/>iIn monitoring recently issued court opinions touching on securities law, we came across one that was particularly interesting because of its potential practical implications in the context of companies responding to SEC comment letters. Any company that has received an SEC staff comment letter related to its disclosures understands that there could be any number of reasons for the company’s decision on how to respond to a given SEC comment. However, the Ninth Circuit’s recent panel opinion in Pino v. Cardone Capital, LLC, suggests that a company’s lack of pushback to an SEC comment may evidence the company’s state of mind for purposes of evaluating potential liability under Section 12(a)(2) of the Securities Act.
Background
Pino is a putative class action alleging that the defendant knew the falsity of opinions it stated to prospective investors while marketing a Regulation A offering in which the plaintiff retail investor purchased interests in real estate investment funds. The plaintiff sued the investment funds, their management entity, and the manager’s founding executive, alleging violations of Section 12(a)(2) due to misstatements and omissions made by the executive on social media to prospective investors around the time of the offering. The complaint primarily alleged that defendants made misleading opinion statements on social media regarding the projected IRR the funds would achieve. Specifically, the executive allegedly boasted on Instagram that investors could double their money and told viewers on YouTube:
[Y]ou’re gonna walk away with a 15% annualized return. If I’m in that deal for 10 years, you’re gonna earn 150%...You can tell the SEC that’s what I said it would be…some people call me Nostradamus, because I’m predicting the future dude, this is what’s gonna happen.
The complaint also alleged that defendants’ social media communications to would-be investors contained misleading omissions by failing to disclose a letter from the SEC to the company asking it to remove the IRR and distribution projections from the Regulation A offering circular on the basis that the projections lacked backing.
The district court granted defendants’ motion to dismiss. Plaintiff appealed to the Ninth Circuit, which reversed.
Ninth Circuit Analysis
Section 12(a)(2) of the Securities Act provides a cause of action where securities are offered or sold using prospectuses or oral communications that contain material misstatements or omissions. The Ninth Circuit panel noted that plaintiff’s Section 12(a)(2) claim regarding defendants’ social media statements must adequately plead “subjective falsity,” meaning under Omnicare that “the speaker did not hold the belief [he] professed.”
In determining that plaintiff adequately pled subjective falsity, the panel placed particular emphasis on the SEC comment letter process relating to the funds’ Regulation A offering statement:
Pino’s allegation of Cardone’s subjective disbelief is both strong and reasonable: Cardone made a projection of 15% IRR and relatedly high distributions in its initial offering circular. The SEC reviewed the offer and in a letter to Cardone stated these projections lacked backing and should be removed. Cardone pushed back on other criticisms from the SEC, but not this one, suggesting Cardone did not truly believe its own projections and lacked evidence to rebut the SEC. [Emphasis added.] Even so, Cardone continued to repeat the IRR and distribution projections in other communications to would-be investors on social media.
That is, in the panel’s view, in acquiescing without objection to the SEC’s challenge to the offering statement disclosure about IRR projections, defendants plausibly could be alleged to have conceded the subjective falsity of their social media statements on the same topic:
We acknowledge that the SEC’s letter itself did not take a position on the subjective belief or objective falsity of the projections. But Cardone’s telling reaction to the SEC letter — removing the projections without any rebuttal or comment — evinces Cardone’s subjective disbelief. Construing the facts in the light most favorable to Pino plausibly supports the claim that Cardone did not believe these projections in the first place.
For reference, the exchange below is what we believe the Ninth Circuit is referencing.
“We note your disclosure on page 17 and throughout the offering statement that references your strategy to pay a monthly distribution to investors that will result in a return of approximately 15% annualized return on investment. We further note you have commenced only limited operations, have not paid any distributions to date and do not appear to have a basis for such return. Please revise to remove this disclosure throughout the offering statement.”
“We have removed the references on pages 17, 26, and 32.”
Perhaps just as interestingly, the Ninth Circuit panel found that plaintiff had plausibly pled a Section 12(a)(2) violation on the basis that defendants’ social media communications did not mention the SEC comment letter, thus constituting under Omnicare a material omission of which the purchaser was not otherwise aware. The panel in this connection rejected defendants’ argument that the availability of the relevant SEC correspondence on EDGAR meant that plaintiff in fact had constructive knowledge of the alleged material omission; instead, the panel ruled that only a plaintiff’s actual knowledge of an omission can defeat a Section 12 claim.
Revisiting Tandy Representations and the Titan Report
Reading this case, we can’t help thinking about the old “Tandy” representations. Beginning in the mid-1970s, the SEC staff began to include in filing review comment letters what became known as “Tandy” language, a name derived from the Tandy Corporation, the first company to receive a letter containing this language. Tandy letters required a company to acknowledge in writing that the disclosure in the document was its responsibility and to affirmatively state that it would not raise the SEC review process and acceleration of effectiveness as a defense in any legal proceeding. (Emphasis added.) In 2004, the staff announced a new policy to release to the public most filing review correspondence without requiring a request for it under the Freedom of Information Act. In connection with this announcement, the staff also indicated that it would begin to include Tandy language in comment letters relating to all disclosure filing reviews. In October 2016, the Staff changed its policy and now no longer requires these representations. Instead, the Staff includes this statement in its comment letters:
We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff.
The Pino opinion suggests that, depending on the circumstances, a company may want to consider including a statement in its comment letter response that is effectively the obverse of a Tandy representation — that is, a statement to the effect that the company’s response to any particular comment should not be construed as indicating the company’s agreement with the comment. In other words, while Tandy said that the company would not use the SEC review process as a shield in a legal proceeding, Pino entailed the plaintiff using the SEC review process as a sword, and companies may wish to consider defending themselves preemptively from that risk.
The idea of a company preemptively including disclaimer language to defend itself from potential disclosed-based claims has some historical precedent, in the form of market practice that developed from the SEC’s Titan Report. That 2005 publication warned that representations and warranties in publicly filed merger agreements can be considered investor disclosures and thus subject to anti-fraud liability if materially misleading. Subsequent to the Titan Report, companies began including disclaimer language to investors about the representations and warranties in a negotiated merger agreement. Below is an example from a recent 8-K:
The Merger Agreement has been attached to provide investors with information regarding its terms. It is not intended to provide any other factual information about [_______], Merger Sub or the Company. In particular, the assertions embodied in the representations and warranties contained in the Merger Agreement are qualified by information in a confidential disclosure letter provided by the Company to [_______] in connection with the signing of the Merger Agreement or in filings of the parties with the United States Securities and Exchange Commission (the “SEC”). This confidential disclosure letter contains information that modifies, qualifies and creates exceptions to the representations and warranties and certain covenants set forth in the Merger Agreement. The representations, warranties and covenants contained in the Merger Agreement were made only for purposes of the Merger Agreement and as of specific dates, were solely for the benefit of the parties to the Merger Agreement, are subject to limitations agreed upon by the parties to the Merger Agreement and are subject to standards of materiality applicable to the parties that differ from those applicable to investors. Information concerning the subject matter of representations and warranties may change after the date of the Merger Agreement, which subsequent information may or may not be fully reflected in [_______]’s or the Company’s public disclosures. Moreover, the representations and warranties in the Merger Agreement were used for the purposes of allocating risk between [_______] and the Company rather than establishing matters of fact. In addition, investors are not third-party beneficiaries under the Merger Agreement. Accordingly, the representations and warranties in the Merger Agreement should not be relied on as characterization of the actual state of facts about [_______], Merger Sub or the Company.
Takeaways
Since virtually all public companies are subject to SEC review and comment on their ’33 and ’34 Act filings, we believe the concept underlying Pino (i.e., the idea that a plaintiff can get Section 12(a)(2) mileage from a company’s decision not to fight an SEC comment) should be considered by companies and their counsel when they are preparing an SEC response letter. While the statements at issue in Pino related to projections, it isn’t difficult to extend the concept to other more customary items subject to SEC comment, such as non-GAAP financial measures, contingencies disclosures, and revenue recognition, among others. Depending on the context, companies may want to consider whether it is appropriate to include some additional disclosure in the response letter when the company’s response (or lack thereof) could be used against them by a plaintiff searching for evidence to support a Section 12(a)(2) or similar claim.
