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SmileDirectClub Directors Hid Risk to Get Rich in IPO: Suit (1)

Nov. 25, 2019, 7:47 PMUpdated: Nov. 25, 2019, 10:40 PM

SmileDirectClub Inc.’s directors were hit with a Delaware lawsuit claiming they got rich selling stock at above-market prices during its initial public offering, even as shares crashed to 40% of their opening value on news the company concealed state enforcement actions.

The web-based teeth-straightening pioneer went public at $23 a share in September through an “up-C” IPO, which involves transforming an existing limited liability company into a subsidiary of a newly formed corporation.

After the company issued 59 million shares, its price plunged 25% the first day, nearly 50% within two weeks, and eventually down to $9 a share, according to the Nov. 22 complaint.

The shareholder derivative complaint was filed in the Delaware Chancery Court by an individual investor who previously led an unrelated securities suit against Twitter Inc.

Raiding Storefronts

Six of the company’s board members sold $625 million worth of stock at $21.85 to a mid-level holding company they controlled, when the shares were already worth significantly less, the lawsuit says.

Those insiders were allegedly aware that SmileDirectClub faced major regulatory hurdles in California, where the state dental board has repeatedly raided its storefronts as part of an ongoing probe accusing the company of illegally practicing dentistry.

SmileDirectClub, which is facing similar investigations in multiple states, sued California last month.

The case opened the latest front in a wave of suits challenging the regulatory authority of state licensing boards under 2015’s N.C. State Board of Dental Examiners v. FTC, in which the U.S. Supreme Court limited their immunity against antitrust claims.

The board kept investors in the dark, despite knowing that the widening controversy, especially in its California chapter, posed a major threat to the company, according to the complaint.

That move inflated its offering price, to the detriment of public investors, the suit says.

Some of the allegations echo the claims from several federal securities suits filed after the IPO contesting the adequacy of the company’s regulatory disclosures. The Delaware suit is partly based on those cases, according to the complaint.

Cause of Action: Breach of fiduciary duty; unjust enrichment; indemnification.

Relief: An accounting, damages, costs, and fees.

Response: SmileDirectClub does not comment on pending litigation.

Attorneys: The plaintiff, the Doris Shenwick Trust, is represented by Rosenthal, Monhait & Goddess PA and Abraham Fruchter & Twersky LLP.

The case is Doris Shenwick Trust v. Katzman, Del. Ch., No. 2019-0940, 11/22/19.

(Updated with response from SmileDirectClub.)

To contact the reporter on this story: Mike Leonard in Washington at mleonard@bloomberglaw.com

To contact the editor responsible for this story: Rob Tricchinelli at rtricchinelli@bloomberglaw.com