Securities Regulation Daily Appeals court flips switch on $36 million fraud award
Tuesday, June 13, 2017

Appeals court flips switch on $36 million fraud award

By John M. Jascob, J.D., LL.M.

A Florida appellate court has reversed a $36 million judgment for securities fraud against Lighting Science Group (LSG), J.P. Morgan Securities, and two J.P. Morgan employees. The appellate court ruled that there were genuine issues of material fact as to whether the corporate defendants’ failure to disclose certain SEC comment letters and LSG’s alleged misrepresentation of accounting figures violated the Florida securities laws. In addition, the trial court erred in denying the motion to dismiss the claims against two individual defendants because the complaint failed to allege that they acted as agents of the seller, LSG (J.P. Morgan Securities, LLC v. Geveran Investments Ltd., June 9, 2017, Cohen, J.).

Obsolete goods. LSG originally focused on selling high-end, made-to-order lighting. In 2010, however, LSG shifted its business model to manufacturing and marketing light-emitting diode (LED) light products. Geveran Investments Limited invested $25 million in LSG in May 2011 based on the expertise of Norwegian businessman and investor Fredrick Halvorsen, whom Geveran had engaged to identify investment opportunities on its behalf. J.P. Morgan Securities served as LSG’s placement agent and underwriter.

Prior to signing the subscription agreement, however, LSG had filed a Form S-1/A with the SEC in anticipation of making a re-IPO in the summer of 2011. The filing prompted the SEC to raise questions about how LSG decided to classify certain expenses as research and development or cost of goods sold and how LSG valued its obsolete goods. When LSG was not able to provide data to justify a more limited restatement, the SEC requested that the entire amount of the company’s obsolete goods be reclassified as cost of goods sold. LSG filed a Form 8-K on June 16, 2011, indicating that the company’s 2008 and 2009 financial statements would need to be restated.

About one year later, Geveran filed suit, alleging that LSG’s failure to disclose the SEC comment letters and the company’s failure to maintain GAAP-compliant financial records constituted material misrepresentations or omissions in violation of the Florida Securities and Investor Protection Act. The trial court ultimately awarded Geveran $25 million in rescissory damages and approximately $11 million in prejudgment interest, attorney’s fees, and costs.

Materiality and reliance. On appeal, however, the Florida Court of Appeal reversed, ruling that material issues of fact existed concerning the elements of materiality and reliance under Florida law. The fact that LSG agreed to restate its previous financial statements provided strong evidence of a material omission, but it was not dispositive. Rather, LSG’s acquiescence to the SEC’s request had to be weighed against expert testimony and analysis by LSG’s accountant along with the fact that LSG’s business model was changing significantly, making the 2008 and 2009 financials less relevant.

In addition, there was a genuine issue of material fact as whether Halvorsen relied on those omissions and misrepresentations when acting on Geveran’s behalf. Even though an average investor would generally rely on assurances given in an investment contract, the court noted that Halvorsen is not an average investor. The court observed that Halvorsen was given complete access to confidential information at LSG as well as J.P. Morgan’s due diligence materials. By his own admission, he looked carefully at LSG and performed an extensive independent review. Accordingly, the appeals court reversed the trial court’s order granting summary judgment on Geveran’s claims under Florida law.

Individual defendants. The Court of Appeal also reversed the trial court’s ruling that two of J.P. Morgan’s employees were liable under the Florida blue sky law for soliciting Geveran’s investment as agents of LSG. While Geveran’s complaint alleged that the two employees "solicited the sale of LSG stock," it did not allege that they had a personal interest in the transaction—only that J.P. Morgan would receive an agency fee. The complaint contained no allegations that the individuals acted to serve the interests of LSG, given that they were actually employees of J.P. Morgan. Thus, Geveran failed to facts sufficient to state a claim on the basis that the J.P. Morgan employees were liable as "sellers" under Florida law.

Geveran also failed to allege facts that would establish that the individual defendants were agents of LSG who participated in the sale. Geveran failed to state a cause of action against them based on an actual agency theory because the complaint did not allege or demonstrate that either defendant had accepted an agency agreement with LSG or that LSG exercised control over them. Moreover, the complaint did not allege any facts relating to the elements of apparent agency theory but merely asserted that the defendants were agents or "subagents" of LSG by virtue of their employment with J.P. Morgan. Accordingly, the trial court erred in denying J.P. Morgan’s motion to dismiss Geveran’s claim against them.

The case is No. 5D15-4272.

Attorneys: Mayanne Downs (GrayRobinson, P.A.) for J.P. Morgan Securities, LLC. Thomas A. Zehnder (King, Blackwell, Zehnder & Wermuth, P.A.) for Geveran Investments Ltd. Barry Richard (Greenberg Traurig, LLP) for Lighting Science Group Corp.

Companies: J.P. Morgan Securities, LLC; Geveran Investments Ltd.; Lighting Science Group Corp.; Pegasus Capital Advisors, LP

MainStory: TopStory FraudManipulation PrivatePlacements FloridaNews

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