Developments in securities litigation move fast, and not all of them matter equally. Each month, Alto Litigation curates and summarizes the cases, rulings, and regulatory actions most likely to shape risk and strategy in the months ahead.
SEC Redraws the Line Between Digital Assets and Securities
In a significant regulatory development, the SEC issued an Interpretative Release stating that most crypto assets will not be considered securities under the Federal Securities Laws.
Previously, the SEC took the position that most digital assets were considered investment contracts, which are defined as securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC’s view was based on the application of the so-called Howey test, based on the Supreme Court’s 1946 decision in SEC v. W. J. Howey Co., defining an investment contract as an investment of money in a common enterprise with a reasonable expectation of profit based on the managerial or entrepreneurial efforts of others. The SEC had employed this test in bringing enforcement actions against firms issuing digital assets, which was criticized as “regulation as enforcement.”
By contrast, the SEC’s Interpretative Release, issued on March 17 for public comment, stated that it was seeking a “tailored regulatory framework” that took into account the uses and functionality of digital assets. In analyzing various categories of crypto assets, the release stated that:
digital commodities, like Bitcoin or Ether, would not be considered securities;
digital collectibles, which are intended to convey rights to artwork, music or videos, are not securities unless they are sold in a manner where the reasonable expectation of profit is based on the efforts of others;
digital tools, which are crypto assets that perform specific functions, are not securities;
stablecoins, which are intended to maintain a stable value relative to the dollar, generally are not considered to be securities (the GENIUS Act, enacted by Congress, created a comprehensive regulatory for type of stablecoin known as a “payment stablecoin”); and
digital securities, which are securities that are formatted or represented by a crypto asset, are considered securities.
The Release also discussed when a crypto asset would become a security and how it would lose that characteristic.
Why It Matters: This policy shift advances the pro-crypto agenda of the second Trump Administration and provides a framework for possible comprehensive regulatory legislation by Congress.
Jury Holds Elon Musk Liable for Misleading Statements, Rejects Broader Fraud Claims
On March 20, a federal jury in San Francisco found that Elon Musk committed securities fraud in a class action lawsuit brought by former investors In Twitter, which Musk acquired for $44 billion in 2022.
The jury found that Musk made materially false and misleading statements in two tweets in May 2022. One tweet stated that the Twitter acquisition was temporarily on hold while he awaited information about the volume of bots and spam on Twitter. The other tweet stated that fake and spam accounts comprised more than 20 percent of Twitter users.
However, the jury rejected the fraud allegations of the plaintiff class, composed of those who sold Twitter stock or call options or purchased put options between May 13 and October 4, 2022, in connection with Musk’s statements at a technology conference.
The jury also found that the investors failed to prove that Musk engaged in an overall scheme to defraud Twitter investors. One of the plaintiffs’ attorneys estimated the damages at about $2.6 billion. Musk attacked the verdict, and his lawyers alleged that the jury was not impartial based on a purported marijuana joke on the verdict form.
Why It Matters: Few securities class action lawsuits go to trial, so the Musk trial was a test case concerning how a jury would respond to claims against a celebrity defendant. Barring a settlement, the verdict will be appealed, and it will be interesting to see how the Circuit Court of Appeals considers allegations that the trial judge and the jury were not impartial.
Delaware Supreme Court Allows Post-Demand Evidence in Books-and-Records Disputes
The Delaware Supreme Court on March 25 issued an opinion in which it held, by a 3-2 vote, that a stockholder in Paramount could cite news reports occurring after a demand to inspect documents as evidence that the stockholder possessed the required “proper purpose” for the demand.
The stockholder had made a demand to inspect documents under Section 220 of the Delaware General Corporation Code, which permits a stockholder to inspect certain “books and records” of a company if it can demonstrate a proper purpose, which the Delaware courts have held has a low threshold of proof. The Paramount stockholder alleged that the company’s controlling stockholder was seeking to sell her ownership interest rather at the expense of seeking to sell the entire company. When Paramount challenged the demand, the Chancery Court, overturning the decision of a Magistrate, permitted the stockholder to cite news reports after the demand was made.
The court’s majority held that Section 220 itself did not prohibit the introduction of post-demand evidence, and it therefore made sense to allow the Chancery Court to exercise discretion and decide to consider or reject such evidence on a case-by-case basis. The court held that the Chancery Court here did not err in considering the post-demand evidence because it was material, credible and not prejudicial to the corporation.
The dissent, by contrast, asserted that a bright-line rule barring such evidence was preferable to the case-by-case consideration favored by the majority.
On another issue, the court unanimously held that the stockholder could cite anonymous sources in reputable publications where there was a sufficient level of specificity and there was an absence of any indicators of unreliability.
Why It Matters: The Delaware Supreme Court had never squarely confronted the issue of whether post-demand evidence could be used to show a proper purpose for an inspection demand. It is now settled that the Chancery Court has discretion to consider such evidence.
SEC’s Enforcement Director Resigns After Seven Months
On March 16, Margaret Ryan resigned as Director of the SEC’s Division of Enforcement after only seven months on the job. In February, Ryan had given a widely publicized speech outlining both substantive and procedural priorities, including revisions to the Wells Submission process after the Division notifies counsel that its client will be the subject of an enforcement proceeding. That speech was followed by publication of a revised Enforcement Manual that reflected the points made in Ryan’s speech.
Prior to being appointed as Enforcement Director, Ryan had been a judge on the U.S. Court of Appeals for the Armed Forces, an unusual background for an Enforcement Director.
While Ryan’s resignation statement did not provide a reason for her resignation, news reports stated that she had clashed with SEC Commissioners over her desire to take a more aggressive pursuit of fraud, including cases against high-profile individuals such as Elon Musk. Principal Deputy Director Sam Waldon was named acting director and the SEC said a permanent director would be named shortly.
Why It Matters: The resignation may signify that the SEC will pursue a more relaxed enforcement attitude against securities fraud, particularly concerning more controversial cases. In particular, the SEC has stated that it will not bring actions against companies issuing crypto assets based on allegations that they were selling unregistered securities.
