On April 11, 2025, Judge Brian M. Cogan of the United States District Court for the Eastern District of New York granted in part and denied in part a motion to dismiss a putative class action alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) against a security products company (the “Company”) and certain of its officers and directors (the “Individual Defendants”), and violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the “Securities Act”) against the Company, the Individual Defendants, and certain of the underwriters (the “Underwriter Defendants”) of the Company’s secondary public offering (the “SPO”). Zornberg v. Napco Sec. Techs., Inc., No. 23-cv-6465-BMC (E.D.N.Y. Apr. 11, 2025). Plaintiffs alleged that defendants made materially false or misleading statements regarding the Company’s inventory levels, cost of goods sold, and profitability, and that the Company’s stock price subsequently dropped over 45% upon the announcement that the Company needed to restate its financials. The Court held that plaintiffs had adequately alleged their Exchange Act claims by pleading scienter through defendants’ allegedly unusual stock sales and by plausibly alleging loss causation between the announcement of the restatement and the drop in the Company’s stock price. The Court also held that plaintiffs adequately alleged their Securities Act claims against the Company and the Underwriter Defendants, but that plaintiffs had not established standing to bring their Section 12(a)(2) claims against the Individual Defendants and could not bring their Section 11 claims against the Individual Defendants because the shelf registration statement they signed took effect before the class period.
The Court first addressed the Exchange Act claims, including whether plaintiffs had sufficiently pleaded scienter and loss causation. As to scienter, the Court held that plaintiffs had adequately pled that defendants had motive and opportunity to commit fraud, reasoning that their stock sales were “highly unusual in timing and amount,” with total proceeds over $108 million from stock sales by the officer defendants, who sold “hefty percentages of their holdings” within days of the alleged misstatements, while they sold no stocks during the year before the class period or after the class period. The Court rejected defendants’ argument that the trading did not support an inference of scienter because the shares were sold pursuant to a pre-planned shelf registration of the SPO, which the Court noted was discretionary. The Court also rejected defendants’ explanation that the shares were sold because the officers were about to retire, reasoning that there was no evidence of the planned retirements, notwithstanding the senior ages of the officers.
The Court also held that plaintiffs had sufficiently pled loss causation, rejecting an argument advanced by defendants that the alleged corrective disclosure did not sufficiently specify the error in the Company’s allegedly misleading financial statements. The Court reasoned that “a corrective disclosure need not be a full recount of the alleged fraud” but “only needs to reveal the alleged misstatement’s falsity,” and held that the press release announcing the Company’s restatement sufficiently revealed the alleged falsity of the Company’s financial statements by suggesting the overstatement of gross profit. The Court also noted that upon the announcement of the restatement, the stock price dropped 45%.
The Court then held that plaintiffs had sufficiently established standing to bring their Section 12(a)(2) claims against the Company and the Underwriter Defendants, but not against the Individual Defendants. The Court reasoned that plaintiffs alleged that the plaintiff bringing the Securities Act claims purchased its stock “pursuant to” the registration statement, which was sufficient. Further, the Underwriter Defendants were sufficiently alleged to be statutory sellers because the SPO was a “firm commitment” underwriting, in which the Underwriter Defendants committed to purchase the shares offered and sell them directly to public investors, and the Company was sufficiently alleged to be a statutory seller because a firm commitment underwriting does not impact an issuer’s seller status under the applicable SEC rules. However, the Court held that the Individual Defendants were not statutory sellers because they did not pass title to the shares and allegations that they signed the prospectus for the SPO were not sufficient to establish solicitation for purposes of Section 12(a)(2) standing.
Finally, the Court held that the Individual Defendants were not liable under Section 11 because the registration statement became effective for them before the class period, and they are not liable for untrue statements in the prospectus supplement filed after that point. The Court reasoned that where, as here, a shelf-registration process is employed, while the offering date is the date of the prospectus supplement for issuers and underwriters, the offering date is the date of the registration statement for directors and signing officers.
Accordingly, the Court granted defendants’ motion to dismiss as to the claims brought against the Individual Defendants under Sections 12(a)(2) and 11 of the Securities Act and otherwise denied the motion.
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