IN RE HEXO CORP. SECURITIES LITIGATION
19 Civ. 10965 (NRB)
United States District Court, Southern District of New York
March 8, 2021
NAOMI REICE BUCHWALD, UNITED STATES DISTRICT JUDGE
Before the Court is defendants’ joint motion to dismiss plaintiffs’ First Amended Class Action Complaint (“FAC“). ECF No. 96. In the FAC, lead plaintiffs Timothy Sweeney and John Medley (“plaintiffs“) bring claims under
Plaintiffs are a putative class of individuals and entities that purchased or otherwise acquired HEXO securities between January 23, 2019 and March 30, 2020 (the “Class Period“) on the New York Stock Exchange (“NYSE“) or the NYSE American exchange, including through or traceable to HEXO‘s initial public offering (“IPO“) on January 25, 2019. Plaintiffs’ claims are asserted against each defendant as follows:
| | Role1 | Securities Act Claim(s) Asserted | Exchange Act Claim(s) Asserted | Defined Terms Applicable to Defendants |
|---|---|---|---|---|
| HEXO Corp. (“HEXO“) | Corporation | Securities Act Defendant Exchange Act Defendant2 | ||
| Sebastian St. Louis | HEXO‘s president, CEO, director, and co-founder | Securities Act Individual Defendant Securities Act Defendant Exchange Act Individual Defendant Exchange Act Defendant | ||
| Adam Miron | Co-founder and HEXO director until July 18, 2019 | Securities Act Individual Defendant Securities Act Defendant | ||
| Michael Munzar | HEXO director and chairman | Securities Act Individual Defendant Securities Act Defendant | ||
| Jason Ewart | HEXO director | Securities Act Individual Defendant Securities Act Defendant | ||
| Vincent Chiara | HEXO director | Securities Act Individual Defendant Securities Act Defendant | ||
| Nathalie Bourque | HEXO director until February 6, 2020 | Securities Act Individual Defendant Securities Act Defendant |
| Ed Chaplin | HEXO‘s CFO until April 30, 2019 | Securities Act Individual Defendant Securities Act Defendant Exchange Act Individual Defendant Exchange Act Defendant | ||
| Steve Burwash | Vice President, Strategic Finance; HEXO‘s interim CFO, May 1-28, 2019; CFO, Oct. 5, 2019 through Class Period | Exchange Act Individual Defendant Exchange Act Defendant | ||
| Michael Monahan | HEXO‘s CFO from May 28 – October 4, 2019 | Exchange Act Individual Defendant Exchange Act Defendant | ||
| Underwriter Defendants3 | Securities Act Defendants |
For the reasons set forth below, the Court grants defendants’ motion to dismiss in its entirety.
I. Background4
This lawsuit arises from HEXO‘s collapse during the year-and-a-half following Canada‘s legalization of adult-use recreational cannabis on October 17, 2018 (“Legalization“). HEXO, a Quebec-based cannabis supplier, FAC ¶¶ 1, 81, anticipated that thе Legalization would create a new market and increase demand for its products, and engaged in a number of actions in order to capitalize on the anticipated growth in demand. First, HEXO entered into supply agreements with major Canadian cannabis dispensaries, including Quebec‘s government-run dispensary, Société Québécoise du Canabis (the “SQDC“). The “SQDC Agreement,” entered into between HEXO and the SQDC, contained a “take-or-pay” provision, which provided that the SQDC would either order or pay for a certain amount of product from HEXO in the first year following Legalization. Second, between December 2018 and January 2019, HEXO circulated a registration statement and a prospectus, and in January 2019, conducted an IPO. Third, HEXO invested in new greenhouse facilities in order to meet the anticipated growth in demand by acquiring Newstrike, another cannabis company.
Unfortunately for HEXO, demand for cannabis — in particular, by the SQDC — fell far short of expectations, and this was reflected in HEXO‘s performance. Following a series of setbacks suffered by HEXO, plaintiffs brought this suit, asserting Securities Act and Exchange Act claims against HEXO, individual directors and officers of HEXO, and underwriters of the IPO.
Central to plaintiffs’ federal securities claims are (a) the SQDC Agreement; (b) HEXO‘s offering prospectus; and (c) HEXO‘s acquisition of Newstrike, each of which are described in greater detail below.
A. October 2018: SQDC Agreement
Canada legalized adult-use recreational cannabis on October 17, 2018. FAC ¶ 86. In Quebeс, the recreational cannabis market is controlled by the government-run cannabis dispensary, the SQDC. On April 11, 2018, in anticipation of the increased demand for its product following Legalization, HEXO entered into a five-year supply agreement with the SQDC, the SQDC Agreement, to become the preferred supplier of the SQDC, which had an option to renew for a sixth year.5 FAC ¶¶ 13, 82.
the Purchase Obligation, using a price of $5.457 per gram – the price for cannabis at the time — plaintiffs estimate that the SQDC Agreement should have generated over $100 million in revenues for HEXO in the first year following Legalization. FAC ¶¶ 13, 86. Per the SQDC Agreement, in the second and third years that cannabis was legal, the SQDC was expected to purchase from HEXO volumes of 35,000 kilograms and 45,000 kilograms respectively (however the second and third years were not governed by a ToP provision). FAC ¶¶ 13, 84. Purchase volumes for the final two years of the contract would be based on the volumes in the first three years. FAC ¶¶ 13, 84.
B. December 2018 - January 2019: Initial Public Offering & Prospectus
Two months after Legalization, on December 20, 2018, in anticipation of its IPO, HEXO filed a Registration Statement on Form F-108 with the SEC (the “Registration Statement“), which was signed by the Securities Act Individual Defendants. FAC ¶ 90. The Registration Statement registered $600 million worth of HEXO shares for trading on the Toronto Stock Exchange and NYSE American Exchange. Id.
On January 25, 2019, HEXO filed a prospectus with the SEC (the “Prospectus“), which incorporated the Registration Statement, and which stated that HEXO would conduct an IPO of 7.7 million shares (which ultimately amounted to 8.8 million shares including the underwriters’ over-allotment). FAC ¶¶ 15, 92. The shares were to be listed in the United States on the NYSE American exchange at $5.15 per share. FAC ¶ 15.9 The IPO was underwritten by the Underwriter Defendants. FAC ¶ 184.
The Prospectus described the SQDC Agreement, providing details about the SQDC‘s Purchase Obligation and the ToP provision that was effective in the first year. FAC ¶ 185. According to the Prospectus, HEXO‘s agreements with other companies did not contain a similar ToP provision. FAC ¶ 187. The Prospectus also stated that HEXO “believes this agreement is the largest forward supply agreement in the history of the cannabis industry in Canada, based on year one volume.” FAC ¶ 185. HEXO closed the IPO on January 30, 2019, having raised approximately C$58 million from investors. FAC ¶ 17.
According to plaintiffs, defendants St. Louis (co-founder, president, and CEO),
(HEXO‘s CFO from May 28 – October 4, 2019) possessed stock options, entitling them to at least 325,000 securities each upon exercise. FAC ¶ 285. For the majority of these options, the strike prices were above trading prices during the Class Period, FAC ¶¶ 283, 285, and in fact, as was disclosed at oral argument, no options were exercised, Tr. of Oral Arg., Feb. 24, 2021 at 10:15-16.
By the time of the IPO, HEXO had been delivering product to the SQDC for over three months, i.e., from the Legalization on October 17, 2018 until January 25, 2019, the date of the Prospectus. FAC ¶¶ 16, 94. During this time, the SQDC ordered from HEXO an average of 840 kilograms of cannabis per month, which constituted 90% of HEXO‘s sales in Quebec. FAC ¶¶ 16, 17, 95. At this rate, the SDQC was not on track to fulfill the Purchase Obligation. FAC ¶¶ 17, 95. Moreover, the SQDC was behind in its plans to open stores, having opened only 12 stores by December 2018 and 24 stores by December 2019. FAC ¶¶ 101-02. According to plaintiffs, however, HEXO conveyed that it was not concerned about these short orders or delayed openings because the ToP feature provided that the SQDC would pay for the 20,000 kilograms of product notwithstanding demand. FAC ¶¶ 17, 96.
C. March 2019: Newstrike Acquisition and Revenue Guidance
In anticipation of increased demand for cannabis following Legalization and the formation of its supply agreements, HEXO sought to expand its operations. FAC ¶ 18. Accordingly, in a
press release dated March 13, 2019, issued on Form 6-K,10 HEXO announced that it would acquire Newstrike in an all-stock transaction for C$263 million. FAC ¶¶ 18, 99, 104, 190-91. Newstrike was another publicly traded Canadian cannabis company. FAC ¶ 18. Through this acquisition, HEXO acquired a number of facilities, including the Niagara Facility. The Niagara Facility conducted 90% of Newstrike‘s production and, according to HEXO, would ultimately account for 40% of HEXO‘s production capacity. FAC ¶¶ 18, 105. In its March 13, 2019 press release, HEXO stated, “[b]ased on the comрletion of the [Newstrike] Transaction, for fiscal 2020, HEXO estimates net and gross revenues from the sale of cannabis in Canada will be in excess of [C]$400 million and [C]$479 million respectively.” FAC ¶ 19.
On March 14, 2019, during an earnings conference call (the “March Call“), President and CEO St. Louis reiterated HEXO‘s C$400 million revenue guidance for the 2020 fiscal year, stating that such guidance was “conservative.” FAC ¶ 20. Also on the March Call, St. Louis explained that there was a licensing delay with respect to a new part of the Niagara Facility. FAC ¶¶ 106, 205. Further, St. Louis spoke positively about the Purchase Obligation, noting:
[T]he SQDC 20-ton commitment is fully on track. Our relationship remains in amazing
standing, and we‘re really excited about all the stores they‘re opening, the education programs they‘re setting up, and the additional products we‘ll be introducing in October.
FAC ¶ 213. Later, during the question and answer portion of the call, when asked
I‘m absolutely confident about that . . . if you look at the multiples we put forth on previous sales, I think there‘s always been a doubt for HEXO‘s ability to ramp up, and we‘ve executed every single time. So I‘m telling everybody now we will execute again.
FAC ¶ 200. He continued, “Are there risks? Yes[,]” and then proceeded to explain some of those risks. Id.
Also on March 13, 2019, HEXO published its Management‘s Discussion and Analysis (“MD&A“), which was attached to its Form 6-K of the same date (the “March MD&A“). See Stokes Decl., ECF No. 117, Ex. 15. In its “Company Overview,” the Mаrch MD&A set forth HEXO‘s sales to date, and also described its current supply agreements, stating, “We currently possess the single largest and longest Canadian forward supply amount among all licensed producers, based upon announced provincial supply agreements.” Stokes Decl., Ex. 15, at 3. Referencing the SQDC Agreement, the March MD&A continued, “In Quebec alone, we will supply 20,000 kg in the first year of legalized adult-use cannabis. . .” FAC ¶
195; Stokes Decl., Ex. 15, at 3. HEXO further explained that it “believe[s] all of this positions us to become one of the two top companies in Canada serving the legal adult-use market.” Stokes Decl., Ex. 15, at 3.
The March MD&A also set forth a number of risk disclosures. The first page of the March MD&A provides a disclosure (“Disclosure“), which states that certain information in the MD&A “contains or incorporates comments that constitute forward-looking information . . .[which] are not historical facts but instead represent management beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond management control” and which are based on reasonable assumptions that “are subject to a number of risks beyond [its] control.” Stokes Decl., Ex. 15 at 2. The Disclosure proceeds to list a number of those risks, including industry competition, product development, changes to government laws, regulations or policies, and supply risks.
The “Risk Factors” section of the March MD&A further provides a long list of specific risks, including that HEXO “operate[s] in a dynamic, rapidly changing environment that involves risks and uncertainties,” and that HEXO “expect[s] to derive a significant portion of [its] future revenues from the recently legalized adult-use cannabis industry and market in Canada, including through its agreements with the SQDC in Quebec, the OCRC in Ontario, and the BCLDB in British Columbia.” Stokes Decl., Ex. 15, at 28-30. The March MD&A continues to explain that the “SQDC has agreed to purchase 20,000 kg of HEXO‘s products for the first year of the agreement,” but that the agreements with the SQDC, the OCRC, and the BCLDB do not otherwise contain purchase commitments or obligate purchasers to buy minimum or fixed volumes. Id. at 29.
D. June 2019: ToP Amendment, Revenues, and Target
On June 13, 2019, St. Louis participated on HEXO‘s third quarter earnings conference call (the “June Call“). During the question and answer portion of the call, an analyst asked whether, in light of the fact that HEXO had sold only 5,500 kilograms to the SQDC in the first half of the contractual year, there was a risk that the SQDC would not need the full Purchase Obligation. FAC ¶ 231. The analyst further wondered if taking the product anyway
St. Louis responded as follows: “Yes, so definitely, a risk. I think the demand is there in Quebec. I think the SQDC has been doing a fantastic job.” Id. He continued to explain that the SQDC‘s store roll-out was slower than expected, but that the SQDC had added stores and “gone back to 7 days of full-time selling” which “adds significant demand.” Id. He further explained that HEXO would relieve the SQDC of its Purchase Obligation for that quarter:
I do think there could be some timing risk around a few of those tons — of those 20 tons. Now, of course, as you pointed out, it is a take-or-pay contract, but we value our relationship with SQDC more than a few million dollars in revenue we could get this quarter. So we‘re working very closely with them.
Id. St. Louis nevertheless remained optimistic about HEXO‘s trajectory, explaining that he thought that it was a “reasonable assumption” that the SQDC would fulfill the Purchase Obligation by the end of 2019 (rather than by the end of the contractual year on October 17, 2019):
We plan on launching a whole bunch of new products over the following couple of quarters, which we think will help that, but expect some timing risk whether it‘s in October, November, December time line to hit the full 20, I think, would be a reasonable assumption. We‘re confident we can completely offset that and more, of course, in other provinces.
Id. ¶ 232. St. Louis also stated that HEXO was going to double its revenues generated between May and July 2019 in the fourth quarter of the year. FAC ¶ 23. He said, “We‘re going to reach the target.” FAC ¶¶ 23, 228.
On June 13, 2019, HEXO also published its MD&A attached to Form 6-K (“June MD&A“). On the topic of the Purchase Obligation, the MD&A stated:
The strategic value of our SQDC relationship cannot be understated. We hold the single largest forward contract in the history of the
emerging cannabis industry with the SQDC and are the preferred supplier for cannabis products for the Quebec market for the first five years following legalization. We will supply the SQDC with 20,000 kg of products in the first year . . .
FAC ¶ 221; see also Stokes Decl., Ex. 16 at 5.11
The June MD&A also sets forth a number of risk disclosures. The first page of the June MD&A provides an identical Disclosure to that contained on the first page of the March MD&A, which, in summary, explains that certain statements contained therein are forward-looking in nature and subject to risks beyond HEXO‘s control. Stokes Decl., Ex. 16 at 2. The June MD&A also contains a long list of Risk Factors, including that HEXO expects to “derive a significant portion of [its] future revenues from the recently legalized adult-use cannabis industry and market in Canada, including through [its] agreements [with] various provincial governing bodies” and that HEXO “operates in a dynamic, rapidly changing environment.” Stokes Decl., Ex. 17, at 31-32.
On June 13, 2019, HEXO‘s stock fell 8%, from $6.45 per share to $5.90 per share. FAC ¶¶ 24, 120.
From this time forward, HEXO experienced a series of setbacks.
First, on October 4, 2019, HEXO‘s CFO, Defendant Monahan, resigned.12 FAC ¶ 29. That day, the stock price fell 6.4%, from $4.06 to $3.80. FAC ¶ 300.
Then, on October 10, 2019, HEXO announced preliminary revenue for its fiscal fourth quarter and, inter alia, withdrew its C$400 million net revenue guidance. FAC ¶¶ 26, 239. On the same day, HEXO estimated that its fourth-quarter revenues were approximately 40% lower than expected. FAC ¶ 131. In a press release dated October 10, 2019, St. Louis attributed the reversal with respect to the guidance to “lower than expected product sell through, . . . [s]lower than expected store rollouts, a delay in government approval for cannabis derivative products and early signs of pricing pressure.” FAC ¶ 133. That day, HEXO‘s stock fell 35%, from $3.66 to $2.85 per share. FAC ¶ 134.
On October 23, 2019, HEXO announced that it entered into a $70 million private placement debt offering with a group of investors. FAC ¶ 139. On October 24, 2019, HEXO announced that it was laying off 200 employees, including its Chief Manufacturing Officer and its Chief Marketing Officer. FAC ¶ 140. That day, HEXO‘s stock fell 6.3%, from $2.69 to $2.52 pеr share. FAC ¶ 142.
On October 29, 2019, in its Annual Report, HEXO announced net revenues 40% below original guidance and substantial impairment
loss on inventory arising from price compression in the market. FAC ¶ 143. Most importantly, HEXO disclosed that it was “temporar[ily]” suspending operations at the Niagara Facility and that to date, it had sold to the SQDC a little over 10,000 kilograms – about half of the Purchase Obligation. FAC ¶¶ 30, 144, 247, 249, 254. On its earnings call of the same date, however, St. Louis explained that since the SQDC purchased less than half of the amount that it initially estimated from all producers, HEXO had maintained its target market share. Batson Decl., Ex. 2 at 6.
That day, HEXO‘s stock fell 5%, from $2.32 to $2.25 per share. FAC ¶ 147.
F. November 2019: Niagara Facility Closure
In a press release on November 15, 2019, HEXO provided additional details about the closure of the Niagara Facility, namely that on July 30, 2019, HEXO had learned that a section of the Niagara Facility was unlicensed. FAC ¶ 153. HEXO also announced that it was “winding down” the Niagara Facility. Id. On November 15, 2019, HEXO‘s stock fell 5%, from $1.89 to $1.79 per share. FAC ¶ 154.
G. December 2019 – February 2020: Financial Disclosures, Debt Offerings, Resignations
On December 16, 2019, HEXO issued financial results for the first quarter of 2020, which reported net losses of C$62.4 million, low sales of C$18.3 million, and an inventory impairment of C$25.5
million. FAC ¶ 156.13 The Company‘s auditor, MNP LLP, issued a reservation of opinion regarding errors related to HEXO‘s tax liability. FAC ¶ 156. On January 2, 2020, HEXO restated its financials for the fiscal year ending July 31, 2019, which, among other things, corrected errors in HEXO‘s
Meanwhile, between December 5, 2019 and January 22, 2020, HEXO completed a private placement of unsecured convertible debentures and multiple offerings in order to obtain cash for working capital, for general corporate purposes, and for business expansion in the United States. FAC ¶¶ 163-66.14 According to plaintiffs, the Exchange Act Individual Defendants were motivated to inflate HEXO‘s stock price to facilitate successful offerings. FAC ¶ 287. Meanwhile, on January 31, 2020, HEXO‘s auditor, MNP LLP, resigned. FAC ¶ 170. On February 6, 2020, Defendant Bourque, a director, resigned. FAC ¶ 173.
H. March 2020: Financial Disclosures, Niagara Facility Sale, and SQDC Agreement Amendment
On March 17, 2020, HEXO announced that it was taking another inventory impairment of up to $280 million, selling the Niagara Facility, and delaying its financial reporting for the second
quarter of 2020. FAC ¶ 174. HEXO also disclosed that the Ontario Securities Commission was reviewing its filings and that “there were questions as to whether HEXO could continue as a going concern.” FAC ¶¶ 174, 269. That day, the stock price fell 30%, from 77 cents to 45 cents per share. FAC ¶ 270.
On March 23, 2020, HEXO filed a Form 6-K indicating that it was unlikely that the SQDC would purchase the product estimated in the SQDC Agreement for the second and third years. FAC ¶ 177. HEXO noted that the estimates were “non-binding targets.” Id. On March 30, 2020, also on Form 6-K, HEXO announced its second quarter financials, reporting a net loss of C$298.2 million, including an impairment loss related to the Niagara Facility and other intangible assets acquired from Newstrike. FAC ¶¶ 178, 272.
In the MD&A attached to the March 30, 2020 Form 6-K, HEXO also repоrted that “[b]y amendment effective on January 17, 2020, [HEXO] contractually relieved the SQDC of the 1st year obligation to purchase the full 20 tons of the outstanding commitment.” FAC ¶¶ 180, 273. HEXO explained that it amended the ToP provision in order to maintain a positive relationship with the SQDC:
While the Company had a right under the contract to require the SQDC to purchase the full 20 tonnes of the outstanding commitment during the first year of the agreement, the Company did not seek to enforce this right on the belief that it would be short sighted given the general results in the industry and the SQDC‘s initial sell-through and from the perspective of its overall business
relationship with the SQDC and its position in Quebec.
HEXO MD&A, March 30, 2020, at 14.15
Following these announcements, on March 30, 2020, the stock price fell over 35%, from $1.09 to 79 cents per share. FAC ¶¶ 183, 275.
II. Procedural Background
The initial complaint in this action was filed by plaintiff Ronnie Perez on November 26, 2019. ECF No. 1. After review of eleven lead plaintiff motions as required
III. Legal Standard
To withstand a
IV. Discussion
A. Securities Act Claims16
Plaintiffs bring claims pursuant to
regarding the SQDC‘s Purchase Obligation.17 For the reasons set forth below, the Court grants defendants’
1. Section 11
Plaintiffs argue that the Securities Act Defendants are liable under
”
Plaintiffs alleging actionable omissions under
As an initial matter, there is no dispute that plaintiffs have alleged the first two elements of a
The analysis, however, does not end here. Plaintiffs’
Plaintiffs’ reliance on IOP Cast Iron Holdings, LLC v. J.H. Whitney Capital Partners, LLC, 91 F. Supp. 3d 456 (S.D.N.Y. 2015), is misplaced because the facts of this case are readily distinguishable. ECF No. 122 at 17-18. There, prior to a sale, a key customer indicated - in no uncertain terms - that it was considering reducing its orders significantly or renegotiating its contract, which contained a minimum purchase requirement. IOP, 91 F. Supp. at 465. Notwithstanding, the issuer represented in the Stock Purchase Agreement that no material customer had any intention to modify its relationship with the issuer. Id. at 463. There, this Court sustained plaintiff‘s claim that this representation was false. Id. at 472-73. Here, by contrast, plaintiffs do not allege that defendants were aware of the SQDC‘s inability to fulfill the Purchase Obligation at the time that they issued the Prospectus. Moreover, to the extent that there were any causes for concern - for example, low sales in the first three months of the SQDC Agreement - HEXO disclosed these facts. Batson Decl., Ex. 5 at 17; see also Davidoff v. Farina, No. 04 Civ. 7617, 2005 WL 2030501, at *10 (S.D.N.Y. Aug. 22, 2005) (dismissing claim predicated on IPO statements where the “risk and the facts underlying it were fully disclosed to potential investors“).
Nor is the Court persuaded by plaintiffs’ insincere extrapolation from IOP. A predominant
Plaintiffs’ reliance on Meyer v. JinkoSolar Holdings Co., 761 F.3d 245 (2d. Cir. 2014), is similarly unavailing. There, in their prospectus, defendants described prophylactic steps they took to prevent pollution. Id. at 247-48. The Court found that the defendants violated
Because “post hoc description[s]” of events “do[] not speak to what the Company knew or should have known at the time of time of the Offering,” plaintiffs’
a. Regulation S-K
In their opposition to defendants’ motion to dismiss, plaintiffs raise for the first time HEXO‘s alleged violation of
b. Bespeaks Caution Doctrine
In any event, even if plaintiffs had alleged misrepresentations in the Prospectus, they would not be actionable under the bespeaks caution doctrine. “Under the bespeaks caution doctrine, alleged misrepresentations in a stock offering are immaterial as a matter of law [if] it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same offering.” Rombach, 355 F.3d at 173 (internal quotation marks omitted; alterations in original).
As discussed supra, plaintiffs do not allege any facts to support the notion that the Securities Act Defendants knew that the SQDC would not fulfill the Purchase Obligation with HEXO, such that statements about the Purchase Obligation in the Prospectus amounted to misrepresentations. HEXO, for its own part, made clear to its investors in its Prospectus that it was operating within a newly legalized industry and that revenues were dependent on the “purchasing decisions of the SQDC, the OCRC, and the BCLDB.” Batson Decl., Ex. 5, at 23-24. Nor have plaintiffs alleged any facts showing that HEXO knew at the time of the IPO that the ToP provision was “illusory” such that HEXO should have included cautionary language regarding the vitality of the ToP provision. Cf. ECF No. 122 at 22 n.13. Where, as here, “[t]he cautionary language addresses the relevant risk directly,” the offering memorandum is not considered misleading. Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 360 (2d Cir. 2002). Accordingly, the bespeaks caution doctrine applies and plaintiffs’
2. Section 12(a)(2)
”
Defendants maintain that plaintiffs lack standing to bring a
Defendants do not dispute that they were statutory sellers. See ECF No. 24 at 12. However, statutory seller status alone is insufficient. A nexus to a plaintiff purchaser is necessary. Here, plaintiffs lack standing to bring their
3. Section 15
B. Exchange Act Claims
Defendants move to dismiss plaintiffs’ Exchange Act claims on the basis that plaintiffs did not allege facts sufficient to show that defendants (1) made misstatements of material fact or (2) acted with scienter. The Court grants defendants’ motion to dismiss plaintiffs’ Exchange Act claims in its entirety.
1. Section 10(b) and Rule 10b-5
a. Legal Standard
To state a claim under
To survive a motion to dismiss on
i. Misstatement or Omission of Material Fact
For a statement to be actionable under
To be actionable under
ii. Scienter
When deciding a motion to dismiss pursuant to
Plaintiffs can satisfy this standard “by alleging facts to show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness.” ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009). “Motive . . . could be shown by pointing to the concrеte benefits that could be realized from one or more of the allegedly misleading statements or nondisclosures; opportunity could be shown by alleging the means used and the likely prospect of achieving concrete benefits by the means alleged.” South Cherry Street, LLC v. Hennessee Group LLC, 573 F.3d 98, 108 (2d Cir. 2009). “Where motive is not apparent . . . the strength of the circumstantial allegations [of conscious misbehavior or recklessness] must be correspondingly greater.” In re Citigroup Inc. Sec. Litig., 753 F. Supp. 2d 206, 233 (S.D.N.Y. 2010). “Defendants’ conduct must be highly unreasonable and . . . represent[ ] an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.” Sinay v. CNOOC Ltd., No. 12 Civ. 1513, 2013 WL 1890291, at *7 (S.D.N.Y. May 6, 2013), aff‘d, 554 F. App‘x 40 (2d Cir. 2014) (citing Tyler v. Liz Claiborne, Inc., 814 F. Supp. 2d 323, 336 (S.D.N.Y. 2011)) (alterations in original; internal quotation marks omitted).
iii. PSLRA Safe Harbor
The PSLRA established a statutory safe harbor for forward-looking statements. Under the safe harbor, a defendant “shall not be liable with respect to any forward-looking statement,” which, in relevant part, is:
Identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.
b. Application
Plaintiffs allege that the Exchange Act Defendants violated
i. Misstatements of Material Fact
1. Purchase Obligation and ToP Provision
First, plaintiffs allege that the Exchange Act Defendants’ statements regarding the SQDC’s Purchase Obligation and the ToP provision constitute actionable misstatements. Specifically, plaintiffs point to the following statements. On the March Call, despite lower-than-anticipated demand for the first six months of the SQDC Agreement, St. Louis, HEXO’s co-founder, CEO, and president, stated that he was “absolutely confident” that the SQDC would fulfill the Purchase Obligation and that the Purchase Obligation was “fully on track.” FAC ¶¶ 200, 213. Further, the March MD&A reiterated HEXO’s plan to supply the SQDC with 20,000 kilograms of product in the first year after Legalization. FAC ¶ 195. The March MD&A also disclosed that HEXO was subject to certain risks outside of its control, including changes to government policies and its dependence on government-run dispensaries. Stokes Decl., Ex. 15, аt 2, 29.
On the June Call, St. Louis disclosed that HEXO would not enforce the ToP provision of the SQDC Agreement for that quarter because HEXO wanted to maintain its positive relationship with the SQDC and did not want the SQDC to have inventory builds. FAC ¶¶ 21, 118, 231. Nevertheless, St. Louis explained that he thought that it was a “reasonable assumption” that the SQDC would fulfill the Purchase Obligation by the end of 2019. FAC ¶ 232. He cautioned that there was some “timing risk,” but explained that HEXO could offset any shortage in demand from the SQDC with demand in other provinces. FAC ¶ 232. Echoing St. Louis’ optimism, the June MD&A provided that HEXO “will supply the SQDC with 20,000 kg of products in the first year.” FAC ¶ 221. Like the March MD&A, the June MD&A also made clear that HEXO was subject to certain risks outside of its control, including changes to government policies and its dependence on government-run dispensaries. Stokes Decl., Ex. 16, at 2, 31-32.
When the SQDC’s demand did not increase as hoped, either by the end of the contractual year in October 2019 or by the end of 2019, HEXO decided to relieve the SQDC of its commitment to pay for the Purchase Obligation altogether, and amended the SQDC Agreement to eliminate the ToP provision. FAC ¶¶ 180, 273.
In their most recent iteration of their argument articulated during oral argument, plaintiffs assert that since investors relied on revenue guaranteed by the ToP provision, HEXO’s failure to enforce that provision was therefore fraudulent. See, e.g., Tr. of Oral Arg., Feb. 24, 2021, at 15:24-16:1; 16:7-9; 19:22-20:1; 21:13-22:11. Relatedly, plaintiffs argue that St. Louis’ statements on the March and June Calls and HEXO’s statements in the March and June MD&As constitute actionable misstatements because they assured the market that the SQDC would fulfill the Purchase Obligation when this was not the case. The Exchange Act Defendants, meanwhile, maintain that amending the
Plaintiffs’ central argument is that the contractual ToP provision amounted to a guarantee and thus became a misrepresentation when HEXO decided in January 2020 to amend the ToP term by not enforcing it. Viewed closely, there are two versions of plaintiffs’ argument, each of which borders on the risible. One version is that, having described the ToP provision, HEXO could not later make a decision considered to be in the best interest of the company (i.e., its shareholders) to relieve its counterparty, the SQDC, of an initial commitment in order to preserve a long-term business opportunity without committing securities fraud.24 However, “[p]laintiffs’ ‘fundamental disagreements with Defendants’ business judgments . . . are not actionable under
at *9 (S.D.N.Y. Nov. 30, 2020) (citing Plumbers & Steamfitters Local 773 Pension Fund v. Canadian Imperial Bank of Commerce, 694 F. Supp. 2d 287, 303 (S.D.N.Y. 2010)); see also HEXO MD&A, March 30, 2020, at 14 (explaining that HEXO’s decision to amend the SQDC Agreement was motivated by a desire to maintain its “overall business relationship with the SQDC and its position in Quebec”).25
The second version of plaintiffs’ argument is that in order to make the initial description of the ToP provision not misleading, HEXO needed to openly state at the outset that it might not enforce the ToP provision. Tr. of Oral Arg., Feb. 24, 2021, at 22:5-11. Such a disclosure would, of course, have weakened HEXO’s bargaining position with the government of Quebec, thereby reducing the pressure on the SDQC to fulfill its commitment to buy 20,000 kilograms of product from HEXO. This Court was unaware that compliance with the securities laws required a corporate suicide pact.
Relatedly, the Court finds that none of plaintiffs’ allegations regarding the Purchase Obligation are actionable. St. Louis’ statements on the March and June Calls are reasonably classified as optimistic. On the March Call, St. Louis stated that he was “confident” about reaching the Purchase Obligation and that HEXO was “on track” to do so. FAC ¶¶ 200, 213. Neither of these statements are guarantees. Likewise, on the June Call, St. Louis allegedly stated that he was “confident” that the SQDC would fulfill the Purchase
Nor do HEXO’s statements in the March and June MD&As, to the effect that HEXO “will supply” 20,000 kilograms to the SQDC in the first year, constitute actionable misstatements. FAC ¶¶ 195, 221. Context, here, is important: the Exchange Act Defendants couched these statements alongside explanations of HEXO’s various supply agreements, and at the times when the March and June MD&As were filed, the SQDC Agreement provided that HEXO would provide 20,000 kilograms of product to the SQDC in the first year. See Stokes Decl., Ex. 15 at 5 (“We hold the single largest forward contract in the history of the emerging cannabis industry with the SQDC.”) (emphasis added); Ex. 16 at 3 (“We currently possess the single largest and longest Canadian forward supply amount”) (emphasis added). HEXO’s later amendment to the SQDC Agreement to remove the ToP provision does not render these statements retroactively untrue. As the ToP provision was in effect at the times that the March and June MD&As were filed, the statements made therein were accurate, and thus do not constitute actionable misstatements.
In any event, the statements in the March and June MD&As are protected by the PSLRA Safe Harbor because the Exchange Act Defendants provided ample cautionary language. Slayton, 604 F.3d at 772. Here, the Disclosure, which appeared in both the March and June MD&As, specifically identified that HEXO’s statements could be affected by risks relating to “changes to government laws, regulations or policies,” as well as “supply risks.” Stokes Decl., Ex. 15 at 2; Ex. 16 at 2. As plaintiffs allege, the low demand for HEXO’s product arose at least in part from the Quebec government’s slow roll-out of stores and avoidance of inventory builds. Moreover, both the March and June MD&As openly state that HEXO operates in a new, “rapidly changing environment” and that HEXO is dependent on contracts with government dispensaries. Stokes Decl., Ex. 15 at 28-29, Ex. 16 at 31-32.27 These risk disclosures should have suggested to a reasonable investor that supply projections were not guaranteed.
2. Renewed Guidance and Inventory and Impairment Loss Figures
Plaintiffs allege that HEXO’s revenue guidance and inventory and impairment loss figures — which account for reductions in the carrying value of assets in a company’s financials — amount to misstatements because they were inaccurate or delayed. The Court disagrees.
With respect to the guidance, plаintiffs allege that during the March Call, St. Louis expressed confidence, stating, “when we hit that $400 million net next year . . . that’s supported by very strong demand. That’s why we’re confident putting out numbers.” FAC ¶ 207. On the June Call, St. Louis further stated, “We’re going to reach the [4Q] target . . . We’re delivering a double this quarter.” FAC ¶ 228. But then, on October 10, 2019, HEXO withdrew its C$400 million net revenue guidance and announced that its fourth-quarter revenues were approximately 40% lower than expected. FAC ¶¶ 26, 239, 131. Plaintiffs argue that HEXO’s initial guidance – which St. Louis called “conservative” on the March Call, FAC ¶ 210 — “lacked any reasonable basis,” ECF No. 122 at 24.
The Exchange Act Defendants correctly maintain that plaintiffs fail to allege that the Exchange Act Defendants made false statements about HEXO’s revenue guidance; to the contrary, plaintiffs’ allegations demonstrate that the Exchange Act Defendants disclosed information with respect to HEXO’s declining position in real time. From the complaint, it appears to the Court that HEXO withdrew and adjusted its guidance only after observing low demand and slow store roll-out. And as the Second Circuit has held, even amidst “disclosures and warnings” regarding “deteriorating financial condition,” “misguided optimism is not a cause of action, and does not support an inference of fraud.” Jones, 550 F. App’x at 26.
With respect to inventory and impairment loss figures, plaintiffs allege that the Exchange Act Defendants misstated HEXO’s inventory and that the figures were misleading because HEXO did not (i) account for slow SQDC orders, (ii) intend to enforce thе ToP provision, (iii) write down or write off stale or depreciated product, or (iv) perform an inventory impairment on the Niagara Facility until five months after acquiring Newstrike. ECF No. 122 at 26.
From plaintiffs’ allegations, HEXO’s inventory and loss impairment adjustments appear to be reactionary to new information. For example, in its October 29, 2019 Annual Report, HEXO recorded an impairment arising from “price compression in the market.” FAC ¶¶ 143, 304. After market close on January 2, 2020, HEXO restated its 2019 financial statements and its interim results for Q12020, and disclosed that it understated its FY2019 inventory impairment by $2.4 million. FAC ¶ 309. On March 17, 2020, HEXO recorded another impairment when it announced that it was selling the Niagara Facility. FAC ¶ 312. Crucially, plaintiffs do not allege, in connection with any of the above examples, that the Exchange Act Defendants withheld information about which they were aware with respect to the guidance or impairment loss figures prior to releasing such information publicly. Hutchinson v. Perez, No. 12 Civ. 1073, 2013 WL 1775374, at *1 (S.D.N.Y. Apr. 25, 2013) (“[A]s long as the public statements are consistent with reasonably available data, corporate officials need not present an overly gloomy or cautious picture of
In any event, even if, arguendo, HEXO’s accounting during the Class Period were incorrect, allegations regarding accounting irregularities are not sufficient to state a securities fraud claim. SEC v. Price Waterhouse, 797 F. Supp. 1217, 1240 (S.D.N.Y. 1992) (stating that the recklessness standard in a securities fraud action “requires more than a misapplication of accounting principles”). “Only where such allegations are coupled with evidence of corresponding fraudulent intent might they be sufficient.” Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000) (internal quotation marks and citations omitted). As will be established infra, plaintiffs fail to allege scienter with respect to revenue guidance and inventory and impairment loss figures.
3. Niagara Facility
Plaintiffs’ allegations about the Niagara Facility fare no better.28 Plaintiffs allege that the Exchange Act Defendants were not forthright about the licensing issues at the Niagara Facility. During the March Call, St. Louis indicated that “250,000 feet” of the Niagara Facility were “licensed operational” but that there was a licensing delay with respect to another part of the Niagara Facility. FAC ¶ 106. In a press release dated October 28, 2019, HEXO announced that it obtained licenses for a different facility in Bellevue without mentioning licensing issues at the Niagara Facility. FAC ¶ 243. In a November 15, 2019 press release, HEXO disclosed that the Niagara Facility’s Block B had been operating without a license — a fact that HEXO learned on July 30, 2019. FAC ¶ 153. In refuting plaintiffs’ argument, the Exchange Act Defendants assert that they disclosed the existence of licensing issues at the Niagara Facility in March 2019 and took corrective action to remedy the licensing oversight. See FAC ¶ 106; ECF No. 116 at 31.
The Court agrees with the Exchange Act Defendants. In the interest of transparency, HEXO perhaps should have disclosed its licensing issues when it discovered thеm in July 2019. However, sight should not be lost of the bottom line reality. There is no allegation that the inability of part of the the Niagara Facility to operate had any effect on HEXO’s supply chain operations, when, in fact, this entire lawsuit is premised on insufficient demand for HEXO’s product. “[A]llegations that defendants should have . . . made certain disclosures earlier than they actually did do not suffice to make out a claim of securities fraud.” Novak, 216 F.3d at 309; see also Marsh & Mclennan, 501 F. Supp. 2d at 469. Here, plaintiffs do not allege particularized reasons that the Exchange
***
In summary, plaintiffs have failed to allege actionable misstatements or omissions pursuant to
ii. Scienter
Even assuming, arguendo, that plaintiffs had adequately alleged actionable misstatements or omissions with respect to the Purchase Obligation and ToP provision, HEXO’s revenue guidance and inventory and impairment loss figures, or the Niagara Facility, plaintiffs’ failure to plead facts giving rise to an inference of scienter provides an independent ground on which to dismiss plaintiffs’
The “court must rеview all the [scienter] allegations holistically.” Matrixx Initiatives Inc. v. Siracusano, 563 U.S. 27, 48 (2011) (internal quotation marks and citations omitted). According to the Second Circuit, at least four circumstances may give rise to a strong inference of the requisite scienter:
where the complaint sufficiently alleges that the defendants (1) benefitted in a concrete and personal way from the purported fraud; (2) engaged in deliberately illegal behavior; (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor.
ECA, 553 F.3d at 199 (internal quotation marks omitted). Here, in their attempt to allege scienter, plaintiffs rely on the first and third categories.
With respect to the first, plaintiffs allege that the Exchange Act Defendants were motivated by a desire to increase HEXO’s stock price to increase their personal options holdings. But as the Second Circuit has held, incentive-based compensation is typically insufficient to support an inference of scienter. Kalnit v. Eichler, 264 F.3d 131, 140 (2d Cir. 2001) (“an allegation that defendants were motivated by a desire to maintain or increase executive compensation is insufficient because such a desire can be imputed to all corporate officers”). “[I]f performance-based compensation were a sufficient predicate for fraud, then “virtually every company in the United States that еxperiences a downturn in stock price could be forced to defend securities fraud actions.” In re Bristol-Myers Squibb Sec. Litig., 312 F. Supp. 2d 549, 561 (S.D.N.Y. 2004). That some of the individual defendants held options with high strike prices is not enough to support a strong inference of scienter, particularly where, as here, it is not ever alleged that the Exchange Act Individual Defendants exercised their options. See Tr. of Oral Arg., Feb. 25, 2021, at 10:15-16.
First, with respect to the Purchase Obligation and the ToP provision, we have repeatedly rejected plaintiffs’ arguments that HEXO knew at the outset and during the relevant disclosures that the SQDC would not fulfill its commitment and that HEXO knew from the start that it would not enforce the ToP provision. We need not reiterate these arguments again here, but do emphasize once more that the “fact that management’s optimism about a prosperous future turned out to be unwarranted is not circumstantial evidence of conscious fraudulent behavior or recklessness.” Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000). Moreover, as the Exchange Act Defendants argue, we note that the purchase of the Niagara Facility in March 2019 undermines the theory that the Exchange Act Defendants knew that the SQDC would not fulfill the Purchase Obligation. Tr. of Oral Arg., Feb. 24, 2021, at 24:2-9. If the Exchange Act Defendants knew that they would not sell 20,000 kilograms of product to the SQDC in the first year, it would be nonsensical for them to invest in the Niagara Facility — which cost C$263 million — and which was intended to generate significant product.
Further, though plaintiffs boldly argue that the Exchange Act Defendants committed fraud on the basis of their renewed guidance and inventory and impairment loss figures, plaintiffs have not alleged particular facts showing that any Exchange Act Defendant was aware of contemporaneous information contradicting their disclosures.30 See In re Magnum Hunter Res. Corp. Sec. Litig., 26 F. Supp. 3d 278, 298 (S.D.N.Y. 2014), aff’d, 616 F. App’x 442 (2d Cir. 2015) (inaccurate financial results that were restated within the year “cannot support a strong inference of scienter sufficient to maintain a claim”). Clearly, HEXO made a number of changes with respect to reporting its inventory and impairment loss figures. See, e.g., FAC ¶¶ 143, 304, 312. However, these facts alone do not give rise to a strong inference that defendants were acting fraudulently. See Sjunde AP-Fonden v. Gen. Elec. Co., 417 F. Supp. 3d 379, 399 (S.D.N.Y. 2019) (internal quotation marks omitted) (“a company’s incremental strategy of taking successive write-downs during a class period contradicts an inference of scienter”). In fact, “that these disclosures occurred in ‘dribs
and drabs’ suggests poor accounting and prognostication, not fraud.” Id. at 400 (citing Magnum, 26 F. Supp. 3d at 297-98).
In one final attempt to allege scienter, plaintiffs rattle off a list of resignations, arguing that “suspiciously-timed resignations” can support a finding of scienter. ECF No. 122 at 31. Plaintiffs point to the resignations of two of HEXO’s CFOs, the co-founder’s resignation, a director’s resignation, and the firings of the Chief Manufacturing and Marketing Officers during the Class Period. FAC ¶¶ 110, 126-27, 140, 173. Plaintiffs also allege that HEXO’s auditor resigned. FAC ¶ 170. With respect to the employee resignations, plaintiffs do not provide any non-conclusory allegations regarding the reasons for the resignations. “Abrupt” resignations, FAC ¶ 42, amidst bad financial news — such as that which HEXO was disclosing — are not surprising. After all, it is “axiomatic that nascent companies with uncertain futures are especially prone to turnover.” Gregory, 297 F. Supp. 3d at 415.
Further, plaintiffs have not alleged facts sufficient to show that the auditor’s resignation amounts to the level of fraud. Plaintiffs allege, “[a]pparently, MNP had clashed with HEXO over the restatement the Company announced on January 2, 2020.” FAC ¶ 36. But plaintiffs allege nothing more. See City of Brockton, 540 F. Supp. 2d at 474 (dismissing case where auditor that resigned agreed with the Company on accounting and financial disclosures).31 Because “plaintiffs fail to plead facts non-speculatively linking the resignations of corporate personnel to the company’s alleged fraud,” their claim predicated on executive and auditor resignations cannot survive. Gregory, 297 F. Supp. 3d at 415.32
For the reasons set forth above, plaintiffs’ allegations do not raise “a cogent and compelling” inference of scienter. Tellabs, 551 U.S. at 324. Ultimately, plaintiffs’ allegations suggest that “defendants were in a constant game of ‘Catch up’ — acknowledging the company’s material weaknesses and disclosing their continued
2. Section 20(a)
Plaintiffs’ claim under
V. Conclusion
For the reasons set forth above, the Court grants defendants’ motion to dismiss in its entirety.
SO ORDERED.
Dated: New York, New York
March 8, 2021
_____________________________
NAOMI REICE BUCHWALD
UNITED STATES DISTRICT JUDGE