On February 6, 2024, Judge Jennifer L. Rochon of the United States District Court for the Southern District of New York dismissed with leave to amend a putative class action asserting claims under the Sections 10(b) and 14(a) of the Securities Exchange Act against a Special Purpose Acquisition Company ("SPAC") and certain of its officers and directors, along with an individual action consolidated with the putative class action and asserting similar claims. In re Lottery.com, Inc. Securities Litigation, No. 1:22-cv-07111 (S.D.N.Y. Feb. 6, 2024), slip op. Plaintiffs alleged that defendants misrepresented certain financial information regarding the SPAC's target company both before and after the merger. The Court held that, while certain challenged statements were adequately alleged to be false, plaintiffs failed to sufficiently allege scienter with respect to any alleged misrepresentation.
As a threshold matter, defendants argued that plaintiffs' allegations amounted to improper "puzzle pleading" by quoting at length from defendants' statements without "explain[ing] with particularity why each statement is false." Id.at 27. The Court disagreed, however, holding that the complaint sufficiently alleged how challenged portions of each quotation were rendered false or misleading. Id.at 28-29. The Court divided the challenged statements into three categories: pre-merger statements, post-merger statements regarding the company's finances and post-merger statements regarding regulatory compliance and controls.
The Court concluded that plaintiffs failed to allege any actionable statement or omission prior to the merger. The Court noted that statements noting the target company's work with regulators amounted to non-actionable puffery because they were "too general to cause a reasonable investor to rely upon them." Id.at 31. The Court further determined that financial projections contained in the Proxy were protected by the bespeaks‑caution doctrine as "forward-looking statement[s] accompanied by sufficient cautionary language." Id.at 34-35. The Court noted that statements were forward-looking if their "truth cannot be ascertained until some time after," and the Proxy's projections were made in October 2021 regarding the company's performance for all of 2021, and therefore could not be checked until after the year had concluded. Id.at 35. The Court also credited the risk disclosures in the Proxy, noting that they cautioned investors regarding potential weaknesses in internal controls—the "very risk that Plaintiffs allege it failed to disclose." Id.at 36. Similarly, the Court also rejected plaintiffs' allegations regarding preliminary revenue results contained in a press release, concluding that the bespeaks-caution doctrine applied to those projections even though the quarter in reference had already ended, as "corporate statements of projections as to corporate earnings" are considered forward-looking regardless of whether the covered earnings period had already ended. Id.at 38.
In addition, the Court rejected plaintiffs' allegations that the Proxy omitted "known trends or uncertainties" required to be disclosed under Item 303 of Regulation S-K. While plaintiffs argued that the Proxy failed to disclose that the company "was not complying with state and federal laws and overstating its cash and revenue," the Court concluded that plaintiffs failed to sufficiently allege that the company's management "actually kn[ew]" about the alleged noncompliance. Id.at 37. Moreover, the Court concluded that risk disclosures relating to cash and revenue statements in the Proxy were sufficient and therefore no further disclosure was necessary under Item 303. Id.at 38.
With respect to post-merger statements relating to the company's financial performance, however, the Court held that plaintiffs had plausibly alleged that the statements were false or misleading at the time they were made, based on plaintiffs' allegation that the figures included $30 million for a sale that allegedly never happened and the company's admissions that its prior financial reporting contained certain errors. Id.at 40, 45. The Court concluded that these statements were not forward-looking and thus were not protected under the bespeaks-caution doctrine. Id.at 41. Moreover, the Court rejected defendants' argument that the statements were inactionable statements of opinion, concluding that even though accounting standards can involve opinions, the allegation that the statements included $30 million from a sale that never took place was fact-based and contravened generally accepted accounting principles ("GAAP"). Id.at 49. The Court further held that, even if the statements were deemed opinions, plaintiffs plausibly alleged that they were subjectively false because they alleged that there was no historical evidence justifying including the $30 million sale. Id.at 50. The Court also concluded that these alleged misstatements were adequately alleged to be material, because they concerned the company's reported revenue—the "exact type of information that would be important to a reasonable investor." Id.
Finally, the Court declined to dismiss allegations that the company's post-closing quarterly and annual reports failed to disclose that the purported $30 million sale never happened and that a subsidiary had entered into a line of credit that was not disclosed in prior financial statements, concluding that these alleged omissions concerned historical facts and were not protected by the bespeaks-caution doctrine. Id.at 54-55. However, the Court held that the SOX certifications in the company's quarterly and annual reports were non-actionable statements of opinion (id.at 57), and the Court held that challenged statements in a post-closing annual report that the company "rel[ied] on technology services to closely monitor and track" regulatory information and "us[ed] this information" to "create strong working relationships with the regulatory authorities" was non-actionable puffery. Id.
Turning to the requirement of scienter, the Court rejected plaintiffs' argument for scienter under a "motive and opportunity" theory, concluding that simply because defendants' compensation stood to increase based on a successful merger was not enough to support a strong inference of scienter. Id.at 63. While the Court suggested some receptiveness to the argument that SPACs should be closely scrutinized in this regard, the Court nevertheless concluded that there was no SPAC "exception" to the general rule that the prospect of a public offering was not enough to infer scienter, and that, in any event, the only statements adequately alleged to be false occurred after the merger, when no SPAC-related motive existed. Id.at 65‑66.
The Court also rejected plaintiffs' argument for scienter under a "conscious misbehavior or recklessness" theory. While plaintiffs argued that the errors in the company's financial statements were enough to infer scienter, the Court noted that "plaintiffs may not plead fraud by hindsight" and that it was not enough to argue that defendants "must have known that their statements were false or misleading given the magnitude of the restatement of revenue of a core operation of the company ... and [defendants'] respective roles at the company." Id.at 68. Indeed, the Court explained that, within the Southern District of New York, the core operations doctrine is generally only considered to supplement other allegations of scienter. Id. The Court also declined to infer scienter from the resignation of certain executives, noting that based on the complaint those allegations were "at least as consistent with punishing those at the helm for their poor judgment and leadership" as opposed to fraud. Id.at 72. Thus, viewing all of plaintiffs' scienter allegations together, the Court concluded that the inference of scienter was less compelling than the alternative inference—"that [d]efendants were negligent and committed acts of corporate mismanagement, not securities fraud." Id.at 73.
In addition, the Court dismissed plaintiffs' claim under Section 14(a) with respect to the pre-merger Proxy, noting that the challenged statements in the Proxy were non-actionable for the same reasons noted in connection with the Section 10(b) claim.
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