SEC Eager to Enforce Amid COVID-19

September 03, 2020

As businesses and companies begin to reopen and attempt to return to normalcy, the U.S. Securities and Exchange Commission (SEC) continues to focus its efforts on companies’ public statements and disclosures relating to COVID-19. On February 4, the SEC warned investors about investment frauds and indicated that it would be pursuing enforcement actions against companies in connection with COVID-19 related securities fraud. The primary anti-fraud provisions that serve as the basis for most securities litigation are Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, which prohibit material misrepresentations and misleading omissions in connection with a purchase or sale of securities. These provisions have been utilized in prior crises by the SEC and should not be overlooked by public companies. The SEC is closely monitoring companies and has already filed complaints against companies alleging fraud.

The SEC Enforcement Division filed its first enforcement action relating to the pandemic on April 28 in the Southern District of Florida against Praxsyn Corporation and its CEO. The SEC alleged that the defendants falsely stated press releases that “[the company] was able to acquire and supply large quantities of N95 or similar masks to protect wearers from the COVID-19 virus” and later that “it had a large number of N95 masks on hand and had created a ‘direct pipeline from manufacturers and suppliers to buyers’ of the masks.” The two press releases were allegedly false because the company never had orders or contracts to purchase masks or obtain masks from manufacturers. Praxsyn’s stock trading volume and stock price increased significantly after the press releases. As a result, the SEC sought civil penalties against both the company and its CEO for violation of antifraud provisions of federal securities laws. [1]

About two weeks later, the SEC filed two more COVID-19 fraud related enforcement actions. One complaint was filed against Turbo Global Partners Inc. and its CEO for allegedly issuing false press releases claiming that the corporation was the “lead intermediary” in a public-private partnership in the U.S. to sell facial recognition screening technology.  The press releases further stated that the technology measured an individuals’ body temperature, an early sign of COVID-19, that the product was available to be deployed immediately, and that the corporation could ship the product within five days of receiving an order. As a result of these press releases, the share price soared. The SEC alleges that in fact there was no public-private partnership, no facial recognition technology but rather only face detection ability (i.e., it could distinguish a face from, e.g., a cup of coffee) and that the corporation was only authorized to distribute the equipment if it had customers willing to buy it. The SEC is now seeking civil penalties for violation of several federal securities laws and barring the CEO of the corporation from serving as a director of a publicly traded company.[2] On the same day, SEC filed a complaint against Applied BioSciences Corp. for its misleading claims in their news releases. The corporation claimed that it had begun shipping home COVID-19 testing kits to the general population. However, the SEC stated that the corporation had not yet shipped such testing kits, had no intention of selling them for home or private use and that such finger-prick tests were not for home use. [3]

Considering that the SEC has been actively investing enforcement resources and prosecuting COVID-19 related securities fraud cases, corporate management must consider the securities litigation risk that might arise from disclosures made with respect to the impact of the pandemic on business operations and financial performance. Proactive measures that can be taken to limit such risk include providing corrective information in a timely manner and taking advantage of safe harbor provisions such as the “bespeaks doctrine”.

On April 8, 2020, SEC Chairman Clayton emphasized that public companies should avoid general boilerplate disclosure language and be more specific about disclosing COVID-19’s impact on the company’s operations and financials.[4] Considering information may be susceptible to evolving responses, due to the pandemic, issuers risk liability under Section 10(b) for providing uncertain or fluid information to investors. To avoid liability, companies are encouraged to provide meaningful and forward-looking information that will help investors gain an insight on the companies’ current and future operations, heighten their level of confidence and understanding, and ultimately reduce their risk aversion. The “bespeaks doctrine” allows forward-looking statements to not be considered misleading if they include appropriate disclosure advising the reader or investor about specific risks that may cause actual results to differ materially from such statements. Therefore, in preparing disclosures relating to COVID-19, issuers are able to mitigate the risk of fraud by including specific cautionary language.

Furthermore, in order to mitigate risk, SEC Chairman Clayton has indicated that public companies should report their financial performance accurately and timely considering each day may bring changes to a business’ revenue and financial condition.[5] While the securities laws do not generally require companies to make disclosures more frequently than what is mandated, obligations change when significant developments occur. Under the duty to update doctrine, public companies must timely provide corrective information if new developments, such as COVID-19, have made prior disclosures inaccurate or misleading. In conclusion, to err on the side of caution, companies should disclose early and often.

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[1] https://www.sec.gov/news/press-release/2020-97

[2] https://www.sec.gov/litigation/complaints/2020/comp-pr2020-111-turbo.pdf; https://www.sec.gov/news/press-release/2020-111

[3] https://www.sec.gov/news/press-release/2020-111

[4] https://www.sec.gov/news/public-statement/statement-clayton-hinman

[5] https://www.sec.gov/news/public-statement/statement-clayton-hinman