Stock Issuer Not Required to Disclose Hiring of Outside Promoters

In the first published appellate court decision to decide the issue, the Eleventh Circuit has held that companies that retain promoters to publish promotional materials to “recommend” or “tout” their stock (and raise the stock price) are not required by federal securities laws to disclose the business arrangement between the issuing company and promoter.  In Ballesteros v. Galectin Therapeutics, Inc., 2016 WL 7240146 (Dec. 15, 2016), an opinion authored by Judge Frank M. Hull, the court upheld the district court’s dismissal of a class action alleging injuries sustained by class members who, unaware that the issuer had paid promoters for their endorsements, were persuaded to purchase stocks that crashed when the relationship between the issuer and the promoters was uncovered and disclosed.

Between 2013 and 2014, Georgia-based pharmaceutical company Galectin Therapeutics, Inc.  made two issuances of common stock to fund its continued drug research and development.   During these offerings, Galectin allegedly retained several promoters to recommend Galectin’s stock and raise the stock price.  The plaintiffs alleged that the stock promoters timed the publication of their Galectin-related articles to coincide with Galectin’s own press releases and “pump” Galectin’s stock price.  Galectin allegedly then made its offerings to “capitalize on the artificially inflated price of its common stock.”

Whether or not Galectin has the promoters to thank, its stock prices did increase during its research and development cycle, from $2 per share to $15.31 per share by the time of Galectin’s second issuance in March 2014.  However, in late July 2014, investment commentators began publishing stories regarding suspected ties between Galectin and stock promoters, and the stock price crashed.  The plaintiffs argued that class members would not have purchased stock had Galectin disclosed its promoter relationships and that class members suffered losses resulting from the stock’s crash in value.

The plaintiffs alleged that Galectin’s disclosures were deficient in two key ways: (1) by representing at its stock issuance that it had not manipulated the stock price in any way; and (2) by omitting that Galectin paid promoters from its SEC Form 10-K and 10-Q reports.

The district court held that paying for promotional articles does not constitute price manipulation and that, because it is permissible to pay stock promoters, Galectin did not impermissibly manipulate the stock price.  The district court also reasoned that Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011) mandated a holding that Galectin was not liable for stock promoters’ own statements.

The court began its analysis by noting that Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission’s Rule 10b-5 prohibit making material misstatements or omissions in connection with the purchase or sale of any security.  Rule 10b-5 prohibits the making of any “untrue statement of a material fact” in connection with the purchase or sale of securities.  However, the court then detailed the Supreme Court’s holding in Janus that a company cannot be held liable for the false statement of third parties, because the “maker” of any statement is the person with ultimate control over the content of the statement and whether and how to communicate it.  The Eleventh Circuit relied on Janus to hold that Galectin could not be held liable for the promoters’ statements.

The Eleventh Circuit further held that Galectin’s statement that it had not manipulated the stock price was not an untrue statement of material fact in violation of 10(b) of the Exchange Act or Rule 10b-5.  The Court noted that nothing in securities laws prohibits Galectin from hiring promoters to publish positive articles and encourage the purchase of Galectin’s stock.  The Court found that there is no disclosure duty imposed on the company paying for promotional material.

Instead, the court cited 15 U.S.C. § 77q(b) in holding that the duty to disclose payments for promotional articles is on the author who receives the payment.  Section 17(b) of the Securities Act of 1933 requires stock promoters to disclose any payment they receive as consideration for their promotional material.  The court did note that the promoters did not disclose Galectin’s payments, but the plaintiffs did not name the promoters as defendants in this suit.

Posted by Margaret Flatt.

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