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On January 6, 2023, the Western District of New York denied dismissal of a putative securities fraud class action against a biotechnology company and two of its executives alleging that they made materially false or misleading statements in violation of Rule 10b-5(b) in various SEC filings, which disclosed issues with the company’s accounting practices but failed to mention an ongoing SEC investigation into purported material weaknesses in the company’s internal accounting practices. Noto v. 22nd Century Grp., 2023 WL 122305 (W.D.N.Y. 2023) (Sinatra, J.). The court held that based on defendants’ motive and opportunity to defraud, plaintiffs sufficiently plead scienter against defendants with respect to some of the allegedly false or misleading SEC filings but not others.

Procedural History

After the district court initially dismissed the class action complaint, the Second Circuit vacated the lower court’s dismissal of plaintiffs’ material misrepresentation claims under 10b-5(b), “holding that Defendants had a duty to disclose the SEC investigation because they addressed their accounting weaknesses in their 10-Ks and 10-Qs and, therefore, disclosing the SEC Investigation was necessary to tell the whole truth.” Noto v. 22nd Century Grp., 35 F.4th 95 (2d Cir. 2022).[1] The Second Circuit concluded that “the complaint adequately alleged that defendants violated Rule 10b-5(b) both by first omitting mention of the SEC investigation and then by affirmatively denying its existence.” After remand, defendants sought dismissal, in part, for failure to allege scienter.

Alleged Misrepresentations Could Have Been Motivated By a Desire to Bolster Capital Gained From Specific Stock Offerings 

The court held that plaintiffs alleged sufficient facts to meet the scienter requirement for their 10b-5(b) claims. Citing Tellabs v. Makor Issues & Rights, 551 U.S. 308 (2007), the court stated that the issue is “whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter . . . .” The court explained that “[t]o meet this standard, a plaintiff may allege facts (1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness.” ASTI Commc’ns v. Shaar Fund, 493 F.3d 87 (2d Cir. 2007).

More specifically, “[a]s to motive, a plaintiff must allege concrete benefits that could be realized by one or more of the false statements and wrongful nondisclosure alleged.” Shields v. Citytrust Bancorp, 25 F.3d 1124 (2d Cir. 1994). And as to opportunity under Shields, “a plaintiff must allege the means and likely prospect of achieving concrete benefits by the means alleged.” The court continued that under In re Time Warner Securities Litigation, 9 F.3d 259 (2d Cir. 1993), “potential increases in raised revenue from specific stock offerings establishes a concrete benefit sufficient to establish motive.”

The court determined that plaintiffs alleged sufficient facts indicating that defendants had motive and opportunity to commit fraud with respect to some of the SEC filings.[2] During the period in question, the company executed multiple stock offerings, the last of which was on October 19, 2016. The court concluded that “[a]lleged misrepresentations before this final stock offering could have been motivated by a desire to bolster capital gained from the stock offering.” By contrast, the alleged misrepresentations after that date could not actually affect any specific stock offerings, meaning that they could not have been motivated by a desire to bolster nonexistent future stock offerings. The court concluded that, while defendants were authorized to raise more capital until January 2020, a general authorization to raise more capital (as opposed to a specific stock offering) did not rise to the level of a concrete benefit sufficient to establish motive.