On December 3, 2020, the Appellate Division of the New York Supreme Court, First Judicial Department, reversed an order that denied defendants' motion to dismiss a securities action complaint against a Chinese e-commerce marketing company (the “Company”) under Section 11 of the Securities Act of 1933, and directed that a judgment be entered dismissing the complaint. Lyu v. Ruhnn Holdings Ltd., No. 12553, 2020 WL 7062118 (1st Dep't Dec. 3, 2020). This is the first substantive Securities Act ruling from a New York appeals court since the United States Supreme Court's decision in Cyan Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), which held that state courts have jurisdiction to adjudicate class actions brought under the Securities Act and that such actions generally cannot be removed from state to federal court.
The Company recruits, trains, and manages social media influencers who are paid to promote, market, and advertise products and services to their followers (referred to as “key opinion leaders” or “KOLs” in the complaint) and provides these marketing services to companies engaged in e-commerce. The Company's two primary business models are (1) selling products through its self-owned brands and stores (the “full-service model”), and (2) providing services to third-party online stores (the “platform model”). Historically, the Company's primary driver of revenue generation was based on the full-service model. In April 2019, the Company conducted an IPO of ADSs. The prospectus (the “Prospectus”) filed in connection with the IPO disclosed that the Company was shifting away from the full-service model to the platform model as the primary revenue generator. The Prospectus also provided information on its historic operating data, including that the Company had 91 self-owned online stores in its full-service business model at the end of 2018. In June 2019, the Company disclosed that it had closed nearly 40% of its stores operated under the full-service model prior to the IPO.
Plaintiff alleged that the Company's omission of information related to the store closings was a material omission that rendered the Prospectus misleading. Defendants moved to dismiss, arguing that the store closures were part of the shift to the platform model that was disclosed in the Prospectus. In a decision now reversed by the First Department, the New York Supreme Court denied the motion, holding that the disclosures regarding the Company's shift communicated only “the expectation that the platform model would grow and perhaps overshadow the full-service market” and not that “it expected to substantially reduce existing full-service business.” The Supreme Court also held that the Company's disclosure of the number of its stores at the end of 2018 was “arguably misleading” because many fewer stores were operating at the time of the IPO and that “investors are entitled to accurate material information at the time of the IPO.”
In a succinct decision, the Court reversed and directed the entry of a judgment dismissing the complaint. The Court held that the omission of data of the store reductions for the period immediately preceding the IPO did not “‘significantly alter the ‘total mix' of information made available' to a reasonable investor” because the Company disclosed that it was shifting to a platform model for its online stores and away from the self-owned, full-service model. The Court further held that the focus on store closures was “myopic” because the “full service sector's revenue was not closely related to either the number of stores or the number of online influencers serving the segment” and disclosure thus “would not have given a more accurate picture of the status of the business.”
Originally Published by Shearman & Sterling, December 2020
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