Kasilingam v. Tilray, Inc.

Background

Ganesh Kasilingam and other purchasers of Tilray common stock sued Tilray, Inc. and Brendan Kennedy under Section 10(b) of the Securities Exchange Act and Securities and Exchange Commission Rule 10b-5. They also sued Kennedy under Section 20(a), which can impose liability on a person who controlled a company that violated the securities laws. Mark Castaneda was no longer named as a defendant in the Second Amended Complaint.

The plaintiffs alleged that, during the proposed class period from January 16, 2019, through March 2, 2020, Tilray and Kennedy inflated Tilray’s stock price by making misleading statements about three subjects: the value of Tilray’s inventory and gross margins, the way labor costs were recorded, and the value of Tilray’s agreement with Authentic Brands Group. Tilray later wrote down its inventory and impaired the value of the agreement, and the plaintiffs alleged that Tilray’s stock price fell after those disclosures.

Procedural Posture and Pleading Standard

The defendants moved to dismiss the Second Amended Complaint under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint states a legally sufficient claim. At this stage, the court generally accepts well-pleaded allegations as true and draws reasonable inferences for the plaintiffs. Because the claims alleged fraud, the plaintiffs also had to plead the circumstances of the alleged fraud with particularity and provide facts supporting a strong inference that the defendants acted with the required fraudulent state of mind, known as scienter.

The defendants asked the court to conduct a broad review of outside materials, including news articles and Securities and Exchange Commission documents. The court declined to use the defendants’ news articles to contradict the complaint and declined to consider several unincorporated, undated, or unsigned Securities and Exchange Commission documents. It stated that further review of those materials could occur at summary judgment, a later stage when the court considers evidence beyond the pleadings.

Inventory Statements

The court held that the plaintiffs plausibly alleged that Tilray overstated the value of inventory that had little or no market value. The allegations included former employees’ descriptions of worthless trim and oils, along with the alleged growth of reported inventory from $16.2 million to more than $110 million before Tilray later wrote down $68.6 million. The court concluded that these allegations plausibly showed that statements describing the inventory and the company’s gross margins were false or misleading when made.

The court also found that the alleged violations of generally accepted accounting principles supported the inventory claim at the pleading stage. It rejected the need to resolve competing accounting views or determine the ultimate truth of the allegations on a motion to dismiss.

Authentic Brands Group Agreement

The court also held that the plaintiffs plausibly alleged that statements about the value and prospects of the Authentic Brands Group agreement were materially false or misleading. The complaint alleged that the agreement was negotiated quickly, was overvalued, and was later impaired by $102.6 million. The court determined that the alleged overvaluation was an objective fact that could support a securities-fraud claim, and that Kennedy’s positive statements could have implied facts about the agreement’s negotiation and prospects that were allegedly untrue.

The court further concluded that a reasonable investor could consider the alleged inventory overvaluation and agreement overvaluation important. It also declined to decide at the pleading stage whether positive statements about the agreement’s long-term relationship and expected benefits were immaterial as a matter of law.

Scienter

The court found that the plaintiffs adequately pleaded scienter as to Kennedy. The complaint alleged that he sold more than $28 million of his Tilray stock during the class period, including a sale of more than $11 million shortly after the Authentic Brands Group agreement was announced and shortly after he had promised not to sell Tilray shares. The court concluded that the timing and size of the sales plausibly suggested a personal benefit from the alleged inflation of Tilray’s stock price.

The defendants argued that Kennedy’s trading plans and other stock sales weakened the inference of fraud. The court rejected those arguments at this stage, reasoning that a trading plan is not automatically a defense when the complaint alleges that the plan was entered close to or during the alleged misconduct. The court also considered allegations concerning Kennedy’s proposed merger objectives and the Smith & Sinclair acquisition, including the alleged personal receipt of proceeds and the later reduction in the value of certain consideration.

Because Kennedy was Tilray’s President and Chief Executive Officer, the court found that the allegations also supported corporate scienter—facts suggesting that a person whose intent could be attributed to the company acted with the required state of mind.

Loss Causation

Loss causation means a required connection between the alleged fraud and the investors’ loss. The court found that the plaintiffs adequately pleaded this connection for the inventory and Authentic Brands Group allegations because they alleged corrective disclosures followed by substantial stock-price declines.

The court reached a different conclusion for the labor-cost allegations. The complaint did not allege that the market learned of the allegedly understated labor costs or that those costs caused a loss. The court therefore found that loss causation was not adequately pleaded for those statements.

Control-Person Liability

The court held that the plaintiffs adequately pleaded Section 20(a) control-person liability against Kennedy. It found that the complaint plausibly alleged a primary violation by Tilray, Kennedy’s control based on his position as President and Chief Executive Officer, and Kennedy’s culpable participation through the same allegations supporting scienter.

Disposition

The court granted the defendants’ motion to dismiss as to the labor statements. It otherwise denied the motion. The order therefore allowed the securities-fraud allegations concerning inventory and the Authentic Brands Group agreement, as well as the Section 20(a) claim against Kennedy, to proceed at that stage.