On November 30, 2020, Judge William H. Pauley III of the United States District Court for the Southern District of New York granted a motion to dismiss a putative securities class action asserting violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against a weight loss company (the “Company”), certain of its officers and directors, and its largest shareholder. In re Weight Watchers Int'l Inc. Sec. Litig., No. 19-cv-2005 (S.D.N.Y. Nov. 30, 2020). Plaintiffs alleged that the Company made false and misleading statements and omissions about its strategic rebranding initiative. The Court dismissed these claims because plaintiffs failed to allege falsity, observing that plaintiffs' claims “have little bearing on disclosure . . . and are [instead] fundamentally about corporate mismanagement.” Although the Court concluded that plaintiffs' failure to allege an actionable misrepresentation was sufficient to dismiss the case, the Court addressed the parties' remaining arguments, including two issues on which the Second Circuit has yet to weigh in, holding that: (1) the exercise of stock options can be considered for the purpose of determining whether an individual's stock sales are sufficient to allege scienter; and (2) a selling shareholder is not a “statutory seller” for purposes of Section 12(a)(2) simply because it signed the registration statement. The Court also held that the selling shareholder was not a “maker” of the allegedly misleading statements and thus could not be held liable under Section 10(b).
In early 2018, the Company launched a strategic rebranding initiative aimed at broadening its appeal and reducing the seasonality of its business model by positioning itself as a year-round wellness program rather than a weight loss program. The Company's previous recruiting strategy depended on getting its “bread and butter customers”—middle-aged, white women—with lapsed membership subscriptions to renew their memberships. As part of its rebranding, the Company announced that it would diversify its customer base by incorporating “a broad-cross section of diversity: age, gender, race, ethnicity, geography and, life stage” and “appeal[ing] to a broader audience who may not have considered . . . the program for them in the past.” As part of its new strategy, the Company departed from its long-standing “formula” of introducing a “meaningful” program innovation at the end of year to motivate potential new subscribers to join the program and, instead, introduced smaller innovations throughout the year. In the summer of 2018, the Company's largest shareholder sold shares in two large public offerings that reduced its holdings from 44% to 22%. Plaintiffs alleged that the Company failed to disclose (1) that its recruiting strategy still relied on recruiting lapsed customers; and (2) that it would not launch a significant program innovation at the end of the year.
The Court rejected each of these claims for failure to allege falsity, explaining that plaintiffs “ignore[d] [the Company's] disclosures.” First, with respect to plaintiffs' allegations that the Company misled investors about its continued reliance on recruiting lapsed members, the Court—pointing to the Company's repeated statements that it would advertise to “both new and returning customers” and that it could “attract new and returning customers efficiently”—held that the Company had merely stated that it was expanding its customer base, not abandoning its existing customer base. Second, with respect to plaintiffs' allegations that the Company misled investors by failing to disclose that it would not release a significant program innovation at the end of the year, the Court found the allegations of falsity lacking because the Company had previously disclosed this shift in strategy. According to the Court, plaintiffs' allegation that the Company's rebranding initiative was ultimately unsuccessful “[wa]s a complaint about strategy, not disclosures as required by securities laws.”
Although this finding could have ended the Court's inquiry, the Court considered the parties' remaining arguments for the “sake of completeness”—including those involving two areas of unsettled law in the Second Circuit. First, the Court examined whether plaintiffs adequately alleged scienter by alleging that the CFO sold 61% of his holdings in the Company during the class period. In contrast, defendants—citing the Company's SEC filings—claimed that the CFO had not sold any shares, but instead had exercised stock options and, as such, began and ended the class period holding the same number of shares in the Company. Defendants argued that the Court should not consider the exercise of these options for the purposes of determining scienter. Alternatively, defendants argued that, if the Court considered the exercise of options, the Court should also take into account the additional options that vested at the end of 2018 and were not sold. Under this approach, the defendants argued that the CFO actually increased his holdings by 18%. The Court noted that whether the exercise of stock options should be considered when calculating stock sales as a percentage of total holdings is an issue on which the Second Circuit has not yet ruled, but noted that most district courts in New York and other Courts of Appeals have held that stock options should be considered in the overall tally. Although the Court appeared inclined to accept defendants' argument, the Court nevertheless explained that it must confine itself to the allegations that the CFO has sold 61% of his holdings and could not rely on the truth of the Company's SEC filings, where the exercise of these options was disclosed. Consequently, the Court concluded that plaintiffs adequately alleged scienter with respect to the CFO.
Second, the Court considered whether the Company's largest shareholder, by signing the registration statements for the offerings, qualified as a “statutory seller” for the purposes of plaintiffs' claims under Section 12(a)(2). Under the Supreme Court decision in Pinter v. Dahl, a defendant is a “statutory seller” if it (1) “passed title, or other interest in the security, to the buyer for value,” or (2) “successfully solicit[ed] the purchase [of a security], motivated at least in part by a desire to serve his own financial interests or those of the securities owner.” Because the Company's largest shareholder had not transferred title, the focus was whether it had “solicited” the purchase of the securities. The Court concluded that merely signing a registration statement does not itself suffice as solicitation: (1) every Circuit Court considering the issue holds that signing a registration statement alone is not sufficient to make an individual a statutory seller; (2) the statutory scheme, which expressly imposes Section 11 liability on those who sign a registration statement but makes no mention of Section 12 liability, “suggests a deliberate choice by legislators to decline to extend Section 12 liability to mere signers of the registration statement”; and (3) the Supreme Court, in Pinter v. Dahl, explained that Congress did not intend to impose liability under Section 12 “for mere participation in unlawful sales transactions.”
Finally, with respect to the Section 10(b) claim, the Court rejected plaintiffs' argument that the Company's largest shareholder was “the maker” of any statement under the Supreme Court's holding in Janus Capital Group, Inc. v. First Derivative Traders. The Court concluded that the shareholder lacked the “ultimate authority” to make the Company's alleged misstatements because (1) the shareholder had only a minority interest in the Company; (2) there was no allegation that the shareholder participated in the preparation of the offering documents; and (3) the shareholder did not actually sign the registration statement (the shareholder's CEO signed the registration statement, but in his capacity as one of the Company's directors).
Originally Published by Shearman & Sterling, December 2020
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