Crisis breeds fraud. And enforcement actions follow. But as we explain below, the SEC’s enforcement actions around fraud in the age of Covid-19 may have a lasting impact beyond the end of the current pandemic.
Trading-suspensions. Questions regarding the accuracy and adequacy of information concerning companies’ products or services relating to Covid-19 have already spurred the SEC to seek suspension of trading in the stocks of 39 companies. In In the Matter of Corporate Universe, Inc., File No. 500-1, (Feb. 9, 2021), trading was halted due to questions about the accuracy of the company’s statement it was selling a face mask that filtered 98% of Covid-19 particles and had a definitive letter of intent to acquire a company that had 30 patents for carbon ion technology. In In the Matter of Arrayit Corp., Rel. No. 88623 (Apr. 13, 2020), trading was halted because of information in the marketplace that the company had successfully developed a Covid-19 blood test.
The SEC only has the authority to impose a 10-day trading suspension; there must be independent grounds to support approval of an additional suspension. But when a 10-day suspension ends, a broker-dealer generally may not solicit investors to buy or sell a previously over-the-counter (“OTC”) suspended stock, or resume quotations, unless the broker-dealer files a form with the Financial Industry Regulatory Authority (“FINRA”) representing that it has satisfied certain requirements. No broker-dealer may solicit or recommend the purchase of the stock unless FINRA approves the submitted form. Thus, even a temporary suspension may serve permanently to halt trading in the stock.
Other Enforcement Actions. The most noteworthy enforcement action arising from Covid-19 is In the Matter of The Cheesecake Factory Inc., Rel. No. 90565 (Dec. 4, 2020), a settled administrative proceeding in which the SEC alleged that the company’s SEC filings in March and April 2020 falsely stated that its restaurants were “operating sustainably” during the pandemic when internal documents showed that the company was losing approximately $6 million weekly and had only 16 weeks of cash remaining. The company provided this internal information to potential private equity investors and lenders in an effort to borrow money. While the company’s March filing disclosed that it was taking measures to preserve financial flexibility, there was no disclosure that landlords had been informed that April rent payments would not be made. The Cheesecake Factory agreed to pay a $125,000 penalty and to cease and desist from further violations. While this action concerned Covid-19, it provides a warning to all public companies not to paper over significant financial difficulties in public disclosures.
Other SEC actions concern more conventional accusations that companies and their management defrauded investors by making materially false and misleading statements about Covid-related products, usually blood tests. Some of the companies were also the subject of stock trading suspensions. In SEC v. Arrayit Corp., Lit. Rel. 25029 (Feb. 11, 2021), the SEC accused a biotechnology company and its CEO of making false statements concerning the company’s purported blood test and its financial condition. In related actions, the SEC also charged the CEO’s brother with making false statements, SEC v. Schena, (Sept. 25, 2020) and a penny stockbroker with conducting a pump-and-dump scheme involving Arrayit stock, SEC v. Nielson, Lit. Rel. 24831 (June 9, 2020). Similar actions were filed against Decision Diagnostics, alleging that company falsely stated that it developed a finger prick blood test that could detect Covid in less than a minute, and Applied Biosciences, Inc., alleging that the company falsely stated it developed a finger prick blood test. In SEC v. Gomes, et. al., the SEC filed an emergency action and obtained an asset freeze against five individuals and six offshore entities that generated more than $25 million in illegal sales of multiple microcap companies, including four that were the subject of trading suspensions. The SEC alleged that the stock sales were supported by promotional efforts falsely stating that the companies had developed Covid-related products and services.
For more information regarding strategy involving interactions with the SEC, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, Ellen London.
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