On June 21, 2017, the United States Court of Appeals for the Second Circuit flatly rejected a securities plaintiff’s invitation to adopt the test devised by the First Circuit for determining the materiality of omissions in securities registration statements and offers of sale—whether the omission in question represents an “extreme departure” from “previous performance”—and openly questioned the usefulness of that test. The decision clarified that there is a split among circuit courts over the proper standard by which to determine materiality, a split which may ultimately have to be reconciled by the United States Supreme Court.
In Stadnick v. Vivint Solar, Inc., a purported class of shareholders alleged that Vivint Solar, a residential solar energy unit installer and lessor, had misled prospective shareholders by failing to disclose certain material information in the registration statement issued in conjunction with Vivint Solar’s IPO.1 In particular, the shareholders argued that Vivint Solar should have disclosed unfavorable financial information for the third quarter of 2014 in its registration statement, which was issued the day after that quarter ended. That financial information showed a $40.8 million decline in net income for shareholders and a drop in earnings-per-share from $0.07 per share to negative $0.45 per share. The United States District Court for the Southern District of New York, applying the First Circuit’s “extreme departure” test for the materiality of omissions, determined that the omission of this information was not an extreme departure from previous performance and dismissed the shareholders’ complaint for failure to state a claim.2
On appeal, the Second Circuit affirmed the dismissal of the complaint, but disagreed with the district court’s use of the First Circuit’s “extreme departure” test. According to the First Circuit, an issuer of securities must disclose “nonpublic information indicating that the quarter in progress at the time of the public offering will be an extreme departure from the range of results which could be anticipated based on currently available information.”3 The Second Circuit, however, rejected that test as “unsound” and “analytically counterproductive” in some situations, and applied the more traditional “total mix of information” analysis that it had applied in prior cases.
In the case of Vivint Solar, the company adopted a non-traditional business plan and equity accounting method that made its corporate viability less subject to evaluation by metrics such as net income and earnings-per-share and more subject to evaluation by “key operating metrics,” including the number of systems and cumulative megawatts installed. These metrics were identified and discussed in Vivint Solar’s registration statement. Thus, although the downward swing in financial figures in the third quarter of 2014 could have been viewed as an “extreme departure” from Vivint Solar’s previous performance, the omission of this information did not “significantly alter the ‘total mix’ of information made available.”4 The Second Circuit reiterated that the “total mix of information” test for the materiality of omissions set forth in DeMaria v. Andersen “remains the operative test” in the Second Circuit, and opined that the “extreme departure” test “leaves too many open questions,” such as: “the degree of change necessary for an ‘extreme departure’; which metrics courts should look to in assessing whether such a departure has occurred; and the precise role of the familiar ‘objectively reasonable investor’ in assessing whether a departure is extreme.”5
Decisions such as this make clear that, even though Congress has attempted to make the federal securities laws more uniform through statutes such as the Private Securities Litigation Reform Act, there are still differences in how courts evaluate federal securities claims. Companies should thus consider which jurisdiction’s law is likely to apply in the event of a securities action before making their determinations regarding what information to disclose or not disclose.