Zymergen

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The SEC recently settled an enforcement action against Zymergen for making false projections about its business.  Prior to its IPO in April 2021, many of these projections were given directly to analysts.  Zymergen did not include the projections in its registration statement, because companies are strictly liable to investors for false statements in a registration statement under Section 11 of the Securities Act, and so they generally try to avoid making projections that may turn out to be overly optimistic.  Instead, Zymergen gave the false projections to analysts, so the analysts would take the projections, and use them in building their models, which they would pass on to investors with a recommendation of some sort.

One question then, is, if the SEC had not brought an enforcement action, could Zymergen have been liable to investors for passing on bad info to analysts?

The answer is, maybe not.  Certainly not under Section 11, which only applies to information in a registration statement.  And maybe not under Section 10(b), the general antifraud statute, because Stoneridge v. Scientific-Atlanta holds that public investors are not deemed to “rely” on behind-the-scenes conduct that’s filtered to the public through the false statements of another entity.  (But see Janus Capital Group, Inc. v. First Derivative Traders, raising the possibility, without deciding, that statements to analysts are public for 10(b) purposes).

Could the analysts themselves be liable for passing on targets based on false projections?  Certainly not under Section 10(b), unless they knew or were reckless about falsity, because Section 10(b) only applies to intentional frauds.

What about under Section 12, which imposes negligence liability for anyone who distributes a false offer for the sale of securities (which could theoretically apply to Zymergen, as well?)

It’s complicated.  The Supreme Court has narrowed the application of Section 12 in ways that are somewhat convoluted, and might preclude liability here, though in the pre-IPO context it's hard to say.  But a second issue concerns whether the research report could be considered an offer in the first place.  Maybe so, except in the JOBS Act of 2012, Congress legislated an exception to the definition of offer, so that any research report is not an offer if it concerns an IPO of an emerging growth company.  So, because Zymergen (like most IPOs) was an emerging growth company, the analysts themselves were free to distribute Zymergen’s false information, without fear of Section 12 liability; they could only be liable if they themselves acted intentionally under Section 10(b). 

The combination creates some… well, troubling incentives, especially for analysts who work for investment banks that are part of the selling group and therefore may feel some pressure to offer positive coverage.  The analyst report itself won’t trigger negligence liability as a false Section 12 prospectus (because of the carveout), shareholders who read the analyst report (probably) can’t sue Zymergen under 10(b) (because of Stoneridge), and neither Zymergen, nor the underwriters who might even employ the analyst, will be liable under Section 11 for false statements in the registration statement, because those false statements were by hypothesis carved out of the registration statement to be farmed out by the analysts instead.

Now, after the dot com scandals of the early 2000s, the SEC procured settlements from the largest investment banks to separate their underwriting and research segments and new FINRA rules also required such separation but, you know, the Zymergen situation does raise the question whether this is the correct balance, especially since I gather it is fairly common practice for pre-IPO firms to share revenue guidance with analysts, in the expectation those analysts will present the information to investors.

On this point, I note that Zymergen’s registration statement contains the following standard language:

We are responsible for the information contained in this prospectus. We and the underwriters have not authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses prepared by us or on our behalf. We and the underwriters take no responsibility for any other information that others may provide you.

The SEC doesn’t mention it; still, it’s weird to me that these companies are permitted to filter their projections through analysts in hopes of flogging an IPO, while simultaneously publicly disclaiming any of that analysis.

That said, investors did, in fact, identify some allegedly false statements that were directly included in Zymergen’s registration statement, and those are the subject of an ongoing securities case under Section 11.  So … all’s well that ends well?

And finally, the latest Shareholder Primacy podcast is up.  This time me and Mike Levin talk TripAdvisor (pending before the Delaware Supreme Court) and 14a-4 shareholder proposals.  Available on Spotify, Apple, and YouTube.