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As COVID-19-Related Fraud Increases, the SEC Ramps Up Enforcement and Investors File Suit

June 3, 2020


In an alert published in March, we warned of an influx of fraudulent schemes related to the COVID-19 pandemic, including financial schemes in which scammers claim that the products or services of publicly-traded companies can prevent, detect, or cure COVID-19. In these “pump-and-dump” schemes, the scammers “pump,” or increase, the stock price of a company by spreading these positive, but false, rumors, causing investors to purchase the stock. Then, they quickly “dump” their own shares before the hype ends. After the scammers reap their profit from the sales, the stock price drops and the remaining investors lose money. Below, we discuss how the Securities and Exchange Commission and private investors are responding to these “pump and dump” schemes and other COVID-19-related financial misconduct.

The SEC’s Response to COVID-19-Related Fraud

On May 12, 2020, Steven Peikin, the Co-Director of the SEC’s Division of Enforcement, announced the formation of a Coronavirus Steering Committee, which is comprised of approximately two dozen leaders from across the Division to “proactively identify and monitor areas of potential misconduct, ensure appropriate allocation of [the Division’s] resources, avoid duplication of efforts, coordinate responses as appropriate with other state and federal agencies, and ensure consistency in the manner in which the women and men of the Division address coronavirus-related matters.”

Mr. Peikin stated that the Steering Committee is focused on “pump and dump” schemes and other types of COVID-19 related financial misconduct. For example, Mr. Peikin stated that increased market volatility and the regular stream of potentially market-moving announcements by issuers related to COVID-19 provides increased opportunities for insider trading. Therefore, the Steering Committee is working with the Division’s Market Abuse Unit to monitor trading activity around COVID-19 related announcements and to identify other suspicious market movements for possible manipulation. Similarly, the economic downturn and stresses on the financial conditions of many issuers may raise the risk to investors from financial statement and issuer disclosure fraud. In response, the Steering Committee has developed a systematic process to review public filings from issuers in highly impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry.

On May 27, 2020, Marc Berger, Director of the SEC’s New York regional office announced that the SEC is responding to a “spike” in COVID-19 related tips, complaints, and referrals (“TCRs”). Mr. Berger stated that the SEC’s proactive monitoring of TCRs, has led to new investigations allowing the SEC to “send a message to others in the marketplace.”

A review of recent activity confirms that the SEC is not all talk. Pursuant to 15 U.S.C. § 78l(k)(1), the SEC has the authority to temporarily suspend trading in a stock “if in its opinion the public interest and the protection of investors so require.” Since February 2020, the SEC has issued over 30 COVID-19-related trading suspensions. These suspensions followed a broad range of claims by issuers, including those concerning testing materials, treatments or vaccines, and personal protective equipment. On May 1, 2020, the SEC announced the temporary suspension of trading in the securities of Texas-based CNS Pharmaceuticals, Inc. because of representations it made about the development of a COVID-19 treatment. Similarly, on May 26, 2020, the SEC announced the temporary suspension of trading in the securities of Canadian company Micron Waste Technologies, Inc. due to questions concerning representations it made regarding its ability to manufacture personal protective equipment.

Although a trading suspension is not an enforcement action or a finding of wrongdoing, in some cases, the SEC has followed up with a formal enforcement action. On March 25, 2020, the SEC suspended trading in the securities of Praxsyn Corp. A month later, on April 28, 2020, the SEC filed charges against the company and its CEO in the Southern District of Florida pursuant to Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5,[1] alleging that the defendants issued false and misleading press releases regarding their ability to acquire and supply large quantities of N95 or similar protective masks. This enforcement action—its first related to COVID-19—was filed 61 days after the first allegedly fraudulent statement, demonstrating the SEC’s capability to conduct streamlined investigations. On May 14, 2020, the SEC filed two more enforcement actions: (1) one against Applied Biosciences Corp. in the Southern District of New York regarding an allegedly misleading press release issued on March 31, 2020 advertising COVID-19 home test kits to the general public and (2) one against Turbo Global Partners, Inc. and its CEO in the Middle District of Florida concerning allegedly false press releases issued on March 31, 2020 and April 3, 2020 announcing their plan to sell crowd-scanning equipment to detect individuals with elevated fevers. We expect more COVID-19-related civil enforcement actions in the coming weeks and months.

Private Investors’ Response to COVID-19-Related Fraud

Publicly-traded companies and their executives also stand to face COVID-19-related class action lawsuits from investors seeking to recover damages caused by allegedly false and misleading statements pursuant to Sections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5. On May 26, 2020, an investor filed a class action lawsuit against Sorrento Therapeutics, Inc. in the Southern District of California, claiming that the company’s stock was artificially inflated on May 15, 2020 after it falsely announced the discovery of an antibody that “demonstrated 100% inhibition of SARS-CoV-2 virus infection.” 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.[2]  That day, Sorrento’s stock rose from $4.14 to $6.76 per share and ultimately reached a high of $10.00 per share. However, on May 22, 2020, the CEO allegedly backtracked, claiming that he did not call the breakthrough “a cure.” Sorrento’s shares then dropped 49.4% to $5.07 per share. The plaintiff investor blames the CEO’s allegedly misleading statements about a COVID-19 cure for the stock price’s rapid rise and fall.

Similarly, on March 12, 2020, investors filed a class action lawsuit against Inovio Pharmaceuticals, Inc. and its CEO in the Eastern District of Pennsylvania.[3] Inovio’s stock price more than quadrupled (from $4.28 to a high of $19.36 per share) after its CEO publicly met with President Donald Trump and allegedly misleadingly announced “an accelerated timeline” for a COVID-19 vaccine. Days later, however, after a third-party research organization called Inovio’s claim “ludicrous and dangerous,” the company’s stock price fell to $5.70 per share. The company then 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 (which allegedly wiped out approximately $643 million in market capitalization). Like with SEC enforcement actions, we anticipate an increase in investor class actions from allegedly misleading statements relating to COVID-19 by public companies.

Conclusion

Increased enforcement by the SEC and lawsuits by private investors pose significant risks, particularly to biopharmaceutical companies, medical device companies, and other companies actively involved in the development, production, manufacture, distribution, or sales of COVID-19 related tests, vaccines, or medical equipment. Although the SEC or an investor must prove scienter to prevail on a Rule 10b-5 claim, recklessness is enough; the plaintiff need not prove that anyone intentionally made a misleading and false statement.[4]

Good intentions alone will not prevent an SEC investigation, a class action lawsuit, or worse yet, a finding of liability against a company. Instead, as the SEC has instructed, companies must carefully maintain and follow corporate controls and procedures to keep material non-public information confidential unless and until it is appropriately vetted for disclosure. Now more than ever, it is critical that companies review and revise their compliance policies and procedures, including those relating to insider trading, codes of ethics, and selective disclosure prohibitions, to ensure that they are effective in addressing these issues. In the event that you are approached by an SEC investigator or learn of an impending enforcement action or class action lawsuit, it is critical that you engage qualified counsel to conduct a prompt internal investigation and respond accordingly.

As a full-service law firm, Montgomery McCracken has experienced attorneys in its White Collar and Government Investigations Practice Group who are available to assist you or your company if you are facing an investigation by the SEC or if the SEC suspends the trading of your company’s shares. Montgomery McCracken’s attorneys in the Business Litigation and Class Action Defense Practice Groups are also available to provide assistance if you or your company are sued by investors. Visit the firm’s Coronavirus (COVID-19) Resource Center for more information and updates on this constantly evolving situation.

[1] To prevail on a 10b-5 claim, the plaintiff must show: (1) A material misrepresentation (or omission); (2) scienter (a wrongful state of mind); (3) a connection between the misstatement and the purchase or sale of a security;  (4) reliance upon the misstatement; (5) economic loss; and (6) loss causation.  Fan v. StoneMor Partners LP, 927 F.3d 710, 714 (3d Cir. 2019).

[2] Wasa Medical Holdings v. Sorrento Therapeutics, Inc., et. al., No. 20-CV-0966 (S.D. Cal. May 26, 2020).

[3] McDermid v. Inovio Pharmaceuticals, Inc. et. al., No. 20-CV-01402 (E.D. Pa. March 12, 2020).

[4] Fan v. StoneMor Partners LP, 927 F.3d 710, 718 (3d Cir. 2019).