Saturday, April 8, 2023

Fourth time's definitely a pattern

I blogged a few times about 10(b) cases raising the question of when shareholders of a publicly traded parent company can sue its wholly-owned subsidiary for the subsidiary’s false statements.  The latest, In re CarLotz Inc. Securities Litigation, 2023 WL 2744064 (S.D.N.Y. Mar. 31, 2023), denied such claims by shareholders of a pre-merger SPAC seeking to hold the pre-merger target liable for misleading investor presentations about its business.  The case was the natural result of the Second Circuit’s decision in Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., 54 F.4th 82 (2d Cir. 2022), which I blogged about here.

CarLotz was in the business of facilitating used car sales from their original owners to retail customers.  Acamar, a SPAC, went public in February 2019, and struck a deal to merge with CarLotz in October 2020.  A prospectus and registration statement were filed in December 2020 to register the new Acamar shares that would be issued as merger consideration, and Acamar shareholders approved the deal in January 2021.

After the announcement of the deal but before the merger, CarLotz’s officers were alleged to have made a false statements about CarLotz’s business.  The truth was revealed after the merger, when CarLotz admitted, among other things, a backlog of inventory that it had to sell at unfavorable prices, and the loss of a critical corporate partner and source of vehicles.

Shareholders of both pre-merger Acamar and post-merger CarLotz sued CarLotz’s officers under Rule 10b-5, as well as Section 11 and Section 12, purporting to represent Acamar/post-merger traders in the period beginning October 2020 through May 2021.

The court held that Frutarom “forecloses Plaintiffs’ challenge to any statements made by Pre-Merger CarLotz about Pre-Merger CarLotz.  As in Frutarom, neither of the named Plaintiffs purchased shares of Pre-Merger CarLotz—a privately held entity. The only pre-merger shares purchased by a named plaintiff in this case were those of Acamar. All of the challenged pre-merger statements, however, were made by Pre-Merger CarLotz about itself, not Acamar.”  Though the court explicitly noted the “policy concerns” of permitting SPAC transactions to escape 10b-5 liability in this manner, the court considered itself bound by the Second Circuit’s holding, even noting that the Second Circuit had explicitly considered – and rejected – arguments about Frutarom’s application to SPACs when the Frutarom plaintiffs petitioned for rehearing.

As for the Section 11 and Section 12 claims, the court held that plaintiffs had not shown they’d purchased shares traceable to the false registration statement or – with respect to Section 12 – in the offering itself (which, in the latter case, would not seem to be possible by anyone except the former CarLotz shareholders).  The court rejected arguments that Section 11 and 12 requirements should be modified for the SPAC context.

Anyhoo, as I previously blogged, at least one court outside the Second Circuit has rejected Frutarom, so … stay tuned.

Ann Lipton | Permalink


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