For any company, going public is fraught with securities litigation risks. As highlighted in the recent New York State Appellate Court decision In The Matter of Sundial Growers, Inc. Securities Litigation, companies operating in the relatively new, but rapidly growing, frontier of legal cannabis must be thorough and careful when issuing public disclosures. Companies must also be aware of venue issues: in particular, the potential for simultaneous federal and state proceedings related to IPO filings following the United States Supreme Court's 2018 Cyan decision, and should consider the adoption of Federal Forum Provisions ("FFPs") to avoid this problem.
Sundial Growers Securities Litigation
Sundial Growers is a Canadian company which commenced cannabis production in December 2018, following legalization of adult-use cannabis in Canada. The company went public via an Initial Public Offering in August 2019.
As is common following an IPO, plaintiff, on behalf of a putative class of investors, brought a claim under the Securities Act of 1933 (the "Securities Act") alleging material misstatements and omissions in the IPO's registration statement that had been filed with the Securities and Exchange Commission. ("SEC").
The complaint at issue was filed in New York State court in September 2019, shortly after the IPO. The complaint follows the trend of increased state filings of Securities Act claims as a result of the Supreme Court's 2018 decision in Cyan Inc. v. Beaver County Employees Retirement Fund, which held that state courts have jurisdiction over claims brought under the Securities Act (and prohibited removal of these claims to federal court). See Dropbox Becomes Third California Superior Court Decision To Enforce Delaware Corporations' Federal Forum Provision For Securities Act Lawsuits (Dec. 8, 2020). New York, in particular, has experienced a high volume of Securities Act filings in its state courts. See Cornerstone Research, Securities Class Action Filings 2019 Year in Review (2020); Cornerstone Research, Securities Class Action Filings 2020 Midyear Assessment (2020).
Like much of the Securities Act litigation following the Cyan decision, Sundial Growers faced parallel suits in federal and state courts. See In re Sundial Growers Inc. Securities Litigation, 19-cv-08913-ALC (S.D.N.Y.). A motion to dismiss has been briefed in the federal action, though a decision has not yet been issued. To avoid duplicative state and federal litigation, we advise corporations to adopt federal forum selection provisions in their bylaws. See Seyfarth Shaw LLP, California Superior Courts Enforce Delaware Corporations' Federal Forum Provision for Securities Act Lawsuits (Nov. 23, 2020) While state courts are generally considered to be more plaintiff friendly, notably, as discussed further below, the New York state court in Sundial Growers issued a defense friendly decision which was affirmed by the Appellate Division.
Dismissal of New York State Complaint
The complaint filed in New York state court alleges that the company misled investors by stating it was a producer of "high-quality" and "premium" cannabis when, allegedly, there were issues with cannabis quality, including an alleged incident in 2018 where a large order was returned.
The lower court dismissed the case, finding that each of the statements alleged to be misleading "was either (1) corporate puffery, too vague to be actionable, (2) a sincere statement of corporate optimism, or (3) sufficiently offset by robust risk disclosures." Relying on well-developed federal case law addressing similar statements, the lower court found the terms "high quality" and "premium" to be general descriptions not subject to verification and as such clear examples of puffery. Again relying on longstanding federal case law, the lower court also deemed the statements to be non-actionable opinions noting that the company had used "opinion-based, forward-looking language" such as "we believe," "we intend," or "will result." Finally, the lower court found that plaintiff had ignored the "robust 35-page risk disclosure section" of the offering documents, including several instances of disclosure of the "exact type of risk" that plaintiff complained was omitted such as risk of crop failure and other risks relating to the quality of the company's cannabis. Pointing to the same risk disclosures, the lower court also dismissed alleged failure to disclose risk factors under Items 303 and 105, which require an issuer to describe material trends, risks and uncertainties.
In a brief opinion, less than one page long, a panel of the First Department Appellate Division in New York State unanimously affirmed the lower court's decision. Relying on well-established federal case law, the appellate court found that "[t]he statements in the offering materials that defendant Sundial Growers, Inc. produced 'high quality' and 'premium' cannabis were non-actionable puffery . . . To the extent the statements were more than puffery, they were non-actionable opinion . . . Moreover, the risk disclosures in the offering materials expressly and repeatedly warned of the risk to the company's quality control . . . ."
The claims at issue in the Sundial Growers action are typical of the types of issues raised in many post-IPO securities suits and they are a reminder of the importance of the use of cautionary language, risk disclosures and clear identification of opinions in public statements. Significantly, the New York state court issued a defense friendly opinion, which was upheld on appeal, relying heavily on federal court precedent. This suggests that until Federal Forum Selection provisions are uniformly adopted to preclude simultaneous litigation of Section 11 suits in state and federal court, New York state courts may not reliably be an inhospitable forum for companies defending these suits.
Takeaway
As the legalization of cannabis becomes more common, both worldwide and in the United States, more cannabis companies will go public and, in doing so, expose themselves to risk of post-IPO and other securities litigation. For example, a Quebec-based cannabis supplier recently won a motion to dismiss securities claims brought under the 1933 and 1934 Acts in New York federal court. See In re HEXO Corp. Sec. Litig., No. 19 CIV. 10965 (NRB), 2021 WL 878589 (S.D.N.Y. Mar. 8, 2021). As the cannabis industry grows and matures, it must keep securities litigation in mind, including ensuring robust disclosures and appropriate cautionary language in any public statements, press releases, and SEC filings. Companies are also advised to adopt federal forum selection provisions to prevent exposure to duplicative state and federal court litigation.
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