The Actionability of Corporate Puffery and Statements of Opinion

• Posted on: Feb 17 2021

“We make premium widgets with the highest quality metals.” Assume for the moment, the widgets are made from alloys that are prone to imperfections. Also assume that the speaker sincerely believed the statement to be true, notwithstanding the instances of imperfections. Is this statement an actionable fraud? In Matter of Sundial Growers, Inc. Sec. Litig., 2021 N.Y. Slip Op. 01014 (1st Dept.Feb. 16, 2021) (here), the Court considered this question and, as discussed below, held that the statements at issue (which were similar to the one above) were non-actionable expressions of corporate optimism and puffery or statements of opinion.

Expressions of corporate optimism and puffery are not actionable fraudulent statements. See Netshoes Sec. Litig. v. XXX, 64 Misc. 3d 926, 932, (Sup. Ct., N.Y. County 2019) (citing Nadoff v. Duane Reade, Inc., 107 F. Appx. 250, 252 (2d Cir. 2004)). “This is especially true where … the allegedly fraudulent statements about future performance [are] accompanied with adequate cautionary language, and not stated as guarantees.” Nadoff at 252 (internal quotation marks and citations omitted).

“Puffery encompasses statements that are too general to cause a reasonable [person] to rely upon them, and thus cannot have misled a reasonable [person]. They are statements that lack the sort of definite positive projections that might require later correction.” See In re Gen. Elec. Sec. Litig., No. 19CV1013 (DLC), 2020 WL 2306434, at *7 (S.D.N.Y. May 7, 2020) (citing In re Vivendi, S.A. Sec. Litig., 838 F.3d 223, 245 (2d Cir. 2016)). To be actionable, expressions of corporate optimism or puffery must be subject to verification.

In addition to expressions of puffery and optimism, a speaker can utter a statement of opinion. As discussed below, to be actionable, a statement of opinion must be, among other things, false and not honestly believed when made. Netshoes Sec. Litg., at 932 (citing Waterford Twp. Police & Fire Retirement Sys. v. Regional Mgt. Corp., 2016 WL 1261135, at *9 (S.D.N.Y. 2016)).

In re Sundial Growers Inc. Securities Litigation

Sundial Growers involved claims under the Securities Act of 1933 (“Securities Act”) in connection with Sundial’s August 2019 initial public offering (“IPO”). Sundial is a Canada-based producer of cannabis products that commenced cannabis production in December 2018, a few months after Canada legalized adult use of cannabis at the federal level. 

In connection with the IPO, Sundial filed with the SEC on Form 424B4 its final prospectus for the issuance of its common stock (the “Prospectus”). The Prospectus formed part of the Registration Statement (the Prospectus and Registration Statement are collectively referred to as the “Offering Documents”), which plaintiffs relied upon in purchasing Sundial’s common stock. Plaintiffs purchased Sundial’s common stock directly in the IPO, or “traceable” to the Registration Statement filed in connection with the IPO. 

In the complaint, plaintiffs alleged that the Offering Documents presented Sundial as a producer of “high-quality” and “premium” cannabis. Plaintiffs maintained that this representation was materially misleading in light of the quality problems Sundial had encountered since 2018. 

Notwithstanding these problems, plaintiffs contended that Sundial sought to distinguish itself in the market by claiming that its product was “high quality” and “premium.”

Plaintiffs alleged that defendants violated Section 11, Section 12 (a)(2) and Section 15 of the Securities Act. Defendants moved to dismiss the complaint, arguing that (1) plaintiffs failed to allege a materially false or misleading statement or omission in the Offering Documents, (2) the statements that plaintiffs identified as misleading could not serve as the basis for a Securities Act claim, and (3) the statements that plaintiffs identified were offset by adequate warnings and risk disclosures. The motion court granted the motion (here).

[Ed. Note: Section 11 of the Securities Act provides recourse to any person acquiring a security if “any part of the registration statement, when such part 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 statements therein not misleading.” 15 U.S.C. § 77k. “The truth of a statement made in the registration statement is judged by the facts as they existed when the registration statement became effective.” In re Initial Pub. Offering Sec. Litig., 358 F. Supp. 2d 189, 205 (S.D.N.Y. 2004). Section 12(a)(2) imposes liability under similar circumstances against “a person who offers or sells a security . . . by means of a prospectus or oral communication.” 15 U.S.C. § 77l(a)(2).]

As an initial matter, the motion court found that plaintiffs satisfied the particularity requirement of CPLR § 3016(b). Under CPLR § 3016(b), a plaintiff must provide sufficient facts to support a “reasonable inference” that the allegations of fraud are true. Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559-60 (2009). 

Turning to the claims under Section 11 and Section 12 (a)(2) of the Securities Act, the motion court held that plaintiffs failed to state a claim upon which relief could be granted.

In the complaint, plaintiffs alleged that several statements in the Offering Documents in which defendants highlighted the company’s brand and product (i.e., cannabis) as premium and high quality were false and misleading. Plaintiffs claimed that Sundial “was producing hundreds of kilograms of adulterated cannabis products that were of low quality, including significant batches that were not fit for human consumption or that failed to meet the Company’s contractual commitments to its most important customers” and “maintained materially deficient manufacturing and quality control processes which had led to the production and distribution of these adulterated cannabis products.” Plaintiffs also claimed that “Sundial’s grow rooms were suffering from chronic contamination including crop diseases, bugs, systematic mold infections and other quality control problems.” Plaintiffs further alleged that “an important customer of Sundial, Zenabis, had rejected 554 kilograms (more than a half-ton) of Sundial cannabis due to its materially deficient quality.” Plaintiffs maintained that “[t]he product had been adulterated with mold, bits of rubber gloves, and other non-cannabis materials, such as jewelry.” 

The motion court held that the statements identified by plaintiff were not actionable as a matter of law. The Court found that each of the statements identified by plaintiffs were either (1) corporate puffery, too vague to be actionable, (2) a sincere statement of corporate optimism, or (3) sufficiently offset by adequate risk disclosures.

In particular, the motion court held that the terms “high quality” and “premium” were “clear examples” of puffery because they were general and not subject to verification. At most, said the motion court, “high quality” and “premium” were statements of opinion, which were also not actionable.

The motion court rejected plaintiffs’ argument that the statements could not be considered puffery or opinions because they “misrepresented current facts.” The reason, said the motion court, in many instances, the sentences in which the statements were made began with “we believe”, “we intend”, “will result” and other opinion-based, or forward-looking language. Statements concerning a company’s business potential, held the motion court, were inactionable as a matter of law. 

The motion court also held that Offering Documents contained a “robust” 35-page risk disclosure section, which addressed “[t]he crux of plaintiff’s allegations about quality issues in Sundial’s product since 2018.” Additionally, noted the motion court, the Offering Documents were replete with warnings that investing in Sundial common stock “involve[d] a high degree of risk.” 

“Based on the context of the alleged misrepresentations, their general nature, and their placement amongst robust risk disclosures,” the motion court concluded that “the Prospectus itself, utterly refuted plaintiffs’ first and second causes of action for violations of Section 11 and Section 12(a)(2) of the Securities Act.”

On appeal, the Appellate Division, First Department unanimously affirmed.

First, the Court agreed with the motion court that the statements at issue were either non-actionable puffery or statements of opinion:

The statements in the offering materials that defendant Sundial Growers, Inc. produced “high quality” and “premium” cannabis were non-actionable puffery.

To the extent the statements were more than puffery, they were non-actionable opinion.

Slip Op. at *1 (citations omitted).

Second, the Court found that the risk disclosures “in the offering materials expressly and repeatedly warned of the risk to the company’s quality control, including fire, insects, and contamination, and noted that there had been such an incident in the past.” Id. (citations omitted). “In light of this,” concluded the Court, “the disclosures were not misleading for not identifying a single incident of returned product, that constituted 10% of the company’s sales for a single quarter.” Id.

Takeaway

To plead fraud, a plaintiff must allege facts showing the defendant made an untrue statement of material fact, or failed to disclose a material fact necessary to make the statements that were made not misleading. See, e.g., 17 C.F.R. § 240.10b-5 (securities fraud). A statement or omission is material only if a reasonable person would consider it important in determining whether to act on the statement or omission. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). 

In applying the materiality element of a fraud claim, courts have identified several categories of statements that are not considered materially misleading. Two such categories are relevant to the statements and omissions at issue in Sundial Growers: statements considered immaterial because they are only vague statements of corporate optimism or statements of opinion, and statements considered immaterial because documents available to the plaintiff contained risk disclosures about the subject matter of the alleged misstatement or omission at issue.

Statements classified as corporate optimism or mere puffery are typically forward-looking statements, or are generalized statements of optimism that are not capable of objective verification. Vague, optimistic statements are not actionable because a reasonable person would not rely on them in making decisions about the subject matter at issue. The reason: speakers, such as the corporate actors in Sundial Growers, must be allowed to express hope and optimism so long as such statements are not known to be untrue at the time the statement is made. Novak v. Kasaks, 216 F.3d 300, 315 (2d Cir. 2000). As the Second Circuit explained: “People in charge of an enterprise are not required to take a gloomy, fearful or defeatist view of the future; subject to what current data indicates, they can be expected to be confident about their stewardship and the prospects of the business that they manage.” Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1129-30 (2d Cir.1994).

Statements containing the words “we believe”, “we think”, “we expect” or “we anticipate” are classified as opinion. Statements of opinion, as in Sundial Growers, are generally not actionable because they are inherently subjective and involve an opinion about the subject matter at issue. Fait v. Regions Fin. Corp., 655 F.3d 105, 110 (2d Cir. 2011). 

When considering the falsity of an opinion, courts have developed the following standards. 

First, when a plaintiff relies on a theory of material misrepresentation, the plaintiff must allege both that “the speaker did not hold the belief she professed” and that the belief is objectively untrue. Omnicare, Inc. v. Laborers Dist. Council Construction Indus. Pension Fund, 135 S.Ct. 1318, 1327 (2015). 

Second, when a plaintiff relies on a theory that a statement of fact contained within an opinion statement is materially misleading, the plaintiff must allege that “the supporting fact [the speaker] supplied [is] untrue.” Id. In this regard, a statement structured, “I believe that x is so because y has occurred,” contains the factual and falsifiable statement, “y has occurred.” If y has not occurred, then the statement of opinion is actionable because an embedded but complete “statement of a material fact” can be proven false. Abramson v. Newlink Genetics Corp., 965 F. 3d 165, 175 (2d Cir. 2020). 

Third, when a plaintiff relies on a theory of omission, the plaintiff must allege “facts going to the basis for the issuer’s opinion … whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.” Id. at 1332. The Supreme Court used the statement, “We believe our conduct is lawful,” as an example. In Omnicare, the Court explained that this statement implies, if the recipient was not informed otherwise, that the speaker had so concluded after investigating the governing law. If the speaker had not investigated the governing law, and had omitted the context, the statement of opinion, although literally true (assuming the speaker believed it) and thus not actionable under the first standard, may be misleading by omission and thus actionable. Omnicare, 135 S.Ct. at 1328-1332.

In Sundial Growers, the motion court and First Department applied the first standard: the opinion statement was not honestly believed when made. 

Finally, both the motion court and the First Department in Sundial Growers found that defendants’ statements were surrounded by “robust” risk disclosures in the Offering Documents in which they identified the risks of the cannabis business that could adversely impact their production, including the return of their products. These disclosures also included a discussion of the quality problems that had already occurred at the time of the IPO. As such, the Sundial Growers’ courts found that the risk disclosures did not “affirmatively create an impression of a state of affairs that differ[ed] in a material way from the one that actually exist[ed]. City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Align Tech., Inc., 65 F. Supp. 3d 840, 855 (N.D. Cal. 2014), aff’d, 856 F.3d 605 (9th Cir. 2017).