United States: Southern District Of New York Grants Reconsideration And Dismisses Exchange Act Claims Against Underwriter Of Regulation A+ Offering, Finding Plaintiffs Failed To Adequately Allege Scienter

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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