On December 3, 2020, the Supreme Court of the State of New York, Appellate Division, First Department, reversed a decision and order of the Commercial Division of the Supreme Court of the State of New York, County of New York, and dismissed in its entirety a putative securities class action against a Chinese defendant-issuer, Ruhnn Holdings Ltd. (“Ruhnn”), certain individuals and the offering’s underwriters. In this case, titled Lyu v. Ruhnn Holdings Ltd., No. 2020-02555, 2020 WL 7062118 (N.Y. App. Div. Dec. 3, 2020), a First Department panel unanimously held that the plaintiffs’ complaint alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 (“1933 Act”) should be dismissed because the alleged omissions in Ruhnn’s offering materials issued in connection with its initial public offering did not significantly alter the total mix of information made available to a reasonable investor.1
Proceedings in the Trial Court
Ruhnn is a Chinese startup that describes itself as a key opinion leader (“KOL”) facilitator that provides “marketing services to Ruhnn-owned-and-operated brands and to Ruhnn’s third-party customers.”2 KOLs are social media influencers who are paid to promote products and services to their followers. This full-service model has influencers interact with followers through Ruhnn’s self-owned online stores. Ruhnn also draws revenue from its service business, otherwise known as its platform model, that markets its KOLs to “third parties such as brands, retailers, designers, and manufacturers.”3
In September 2019, the plaintiffs commenced a putative class action asserting claims based on violations of Sections 11, 12(a)(2) and 15 of the 1933 Act against Ruhnn, certain of its officers and directors, including the chairman, CEO and COO, and its underwriters, Citigroup Global Markets Inc. and UBS Securities LLC, for failing to disclose that nearly 40 percent of its stores had closed prior to the IPO, leaving only 56 of its 91 stores remaining. In turn, the plaintiffs alleged this caused Ruhnn’s full-service revenue to drop by nearly half in the quarter preceding the IPO. Ruhnn and its underwriters moved to dismiss, claiming the alleged omission was “immaterial based on [its] disclosures in the Offering Materials [that] express[ed] a shift away from the full-service model to the platform model as the primary generator of revenue.”4
In the trial court, Judge Jennifer G. Schecter agreed with the plaintiffs and found that Ruhnn’s disclosures communicated that the platform model would grow and maybe overtake the full-service model but not that Ruhnn expected to reduce the existing full-service business. Judge Schecter also found it notable that, at the time of the IPO, Ruhnn had already closed nearly 40 percent of its stores. This fact, according to the court, made Ruhnn’s disclosure arguably misleading because “investors are entitled to accurate material information at the time of the IPO.”5 Thus, the court denied the defendants’ motion to dismiss the Section 11 and 15 claims.
Judge Schecter dismissed the Section 12(a)(2) claim against Ruhnn because Ruhnn did not pass title to the plaintiffs. Instead, the court found that the IPO was a firm-commitment underwriting and that the underwriters passed title to the plaintiffs.6 Because the underwriters, not Ruhnn, passed title to the plaintiffs, the court held that the plaintiffs could not assert a Section 12 claim against its seller’s seller.7
The Ruling of the Appellate Division, First Department
The defendants appealed the trial court’s decision to the Appellate Division, First Department, on the belief that Ruhnn had fully disclosed a transition toward a platform model and that it did not need to release information instantaneously at quarter-end in its offering materials to comply with the US Securities and Exchange Commission’s rules and regulations.8 The appellate court unanimously agreed with Ruhnn and dismissed the suit.
The appellate court found that Ruhnn had disclosed that it was making a shift away from its full-service model toward a platform model. It held that because Ruhnn made this disclosure, “the omission of data from the period immediately preceding the issuance of the final prospectus showing that there had already been a reduction in the full service segment of the company did not significantly alter the total mix of information made available to a reasonable investor.”9
Additionally, the appellate court held that focusing on the full-service sector’s revenue would be “myopic” because it was not significantly related to the number of stores or the number of online influencers serving the segment.10 The appellate court therefore found that the complaint failed to state a cause of action because Ruhnn had disclosed the shift to the platform model and any associated risks in the offering material.
Ruhnn is one of the first cases involving alleged violations of the 1933 Act decided by a New York State appellate court following the United States Supreme Court’s decision in Cyan v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), which held that state and federal courts have concurrent jurisdiction over class actions alleging violations of the 1933 Act.
It will be interesting to follow the post-Cyan trial and appellate decisions coming out of state courts around the country to see the effects, if any, of the Supreme Court’s landmark decision on defendants’ ability to obtain decisions dismissing meritless securities claims prior to lengthy and costly discovery.