Wandel v. Gao

Background

Phoenix Tree Holdings Limited, a residential rental company operating in China, held an initial public offering on the New York Stock Exchange in January 2020. Katherine Wandel and Gerard L. Kirkpatrick, acting for themselves and a proposed class, bought Phoenix Tree American Depositary Shares on January 17, 2020.

The amended complaint asserted three claims under the Securities Act of 1933. Count I alleged that all defendants violated Section 11 by issuing registration materials containing material misstatements or omissions. Count II alleged that all defendants violated Section 12(a)(2) through misleading prospectus statements. Count III alleged control-person liability under Section 15 against Phoenix Tree, its officers and directors, Tiger Brokers (NZ) Limited, and the Cogency defendants.

The plaintiffs alleged that Phoenix Tree’s offering documents failed to disclose four categories of information: the company’s exposure to the coronavirus, rising renter complaints, increased returns of upfront payments to lenders during the fourth quarter of 2019, and changes to sales and marketing strategies. The underwriter defendants and the Cogency defendants moved to dismiss. The opinion states that several other defendants, including Phoenix Tree, were not active in the case.

Legal standard

The court applied Federal Rule of Civil Procedure 12(b)(6), which asks whether a complaint alleges enough facts to make a claim legally plausible, while accepting the complaint’s factual allegations as true for purposes of the motions. Sections 11 and 12(a)(2) impose liability for material misstatements or omissions in registration statements and prospectuses, but an omission is actionable only when the issuer had a duty to disclose the information.

The court considered the offering documents as a whole. It explained that the plaintiffs did not need to allege an intent to deceive, but they did need to plausibly allege that the offering documents contained a material misstatement or omission.

Court’s analysis

For the coronavirus allegations, the court treated January 17, 2020—the date the plaintiffs purchased their shares—as the relevant date for evaluating the documents’ accuracy. The court held that the plaintiffs had not plausibly alleged that Phoenix Tree knew, or should have known, by that date that the coronavirus posed a material risk to its business. The court emphasized that only 41 cases had been identified by then, human-to-human transmission had not been confirmed, and the later escalation of the outbreak could not be used as hindsight. The offering documents also warned about the possible effects of epidemics, including SARS and other diseases.

The court rejected the plaintiffs’ argument that Phoenix Tree’s operations and employees in Wuhan showed that the company had special knowledge. The amended complaint did not allege enough about the size or nature of the Wuhan operations or what any employee knew about the threat. The court also did not decide whether Phoenix Tree might have had a duty to update its documents after January 17 for later purchasers, because the complaint identified no such purchasers.

The court also found the other alleged omissions insufficient. The offering documents discussed renter satisfaction, renter complaints, the company’s rental-financing practices, and the risks those practices could create. The documents warned that early lease terminations and missed tenant payments could materially harm the company and explained that fourth-quarter financial information was preliminary because the quarter had ended only two weeks before the offering. The court further concluded that the disclosure that Phoenix Tree had changed its sales and marketing strategies did not mislead investors by failing to identify every specific change.

The court rejected the plaintiffs’ claims based on Items 105 and 303 of Securities and Exchange Commission Regulation S-K. It held that those provisions required plausible allegations that Phoenix Tree actually knew about an undisclosed risk, trend, event, or uncertainty, and the amended complaint did not adequately allege that knowledge.

Because the Section 11 claims failed, the court dismissed the related Section 12 and Section 15 claims, which relied on the same factual allegations. Section 15 control-person liability requires an underlying violation, and the court concluded that no adequately pleaded Section 11 or Section 12 violation remained.

Disposition

Judge Crotty granted the underwriter defendants’ and Cogency defendants’ motions to dismiss and dismissed the amended complaint without prejudice. The court granted leave to amend and permitted the plaintiffs to file a second amended complaint by April 15, 2022, with a blacklined version showing the changes. The order stated that if the plaintiffs did not file a new pleading by that date, the dismissal would be with prejudice. The court directed the clerk to close the two motions.