On September 30, 2020, the United States Court of Appeals for the Second Circuit affirmed the dismissal of a putative securities fraud class action asserting violations of Sections 10(b), 14(a), and 20(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 14a-3, and 14a-9 against a company that provides tax preparation services (the "Company") as well as certain of its officers. In re Liberty Tax, Inc. Sec. Litig., No. 20-652, 2020 WL 5807566 (2d Cir. Sept. 30, 2020). Plaintiffs alleged that the Company made false or misleading statements and omissions concerning its compliance efforts and the termination of its CEO and Chairman, in light of an ongoing internal investigation into allegations that he had engaged in sexual misconduct. The district court dismissed the suit for failure to adequately allege material misrepresentations and loss causation. The Second Circuit, in a summary order, affirmed the district's courts dismissal of the claims for failure to adequately allege any material misrepresentations.
In September 2017, the Company terminated the CEO following an internal investigation, which revealed that he had dated female employees and franchisees, had sex with them in his office, had taken them on business trips, and had hired the friends and relatives of these women. However, the CEO, as the sole owner of the Company's Class B shares, remained Chairman and had the power to appoint the majority of the Company's directors. In November 2017, the CEO removed two directors and, the next day, a third director resigned. Shortly thereafter, a local newspaper published a report chronicling his misconduct. In the wake of the newspaper article, the now former CEO also resigned as Chairman, and the Company publicly confirmed that the newspaper article was based on "credible evidence."
Although the district court dismissed the suit for failure to adequately allege material misrepresentations and loss causation, the Second Circuit focused solely on plaintiff's failure to allege actionable misrepresentations in affirming the dismissal.
First, plaintiffs alleged that the Company made a misrepresentation during a December 2016 quarterly earnings call, when the then CEO announced that the Company's "compliance task force was very successful in analyzing, reviewing, and evaluating the work of our compliance department and taking appropriate action to ensure that the standards of the [the Company's] brand are upheld and that those who do not uphold [these] standards are exited." Plaintiffs alleged that the CEO's statement was misleading because the Company had already hired a law firm to investigate his misconduct, which was inconsistent with his claim that the compliance task force had been "very successful."
After noting that the Company had convened the compliance task force to investigate fraud at franchise locations, which was wholly unrelated to the sexual misconduct allegations, the Court determined that the CEO's statement was mere puffery. Although the Court acknowledged that statements about a company's reputation for ethical conduct can give rise to actionable misrepresentations, the Court found that the CEO's statement was not actionable because: (1) it did not provide any details about the work the task force had actually conducted, and (2) it contained "no qualitative assurances" about the Company's compliance with applicable laws or what it had done to achieve this compliance.
Second, plaintiffs alleged that the Company made a misrepresentation in a September 2017 press release announcing the CEO's termination. Specifically, the Company announced that it "had engaged in a deliberate succession process" that resulted in the appointment of a new COO as an interim step before he would assume the role of CEO, but subsequently "determined that it was in the Company's best interest to terminate [the current CEO]." Plaintiffs alleged that this press release was materially misleading because: (1) it implied that the CEO's departure was the result of a "deliberate succession planning process" rather than sexual misconduct, and (2) it did not disclose that the now former CEO would remain extensively involved in the Company as its Chairman.
The Court was unpersuaded. The Court first pointed out that the press release explained that succession planning was the reason for hiring a new COO, not for terminating the CEO. Second, the Court noted that the press release disclosed that the former CEO retained his Class B shares, which gave him the right to appoint the majority of the Board, and that any agreement to re-purchase the former CEO's shares remained "uncertain."
The Court concluded by rejecting plaintiffs' appeal for leave to amend, finding that nothing in the record could cure the legal deficiencies in plaintiffs' claims.
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