Securities And Exchange Commission v. Richman

Background

The Securities and Exchange Commission (SEC) sued Jessica Richman and Zachary Apte, co-founders of uBiome. The SEC alleged that, during uBiome’s Series C funding round from May through September 2018, Richman and Apte misled investors about the company’s business model, revenue growth, and ability to obtain insurance reimbursement for its tests.

According to the complaint, uBiome shifted from tests paid for directly by consumers to tests billed to insurers. The SEC alleged that the company’s doctor network sometimes allowed tests to be prescribed based only on online questionnaires, without a live consultation, and that uBiome presented retests of old samples as requests involving new samples. The complaint also alleged that Richman and Apte directed employees to create and backdate medical records, bill for tests that had not been performed, and manipulate insurance billing codes.

The SEC alleged that Richman and Apte nevertheless told Series C investors that uBiome’s tests were “ordered by doctors” and “reimbursed by insurance.” It also alleged that Richman provided information stating that insurance reimbursements generated nearly 91% of the company’s revenue by the first quarter of 2018 and that the company projected more than $100 million in total revenue for 2018. The funding round raised $59 million from 27 investors. The complaint alleged that Richman and Apte each sold $5 million worth of company shares as part of the offering.

Motion to Dismiss

The SEC brought claims under Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Richman and Apte jointly moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), arguing primarily that the SEC had not pleaded the alleged securities fraud with the particularity required by Rule 9(b).

The defendants argued that the complaint was an improper “shotgun” pleading, failed to identify the alleged misrepresentations specifically, failed to distinguish between the defendants, and did not adequately plead falsity, materiality, or scheme liability. A motion to dismiss under Rule 12(b)(6) tests whether the complaint states a legally sufficient claim, while Rule 9(b) requires fraud allegations to identify the circumstances of the alleged fraud with particularity, including the “who, what, when, where, and how.”

Court’s Analysis

The court rejected the defendants’ pleading arguments. It held that the complaint presented a clear theory of fraud and gave the defendants enough information to understand the claims and prepare a defense. The court explained that Rule 9(b) does not require the SEC to plead every piece of evidence or every allegedly fraudulent act.

The court found the alleged misrepresentations sufficiently detailed because the complaint identified the subject of the statements, the Series C investors as the audience, the May-to-September 2018 funding-round period, and examples involving emails, pitch decks, and promotional materials. It also found that the complaint adequately alleged Richman and Apte’s substantial participation in preparing or presenting the statements and their knowledge, or reckless disregard, of concerns about uBiome’s business practices.

The court further held that the complaint adequately alleged falsity and materiality. It reasoned that statements about the company’s revenue growth and insurance reimbursement prospects could be misleading because the defendants allegedly failed to disclose serious concerns raised by employees and insurers about the doctor network, retesting practices, documentation, billing, and the legitimacy of the business model. Materiality means that there is a substantial likelihood that a reasonable investor would have acted differently if the information had been disclosed.

Finally, the court held that the complaint adequately alleged scheme liability. It concluded that the alleged conduct could constitute a scheme to create a false appearance about the strength and sustainability of uBiome’s business model by misleading Series C investors.

Disposition

Judge Charles R. Breyer denied the defendants’ motion to dismiss.