COVID-Related SEC Enforcement Actions Not a Thing of the Past
The sun is shining, children are out of school, families are headed off on summer vacations, and the SEC is … bringing enforcement actions against companies for 2020 fraud related to COVID-19 products. One such action was recently filed against SCWorx Corp. and its former CEO and chairman, Marc Schessel.1 In bringing charges almost two years after the fraudulent statements at issue were made, the SEC has confirmed our expectation that it is prepared to take a long-term approach to COVID-related fraud cases. SCWorx also creates the potential for increased flexibility in how defendants are able to satisfy disgorgement obligations in the future.
A Deal Too Good to Be True
SCWorx Corp. is a hospital supply chain company that provides software solutions within the healthcare provider market.2 As alleged by the SEC, the company was struggling financially at the start of the COVID-19 pandemic and saw an opportunity to capitalize on the nation's critical need for medical supplies.3 On April 13, 2020, the defendants announced in a press release that SCWorx had a deal valued at $840 million to sell COVID-19 rapid test kits under a "committed purchase order."4 As part of the alleged deal, SCWorx would provide the buyer 2 million test kits for 24 weeks, for a total of about $35 million per week.5 After the press release, SCWorx's stock price surged 425 percent from the prior trading day on 96.2 million shares, a volume of shares that was more than 900 times the prior three-month daily average.6
Shortly after the company published the press release, however, securities researchers and analysts issued reports identifying numerous red flags associated with the SCWorx deal.7 The reports described the deal as "completely bogus" and a "scam," calling attention to Schessel's "checkered past" of felony tax evasion and expense report fraud as support.8 These reports, in addition to several prior statements made by SCWorx in April about the distribution of rapid test kits, led the SEC to suspend trading in SCWorx securities from April 21 to May 5, 2020.9
Litigation and Enforcement
After the trading suspension expired, several private parties filed complaints against SCWorx and Schessel, which were ultimately combined into a Consolidated Class Action Complaint filed on Oct. 19, 2020.10 In their complaint, the class action plaintiffs, who were SCWorx investors, asserted violations of Section 10(b) of the Securities Exchange Act (Exchange Act) and Rule 10b-5 against both SCWorx and Schessel and a claim under Section 20(a) of the Exchange Act against Schessel individually.11 The parties entered into settlement discussions shortly thereafter and SCWorx and the plaintiffs reached a settlement agreement by March 25, 2022. During this period, the SEC took no further public action.
Almost two years after instituting the SCWorx trading suspension, the SEC announced an enforcement action against SCWorx and Schessel, filed under seal in federal district court in New Jersey on March 31, 2022.12 The complaint charges both defendants with violating antifraud provisions of federal securities laws and seeks permanent injunctive relief, disgorgement, prejudgment interest and civil penalties.13 Additionally, the SEC seeks to bar Schessel from ever again serving as a public company officer or director.14 SCWorx, for its part, has agreed to settle with the SEC, which includes entry of a permanent injunction, payment of a $125,000 penalty, disgorgement of $471,000 and prejudgment interest of $32,761.56.15 SCWorx has also agreed to settle with class action plaintiffs for $3.3 million.16 Schessel appears prepared to litigate the claims against him.
Moving Forward: Old Cases, New Resolutions
This case presents a notable study for several reasons. First, it stands as a reminder to companies that SEC investigations can have a long life, so silence from the SEC does not necessarily mean closure. Here, the SEC suspended trading in April and May 2020 – some of the earliest days of the COVID lockdown – but did not file a complaint alleging underlying violations of securities laws until March 2022.
Second, SCWorx presents an interesting illustration of the unique ways in which the SEC may handle a defendant's satisfaction of a disgorgement payment. Traditionally, disgorgement has been satisfied by a defendant's return of money to harmed investors or the U.S. Treasury, or by deeming disgorgement satisfied when paid as criminal forfeiture in a parallel criminal proceeding.17 In this case, however, SCWorx is expected to satisfy its disgorgement and prejudgment interest obligations by contributing stock, valued at $600,000 at the time of issuance, to the class action plaintiffs.18 Thus, while a rare occurrence thus far, SCWorx may mark an increased willingness by the SEC to pursue creative paths to securing disgorgement, including possibly accepting "in kind" satisfactions of disgorgement and interest payment obligations from defendants, at least where there are private proceedings based on the same core set of facts and parties.19
Lastly, the U.S. Attorney's Office for the District of New Jersey and the Fraud Section of the U.S. Department of Justice's Criminal Division have also announced criminal charges against Schessel that parallel those leveled against him by the SEC.20 Whether Schessel will settle with the SEC and private investors – and what impact the criminal proceedings will have on his obligations under any such settlements – are matters to keep an eye on as the cases progress. Given the serious Fifth Amendment issues involved, we wager that the SEC and class actions, both civil in nature, may well be stayed so long as Schessel remains under indictment and facing a criminal trial.
As the SEC continues to bring new enforcement actions against companies based on allegedly false and misleading claims made during the early days of COVID, investors should remain vigilant for companies making new false claims while looking to capitalize on new COVID variants, therapeutic and diagnostic developments, or other unverified claims and tactics designed to boost stock prices.21
The Holland & Knight SECond Opinions Blog will continue to monitor this space and provide updates as to future developments. If you need any additional information on this topic – or anything related to SEC enforcement or internal investigations – please contact the authors or another member of Holland & Knight's Securities Enforcement Defense Team.
1 Press Release, U.S. Sec. & Exch. Comm'n, SEC Charges Company and Former CEO with Misleading Investors about Sale of Covid-19 Test Kits (May 31, 2022); Yannes v. SCWorx Corp., 20-CV-03349 (JGK) at *1 (S.D.N.Y. June 21, 2021).
4 Yannes, 20-CV-03349 (JGK) at *1.
7 Yannes, 20-CV-03349 (JGK) at *1. The two reports mentioned are the "SCWorx Short Report" by Utopia Capital Research and a report by Hindenburg Research entitled "SCWorx: Evidence Points to its Massive COVID-19 Test Deal Being Completely Bogus, Price Target Back to $2.25 Or Lower."
8 Id. at *1–*2.
9 Id. at *2. See also Order of Suspension of Trading, In the Matter of SCWorx Corp, File No. 500-1 (April 21, 2020); Press Release, U.S. Sec. & Exch. Comm'n, SEC Charges Company and Former CEO, supra note 1. Pursuant to federal securities laws, the SEC may suspend trading in any stock for up to 10 business days with no prior warning to investors. For more information on trading suspension protocol, visit the SEC's Investor Bulletin: Trading Suspensions (Dec. 14, 2021).
10 Yannes, 20-CV-03349 (JGK) at *2; Consol. Class Action Compl., filed Oct. 19, 2020, Yannes v. SCWorx Corp., et al., 1:20-cv-03349.
11 Yannes, 20-CV-03349 (JGK) at *1.
17 Of course, the Supreme Court's June 22, 2020, Liu decision reset the framework for seeking and securing disgorgement. For an analysis of the Liu v. SEC, 140 S. Ct. 1936, 1949 (2020) decision, see SECond Opinions Blog post "Supreme Court Affirms But Limits SEC's Authority to Seek Disgorgements in Judicial Proceedings." This article discusses the Supreme Court's decision to simultaneously affirm and limit the SEC's authority to seek the remedy of disgorgement in judicial proceedings by requiring proceeds to be disbursed to fraud victims, requiring a deduction of legitimate expenses from the receipts of fraud and limiting the imposition of joint and several liability. Additionally, see SECond Opinions Blog post "Fifth Circuit: SEC's Plan for Distributing Disgorged Amounts to Investors Satisfies Liu" for the Fifth Circuit's analysis on Liu's requirement that disgorgement be for "the benefit of investors." The post discusses SEC v. Blackburn, No. 20-30464 (5th Cir. Oct. 12, 2021), a case in which the Fifth Circuit upheld a disgorgement order which sent disgorged funds to the SEC to hold as a "de facto trustee" of defrauded investors for later disbursement.
19 While rare, this is not the first time that the SEC has taken a creative approach to disgorgement satisfaction. See Order, In the Matter of Foundations Asset Management, et al., Release No. 86446 (July 24, 2019) and Press Release, U.S. Sec. & Exch. Comm'n, Post-SPAC Music Streaming Company Reaches $38.8 Million Settlement in Ongoing Fraud Action (Oct. 27, 2021).