Corporations that primarily generate revenue from business activities related to cannabis have not historically had access to traditional sources of financing. However, with the passage of the Agriculture Improvement Act of 2018 (Public Law 115-334) (the Farm Bill), which legalized the cultivation of hemp, as well as the legalization of medical and, in some cases, recreational cannabis products by many states (though marijuana remains an illegal controlled substance under the Controlled Substances Act, 21 U.S.C. §§801, et seq.), many cannabis-related corporations have sold shares on the New York Stock Exchange (NYSE) and the NASDAQ, while other corporations, already listed on these exchanges, have entered the industry. With the advent of publicly-traded cannabis corporations has come a response by the plaintiffs' bar: private lawsuits alleging violations of the securities laws.

In November 2018, a cannabis-related securities lawsuit, Tchathchou v. India Globalization Capital, No. 18-cv-3396 (D. Md. 2018), was filed against India Globalization Capital, its CEO, and its CFO. That December, another cannabis-related securities class action was filed. The defendant had only begun trading on the NYSE the previous month.

At least 11 other lawsuits alleging violations of the securities laws have been filed against publicly-traded cannabis corporations. Most of these actions have been brought pursuant to §10(b) of the 1934 Securities Exchange Act, the law governing the secondary trading of securities. Section 10(b) is the primary anti-fraud provision of this statute. In addition, at least one cannabis-related securities action, In re Sundial Growers Securities Litigation, 19-cv-8913 (S.D.N.Y. 2019), has been brought pursuant to §11 of the 1933 Securities Act, the enforcement provision of the law governing the registration of securities. The increasing prevalence of these types of actions has caught the attention of economists: NERA Economic Consulting identified securities litigation against the cannabis industry as a new development worth watching in the coming year. See NERA, Recent Trends in Securities Class Action Litigation: 2019 Full-Year Review, at p. 7.

While securities litigation targeted at the cannabis industry is still at an early stage, some common themes have emerged. Like most securities litigation, lawsuits against cannabis companies have been brought on behalf of a purported class of plaintiffs consisting of all purchasers and sellers of company stock within defined date ranges.

In most of the cases, a lead plaintiff and a lead plaintiffs' counsel have not yet been appointed pursuant to the Private Securities Litigation Reform Act (PSLRA). See 15 U.S.C. §78u-4(c)(a)(3). No court has yet ruled on the legal merits of the claims asserted in any of these cases (one case was voluntarily dismissed). As a result, at this stage, there is no data available on which to predict how courts will view these cases.

Most of the lawsuits, however, advance similar allegations regarding alleged misstatements and/or material omissions by the defendant corporations. For example, many of the complaints allege that the defendant company made affirmative misrepresentations about earning prospects, or knowingly failed to disclose the limited demand for its products, the full risk of regulatory impediments, and/or declines in revenue. See, e.g., In re Curaleaf Holdings Securities Litigation, 19-cv-4486 (E.D.N.Y. 2019) (alleging that Curaleaf Holdings failed to adequately disclose the risk of FDA regulation); Ganovsky v. Tilray, No. 20-cv-1240 (E.D.N.Y. 2020) (alleging that Tilray misled investors by overstating the value of an agreement with a third-party vendor); Ortiz v. Canopy Growth, 19-cv-20543 (D.N.J. 2019) (alleging that Canopy Growth misled investors about the actual demand for its products).

The defendants in Curaleaf Holdings have already sought dismissal of the §10(b) claims filed against it on the grounds that "the Company's statements" concerning FDA regulation "could not have misled reasonable investors" because "the Company disclosed the risk of FDA regulation" and "the allegedly omitted information was … widely available in the public domain," both common defenses to such claims. In cases alleging misleading statements about future projections/earnings, defendants typically argue that the alleged misstatements are actually "forward-looking statements," which are protected, unless known to be false at the time they are made, under the PSLRA. See 15 U.S.C. §78u-5(c).

Another common thread in this litigation has been sparse pleadings with regard to the defendants' intent to commit fraud, a key element of a claim under §10(b). Claims brought under §10(b) are necessarily claims of fraud, and are thus subject to the pleading requirements of Rule 9 of the Federal Rules of Civil Procedure, Fed. R. Civ. P. 9(b), which requires that each of the elements of a fraud claim be pleaded with specificity. Further, with regard to the defendant's state of mind, known as "scienter," the PLSRA imposes a further requirement: that plaintiffs "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. §78u-4(b)(2). This requirement assists courts in culling claims in which the plaintiff merely points to an allegedly false statement and declares that the defendant "must have known" that the statement was false, based upon his position within the company.

The U.S. Court of Appeals for the Second Circuit (the circuit in which most of these lawsuits have been filed) has ruled that adequate pleading of scienter under the PLSRA requires allegations (1) that the defendant had "motive and opportunity to commit fraud;" or (2) that there is "strong circumstantial evidence of conscious misbehavior or recklessness." ECA & Local 134 Ibew Joint Pension Trust v. J.P. Morgan, 553 F.3d 187, 198 (2d Cir. 2009). Generally, to satisfy the "motive and opportunity" prong, plaintiffs include allegations of insider trading or some other concrete benefit to a corporate executive. Allegations concerning routine salary and incentive compensation have been rejected as insufficient to establish "motive and opportunity." Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir. 2001). In the absence of allegations of motive, the plaintiff must allege that the defendant engaged in "conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care." Id. at 142. This is "not merely a heightened form of negligence," but rather "conscious recklessness," which is defined as "a state of mind approximating actual intent." S. Cherry St. v. Hennessee Group, 573 F.3d 98, 109 (2d Cir. 2009).

To date, in nearly all of these cases, plaintiffs have attempted to meet the requirement of pleading scienter through allegations that company executives had access by virtue of their positions to the "truth," but intentionally or recklessly failed to disclose this information to shareholders. For instance, in Finch v. Cronos, 20-cv-1324 (S.D.N.Y. 2020), the plaintiffs have attempted to plead scienter through allegations that: "the Individual Defendants, by virtue of their involvement in the establishment and maintenance of the Company's internal control over financial reporting and due diligence in ensuring the financial information disclosed by the Company fairly presented Cronos' financial condition and performance, made them privy to confidential information concerning Cronos." The alleged "confidential information" in Cronos is not specifically identified, but it appears to be described in the complaint as information concerning the company's improper recognition of "revenue from several bulk resin purchases and sales of products through the Company's wholesale channel." In other cases, arising outside the cannabis context, similar allegations have been found insufficient unless the plaintiff "specifically identif[ies] the reports or statement containing" the true "information." See Teams. Local 445 v. Dynex Cap, 531 F. 3d 190, 196 (2d Cir. 2008). Indeed, to date, motions to dismiss have been filed in three of the cases; and in each, the motion has focused on the plaintiff's failure to adequately allege scienter. In one cannabis case filed earlier this year, Warren v. Aurora Cannabis, et al., 20-cv-555 (D. N.J. 2020), the plaintiffs have attempted to plead scienter with somewhat more detail, alleging that a member of Aurora's board of directors sold 57% of his holdings in Aurora prior to the full revelation of the alleged fraud.

It remains to be seen how the courts will analyze the allegations made against companies involved in the cannabis industry. One thing that can be predicted, however, is that as more cannabis-related entities choose to finance themselves by going public, more will become the target of shareholder actions. Counsel for both plaintiffs and defendants will hone their strategies, and the courts will develop a framework for decisions. That will take time; until then, uncertainty will of necessity be the rule.

Chris Gismondi is of counsel and Wendy Michael is senior counsel at DLA Piper.