Southern District Of New York Grants In Part And Denies In Part Motion To Dismiss Securities Class Action Against Chinese Grocery Delivery Company
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  • Southern District Of New York Grants In Part And Denies In Part Motion To Dismiss Securities Class Action Against Chinese Grocery Delivery Company

    On November 6, 2023, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York granted in part and denied in part a motion to dismiss a putative securities class action alleging that a Chinese grocery delivery company (the “Company”) violated Sections 11, 12(a), and 15 of the Securities Act of 1933 (the “Securities Act”).  Chen v. Missfresh Ltd., 1:22-cv-09836 (JSR) (S.D.N.Y. Nov. 6, 2023).  The lawsuit followed an announcement of a restatement by the Company, with plaintiffs claiming that the Company’s offering documents in connection with its initial public offering (“IPO”) misled investors about its revenues and sales, internal controls, and the long-term sustainability of its business.  The Court allowed the case to proceed based on the restated financial information but dismissed claims based on alleged misrepresentations relating to the Company’s internal controls and the sustainability of its online business.

    The Company has two main lines of business for grocery delivery.  The first utilizes a “distributed mini warehouse” model to deliver groceries from thousands of small warehouse locations to customers within an hour.  The second offers a wider array of products through a next-day delivery business.  In July 2022, approximately one year after the IPO, the Company announced that it identified certain questionable transactions in its next-day delivery business.  In November 2022, the Company filed its 2021 annual report in which it restated certain financials, identified material weaknesses in its internal controls, and disclosed that it had suspended its next-day delivery business.

    The Court held that plaintiffs alleged a plausible claim based on the restated financial information.  In reaching this conclusion, the Court first rejected defendants’ argument that the restatement had no impact on bottom-line profits and was thus not material because the amount by which revenues were adjusted downward in the restatement was offset by an equal amount of reduced costs.  The Court held that plaintiffs plausibly pleaded materiality for purposes of the motion to dismiss because the 11% restatement of revenues exceeded the 5% materiality benchmark set out by the SEC’s Staff Accounting Bulletin.  The Court also rejected for purposes of the motion to dismiss defendants’ argument that the offering documents sufficiently warned of material weaknesses in internal controls and the possibility of a restatement, observing that the “bespeaks caution” doctrine applies to forward-looking statements rather than historical financial data.  Finally, the Court found that the Company’s negative causation argument that the restatement was followed by a price increase and thus did not cause losses presented factual issues that could not be resolved on a motion to dismiss.

    The Court otherwise dismissed plaintiffs’ claims.  With respect to alleged omissions regarding material weaknesses in the Company’s internal controls, the Court explained that a company is not under an obligation to disclose the “mere existence” of internal control deficiencies.  A plaintiff is also required to plead either that a company has a duty to disclose the deficiencies or that the lack of disclosure rendered another statement misleading.  In this case, the Company was a newly public company that was not required to provide a report or audit of its internal controls under the SEC rules or otherwise.  Additionally, the Company provided a “litany of warnings that made clear” that its measures to remediate previously identified control deficiencies might not be effective, and plaintiffs failed to allege that the offering documents “misleadingly suggested that the subsequently-identified deficiencies did not exist.” (Emphasis in original).  With respect to alleged misstatements regarding the sustainability of the Company’s online business, the Court found that plaintiffs’ allegations were too vague as to the “unsustainable business practices” plaintiffs claimed should have been disclosed.  In any event, plaintiffs failed to allege either that the Company’s business was unsustainable at the time of the IPO or that the Company failed to disclose the risk that its online business might become unsustainable.  To the contrary, the Company provided extensive risk disclosures, including “relating to the neighborhood retail industry,” “the impact of COVID-19” on the Company’s industry, and “the liquidity risk faced by [the Company].”

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