A recent guest post on this site opined 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 New York appellate court ruling reversing a trial court’s dismissal motion denial in a state court Section 11 action could be significant. According to a December 4, 2020 Law360 article (here), the ruling represents the first time the New York appellate division has addressed the merits of a federal ’33 Act claim since the U.S. Supreme Court’s decision in Cyan. The New York appellate court’s December 3, 2020 ruling can be found here.
Background Regarding Cyan
In March 2018, the U.S. Supreme Court unanimously held in Cyan that state courts retain concurrent jurisdiction for liability actions under the Securities Act of 1933. As a result, defendants face the prospect of parallel litigation in both federal and state court, with no means of consolidating the proceedings. For their part, plaintiffs’ lawyers are drawn to file ’33 Act class action lawsuits in state court because of a perception that, given the difference in pleading standards between state court and federal courts, state court lawsuits are less likely to be dismissed. Indeed, recent academic research does corroborate the view that state court lawsuits are likelier to survive defendants’ motions to dismiss. Given these considerations, state courts’ willingness to dismiss state court securities class action lawsuits is an important benchmark to watch.
The recent New York appellate decision involved a Ruhnn Holdings, Ltd., a Chinese social media and e-commerce company that facilitates social media influencers’ marketing and promotional efforts and that completed a U.S. IPO in April 2019. In September 2019, a Ruhnn investor filed a securities class action lawsuit in New York state court against the company; certain of its directors and officers; and its offering underwriters. Among other things, the plaintiff shareholders alleged that the company’s IPO offering documents failed to disclose that the company had closed nearly 40% of its proprietary online stores in the three months prior to the IPO. The defendants filed a motion to dismiss.
In an April 22, 2020 order, New York (New York County) Supreme Court Judge Jennifer G. Schecter denied the defendants’ motion to dismiss, and the defendants appealed.
The Appellate Court Decision
In a terse two-page December 3, 2020 per curiam order, the New York Supreme Court Appellate Division, First Judicial Department, unanimously reversed the trial court’s dismissal motion denial, directing that the lower court enter judgment dismissing the complaint.
In reversing the lower court, the appellate court specifically noted that the offering documents had disclosed that Ruhnn was shifting to a “platform” model for its online sales and away from a self-owned, “full service” model.
Given this disclosure, the appellate court said, “the omission of data from the period immediately preceding the issuance of the final prospectus showing that there had already been a reduction in the full service segment of the company did not significantly alter the total mix of information made available to a reasonable investor.”
The appellate court added that “as the full service sector’s revenue was not closely related to either the number of stores or the number of online influencers service the segment, the focus on these metrics was ‘myopic’; disclosure would not have given a more accurate picture of the status of the business.”
Readers who follow post-Cyan legal developments know that there has been significant focus on the possibility that corporate defendants may be able to avoid having to face securities litigation in state court by adopting a charter provision designating federal court at the preferred forum for securities claims. Indeed, in that regard, there have been recent significant California state court developments affirming the enforceability of federal forum provisions (as discussed in detail here). The trend to date certainly provides encouraging signs that companies may be able to avoid the full panoply of Cyan-related problems by adopting a federal forum provision in their corporate charters.
In the meantime, the approach state courts take with respect to dismissal motions in securities class action lawsuits will remain important and will continue to be worth watching. In that respect, the appellate court’s willingness here to overturn the lower court’s dismissal motion denial is certainly encouraging.
In addition to the appellate court’s decision here, there have been several other recent state court dismissal motion rulings that suggest that at least some state courts can and will take a disciplined and thorough approach to dismissal motions. A separate New York trial court (as discussed here), as well as state courts in Connecticut (here), and Texas (here), among others, have granted dismissal motions in state court securities class action lawsuits. While these decisions alone are not sufficient to remedy the situation, they do suggest that at least some of the state courts that find themselves presiding over federal securities class action litigation will afford defendants appropriate opportunities to test the plaintiffs’ pleadings. All of these developments could be particularly important in New York, where, as I noted at the outset, a significant portion of the state court securities lawsuits are being filed.
The appellate court’s brief two-page opinion does not incorporate elaborate legal citation, but interestingly, among the cases the court did cite is the Second Circuit’s 2017 opinion in the Vivint Solar case, which addressed the question of the standard to be used to determine when an IPO company must disclose interim financial information in its registration statement in order to ensure that its disclosures are not otherwise misleading. As I discussed in a blog post at the time, the Second Circuit split from a prior decision by the First Circuit requiring the interim financial information to be disclosed if the information represented an “extreme departure” from the company performance reflected in an IPO company’s registration statement. The Second Circuit rejected the “extreme departure” standard, saying the proper inquiry is instead whether from the perspective of a reasonable investor the omitted information would have significantly altered the total mix of information available. In referring to and relying on the Vivint Solar decision, the NY appellate court come down squarely on the side of the Second Circuit in connection with the circuit split on the question of the standard to be used to determine whether IPO companies must disclose interim financial information.
One final note. It is important to keep in mind that the recent ruling in the Ruhnn case involves a ruling by an intermediate appellate court. Plaintiffs may well seek to appeal the ruling to the New York Court of Appeals, which does suggest that a note of caution is advised before attaching too much significance to the intermediate appellate court’s decision.