How an investor awareness campaign can implicate securities laws
Traditional IR firms share their client’s story in forums ranging from widely attended roadshows to one-on-one investor meetings. There are some firms, though, that push the limits of standard practices. One such firm allegedly began an ‘investor awareness campaign’ where it anonymously wrote positive articles about its client on financial blogs, and in so doing, exposed itself (and its client) to potential liability under the Securities Laws.
The story is told in a class action complaint recently filed against IR firm DreamTeamGroup and its client, Galena Biopharma. It is claimed that DreamTeam improperly promoted Galena through ‘articles posted on third-party websites… using a variety of aliases… claim[ing] to be established, credible investment professionals’. One typical post appearing on Seeking Alpha touted the strengths of the company and concluded that investors in Galena ‘will be handsomely rewarded in due time’. An investor reading the post (and many others like it) would have no idea the anonymous author was paid to make that statement.
In fact, the complaint further alleges that to add credibility to the statements and give the impression of broad-based support for Galena’s stock, DreamTeam referred back to its own articles ‘using different aliases on various blogs, message boards, and in social media’. According to the complaint, during that time Galena’s stock rose in price from $2 to $7.50. Investors that bought at the high price were understandably upset when the scheme was exposed and the price reverted to $2.
The case of DreamTeam’s questionable actions on behalf of Galena even drew the attention of the financial press. Adam Feuerstein exposed the scheme in an article on TheStreet.com, writing: ‘Publicly traded companies routinely pitch their stock to new investors, but some of DreamTeam’s marketing tactics appear to resemble stock promotion schemes that run afoul of standard investor relations practices.’ Feuerstein does an excellent job of describing how DreamTeam may have gone beyond standard investor relations practices. When that line is crossed, there may be legal implications as well.
The complaint filed on behalf of harmed investors seeks damages against DreamTeam under section 10(b) of the Exchange Act, which prohibits securities fraud. To prevail against DreamTeam, at a minimum, investors will need to show that the blog posts contained materially false statements. That may be difficult because many of the statements in question appear to be mere opinions, such as: investors in Galena ‘will be handsomely rewarded in due time’. On the other hand, even opinions are considered materially misleading for the purposes of section 10(b) if they are not reasonably held when made. As this case moves forward, it will be important for plaintiff shareholders to explore ‒ likely through deposition ‒ whether the authors believed their own hype.
Alternatively, the plaintiffs can attempt to show that the blog posts were materially misleading because they omitted necessary facts. Here, failing to disclose the fact that the authors were conflicted (because they were hired by Galena) arguably harmed the ability of an investor to determine how much credibility to give statements touting Galena’s stock.
Where the plaintiffs will have the most difficulty, however, is trying to claim that DreamTeam is a proper defendant in a section 10(b) action. This difficulty arises from the Supreme Court’s declaration - articulated in the cases of Central Bank of Denver and Janus Capital Group - that only primary violators are responsible for securities fraud, and that the primary violator is the person with ultimate authority to make the statement. The line between primary violators (as opposed to aiders and abettors) is one of the murkiest areas of securities law practice. Suffice to say that the issue will be heavily litigated.
But should the SEC decide to get involved by way of enforcement action against DreamTeam, it will not suffer from such a limitation. The regulator can pursue both primary violators and aiders and abettors ‒ and has done so. Indeed, it is likely the SEC already has DreamTeam on its radar, if Galena's quarterly report from November 2014 can be believed, which discloses that the regulator is looking into the relationship between the two companies.
Further, if the regulator chooses to pursue DreamTeam, it could proceed under section 17(b) of the Securities Act, commonly called the anti-touting rule, which prohibits the promotion of stock via the internet (or other forms of communication) for compensation without disclosing such compensation. The SEC has shown a willingness to pursue such civil enforcement actions: for example, in 2005 it brought an action against an IR firm that disseminated via the internet positive opinions about its client’s stock, including that it was ‘a great buy’, without disclosing that the firm was being compensated for those opinions. The court reasoned that the civil penalties were necessary to ‘punish the individual wrongdoer as well as deter him and others from future securities law violations.’
In short, this will be an interesting case to watch. It is currently before Judge Michael Simon in the US District Court for the District of Oregon, and he will likely be ruling on several motions to dismiss (and thus giving us our first view of the strength of the case) over the next year. The outcome is not just important to fringe IR firms like DreamTeam; the line between mere puffery designed to create buzz about a client and misleading statements that may run afoul of the Securities Laws is an important one for any IR professional who uses social media to communicate his or her client’s story.
Brent J. Horton is an Associate Professor of Law and Ethics at Fordham University's Gabelli School of Business, and Faculty Director of Fordham University's Master of Science in Investor Relations