New York Supreme Court Dismisses Securities Act Of 1933 Claims, Holding That Plaintiffs’ Allegations Of Misleading Statements Are Inactionable Forward-Looking Statements Or Opinions Under Omnicare
On July 11, 2019, Justice Andrew Borrok of the New York State Supreme Court, County of New York, Commercial Division, dismissed a putative securities class action against a Brazilian based online retailer (the “Company”), certain of its executives and directors, and its underwriters in connection with the Company’s initial public offering (“IPO”). In re Netshoes Sec. Litig., Index No. 157435/2018 (Sup. Ct., N.Y. Cty., July 11, 2019). Plaintiffs—purchasers of the Company’s stock—brought claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the “Securities Act”), claiming that defendants made materially false and misleading statements in a registration statement filed with the SEC in connection with the IPO. The Court dismissed the Securities Act claims without prejudice, finding that the allegations were inactionable opinions under the Supreme Court’s decision in Omnicare, Inc. v. Laborers Dist. Council Const. Indus., 135 S. Ct. 1318 (2015), or were inactionable because they were about past performance, were forward-looking, or were expressions of puffery.
At the outset, the Court noted that based on the Supreme Court’s 2018 decision in Cyan, Inc. v Beaver Cty. Emps. Ret. Fund, 138 S. Ct. 1061 (2018), Securities Act claims can continue to be brought in either state or federal court, and removal is disallowed once such action is filed in state court. The Court then turned to the substance of plaintiffs’ allegation that defendants made misleading statements in the Company’s IPO offering documents regarding the Company’s “competitive position, ‘high margin’ business strategy, and the new business-to-business (B2B) supplements and vitamins distribution business.” According to plaintiffs, defendants “knew or should have known” that the Company's income identified in the Company’s financial statements was overstated because of the “substantial write-downs taken subsequently for its accounts receivables.” Plaintiffs alleged that these write-downs demonstrated “that there must have been a return policy which was not disclosed to investors, and, accordingly, the financial statements were not prepared in accordance” with the International Financial Reporting Standards (IFRS)—an international analogue to GAAP.
Defendants moved to dismiss the amended complaint, requesting that the Court apply the heightened pleading standards under CPLR 3016(b), the state court analogue to Rule 9(b) of the Federal Rules of Civil Procedure. The Court, however, found that the heightened pleading standards did not apply because the amended complaint did not “explicitly allege fraud,” but instead only alleged claims based on negligence and strict liability.
Turning to the merits of the claims under Sections 11 and 12(a)(2) of the Securities Act, the Court considered plaintiffs’ allegations that defendants misrepresented the Company’s competitiveness in the market, the strength of its customer base and customer loyalty, its high-margin business model, its past performance, and its financial reporting. The Court first found that certain statements the Company made about its lack of competition were statements of opinion—citing the Supreme Court’s holding in Omnicare that “[a] sincere statement of pure opinion is not an ‘untrue statement of material fact.’” In so finding, the Court emphasized that the Company used language that indicated it was an opinion (i.e., “we believe we have become a clear contender for the market leader in Brazil”) (emphasis added), and that, in any event, the Company included a prominent disclosure in the risk factors section of its prospectus concerning the competitive nature of the online retail industry.
The Court next considered plaintiffs’ allegations that the Company “hid from investors [its] poor performance” in certain ventures and made statements that violated accounting standards. The Court found such statements inactionable, noting that the Company did not restate its “financial documents” but rather only “increase[d] its allowance for ‘doubtful accounts’ relating to the [venture],” which did not amount to a violation under IFRS. According to the Court, plaintiffs needed to specifically allege facts showing the Company “did not subjectively believe its accounting judgments at the time that these judgments were made”—which plaintiffs failed to do in the amended complaint. The Court was similarly unpersuaded by plaintiffs’ general allegation that the Company “must have had a [secret] returns policy” given the extensive write-downs and that failing to disclose the “supposed secret returns policy” rendered the financial statements materially false and misleading. According to the Court, this argument was thinly supported and, accordingly, “[t]hese house of cards suppositions without any supporting facts are simply insufficient . . . to give rise to a cause of action under the 1933 Act.”
The Court next considered plaintiffs’ allegation that the Company’s “statements of future growth” were material misrepresentations under the Securities Act. The Court found that such statements, including that there was “significant room to further grow the customer base,” were inactionable because they amounted to forward-looking statements that were protected by PSLRA’s safe harbor provision. Likewise, the Court held that numerous alleged misstatements—including that the Company would “continue to be well-positioned,” had a “leading” position in the expanding sports eCommerce market, and “has become a clear contender for the market leader in Brazil”—were inactionable statements or puffery or corporate optimism. The Court also found that plaintiffs failed to allege any actionable omissions by defendants, noting that the alleged information was already publicly available at the time of the IPO and defendants therefore had no duty to disclose it. Lastly, the Court found that the Company did not violate Item 303 of SEC Regulation S-K because it had no disclosure obligation of any known trend or uncertainties that have had or were expected to have a material impact on the Company’s financial operations. Specifically, the Court held that the Company’s offering documents substantially disclosed the Company’s actual financial metrics.
Finding that plaintiffs failed to sufficiently allege any actionable misstatements, the Court dismissed plaintiffs’ Section 11 and 12(a)(2) claims without prejudice. Having found that plaintiffs failed to “demonstrate primary liability” under either Section 11 or 12(a)(2), the Court dismissed plaintiffs’ Section 15 claims against the individual officers and directors as a matter of law, also without prejudice.
After the Supreme Court’s decision in Cyan permitting Securities Act class actions in state court, the growth and trajectory of the body of precedent in New York Supreme Court will be important, an example of which is this decision.