On December 4, 2020, the Cheesecake Factory Incorporated (the “Cheesecake Factory”) agreed to pay a $125,000 civil penalty to settle Securities and Exchange Commission (“SEC”) allegations that the company’s March 23, 2020 and April 3, 2020 Forms 8-K contained material misstatements concerning COVID-19’s impact on its business.
In its order instituting cease-and-desist proceedings under Section 21C of the Securities Exchange Act of 1934 (“Exchange Act”), the SEC alleged that Cheesecake Factory’s disclosures between March and April 2020 did not sufficiently inform its investors regarding “the extent of COVID-19’s impact on the company’s operations and financial condition.” The SEC explained that, by late March, the Cheesecake Factory had taken “steps to conserve cash and increase liquidity in the near-term,” including by informing landlords that it would not be paying April rent, and by securing a $90 million line of credit. The company thereafter sought additional liquidity through further loans or private-equity funding to the tune of $100 million.
The Cheesecake Factory purportedly disclosed its concerning cash position in presentations to potential lenders and investors, projecting that it had enough cash to sustain only sixteen weeks of operations. But in its Form 8-K, dated March 23, 2020, the Cheesecake Factory attached a press release of the same date, noting that its current operations were “sustainabl[e],” and did not disclose that it was “experiencing a negative cash flow rate of $6 million per week,” or that it would not be paying April’s rent. Additionally, on April 3, 2020, the company filed a second Form 8-K, which again indicated that “the restaurants [we]re operating sustainably,” and did not disclose the company’s negative cash rate or that it had only sixteen weeks of cash on hand. The SEC claimed that the above omissions caused the company’s 8-Ks to be materially misleading — a violation of Section 13(a) of the Exchange Act and SEC Rules 13a-11 and 12b-20.
The Cheesecake Factory opted to cooperate with the SEC in its investigation. The SEC cited this cooperation when imposing its sanctions, which included — on top of the civil penalty of $125,000 — an order to refrain from further Exchange Act violations. The SEC sanctions for misleading COVID disclosures are the first of its kind for a public company.
New York State Appellate Court Dismisses Putative Securities Act Class Action On Merits For First Time Since 2018 U.S. Supreme Court Cyan Decision
On December 3, 2020, in Lyu v. Ruhnn Holdings Ltd. et al., the New York State Appellate Division, First Judicial Department, unanimously reversed a lower-court decision that held that claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (“Securities Act”) stated a claim for relief against Ruhnn Holdings Limited (“Ruhnn”) and its Initial Public Offering (“IPO”) underwriters, and dismissed the putative class action complaint in its entirety. The case represents the first time a New York state appellate court has addressed the merits of a Securities Act claim since the U.S. Supreme Court’s decision in Cyan v. Beaver County Employees Retirement Fund, which held that Securities Act claims could be brought in state court.
The state suit stemmed from allegations that Ruhnn, a Chinese company providing an e-commerce and marketing platform for online influencers, failed to disclose in its offering materials that the company had closed nearly 40% of its self-owned online store platforms in the months leading up to its April 2019 IPO. The lower court allowed the claims to proceed, holding that the proposed class had adequately stated a Securities Act claim.
However, in a two-page summary opinion, the appellate court reversed the lower court holding, because Ruhnn fully disclosed that it was “shifting” away from a “full service” model of operating its own online stores toward a “platform” model (where Ruhnn would facilitate use of third-party platforms) and, thus, the failure to include the store-closure data in Ruhnn’s prospectus did not materially “alter the total mix of information” available to its investors.
Since Cyan, Securities Act defendants find themselves vulnerable to duplicative proceedings brought in parallel lawsuits in state and federal court. Plaintiffs are increasingly filing Securities Act lawsuits in state courts because they are generally considered more plaintiff-friendly. In fact, published statistics suggest that federal courts dismiss a higher percentage of Securities Act cases than state courts. Since 2018, New York has experienced a relatively high volume of Securities Act filings in its state courts.
Though it is too early to tell whether Ruhnn will have an impact on the current trend of state filings, the appellate decision is still an important demonstration that not all such lawsuits will survive a motion to dismiss.
Goodwin Secures Third Circuit Victory In Securities Class Action Against Former Officers And Directors Of Lionbridge Technologies
On December 2, 2020, in Laborers’ Local No. 231 Pension Fund v. Rory J. Cowan et al., the Third Circuit Court of Appeals affirmed summary judgment in favor of several former officers and directors of Lionbridge Technologies, Inc. (“Lionbridge”) in a securities class action arising out of H.I.G. Capital, LLC’s (“HIG”) acquisition of Lionbridge, a software company specializing in language translation. The Third Circuit also affirmed the denial of plaintiff’s motion to amend the complaint to add additional purported omissions to plaintiff’s claims. Lionbridge’s former officers and directors are represented by Goodwin.
The case related to Lionbridge’s January 31, 2017 proxy statement disclosures regarding the Lionbridge Board of Directors’ (the “Board”) approval of a merger agreement with HIG in December 2016. In that proxy, the Board approved and recommended the proposed sale, in part, because Lionbridge’s financial advisor issued an opinion finding that the proposed sales price was fair. The proxy statement disclosed that the fairness opinion was based on “certain financial projections provided” by the company, while also noting that shortly before Lionbridge’s financial advisor provided the opinion, the company had changed the projections upon which the advisor relied. Lionbridge shareholders subsequently and overwhelming approved the merger.
In April of 2017, a former Lionbridge shareholder initiated the action, and a year later filed a second amended complaint alleging that defendants made material misstatements in its proxy statement by stating, among other things, that the directors believed the financial advisor’s fairness opinion to be a “positive reason” favoring the merger, in violation of Sections 14(a) and 20(a) of the Exchange Act and SEC Rule 14a-9. Plaintiff claimed this statement was materially misleading because (i) the fairness opinion was based, in part, on projections that omitted the possibility of future acquisitions by Lionbridge, and (ii) the proxy allegedly did not disclose this fact. The United States District Court for the District of Delaware granted defendants’ motion to dismiss only in part, allowing the claims to proceed as to a single statement in the proxy — i.e., that the fairness opinion was a “positive reason” for approval of the merger.
At the end of lengthy discovery — including more than ten depositions of former directors and officers — plaintiff sought to amend the complaint yet again to add additional alleged omissions concerning the fairness projections whilst defendants moved for summary judgment. The district court denied plaintiff’s motion to amend as futile, and granted summary judgment in favor of defendants. Plaintiff appealed both decisions to the Third Circuit Court of Appeals.
The Third Circuit affirmed the district court’s grant of summary judgment concerning defendants’ statement that the fairness opinion was a “positive reason” for approving the HIG buyout because the proxy “unambiguous[ly]” stated that the projections did not account for future acquisitions. Specifically, the proxy disclosed that: “[T]he forecasts do not take into account any circumstances, transactions or events occurring after the dates on which the forecasts were prepared.” Thus, the court concluded that there was no factual omission in the proxy statement about the fairness opinion that could have rendered it materially misleading.
Meanwhile, in affirming the denial of the motion to amend as futile, the Third Circuit held that, under established circuit precedent, such projections could not be false and misleading because they were not included “as an estimate of Lionbridge’s future performance, but rather solely to provide shareholders with the same information that had been provided to the Special Committee, the Board, and the [financial advisor].” Moreover, the projections were “expressly disclaimed” in the proxy statement, which contained language (i) noting that the projections were not included to influence stockholders’ decisions, (ii) clarifying that the projections were not predictive of future events, and (iii) explaining that shareholders should not rely on the projections.
Hemp Inc. And Ceo Sign Consent Decrees Settling Long-Running Sec Lawsuit Over Unregistered Securities
On December 3, 2020, in U.S. Securities & Exchange Commission v. Hemp Inc. et al., Hemp Inc. (“Hemp”) and its CEO Bruce Perlowin signed consent decrees to settle a 5-year old SEC civil lawsuit alleging that the company fraudulently sold unregistered securities through a network of shell companies.
In 2016, SEC brought the lawsuit in the U.S. District Court of the District of Nevada, alleging that Hemp, an industrial hemp company, and its CEO schemed to illegally sell unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act. Specifically, SEC alleged the existence of a “long-running and profitable scheme” that “resulted in the sale of hundreds of millions of unregistered and purportedly unrestricted Hemp shares to public investors,” which involved fake “gifts and consulting agreements” as well as “fraudulent statements made to [SEC]-registered broker-dealers.” As to Perlowin specifically, the SEC alleged that he directed hundreds of millions in Hemp shares to various shell companies so they could then sell those purportedly unrestricted shares “under the guise of being non-affiliates.” According to SEC, the scheme was an effort “to remove the registration restriction and sell the shares to public investors to obtain funding for Hemp and  Perlowin.”
The December 3, 2020 consent orders provide that, on SEC’s motion, the court will determine whether it is “appropriate to order disgorgement of ill-gotten gains and/or a civil penalty” and the amount “of the disgorgement and/or civil penalty.” None of the companies or individuals named, however, either admitted or denied the SEC’s allegations. Nevertheless, Hemp has publicly announced that Perlowin will be replaced as CEO. He is currently transitioning to the newly created role of Chief Visionary Consultant.
David R. Callaway