By Rodney F. Tonkovic, J.D.
A district court concluded that a company's CEO was the "maker" of a press release containing an alleged omission, but evidence was lacking as to the liability of two CFOs. In this case, the plaintiffs argued that a holding company's 2018 press release announcing that its FY2016 financial statements should not be relied upon, omitted facts concerning its auditor's skepticism about management. At issue here was whether the company's CEO and two co-CFOs were liable for the statements in the release. The court found that the CEO was the "maker" of its statements, but there was insufficient evidence to find liability as to the CFOs (Xu v. Gridsum Holdings Inc., August 29, 2022, Woods, G.).
Background. In 2016, Gridsum Holdings, an overseas holding company operating a portfolio of Chinese software firms, conducted an IPO of American Depository Shares. In March 2017, a press release of the audited financial results for 2016 disclosed a one-time tax liability related to moving offshore capital to onshore entities. In April 2018, the company announced that the audit report for 2016 should not be relied on and that 2016 revenue and expenses could be impacted by millions of yen. In 2019, Gridsum filed its 2017 Form 20-F with the SEC, which included both 2017 financial information and restatements of the company’s 2015 and 2016 revenue, tax expenses, and accounts receivable payable for 2015 and 2016.
The plaintiffs, through third amended complaints, alleged that Gridsum's IPO materials, financial statements, press releases, and SEC filings contained misstatements and omissions that violated Securities Act Section 11 and Exchange Act Section 10(b). The court previously allowed Exchange Act claims relating to Gridsum’s 2016 Form 20-F and the April 2018 press release to proceed, but dismissed the Securities Act claims and Exchange Act claims related to the tax liability and statements about the company's internal controls.
2018 press release. On April 23, 2018, Gridsum issued a press release reporting the suspension of its 2016 audit report. Specifically, the release said that the audit report for Gridsum's financial statements for the year ending December 31, 2016 should no longer be relied upon. According to the release, the audit informed Gridsum about issues relating to certain revenue recognition, cash flow, cost, expense items, and their underlying documentation, and there was a possibility that more items could be identified; the release noted that the auditor had previously raised these issues with the company. The release contained a statements from Gridsum's CEO regarding the measures Gridsum was undertaking to address the situation.
The plaintiffs alleged that this release was materially false and misleading because it omitted the fact that the auditor also told Gridsum that there were "questions related to its ability to rely upon the representations of management." The defendants moved to dismiss this surviving claim from the Third Amended Complaint, arguing that they were not "makers" of the April 2018 press release.
"Makers." The court concluded that Gridsum's CEO had "ultimate authority" and could be held liable for the press release's alleged misstatements and omissions. The complaint pointed to a number of indicia of control, including that the CEO was Gridsum's co-founder and Chairman of the Board and that he was described as the "chief decision maker." In addition, the press release contained a lengthy statement from the CEO discussing the identified accounting issues. The CEO's statement, the court said, indicated that he had knowledge of the "issues" prompting the release. All of these factors taken together supported in inference that the CEO was the "maker" of the release and had authority over the release as a whole.
There were not sufficient facts showing that the CFOs were "makers" of the release, however. The court said that their position as CFO was not by itself sufficient to render them makers of the company's statements. In addition, a reference in the press release to the conduct of the "co-chief financial officer" was similarly insufficient because such a general reference—without saying which CFO was referred to—did not suggest authority over, or responsibility for, the release. Finally, the fact that one of the CFOs signed the Form 6-K to which the release was attached did not mean that he had anything to do with the press release itself.
The court accordingly denied the defendants' motion to dismiss as to the CEO, but granted it for the CFOs. The court also granted leave to replead the dismissed claims against the CFOs.
The case is No. 18-cv-03655.