TheCorporateCounsel.net

Last week, the SEC announced settled enforcement proceedings arising out of allegedly misleading IPO disclosures about a biotechnology company’s overall market potential, revenue prospects, and customer pipeline for the company’s only commercially available product. Without admitting or denying the SEC’s findings, the company consented to an order to cease and desist from future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act (which do not require proof of scienter) and agreed to pay a $30 million civil penalty to resolve the charges. Here’s an excerpt from the SEC’s press release:

According to the SEC’s order, Zymergen claimed that it had a $1 billion electronics display market opportunity for Hyaline, but the estimate was based on flawed and unreasonable assumptions that included product markets that were poor fits for Hyaline’s technical characteristics and unsupported premium pricing.

The SEC’s order also finds that Zymergen provided misleading revenue forecasts to research analysts that far exceeded internal estimates.

Additionally, the order finds that Zymergen misled investors during its first public earnings call by misrepresenting the status of Hyaline’s customer pipeline while omitting significant technical and commercial problems facing the product.

As hinted at above, the order takes issue with inconsistencies between the public statements and projections used and concerns raised internally. The order alleges that the company’s sales team had or used different market assumptions and revenue projections and was aware of “adverse facts” regarding customer orders that were omitted in the earnings call response. For example:

The $1 billion [market opportunity] figure was misleading because it included product markets that the sales team was not targeting and/or that were poor fits for Hyaline’s technical characteristics. Specifically, the estimate included the rigid-touch-sensors market and fingerprint-on-display market, which together comprised over 99 percent of the $1 billion market opportunity figure provided in the Form S-1.

No member of Zymergen’s sales team reviewed this assumption, nor did the information provided by the sales team support the inclusion of these markets. In fact, the sales team knew that past attempts to sell Hyaline in these markets had already failed after customers found Hyaline was either too expensive, unnecessary, or both. Thus, Hyaline’s customer pipeline maintained by the sales team did not list any customer that was testing the product for either the rigid-touch-sensors market or the fingerprint-on-display market as of the end of 2020. Despite this information, Zymergen included these markets in the $1 billion figure provided to investors.

The SEC’s press release focuses on these market potential numbers — where the internal estimate was “approximately $42 million to $100 million—or approximately 5 to 10 percent of the $1 billion market opportunity for 2020 presented in the Form S-1.” The press release has this reminder:

“Pre-revenue and early-stage companies that seek to tap the capital markets must do so with reasonable estimates of their market potential,” said Monique C. Winkler, Director of the SEC’s San Francisco Regional Office. “Today’s order finds that Zymergen failed to satisfy this obligation when it misled investors with what amounted to unsupported hype.”

While relevant to all companies, as the quote notes, it’s particularly important for pre-revenue and early-stage companies to carefully consider their market opportunity statements and for all involved to understand, agree and disclose what markets are included, or excluded, from the estimates and the assumptions involved.

– Meredith Ervine