On August 30, 2021, Judge Lewis A. Kaplan of the Southern
District of New York granted a motion to dismiss a claim under
Section 10(b) of the Securities Exchange Act of 1934
("Exchange Act") and Rule 10b-5 thereunder against a
cannabis company ("Company"), its senior secured lender
("Financing Company"), and certain executives at both
companies. In re iAnthus Capital Holdings Inc.
Securities Litigation, 1:20-cv-03135 (S.D.N.Y. Aug. 30,
2021). Plaintiffs, in consolidated purported class actions
and an individual action brought by a shareholder, alleged the
Company failed to disclose the nature of its relationship with the
Financing Company, which allegedly obtained approximately half of
the equity of the Company after the Company defaulted on its
loan. The Court granted defendants' motion to dismiss
plaintiffs' first amended class action complaint ("Amended
Complaint"), holding that plaintiffs failed to allege their
transactions with the Company satisfied the jurisdictional
limitations of the Exchange Act established by the Supreme Court
in Morrison v. Nat'l Australia Bank Ltd., 561
U.S. 247, 267 (2010). The Court permitted plaintiffs to move
for leave to further amend.
The Company is a Canadian cannabis corporation whose shares are
listed on the Canadian Stock Exchange ("CSE"). The
Company operates cultivation and dispensary facilities in the
United States, and its shares trade over-the-counter
("OTC") in the U.S. on the OTCQX, which is part of the
OTC Markets Group. According to the Amended Complaint, on
April 6, 2020, the Company announced that it had defaulted on a
debt to the Financial Company, which is the Company's senior
secured lender and largest source of financing. The Company
later announced that its CEO had accepted an interest-free loan
from the Financing Company. Shortly thereafter, the Company
allegedly negotiated a restructuring support agreement (the
"Restructuring Transaction") with the Financing Company,
which would result in the Financing Company obtaining "almost
half of the equity" in the Company in exchange for reducing
the Company's debt and providing additional financing,
allegedly leaving other equity holders with "only
fractions" of their investments. The Restructuring
Transaction was approved by the Supreme Court of British Colombia
in October 2020.
Plaintiffs alleged that defendants "fail[ed] to disclose
information regarding [the Company's] relationship with [the
Financing Company] and certain terms governing financing provided
by [the Financing Company]." Plaintiffs further alleged
that these facts caused the Company to default on its loans to the
Financing Company which positioned it to take over the Company
following the default.
Under Morrison, the Exchange Act's application is
limited to "transactions in securities listed on domestic
exchanges and domestic transactions in other
securities." While plaintiffs did not contend that the
CSE is "domestic," they contended the OTCQX qualified as
a "domestic exchange." The Court disagreed, holding
that the SEC's implementing regulations limit
"exchange" to "an organization, association, or
group of persons who (1) bring 'together the orders for
securities of multiple buyers and sellers' and (2) use
'established, non-discretionary methods . . . under which such
orders interact with each other, and the buyers and sellers
entering such orders agree to the terms of a
trade.'" In contrast, the OTC markets "are not
national securities exchanges within the scope
of Morrison," because the Exchange Act refers to
securities exchanges and OTC markets separately, "which
suggests that one is not inclusive of the other" and,
moreover, the phrase "a national securities exchange" is
listed in Section 10(b) to the "exclusion of the OTC
markets." Separately, the Court rejected plaintiffs'
argument that the Exchange Act applied because the Company's
securities traded through OTC Link, which is registered with the
SEC, because OTC link is registered as an "alternative trading
system," which is "separately regulated by the SEC and is
specifically exempt from the Exchange Act's definition of
'exchange.'" Therefore, as explained by the
Court, because neither the CSE nor the OTCQX qualify as domestic
exchanges, the alleged transactions did not qualify
under Morrison's first prong.
The Court turned next to Morrison's second
"domestic transaction" prong, observing that a
transaction is domestic if "the parties incur irrevocable
liability to carry out the transaction within the United States or
when title is passed within the United States." The
Court noted that conclusory assertions as to irrevocable liability
or passage of title are insufficient, and the location or residency
of the parties to the transaction "will not necessarily
establish the situs of the transaction." Instead,
"plaintiffs must allege specific facts 'including, but not
limited to, facts concerning the formation of the contracts, the
placement of purchase orders, the passing of title, or the exchange
of money.'" Moreover, the allegations must relate to
the "'transactions themselves' and not merely the
'actions needed to carry out the transactions.'"
In analyzing the Amended Complaint's allegations, the Court
determined that there were three different transactions at
issue: (i) lead plaintiff's purchase of shares of the
Company's common stock, (ii) the Company's largest
shareholder's conversion of shares of common stock through a
transaction between the Company and a biopharmaceutical
corporation, and (iii) the same shareholder's purchase of a
convertible debenture from the Company.
First, with respect to lead plaintiff's alleged stock
purchases, the Court found that plaintiff listed these transactions
in a Certification filed with the Court, but "[did] not
otherwise indicate where or how any of those transactions were
made." Although lead plaintiff listed those transactions
under the Company's ticker symbol for the OTCQX market, the
Court highlighted that "listing [those] transactions under
that symbol . . . [did not mean] that those transactions occurred
through the OTCQX market." Rather, the Court found that
"[a]t most, [plaintiff's] allegations support an inference
that [they] purchased shares that trade also in the United States
over-the-counter market," which is "plainly insufficient
to allege a domestic transaction." Moreover, even if
lead plaintiff purchased the stock through a U.S. OTC market,
"the mere assertion that transactions took place in the United
States is insufficient to plead a domestic transaction,"
because it "does not indicate where the parties to that
transaction incurred irrevocable liability or where title
passed." Instead, lead plaintiff was required to make
specific allegations concerning the location of the transactions
and the structure of the transactions, including "facts
concerning the formation of the contracts, the placement of orders,
the passing of title[,] . . . the exchange of money or other detail
sufficient to discern . . . the situs of over the counter
transactions." The Court took note of lead
plaintiff's declaration that he purchased the common stock
through his U.S. brokerage account which he had no discretion to
revoke or cancel while he was in Louisiana, but found that these
facts were not alleged in the Amended Complaint and were not
properly before the Court.
Second, concerning the alleged acquisition by plaintiff shareholder
of Company shares through a stock conversion, the Court found that
"[g]enerally, the acquisition of shares through a merger of
foreign entities is not a domestic transaction." Indeed,
the pleadings failed to allege "that the parties to the merger
incurred irrevocable liability in the United States," and
"the only alleged connection between the transaction and the
United States" was plaintiff shareholder's "assertion
that its ownership of [the Company's] stock was
'memorialized' in Direct Registration Certificates sent to
[plaintiff] in the United States." Accordingly, the
Court held that delivery of these certificates to the U.S. was
insufficient to establish that the transaction itself or the
passage of title occurred in the United States. Further, the
Court disagreed with individual plaintiff's assertion that its
acquisition of the Company's shares was a domestic transaction
because its Conversion Notice was executed in the U.S. In
particular, the Court found that, even assuming that the Conversion
Notice was incorporated by reference in the Amended Complaint,
"it is not indicative of a domestic transaction," because
"the Conversion Notice does not indicate that it was executed
in the United States, and the Court cannot properly rely on
[plaintiff's] assertions in its opposition brief to establish
otherwise." Moreover, the Court did not find the
Conversion Notice to be relevant to individual plaintiff's
stock acquisition because it did not allege "that its
execution of the Conversion Notice created irrevocable liability
for that transaction nor could it, as the transaction at issue was
between" the Company and the biopharmaceutical company, and
not individual plaintiff.
Third, the Court turned to the issue of individual plaintiff's
alleged debenture purchase. Although the Amended Complaint
did not allege where the purchase occurred, plaintiff argued that
the debenture was a domestic transaction because its terms
indicated that title passed in the United States. The Court
disagreed, finding that the Company's acknowledgment that it
promised to make payments to the shareholder at its U.S. address
"merely reflected [the Company's] agreement
to repay the principal on the debenture [at that
address]," which was "entirely irrelevant to the passage
of title" to the debenture. Moreover, according to the
Court, the fact that the terms and conditions attached to the
debenture required individual plaintiff to send any notices or
communications to the Company's office in the United States was
"[e]qually unpersuasive," because it merely
"indicate[d] that [the Company] operated in the United
States." The Court maintained that "a party's
residence or location is not indicative of where a transaction
occurs." Consequently, the Court dismissed the Exchange
Act claims, holding that plaintiffs failed to allege "a
transaction in securities traded on a domestic exchange or a
domestic transaction."
Finally, the Court considered individual plaintiff's request
for the Court to exercise supplemental jurisdiction over its common
law claims. Noting that the balance of factors points toward
declining supplemental jurisdiction where all federal-law claims
are eliminated before trial, the Court declined to exercise
supplemental jurisdiction. The Court gave weight to the fact
that individual plaintiff had filed a related law suit in
Canada and the debenture was governed by Canadian law, and held
that adjudicating the common law claims in federal court would be
inefficient for the parties and the Court. The Court,
however, permitted plaintiffs to move for leave to file proposed
second amended complaints.
In re iAnthus Capital Holdings Inc. Securities Litigation
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