As regular readers of this blog will know, you can’t go touting crypto-securities without disclosing how much you’ve been paid to push those products.  I first wrote about this issue in 2018 after Evander Hollyfield attracted attention for promoting the fraudulent AriseBank coin. The same issue showed up again with Kim Kardashian last year.  Now, we’ve got the SEC taking action against eight more:

• Lindsay Lohan

• Jake Paul

• DeAndre Cortez Way (Soulja Boy)

• Austin Mahone 

• Michele Mason (Kendra Lust)

• Miles Parks McCollum (Lil Yachty)

• Shaffer Smith (Ne-Yo)

• Aliaune Thiam (Akon)

They all allegedly touted TRX and BTT without disclosing that they were paid to do so or the amount they were paid.  The enforcement actions arise out of the SEC’s pursuit of Justin Sun for allegedly fraudulently manipulating the secondary market for TRX through wash trades.  

I remain skeptical about much of the asset valuation in the crypto and NFT space.  I’d expect that the SEC will continue to pursue these kinds of actions when it has evidence that much of the market for a particular cryptocurrency or type of NFT is largely illusory wash trading designed to generate the appearance of value to suck in money.

Soulja Boy and Austin Mahone have not yet reached an agreement with the SEC to resolve the matter.  Hopefully, going forward, Soulja Boy will tell ’em to stop touting crypto without disclosing what they have been paid.  To help with that, I asked ChatGPT to write a song in the style of Soulja Boy to warn people not to tout crypto for compensation without disclosure.  And here it is:

Listen up, y’all, I got something to say ‘Bout this crypto game that people play Everyone’s talking ’bout how much they make But some of y’all ain’t being straight

Chorus: Don’t tout your crypto without disclosure SEC will bring that regulatory exposure If you’re being paid, you gotta let people know Or else you might end up in a world of woe

Verse 2: I know it’s tempting to flex on the ‘gram Posting pics with your new Lambo, damn But you gotta remember the rules of the game Or else you might end up in shame

Chorus: Don’t tout your crypto without disclosure SEC will bring that regulatory exposure If you’re being paid, you gotta let people know Or else you might end up in a world of woe

Verse 3: It’s all good to be excited ’bout your gains But don’t forget to disclose the chains That tie you to the coins you’re promoting Or else you might find yourself floating

Chorus: Don’t tout your crypto without disclosure SEC will bring that regulatory exposure If you’re being paid, you gotta let people know Or else you might end up in a world of woe

Verse 4: So listen up, my friends, and hear me loud Don’t be a shill, don’t be part of the crowd Just be honest, disclose what you’re paid And you’ll be safe in the crypto game

Chorus: Don’t tout your crypto without disclosure SEC will bring that regulatory exposure If you’re being paid, you gotta let people know Or else you might end up in a world of woe

Outro: That’s my message, hope you learned something new Don’t be a scammer, be honest and true And you’ll succeed in the crypto space Just remember to disclose, and keep up the pace.

 

 

Earlier this month, Daniel Lennington, deputy counsel at the Wisconsin Institute for Law and Liberty, published a piece at The Federalist entitled, “How Corporations Launder Their Race Discrimination Through Third Parties.” Here is an excerpt:

[T]he world’s largest corporations desperately want credit for being “woke” and advancing “racial equity” through programs targeted solely at certain races. Such practices — involving blatant race discrimination — are immoral and contrary to core American values, despite being in fashion with corporate elites. Yet the typical guide rails — state and federal law — may be less available remedies if corporations launder their discrimination through third parties. Corporations should avoid this temptation to outsource their discrimination and perhaps take a lesson from Comcast, one of the first corporations to face legal scrutiny for its race-based program. Following the settlement with our clients, Comcast renewed its efforts toward something called “Project Up,” which, from all indications, is a race-neutral program designed to “advance economic mobility, and open doors for the next generation of innovators, entrepreneurs, storytellers, and creators.” Comcast will run this program itself and reap the goodwill that will undoubtedly come, while adhering to (lawful) nondiscrimination principles.

In response to this piece, Scott Shepard, director of the Free Enterprise Project at the National Center for Public Policy Research, published “States Can Stop the Outsourcing of Race Discrimination by Corporations” over at RealClearMarkets. Here is an excerpt:

The clearest route to ending this practice is through state corporations laws. A very short amendment would serve the purpose. Add to the law this phrase at an appropriate spot: “Corporate donations or other pecuniary grants to entities that discriminate, facially or in fact, on grounds forbidden by the civil rights acts of this state have breached their fiduciary duty to shareholders unless they have secured from each shareholder written confirmation of their desire to contribute corporate assets to discriminatory entities.”… [A] second move by states inclined to rein in the new discrimination …. [is to] add to their civil rights statutes a line to the effect that “publicly traded corporations doing business in this state violate this statute if they use corporate assets to fund entities that discriminate in violation of this statute” unless getting the express permission of all shareholders.

From a New Civil Liberties Alliance press release (here):

In a thorough and well-reasoned decision, Judge Terry A. Doughty of the U.S. District Court for the Western District of Louisiana has denied government defendants’ motion to dismiss in State of Missouri, et al. v. Joseph R. Biden, Jr., et al. The New Civil Liberties Alliance, a nonpartisan, nonprofit civil rights group, represents renowned epidemiologists Drs. Jay Bhattacharya and Martin Kulldorff, as well as Dr. Aaron Kheriaty and Ms. Jill Hines, in a lawsuit that has exposed an elaborate, multi-agency federal government censorship regime. Judge Doughty wrote, “The Court finds that the Complaint alleges significant encouragement and coercion that converts the otherwise private conduct of censorship on social media platforms into state action, and is unpersuaded by Defendants’ arguments to the contrary.”

UPDATE (3/21/23): Keith Bishop was kind enough to pass along a related post of his entitled “Government Censorship By Proxy?” wherein he notes:

Last week, I wrote about an unsuccessful challenge to the activities of the Office of Elections Cybersecurity within the California Secretary of State’s office: Is The California Secretary of State Monitoring What You Publish Online? In that case, O’Handley v. Weber, 2023 WL 2443073, the Ninth Circuit Court of Appeals found that the Secretary of State did not violate federal law when it notified Twitter of tweets containing false or misleading information that potentially violated the company’s content-moderation policy. More recently, Judge Terry A. Doughty, who sits in the Western District of Louisiana, refused to dismiss claims for “alleged coercion by the Biden Administration and various government agencies and officials of social-media companies, urging those companies “to censor viewpoints and speakers disfavored by the Left”. In this memorandum ruling, Judge Doughty distinguishes O’Handley as follows: ….

I’ve previously blogged about confusion regarding Section 10(b)’s requirement that a false statement be made “in connection with” a securities trade, when the speaker is a subsidiary of the securities’ issuer.  We have a new entry in the genre in In re Volkswagen AG Sec. Litig., 2023 U.S. Dist. LEXIS 43031 (E.D. Va. Mar. 14, 2023).

This case concerns Volkswagen’s stupid joke from two years ago where it announced that it was changing its name to “Voltswagen,” which roiled the stock for a couple of days until the company admitted that it was just kidding.  An equally stupid securities fraud lawsuit naturally followed, resulting in what is actually a fairly baffling dismissal.  Because whatever one thinks of the claim or its merits, the legal reasoning matters, not just for this case but for future cases. 

The setup:

Volkswagen is a German company, and its stock is not listed on a U.S. exchange.  Its “unsponsored” ADRs trade in the U.S. 

VWGoA is Volkswagen’s American subsidiary.  It is wholly owned by Volkswagen.

The original press release announcing the name change came from VWGoA and its officers, who posted it to the VWGoA website on March 29, 2021.  The press release was taken down, but news media got wind of it, and it popped back up again on March 30, 2021, including quotes from VWGoA’s CEO.  A Volkswagen twitter account – apparently controlled by VWGoA – also announced the change.  VWGoA’s Head of Technology confirmed the story to the Associated Press.  By the close of business on March 30, though, the press release was gone again, and the WSJ was reporting that it was all a joke.

The price of ADRs fell in response, and investors filed a Section 10(b) lawsuit against Volkswagen, VWGoA, VWGoA’s CEO, and VWGoA’s Head of Technology.

In dismissing the complaint, the court actually took the claims seriously, and conducted a thorough analysis of some of the knotty issues concerning Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), but I think its reasoning faltered when it came to the ultimate holding.

The first issue: did plaintiffs allege a “domestic transaction” for Morrison purposes?  In Stoyas v. Toshiba Corp., 896 F.3d 933 (9th Cir. 2018), the Ninth Circuit held that if the ADRs are traded in the U.S., transactions in them are domestic for Morrison purposes.  If they are unsponsored – the subject company truly had no involvement in their creation – there might be a question whether the subject company’s false statements are made in connection with a domestic transaction, but the transaction itself remains domestic and subject to U.S. law.

The Volkswagen court followed this reasoning, and concluded that the plaintiffs’ ADR purchases were domestic.  (Recently, the district court in Toshiba held that even a domestic ADR purchase might be treated as “foreign” if it involved the creation of a new ADR via an overseas purchase of the underlying shares, Stoyas v. Toshiba Corp., 2022 WL 220920 (C.D. Cal. Jan. 25, 2022), but the Volkswagen court questioned that reasoning, see op. at *32 n.8, and in any event, found that such determinations were inappropriate on a motion to dismiss). 

So. Domestic purchase.

Next, the court turned to the potential liability of the Volkswagen parent.  And here, the court employed Janus Capital Grp., Inc. v. First Derivative Traders, 564 U.S. 135 (2011) to hold that the plaintiffs had not alleged sufficient facts to show that Volkswagen had exercised “ultimate authority” over the statements issued by VWGoA; therefore, Volkswagen had not “made” a statement for Janus purposes.

I mean, I could go on a riff about the artificiality of treating Volkswagen as distinct from its wholly-owned subsidiary, which the court recognized as being completely under the control of its parent, but the court gave the plaintiffs leave to replead on this and I’ll skip it. 

That left the liability of VWGoA and its officers.  The court agreed that the officers had acted at least recklessly when issuing the press release, their scienter could be attributed to VWGoA, and that plaintiffs had established materiality and loss causation. 

So, the court turned to the defendants’ arguments that, because the ADRs were unsponsored, any statements by VWGoA were not made “in connection with” ADR transactions.

The court first held that, given the relationship between the subsidiary and the parent, the statements by VWGoA were not so attenuated from securities of Volkswagen as to eliminate 10(b) liability.  Op. at *67. 

The court next held that, while it was possible that statements about underlying securities may not be made “in connection with” unsponsored ADRs, in this case, plaintiffs had sufficiently alleged that Volkswagen had had some approval power/involvement with the creation of the ADRs, such that statements about Volkswagen stock would also be “in connection with” its ADRs.  The court thus concluded, “because Plaintiffs have implicated a specific depositary institution, which has publicly confirmed it requires the approval of the foreign issuer prior to launching an unsponsored ADR program, Plaintiffs’ allegations provide a plausible basis that the alleged misstatement ‘touches’ or ‘coincides’ with ‘the purchase or sale of any other security in the United States.’” Op. at *70-71.

Finally, the court held that the statements themselves were distributed in a medium on which investors would rely: “Plaintiffs have adequately averred that VWGoA publicly disseminated a press release on multiple occasions and that such announcement was material. Not only did the announcement itself detail an upcoming significant rebranding effort by the Company across North America, but it also generated a widespread public response.  Given the alleged seriousness with which the market perceived the name change, it is entirely reasonable that investors would have relied upon the press release.” Op. at *71.

But did the claims against the VWGoA defendants survive?

They did not.  The court concluded:

This Court will not contravene Janus by holding that the statements of a non-publicly traded wholly-owned subsidiary and its employees may be actionable upon the parent issuer when the Amended Complaint fails to adequately plead that the alleged material misstatements may be attributed to the parent issuer. Without a plausible theory of liability ascribed to the issuer, Plaintiffs’ purchase or sale of Volkswagen ADRs cannot be said to “touch[]” or “coincide” with the alleged false statements of the Individual Defendants and VWGoA.

In sum, Plaintiffs have sufficiently alleged that Volkswagen continues to play an active role in the unsponsored ADR program and that it was reasonable for investors to rely upon those alleged false statements. But they have not sufficiently pleaded that the alleged false statements by the Individual Defendants and VWGoA “coincide” with or “touch[]” the ADRs purchased by Plaintiffs because the issuer of the underlying securities has not been shown to be liable under § 10(b).

Op. at *72-73.

I … do not follow.  The court seems to be hung up on Volkswagen’s liability, when the question of the liability of VWGoA and its officers is distinct.  Why should VWGoA’s liability for false public statements turn on whether Volkswagen parent is liable?  We have three actors: VWGoA, its CEO, and its head of tech, all of whom, with scienter, made false statements about Volkswagen’s business – about, the court found, Volkswagen’s securities – in a medium on which investors would (and did) rely.  It’s now well-established – the court even says in its opinion, at *65-66 – that actors other than issuers can be liable for issuing fraudulent statements in connection with the issuers’ securities.  Analysts, auditors, brokers, all might lie about a company’s securities; the company may be entirely innocent, but that does not absolve the speaker.  If I adopt some kind of pseudonymous identity and go online and make false statements about a publicly traded security, I would surely expect the SEC to come after me, even if the issuer had nothing to do with it.  

Nonetheless, the court seemed to hold, that logic only extends to actors who are independent of the issuer.  It does not extend to actors who are related to the issuer, such as wholly owned subsidiaries.  Those speakers, uniquely, get a free pass.

In other words, VWGoA and its officers escape liability because there is both too much control by Volkswagen – it would contravene Janus to hold a controlled subsidiary liable for statements it actually made about its parent – and too little, because there was not enough control by Volkswagen to make Volkswagen the legal “maker” of the statements.

Notably, the court’s holding would seem to create an open season for subsidiaries to make false statements about parent companies – which is particularly bizarre because, earlier in its opinion, that’s exactly what the court wanted to avoid:

For purposes of standing, Plaintiffs’ fulsome allegations demonstrate the appropriateness of extending Rule 10b-5’s reach to securities of a parent company, when that parent company exercises substantial involvement over the day-to-day operations of a wholly-owned subsidiary alleged to have violated federal securities laws. If this were not so, issuers exercising such concrete control over their subsidiaries would never be legally responsible for the statements of their non-publicly traded wholly-owned subsidiaries. That would reward issuers with a scapegoat mechanism through their unlisted subsidiaries to avoid§ 10(b)’s remedial scheme.

Op. at *66-67. 

Yes!  I agree!  But still, the court says there’s no liability even for the subsidiary that made the statements, with scienter.

In any event, the plaintiffs have leave to replead (including to replead Volkswagen’s involvement in the whole thing), so we’ll see what happens.