Pomerantz Wins 2nd Circuit Reversal in 22nd Century Group Securities Litigation

On May 24, 2022, the 2nd Circuit reversed, in part, the district court’s decision in dismissing the Plaintiffs’ Complaint in Noto v. 22nd Century Grp., Inc., 35 F.4th 95 (2d Cir. 2022). This securities class action alleges, among other things, that 22nd Century Group, Inc. (“22nd Century” or the “Company”), failed to disclose that it was the subject of an investigation by the U.S. Securities and Exchange Commission (“SEC”) in connection with material weaknesses in the Company’s accounting controls.

22nd Century is a biotechnology company working to genetically engineer tobacco plants to produce reduced-nicotine tobacco products. The Company is also developing cannabis plants that will purportedly produce cannabis-based products that contain little or no tetrahydrocannabinol (known as THC – the primary psychoactive component in cannabis).

As alleged in the amended complaint, 22nd Century had essentially run out of money by the start of 2016. As the Company was about to embark on three successive secondary stock offerings in a nine-month period, beginning in February 2016, Defendants identified material weaknesses in the Company’s accounting controls in connection with its segregation of accounting duties. The weaknesses were so severe that the SEC was actively investigating 22nd Century, and the CFO believed he could lose his CPA license or even go to jail. Rather than tell investors the truth, however, Defendants disclosed the material weaknesses and their remediation efforts in their annual and quarterly regulatory filings, but omitted the existence of the SEC investigation. This omission made these statements materially misleading, Plaintiffs alleged, because an SEC investigation into a barely solvent microcap company’s accounting protocols, when the company is conducting over $20 million worth of public offerings in a desperate bid to obtain capital, “significantly altered the ‘total mix’ of information made available” to a reasonable investor.  Further, disclosing only the underlying weakness, without disclosing the SEC investigation, was misleading because Defendants’ limited disclosure signaled to investors that the weakness was minor, when in truth the weaknesses were serious enough to attract the SEC’s attention and even make the CFO fear the loss of his CPA license and incarceration.

Defendants later doubled down on these misrepresentations in fall 2018 and spring 2019, when the existence of SEC investigations into 22nd Century was reported in blog posts by the Company’s former CEO, using the pseudonym “Fuzzy Panda.” Although Defendants could have used the opportunity to come clean to investors—or simply said nothing at all—they effectively denied the existence of any investigation again.

In January 2021, the district court in the Western District of New York dismissed the amended complaint with prejudice, finding that Defendants had no duty to disclose either the use of paid stock promotions or the SEC investigation.

On appeal, the 2nd Circuit affirmed the dismissal of the claim related to the paid stock promotions but found that Pomerantz, as Lead Counsel, had successfully alleged that 22nd Century’s failure to disclose the SEC investigation was materially misleading.

Specifically, Pomerantz argued that the District Court erred in finding that “Defendants had no duty to disclose” the investigation because the court overlooked that omitting the existence of the SEC investigation made statements about the accounting weaknesses and Defendants’ subsequent denials of the investigation misleading. Specifically, the question before the court was not whether Defendants had an independent duty to disclose the SEC investigation; but rather “whether, in light of that Investigation, the statements [Defendants] chose to make were materially misleading.”

The 2nd Circuit agreed, and held that:

“Defendants had a duty to disclose the SEC investigation in light of the specific statements they made about the Company’s accounting weaknesses. “Even when there is no existing independent duty to disclose information, once a company speaks on an issue or topic, there is a duty to tell the whole truth.” An omission is material when a reasonable investor would attach importance to it when making a decision. Here, the fact of the SEC investigation would directly bear on the reasonable investor’s assessment of the severity of the reported accounting weaknesses. Thus, the Company had a duty to disclose the SEC investigation into the weaknesses throughout the class period. Because Defendants here specifically noted the deficiencies and that they were working on the problem, and then stated that they had solved the issue, “the failure to disclose [the investigation] would cause a reasonable investor to make an overly optimistic assessment of the risk.””

The 2nd Circuit concluded that:

“Finally, Defendants’ false public denial of any knowledge of the SEC investigation amounts to an admission of the materiality of its nondisclosure. Otherwise, the Company would not have tried to hide it. Moreover, these denials were affirmatively misleading in their own right. Thus, we easily find that the complaint adequately alleged that Defendants violated Rule 10b-5(b) both by first omitting mention of the SEC investigation and then by affirmatively denying its existence.”

With the district court’s dismissal vacated in part, the case has been remanded back to the Western District of New York for further proceedings.

Managing Partner Jeremy A. Lieberman and Of Counsel Brian Calandra led the litigation, in which Pomerantz LLP serves as Lead Counsel. Noto et al v. 22nd Century Group, Inc. et al, No. 1:19-cv-01285 (W.D.N.Y.).