Original post with images here: https://x.com/NuclearHerbs/status/1753558195812098095

Welcome back to #PulseChainLawSchool.

Are you ready to look for some fraud today?

I hope everyone has seen @THoSdocumentary by now so you get that!

Well, I’ve read this Complaint more times than you have, and I can’t f**king find any fraud. Maybe you’ll have better luck.

Let’s take it from the top. What is fraud anyway?

Well, there are lots of different types, which really doesn’t help you one bit, does it? So let’s focus just on the one at issue in Richard’s case – securities fraud.

I was hoping to have this done a week ago, but the rabbit holes I’ve had to go down almost made me give up on the topic completely and post some cat videos instead. But since I have way too much time on my hands, and the NHL is on break for the all-star game, I decided to jump back in and try and decipher some of it for you.

To grossly oversimplify things, the SEC can bring an action for securities fraud, but so can you or I. When you or I do it, it’s called a private right of action, and we become the Plaintiffs. Because government likes to make the rules, they made the rules for the SEC simpler than the rules for private plaintiffs. Essentially, the SEC gets to short-cut a few things in order to win that you or I would have to prove in court. I was able to find a matrix outlining what needs to be proven in different private securities laws claims, and I posted it below. Since I’m not being paid for any of this, I’m not reading it. I like y’all a lot, but not enough to kill off that many brain cells.

So I went back to researching case law, and after sifting through myriad cases, all of which were painfully boring, I focused on a few 2nd Circuit cases, since that’s what’s important here. And recall that the fraud claims against Richard are under 10b-5 and 17(a)(1) and (a)(3). You can google them the next time you can’t sleep.

In SEC v. First Jersey Securities, 101 F.3d 1450 (2nd Cir 1996), the Court stated that in order to establish liability under Rule 10b-5, the Plaintiff “is required to prove that in connection with the purchase or sale of a security the defendant, acting with scienter, made a material misrepresentation (or a material omission if the defendant had a duty to speak) or used a fraudulent device.” A fraudulent device here doesn’t mean a fake iPhone. It means some sort of investment device.

So what the hell is “scienter”? It means “intent to deceive, manipulate, or defraud.” This is also a quote from SEC v First Jersey. It’s a fancy way of saying someone intended to do something they knew was bad.

Now here’s where the SEC gets a break. In order to prove a claim under 17(a)(3) – one of the claims against Richard, you and I would have to prove scienter. The SEC doesn’t. Awesome, right? That’s what happens when government entities write the rules for government entities. At least the SEC still has to prove scienter for its 10b-5 and 17(a)(1) claims, so there’s that. It took the US Supreme Court to make that happen, though, in Aaron v SEC, 446 US 680 (1980).

All of that to get to the point. Richard’s attorneys claim that the SEC didn’t allege its fraud claims properly in the Complaint. And they’re right. You can’t plead fraud the same way you plead negligence or a breach of contract. Rule 9(b) is what we call a “heightened pleading standard,” which means you can’t just say “all the shit I put in the facts section above applies to this fraud claim.” Doesn’t work. But that’s what the SEC did, and that’s why Richard’s attorneys said they’ll raise this issue.

So what do you have to do to plead fraud then? I’m glad you asked. The 2nd Circuit has an answer for us. It said “securities fraud complaints [must] specify each misleading statement . . . [and] state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”

And in order to plead scienter (state of mind) “so as to survive a motion to dismiss, a plaintiff must state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind by either alleging facts (1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness.”

You asleep yet? I just about nodded off myself.

Fine. If you don’t remember anything else, just get the principle here, which is that when you plead fraud, you must tell someone the exact reason you’re suing them, so they know what specific statement(s) they’re supposed to be defending.

Anyway, to close this out, the SEC pled claims 1 and 2 this way:

“Plaintiff re-alleges and incorporates paragraphs 1 through 76 of this Complaint by reference as if set forth verbatim in this Claim.”

I actually found a case where Plaintiffs did exactly this and got slapped down, then I lost it, couldn’t find it again, and eventually gave up looking in order to get this thing done. But basically, the court said you can’t do that in fraud claims (it’s generally ok in most other types of claims, fyi). But when pleading fraud, you have to tell someone the specific things they said that you believe were fraudulent, and why you believe the defendant knew they were fraudulent. You can’t just point to a few dozen or few hundred paragraphs and say “yeah, it’s somewhere in there, go figure it out.”

Bottom line:
1. The SEC didn’t draft its fraud claims properly.
2. This is a solid argument that I believe RH should prevail on.
3. Unfortunately, the likely remedy is that the SEC will get another swing at redrafting their Complaint.
4. If the SEC can’t cure the deficiency properly, you may see a second motion to dismiss on this issue.
5. All of the above assumes that the court has personal jurisdiction over Richard, which is an open question that will also be raised by his attorneys. Remember, no personal jurisdiction, no case.
6. All of the above also assumes that these things are securities, which is also an open question that I expect will be litigated in October (and perhaps again throughout this case if necessary).

Strictly my guess. I could be wrong. I’m wrong a lot. Nothing I say is legal advice.

But I honestly can’t wait to see what Richard’s all-star team comes up with in their motion.