A recent guest post on this site expressed the view that because of the volume of Section 11 litigation being filed in New York state court, New York’s courts “will have a major role in shaping the standards applied in Securities Act litigation going forward.” If that is the case, then the recent ruling by a New York trial court judge granting the defendants’ motion to dismiss in a state court Section 11 action could be significant. New York (New York County) Supreme Court Judge Barry Ostrager’s May 15, 2020 ruling in the consolidated Sundial Growers Securities Litigation can be found here.

Background

Sundial Growers, Inc. is a Canadian-based producer of cannabis products. Sundial completed its IPO in August 2019. In September 2019, Sundial was hit with the first of a series of New York state court Section 11 class action lawsuits. The New York state court lawsuits were later consolidated. (The separate Section 11 lawsuits filed against Sundial in federal court were separately consolidated in the Southern District of New York. The federal court actions and the state court actions, of course, are not consolidated with each other.)

The New York state court Section 11 actions allege that the offering documents Sundial issued in connection with its IPO contained material misrepresentations and omissions. The plaintiffs allege that the defendants misrepresented Sundial as a producer of “high-quality” and “premium” cannabis product. The plaintiffs allege that this representation was misleading in light of the quality problems Sundial had encountered, and specifically an incident in which Sundial had a large order (the Zenabis Global transaction) returned because of its deficient quality.

The consolidated New York state court complaint names as defendants the company; certain of its directors and officers; and its offering underwriters. The complaint alleges that the defendants violated Section 11, Section 12(a)(2) and Section 15 of the Securities Act. The complaint seeks to recover damages on behalf of investors who purchased Sundial securities traceable to the company’s IPO.

The defendants filed a motion to dismiss the plaintiffs’ consolidated state court action.

The May 15, 2020 Order

On May 15, 2020, Judge Ostrager issued an order granting the defendants’ motion to dismiss. In issuing this ruling, Judge Ostrager noted that “though the plaintiff’s claims were stated in detail,” the defendants presented cited statements in the offering documents that “utterly refute the plaintiff’s claims.”

The offering documents, Judge Ostrager said, “show that Sundial made no guarantees with respect to the quality of its product, and instead claimed that it intended to produce ‘high quality and premium’ cannabis, while warning that (1) efforts to do so may be frustrated due to agricultural risks and (2) a market for high-quality, premium cannabis products may not materialize.”

With respect to the specific statements the plaintiff alleged to be misleading, Judge Ostrager said that each of the statements “was either (1) corporate puffery, too vague to be actionable, (2) a sincere statement of corporate optimism, or (3) sufficiently offset by robust risk disclosures.”

Judge Ostrager also noted that the plaintiff “ignores the robust 35-page risk disclosure section of the Offering Documents.” The supposed defects in the Zenabis transaction shipment on which the plaintiff relied in trying to assert that the offering document statements about the quality of Sundial’s products were, Judge Ostrager said, the “exact type of risk” that was “disclosed in the Offering Documents.”

Because of the “context of the alleged misrepresentations, their general nature, and their placement amongst robust risk disclosures,” Judge Ostrager concluded that “the Prospectus itself utterly refutes” the plaintiff’s claims for violations of Sections 11 and 12 of the Securities Act.

Because, Judge Ostrager said, the plaintiff “failed to identify any materially false or misleading statements or omissions in the Offering Documents, the Complaint must be dismissed.”

Discussion

In the wake of the U.S. Supreme Court’s March 2018 decision in Cyan, many observers have been concerned about the proliferation of state court securities class action litigation alleging violations of the Securities Act. Among the concerns with the rise of state court litigation is that state court judges would prove more reluctant to grant defendants’ motions to dismiss that federal court judges.

Indeed, there is academic research substantiating the concern that state court judges grant motions to dismiss in Securities Act liability actions less frequently than federal court judges. In their October 2019 paper (here), Stanford Law School Professor Michael Klausner and his colleagues found that since the Cyan decision, motions to dismiss Section 11 cases were granted in only 19% of state court cases, while  the motion were granted 42% of the time in federal court cases.

Following the Cyan decision, one of the significant developments has been the increase in the number of Securities Act liability actions filed in New York state court. According to Cornerstone Research (here, page 19), of the 49 state court securities act lawsuit filings in 2019, 18 were filed in New York state court (compared to zero filed in New York state court in 2017). As I noted at the outset, because of the volume of state court Section 11 lawsuits now being filed in New York state court, New York’s courts will have a significant role in the overall development of state court securities class action litigation.

Because of the relative significance of New York state court securities litigation, Judge Ostrager’s ruling in the Sundial Growers case is itself significant. First, Judge Ostrager is himself a respected judge, who joined the state court bench after a distinguished legal career. Second, Judge Ostrager’s opinion showed no judicial reluctance to grant the dismissal motion. Judge Ostrager’s willingness to grant the defendants’ dismissal motion may show the way for other New York state court judges. At a minimum, it shows that dismissal may the correct approach at least in certain cases.

For observers on the defense side, we can hope that if it eventually becomes apparent that plaintiffs derive no particular benefit from attempting to proceed in state court, that eventually plaintiffs will become less eager to file Securities Act liability actions in state court.

Unfortunately, until either Congress acts to fix the Cyan problem or plaintiffs’ lawyers become less enthusiastic about proceeding in state court, the problem of state court Securities Act litigation will continue.

The full litigation picture confronting Sundial Growers illustrates the problem that Cyan creates. Even though Sundial has managed to get the New York state court Securities Act litigation dismissed, the parallel federal court Securities Act litigation remains pending; Sundial will, at its own considerable expense, have to keep litigating the federal court action. Even if Sundial eventually succeeds in getting the federal court litigation dismissed, it will have incurred double costs in defending itself.

Even if state court judges establish themselves as reliable gatekeepers for Securities Act litigation, companies will continue to face the deeply undesirable prospect of having to defend against parallel litigation in multiple forums. The need for Congress to act to correct this absurd situation is self-evident.