On January 17, 2017, Judge Nicholas G. Garaufis of the United States District Court for the Eastern District of New York dismissed a putative class action asserting claims under Sections 10(b), 14(a), and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5, against a tax preparation services provider (the “Company”) and its former CEO and CFO (collectively, “Defendants”). In re Liberty Tax, Inc. Sec. Litig., No. 2:17-CV-07327 (NGG) (RML) (E.D.N.Y. Jan. 17, 2020). Plaintiffs alleged that Defendants made false and misleading statements and omissions about the Company’s compliance efforts and internal controls, which concealed the CEO’s extensive misconduct that ultimately caused steep declines in the Company’s stock price. The Court dismissed the action on the basis that the statements at issue were unrelated to the CEO’s misconduct or were mere puffery, and that plaintiffs failed to establish loss causation linked to any corrective disclosures.
The complaint, brought on behalf of investors of the Company’s stock, alleged that the Company’s CEO used his position to inappropriately advance his romantic interests, including dating and engaging in sexual relationships with female employees and franchisees, and hiring their friends and relatives for positions at the Company. According to plaintiffs, this misconduct came to light after employees reported the CEO to the Company’s ethics hotline in June 2017. The CEO was terminated in September 2017, and in November 2017, a local newspaper published a report that made public the CEO’s misconduct. Just a few days after the news report, a resigning independent director of the Company penned a letter that stated that the news report was based on “credible evidence.” The Company experienced further turnover in both its board and management, and the accounting firm that served as the Company’s independent auditor also resigned. The Company then suffered steady decline in its stock price. Plaintiffs alleged that the Company’s risk disclosures and statements in SEC filings and on investor calls lauding the effectiveness of its compliance regime concealed the CEO’s misconduct and its detrimental effects on the Company.
The Court dismissed plaintiff’s claims that Defendants had violated Sections 10(b), 14(a) and Rule 10b-5, because plaintiffs had failed to identify any actionable misstatements or omissions. First, plaintiffs contended that the Company’s risk disclosures regarding the CEO’s control over the Company’s board, including that the CEO “may make decisions regarding [the] Company and business that are opposed to other stockholders’ interests” were material misrepresentations, because the conflict of interest was not merely a risk but a present reality. The Court rejected this argument on the basis that the CEO’s control over the board was not related to his misconduct and because the statement was too general for an investor to reasonably reply upon. Second, plaintiffs claimed that the Company’s statements regarding the effectiveness of the disclosure controls and procedures and its commitment to ethics, standards and compliance were material misstatements. The Court disagreed and found that these statements were inactionable puffery. Third, plaintiffs alleged that the Company’s statement that the CEO had been terminated and that the Company “had engaged in a deliberate succession planning” materially represented the true reason for the CEO’s termination. The Court rejected that argument as well, because plaintiffs did not allege the statement’s contemporaneous falsity. Lastly, the Court also rejected plaintiffs’ claims that the Company’s failure to disclose the CEO’s misconduct as a negative trend under Item 303 of Regulation S-K was a material omission. The Court held that the lack of disclosure regarding the CEO’s misconduct did not meet the reporting requirements that the “known trends or certainties” be related to the operational results and that the trend have a “tight nexus” to the Company’s revenue.
The Court also ruled that plaintiffs failed to plead loss causation, because the alleged corrective disclosures did not reveal the truth about any alleged misstatements or omissions. Specifically, the Court was unpersuaded that the 8-Ks that reported on diminished productivity and increased losses and debt were corrective disclosures, finding it significant that the Company had not misstated or omitted any material facts about the Company’s financial performance.
Finally, the Court held that plaintiffs had not sufficiently pled a violation of Section 20(a) against the individual defendants, because they had not pled an underlying violation of any securities law.
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