In In re Fairway Group Holding Corp. Securities Litigation, 2015 BL 12688 (S.D.N.Y. Jan. 20, 2015), the District Court for the Southern District of New York granted in part and denied in part the motions to dismiss the complaint brought by Jacksonville Police and Fire Pension’s (“Plaintiff”) against Fairway Group Holding Corp. (“Fairway”), Sterling Investment Partners, et al. (“Sterling”), certain directors and officers of Fairway, and the syndicate of underwriters involved with Fairway’s initial public offering (collectively, the “Defendants”) alleging securities fraud.   The complaint specifically alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 in connection with Fairway’s initial public offering (“IPO”).

According to the allegations in the complaint, Defendants in the period preceding the IPO made certain representations about Fairway’s business in the grocery store industry, specifically regarding new store growth, same store sales growth, and deferred tax assets reported in the financial statements. Plaintiff alleged that the statements were misleading and that it relied upon the statements in purchasing stock after the IPO.   

Plaintiffs alleged that Fairway’s statements about its “proven ability to replicate its store model” and its “scalable infrastructure” indicated Fairway’s ability to continue its new store growth strategy, which failed to be true. Plaintiffs further alleged that statements about the “disruption” to sales caused by Hurricane Sandy omitted that in actuality, sales were boosted by the storm. Lastly, Fairway stated beliefs about future taxable income that were alleged to be false.  Defendants argued Plaintiff did not adequately plead a material misstatement or omission, scienter, or loss causation.

A prima facie claim under Rule 10b-5 requires allegations of “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” The Private Securities Litigation Reform Act (“PLSRA”) requires a securities fraud complaint to specify each statement alleged to have been misleading, the reasons such statements were misleading, and include the information on which such belief was formed.

Scienter refers to the required state of mind. The PLSRA requires the complaint to allege facts giving rise to a strong inference of scienter.  Plaintiff can meet the pleading standard by showing that the Defendant had the motive and opportunity to commit the alleged act or by showing  “circumstantial evidence of conscious misbehavior or recklessness.”

The court found that the IPO constituted a sufficient motive to commit fraud. Id. (“Plaintiff alleges that in misrepresenting and concealing the state of Fairway's business, defendants were able to raise millions of dollars in the offering, nearly recouping their entire $150 million investment in Fairway, "that they otherwise would not have been able to if they presented a more complete and accurate financial snapshot." ).  Further, because Defendants were officers and directors of the company with access to all the key company information, the court inferred they had ample opportunity to commit fraud.   

Additionally, the court found loss causation was inferred due to the drop in share prices following Plaintiff’s purchases of Fairway stock and the Defendants’ correction to their previous false statements. Plaintiff, therefore, adequately alleged violations of Rule 10b-5.

Section 20(a) liability arises where the defendant controls the person who commits a fraudulent act and is therefore responsible “in some meaningful sense.” Plaintiff’s claim under this section survived as to all Defendants except for Sterling Advisors, a member of Sterling Investment Partners. While the other Defendants met the elements of Section 20(a), the court found Sterling Advisors only gave advice and did not reach the needed level of control.

Finally, Sections 11 and 12 apply to omissions and misstatements of material fact in a registration statement or in a prospectus, and Section 15 assigns liability to those persons with control over anyone liable under Sections 11 or 12. The court found Plaintiff sufficiently alleged omissions and misstatements required by Section 11. It also found, however, that Section 12(a)(2) did not apply because Plaintiff did not allege that shares were acquired in the IPO. 

Ultimately, the court found Plaintiff sufficiently alleged claims under Section 10(b) and 20(a) of the Securities Exchange Act and Rule 10b thereunder, as well as Sections 11 and 15 of the Securities Act. The court also dismissed Plaintiff’s claims as to defendant Sterling Advisors and all claims under Section 12(a)(2) of the Securities Act.

The primary materials for this case may be found on the DU Corporate Governance Website.