Garnett v. Wang

Background

Alex Garnett filed a proposed class action on behalf of purchasers of RLX Technology Inc.’s American Depositary Shares issued in connection with RLX’s January 22, 2021 initial public offering. The complaint named RLX; certain RLX officers and directors; Cogency Global Inc., RLX’s designated U.S. representative; and Citigroup Global Markets Inc. and China Renaissance Securities (Hong Kong) Limited, the IPO underwriters.

The plaintiffs asserted strict-liability claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. They alleged that RLX’s registration statement and prospectus misleadingly described China’s regulatory environment for e-cigarettes and failed to disclose that Chinese regulators were preparing to regulate e-cigarettes under the same framework as traditional tobacco products. The plaintiffs also alleged that the Offering Materials understated the resulting risks to RLX’s financial condition and prospects. After Chinese regulators posted draft regulations on March 22, 2021, RLX’s share price fell from $19.46 to $10.15 per share.

A subset of defendants moved to dismiss the Second Amended Complaint under Federal Rule of Civil Procedure 12(b)(6), which permits dismissal when a complaint does not state a legally sufficient claim. The court stated that it would accept well-pleaded factual allegations as true for purposes of the motion and draw reasonable inferences for the plaintiffs.

Sections 11 and 12(a)(2)

The court held that the plaintiffs did not plausibly allege an actionable misstatement or omission. Reviewing the Offering Materials as a whole, the court found that they disclosed existing Chinese restrictions on e-cigarettes, the possibility that China would impose stricter regulation, the uncertainty of the regulatory environment, and the potential for regulation to harm RLX’s business, revenues, and financial condition.

The court rejected the plaintiffs’ argument that RLX was required to disclose that regulation of e-cigarettes as traditional tobacco products was inevitable or imminent. The Chinese regulatory statements cited in the complaint showed an inclination toward increased regulation, but they described an ongoing study and consultation process and did not establish that the final form or timing of regulation was certain. The court also found that the Offering Materials did not need to specifically cite each regulatory communication because the broader disclosures were not misleading without those citations.

The court gave three additional reasons supporting dismissal of the allegations concerning the prospect of enhanced regulation. First, the relevant regulatory statements were already in the public domain and were therefore part of the information available to investors. Second, the Offering Materials’ warnings about possible stricter regulation sufficiently addressed the risk that later materialized under the doctrine protecting forward-looking statements accompanied by adequate cautionary language. Third, RLX was not required to speculate about future regulation or its potential effects.

The court likewise rejected the claim that RLX misleadingly presented its financial condition and prospects. That theory depended on the same unsupported premise that regulation treating e-cigarettes like traditional tobacco products was a foregone conclusion at the time of the IPO. The court also held that statements describing RLX as an industry leader or expressing optimism about its future were protected corporate optimism, particularly because the Offering Materials repeatedly warned that regulatory changes could materially harm RLX.

The court dismissed the claims based on Item 105 and Item 5(D) of Form 20-F. Item 105 requires disclosure of material factors making an investment risky, while Item 5(D) requires certain foreign issuers to discuss known trends and uncertainties likely to materially affect their financial condition or results. The court found these claims redundant of the rejected Securities Act disclosure claims and concluded that the Offering Materials adequately disclosed the existing regulations, regulatory trends, uncertainty, and potential financial consequences.

Section 12(a)(2) standing and statutory sellers

The court separately held that the plaintiffs lacked statutory standing to pursue their Section 12(a)(2) claims because the complaint did not allege that they purchased shares directly from defendants in the IPO. The complaint said that the lead plaintiffs purchased shares “pursuant and traceable to” the registration statement and IPO, but did not allege when or from whom they purchased. Their certifications showed purchases after the IPO and at prices different from RLX’s $12.00 offering price.

The court rejected, as an additional basis for dismissal, the argument that Colleen A. DeVries and Cogency Global Inc. could not be statutory sellers. A statutory seller is generally a person or entity that transferred the security for value or successfully solicited its purchase for a financial interest. The allegations that DeVries reviewed, contributed to, and signed the registration statement and solicited investors were sufficient at the pleading stage to prevent dismissal on that ground alone. The allegations against Cogency depended on DeVries’s alleged conduct and relationship with the company.

Section 15

The court dismissed the Section 15 control-person claim because that claim depended on an underlying violation of Sections 11 or 12(a)(2), and the court found no viable primary securities-law violation.

Disposition

Judge Engelmayer granted the motion to dismiss the Second Amended Complaint. The dismissal was with prejudice. The court stated that the deficiencies applied equally to claims against Ying (Kate) Wang, Long (David) Jiang, Yilong Wen, and Yueduo (Rachel) Zhang, who had not been served, and dismissed the complaint as to those defendants as well. The court directed the Clerk of Court to close the pending motions and the case.