NY Securities Rulings Don’t Constitute Cyan Backlash

Written by: EdKorsinsky

March 8, 2021

A recent Law360 guest article described two recent decisions by the New York Appellate Division, First Department, in prospective class actions brought under the federal Securities Act, In the Matter  of Sundial Growers Inc. and Lyu v. Ruhnn Holdings Ltd.

The premise of the article was that the two decisions, both of which happened to be in favor of the defendants, were “signaling a growing backlash against the influx of these suits into state courts following the U.S.  Supreme Court’s 2018 decision in Cyan Inc.  v. Beaver County Employees  Retirement Fund.” I disagree. A fair  reading of those decisions is they were very  narrowly decided based on the facts presented, and rather than reflecting some  general ill-disposition toward such suits, or  their being brought in state court versus federal court — as expressly permitted  under Cyan — the court was simply calling  balls and strikes by applying precedent to  the facts, as it should.

Moreover, the brevity of both opinions  tends to undermine any notion of  expansive intent to send signals beyond the  contours of the cases presented before  the court.

As an initial matter, it should be noted that  there has been no run on the state courts,  as suggested, of filings under the Securities  Act in the wake of the 2018 Cyan decision,  which expressly provided for concurrent  jurisdiction in state and federal courts for  cases brought under the Securities Act.  Only 17 such cases were filed in state courts  in 2020, mostly in California and  New York.[1]

Turning to the two Appellate Division decisions, Sundial Growers and Lyu, both  cases were decided for the defendants, with Sundial Growers affirming dismissal and  Lyu reversing denial of a motion to dismiss. While defendants can take limited comfort  from these decisions, the caveat for defendants, and reassurance for plaintiffs,  is that both decisions are limited to the  facts in those cases.

Moreover, both opinions were abbreviated,  consisting of four sentences each, and  broke no new ground in the jurisdiction.

A recent Law360 guest article described two recent decisions by the New York Appellate Division, First Department, in prospective class actions brought under the federal Securities Act, In the Matter  of Sundial Growers Inc. and Lyu v. Ruhnn Holdings Ltd.

The premise of the article was that the two decisions, both of which happened to be in favor of the defendants, were “signaling a growing backlash against the influx of these suits into state courts following the U.S.  Supreme Court’s 2018 decision in Cyan Inc.  v. Beaver County Employees  Retirement Fund.” I disagree. A fair  reading of those decisions is they were very  narrowly decided based on the facts presented, and rather than reflecting some  general ill-disposition toward such suits, or  their being brought in state court versus federal court — as expressly permitted  under Cyan — the court was simply calling  balls and strikes by applying precedent to  the facts, as it should.

Moreover, the brevity of both opinions  tends to undermine any notion of  expansive intent to send signals beyond the  contours of the cases presented before  the court.

As an initial matter, it should be noted that  there has been no run on the state courts,  as suggested, of filings under the Securities  Act in the wake of the 2018 Cyan decision,  which expressly provided for concurrent  jurisdiction in state and federal courts for  cases brought under the Securities Act.  Only 17 such cases were filed in state courts  in 2020, mostly in California and  New York.[1]

Turning to the two Appellate Division decisions, Sundial Growers and Lyu, both  cases were decided for the defendants, with Sundial Growers affirming dismissal and  Lyu reversing denial of a motion to dismiss. While defendants can take limited comfort  from these decisions, the caveat for defendants, and reassurance for plaintiffs,  is that both decisions are limited to the  facts in those cases.

Moreover, both opinions were abbreviated,  consisting of four sentences each, and  broke no new ground in the jurisdiction.

Sundial Growers

In Sundial Growers, the First Department affirmed dismissal on the grounds that a cannabis company’s description of its products as “high quality” and  “premium” were nonactionable “puffery.”

The First Department noted that, even if  that were not the case, the prospectus  specifically warned that these were  agricultural products where each unique  unit was subject to quality issues and  customer returns, that there had previously  been such an incident, and that  the case concerned only a single incident of  returned product.

Essentially, Sundial Growers followed prevailing Securities Act case law and stands for the unremarkable proposition that if there is no misrepresentation or omission in an initial Eduard Korsinsky public offering prospectus that would mislead a reasonable investor, there is no viable claim under the Securities Act.

Lyu

In Lyu, the First Department reversed the trial court’s denial of a motion to dismiss, where a company had disclosed in its IPO prospectus that it was shifting from a full-service ecommerce model whereby it sold products through its own online stores, to a platform model where it would provide  marketing services to third-party sellers.

The plaintiffs alleged the company failed to disclose that it had already begun to reduce the number of its full-service stores just  before the IPO. The First Department  noted that, in fact, the full-service sectors’ revenue was not closely related to the number of online stores or number of online influencers, and since (1) those reductions did not significantly affect pre-IPO revenues, and (2) the change in models was disclosed in the IPO, merely demanding more details on these metrics  was “myopic,” and the failure to do so thus  was not actionable.

Future Implications

Neither decision addressed any other facet of Securities Act suits brought in state  courts, their numerical levels or Cyan to divine any other implication from those decisions other than the rulings on the facts before the court.

Another area where I respectfully take a somewhat different view than that  articulated in the March 3 article is with  respect to the application of Rule 3016(b)  of the New York Civil Practice Law and  Rules to Securities Act cases brought in  New York state courts.

Neither First Department decision  addressed — and therefore both left  standing — the growing trend in New York  state decisions declining to apply the CPLR  3016(b) heightened pleading standards to  nonfraud claims such as those brought  under Section 11 or 12(a)(2) of the  Securities Act, which are claims for  negligence, or strict liability on the part of  the issuer under Section 11.[2]

Instead, the growing majority of cases in the New York Supreme Court Commercial  Division have applied the traditional CPLR  3013 notice pleading standard to these  cases.

While federal courts have sometimes  applied heightened pleading standards in  actions alleging claims for fraud under  Section 10(b) of the Securities Exchange  Act on the ground that the entire complaint  “sounds in fraud,” they  generally do not apply them to cases brought only under the Securities Act  unless the plaintiffs have effectively pled  themselves out of the strict liability  negligence standard by alleging fraud.

While defendants in New York state court cases have sometimes argued that CPLR  3016(b) by its terms applies to claims  “based upon misrepresentation, fraud, [or]  mistake” — and that Section 11 cases  involve a misrepresentation — plaintiffs  have responded that this provision must be  understood in the context of the specific  claim, which in Section 11 and 12(a)(2)  cases under the Securities Act lies in strict  liability or negligence.

Moreover, because under Cyan there is no concurrent jurisdiction in state courts for  Section 10(b) fraud claims, which are  bbrought under the Exchange Act, the  Section 11 cases brought in New York state  court are less likely to sound in fraud,  unless the plaintiffs opt to plead their  claims that way. If they do so, the inclusion  of fraud allegations would likely be readily  apparent.

In any event, whereas under  Section 10(b) the heightened pleading  requirement is most difficult to surmount  with respect to the element of scienter, or  fraudulent intent, in Section 11 cases the  requisite pleading detail generally pertains  to whether plaintiffs have identified the  particular statements alleged to be  misleading, and why they are misleading,  with sufficient specificity.

Thus, unless a  plaintiff is unable to specify the challenged  statements, e.g., by quoting them, and the  facts allegedly rendering those statements  materially misleading, the application of  CPLR 3016(b) may not make a substantial  practical difference in cases brought under  the Securities Act in New York state court.

All told, these two Appellate Division decisions are generally consonant with the body of jurisprudence in Section 11 cases in both federal and state courts, and appear to have been narrowly decided on the specific facts of each case.

The limited and straightforward nature of these decisions also indicates that the Appellate Division is resisting the call of some — I do not refer to the authors of the earlier Law360 guest article here — to legislate from the bench and effectively overturn Cyan from below, ceding the jurisdictional authority away from the state courts, which Cyan had expressly affirmed, thereby preserving the state courts’ rightful authority.

These decisions offer no indication of anything other than following such prevailing precedent.

Eduard Korsinsky is a founding partner at Levi & Korsinsky LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general  information purposes and is not intended to be and should not be taken as legal advice.

[1] See Cornerstone Research, Securities Class Action Filings: 2020 Year in Review.

[2] See, e.g., In re Netshoes Sec. Litig., No. 157435/2018, 2020 WL 2893433, at *4 (Sup. Ct., N.Y. Cnty. June 2, 2020) (Borrok, J.); Kirkland v WideOpenWest, Inc., No. 653248/2018, 2020 N.Y. Misc. LEXIS 2260, at *5-6 (Sup. Ct., N.Y. Cnty. May 18, 2020) (Masley, J.); In re PPDAI Grp. Sec. Litig., No. 654482/2018, 125 N.Y.S.3d 533, at *6 (Sup. Ct., N.Y. Cnty. Feb. 26, 2020) (Scarpulla, J.).

NY Securities Rulings Don’t Constitute Cyan Backlash – Law360

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