Tag Archives: SEC

Federal Judge Reminds Plaintiff Investors That Securities Laws Are Not Broad Insurance Against Market Losses

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On September 30, a federal judge dismissed a putative class action against New Energy Systems (“New Energy”), a lithium battery company with Chinese operations, finding that plaintiffs had failed to connect the dots between the alleged misrepresentation (overstated earnings) and any drop in stock price when the “fraud” was revealed.[1] Because there was no material change in stock price when New Energy amended its SEC filings thereby “revealing” the company’s problems, the plaintiffs attempted to tie their losses to an earnings press release, issued 8 months after the amended filings. The Court flatly rejected this later, “materialization of concealed risk” theory.

The Complaint focused on income discrepancies between New Energy’s 2008-2009 filings with the SEC and its filings with the Chinese equivalent of the SEC. Plaintiffs alleged that the revenue and earnings numbers in the SEC filings were hundreds and sometimes thousands of percentage points higher than the numbers in the Chinese filings. Both sets of numbers were publicly available to investors.[2]

Then, in March 2011, New Energy amended its Chinese filings such that they conformed to the higher numbers in its SEC filings. The market had no reaction whatsoever to the amended filings. In November 2011, however, New Energy issued a press release announcing a 42% decline in year-over-year revenues for the third quarter of 2011. The stock dropped 48.6%.[3]

Plaintiffs argued that the late 2011 drop after the press release was connected to an ongoing fraud dating back to 2008 and that New Energy had merely covered up past problems by moving such losses into its late 2011 numbers, rather than coming forth and admitting that the 2008-2009 amended filings were false. The Court rejected this late “materialization of concealed risk” as too tenuous, finding no link between the loss in late 2011 and the alleged misstatements about income for 2008-2009. Among other things, the Court noted that, “private securities fraud actions are available not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.”[4]

Importantly, it does not appear that the Court completely shut the door – the Order does not state the complaint is dismissed with prejudice. It may be that the plaintiffs can try to amend or re-file with sufficient allegations to better tie the November 2011 “corrective disclosure” to a particular fraud. But the message is clear, would-be plaintiffs must allege facts sufficient to show that their losses are at least “within the zone of risk concealed by the misrepresentations and omissions” about which the plaintiff complains.

[1] In re: New Energy Systems Securities Litig., 12-cv-01041 (LAK), Dkt. No. 49 (S.D.N.Y. Sept. 30, 2014).

[2] See id. at 3-4.

[3] See id. at 4.

[4] See id. at 7.

Bitcoin is a “Security” According to Federal Judge

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On August 6, 2013, a federal magistrate judge in the Eastern District of Texas ruled that Bitcoin, the virtual online currency, is a security under the federal securities laws, thereby green lighting a suit by the SEC’s Enforcement Division against a defendant accused of running a Ponzi scheme using the digital currency.[1]  To the extent that other courts follow this decision, the road for SEC regulation and enforcement of Bitcoin markets is open.

Bitcoin is an electronic currency that is not backed by any real asset and is without specie, such as coin or precious metal.[2]  It is not regulated by a central bank or any other form of governmental authority; instead, the supply of Bitcoins is based on an algorithm, which structures a decentralized peer-to-peer transaction system.[3]  Bitcoin can be used to purchase items online, and some retail establishments have begun accepting Bitcoin in exchange for gift cards or other purchases.[4]

In the Texas case, the SEC alleges that defendant Trendon Shavers, the founder and operator of Bitcoin Savings and Trust, solicited investors to provide him with over 700,000 Bitcoin, worth as much as $4.6 million, in return for up to 7 percent weekly interest.  Shavers allegedly claimed that he could pay the interest based on certain Bitcoin arbitrage activities that he would conduct online.  The SEC claims that there was no such arbitrage activity; instead, Shavers paid interest to old investors with new investor Bitcoin and also converted some Bitcoin to U.S. currency for his own expenses.

Shavers argued that the SEC had no jurisdiction to bring the case against him because the subject matter – Bitcoin – is not money and is not part of anything regulated by the United States.  The Court disagreed, citing the definition of a “security” which includes “investment contracts.”[5]  Investment contracts involve the investment of money, in a common enterprise, with the expectation that profits will be derived from the efforts of a promoter or third party.  The Court had no problem concluding that Bitcoins involve money since they can be used to purchase goods and services and are exchangeable for currencies such as U.S. dollars.  The Court also found a common enterprise to profit where the investors relied in Shavers as a promoter and purportedly knowledgeable Bitcoin trader to make money for them.[6]

On a somewhat related note, Cameron and Tyler Winklevoss, the twins who became famous for alleging that Mark Zuckerberg stole their idea for Facebook, have applied for SEC approval to launch a Bitcoin-tracking exchange-traded product known as the Winklevoss Bitcoin Trust (“WBT”).[7]  As of April, 2013, the twins personally held approximately 1% of all outstanding Bitcoin valued at about $10 million.  They claim that through the proposed WBT shares they would be giving ordinary retail investors access to this meta-market and further legitimizing it in the mainstream world.[8]  Whether the SEC will approve this venture is unclear.  It is also unclear what Bitcoin true believers, many of whom use this meta-currency precisely to avoid “mainstream” currencies, think of the proposed WBT.

[1] SEC v. Shavers et al., 13-cv-00416, Dkt. No. 23 (E.D. Tex. Aug. 6, 2013).

[2] See id.

[3] See id.

[4] See id.

[5] See id. at 4-5.

[6] See id.

[8] See id.