Theranos' anni horrorum began in October 2015 with the publication of a story by investigative reporter John Carreyrou at The Wall Street Journal. Lawsuits and government investigations ensued. Although the Theranos recently announced agreements with the Arizona Attorney General and the Centers for Medicare & Medicaid Services, U.S. District Court Magistrate Judge Nathanael M. Cousins last week dealt a setback to the company and its founder, Elizabeth Holmes. Colman v. Theranos, Inc., 2017 U.S. Dist. LEXIS 59254 (N.D. Cal. Apr. 18, 2017).
Judge Cousins issued his ruling in a class action lawsuit brought by purchasers of Theranos' stock. Although Theranos' shares are not publicly traded, the plaintiffs did not acquire their shares directly from the company. Nonetheless, they sought to hold Theranos, Ms. Holmes and others liable under Sections 25400(d) and 25401 of the California Corporations Code and for common law fraud.
Section 25400 was modeled on Section 9 of the Securities Exchange Act of 1934 and was intended to address market manipulation. Subdivision (d) declares that it is unlawful:
If such person is a broker-dealer or other person selling or offering for sale or purchasing or offering to purchase the security, to make, for the purpose of inducing the purchase or sale of such security by others, any statement which was, at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, or which omitted to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and which he knew or had reasonable ground to believe was so false or misleading.
In ruling on the defendants' motions to dismiss, Judge Cousins concluded that the statute did not require that the plaintiffs to have purchased directly from Theranos or that the individual defendants have sold or offered for sale the securities. Faithful readers may recall this post from May, 2011 discussing U.S. District Court Judge Jeffrey S. White ruling that privity is required by Section 25500 and this post from July 2011 discussing U.S. District Court Judge Susan Y. Illston's contrary conclusion. Judge Cousins did note, however, that the plaintiffs must still prove "defendants' intent to induce the purchase of securities through misleading statements, which necessarily limits the relationship between a seller and foreseeable buyers." Judge Cousins' ruling is likely to be an unpleasant awakening for private companies who may expect to face liability for misstatements made to investors purchasing securities from the company itself but not to investors, like the plaintiffs, who purchased securities indirectly.
The defendants did succeed in obtaining the dismissal of the plaintiffs' claims under Section 25401 which provides:
It is unlawful for any person to offer or sell a security in this state, or to buy or offer to buy a security in this state, by means of any written or oral communication that includes an untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in the light of the circumstances under which the statements were made, not misleading.
Citing Apollo Capital Fund, LLC v. Roth Capital Partners, LLC, 158 Cal. App. 4th 226 (2007), Judge Cousins found that Section 25401 requires privity, something not alleged by the plaintiffs.