A Two-to-One Circuit Split: Is An Investor Who Lost Nothing, Owed Something?
On August 7, 2026, Pomerantz secured a victory on behalf of a proposed class of investors in a securities class action against Xiao-I Corporation, when Judge Gregory H. Woods of the Southern District of New York denied Defendants’ motion to dismiss Plaintiff’s claims pursuant to Sections 11 and 15 of the Securities Act of 1933. Pomerantz is Lead Counsel for Lead Plaintiff Qiao Shiyao and the putative class.
Xiao-I Corporation is a global artificial intelligence company that operates through subsidiaries in China. In December 2022, Xiao-I filed a registration statement with the Securities and Exchange Commission (the “SEC”) in connection with its initial public offering, which was declared effective in March 2023.
Plaintiff alleged violations of Section 11 and Section 15 of the Securities Act of 1933. A Section 11 claim may be filed if a company’s public registration statement contains a material misstatement or omission when it becomes effective. A Section 15 claim holds individuals or entities secondarily liable for securities violations if they control a person or company that committed the primary violation.
Plaintiff Qiao Shiyao asserted that Xiao-I’s registration statement failed to disclose the company’s costs of revenues by product or service revenue class. This omission was in contravention of an affirmative legal disclosure obligation pursuant to Rule 5-03 of SEC Regulation S-X (“Rule 5-03”), which outlines how registrants must report and disclose information relating to financial statements in registration statements, periodic reports, and other filings. Rule 5-03 specifies the various line items which, if applicable, should appear on the face of statements of comprehensive income filed with the SEC. For example, Rule 5-03(b) directs issuers to separately disclose revenue from five specified classes of revenue if those classes, or some logical or operational interpretation thereof, constitute more than 10% of the sum of the revenue classes. These classes include: (a) net sales of tangible products (gross sales less discounts, returns and allowances); (b) operating revenues of public utilities or others; (c) income from rentals; (d) revenues from services; and (e) other revenues. Additionally, Rule 5-03 requires the issuer to disclose costs and expenses applicable to sales and revenues and requires that the issuer state separately the amount of: (a) cost of tangible goods sold; (b) operating expenses of public utilities or others; (c) expenses applicable to rental income; (d) cost of services; and (e) expenses applicable to other revenues.
Defendants argued that the Section 11 claims “sounded in fraud,” rather than negligence, and were therefore subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b), which Plaintiff failed to meet. In response, Plaintiff successfully argued that Federal Rule of Civil Procedure 8(a)(2), which requires only a “short and plain statement of the claim showing that the pleader is entitled to relief,” was indeed applicable here. The Court agreed. In doing so, the Court held that Plaintiff’s Securities Act claims “sound in negligence,” in other words, in carelessness or a failure to meet a standard of reasonable care. The Court found that the complaint not only contained numerous blanket disclaimers of fraud with respect to the Securities Act claims but Plaintiff also “made more than nominal efforts to distinguish the negligence-based claims from the fraud-based claims.” The Court explained that the complaint “expressly disclaims fraud, scienter, and the intent of Defendants to defraud investors and painstakingly segregates the fraud and negligence claims.” The Court further reasoned that each claim is set forth under its own heading and incorporates only certain factual allegations such that, although all claims follow a general recitation of the factual background, the Securities Act claims expressly do not incorporate the allegations supporting findings of scienter and reliance.
Defendants also argued that the Section 11 claims should be dismissed because Plaintiff failed to allege that the company’s financial disclosures in its registration statement omitted information that was required to be stated therein, but the Court disagreed. The company improperly reported costs of revenues in the aggregate and did not break out the costs of revenues for each line of business, as required by Rule 5-03. The registration statement contained, inter alia, the company’s consolidated financial statements for the year ended December 31, 2020, as well as for the six-months ended June 30, 2021 and June 30, 2022. It also provided that the company had four lines of business from which it generates revenue—including maintenance and support (“M&S”) service. The Court focused on “M&S service” and noted that it constituted more than 10% of Xiao-I’s revenue for the year ending December 31, 2020, and the six-month periods ending June 30, 2021 and June 30, 2022. It follows that, for those periods, “revenues from services” exceeded 10% of total revenue. The Court explained that for at least those periods, Xiao-I was obligated to “state separately the amount of . . . cost of services.” However, the company “failed to include cost of revenues by product or service revenue class” on the face of its comprehensive income statements. Thus, the Court held that Plaintiff adequately alleged that the registration statement failed to include the information required by Rule 5-03.
The Court also found that Plaintiff sufficiently pled the omissions in the registration statement were material. As discussed above, the statement failed to disclose Xiao-I’s costs of revenues by product or service revenue class, which was an omission in contravention of an affirmative legal disclosure. When evaluating materiality, the Court recognized that the information omitted allows investors to make determinations about an entity’s gross margin in each particular product or service line from which it generates substantive revenues. Plaintiff asserted that gross margin is an important financial metric to investors because it provides unfiltered insight into whether an entity has the ability to make money from the very thing it purports to be in business to do—produce goods or provide services. Plaintiff further alleged that the company’s failure to disclose the cost of revenues information was materially misleading because it left investors without the required transparency regarding the embedded gross margin information by revenue class, as well as the direction of the company with respect to its varied revenue streams—creating an unduly favorable picture of the company’s business. Therefore, the Court could not conclude that the omission of information required by Rule 5-03 was “so obviously unimportant to a reasonable investor” as to support dismissal for failure to plead materiality. Thus, the Court held that Plaintiff sufficiently pled Section 11 claims as to all Defendants.
The Court also found that Plaintiff adequately pled claims pursuant to Section 15 of the Securities Act against Individual Defendants Hui Yuan, Wei Weng, and Wenjing Chen. The complaint states that at all relevant times: (i) Defendant Yuan served as Xiao-I’s Chairman of the Board of Directors and Chief Executive Officer; (ii) Defendant Weng served as Xiao-I’s Chief Financial Officer; and (iii) Defendant Chen served as a Director on Xiao-I’s Board of Directors. Additionally, Plaintiff alleged that the aforementioned Individual Defendants “signed or authorized the signing of the Registration Statement.” Accordingly, the Court denied Defendants’ motion to dismiss the Section 15 claims as it relates to Defendants Yuan, Weng, and Chen.
Following Plaintiff’s win, the case will now proceed into discovery. Led by Partner Brenda Szydlo, the litigation team includes Associate Dean P. Ferrogari.
The case is Shiyao v. Xiao-I Corporation, et al., No. 1:24-cv-07837 (S.D.N.Y.).