In the wake of the U.S. Supreme Court’s March 2018 Cyan decision, in which the Court affirmed that state court’s retain concurrent jurisdiction for liability action under the ’33 Act, plaintiffs’ lawyers have initiated a number of Section 11 actions in the courts of a number of states. This new wave of state court Securities Act lawsuits is now making its way through the courts. As the cases have progressed, in some instances the state courts have granted the defendants’ motions to dismiss. The latest example of a state court granting a defendants’ motion has now occurred in the Connecticut state court claim alleging ’33 Act violations in connection with Pitney-Bowes September 2017 debt note IPO. The Connecticut court’s October 24, 2019 order granting the defendants’ motion to strike, a copy of which can be found here, raises a number of interesting issues.
In March 2017, Pitney Bowes filed a shelf registration statement, intending to offer securities in the future. On September 13, 2017, the company filed a prospectus with the SEC in connection with the sale on that date of $700 million in notes in an IPO. The prospectus incorporated by reference certain of Pitney Bowes prior SEC filings.
A plaintiff security holder subsequently brought a liability action in Connecticut state court purportedly on behalf of a class of investors who purchased the Notes in the September 2017 offering. The lawsuit was filed against the company, certain of its directors and officers, and against the company’s offering underwriters. The gist of the complaint is that the company failed to disclose at the time of the offering a number of items that subsequently were disclosed when the company reported its third quarter financial results as of September 30, 3019 quarter end. The company and the individual defendants filed a motion to dismiss, alleging that the plaintiff’s complaint had failed to state claim on which relief could be granted.
In his October 24, 2019 opinion, Connecticut Superior Court Judge Charles T. Lee granted the defendants’ motion to strike. In granting the motion, Judge Lee reviewed each of three main alleged misrepresentations and omissions on which the plaintiff sought to rely.
Judge Lee first addressed the plaintiff’s allegation that the defendants violated the disclosure obligations under Item 303 of Regulation S-K, requiring the company to disclose “trends” and “uncertainties,” by failing to disclose in the offering documents that lower equipment sales and margins during the in-progress third quarter in Pitney Bowes’ Small and Medium Business Solutions. Judge Lee noted that other courts in implying duty to disclose a trend have required that the development must “take place over a longer period of time that merely one quarter.”
Here, by contrast, Judge Lee noted, the plaintiff has simply alleged that equipment sales and margins declined in the third quarter compared to the prior quarter. He said that
Nothing in the plaintiff’s complaint suggests that this decline was part of an ongoing pattern, nor that it was caused by a persistent condition affecting Pitney Bowes’ business rather than ordinary, quarter-to-quarter business fluctuations. Accordingly, because neither the duration nor the substance of the alleged declines at issue meet the criteria of a ‘trend’ under Item 303, Pitney Bowes was under no independent duty to disclose the alleged declines in equipment sales and margins during a quarter which had not yet closed, nor their overall impact on company financial performance, prior to or at the time of, the IPO.
Judge Lee then addressed the plaintiff’s allegation that the statement in offering documents that the company’s Small and Medium Solutions segment was “characterized by a high level of recurring revenue” was misleading absent additional disclosures concerning the purported third quarter decline in segment revenue. The plaintiff argued that the statement implied that the segment would generate continuously high revenue going forward.
Judge Lee said that “a plain reading of the statement makes clear that it did not carry with it the promise that the … segment would generate consistently high levels of overall revenue in the future. Rather, the statement indicates that, irrespective of the total amount of revenue earned with the segment, much of it was derived from recurring sources.” The declines in the third quarter revenue in the segment “did not render the statement … misleading.”
Finally Judge Lee addressed the plaintiff’s allegations based on the statements in the offering documents about improvements in equipment sales and margins in the Small and Medium Business Solutions segment during the second quarter. The plaintiff contended that these statements, which the plaintiff alleged presented a “transformative turnaround story,” were misleading in the absence of additional disclosures about the declines in these metrics during the third quarter.
Judge Lee said with respect to these statements about second quarter performance that the “are unequivocally in the past tense” and merely describe the quarter’s second quarter performance. The plaintiff’s claim that the statements implied a “transformative turnaround” relies on “a reading of the statements that is completely divorced from the context in which they appear.” Nothing in these statements “suggests, explicitly or implicitly that any of this performance would continue into the future.” To the contrary they were merely “accurate statements of historic fact that cannot form the bases of a securities claim.”
The Connecticut court joins the courts of a number of other states that have recently granted motions to dismiss (or in this case a motion to strike) in Securities Act liability actions filed in the courts of those states, including Texas (as discussed here) and New York (discussed here).
The fact that the courts in these various jurisdictions are granting these dismissal motions is significant, if for no other reason than the plaintiffs’ lawyers clearly sought to pursue these various actions in state court because they believed they would fare better there rather than in federal court. Indeed, in an interesting and useful recent paper (here), Stanford Law School Professor Michael Klausner and his colleagues posited that one of the reasons for the “dramatic increase” in state court Securities Act liability actions in the wake of Cyan is the plaintiffs’ counsel’s belief that state court pleading standards are generally lower than those in federal court, which should make the lawsuits filed in state court less likely to be dismissed.
If as a result of the dismissals granted in this and the other state court Securities Act liability actions it become clear that the plaintiffs will not actually enjoy — or at least are not certain to enjoy — an advantage at the pleading stage, some of the plaintiffs’ incentives to pursue the claims in state court may be diminished. At a minimum, it is clear at least in the Pitney Bowes case, the complaint received every bit as much scrutiny as the complaint would face in federal court.
While I believe that the ruling in the Pitney Bowles is significant, as it is just the ruling of a state court trial judge – and of a state court trial judge in Connecticut, which is not one of the states in which many of the post-Cyan state court lawsuits are being filed. The states with the most post-Cyan Securities Act lawsuits are California and New York. In that regard, it is important to note that July 2019, the New York state court judge presiding in the Netshoes Securities Litigation did grant the defendants’ motion to dismiss in that Securities Act liability action (as discussed here).
These various dismissal motions rulings are of course themselves without precedential value and are subject to appeal. However, one can hope that these rulings may send a message that the plaintiffs should reconsider whatever perceived advantages they may think they have in proceeding in state court rather than federal court.
Ultimately, we can hope that Congress will fix the problem that Cyan created; it makes no sense to have a system that permits parallel or duplicative litigation and that has a multitude of state courts enforcing and applying the federal securities laws. However, unless or until Congress gets around to amending the ’33 Act’s jurisdictional provision, plaintiffs’ lawyers will have the option of filing their suits in state court. One can only hope that decisions like Judge Lee’s in the Pitney Bowes case will help persuade the plaintiffs’ lawyers to stick with the federal court forum.
One final thing that D&O insurance underwriters will want to note is that this ’33 Act liability lawsuit was brought in state court against Pitney Bowes, a company whose shares were publicly traded prior to the debt offering that was the subject of the lawsuit. D&O Underwriters have tended to consider the Cyan-related state court lawsuit problem as relating primarily to classic IPO companies – that is, companies that have only recently launched their securities to trade for the first time in the public markets. It is a point that I have made before, but companies engaging in follow-on or secondary offerings can also be subject to ’33 liability litigation, and therefore also face the possibility of separate or parallel state court securities class action litigation.
This lesson from the Pitney Bowes case could easily be lost as the Connecticut court referred to the company’s notes offering as an IPO (because the debt securities were traded for the first time in the public markets as a result of the offering) but Pitney Bowes undeniably was a public company prior to the note offering that was the subject of the state court lawsuit. The point that should not be lost here is that companies whose securities are already publicly traded could upon completion of subsequent securities offerings face the possibility of state court securities class action litigation, even if the companies are well past their initial IPO.
Special thanks to a loyal reader for sending the Connecticut decision to me.