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Post Cyan, New York State Court Dismisses Action Under the Securities Act of 1933

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  • Posted on: Jul 24 2019

Following the stock market crash in 1929, Congress enacted the Securities Act of 1933 (the “1933 Act”) and the Securities and Exchange Act of 1934 (the “1934 Act”). Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund, 138 S. Ct. 1061, 1066 (2018).

The 1933 Act has two primary objectives: (1) to provide transparency in financial statements so investors can make informed decisions about securities being offered for public sale; and (2) to address misstatements and omissions in the securities markets.

To accomplish these goals, Congress required the disclosure of material information through the registration process. Thus, under the 1933 Act, companies that issue securities must file with the SEC a statement (known as a registration statement) that contains the following information: a description of the company’s business, the securities offered to the public, the company’s corporate management structure, and recent audited financial statements.

In addition to the registration statement, registrants are required to file a prospectus. A prospectus is used to market securities to potential investors. The prospectus is included as part of the registration statement.

Registration statements are subject to SEC examination for compliance with disclosure requirements. A registrant cannot make false statements in, or omit material facts from, a registration statement or prospectus. In fact, when a fact is disclosed, the registrant must disclose all information required to make that fact not misleading.

Section 11 of the 1933 Act provides securities purchasers a private right of action if any part of a registration statement, when it became effective, “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statement therein not misleading.” 15 U.S.C. § 77k(a). A plaintiff bringing an action under Section 11 must establish one of the following bases of liability: “(1) a material misrepresentation; (2) a material omission in contravention of an affirmative legal disclosure obligation; or (3) a material omission of information that is necessary to prevent existing disclosures from being misleading.” Hutchison v. Deutsche Bank Sec. Inc., 647 F.3d 479, 484 (2d Cir. 2011). Section 11 “‘imposes strict liability on issuers and signatories, and negligence liability on underwriters,’ for material misstatements or omissions in a registration statement.” Fed. Hous. Fin. Agency for Fed. Nat’l Mortg. Ass’n v. Nomura Holding Am., Inc., 873 F.3d 85, 99 (2d Cir. 2017) (quoting NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 156 (2d Cir. 2012)).

To be actionable under Section 11, any misrepresentation or omission must be material. Materiality is an “inherently fact-specific finding.” Basic Inc. v. Levinson, 485 U.S. 224, 236 (1988). A plaintiff demonstrates materiality when there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000) (quoting Basic, 485 U.S. at 231-32).

Unlike a securities fraud, plaintiff proceeding under Section 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), a Section 11 plaintiff need not demonstrate “scienter, reliance, or loss causation.” In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir. 2010). Nevertheless, a defendant in a Section 11 action will not be liable if it can prove “negative loss causation” – that is, if it can demonstrate that the alleged misstatement or omission did not lead to a decline in the company’s stock price. See 15 U.S.C. § 77k(e) (“[I]f the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from [the alleged misstatement or omission], such portion of or all such damages shall not be recoverable.”). To sustain this defense, a defendant must establish that “the risk that caused the losses was not within the zone of risk concealed by the misrepresentations and omissions,” or that “the subject of the misstatements and omissions was not the cause of the actual loss suffered.” Fed. Hous. Fin. Agency, 873 F.3d at 154 (alterations and internal quotation marks omitted). Because Section 11 “allocate[s] the risk of uncertainty to the defendants,” courts have described rebutting loss causation as a “heavy burden.” Akerman v. Oryx Commc’ns, Inc., 810 F.2d 336, 341 (2d Cir. 1987).

“Section 12(a)(2) provides similar redress where the securities at issue were sold using prospectuses or oral communications that contain material misstatements or omissions.” Morgan Stanley, 592 F.3d at 359 (citing 15 U.S.C. § 77l(a)(2).) Claims under Section 12(a)(2) may be brought against a “statutory seller,” which includes those who successfully solicited the purchase of the security in service of their own financial interests. Id. “[T]he elements of a prima facie claim under section 12(a)(2) are: (1) the defendant is a ‘statutory seller’; (2) the sale was effectuated ‘by means of a prospectus or oral communication’; and (3) the prospectus or oral communication ‘include[d] an untrue statement of a material fact or omit[ted] to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading.’” Id. (quoting 15 U.S.C. § 77l(a)(2)).

Courts have characterized Sections 11(a) and 12(a)(2) as “Securities Act siblings with roughly parallel elements….” Id. Section 11 imposes “‘virtually absolute’ liability” as to issuers, while other defendants under Sections 11 and 12(a)(2) “may be held liable for mere negligence.” Id.

On July 11, 2019, Justice Andrew Borrok of the Supreme Court, County of New York, Commercial Division, dismissed a putative securities class action against a Brazilian sports and lifestyle online retailer in Latin America (the “Company” or “Netshoes”), certain of its executives and directors, and its underwriters in connection with the Company’s initial public offering (“IPO”).  In In re Netshoes Sec. Litig., 2019 N.Y. Slip Op. 29219 (Sup. Ct., N.Y. County July 16, 2019) (here), plaintiffs brought claims under Sections 11, 12(a)(2), and 15 of the 1933 Act, alleging that, in connection with the IPO, defendants made materially false and misleading statements in the registration statement and prospectus they filed with the SEC.  The Court dismissed the claims without prejudice, holding that the challenged statements were inactionable opinions, protected under the bespeaks caution doctrine, and inactionable expressions of corporate optimism and/or puffery.

Matter of Netshoes Securities Litigation


Netshoes was brought in the Supreme Court, Commercial Division after the U.S. Supreme Court decided Cyan. In Cyan, the U.S. Supreme Court unanimously held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) does not strip state courts of subject-matter jurisdiction over class actions involving claims exclusively brought under the 1933 Act, and does not allow for the removal of those cases to federal court. [This Blog wrote about the decision here.]

Plaintiffs alleged that the Company’s registration statement and prospectus (collectively, the “Offering Documents”) issued in connection with its IPO, contained materially false and misleading information about the Company’s business. In particular, plaintiffs alleged that defendants overstated the Company’s competitive market position, misrepresented the performance of the Company’s business-to-business supplements and vitamins distribution business (“B2B Business”), misrepresented its future growth prospects, and inaccurately reported information in the Company’s financial statements.

Plaintiffs alleged that although the Offering Documents touted Netshoes’ competitive position, “high margin” business strategy, and B2B Business, the Company’s core sports and lifestyle eCommerce business was under intense pressure to significantly increase its marketing spend and provide further and deeper discounts to customers, so as to preserve its market share at the expense of its supposedly “high margin” business model. In addition, plaintiffs alleged, the B2B Business was receiving substantial returns of product sales that had been improperly recognized as revenue in earlier periods. Indeed, maintained plaintiffs, information made public since the IPO indicated that Netshoes’ financial statements for the year ended December 2016 (the “2016 Financial Statements”), which were included in the Offering Documents, misstated revenues, assets, and losses and were not prepared in accordance with International Financial Reporting Standards, contrary to the representation contained in the Offering Documents.

Plaintiffs alleged that as a result of the foregoing, Netshoes’ stock collapsed from its $18 per share IPO price on April 12, 2017, to $2.87 per share on May 15, 2018.

Defendants moved to dismiss the complaint with prejudice, pursuant to CPLR § 3211(a)(1), (a)(5), and (a)(7) – i.e., based on documentary evidence, statute of limitations, and failure to state a claim. Plaintiffs moved for alternative service as it relates to certain unserved defendants.

The Court granted defendants’ motion. In doing so, the Court addressed several principles, that prior to Cyan, were most often seen in federal court decisions. We discuss these issues below.

The Court’s Decision

Statements of Opinion

Plaintiffs alleged that unbeknown to investors, Netshoes faced competition from MercadoLibre, an eCommerce retailer active across all of Latin America, and from Amazon, which was active in Mexico, at the time of the IPO. Notwithstanding, plaintiffs alleged that defendants made a number of statements in the Offering Documents that falsely conveyed the impression that the Company was a leader in the industry without any competition – e.g., “we do not believe we have a relevant direct competitor in eCommerce sports category in the region,” and “we believe we have become a clear contender for the market leader in Brazil.” The Court considered the challenged statements to be statements of opinion and, therefore, inactionable under Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S.Ct. 1318, 1326-27 (2015). Slip Op. at *4.

In Omnicare, the U.S. Supreme Court held that a statement of opinion is not actionable under the securities laws, even if the opinion is ultimately wrong, if it was sincerely believed at the time it was made. 135 S.Ct. at 1327 (“[a] sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless [of] whether an investor can ultimately prove the belief wrong”). Thus, to be actionable, a statement of opinion must be (1) false, and (2) not honestly believed when made. Waterford Twp. Police & Fire Retirement Sys. v. Regional Mgt Corp., 2016 WL 1261135, at *9 (S.D.N.Y. 2016).

In addition, the Court found that certain risk disclosures in the Prospectus negated any falsity because they spoke to the competitive nature of the online retail industry. Slip Op. at **4-5.

The Court also rejected plaintiffs’ argument that the Company’s financial statements were false at the time of the IPO because there were subsequent increases in allowances for “doubtful accounts” related to the B2B Business, finding that the adjustments involved subjective determinations that were honestly held at the time of the IPO. As explained by the Court: “‘[v]aluations and write-downs are subjective statements of opinion’ that are ‘actionable only if they are (1) subjectively disbelieved, i.e., not “honestly held”; or (2) omit[] material facts about the issuer’s inquiry into or knowledge concerning [the] statement if those facts conflict with what a reasonable investor would take from the statement itself.’” Slip Op. at *5, quoting In re Barclays Bank PLC Sec. Litig., 2017 WL 4082305, *8 (S.D.N.Y. Sept. 13, 2017), aff’d, 2018 WL 6040846 (2d Cir 2018) (dismissing securities claims based on allegations defendant misvalued certain assets in its financial statements).

The Bespeaks Caution Doctrine

The Court found that alleged misstatements about the role of the B2B Business on the Company’s long-term growth, the projected growth of the Company’s customer base, the growth of the market, and the overall growth prospects of the Company were protected forward-looking statements under the bespeaks caution doctrine because they were accompanied by meaningful cautionary language that warned investors actual results could differ from the challenged statements.

Under the bespeaks caution doctrine, “‘alleged misrepresentations in a stock offering are immaterial as a matter of law [where] it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same offering.’” Id., quoting Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir. 2002). See also Rombach v. Chang, 355 F.3d 164, 174 (2d Cir 2004). When such cautionary language is included, courts analyze “the allegedly fraudulent materials in their entirety to determine whether a reasonable investor would have been misled.” Id. at *7, quoting Halperin, 295 F.3d at 173.

Notwithstanding, cautionary language about future risk does not insulate a defendant from liability under the doctrine when the defendant fails to disclose that the risk has already transpired. Halperin, 295 F.3d at 173.  As one court explained, the bespeaks caution “provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away.” In re Prudential Sec. Inc. Partnerships Litig., 930 F. Supp. 2d 68, 72 (S.D.N.Y. 1996).

Corporate Optimism and Puffery

The Court held that plaintiffs’ allegations concerning the Company’s position in an expanding market, the Company’s leadership in the Brazilian sports eCommerce market, the recognition of Netshoes’ Zattini website by its customers, and the Company’s customer loyalty and their “high” repeat purchasing were inactionable expressions of puffery and optimism. Slip Op. at *8, citing In re Duane Reade Inc. Sec. Litig., 2003 WL 22801416, at *5 (S.D.N.Y. 2003).

Item 303

Under Item 303 of SEC Regulation S-K, 17 C.F.R. § 229.303 (“Item 303”), the registrant is required to “[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 C.F.R. § 229.303(a)(3)(ii). Disclosure under Item 303 is required where a trend or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant’s financial conditions or results of operations. Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 716 (2d Cir. 2011).

To be a required disclosure under Item 303, the information must be material, i.e., “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” Litwin, 634 F.3d at 717 (internal quotation and citation omitted). Courts have “consistently rejected a formulaic approach to assessing the materiality of an alleged misrepresentation.” Id. Although bright-line numerical tests for materiality are inappropriate and have been rejected, courts do not entirely exclude analysis based on quantative considerations. Id.; Ganino, 228 F.3d 154 (2d Cir. 2000). As the court in Litwin explained, a court must consider “both ‘quantitative’ and ‘qualitative’ factors in assessing an item’s materiality,” SAB No. 99, 64 Fed Reg at 45,151, and that consideration should be undertaken in an integrative manner. Id.; Ganino, 228 F3d at 163.

Based upon the foregoing, the Court found that defendants did not violate Item 303.

Here, the B2B business constituted 4.3% of Netshoes’ net sales. Just as importantly, the Offering Documents disclosed Netshoes’ actual financial metrics for years 2014 through 2016, including that, from 2015 to 2016, its gross margins had decreased and its annual net sales growth had halved; its customer “credit risk” from overdue B2B accounts receivable had nearly quadrupled; and that its allowance for doubtful accounts had more than tripled. Thus, under either a quantative or a qualitative analysis, Netshoes did not violate Item 303.

Slip Op. at *9.

Having determined that plaintiffs failed to allege any actionable misstatements of fact, the Court dismissed plaintiffs’ Section 11 and 12(a)(2) claims, though it did so without prejudice. And, because the Court dismissed plaintiffs’ claims under Section 11 and 12(a)(2) of the 1933 Act (i.e., the primary violations of the 1933 Act), the Court dismissed plaintiffs’ secondary liability claims under Section 15 of the 1933 Act against the individual officers and directors, also without prejudice.

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