Lian v. Tuya Inc.

Background

Lead Plaintiffs Kyle Nelson and Jiyi Qiu, together with Plaintiff Xiaomeng Lian, brought claims under Sections 11 and 15 of the Securities Act of 1933 concerning Tuya Inc.’s March 2021 initial public offering of American Depositary Shares. Section 11 addresses material misstatements or omissions in a securities registration statement. Section 15 imposes control-person liability on a person who controls someone liable under Section 11.

Plaintiffs alleged that Tuya’s registration statement failed to disclose a fake-review scheme allegedly involving a material percentage of Tuya’s e-commerce customers. They claimed that those customers’ practices violated Amazon’s policies and created a substantial risk that Amazon would ban them, harming Tuya’s sales and business prospects. The Section 11 claim named Tuya, the Individual Defendants, and the Underwriter Defendants. The Section 15 claim named the Individual Defendants.

Motion to dismiss

All Defendants joined a motion under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint states a legally sufficient claim. The court accepted the complaint’s factual allegations as true for purposes of the motion but did not accept unsupported legal conclusions.

Item 303 claim

Plaintiffs alleged that the fake-review scheme was a known trend or uncertainty that Tuya had to disclose under Item 303 of Securities and Exchange Commission Regulation S-K. The court held that Item 303 requires allegations supporting a plausible inference that the issuer actually knew of the relevant trend or uncertainty when the registration statement was issued.

The court found that Plaintiffs’ allegations about public reports of fake reviews did not connect those reports to any particular Tuya customer. The complaint did not allege that the reports identified Tuya or its customers, and it did not provide facts showing that Tuya’s founders’ prior employment at Alibaba gave them specific knowledge of fake reviews among Tuya’s customers. The court therefore dismissed the Section 11 claim to the extent it was based on Item 303.

Item 105 claim

Plaintiffs also alleged that Tuya failed to disclose the fake-review scheme as a material investment risk under Item 105 of Regulation S-K. The court adopted the view that an Item 105 claim requires the issuer to know about the relevant risk factor at the time of the offering.

Because Plaintiffs had not adequately alleged facts supporting an inference that Tuya actually knew about the fake-review scheme, the court granted Defendants’ motion to dismiss the Section 11 claim insofar as it was based on Item 105.

Other registration-statement statements

Plaintiffs alleged that the failure to disclose the fake-review scheme made five categories of statements misleading: statements about Tuya’s customer relationships; its ability to gain customers and increase adoption; the reasons for its success; its sales and marketing efforts; and risks involving customer reviews.

The court rejected Defendants’ general argument that Plaintiffs had not shown why Tuya could or should have known information held by third parties. The court explained that Section 11 does not require an issuer to have known, or reasonably should have known, the omitted fact, although the fact must have been knowable. The court stated that Defendants had not adequately developed an argument that the fake-review scheme was unknowable.

Net Promoter Score

Tuya’s registration statement reported a January 2021 Net Promoter Score of 75 and described that score as indicating a high degree of customer satisfaction. Plaintiffs alleged that the statement was misleading because it did not mention the fake-review scheme. Plaintiffs did not address Defendants’ argument about this theory in their opposition brief and confirmed at oral argument that they were no longer pursuing it. The court therefore granted the motion to dismiss the Section 11 claim to the extent it was based on the Net Promoter Score statements.

Risk warnings

Defendants argued that the registration statement warned investors about the possibility of losing customers, reduced customer usage, negative publicity, and negative customer feedback. Plaintiffs argued that those warnings did not disclose the more specific risk of customers using fraudulently positive reviews and then facing enforcement action by Amazon.

The court denied the motion on this ground. It held that the cited warnings did not specifically address the risk alleged by Plaintiffs. General warnings about losing customers and negative publicity did not necessarily warn investors that customers might be involved in fake-review practices and might be banned by Amazon. Viewing the disclosures together and drawing reasonable inferences for Plaintiffs, the court concluded that the registration statement plausibly focused investors on different risks.

Section 15 claim against Immelt

Defendants separately challenged the Section 15 claim against Jeff Immelt, arguing that the complaint did not adequately allege that he exercised actual control over Tuya. The court explained that a Section 15 claim requires a primary violation by a controlled person and control by the defendant over that person. Being a director, by itself, is not enough to establish control.

The complaint alleged that Immelt became a Tuya director, had joined New Enterprise Associates as a venture partner, had previously served as General Electric’s chairman and chief executive officer, consented to being named as a director in the registration statement, and participated in soliciting and selling Tuya securities. The court held that these allegations did not show that Immelt had the power to direct Tuya’s management and policies. It therefore granted Defendants’ motion to dismiss the Section 15 claim against Immelt.

Disposition and amendment

The court granted in part and denied in part Defendants’ motion to dismiss. It granted the motion with respect to the Section 11 claims based on Items 303 and 105, the Net Promoter Score statements, and the Section 15 claim against Immelt. The motion was otherwise denied.

The court also granted Plaintiffs leave to file a second amended complaint addressing the identified pleading deficiencies. The court stated that any second amended complaint had to be filed within thirty days of the Opinion and Order. Judge John P. Cronan signed the order on March 5, 2024.