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On March 31, 2023, the Southern District of New York dismissed[1] a securities fraud class action against a post de-SPAC company alleging that the pre-merger privately held company had made false and misleading statements before the merger in violation of Section 10(b). In re CarLotz Sec. Litig., 2023 WL 2744064 (S.D.N.Y. 2023) (Abrams, J.).[2]  The court held that plaintiffs—who purchased shares of the SPAC and the post-merger public company, not the privately held pre-merger company—lacked standing and that their challenge to any statements the pre-merger private company made about itself was foreclosed by Menora Mivtachim Insurance v. Frutarom Industries, 54 F.4th 82 (2d Cir. 2022).[3]

Background

The defendant company is an online used car marketplace that went public in January 2021 following a de-SPAC transaction. Plaintiffs brought this securities class action against the company, and various related entities and individuals. Plaintiffs alleged that officers of the pre-merger private company made materially false and misleading statements concerning their business model prior to the shareholder vote approving the de-SPAC transaction. Following the merger, the post-merger public company's stock dropped. All defendants moved to dismiss on the basis that plaintiffs lacked standing under Section 10(b) to challenge any statements made by the pre-merger private company or its officers about the pre-merger private company.

The Court Looks to the Purchaser-Seller Rule as Interpreted in Frutarom

In Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), the Supreme Court endorsed the “purchaser-seller rule” established in Birnbaum v. Newport Steel, 193 F.2d 461 (2d Cir. 1952), which limited plaintiffs under Section 10(b) to “actual purchasers or sellers of securities.” In Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks, 369 F.3d 27 (2d Cir. 2004), the Second Circuit addressed the purchaser-seller rule, and held that plaintiff stockholders lacked standing for their Section 10(b) claim because while the stock of the company that they did purchase was negatively impacted by the material misstatement of another company (which had been involved in a number of business relationships with the company they owned stock in), they did not purchase the stock of the company that allegedly made the misstatement. Noting that a potential merger might require a different outcome, the court declined to decide how the purchaser-seller rule would apply to a potential merger. Subsequently, in Frutarom, the Second Circuit answered that question and held that “purchasers of a security of an acquiring company do not have standing under Section 10(b) to sue the target company for alleged misstatements the target company made about itself prior to the merger between the two companies.”[4]

Determining that Frutarom foreclosed plaintiffs’ challenge, the court pointed out that in this case neither of the named plaintiffs purchased shares of the pre-merger private company and that the only pre-merger shares purchased were those of the publicly traded SPAC. The court further noted that the challenged statements were made by the pre-merger private company about itself, not the SPAC. The court rejected plaintiffs’ attempt to equate the pre-merger private company with the post-merger public company, finding that “[p]laintiffs provide no explanation as to why, as a legal matter, the post-merger entity can be considered interchangeable with the pre-merger, privately held company.”

In response to plaintiffs’ concern that Frutarom allows parties to make misstatements before a de-SPAC transaction with impunity, the court pointed out that the Frutarom majority considered similar policy arguments and rejected them, reasoning that plaintiffs could still bring claims alleging material misstatements against target companies through SEC enforcement actions, shareholder derivative suits, or under state law.