Many of us have previously heard the expression that there is a fine line between fact and fiction. In securities law that holds especially true where companies that risk walking the “fine line” in their registration statements and prospectuses could find themselves liable to their stockholders.
In a recent decision, Justice Barry R. Ostrager granted defendants’ motion to dismiss a class action complaint in the Matter of Sundial Growers Inc. Securities Litigation, which was brought by stockholders against Sundial Growers Inc. (“Sundial”), a Canada-based producer of cannabis products, its individual officers and directors, and underwriters.
The class action complaint alleged violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 (“Securities Act”), among other violations, related to misrepresentations made in Sundial’s Prospectus and Registration Statement regarding the “high-quality” of its cannabis in light of the fact that Sundial had previously experienced quality problems which resulted in production of contaminated cannabis that had been rejected by one of its major customers due to its materially deficient quality.
Under Section 11 of the Securities Act, a plaintiff who acquires security may bring suit to hold insurers, directors, or underwriters liable based on allegations that a registration statement “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. Code § 77k). Similarly, under Section 12(a)(2) of the Securities Act, a plaintiff may also bring suit against “a person who offers or sells a security…by means of a prospectus or oral communications” under similar conditions (15 U.S. Code § 771[a]).
However, as the Court explained, not all statements are actionable. Both the First Department and Second Circuit have previously held that expressions of mere puffery or corporate optimism are not actionable under the securities laws (see Northern Group Inc. v Merrill Lynch, Pierce, Fenner & Smith Inc., 135 AD3d 414 [1st Dept 2016]; see Nadoff v Duane Reade, Inc., 107 Fed Appx 250, 252 [2d Cir 2004]).
“Puffery” includes statements that are “too general to cause a reasonable investor to rely upon them, and thus cannot have misled a reasonable investor” or “lack the sort of definite positive projections that might require later correction” (In re Vivendi, S.A. Sec. Litig., 838 F3d 223 [2d Cir 2016]).
The Court further noted that opinions are not actionable. For a statement of opinion to be actionable under securities law it must be false and not honestly believed when made (Waterford Township Police & Fire Retirement Sys. v Regional Mgt. Corp., 2016 WL 1261135 [S.D.NY 2016]). As Justice Ostrager explained in one of his earlier decisions (Hoffman v AT & T Inc.), when analyzing the truthfulness of a statement made in a registration statement under Section 11, courts look at the facts represented as they existed when the registration statement became effective (In re Initial Pub. Offering Sec. Litig., 358 F Supp 2d 189 [S.D.NY 2004]). Section 12(a)(2), however, does not specify a time to which materiality is related, thus, courts have held that time of purchase of the securities is the crucial moment for determining materiality of misrepresentations or omissions in a prospectus (In re Alliance Pharm. Corp. Sec. Litig., 279 F Supp 2d 171 [S.D.NY 2003])
In this case, the Court did not engage in the analysis of relating the alleged misrepresentations and omissions in the Registration Statement and Prospectus to the operative time frames. Rather, the Court found that the alleged misrepresentations were not actionable. Many of the statements, which began with opinion-based language such as “we believe” and “we intend,” were either “(1) corporate puffery, too vague to be actionable, (2) sincere statements of corporate optimism, or (3) sufficiently offset by robust risk disclosures.” Thus, the Court held that Sundial made no guarantees regarding the quality of its cannabis.
The Court further explained that Sundial provided sufficient risk warnings in the disclosure section of their Prospectus, in which they outlined the inherent risks of the agricultural business, which could adversely impact their cannabis production, including manufacturers’ return of their products.
Takeaway: Courts view and analyze registration statements and prospectuses with a critical eye. Thus, companies should take heed to disclose facts accurately and with sufficient detail. Additionally, using proper diction and syntax in registration statements and prospectuses could differentiate a statement from being viewed by courts as actionable versus non-actionable under the Securities Act.