Monday, September 21, 2015
Haskell Murray had an interesting post on Friday about businesses buying fake reviews, followers, or friends online. That post led me to think about another issue—if a company did that, could it be liable under Rule 10b-5 for securities fraud?
Consider this scenario: An investor is thinking about investing in a company called Ebusiness, Inc. She carefully reviews the company’s online presence and sees that Ebusiness has more followers and friends than anyone else in the industry. The reviews of its products are overwhelmingly positive. She concludes that Ebusiness is destined for greatness and buys its stock.
Later, the press discloses that most of Ebusiness’s followers and friends, and most of its online product reviews, are fake. Ebusiness paid someone else to produce them. The price of Ebusiness’s stock drops precipitously. Would Ebusiness be liable under Rule 10b-5?
Rule 10b-5 makes it unlawful "to make any untrue statement of a material fact . . . in connecton with the purchase or sale of any security. There’s no question that Ebusiness, through its paid agent, made fraudulent statements. There’s also no question that the investor relied on those fraudulent statements and suffered a loss when the truth became known. The real issue is whether those fraudulent statements were “in connection with the purchase or sale of any security,” as required by Rule 10b-5.
The courts have read the “in connection with” requirement broadly, but its meaning is still far from clear. The Second Circuit has indicated that the false statement must be disseminated “in a manner reasonably calculated to influence the investing public.” SEC v. Texas Gulf Sulphur Co. 401 F.2d 833, 862 (2d Cir. 1968). The false statements do not have to be directed specifically at investors, as long as the statement is of a sort that reasonable investors would rely on. In Re Carter-Wallace, Inc. Securities Litigation, 150 F.3d 153, 156 (2d Cir. 1998). The Carter-Wallace case held that product advertisements in medical journals could be covered by Rule 10b-5, although the primary goal of advertising is to influence consumers, not investors.
The same can be said of false "likes" and product reviews. Their primary goal is to influence consumers, not to convince investors to buy the company's stock. A reasonable investor certainly would not rely on a single "like" or product review. But, given the importance of a company's Internet presence, a reasonable investor might rely on the overall weight of likes and product reviews. Such use by an investor is certainly reasonable foreseeable.
Given the uncertainty of the case law, a definite conclusion is impossible. But it is at least possible that fraudulent product reviews or Facebook “likes” could trigger liability under Rule 10b-5. It’s probably just a matter of time before an ambitious plaintiff’s lawyer tries.