On May 23, 2017, Judge Victor Marrero of the United States District Court for the Southern District of New York denied in part and granted in part a motion to dismiss a putative securities class action against Inovalon Holdings, Inc. (“Inovalon”), six of Inovalon’s officers and directors (the “Individual Defendants”), and nine underwriters of Inovalon’s IPO (the “Underwriter Defendants”). Xiang v. Inovalon Holdings, Inc., No. 16-CV-4923 (VM). Plaintiffs asserted claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (“Securities Act”) on the basis of alleged misstatements in Inovalon’s IPO registration statement and prospectus. The Court dismissed the Section 12 claims against the Individual Defendants and found the remaining claims to be adequately pleaded.

Plaintiffs filed suit in June 2016, claiming that defendants failed to disclose in Inovalon’s IPO offering materials that Inovalon derived significant revenues from New York customers and that Inovalon’s earnings would be significantly reduced by impending increases in its New York State and New York City taxes. When Inovalon disclosed the impact of these increased tax liabilities in August 2016, the company’s share price dropped 30 percent.

The Court first rejected defendants’ contention that plaintiffs’ claims were time-barred because Inovalon had disclosed several increases in its tax rate more than one year before suit was filed. The Court held that claims under the Securities Act must be brought within one year after discovery of the untrue statement or omission or after such discovery could have been made in the exercise of reasonable diligence. While noting that the Second Circuit has not yet resolved whether the “inquiry notice” or “discovery rule” applies to Section 11 claims, the Court observed that most district courts in the Southern District have determined that inquiry notice applies to Section 11 claims. The Court also observed, however, that the Second Circuit has held that a reasonably diligent plaintiff has not “discovered” one of the facts constituting a securities fraud violation until he can plead that fact with sufficient detail to survive a motion to dismiss, and appeared to apply a standard more closely resembling this discovery rule. Thus, while acknowledging that it was a “close question,” the Court found that plaintiffs could not have discovered their claim until Inovalon’s stock price fell in August 2015, rendering the June 2016 Complaint timely.

The Court also found that plaintiffs had adequately pleaded that Inovalon should have disclosed its increased tax liability under Item 303, which requires disclosure of known trends reasonably expected to have a material impact on the registrant’s revenues or income. Plaintiffs adequately pleaded that defendants knew of the tax change by pleading that Inovalon was a client of Deloitte, and as such “would have received Deloitte’s January 23, 2015 client alert” regarding the impending tax reforms. This directed communication, the Court held, adequately alleged actual knowledge even though allegations of public information alone have been held insufficient to establish such knowledge in other cases.

The Court also concluded that plaintiffs had standing to assert Section 12(a)(2) claims against the Underwriter Defendants, but not against the Individual Defendants. The Court reasoned that while the Second Circuit has not yet opined on the issue, the prevailing view was that Individual Defendants do not become “statutory sellers” merely by virtue of signing a registration statement—they had to solicit investment.

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