Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—E.D.N.Y.: Dismissal motion granted only for one piece of fraud case involving phony prescriptions, (Jul 18, 2025)

By Rebecca E. Hoffman, J.D.

The court found that “scheme liability” claims against a former CFO of an online pharmacy can be dismissed, since he disseminated his own misstatements, and did not do anything else to further the scheme.

In an enforcement action arising from an alleged scheme to artificially inflate the revenue of an online pharmacy, the Eastern District of New York on July 17 dismissed scheme liability claims against the pharmacy’s former CFO, finding that there could not be scheme liability where the defendant disseminated his own misstatements. (SEC v. Patel, No. 1:24-cv-06405 (E.D.N.Y. July 17, 2025)).

However, the scheme liability and aiding and abetting claims against the manager, and the misstatement claims against the former CFO, can proceed, the court decided.

The “Head of Rx Operations” for Medly Health, Inc., was responsible for finding ways to meet agreed-upon revenue targets, but these strategies “became crooked” in 2020, when he began creating prescriptions out of thin air within the company’s software, using invented or deceased patients, for whom drugs were “billed” to fake insurance companies, thereby increasing the pharmacy’s revenue on paper. As a result, an anomaly in the balance sheet led the CFO to investigate. He told the board that it had been resolved, but other events belied that conclusion.

The CFO and CEO successfully used the inflated numbers to raise funds from investors, “[b]ut all the while, the walls came crumbling down around defendants,” the court said. The CFO and CEO were terminated, the manager resigned, and Medly filed for bankruptcy. The SEC brought this action against all three, alleging that “‘Medly created at least $70 million in fake revenue and reported revenue to prospective investors that was fraudulently inflated by between 10 percent and 24 percent.’”

Misstatements. The SEC alleged that the CFO and CEO are liable under Securities Act Section 17(a) and Exchange Act Section 10(b) for misstatements and omissions. Addressing the CFO’s motion to dismiss these claims, the court observed that “[t]he factual allegations in the amended complaint form a sturdy foundation for misstatement claims” against him, showing that he at least suspected the revenue amounts quoted to investors were inflated. The CFO argued that he did not have access to the information that would have definitively shown the discrepancy, and that he was the one who initiated the investigation. But the SEC need only show that the defendant recklessly disregarded or should have known that the numbers did not add up, not that he knew for certain, the court found.

The CFO attempted to argue that one cannot make a reckless statement about an unknown fact, but “[a]lthough he gets points for originality, [his] newly concocted axiom has no application here,” the court found, noting that it would be a recklessly false statement if you saw smoke coming from your roof and said everything was fine, even if you did not actually see a fire.

Scheme Liability. To set forth a scheme liability claim, the SEC must allege that the manager and CFO committed a deceptive or manipulative act in furtherance of a fraudulent scheme with scienter. “[T]he amended complaint sets forth a textbook scheme-liability claim” against the manager, the court said, noting that the fake prescriptions constitute deceptive acts, even if they did not directly deceive investors, but only led to them ultimately being deceived. It can also be inferred that the manager knew his actions would lead to inflated numbers, and that investors would rely on those false numbers. He “modified key internal data knowing full well that it would artificially juice Medly’s stated revenue and that Medly’s executives would present the revenue statements to investors in its upcoming fundraising round,” the court observed. “He accordingly committed fraud independent of any other defendant’s violation.”

As to the CFO, however, the court said that the Second Circuit and Supreme Court “have long wrestled with the interplay between the scheme liability subsections, their neighboring misstatement-and-omissions subsections, and the Acts’ separate aiding-and-abetting prohibitions.” If a misrepresentation on its own could be the basis for scheme liability, it would render the misstatement subsections of the statute superfluous, the Second Circuit determined.

The court here was able to distinguish cases that appeared to hold differently. Because the CFO had control over his communications with investors, his dissemination of the false financial statements was “itself a misstatement and cannot independently undergird a scheme-liability claim,” the court found. The scheme language in the statutes require something apart from the misstatement itself, and the CFO is not alleged to have done anything else.

Aiding and abetting. The SEC also properly alleged that the manager aided and abetted the other defendants’ violations, by showing that he acted at least recklessly and provided substantial assistance in achieving the others’ violations. The allegations show “substantial assistance” in that the manager’s false prescription conduct was “essential” to the CFO’s false statements, and there is a sufficient showing of recklessness—“even if he did not know about each of the misstatements, he was at least reckless in not knowing that [the CFO] was inclined to present the revenue to investors,” the court found.

The case is No. 1:24-cv-06405.

Judge: Cogan, B.

Attorneys: Christopher M. Colorado for the SEC. Matthew Stephen Adams (Fox Rothschild LLP) for Marg Patel.

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