Southern District of New York Dismisses Securities Act Claims Where Alleged Misstatement Affected Less Than 5% of Total Revenue
On July 6, 2016, Judge William H. Pauley III of the United States District Court for the Southern District of New York dismissed with prejudice a federal securities class action filed against Controladora Vuela Compañía de Aviación, S.A.B. de C.V. (“Volaris”), a low-cost airline, and certain other participants in its September 2013 initial public offering (“IPO”). See Dekalb Cnty. Emps.’ Ret. Sys. v. Controladora Vuela Compania de Aviacion, S.A.B. de C.V., No. 15 Civ. 1337 (S.D.N.Y. July 6, 2016). In dismissing plaintiffs’ claims under Sections 11 and 15 of the Securities Act of 1933 (the “Securities Act”), the Court found that the alleged misstatements were not material because they affected less than 5% of Volaris’s overall revenue and also because the drop in stock price could not be attributed solely to the alleged misstatement but rather a “host of negative market-moving facts.” Judge Pauley’s decision serves as a reminder that the materiality standard remains a “meaningful pleading obstacle” in Securities Act claims.
The alleged misrepresentations in the offering documents related to statements that Volaris’s non-ticket revenues were “collected from passengers and recognized as non-ticket revenue when the service has been provided, which is typically the flight date” in compliance with International Financial Reporting Standards. Contrary to these statements, approximately five months after the IPO, Volaris acknowledged that at least some of the non-ticket revenues were being recognized prior to the date of the service, and announced that it was making a one-time deferral of $3.6 million in its fourth-quarter 2013 revenue into 2014, due in part to the timing of non-ticket revenue recognition. Plaintiffs, purported purchasers of American Depository Shares (“ADS”) in Volaris’s IPO, claimed that the offering documents thus contained material misstatements in violation of Section 11.
The Court found that the alleged misstatements in the offering documents did not meet the materiality requirement for Section 11 claims. In reaching that conclusion, the Court relied on both quantitative and qualitative factors as identified in recent Second Circuit decisions. First, it found that the alleged misstatements were not quantitatively material because the deferral amount of $3.6 million was merely 1.46% of Volaris’s fourth-quarter revenue and 0.36% of its annual revenue. The Court looked to guidance from the Securities Exchange Commission (“SEC”) for assessing quantitative materiality based on “[t]he use of a percentage as a numerical threshold such as 5%,” and assessed the effect of the alleged misstatement as against the total value of a defendant’s relevant assets. Second, the Court ruled that plaintiffs failed to demonstrate that the alleged misstatements were qualitatively material because slight deviations from accounting standards by themselves are not enough. The Court rejected plaintiffs’ responding argument that the drop in stock price suggested that the statement was material because Volaris had also disclosed “a host of [other] negative, market-moving facts” that contributed to the drop.
Finally, because the complaint failed to allege a primary violation of Section 11, Judge Pauley also dismissed plaintiffs’ Section 15 claims. Judge Pauley therefore dismissed the action in its entirety and with prejudice, citing plaintiffs’ failure to either seek leave to amend or to identify any additional information that could suggest a finding of materiality.