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Southern District Of New York Dismisses Putative Class Action Against Cryptocurrency Mining Hardware Manufacturer For Failure To Allege Loss Causation And Materiality
07/20/2021On July 8, 2021, Judge J. Paul Oetken of the United States District Court for the Southern District of New York dismissed a putative securities class action against a Chinese manufacturer of cryptocurrency mining hardware (the “Company”) alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11 and 15 of the Securities Act of 1933. Boluka Garment Co. v. Canaan Inc., No. 20-cv-07139 (S.D.N.Y. July 8, 2021). Plaintiffs alleged that the Company failed to disclose material information regarding alleged related-party transactions in its registration statement. The Court dismissed the complaint with leave to amend because plaintiffs failed to allege loss causation and materiality.
After three unsuccessful attempts to go public in certain Asian markets, allegedly because of regulatory scrutiny, the Company launched an initial public offering in the U.S. on November 21, 2019. On February 20, 2020, a short seller published an online report (the “Report”) accusing the Company of deceptive business practices, including allegations that the Company inflated its customer base, overstated its financial prospects, and failed to disclose related-party transactions between the Company and its executives or major shareholders. With respect to the related-party transactions, the Report stated that “[t]ransactions with related parties and/or sham entities have been a hallmark of . . . fraudulent US-listed Chinese companies,” and that the Company used related-party transactions to “boost[] sales prior to [its] Chinese listing attempts.” The Company’s stock value fell by more than 6.8% the day the Report was published.
Against that backdrop, plaintiffs alleged the registration statement failed to disclose (1) that an individual who held 8.8% of the Company’s total shares also served as a senior executive in charge of the Company’s international sales and marketing; (2) that another company, controlled in part by two of the Company’s directors, had purchased approximately $150,000 worth of the Company’s products between January and April 2017; and (3) that a separate company controlled by that same executive had announced a “strategic cooperation framework agreement” to purchase or distribute the Company’s equipment worth up to $150 million. The first two transactions were not disclosed in the Report, though the third was.
The Court first dismissed the claims under Section 10(b) based on the first two alleged related-party transactions for failure to allege loss causation. Rejecting arguments based on statements in the Report about related-party transactions by Chinese issuers generally or that other statements in the Report suggested an “over-arching fraudulent scheme,” the Court held that the Report did not “disclose the information that the [complaint] describes” and that the allegations of a scheme were an unsupported “stretch.” The Court also held that the negative causation defense to the Section 11 claim was “apparent from the face of the complaint” because the Report did not disclose the specific related-party transactions alleged in the complaint.
Finally, with respect to plaintiffs’ allegation that the Company failed to disclose the $150 million cooperation framework, which was disclosed in the Report, the Court dismissed plaintiffs’ claims for failure to allege materiality. The Court noted that under Basic Inc. v. Levinson a court must determine whether a given event is material by balancing “both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.” Applying this balancing test, the Court held that the probability of the deal impacting the Company’s financials was “speculative” because the deal itself was non-binding and the Company’s public statements disclosed its non-binding nature. The Court noted that even if the Company had disclosed the transaction in its SEC filings, such disclosure might have misled investors by giving “the false impression that [the Company] expected to receive substantial revenue from [the deal] even though the agreement was provisional and nonbinding.”
