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Eastern District Of New York Sustains Securities Act Claims And Dismisses Exchange Act Claims In A Putative Class Action Against An International Portfolio Management Company
10/11/2023On September 25, 2023, Judge Pamela K. Chen of the United States District Court for the Eastern District of New York granted in part and denied in part a motion to dismiss a putative securities class action alleging that an IT portfolio management services company, its CEO, and its CFO violated Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. Handal v. Tenet Fintech Grp. Inc., No. 1:21-cv-06461 (PKC) (RER) (E.D.N.Y. Sept. 25, 2023). Plaintiffs alleged that defendants made material misstatements regarding several business transactions in the Company’s registration statement and the CEO’s subsequent public statements. The Court denied the motion with respect to the Securities Act claims but granted it with respect to the Exchange Act claim because plaintiffs failed to adequately allege reliance.
The Company, which is based in Canada and operates primarily in China, is engaged in IT portfolio management services. The Company’s stocks were traded on the Canadian Stock Exchange beginning in October 2015 and on over-the-counter (“OTC”) markets between October 2015 and September 8, 2021. On September 3, 2021, the Company filed its Registration Statement using Form 40-F with the Securities and Exchange Commission, seeking to list its securities on the Nasdaq Stock Market. The Company’s securities began trading on the Nasdaq on September 9, 2021, upon the Company and Nasdaq’s joint request to accelerate the effective date of registration, prior to the SEC issuing a notice of effectiveness of the Registration Statement. On September 21, 2021, the Company issued a statement that the SEC was still reviewing the Company’s Registration Statement, and Nasdaq halted the trading of the Company’s stock until the SEC completed its review and issued a notice of effectiveness of the Company’s Form 40-F. Plaintiffs purchased Company stock during the eleven-day window that the stock was trading on the Nasdaq. On September 28, 2021, Nasdaq delisted the Company stock. The Company stock currently trades on the OTC markets in the United States.
On October 4, 2021, a short seller report asserted that the Company had engaged in “questionable” business practices and identified three corporate transactions disclosed in the Registration Statement as false: (i) an acquisition in process for a 70% equity stake in a Chinese financial lending application company; (ii) a planned acquisition of a 51% stake in one of the Company’s key subsidiaries; and (iii) its acquisition of the assets of a Beijing software company. The Report claimed that, based on a search of publicly available records, there were no connections between each of these entities and the Company. On October 5, 2021, the Company’s CEO responded to the Report’s assertions explaining the details of the transactions and affirming the acquisitions. On October 13, 2021, the short seller published a rebuttal report (together with the initial short seller report, the “Reports”) reiterating the assertions in its initial report.
With respect to the Section 11 claims, the Court held that plaintiffs sufficiently alleged a cause of action and rejected each of defendants’ arguments. First, the Court rejected defendants’ argument that the Form 40-F, which foreign companies can use to register their stocks on U.S. exchanges, was not a registration statement under the meaning of the statute. The Court stated that Form 40-F was used to register the Company’s common stock pursuant to the Exchange Act and that to hold otherwise would allow foreign companies to skirt Section 11 liability. Second, the Court rejected defendants’ argument that Section 11 liability could not be attached because the SEC did not approve the Registration Statement and the Statement never became effective. As the Court explained, if the public was able to buy the Company stock on the Nasdaq, then Section 11’s disclosure requirements must apply to the Registration Statement pursuant to which the stock was listed: “To find otherwise would penalize purchasers of securities that were actively traded on the Nasdaq for over a week in reliance on a listing they had no reason to doubt.” Third, the Court also rejected defendants’ argument that plaintiffs could not trace their shares to the Registration Statement because the stock was also trading on the OTC markets. The Court found that trading on OTC markets stopped when the Company stock was listed on the Nasdaq, and plaintiffs purchased their shares during the period that the stock was listed. Accordingly, the Court found that plaintiffs could trace their shares back to the Registration Statement. Finally, the Court held that plaintiffs sufficiently met Rule 9(b)’s heightened standard to plead fraud with particularity. In this regard, the Court held that Rule 9(b) applied to Section 11 claims where they are premised on fraud rather than mere negligence, as was the case with plaintiffs’ complaint, which suggested “knowing and intentional deception and fraud” and contained nearly identical allegations for both the Section 11 and Section 10(b) claims. Having found a primary violation, the Court sustained plaintiffs’ Section 15 control person liability claim as to the CEO who signed the Registration Statement but dismissed it as against the CFO who did not sign the Registration Statement because the complaint only contained boilerplate allegations.
With respect to the Section 10(b) claim, the Court found that plaintiffs adequately alleged material misstatements and scienter, but it dismissed the claim for failure to sufficiently allege reliance. First, the Court acknowledged that courts sometimes dismiss complaints that rely on short-seller reports that cite anonymous sources but distinguished the claims here because the Reports relied on a number of databases, press releases and other publicly available information, and also because plaintiffs’ counsel took further investigation to corroborate the assertions in the Reports. Second, the Court found that, although plaintiffs had not alleged opportunity and motive, they had sufficiently alleged conscious disregard and recklessness with respect to the CEO’s statements made after the Report. Specifically, the Court credited plaintiffs’ argument that “upon publication of the [Report], [d]efendants ‘had a duty to verify the accuracy’” of the Report and that the CEO’s subsequent response explaining the details of the acquisitions were sufficient to show scienter. The Court, however, found that plaintiffs failed to specifically allege any facts imputing scienter to the CFO. Finally, the Court found that plaintiffs did not sufficiently plead reliance on the alleged misstatements, because plaintiffs purchased shares before the actionable misrepresentations in the case, which were made by the CEO in its post-Report response on October 5, 2021. (The last date that any lead plaintiff purchased Company stock was on September 15, 2021, when the stock was still listed on Nasdaq.) Because the Court dismissed plaintiffs’ underlying Exchange Act claims, plaintiffs’ accompanying control person liability claims were dismissed.
