On March 9, 2020, Justice Andrew Borrok of the Supreme Court of the State of New York, New York County, Commercial Division, granted in part a motion to dismiss a putative securities class action asserting claims under Sections 11, 12 and 15 of the Securities Act of 1933 (the "Securities Act") against a used car e-commerce company (the "Company"), certain of its executives and directors, and the underwriters for its initial public offering ("IPO") of American Depository Shares ("ADSs"). In re Uxin Limited Securities Litigation, No. 650427/2019 (N.Y. Sup. Ct. Mar. 9, 2020). Plaintiffs alleged that the Company made materially false and misleading statements and omissions concerning changes to the Company's business model and certain financial and operational data reported by the Company in connection with its IPO. The Court granted in part and denied in part defendants' motion to dismiss.
The Company is a Chinese used car e-commerce platform comprised of two business segments—its "2B Business" and "2C Business." As a part of its 2B Business model, the Company facilitates other companies (such as car dealerships) in sourcing vehicles, optimizing turnover, and facilitating cross-regional transactions. As a part of this service, the Company facilitates "B2B" transactions and it also facilitates sales and purchases among dealers. Additionally, the Company received fees for facilitating sales in which consumers sold used vehicles to car dealers. As part of its 2C Business, the Company provides consumers with customized car recommendations, financing, title transfer, delivery, insurance referral, warranty and other related services.
According to the consolidated amended complaint, two months after the Company's IPO in August 2018, the Company announced its second quarter earnings and an "abrupt change to its business model," which involved scaling back the Company's 2B Business services such as "inspections and ancillary services to consumers" who sold on their platform—an aspect of the Company's business that plaintiffs allege provided the Company a competitive advantage by setting it apart from the market. Plaintiffs alleged that the Company did not disclose any information concerning the risk associated with scaling back its 2B Business and the effect it would have on the Company, including a corresponding decrease in transactions on its 2B platform, as well as a decrease in "its Gross Merchandise Value" and take rate for the 2B business. The complaint further alleged the Company made misleading statements about its financial health. In particular, plaintiffs relied on a report issued by a short-seller company (the "J Capital Report") that claimed the Company "grossly inflated its revenues, transaction volumes, car values, and inventories, and understated its debt load." According to the complaint, the J Capital Report disclosed that the Company "exaggerate[d] the volume of auto sales . . . by as much as 40%," had "a staggering level" of undisclosed debt, sold used cars at "artificially [high prices] to raise loan values," and allegedly overstated its revenue and inventory. As such, plaintiffs alleged that defendants "violated their independent, affirmative duty to provide adequate disclosures about known adverse conditions, trends, risk, and uncertainties about [the Company's] business."
The Court first addressed defendants' argument that plaintiffs' claims are subject to the heightened pleading standard of CPLR 3016(b) because they are based upon alleged misrepresentations. Citing the Second Circuit's decision in Litwin v. Blackstone Group, L.P., 634 F.3d 706 (2d Cir. 2011), the Court reasoned that Sections 11 and 12(a)(2), "at their heart," are negligence-based claims, and therefore, "a heighted pleading standard need not be satisfied because the defendant's state of mind is not relevant because scienter is not an element" under either of those claims. Accordingly, the Court held that plaintiffs' claims are subject to the ordinary notice pleading standard.
The Court then addressed the substance of plaintiffs' Sections 11 and 12(a)(2) claims as to the Company's changes to its business model, and held that plaintiffs failed to allege the Company made misrepresentations in its offering documents because the change in the 2B Business "did not retroactively render anything . . . false or misleading." In so holding, the Court emphasized that plaintiffs were unable to identify any allegation in the complaint "concerning the defendants' knowledge about the change to the 2B Business at the time of the IPO such that [it] would make the offering documents misleading at the time of the IPO." Rather, plaintiffs merely alleged that "the Company [omitted it] would imminently and drastically shrink the scope of its much-touted 2B business services," which, according to the Court, was insufficient to adequately allege the defendants' knowledge at the time of the IPO. The Court also rejected plaintiffs' allegation that defendants failed to disclose the risk of a drop in transactions that would result from discontinuing its 2B Business inspection and ancillary services, noting that the Company's prospectus clearly disclosed the risks involved if it failed to "properly manage [its] warranty and car inspection programs."
The Court similarly dismissed plaintiffs' allegation that Item 303 required disclosure, finding that "a business strategy decision, such as the one made by [the Company] concerning the change to its 2B Business 'is not the type of disclosure Item 303 requires.'" According to the Court, plaintiffs "critically" failed to allege "any facts showing . . . defendants knew or should have known" the Company would adjust its business model after the IPO. Citing Second Circuit precedent, the Court noted that policy statements found in offering documents are "not promises to maintain that policy in the future" but rather "simply reflect company policy at [that] time." The Court further noted that other alleged statements—such as those referencing the Company's unique inspection service—were inactionable statements of opinion, and other statements about the importance and value of the inspection services did not give rise to a securities claim where, as in this case, "the offering documents indicate that a change to the manner in which the company differentiated itself . . . could have a material adverse effect on its business." As such, the Court dismissed plaintiffs' claims regarding the Company's change to its business model.
The Court next turned to plaintiffs' allegations based on the J Capital Report concerning the Company's financial and operational data, and held that plaintiffs adequately alleged—for the purposes of the motion to dismiss—that the Company made misleading statements with respect to its sales volumes and revenue. In so holding, the Court rejected defendants' argument that plaintiffs' claims concerning the Company's financial and operational data should be dismissed because the basis of the allegations was an "inherently unreliable" report from a short seller. The Court noted that "[f]ederal courts in the Second Circuit have permitted securities claims to go forward at the pleading stage on the basis of short seller reports," and as such, found that the reliability of a short seller report is an issue of fact. The Court further held that defendants' securities filings refuting the J Capital Report "[did] not conclusively refute that [the Company] has inflated or misstated its financial and operational data" and the question could not be resolved at the motion to dismiss stage. Therefore, the Court denied defendants' motion to dismiss as it related to plaintiffs' claims based on alleged misstatements concerning the Company's financial and operational data.
Finally, the Court considered the control person liability claims against the individual defendants under Section 15 of the Securities Act. Having found that the complaint sufficiently alleged certain aspects of plaintiffs' Sections 11 and 12(a)(2) claims, the Court allowed plaintiffs' Section 15 to go forward.
In re Uxin Limited Securities Litigation
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