Securities Regulation Daily SEC plausibly alleged that communications firm, executives defrauded merger investors
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Tuesday, September 8, 2020

SEC plausibly alleged that communications firm, executives defrauded merger investors

By Amy Leisinger, J.D.

The Commission pleaded adequate facts to establish that the defendants made misrepresentations and withheld critical information to convince investors to vote in favor of the acquisition.

The Southern District of New York declined to dismiss SEC claims that an Israel-based intelligence communications company and two of its executives misled investors to get shareholder approval of a merger within the required timeframe. According to the court, the Commission presented sufficient facts and allegations to demonstrate that the defendants misrepresented the target company’s business prospects and failed to take reasonable steps to ensure the accuracy of proxy materials. Facts regarding the executives’ involvement were also enough to raise an inference of scienter that cannot be addressed on a motion to dismiss, the court stated (SEC v. Hurgin, September 4, 2020, Vyskocil, M).

Merger and alleged misconduct. In 2013, Cambridge Capital Acquisition Corp. was incorporated as a special purpose acquisition company and had two years to acquire a target company with capital raised in its IPO before required to release the capital back to shareholders. Cambridge identified Ability, Inc., an Israeli business that sold cell phone and satellite interception products, as an acquisition candidate. Cambridge shareholders ultimately voted to approve the merger. Ability received approximately $19 million, and its CEO and chief technology officer each received millions in cash and put options.

The SEC filed a complaint alleging that Ability and its executives lied to the Cambridge shareholders about its business prospects to convince them to vote in favor of the merger, making misstatements in investor roadshows and proxy materials regarding the company’s purported ownership of a new "game-changing" interception product and a "large backlog" of existing customer orders and probable future orders. The defendants committed fraud and violated proxy solicitation rules in connection with the merger, the Commission stated.

Fraud elements. The court found that the SEC adequately alleged that Ability’s CEO made materially misleading representations about its product. The executive contended that the statement that Ability was "the only owner" of the product was not materially misleading because Ability had a long-term exclusive license to sell it. The court stated it was "not remotely persuaded" that Ability did not fully own the product would be unimportant to investors. The Commission also adequately alleged that the CEO was responsible for materially misleading statements and omissions about Ability’s backlog and future orders. Further, the court explained, the SEC adequately demonstrated that the CEO omitted material facts regarding Ability’s relationship with a Latin American police agency and related personnel changes.

"[N]otwithstanding the disclosures about potential risks of doing business in Latin America, the bespeaks caution doctrine does not apply because the terminations at the police agency were problems that already ha[d] materialized," according to the court.

The executive’s argument that the Commission failed to establish scienter cannot be resolved on a motion to dismiss, the court stated. He argued that the Commission cannot establish that he acted with an intent to deceive Cambridge shareholders because he sincerely believed his representations and made disclosures, but the SEC has clearly pleaded facts that, if true, could support the inference that the CEO acted with at least a reckless disregard for the truth, the court found.

Personal jurisdiction over co-owner. Ability’s co-owner argued that the court lacks personal jurisdiction over him because he resides in Israel and never has been registered with the SEC. In addition, he contended that he was "barely involved" in the merger and that his board status is not sufficient to establish jurisdiction." However, the court found, the Commission has made a prima facie case for jurisdiction. The Commission’s complaint pleaded facts showing that the executive purposefully availed himself of the privilege of doing business in the United States and could have anticipated being brought into court in connection with the merger. The SEC also alleged that, as a 50-percent owner of Ability, his consent was necessary for the merger to proceed, even though he remained in Israel, and the merger agreement contained a "consent to jurisdiction" in the Southern District.

The Commission also adequately alleged that the co-owner put his reputation at issue in the proxy materials such that he owed a duty to the Cambridge shareholders and pleaded sufficient facts about his involvement to survive his motion to dismiss the agency’s negligence-based claims against him.

As such, the court denied the defendants’ motions to dismiss and required them to file their answers by September 22, 2020.

The case is No. 19-cv-5705 (MKV).

Attorneys: Donald W. Searles for the SEC. Jason P. Gottlieb (Morrison Cohen, LLP) for Anatoly Hurgin.

Companies: Ability Computer & Software Industries Ltd.; Ability Inc.

MainStory: TopStory Enforcement FraudManipulation MergersAcquisitions Proxies NewYorkNews

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