Be mindful of any statements or disclosures involving COVID-19

As the COVID-19 public health emergency continues one issue that all companies stand to face, whether publicly traded or private, is the rising threat of Rule 10b-5 claims made in connection with the purchase or sale of securities.

What is Rule 10b-5?

Rule 10b-5 promulgated under Section 10 of the Securities Exchange Act of 1934 (the Exchange Act), as amended, is the most widely used securities anti-fraud rule. It makes it illegal for anyone to use any measure to defraud, make false statements or omit relevant, material information that would deceive another person in the process of buying or selling securities. Although Rule 10b-5 claims are usually publicized and capture headlines when they involve public companies, such rule applies with equal force and effect to securities transactions of private companies as well.

While this article provides examples of applications of Rule 10b-5 claims involving public companies in the context of COVID-19 related disclosures or omissions, the scope of such rule extends to any and all material misstatements or omissions made by any company, whether related to COVID-19 or not.  

Rule 10b-5 violations related to COVID-19 disclosures or omissions

As the examples below illustrate, the Securities and Exchange Commission (SEC) has the right and power to take various enforcement measures if Rule 10b-5 is violated. In addition, companies and their executives are also subject to class action lawsuits from private investors seeking to recover damages caused by COVID-19 related allegedly false and misleading statements pursuant to SEC Rule 10b-5 (and Sections 10(b) and 20(a) of the Exchange Act).

On May 1, 2020, the SEC announced a temporary trade suspension of the securities of Texas-based CNS Pharmaceuticals, Inc. because of certain representations the company had made about the development of a COVID-19 treatment. Although a trading suspension is not an enforcement action or finding of wrongdoing, there have been cases where the SEC follows these suspensions with the filing of formal enforcement actions.

• On April 28, 2020, the SEC filed suit in the Southern District of Florida against Praxsyn Corporation, a healthcare company and its CEO. The complaint alleges that on February 27, 2020, Praxsyn issued a press release stating that it was negotiating the sale of millions of N95 standard masks and was vetting suppliers to establish a dependable supply chain of masks. Then, on March 4, 2020, Praxsyn issued a second press release stating that it had a large number of N95 masks on hand and had created a “direct pipeline from manufacturers and suppliers to buyers.” Finally, on March 31, 2020, Praxsyn issued a third press release disclosing that it never had any masks on hand, which was allegedly supported by “[d]ozens of emails and other documents from late February through March [that] show that the [CEO] and at least one Praxsyn director knew efforts to obtain and sell N95 or other masks were proving futile.” According to the complaint, Praxsyn’s stock nearly doubled after both of the initial releases “fluctuating between $.0095 and $.0188” on February 27, 2020, and between “$.0053 and $.0091” on March 4, 2020.
• On May 13, 2020, the SEC filed suit in the Southern District of New York against Applied Bioscience Corp., based on the company’s claims in a press release that it was offering and shipping products to combat the COVID-19 virus. The March 31 press release stated that Applied Bioscience had begun offering and shipping supposed finger-prick COVID-19 tests to the general public that could be used for homes, schools, hospitals, law enforcement, military, public servants or anyone wanting immediate and private results. The complaint alleges that contrary to these claims, the tests were not intended for home use by the general public and could be administered only in consultation with a medical professional. The complaint further alleges that Applied BioSciences had not shipped any COVID-19 tests as of March 31, and its press release failed to disclose that the tests were not authorized by the U.S. Food and Drug Administration. As a result of the March 31 press release, the SEC alleges that Applied Bioscience stock prices increased almost 80 percent from the previous day.
• The SEC sued Turbo Global Partners, Inc. and its Chief Executive Officer, Robert Singerman, in federal court in the Middle District of Florida, alleging that they issued false and misleading press releases regarding a purported “multi-national public-private-partnership” to sell thermal scanning equipment to detect individuals with fever. The complaint alleges that the company had no agreement to sell the product and no partnership with government or private entities. As one could imagine, these misstatement materially impacted Turbo Global’s stock, nearly doubling its trading volume following the press releases.
• On March 12, 2020, investors filed a class action lawsuit against Inovio Pharmaceuticals, Inc. and its CEO in the Eastern District of Pennsylvania. Soon after a meeting with President Donald Trump, Inovio’s CEO misleadingly announced that the company has in plan “an accelerated timeline” for the development of a COVID-19 vaccine, thereby causing its stock price to jump from $4.28 to a high of $19.36 per share, nearly quadrupling in value based on such remarks. Days later, a third-party research organization deemed Inovio’s claim “ludicrous and dangerous,” and the company’s stock price fell to $5.70 per share. Ultimately, the company admitted that it had not developed a COVID-19 vaccine, but rather had “designed a vaccine construct.” The investors blame the allegedly misleading statements for the stock price’s rapid rise and fall.
• On May 26, 2020, an investor filed a class action lawsuit against Sorrento Therapeutics, Inc., a clinical-stage biopharmaceutical company that engages in the development of therapies for the treatment of cancer, autoimmune, inflammatory, and neurodegenerative diseases, in the Southern District of California. The suit claimed that the company’s stock was artificially inflated on May 15, 2020 after the company falsely announced the discovery of an antibody that “demonstrated 100% inhibition” of the COVID-19 virus. The complaint further alleged that the company’s founder and CEO allegedly “misleadingly referred to Sorrento’s research as a ‘cure’” in a statement to Fox News. Based on the initial announcement, Sorrento’s stock price rose $4.14 per share, or 158.02%, to close at $6.76 per share and subsequently rose to $10.00 per share on May 18, 2020 based on the later commentary which represented an increase of 281.68% from the May 14, 2020 closing price. Ultimately, the CEO allegedly backtracked, claiming that he did not call the breakthrough “a cure” on May 22, 2020. As a result, Sorrento’s shares dropped 49.4% to $5.07 per share and the plaintiff investor blames the CEO’s allegedly misleading statements about a COVID-19 cure for the stock price’s rapid rise and fall.

Be very careful in what information you disseminate regarding COVID-19

Based on the examples above, it becomes clear that the SEC and private investors are paying close attention to any statement or misstatement involving COVID-19. Hence, public companies, their officers and private companies alike should be very careful in what information they disseminate regarding COVID-19.

In addition, all companies engaged in the sale of securities should pay particular attention to their risk factors and revise or update them based on the new reality that many such companies are facing due to COVID-19 and related shutdowns. While it is not a formal rule, the SEC released CF Disclosure Guidance: Topic No. 9, on March 25, 2020, making it clear that the SEC acknowledges that assessing the evolving effects of COVID-19 and related risks is an ongoing facts and circumstances analysis. The guidance indicates that disclosure about these risks and effects, and how the company and management are responding to them, should be specific to a company’s situation just as any other risk factors should be disclosed. The guidance provides a list of questions for consideration as companies assess COVID-19 related effects and their disclosure obligations including but not limited to impacts to current and future financial conditions, capital and financial resources, and the ability to comply with GAAP and timely accounting, as well as the impacts of remote working and/or travel restrictions on business goals. For more information, you can access CF Disclosure Guidance: Topic No. 9 here.  

Many companies are doing praise-worthy work and are contributing to global efforts to combat COVID-19 and its effects. Obviously, it is in everyone’s interest that such work continues. In the process, however, all companies must keep in mind to provide honest and straightforward disclosures to their investors, accompanied by appropriate risk factors related to COVID-19, if applicable.

If you have any questions regarding the contents of this blog post, please contact one of the attorneys listed below. Our team is ready to help companies that face any of the issues discussed in this posting.