Denny v. Canaan Inc.

Background

Lead Plaintiffs Bill Lu and Liying Huang alleged that Canaan Inc., Nangeng Zhang, and Tong He violated Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 by making materially false or misleading statements about Canaan’s Bitcoin-mining-machine business. They also alleged that Zhang and He were controlling persons liable under Section 20(a) of the Exchange Act. The proposed class consisted of people who purchased Canaan American Depositary Shares between February 10, 2021, and April 9, 2021.

The complaint challenged statements in three publications: a November 30, 2020 press release, a February 10, 2021 press release, and an April 9, 2021 Decrypt article reporting an interview with Zhang. The alleged problems concerned the effect of prepaid orders on Canaan’s fourth-quarter 2020 revenue and whether Canaan had secured enough chips to reduce supply-chain risks. After Canaan released its fourth-quarter and full-year 2020 results on April 12, 2021, its shares closed at $13.14, down from $18.67 at the April 9 close.

Motions and pleading standards

Defendants moved to dismiss the Amended Complaint for failure to adequately plead a materially false or misleading statement and the required state of mind, known as scienter. Securities-fraud claims must meet heightened pleading requirements under Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act. The court also addressed Defendants’ request for judicial notice of documents. It granted that request for Exhibits 1, 4, 6, 7, and 9, and declined to take judicial notice of Exhibits 2, 3, 5, and 8 because it did not need to decide whether to consider them.

Analysis of the Section 10(b) and Rule 10b-5 claims

The November 30, 2020 statements were made before the class period. The court explained that an earlier statement could potentially support liability if a duty to correct or update arose during the class period. But the Amended Complaint did not allege facts showing that Defendants gained the relevant knowledge during the class period. The court therefore held that those statements were not actionable.

The court concluded that the February 10, 2021 press release adequately alleged a misleading omission. The release praised prepaid purchase orders for improving Canaan’s future revenue visibility but allegedly omitted that the same orders had been locked in at prices below later Bitcoin-related market prices, reducing Canaan’s ability to earn more revenue in the fourth quarter of 2020. Because the alleged positive and negative effects came from the same business decision, the court found a sufficiently close connection between the statements and the omitted information. At that stage, the court treated the alleged omission as material to a reasonable investor.

The court nevertheless held that the complaint did not adequately plead scienter for the February 10 statements. The complaint alleged that Zhang and He must have known the effect of the prepaid orders because of their positions, the timing of the statements, the size of Canaan’s revenue decline, the departure of Canaan’s former chief financial officer, and the importance of mining-machine sales to Canaan. The court found these allegations insufficient because the complaint did not identify reports or other statements showing that Zhang or He had access to the specific revenue information before the February 10 release. The former chief financial officer’s resignation, without additional suspicious facts, also did not support a strong inference of scienter. The court further stated that the core-operations theory, even if available, could not independently cure these deficiencies.

As to the April 9, 2021 Decrypt article, the court treated statements attributed to Zhang—including a direct quote and a paraphrased statement—as potentially attributable to him. But it held that the complaint did not adequately allege that those statements were false or misleading. The April 12 statements referred to general supply-chain disruptions or an industry-wide chip shortage and did not establish that Canaan itself had failed to secure chips or reduce supply-chain risks. The complaint also did not adequately identify the extent of any shortage affecting Canaan.

Section 20(a) claims and disposition

Because the court dismissed the Section 10(b) and Rule 10b-5 claims, it also dismissed the Section 20(a) claims against Zhang and He for lack of an underlying violation. The court granted Defendants’ motion to dismiss. It granted Lead Plaintiffs leave to amend because the Amended Complaint was their first complaint. Any Second Amended Complaint had to be filed within thirty days. The court stated that if Lead Plaintiffs did not amend within that period and did not show good cause, it would dismiss the action with prejudice. The opinion did not itself state that the present dismissal was with prejudice.