiss
plaintiffs’ claim that the Underwriter committed fraud in
violation of Section 10(b) of the Securities Exchange Act of 1934
(the “Exchange Act”), and Rule 10b-5 promulgated
thereunder. In granting the Underwriter’s motion for
reconsideration and dismissing the Exchange Act claims, the Court
found that plaintiffs’ Second Amended Complaint
(“SAC”) failed to plausibly allege the Underwriter knew
and participated in an alleged fraudulent “scheme” and
that the more compelling inference was that the Company lied to the
Underwriter to secure its participation in the Offering.
In the First Amended Complaint (“FAC”), plaintiffs
alleged that the Underwriter violated the Exchange Act by
participating in the Company’s alleged fraudulent
“scheme” to appear compliant with NASDAQ’s
listing requirement that a company have at least one million
publicly-held shares. As part of that scheme, plaintiffs
alleged that the Company transferred over 400,000 Class A shares to
24 individuals—including those who had close relationships to
the Company—without adequate consideration, in order to meet
the listing eligibility requirement. In initially allowing
Exchange Act claims to proceed against the Underwriter based on the
FAC, the Court held that plaintiffs had sufficiently alleged that
the Underwriter should have known that certain sales of shares were
invalid, because the Underwriter received bank statements from the
Company demonstrating that the sales were made to individuals who
were closely related to the Company, and the bank statements did
not contain proof that individuals provided valid consideration in
exchange for the shares. In its prior decision, the Court
found that, although a “close[] question,” such
allegations gave rise to a “strong inference” that the
Underwriter knew or was reckless in ignoring that the purported
sales were in fact invalid. Plaintiffs subsequently filed the
SAC (to correct errors in the numbering of paragraphs in the FAC
and to add language from filings in two related SEC actions).
Separately, the Underwriter moved for reconsideration of the
Court’s prior order denying the Underwriter’s motion to
dismiss in part.
In its order reconsidering its prior decision, the Court noted that
it previously “relied upon the allegations in the FAC that
the bank statements provided [to the Underwriter] did not contain
proof of purchase” of the relevant shares, and that the
Underwriter “would have recognized insiders” in the
list of 24 individuals who purchased the shares. Upon
reconsideration, including additional allegations in the SAC, the
Court found that such allegations were “not as cogent or
compelling as the inference that [the Underwriter] was lied to by
[the Company].” In reaching this conclusion, the Court
emphasized that the Underwriter “asked for confirmation that
the . . . [s]hares had been paid for on three separate occasions
and each time was assured that they had been validly
purchased” and that such conduct “give[s] rise to an
inference that [the Underwriter] did not know that the . . .
[s]hares were issued for no consideration.” The Court
further noted that “while the SAC asserts that [the
Underwriter] ‘must have known’ that individuals on the
list of 24” were “insiders,” the SAC
“provides no particularized allegations that support this
assertion.”
The Court next turned to plaintiffs’ argument that the
Underwriter’s requests for payment confirmation suggested
they were creating a “paper trail to conceal [their]
participation” in the alleged scheme and that the repeated
requests “suggest that the bank statements . . . did not in
fact show that the [shares] were validly purchased.”
The Court rejected this argument, stating that the “SAC does
not provide a sufficient description of the bank statements to
support that inference,” finding rather that “the
allegations in the SAC lead to a stronger inference that [the
Underwriter] was not aware of its role in [the Company’s]
scheme to defraud investors than the inference that it was a
knowing participant.” The Court thus dismissed the
Exchange Act claims against the Underwriter, holding that
“[w]hile it would not be difficult to imagine the various
ways in which a lead underwriter in the Reg A+ offering could have
acted to knowingly further this manipulative scheme, the plaintiffs
must plausibly and adequately plead such knowing
participation. The SAC does not do so.”
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