Noto v. 22nd Century Grp., Inc.

CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)
Citation35 F.4th 95
Docket Number21-0347-cv,August Term 2021
Parties Joseph NOTO, Garden State Tire Corp., Stephens Johnson, Individually and on Behalf of All Others Similarly Situated, Plaintiffs-Appellants, v. 22ND CENTURY GROUP, INC., Henry Sicignano, III, John T. Brodfuehrer, Defendants-Appellees.
Decision Date24 May 2022

Jeremy A. Lieberman, Pomerantz LLP, New York, NY, for Plaintiffs-Appellants

John A. Tucker (Jonathan H. Friedman, on the brief), Foley & Lardner LLP, Jacksonville, FL, New York, NY; Charles C. Ritter, Jr., on the brief, Duke, Holzman, Photiadis & Gresens LLP, Buffalo, NY, for Defendants-Appellees

Before: Walker, Calabresi, and Lohier, Circuit Judges.

John M. Walker, Jr., Circuit Judge:

Plaintiffs Joseph Noto, Stephens Johnson, and Garden State Tire Corporation appeal from a judgment of the Western District of New York (Sinatra, J. ) dismissing their complaint against 22nd Century Group and its former CEO and CFO, Henry Sicignano, III and John T. Brodfuehrer. Plaintiffs, investors in 22nd Century Group, allege on behalf of an investor class that (1) defendants engaged in an illegal stock promotion scheme in which they paid authors to write promotional articles about the company while concealing the fact that they paid the authors for the articles; and (2) defendants failed to disclose an investigation by the Securities and Exchange Commission ("SEC") into the company's financial control weaknesses. After public articles revealed the promotion scheme and SEC investigation, the company's stock price fell, and plaintiffs allege they were harmed. The complaint was dismissed by the district court for failing to state a claim upon which relief could be granted.

On appeal, plaintiffs argue that (1) they adequately alleged material misrepresentations and manipulative acts sufficient to sustain claims under subsections (a), (b), and (c) of SEC Rule 10b-5; (2) their claim under § 20(a) of the Securities Exchange Act was premised on a valid predicate violation of § 10(b); and (3) the district court erred in dismissing the complaint with prejudice. On the first and second points, we agree that the allegation that defendants failed to disclose the SEC investigation states a material misrepresentation and could also support § 20(a) liability. We find no merit in the remaining challenges. Accordingly, we AFFIRM in part, VACATE in part, and REMAND for further proceedings consistent with this opinion.

BACKGROUND

The corporate defendant, 22nd Century Group, Inc. ("22nd Century" or "the Company"), is a publicly traded company that strives to genetically engineer tobacco and cannabis plants to regulate their nicotine levels or cannabinoids. From 2015 to 2019, Henry Sicignano, III was the Company's CEO, and from 2013 to 2019, John T. Brodfuehrer was the Company's CFO. Shortly after Sicignano became CEO, he engaged the consulting firm IRTH Communications ("IRTH") to handle 22nd Century's investor relations. For purposes of this appeal, we accept as true the following allegations in the complaint.1

I. Stock Promotion Scheme

Confidential Witness 1 ("CW1"), Sicignano's executive assistant from January 2016 to February 2018, worked directly with Sicignano and interacted frequently with Brodfuehrer. CW1 saw Sicignano review and approve the Company's press releases. In February and March 2017, Sicignano told CW1 several times that he was "working behind the scenes" to prop up 22nd Century's stock price because the Company "did not have enough cash to operate for much longer."2 The same year, Brodfuehrer repeatedly told CW1 that, because he had concerns about Sicignano's conduct, he was not comfortable signing the Company's SEC filings.

From February 2017 through October 2017, various writers published positive online articles about the prospects for 22nd Century's stock. Many articles repeated statements from the Company's press releases, the FDA's press releases, and Sicignano on earnings calls, in presentations, and at conferences. Defendants paid the writers directly, or indirectly through IRTH, to publish the articles. The articles did not reveal that the Company was compensating the writers.

Based on his conversations with Sicignano, CW1 "came to understand that Sicignano and the Company were paying for writers to write articles disguised as [ ] legitimate articles that just promoted [the Company's] stock" but which were not identified as stock promotion articles.3 Based on Sicignano's comments, it was "clear" to CW1 that Sicignano knew that paying third parties to write promotional articles without disclosing that the Company had paid for them was inappropriate.4 CW1 stated that he was "sure" that Sicignano "reviewed, edit[ed], and/or approv[ed]" the paid stock promotion articles "because Sicignano was intensely focused on everything that was said publicly about the Company and ‘went over every Company press release with a fine-toothed comb.’ "5

On multiple occasions, after the articles were published, 22nd Century's stock price rose. From February 2017 until October 2017, the stock price more than tripled. On October 10, 2017, the Company closed a registered direct common stock offering that yielded $50.7 million in net proceeds.

Then, in the Company's annual 2017 Form 10-K submitted in March 2018 to the SEC, the Company reported that it had sufficient cash on hand to sustain normal operations for several years. The 2017 10-K, as well as the other 10-Ks filed in the class period, also stated that the Company's stock price was subject to volatility and listed 19 factors that, "in addition to other risk factors ... may have a significant impact on" its stock price.6

II. SEC Investigation

In February 2016, defendants filed the Company's 2015 10-K. That 10-K disclosed that the Company's management had concluded that its "internal controls over financial reporting were not effective and that material weaknesses exist[ed] in [its] internal control over financial reporting" as it related to segregation of duties.7 To ameliorate these weaknesses, defendants hired an accounting manager, Confidential Witness 2 ("CW2"), who reported directly to CFO Brodfuehrer. In its SEC Forms 10-Q for the first, second, and third quarters of 2016, as well as its 2016 10-K, the Company repeated that its financial reporting controls and procedures were not effective and noted that it was undertaking remediation efforts.8 Ultimately, in its Form 10-Q for the second quarter of 2018, the Company stated that it had "completed the implementation and testing of a remediation plan that was targeted at eliminating our previously reported material weakness in our internal controls over financial reporting primarily resulting from a lack of segregation of duties."9

According to CW2, the SEC was investigating the Company at the time he was hired in 2016. CW2 stated that the investigation continued throughout 2016, and that, by the time he left in 2019, he had not seen any statement from the SEC formally closing the investigation. The Company retained counsel to represent it in connection with the investigation, and, in 2016, Brodfuehrer traveled to Washington, D.C. to meet with the SEC. Brodfuehrer told CW2 that he feared that the investigation could cost Brodfuehrer his CPA license or lead to his imprisonment. The SEC investigation was underway throughout the time that the Company was disclosing its ineffective financial reporting controls.

On July 16, 2018, the SEC received a nonpublic Freedom of Information Act ("FOIA") request seeking "all documents in the [SEC's] possession ... pertaining to investigations regarding [the Company] for the time period January 1, 2016 through July 16, 2018."10 On August 13, 2018, a FOIA Officer denied the request pursuant to the FOIA exemption that authorizes the withholding of "records or information compiled for law enforcement purposes, but only to the extent that production of such law enforcement records or information ... could reasonably be expected to interfere with enforcement proceedings."11 The SEC Office of the General Counsel affirmed the denial.

III. The Public Revelations

On February 2, 2018, an online commentator, "Fuzzy Panda" posted an online article that claimed that 22nd Century engaged in a paid stock promotion scheme to illegally inflate its share price. The Company's stock price fell by 16.9%. On October 25, 2018, Fuzzy Panda posted a second article that disclosed the FOIA request denial and suggested that the SEC was investigating the Company. The article also suggested that the Company had paid undisclosed promoters to pump up its stock price in advance of the October 2017 stock offering. The next day, the Company's stock price fell by 4.3%.

In response, on October 26, 2018, the Company, for the first time, broke its silence about the SEC investigation. But it did so by denying any knowledge of an "enforcement proceeding." The Company issued a press release saying the October 25 article was "highly deceptive" and that the Company "has not received any notice of, and the Company has no knowledge of, any enforcement proceeding against [the Company] by the SEC or any other regulator."12

On April 17, 2019, Fuzzy Panda posted a third article, repeating the undisclosed stock promoters and SEC investigation allegations. The Company's stock price fell again. The next day, the Company issued another statement denying both the illegal stock promotion and SEC investigation claims, stating that the article "falsely alleges that [the Company] is supposedly under SEC investigation."13

On July 26, 2019, the Company announced that Sicignano had resigned as CEO for "personal reasons" but would continue to act as a consultant to the Company.14 The Company's stock price fell in the days following the announcement. On December 3, 2019, CFO Brodfuehrer retired.

IV. Procedural History

In November 2019, after this case was transferred to the Western District of New York, plaintiffs...

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