On August 21, 2023, Judge Paul A. Crotty of the United States District Court for the Southern District of New York granted a motion for reconsideration of his denial of an earlier motion to dismiss a putative securities class action against a pharmaceutical and cannabis company that sells cannabis, hemp, and related products (the "Company") and certain of its officers (the "Individual Defendants"). Kasilingam et al. v. Tilray Inc., et al., No. 1:20-cv-03459 (S.D.N.Y. Aug. 21, 2023). Based on the Court's reconsidered analysis, the Court granted defendants' second motion to dismiss. Plaintiffs alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder by making false and misleading statements to inflate the Company's stock price.
The Company's predecessor was allegedly formed in 2014 as a subsidiary of a holding company formed by the CEO and two non-parties (the "Kennedy Group") to invest in the cannabis industry. According to plaintiffs, over time, the Kennedy Group privately sold economic interests in the holding company but retained voting control through "supervoting" shares. In July 2018, at the time of the Company's initial public offering, the holding company allegedly purchased the majority of the shares. Plaintiffs are purchasers of the Company's common stock during the purported class period—from January 16, 2019 through March 2, 2020, which spans from the day after the Company entered a high-profile co-marketing deal with a marketing company (the "Marketing Agreement") until the day the Company allegedly announced it had impaired its valuation of the Marketing Agreement by $102.6 million and also written down the value of its inventory by $68.2 million. In December 2019, the Company allegedly executed a downstream merger (the "Share Exchange") with the holding company to wind down the holding company's operations.
The Court granted defendants' first motion to dismiss plaintiff's First Amended Complaint (the "FAC"), with leave to replead. Plaintiffs filed the Second Amended Complaint (the "SAC"), alleging false statements falling into three categories: (1) the value of the Company's inventory and its gross margins; (2) the misclassification of labor as an input; and (3) the value of the Marketing Agreement. Plaintiffs further alleged that the purpose of the Share Exchange was to eliminate the holding company's corporate sales tax, control the flow of the holding company investors' shares of the Company into the market, and secure personal control over the Company. Defendants again moved to dismiss, and the Court granted in part and denied in part defendants' motion. Defendants moved for reconsideration.
At the outset, the Court noted that it would decline to address the bulk of defendants' arguments on reconsideration. However, the Court credited one argument presented by defendants as a ground for reconsideration regarding an oversight in the Court's scienter evaluation of plaintiffs' Section 10(b) and Rule 10b-5 claim. In addressing defendants' second motion to dismiss, the Court determined that plaintiffs' allegations regarding the CEO's motives created an inference of scienter at least as compelling as the inferences offered by defendants. The Court based its determination on the circumstances surrounding the CEO's individualized trades, including the timing and volume, indicating that the CEO may have profited from the alleged misrepresentations. As a competing inference, defendants advanced the argument that the CEO's trades were made pursuant to Rule 10b5-1 trading plans. The Court noted that "the mere presence of a 10b5-1 plan is not a complete defense to scienter," especially because the plans were entered into during the putative class period, and held that the trades were suspicious enough to overcome defendants' proposed inference of the 10b5-1 plan's probative value negating scienter.
On reconsideration, the Court found that, in so previously holding, it had neglected aspects of defendants' arguments and overlooked controlling Second Circuit precedent. The Court noted that, in Arkansas Pub. Emps. Ret. Sys. v. Bristol-Myers Squibb Co., 28 F.4th 343 (2d Cir. 2022), the Second Circuit affirmed the dismissal of Section 10(b) claims, finding a failure "to adequately allege a material misstatement or omission or facts giving rise to a strong inference of scienter." With respect to scienter, the Second Circuit determined that the defendants' stock trades were not unusual enough to warrant a finding of motive. The Second Circuit in Bristol-Myers Squibb concluded that "the vast majority of the sales were conducted pursuant to a 10b5-1 trading plan or were executed for procedural purposes, and therefore could not be timed suspiciously." It similarly concluded that the plaintiffs in that case failed to allege suspicious timing of the plan, even though the defendant "entered into such plan during the putative class period," because the complaint itself did not allege that the plan was entered into in bad faith.
On defendants' motion for reconsideration, the Court first held that it had erred in its scienter analysis when considering defendants' motion to dismiss, because it did not address whether the SAC alleged that the CEO entered into the 10b5-1 plans in bad faith but instead relied solely on the alleged suspicious timing of the 10b5-1 plans as related to the putative class period.
Turning anew to plaintiffs' allegations, and applying Bristol-Myers Squibb, the Court found that it could no longer determine that plaintiffs' allegations related to the CEO's motive created a strong inference of scienter. The Court previously found that the CEO's proceeds from stock sales were a factor that had weighed heavily in establishing scienter, but that in light of Bristol Meyers Squibb, the Court found it had weighed the CEO's financial benefit too heavily in its initial analysis. The Court noted that, by alleging that the CEO traded pursuant to 10b5-1 plans, defendants offered at least one cogent inference of a non-culpable explanation for the CEO's trades and his financial benefit during the putative class period for at least 12 out of the 14 trades at issue, and that inference was stronger than the one presented by plaintiffs. The Court emphasized that this significantly "narrowed" any potential untoward benefit received by the CEO. Regarding plaintiffs' allegations that the CEO sold 34% of the shares available for sale at the beginning of the putative class period and 26.7% of the shares that were available to sell during the putative class period for a total of 643,164 shares and $28,389,051.71, the Court noted that scheduled 10b5-1 plan trades accounted for approximately 274,278 of the shares sold and approximately $16 million in profit for the CEO. The existence of the 10b5-1 plan thus made the stock sales and profits less probative of scienter. According to the Court, the lack of allegations as to the CEO's financial benefit therefore weakened plaintiffs' arguments that he "sought to be the leader of the cannabis world."
Turning next to its analysis of plaintiffs' allegations as to defendants' conscious misbehavior or recklessness—a separate basis for finding scienter where motive allegations are lacking—the Court found that, in analyzing defendants' first motion to dismiss, it had determined that plaintiffs failed to meet the high bar of alleging "a state of mind approximating actual intent, and not merely a heightened form of negligence." Moreover, the Court found that plaintiffs failed to allege specific facts pertaining to the CEO's state of mind. The Court found that the confidential witness ("CW") allegations in the FAC and SAC were insufficient to suggest that the CEO or other decisionmakers from the company subjectively believed the Company's due diligence was lacking, or that the CEO "actually knew or had been presented with information indicating that [the Company's] trim was worthless."
Upon reconsideration, the Court found that plaintiffs had not sufficiently pled new facts related to the CWs between the FAC and SAC to support the circumstantial evidence of the CEO's intent to deceive the public. The Court found that the CWs still failed to allege that the CEO had any knowledge of the inventory discrepancies. Moreover, the SAC contained no allegations that the CEO himself was or should have been on notice that the inventory analysis was false. Regarding the Marketing Agreement, the Court reiterated its finding on defendants' first motion to dismiss that plaintiffs did not adequately allege that any decisionmakers at the Company subjectively felt that the Company's due diligence was lacking. Likewise, the Court rejected the other alleged categories of circumstantial evidence plaintiffs relied on to bolster their scienter allegations, finding that allegations regarding the CEO's statements on extract revenue and trim, even if false, failed to sufficiently allege that he knew facts or had access to information suggesting that his public statements were not accurate. The Court similarly rejected plaintiffs' circumstantial evidence allegations regarding stock acquisitions and the increase in the volume of the Company's trades, noting that plaintiffs did little to tie these vague allegations to the alleged misrepresentations at issue.
Finally, the Court found that, because plaintiffs failed to allege an underlying securities claim, it also reconsidered and dismissed plaintiffs' claims under Section 20(a) and 20A of the Exchange Act.
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