(Article from Securities Law Alert, June 2022)
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On May 24, 2022, the Second Circuit affirmed in part the dismissal of a putative securities fraud class action alleging that a company, its former CEO, and former CFO engaged in an illegal stock promotion scheme by allegedly concealing that they paid authors to write promotional articles about the company. Noto v. 22nd Century Grp., 2022 WL 1633827 (2d Cir. 2022) (Walker, J.). The court held that plaintiffs failed to state a claim that the existence of the stock promotion scheme constituted a materially misleading omission because the complaint did not adequately allege that defendants had a duty to disclose that they paid for the articles’ publication. The court held that “only an article’s maker, not its benefactor, has a duty to disclose that it was paid for.”
Background and Procedural History
In 2017, various writers published positive online articles about the prospects for the company’s stock. Many of the articles repeated statements from company press releases, FDA press releases, and the CEO’s statements in earnings calls, presentations, and at conferences. Defendants paid the writers to publish the articles, but did not disclose that the company was compensating the writers. Subsequently, the company’s stock price fell after articles were published online claiming that the company had engaged in a paid stock promotion scheme to illegally inflate its share price. Plaintiffs sued claiming that defendants violated Section 10(b) of the Exchange Act and SEC Rule 10b-5 by not disclosing that they were paying authors to promote the company’s stock. The district court dismissed.
No Duty to Disclose That Defendants Paid for the Articles’ Publication
On appeal, plaintiffs argued that defendants had a duty to disclose that the company paid the authors “because defendants provided content for, edited, reviewed, and/or approved those articles.” However, the court concluded that “[b]ecause the complaint does not adequately allege that defendants had a duty to disclose that they paid for the articles’ publication, plaintiffs fail to state a claim . . . .” Citing Janus Capital Group v. First Derivative Traders, 564 U.S. 135 (2011), the Second Circuit stated that “only an article’s maker, not its benefactor, has a duty to disclose that it was paid for.” The court went on to state that Janus made it clear that neither the company nor the executives qualified as a maker. In Janus, the Supreme Court held that a mutual fund investment advisor could not be liable for misstatements included in its client mutual funds’ prospectuses because “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” The mutual funds in Janus were determined to be the makers of the statements in the prospectuses because they filed the prospectuses with the SEC and had ultimate control over their content, while the investment advisor was not a “maker,” even if he was involved in the preparation of the prospectuses.
Plaintiffs Failed to Allege Defendants Had Ultimate Control Over the Articles
The Second Circuit determined that plaintiffs did not adequately allege that defendants had ultimate control over the articles. The court found that the complaint did not contain sufficient factual allegations to support the contention that “defendants furnished information and language for, prepared, reviewed, approved, and/or ratified the articles . . . .” While statements from the company’s press releases were included in the articles, the court observed that preparing a press release that is repeated in a separate article by a different author does not qualify that press-release-preparer as the maker of the separate article’s statements. The court stated that in Janus the Supreme Court “specifically rejected a holding that would allow plaintiffs to sue a person who provides the false or misleading information that another person then puts into a statement.” The Second Circuit further noted that plaintiffs failed to adequately allege that the CEO directly wrote the articles, controlled what the authors put into the articles, or even saw them before their publication.
The court pointed out that even in the event that the CEO did provide some input on the articles’ content, the complaint did not support the conclusion that he was the articles’ maker. The court found that the complaint did not sufficiently allege that: (i) the articles were published by anyone except the authors; (ii) the authors lacked final control over the content of the articles; (iii) the authors did not make the ultimate decision as to what specific information to include; or (iv) defendants and authors collaborated to such an extent that defendants controlled the articles’ publication.
Defendants Had a Duty to Disclose an Ongoing SEC Investigation to Make Their Statements Complete and Accurate
Separately, the Second Circuit vacated the dismissal of plaintiffs’ claim that defendants’ failure to disclose an ongoing SEC investigation into the company’s accounting controls was a material misrepresentation. Drawing on the principle that once a company speaks on an issue or topic, there is a duty to tell the whole truth, the court agreed with plaintiffs that defendants had a duty to disclose the investigation because by not mentioning it, their disclosures were misleading. As defendants had specifically noted the accounting control deficiencies, stated that they were working on them, and later stated that they had solved the issue, the court concluded that “the failure to disclose the investigation would cause a reasonable investor to make an overly optimistic assessment of the risk.” Quoting
Meyer v. Jinkosolar Holdings, 761 F.3d 245 (2d Cir. 2014).