On March 20, 2018, the United States Supreme Court decided Cyan, Inc. v. Beaver County Employees Retirement Fund, in which it unanimously held that the Securities Litigation Uniform Standards Act of 1998 does not strip state courts of subject-matter jurisdiction over class actions involving claims brought under the Securities Act of 1933 (the “Securities Act”) and does not allow for the removal of those cases to federal court. Since that time, there has been an increase in the number of state court class action lawsuits asserting claims under the Securities Act. Today, we examine one such case, City of Hialeah Employees’ Retirement System v. Teladoc Health, Inc., 2023 N.Y. Slip Op. 50876(U) (Sup. Ct., N.Y. County Aug. 23, 2023) (here).

[Eds. Note: This Blog examined the Supreme Court’s Cyan decision here.]

A Primer on The Securities Act

Following the stock market crash in 1929, Congress enacted the Securities Act and the Securities and Exchange Act of 1934 (the “Exchange Act”).

The Securities Act has two primary objectives: (1) to provide transparency in financial statements so investors can make informed decisions about securities being offered for public sale; and (2) to address misstatements and omissions in the securities markets.

To accomplish these goals, Congress required the disclosure of material information through the registration process. Thus, under the Securities Act, companies that issue securities must file with the Securities and Exchange Commission (“SEC”) a statement (known as a registration statement) that contains the following information: a description of the company’s business, the securities offered to the public, the company’s corporate management structure, and recent audited financial statements.

In addition to the registration statement, issuers are required to file a prospectus. A prospectus is used to market securities to potential investors. The prospectus is included as part of the registration statement.

Registration statements are subject to SEC examination for compliance with disclosure requirements. An issuer cannot make false statements in, or omit material facts from, a registration statement or prospectus. In fact, when a fact is disclosed, the issuer must disclose all information required to make that fact not misleading. This includes all known trends or uncertainties that the registrant reasonably expects will have a material, unfavorable impact on revenues or income from continuing operations,¹ and “material factors that make an investment … speculative or risky.² 

Section 11 of the Securities Act provides securities purchasers a private right of action if any part of a registration statement, when it became effective, “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statement therein not misleading.” A plaintiff bringing an action under Section 11 must establish one of the following bases of liability: “(1) a material misrepresentation; (2) a material omission in contravention of an affirmative legal disclosure obligation; or (3) a material omission of information that is necessary to prevent existing disclosures from being misleading.”⁴ Section 11 “‘imposes strict liability on issuers and signatories, and negligence liability on underwriters,’ for material misstatements or omissions in a registration statement.”⁵ 

To be actionable under Section 11, any misrepresentation or omission must be material. Materiality is an “inherently fact-specific finding.”⁶ A plaintiff demonstrates materiality when there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”⁷ 

Neither accurate statements about past performance, nor expressions of puffery and corporate optimism are actionable under the Securities Act.⁸ 

Unlike a securities fraud under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), a Section 11 plaintiff need not demonstrate “scienter, reliance, or loss causation.”⁹ Nevertheless, a defendant in a Section 11 action will not be liable if it can prove “negative loss causation” – that is, if it can demonstrate that the alleged misstatement or omission did not lead to a decline in the company’s stock price.¹⁰ To sustain this defense, a defendant must establish that “the risk that caused the losses was not within the zone of risk concealed by the misrepresentations and omissions,” or that “the subject of the misstatements and omissions was not the cause of the actual loss suffered.”¹¹ Because Section 11 “allocate[s] the risk of uncertainty to the defendants,” courts have described rebutting loss causation as a “heavy burden.”¹² 

“Section 12(a)(2) provides similar redress where the securities at issue were sold using prospectuses or oral communications that contain material misstatements or omissions.”¹³ Claims under Section 12(a)(2) may be brought against a “statutory seller,” which includes those who successfully solicited the purchase of the security in service of their own financial interests.¹⁴ “[T]he elements of a prima facie claim under section 12(a)(2) are: (1) the defendant is a ‘statutory seller’; (2) the sale was effectuated ‘by means of a prospectus or oral communication’; and (3) the prospectus or oral communication ‘include[d] an untrue statement of a material fact or omit[ted] to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading.’”¹⁵ 

Section 11 imposes “‘virtually absolute’ liability” as to issuers, while other defendants under Sections 11 and 12(a)(2) may be held liable for mere negligence.

Securities Act claims “must be brought ‘within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.’”¹⁶ Under CPLR § 3211(a)(5), defendants bear the “initial burden” to establish that the limitations period has expired and if successful, the “burden then shifts to the plaintiff to raise an issue of fact as to whether the statute of limitations is tolled or otherwise inapplicable.”¹⁷ “In considering [a CPLR § 3211(a)(5) motion], a court must take the allegations in the complaint as true and resolve all inferences in favor of the plaintiff” and give the plaintiff’s responses “their most favorable intendment[.]”¹⁸

City of Hialeah Employees’ Retirement System v. Teladoc Health, Inc.

Background

Teladoc is a securities class action brought on behalf of all persons who purchased or otherwise acquired shares of Teladoc Health, Inc. (“Teladoc” or the “Company”) common stock in connection with Teladoc’s merger with Livongo Health, Inc. (“Livongo”) on or about October 30, 2020 (the “Merger”).

Teladoc is a virtual healthcare company. The Company generates revenue by selling access to the Company’s platform and services to clients, such as large employers or insurance companies. The Company charges clients a subscription access fee on a per-member-per-month basis, where a member is an individual user of the Company’s platform. As alleged, the Company’s subscription access revenue is the primary source of its revenue and is driven primarily by how many clients and members it has under contract, with the majority of its members and subscription access revenue coming from the United States. As such, U.S. membership is one of the most important metrics in assessing the Company’s success and future prospects. 

In August 2020, the Company issued a press release indicating that it had agreed to merge with Livongo in a deal valued at $18.5 billion. The press release provided that pursuant to the terms of the Merger, Livongo shareholders would receive 0.592 Teladoc shares for each Livongo share and following closing, Teladoc shareholders would own 58% and Livongo shareholders would own 42% of the combined Company. The Merger required Livongo shareholder approval.

Plaintiff alleged that the Company continued to report significant U.S. membership growth in the lead up to the Merger and otherwise indicated that there remained a lot of opportunity for continued growth. However, claimed plaintiff, despite these assurances, the Company’s pipeline was virtually depleted, that the rebuilding process would take more than a year following the Merger, and that U.S. memberships would grow as little as 1% in the 18 months following the Merger.

The Company filed a registration statement in connection with the Merger on September 3, 2020; it was declared effective as of September 15, 2020. The Company also filed a joint proxy statement and prospectus on September 15, 2020, incorporating various financial reports and other SEC filings for the Company.

The registration statement did not make any projection about membership growth. The registration statement did, however, make a projection about 2021 revenue. As noted by the motion court, it was “undisputed that the Company met its 2021 projection.”¹⁹

Plaintiff alleged that the registration statement was materially misleading because it failed to disclose that the extraordinary growth in membership tied to the COVID-19 pandemic had been pulled forward to be booked prior to the Merger and that the Company should have disclosed that its pipeline for future membership growth would take more time to rebuild than the market anticipated based on the track record that defendants stated in the registration statement. Thus, plaintiff alleged that investors had a false and misleading picture about the future membership growth and cash flows for the Company.

Plaintiff alleged that, on February 24, 2021 (the “February Disclosure”), the Company issued a press release revealing the Company’s financial results for Q4 2020 and full year 2020 detailing a low membership outlook for 2021. Plaintiff claimed that this negative trend was known by the Company at the time of the Merger and that, as a result of the low membership growth in 2021, the price of the Company’s stock fell substantially. 

Defendants moved to dismiss the complaint on two grounds: the action was time-barred, and plaintiff failed to state a cause of action. The motion court granted the motion.

The Motion Court’s Decision

First, the motion court held that the action was time-barred by the one-year statute of limitations.²⁰ The motion court noted that in “a previously filed lawsuit in [Illinois] (the Illinois Lawsuit), the amended complaint filed by the Plaintiff in that action alleged that the Company … first disclosed the alleged misstatements on January 11, 2021 (the January ‘Bombshell’ Disclosure) during an analyst conference.”²¹ The motion court found that “Plaintiff then waited until January 26, 2022 to file this action.”²² In a footnote, the motion court rejected plaintiff’s argument that “the January ‘Bombshell’ Disclosure … was actually [on] February 24, 2021” and “that the January ‘Bombshell’ Disclosure’ ‘did not include every problem that the [C]ompany disclosed’ or that the disclosures [did] not perfectly match the Plaintiff’s allegations.”²³ The motion court concluded that “[w]hat matters is that this Plaintiff previously admitted that the January ‘Bombshell’ Disclosure disclosed the basis upon which the [registration statement] was allegedly misleading and they did not proceed to prosecute this action within the statute of limitations period provided for by the United States Congress.”²⁴ Since there was no tolling agreement entered into between the parties and plaintiff was not entitled to class action tolling, the lawsuit was dismissed.²⁵

Second, the motion court held that even if timely, plaintiff failed to state a claim.²⁶ In that regard the motion court found that plaintiff failed to “allege a material misstatement of fact.”²⁷ The motion court explained that the “complaint [was] predicated on the theory that the Registration Statement … was materially misleading because the defendant Company … failed to disclose, in connection with [the Merger] … that a surge of membership growth occasioned by the COVID-19 pandemic had been pulled forward prior to the [M]erger and, because the [registration statement] indicated that membership growth was important to the Company’s revenue growth, the [registration statement] should have disclosed that the pipeline for membership growth was to be truncated for the next year — 2021.”²⁸ “The problem,” said the motion court, was that the registration statement “did disclose the effects of the COVID-19 pandemic and did not otherwise make any projection about membership growth.”²⁹ “In fact,” said the motion court, the registration statement “set forth historical data, made other accurate statements, and made a 2021 revenue projection which projection the Company met.”³⁰

“In addition,” noted the motion court, “the record … indicate[d] that the Company did disclose that it had pulled forward its surge in membership in other filings, and that this was in fact discussed on, among other things, an earnings call on April 29, 2020 … — approximately five months before the September, 2020 [registration statement] was issued and approximately six months before the October 2020 [M]erger was consummated.” “Thus,” concluded the motion court, “it can not [sic] be said that the failure to disclose the timeline for growth in membership was material or would have otherwise affected the ‘total mix of information’ available to investors.”³¹ 

Finally, the motion court rejected plaintiff’s argument that information from other sources could not be incorporated into the registration statement, finding that the complaint made “clear that membership did not decline. It had surged during the pandemic to 51.5 million members in a six-month period at the beginning of 2020 and it remained at 51.8 million at the end of 2020….”³² “Thus,” concluded the motion court, “it [did] not matter that the [registration statement] disclaimed that investors could not rely on information not incorporated into the [registration statement (as registration statements typically provide) because this alleged omission of interim membership rate growth and membership pipeline activity was not material and [was] simply not actionable.”³³

Footnotes

1. Item 303, 17 C.F.R. § 229.303. See also Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 716 (2d Cir. 2011).
2. Item 105, 17 C.F.R. §229.105. See also Citiline Holdings, Inc. v. iStar Financial Inc., 701 F. Supp. 2d 506, 514 (S.D.N.Y. 2010).
3. 15 U.S.C. § 77k(a).
4. Hutchison v. Deutsche Bank Sec. Inc., 647 F.3d 479, 484 (2d Cir. 2011).
5. Fed. Hous. Fin. Agency for Fed. Nat’l Mortg. Ass’n v. Nomura Holding Am., Inc., 873 F.3d 85, 99 (2d Cir. 2017) (quoting, NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 156 (2d Cir. 2012)).
6. Basic Inc. v. Levinson, 485 U.S. 224, 236 (1988).
7. Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000) (quoting, Basic, 485 U.S. at 231-32).
8. In the Matter of Netshoes Sec. Litig., 64 Misc. 3d 926 (Sup. Ct., N.Y. County 2019); Nadoff v. Duane Reade, Inc., 107 Fed. App’x 250, 252 (2d Cir. 2004).
9. In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir. 2010).
10. See 15 U.S.C. § 77k(e) (“[I]f the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from [the alleged misstatement or omission], such portion of or all such damages shall not be recoverable.”).
11. Fed. Hous. Fin. Agency, 873 F.3d at 154 (alterations and internal quotation marks omitted).
12. Akerman v. Oryx Commc’ns, Inc., 810 F.2d 336, 341 (2d Cir. 1987).
13. Morgan Stanley, 592 F.3d at 359 (citing, 15 U.S.C. § 77l(a)(2)).
14. Id.
15. Id. (quoting 15 U.S.C. § 77l(a)(2)).
16. Netshoes, 64 Misc. 3d at 933 (quoting, 15 U.S.C. §77m).
17. Id. at 930.
18. Benn v. Benn, 82 A.D.3d 548, 548 (1st Dept. 2011).
19. Slip Op. at *2.
20. Id. at **1, 4.
21. Id. at *1.
22. Id.
23. Id. at n.1 (citations omitted). See also id. at *4.
24. Id. (citation omitted).
25. Id. at **1 and 4 (citing, American Pipe & Const. Co. v. Utah, 414 U.S. 538, 553-555 (1974)).
26. Id. at **1 and 5.
27. Id. at *1.
28. Id.
29. Id.
30. Id.
31. Id. (citations omitted).
32. Id.
33. Id. See also id. at *5.