Cheryl V. Reicin
In every crisis, an opportunity; and in every opportunity, the potential for fraud. Unsurprisingly, there has already been a surge of companies purporting to develop vaccines and other treatments for COVID-19, as well as personal protective equipment (PPE), and those that issue securities may be subject to regulatory enforcement and possible legal actions. Securities regulators in the U.S. and Canada have indicated that they are actively scrutinizing market participants for disclosures related to COVID-19.
U.S. and Canadian regulators are investigating and bringing action against:
In pursuit of these investigations, regulators are:
On May 12, 2020, the Co-Director of the Division of Enforcement at the U.S. Securities and Exchange Commission (SEC) publicly spoke about the SEC’s recent enforcement and investigative efforts related to COVID-19, including the formation of a Steering Committee which is coordinating with the Division’s Microcap Fraud Task Force and Office of Market Intelligence to obtain and analyze market intelligence and to organize matters for potential trading suspensions or enforcement actions.
Likewise, Canadian Securities Administrators (CSA) published guidance on May 6, 2020 providing insight on the current focus of regulatory enforcement related to COVID-19 disclosures. The guidance addressed how issuers must meet their obligation to provide the public with accurate and reasonable information in Management’s Discussion and Analysis (MD&A), financial information and material change reports in light of COVID-19.
The SEC Director noted that its investigations into such potential scams have resulted in an uptick of trading suspensions initiated by the SEC in recent months. Since February 7, the SEC has suspended trading in the securities of more than 30 issuers as a result of questions about the adequacy and accuracy of COVID-19 related information. These suspensions followed a broad range of claims by issuers, including those relating to access to PPE and testing materials, and developments of treatments or vaccines. The SEC has also suspended trading in the stock of at least three microcap issuers whose names or ticker symbols closely resembled those of unrelated companies providing COVID-19 related products and services, due to concerns about investor confusion, among other things.
Similarly, Canadian regulators are investigating instances of fraud and misrepresentation, and are alerting the public to COVID-19 related schemes. In one case, the British Columbia Securities Commission (BCSC) warned the public of an unregistered issuer marketing securities for a holistic cure to the virus. In another case, the BCSC warned of a cannabis and psychedelic life sciences company previously focused on researching liver disease treatments via CBD that was aggressively marketing securities by touting their success with products that detect, cure or treat COVID-19.
How do regulators such as the SEC and the OSC identify these potentially fraudulent issuers? These regulators often receive tips from various sources, ranging from the Financial Industry Regulatory Authority, Inc. (FINRA), and in Canada, the Investment Industry Regulatory Organization of Canada (IIROC), tips from investors, or from the SEC staff’s own market surveillance. Enforcement investigators at these agencies are engaging in expedited fact gathering and analysis, which may include review of public statements by and about the company in question and review of trading data related to their securities. SEC staff has been contacting brokers, promoters, or others for documents or information in pursuit of these claims. Where claims have been made about contracts or new products, SEC staff may even contact counterparties to such arrangements. While a trading suspension by itself does not constitute a finding of fraud or misconduct, it can lead to the initiation of regulatory enforcement proceedings against the company. One recent example was the SEC’s suit against Praxsyn Corporation and its CEO that was filed in a federal court in Florida on April 28, which was filed following the SEC’s trading suspension of Praxsyn (quoted on the OTC Link LLC (previously “Pink Sheets”)) on March 26 for having issued a pair of press releases that had touted their ability “to obtain, large quantities of N95 masks used to protect wearers from COVID-19.”
In addition, regulators are actively looking for disclosures, impairments, or valuations that may represent an attempt by the company to mischaracterize previously undisclosed problems or weaknesses as being related to COVID-19. In this area, the SEC Director noted that they are currently conducting investigations that may lead to a trading halt or more serious enforcement action. In Canada, CSA communicated that they expect full and complete disclosure in MD&As, financial information and Material Change Reports. The guidance provided that the MD&A should include issuer-specific details of how the issuer’s operations, liquidity and capital resources and forward-looking information are affected by COVID-19 and provide the risk factors related of COVID-19. The CSA specifically warned issuers not to mislead the public by categorizing losses or expenses as non-recurring where indicators of impairment were present prior to the pandemic.
Issuers engaged in COVID-19 related business activities should therefore be vigilant in ensuring that public disclosures and statements by management regarding COVID-19 issues are balanced and accurate, and all public companies should be careful to provide accurate and meaningful disclosures regarding the impact of COVID-19 on their businesses—including considering appropriate forward-looking statements regarding future impact. Legitimate COVID-19 companies should also be wary of business dealings with potential business partners who themselves may be fraudulent, and market participants generally should consider reporting any COVID-19 related market activity that appears suspect.
Read all our coronavirus-related updates on our COVID-19 guidance for organizations resource page.
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