Chen v. Missfresh Limited

Background

This putative class action concerns Missfresh Limited’s June 2021 initial public offering of American Depositary Shares. Plaintiffs alleged violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 based on alleged misstatements and omissions in Missfresh’s offering documents. The defendants moved to dismiss the amended complaint in its entirety.

Missfresh operated online grocery-delivery businesses using a distributed mini warehouse model and a next-day delivery business. The offering documents reported financial results for the quarter immediately before the offering. After the offering, Missfresh disclosed that those documents overstated first-quarter 2021 sales through online platforms by 11.7% and overall net revenue by 11.4%. Missfresh later disclosed internal-control problems and temporarily suspended both its distributed mini warehouse and next-day delivery businesses.

Plaintiffs challenged three groups of disclosures: (1) the overstated first-quarter financial results; (2) the failure to disclose internal-control weaknesses that later contributed to the accounting restatement; and (3) the alleged failure to disclose that Missfresh’s online-delivery business was fundamentally or potentially unsustainable.

Accounting-restatement claims

The court denied the motion to dismiss the claims based on the misstated financial results. It concluded that the alleged overstatements were sufficiently material to proceed. The 11.7% and 11.4% figures exceeded the 5% quantitative benchmark discussed in Securities and Exchange Commission accounting guidance. The court also emphasized that online-platform sales represented well over 90% of Missfresh’s revenue, that revenue was an important metric in the offering documents, and that the misstated quarter immediately preceded the initial public offering.

The court rejected the argument that the errors were immaterial because corresponding cost errors left gross profits unchanged. It explained that materially overstated revenue may mislead investors even when the effect on reported earnings is offset by overstated expenses. The court also rejected the argument that warnings about possible internal-control problems excused inaccurate historical financial results. Missfresh had an obligation to report its financial results accurately, and cautionary language did not eliminate that obligation.

The court further held that the plaintiffs did not have to establish loss causation at the pleading stage for their Securities Act claims. Although Missfresh’s share price had already fallen substantially and later rose after disclosure of the restatement, the court said whether the disclosures affected the market price was a factual issue. It also explained that the defendants had not shown on the motion to dismiss that the alleged misstatements had no effect on the plaintiffs’ losses.

Internal-control claims

The court granted the motion to dismiss the claims alleging that the defendants failed to disclose internal-control weaknesses. Missfresh had no express obligation to disclose every internal-control problem. The question was instead whether its disclosures about internal controls were misleading without additional information.

The offering documents disclosed one identified material weakness involving insufficient qualified financial-reporting and accounting personnel. They also warned about employee and supplier misconduct, stated that Missfresh had not conducted a comprehensive assessment of its internal controls, and warned that additional weaknesses could be identified and that remedial measures might not be effective.

The court concluded that these disclosures suggested caution rather than confidence in Missfresh’s internal controls. Because the offering documents did not suggest that Missfresh had identified every existing weakness, the plaintiffs had not adequately alleged a duty to disclose the additional weaknesses later found. The court also stated that the plaintiffs did not need to allege that defendants knew about the weaknesses, because knowledge is not required for a Section 11 claim; however, the plaintiffs still had to show that the omission violated a duty to disclose.

Alleged unsustainability of the business

The court granted the motion to dismiss the claims that Missfresh failed to disclose the unsustainability of its online-delivery business. The plaintiffs had not plausibly alleged that the facts underlying the later business shutdowns existed when the offering occurred. The court found that the alleged internal-control problems related to the next-day delivery business and did not explain the shutdown of the distributed mini warehouse business. The amended complaint instead suggested that the distributed mini warehouse shutdown resulted from liquidity problems after an expected investment failed to close.

The court also found that the complaint did not plausibly connect the internal-control problems to the later shutdown of the next-day delivery business. Missfresh continued operating that business for months after the internal-control issues became public, and the cited annual-report language did not state that the internal-control problems caused the shutdown.

The court separately rejected the argument that Missfresh violated Item 105 by failing to disclose the risk that its business model might become unsustainable. The offering documents warned about difficulty managing growth, uncertain prospects for the online neighborhood-retail industry, the risks affecting the distributed mini warehouse business, continuing losses and negative cash flow, liquidity needs, and uncertainty about obtaining financing. The court concluded that these disclosures addressed the potential causes of the later shutdowns identified in the complaint. It also rejected the plaintiffs’ Item 303 argument because they had not plausibly alleged that the alleged unsustainability existed at the time of the offering or that management knew of the relevant trend.

Disposition

Judge Jed S. Rakoff stated that the court’s September 12, 2023 order granted in part and denied in part the defendants’ motion to dismiss. The motion was denied as to the accounting-restatement claims and granted in all other respects.