As COVID-19 has continued to spread across the United States, the Securities and Exchange Commission (SEC) has remained keenly focused on monitoring the market “for frauds, illicit schemes and other misconduct affecting U.S. investors relating to COVID-19.”1 Since the SEC made its first statements related to COVID-19, described in our earlier alert, the SEC has reiterated and expanded on its guidance for public companies, emphasizing that it will pay attention to “how companies are disclosing the effects and risks of COVID-19 on their businesses, financial condition, and results of operations.”2
Through its guidance, the SEC has also continued to encourage public companies to make disclosures that “enable investor[s] to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.”3 The agency’s more recent guidance describes a number of operational adjustments undertaken by companies—including transitioning to telework, modifying supply chains and suspending certain functions—that “may have an effect on a company that would be material to an investment or voting decision.”4 Following the release of that guidance, former SEC Chairman Jay Clayton and other division directors provided an assessment of the actions that the SEC had taken in response to the pandemic, including whether the SEC anticipated extending various forms of relief that it had offered earlier in the year.5 For instance, the SEC extended certain rules related to capital formation for small businesses, while declining to continue to provide public companies with additional time to file their periodic reports.
As part of its continued oversight, the SEC has also continued to file COVID-19-related securities fraud enforcement actions. As we previously observed, in the first two months of COVID-19-related securities fraud enforcement actions—filed by the SEC in April and May 2020—the agency primarily challenged public statements made by microcap issuers that were purporting to manufacture COVID-19-related products, including N95 masks and COVID-19 test kits. In those cases, the SEC largely focused on public statements that companies made about their ability to manufacture and the effectiveness of such products.
In the following months of enforcement actions—between June and December 2020—the SEC continued to bring suit primarily against microcap issuers purporting to manufacture COVID-19-related products but also broadened its scope. More recently, the SEC has also targeted defendants that are not directly involved in businesses related to COVID-19 but that made allegedly misleading statements related to the impact of COVID-19 on their business. Additionally, while the SEC brought its initial enforcement actions against companies, the agency has since also begun bringing suits against individuals. Below we provide an overview of these more recent enforcement actions, beginning with those that pertain to issuers that purport to manufacture COVID-19-related products and following with those brought against issuers that made statements about how COVID-19 impacted their business.
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I. Enforcement Actions Against Issuers Purporting to Manufacture COVID-19-Related Products
Nelson Gomes et al. On June 9, 2020, the SEC filed suit in the District of Massachusetts alleging securities fraud and Securities Act claims against Nelson Gomes, Michael Luckhoo-Bouche and six other defendants alleged to have enabled the unlawful sale of shares of several companies, including one company that allegedly manufactured medical-quality face masks. The SEC alleges that from January 2018 to the filing of the complaint, Gomes, in conjunction with other defendants, “facilitated stock dumps of shares of more than twenty penny stock companies” by “dominat[ing] the market for the issuer’s stock” and selling the stock without complying with SEC regulations requiring disclosure of stock sales by corporate control persons. The complaint alleges that the stock sales were accompanied by “promotional campaigns [that] included false and misleading information about the companies whose shares Gomes was selling, including false and misleading claims designed to fraudulently capitalize on the COVID-19 pandemic.” For instance, the complaint alleges that such campaigns included false statements regarding company-owned kiosks, stating that the “kiosks were a solution for retailers in response to the COVID-19 pandemic” when, in fact, the company “reported no revenue and reported that it only owned three kiosks when it filed its annual report” with the SEC.
The scheme purportedly generated more than $25 million in unlawful profits. The SEC suspended trading on four different companies related to the scheme and obtained an emergency asset freeze against five individuals and six offshore entities. On December 4, 2020, a final judgment was entered against four defendants, not including Gomes, ordering those defendants to pay more than $12 million in penalties, disgorgement and prejudgment interest.
Nielsen and Schena. On June 9, 2020, the SEC filed suit in the Northern District of California against Jason Nielsen, a penny stock trader in California. The complaint alleges that Nielsen conducted a fraudulent “pump and dump” scheme involving the stock of Arrayit Corporation, a biotechnology company. The SEC alleges that between approximately March 2, 2020, and April 13, 2020, Nielsen, who owned approximately 10 percent of Arrayit’s stock, “posted numerous false and misleading statements on an internet forum that were designed to encourage other investors to buy Arrayit stock” and sold his shares “at the artificially-inflated price and reaped the profit.” The alleged fraudulent assertions included a claim that Arrayit had developed an “approved” blood test for COVID-19 when, according to the complaint, Arrayit had not at that time submitted an application for authorization to the Food and Drug Administration (FDA). The SEC alleged that such statements increased the stock price of Arrayit, allowing Nielsen to “realize[] a profit of approximately $137,000.” On April 13, 2020, the SEC temporarily suspended trading in Arrayit stock until April 27, 2020.
Approximately four months later, on September 25, 2020, the SEC filed suit in the Northern District of California against Mark Schena, the president of Arrayit. The complaint alleges that “in March and April 2020, Schena made a series of false and misleading statements in emails to investors,” including that the company “had a COVID-19 test before [it] possessed all the essential components for such a test.” The SEC alleges that Schena further misled investors who asked whether the company had an “approved” COVID-19 test, responding that “we have a test” but “omitting the fact that the test was not approved by the FDA or any other regulatory entity.” The SEC alleges that such statements caused Arrayit’s share price to increase 55 percent and its trading volume to increase 99 percent. No substantive action has been taken by the court in either case.
Decision Diagnostics Corp. On December 17, 2020, the SEC filed suit in the Southern District of New York against Decision Diagnostics Corporation (DECN), a biotechnology company, and Keith Berman, its president and CEO. The SEC alleges that from March through at least June 2020, Berman issued false and misleading press releases during a “publicity blitz” during which he portrayed DECN “as having created a working, breakthrough technology that could accurately test for” COVID-19 using a “finger-prick of blood and provide results in less than a minute.” Berman is also alleged to have made false statements about DECN’s efforts to obtain emergency use authorization from the FDA, which was required before DECN could sell its tests in the United States. The SEC asserts that, in fact, at the time Berman made these statements, DECN had not manufactured a single test kit or prototype and Berman knew that DECN was unlikely to meet the FDA’s testing requirements. Following DECN’s press releases, its stock price rose approximately 1,200 percent and its trading volume rose 1,700 percent. No substantive action has been taken by the court in the case.
II. Enforcement Actions Against Issuers That Made Statements Related to the Impact of COVID-19 on Their Businesses
Complete Business Solutions Group, Inc., et al. On July 24, 2020, the SEC filed suit in the Southern District of Florida against Lisa McElhone and her husband, Joseph LaForte, a convicted felon. The complaint alleges that McElhone and LaForte raised investor funds through unregistered securities offerings for Complete Business Solutions Group, Inc., which was doing business under the name “Par Funding.” According to the SEC, through Par Funding, McElhone and LaForte made “opportunistic loans—some of which charge more than 400 percent interest—to small businesses across America.” The SEC further alleges that McElhone and LaForte made false and misleading statements about their business, including false claims about a low loan default rate, how investor funds would be used, and LaForte’s role and criminal history of grand larceny and money laundering. The complaint also alleges that an agent for Par Funding led investors to believe that it would be futile to sue Par Funding after the company defaulted on promissory notes because of the financial impact of COVID-19 on Par Funding’s business, which led investors instead to agree on restructuring the payments. The agent, however, allegedly later stated that the company was “post-COVID pretty healthy.”
On July 28, 2020, the District Court for the Southern District of Florida granted emergency relief and ordered a temporary asset freeze against Par Funding, McElhone and LaForte, as well as related companies that participated in the alleged scheme. The SEC filed an amended complaint on August 10, 2020. Defendants’ motion to dismiss the amended complaint remains pending.
Wallach. On September 29, 2020, the SEC filed suit in the Northern District of California against Lewis Wallach, former president of a California real estate development company. The complaint alleges that Wallach and the deceased founder of Professional Financial Investors, Inc. (PFI) raised approximately $330 million by fraudulently communicating to investors that their money would be invested primarily in multi-unit residential and commercial real estate managed by PFI. The SEC alleges that, in reality, “a significant portion of investor funds was used in a Ponzi-like fashion to pay existing investors.” The SEC further alleges that, “in response to investor concerns regarding the effects of the COVID-19 pandemic on PFI,” Wallach made false reassurances regarding the company’s financial security. No substantive action has been taken by the court in the case.
The SEC alleges that the fraud was revealed following the death of PFI’s founder on May 6, 2020, after which a review of the involved companies’ financial records revealed concerns about their historical operations. Wallach allegedly confessed to his role in the scheme following the review.
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Because the SEC has filed only a handful of COVID-19-related securities fraud enforcement actions, the extent to which these litigated enforcement actions are representative of nonpublic SEC investigations remains unclear. Nonetheless, these cases provide a window into the SEC’s securities fraud enforcement efforts in the COVID-19 era. The SEC’s recent guidance and its continued filing of COVID-19-related securities fraud enforcement actions suggest that the focus on pandemic-related fraud appears unlikely to soon abate, particularly because COVID-19 issues are expected to remain a focus of the Biden Administration.
WilmerHale is closely monitoring developments in SEC enforcement actions and securities fraud litigation related to the COVID-19 pandemic. If you have any questions, or require assistance with a securities litigation matter, please feel free to reach out to this alert’s authors or any of your contacts at WilmerHale.
