Securities Law Alert
In This Edition:• Southern District of New York: Dismisses Securities Fraud Class Action Due to Conclusory Factual
Allegations and Unidentified Sources• Southern District of New York: Plaintiff Failed to Plead That Crypto Exchange Platform Was a Statutory
Seller or Actively Solicited Sales Under Pinter• Court of Chancery of Delaware: Clarifies for the First Time That Corporate Officers, Not Just Directors,
Have a Duty of OversightFebruary 2023

Southern District of
New York: Dismisses
Securities Fraud Class Action
Due to Conclusory Factual
Allegations and Unidentified
Sources
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On January 10, 2023, the Southern Districtof New York dismissed with prejudice aputative securities fraud class action alleging
that an online sports betting company andcertain affiliated executives made false
and misleading statements concerning atarget company in advance of a three-way
business combination between the company,
the target, and a SPAC, with the resulting
company becoming public. In re Draftkings
Sec. Litig., 2023 WL 145591 (S.D.N.Y. 2023)(Engelmayer, J.). Noting that plaintiffs’
allegations were based almost entirely on ashort seller report, which itself was basedlargely on unsourced or anonymously
sourced allegations, the court held that thecomplaint’s “threadbare sourcing and theconclusory quality of these factual allegations
and attributions are ultimately fatal” to all of
its claims.

The target developed software for online andretail sportsbook and casino gaming products.
Following the business combination, apublished short seller report claimed that thetarget operated in certain foreign jurisdictions
where gambling was illegal (so-called “blackmarket” jurisdictions). Within weeks, plaintiffs
commenced this action and asserted claims
under Section 10(b) and Rule 10b-5, alleging
that the company had made materially false
and misleading statements about the target’s
violations of foreign law and their potential
consequences. Specifically, plaintiffs allegedthat while the company had stated in themerger agreement, the proxy statement, otherpublic filings and press releases that the target
was in compliance with the gaming laws of six
black-market foreign countries, that the target
had, in fact, secretly and illegally operated
in these jurisdictions. Defendants moved
to dismiss.
Noting that the complaint relied almost
entirely on the short seller report, the court
found that two features of the report were
problematic, in compounding ways. First,
the court explained that it must consider thecomplaint’s allegations with caution because
the short seller has an economic motivation

to drive down the company’s stock price. See
Long Miao v. Fanhua, Inc., 442 F. Supp. 3d774 (S.D.N.Y. 2020). Second, the short seller
report was based on “confidential sources,”
rather than identifiable and/or verifiable
sources. The court explained that while “aconfidential source need not be identified
for his or her statements to be credited ona motion to dismiss, such a source must be‘described in the complaint with sufficientparticularity to support the probability
that a person in the position occupied by
the source would possess the information
alleged.’” Emps.’ Ret. Sys. of Gov’t of the V.I.
v. Blanford, 794 F.3d 297 (2d Cir. 2015).
Putting these factors together, the court notedthat “[a]s the case law further reflects, wherethese two problematic features coincide—when a complaint’s factual attributions
to unidentified sources derive not frominterviews by plaintiffs’ counsel, but froma short-seller report’s attributions to such
sources—there is still greater need for care.”
In re Draftkings Sec. Litig., 2023 WL 145591,
at *56.
The court further explained that if plaintiffs’
counsel has not interacted with theunidentified source and was ignorant of thesource’s name, position, and other attributes
tending to bear on the source’s credibility,“and instead extracted and pled as true
statements from a report by a short seller
attributing adverse facts to unidentified
persons, these aspects of the complaint, if
not corroborated, are fairly discounted or put
aside altogether as ill-pled.” Long Miao, 442
F. Supp. 3d. The court found that such was
the case here, noting that the complaint reliedon statements from the short seller reportattributed to unidentified former employees
to support plaintiffs’ claim that the target
engaged in black-market operations. The
court noted that the statements of attribution

were general in nature and “devoid of details
lending themselves to corroboration” such aswhere, when, and how the target operated ineach jurisdiction at issue.
Explaining its denial of plaintiffs’ request
to amend, the court noted that plaintiffs
had already amended the complaint twice(once before and once after a motion todismiss). The court had warned plaintiffs
then that if they chose to amend rather than
oppose a motion to dismiss, then no further
opportunities to amend would ordinarily
be granted. Further, the court stated thatplaintiffs failed to: (i) identify additional
factual allegations that would cure thedeficiencies noted in the motion to dismiss;(ii) explain how further investigation or
diligence would rectify the deficiencies; or(iii) offer any reason for the court to disregard
its earlier warning.

Southern District of New York:
Plaintiff Failed to Plead That
Crypto Exchange Platform
Was a Statutory Seller orActively Solicited Sales Under
PinterOn February 1, 2023, the Southern Districtof New York dismissed a putative class action
brought by customers alleging that a company
sold cryptocurrencies as unregisteredsecurities through its two online digital
trading platforms. Underwood v. Coinbase
Global, 2023 WL 1431965 (S.D.N.Y. 2023)(Engelmayer, J.). Discounting the amended
complaint’s allegations, which contradicted
the original complaint, the court held thatplaintiffs failed to plead that the company was2

a “statutory seller” under Pinter’s first prong1
as plaintiffs did not plead that the company
passed title to the buyer. The court also
held that plaintiffs failed to allege that thecompany actively solicited the sales under thesecond prong.2“Section 12(a)(1) of the Securities Act createsa private right of action for the purchaser
against the seller in any transaction that
violates Sections 5(a) or (c),” which “prohibit
any person from selling unregisteredsecurities using any means of interstate
commerce unless the securities are exempt
from registration.” 15 U.S.C. § 77e(a), (c). To
state a claim under Section 12(a)(1), plaintiff
must allege defendant meets the “statutory
seller” requirements articulated in Pinter.
Under Pinter an individual is a “statutory
seller” if defendant either: (i) “passed title,or other interest in the security, to the buyer
for value” (in other words, was the “direct
seller”); or (ii) “successfully solicited thepurchase of a security, motivated at leastin part by a desire to serve its own financial
interests or those of the securities’ owner.”In their amended complaint, plaintiffs allegedthat the company was the statutory seller
under the first prong of Pinter because thecompany held title to the cryptocurrencies
1. Pinter v. Dahl, 486 U.S. 622 (1988).
2. Plaintiffs also asserted certain state-law claims that are
not discussed in this summary, which were based on thecompany’s alleged sale of unregistered securities and failure
to register as a broker-dealer. These state-law claims weredismissed without prejudice based on the court’s decision not
to exercise supplemental jurisdiction. Additionally, plaintiffs
brought a claim under Section 29(b) of the Exchange Act,
alleging that the company utilized illegal contracts with users
in violation of the Exchange Act’s registration requirements.
As with plaintiffs’ Securities Act claim under Section 12(a)(1),
the Exchange Act claim was also dismissed with prejudice.

at the time of the transactions among theusers because the digital assets were placedin a centralized wallet. Therefore, plaintiffs
alleged that for every transaction involving
these digital assets, the only blockchain
address that a user ever interacted with wasprovided and owned by the company suchthat users interacted with the company,
not with each other. Noting that while such“allegations would ordinarily assist plaintiffs
in pleading this theory” the court determinedthat because these allegations were contrary
to those in the original complaint, it should
disregard the amended pleading.
The court observed that the originalcomplaint’s factual allegations related
to counterparties undermined plaintiffs’
thesis in the amended complaint that thecompany was a statutory seller under the firstprong. Specifically, the original complaint
had alleged that once digital assets werecredited to a user’s wallet, the user could
enter into trade agreements with other users
for purchases and sales of digital assets;
however, the amended complaint alleged thatbuyers and other users as sellers were not in
privity with one another. The court further
observed that the original complaint’s factual
allegations about who held title to the digitalassets undermined plaintiffs’ thesis in theamended complaint. Specifically, the originalcomplaint incorporated a user agreementthat was in effect during the class period
and indicated that the users were the title
holders, thereby contradicting the amended
complaint’s allegations that the company held
title to the digital assets. In language directedto the user, the user agreement stated, “You
control the Digital Currencies held in your
Digital Currency Wallet” and that “Title to
Digital Currency shall at all times remain withyou and shall not transfer to [the company].”
Therefore, the court held that amended
complaint’s allegations fell short of meetingthe first prong of Pinter.
Regarding the second prong of Pinter—examining whether the company solicitedthe transactions—the court explained thatto hold a defendant liable under Section
12 as a seller, plaintiffs must demonstrate
defendant’s “direct and active participationin the solicitation of the immediate sale.”
The court determined that the amended
complaint’s allegations failed because
they did not “describe conduct beyond the3‘collateral’ participation that Pinter and its
progeny exclude from Section 12 liability.”
The amended complaint alleged, among otherthings, that the company promoted the tokens
with descriptions of the tokens, participatedin direct promotions, and wrote news
updates on token price movements. The court
described these efforts as akin to marketing
efforts, materials, and services that courts
have held to be insufficient to establish active
solicitation under Pinter’s second prong.
Generally, it appears that active solicitation
involves defendant directly contacting
investors. For example, in Holsworth v.
BProtocol Foundation, 2021 WL 706549(S.D.N.Y. Feb. 22, 2021), the court dismissed
a Section 12 claim, stating that plaintiff failed
to show that he was directly contacted bydefendants or that he purchased securities
as a result of any active solicitations
by defendants.

Court of Chancery of
Delaware: Clarifies for theFirst Time That Corporate
Officers, Not Just Directors,
Have a Duty of Oversight
On January 25, 2023, the Court of Chanceryof Delaware denied dismissal of a derivative
action alleging that the defendant former
head of human resources for a global
fast food company breached his fiduciary
duties by: (i) consciously ignoring red flags
regarding sexual harassment and misconduct
at the company (duty of oversight); and(ii) personally engaging in sexual harassment(duty of loyalty). In re McDonald’s S’holder
Derivative Litig., 2023 WL 387292 (Del. Ch.
2023) (Laster, V.C.). Rejecting defendant’s
argument that Delaware law does not impose
any obligation on officers that are comparable
to the duty of oversight for directors

established by In re Caremark International
Derivative Litigation, 698 A.2d 959 (Del.
Ch. 1996), the court announced that “[t]his
decision clarifies that corporate officers owe a
duty of oversight.” While acknowledging thatno previous Delaware decision has explicitly
stated this proposition, the court stated that“diverse authorities indicate that officers owe
a fiduciary duty of oversight as to matterswithin their areas of responsibility.”3

The Scope of an Officer’s Dutyof OversightConcluding “that oversight liability for officers
requires a showing of bad faith[,]” the court
explained that “[t]he officer must consciously
fail to make a good faith effort to establish
information systems, or the officer must
consciously ignore red flags.” The court statedthat the duty of oversight is context-driven
and its application will differ depending on
the officer’s role. For example, some officers,
like the CEO, will have a company-wide
remit, while others are generally limited toparticular areas, reporting red flags only
within their areas of responsibility. The court
cautioned, however, “a particularly egregious
red flag might require an officer to saysomething even if it fell outside the officer’s
domain.”Plaintiffs’ Allegations Support an
Oversight Claim Against Officer
Defendant
As to the applicable standard, the court
stated: “To plead a Red-Flags Claim that willsurvive a Rule 12(b)(6) motion, a plaintiff
must plead facts supporting an inference thatthe fiduciary knew of evidence of corporate
misconduct. The plaintiff also must plead
facts supporting an inference that thefiduciary consciously failed to take action
in response. The pled facts must support aninference that the failure to take action was
sufficiently sustained, systematic, or striking
to constitute action in bad faith. A claim thata fiduciary had notice of serious misconduct
and simply brushed it off or otherwise
failed to investigate states a claim for breachof duty.”
3. Among these authorities, the court cited Caremark, Gantler
v. Stephens, 965 A.2d 695 (Del. 2009) (holding that officers’
fiduciary duties are the same as directors’ fiduciary duties),
principles of agency, decisions from other jurisdictions, andacademic commentary.
4The court found that plaintiffs asserted
a “Red-Flags Claim” because plaintiffs
described that defendant: (i) knew about
evidence of sexual misconduct; and (ii) acted
in bad faith by consciously disregarding
his duty to address the misconduct.
The court found that plaintiffs alleged anumber of red flags, including coordinated
EEOC complaints, employee strikes andCongressional inquiries, indicating forpleading purposes that sexual harassment
occurred at the company and supporting areasonable inference that defendant knew
about the red flags. The court observed that
defendant was the executive officer with
day-to-day responsibility for overseeing thehuman resources function and promoting
a safe and respectful environment, andwas thus “supposed to have his ear to theground and be knowledgeable about theCompany’s employees.” As to bad faith, thecourt explained that Delaware law presumes
that directors and officers act in good faith,
and a complaint must plead facts sufficient
to support an inference of bad faith intent.
The court stated that several factors support
an inference of scienter. In this regard, thecourt pointed to plaintiffs’ allegations that
defendant engaged in multiple acts of sexual
harassment and concluded that “[w]hen acorporate officer himself engages in acts ofsexual harassment, it is reasonable to inferthat the officer consciously ignored red flags
about similar behavior by others.”

Plaintiffs Also Stated a Claim for
Breach of the Duty of Loyalty Basedon Officer Defendant’s Own Acts of
Sexual Harassment
The court also denied dismissal of plaintiffs’
claim that defendant’s own acts of sexual
harassment constituted a breach of the dutyof loyalty. The court explained that an allegedharasser acts in bad faith and breaches theduty of loyalty because a harasser engages insexual harassment for selfish reasons, whichconflicts with an officer’s duty of loyalty.
The court concluded by noting: “Sexual
harassment is bad faith conduct. Bad faithconduct is disloyal conduct. Disloyal conduct
is actionable.”This edition of the
Securities Law Alert was edited by
Meaghan A. Kelly / +1-202-636-5542
mkelly@stblaw.com
Rachel S. Sparks Bradley / +1-212-455-2421
rachel.sparksbradley@stblaw.com andJanet A. Gochman / +1-212-455-2815
jgochman@stblaw.com

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