In a significant number of the many SPAC-related lawsuits that have been filed in recent years, SPAC investors allege that executives at the previously private target company into which the SPAC merged made pre-merger misrepresentations about the target company’s operations or prospects. In an interesting decision in a securities suit involving Lucid Motors and that has a great deal of potential significance for many of these SPAC-related suits, the Ninth Circuit has held that the SPAC investors, who were neither purchasers nor sellers of the stock of the target company, lack standing to pursue their claims against Lucid Motors for alleged pre-merger misrepresentations. The Ninth Circuit’s August 8, 2024, opinion in the Lucid Motors case can be found here.

Background

Churchill Capital Acquisition Corporation IV (Churchill IV) is a special purpose acquisition corporation (SPAC) formed in April 2020 and that completed an IPO on July 30, 2020. On February 22, 2021, Churchill IV announced that it had entered an agreement to merge with Lucid Motors, an electric automobile manufacturing company. Lucid was founded by Peter Rawlinson in 2007.

On February 4, 2021 (that is, still weeks before the merger was announced), Rawlinson, the Lucid CEO, told Forbes that the company wants to build 6,000 vehicles in 2021, potentially generating revenues of $900 million. That day, Churchill IV’s shares closed at $30.22.

According to the subsequently filed securities lawsuit complaint, Rawlinson appeared in interviews on CNBC on February 5, 2021, and on Fox Business News on February 16, 2021, in which he talked about the company’s 2021 production plans and plans for growth. Churchill IV’s stock price continued to climb, closing on February 18, 2021, at an all-time high of over $58 per share.

On February 22, 2021, the Churchill IV merger was formally announced. That same evening, Rawlinson told Bloomberg News that production of the first Lucid car would be delayed until at least the second half of 2021, and that the company was projecting 2021 production of 557 vehicles, instead of 6,000 as he had previously said. After the merger closed, the company announced further reductions in its production plans and production timetable.

A plaintiff shareholder subsequently filed a securities class action lawsuit against Lucid and Rawlinson. The complaint was filed on behalf of pre-merger purchasers of the SPAC’s stock, based on allegations that the various pre-merger statements had driven up the SPAC’s stock price due to assertions about Lucid’s future production capabilities and the expectation that the two companies were about to merge. The defendants filed motions to dismiss.

The District Court’s Motion to Dismiss Ruling

As discussed here, in a January 11, 2023, opinion (here), Northern District of California Judge Yvonne Gonzalez Rogers granted the defendants’ motion to dismiss (although denying the defendants’ motion to dismiss the complaint on the grounds that the plaintiff lacked standing).  Judge Gonzalez Rogers granted the motion on the grounds of materiality, holding that the plaintiff’s complaint “does not plead facts showing that statements” concerning Lucid “would be material to any reasonable purchaser of [the SPAC’s] stock at a time when no merger between the companies had been announced and, indeed, when it remained unconfirmed that the parties were even engaged in discussions.” The plaintiffs appealed.

The August 8, 2024, Ninth Circuit Opinion

In an August 8, 2024, Opinion written by Judge Ronald Gould for a unanimous three-judge panel, the Ninth Circuit affirmed the district court’s dismissal, doing so on the alternate ground that the plaintiffs lacked standing to sue. (The appellate court did not reach the district court’s ruling on materiality.)

In concluding that the SPAC investors lacked standing to sue over Lucid’s pre-merger statements, the appellate court began its analysis by referring to the “purchaser-seller rule” (also known as the Birnbaum Rule) which limits securities suit standing to “purchasers or sellers of the stock in question.” The appellate court noted that the Supreme Court has recognized that the Birnbaum Rule’s bright line “could be fairly criticized as an arbitrary restriction from which unreasonably prevents some deserving plaintiffs from recovering damages,” but nevertheless held that the “countervailing advantages” of the “bright-line rule” in that the bright line test would prevent “endless case-by case erosion on the limitations on standing.

Having reviewed these general principles, the appellate court then considered the decision of the only circuit to have considered these standing questions in the context of alleged misstatements made in advance of an anticipated merger — the Second Circuit, in its 2022 decision in Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd.

The Frutarom case arose out of merger between International Flavors & Fragrances, Inc. (IFF) and Frutarom. The plaintiffs were purchasers of IFF securities who alleged that prior to the merger, Frutarom made misleading statements about certain of its business practices and policies. The Second Circuit held that the plaintiff lacked standing to sue the Frutarom Defendants for statements relating to Frutarom, because the plaintiff had never purchased or sold Frutarom securities. The appellate court said that “purchasers of a securities of an acquiring company do not have standing under Section 10b) to sue the target company for alleged misstatements the target company made about itself prior to the merger between the two companies.” The Second Circuit reiterated the importance of maintaining the bright line standard that this standing requirement requires.

The district court in this case had declined to follow the Second Circuit’s Frutarom decision, but the Ninth Circuit, on appeal from the district court and following Frutarom, agreed with the Second Circuit that the Birnbaum Rule applied and limits Section 10(b) standing to purchasers and sellers of the security about which the alleged misrepresentations were made. Specifically, the Ninth Circuit said, “we endorse and apply the bright-line rule that we think is commanded by Supreme Court precedent.”

The Ninth Circuit specifically rejected the plaintiffs’ argument that it was sufficient to establish standing that the security the plaintiff purchased was sufficiently “connected” to the misstatement. The appellate court said that the plaintiffs’ interpretation “would vastly expand the boundaries of Section 10(b) standing and contradict the express limiting purpose of the Birnbaum Rule,” adding that Section 10(b) “does not provide a cause of action to the world at large.”

Finally, applying these principles to the case at hand, the appellate court said that “the securities about which Defendants allegedly made misrepresentations were those of Lucid,” yet, the court added the plaintiffs “did not purchase or sell Lucid stock” but rather purchased shares of the SPAC.

Because the plaintiffs did not purchase or sell the securities about which the alleged misrepresentations were made, the appellate court held, the plaintiffs lack standing under Section 10(b). The appellate court noted that the fact that the SPAC later acquired Lucid does not change anything; at the time the statements were made, Lucid and the SPAC were two entirely different companies, and the fact that the acquiring company was a SPAC does not alter the analysis, as “there is no recognized exception for transactions involving SPACs.”

Discussion

The Ninth Circuit in this case is not the first court to rule that SPAC investors lack standing to sue over pre-merger statements of the merger target company. As discussed here, in March 2023, a Southern District of New York judge also held, in a case involving CarLotz, a company formed by the merger of a private company with a SPAC, that the SPAC’ ‘s investors lacked standing to sue over pre-merger statements by the target private company. However, as a district court in the Second Circuit, the court in CarLotz was bound to follow the Second Circuit’s decision in the Frutarom case and apply the bright-line standing test required by the Birnbaum Rule.

Interestingly, the district court in this case, not bound by the Second Circuit’s holding, declined to follow Frutarom and specifically held that these plaintiffs have Section 10(b) standing. In the end of course, the Ninth Circuit followed the Second Circuit’s decision in Frutarom and held that under the Birnbaum Rule these plaintiffs lacked Section 10(b) standing.

Applying the bright line test required by the Birnbaum Rule has the twin virtues of clarity and of judicial efficiency. As the appellate court noted, the bright line test avoids factually intense case by case squabbles. I get that – but I am still a little troubled. If, as we must at this procedural stage, we assume that the plaintiffs’ allegations are true, then arguably the appellate court’s standing ruling arguably leaves an alleged wrong without a remedy (although see my further comments below). To be sure, this appears to be the result that the Supreme Court precedent on which the appellate court relied seems to require. However, even if the outcome is correct, that doesn’t make it right, if you know what I mean.

I suppose it should be considered that even if the appellate court had concluded that these plaintiffs had standing, that doesn’t mean that their case would have gone forward. Keep in mind that the district court, which had concluded that the plaintiff had standing, had nevertheless dismissed the plaintiffs’ case on the grounds that the alleged misrepresentations were not material. In other words, the plaintiffs may not have obtained redress for their grievances even if they had established that they had standing.

In any event, the appellate court’s ruling in this case is potentially significant in other SPAC-related securities lawsuits. As readers of this site well know, there has been a flood of SPAC-related litigation that followed in the wake of the decline of the SPAC frenzy that peaked in the years 2020 and 2021. Many of these SPAC related suits were brought by or on behalf of SPAC investors who allege that prior to the SPAC merger the private company target had made misrepresentations about the private company’s future prospects. The Ninth Circuit’s decision in this case, following on the Second Circuit’s decision in the Frutarom case, will make it difficult for these SPAC investors to pursue their claims against the former private company executives.

One final note. In their briefs in the CarLotz case that I mentioned above, the plaintiffs had tried to argue that applying the Birnbaum Rule (which the plaintiffs characterized as a “loophole”) would allow individuals who stood to profit from a proposed merger to “lie with impunity.” For reasons I noted above about the problem with a wrong that lacks a remedy, this argument has a certain appeal. However, as the Second Circuit noted in response to these same arguments in the Frutarom case, the target companies pursuing a potential merger could still be subject to SEC enforcement liability, shareholder derivative lawsuits, and possibly to state law securities claims.

In other words, there are still potential legal deterrents to discourage “lies,” even if the private securities plaintiffs lack standing under the federal securities laws to pursue liability actions for the statements. The fact that these other legal procedures might operate to deter alleged misrepresentations is, of course, cold comfort to claimants (like the plaintiffs in the Lucid Motors case) that believe they were misled and who want to recover their losses they believe stem from the misrepresentations.