Cannabis Industry Class Action Dismissed in California Federal Court
Case Study

Cannabis Industry Class Action Dismissed in California Federal Court

Goldberg Segalla’s Management and Professional Liability team secured the dismissal of multimillion-dollar securities fraud claims in a highly publicized class action brought by aggrieved investors in a publicly traded cannabis company.

The plaintiffs, investors in KushCo Holdings, Inc., brought a lawsuit in the U.S. District Court for the Central District of California, claiming that the company’s C-Suite officers and outside auditor intentionally misled the public regarding the financial health of KushCo by filing quarterly and annual financial statements with the SEC that contained material misrepresentations. In particular, the plaintiffs claimed the financial statements mischaracterized contingent stock, payable in connection with three separate M&A deals, as equity rather than a liability.

To prove the element of scienter, the plaintiffs alleged that the applicable accounting standards governing the accounting treatment of contingent stock consideration unequivocally required characterization as a liability with no room for professional judgment. In other words, they claimed, the defendants knew that it was improper to characterize the contingent stock consideration as equity.

The plaintiffs sought damages exceeding $15 million, based on the precipitous drop in KushCo’s stock price after the discovery of the errors. The plaintiffs sought publicity and the suit immediately drew attention in finance, business, and cannabis industry media.

Representing KushCo’s outside auditor, Goldberg Segalla combined the forces of the firm’s Management and Professional Liability and Cannabis and Hemp practices, leveraging experience in defending accounting malpractice claims and securities class actions as well as a deep understanding of issues unique to the cannabis industry. Heading up the defense team were Jonathan S. Ziss, chair of the firm’s Management and Professional Liability practice, and David Y. Choi, co-chair of the Cannabis and Hemp practice and a leader in the Management and Professional Liability group, with assistance from associate Jeffrey Cunningham.

We filed a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), arguing that the plaintiffs failed to meet the high standard to plead securities fraud against an outside auditor—and, in particular, we attacked the element of scienter, emphasizing that application of the accounting standards was complex and absolutely required professional judgment given the nature of the transactions. To support our argument, we presented the legislative history regarding the accounting standards, which expressly stated that an auditor would need to exercise professional judgment to properly apply the accounting standards.

The court ultimately sided with our client and adopted the arguments of the defense, issuing a lengthy, detailed ruling granting the motion to dismiss with leave to amend. One day before the deadline to file an amended complaint, the plaintiffs elected to dismiss the action.


 

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Attorneys in Goldberg Segalla’s nationwide Management and Professional Liability practice leverage hindsight, foresight, and insight to deliver cost-efficient and strategic legal solutions for our clients—every time. Our experience serving clients across countless professions and industries includes aggressively defending plaintiffs’ claims; minimizing damages from legitimate errors, mistakes, and accidents; and educating and preparing professionals to meet evolving and emerging industry-specific risks.

MORE ABOUT GOLDBERG SEGALLA’S CANNABIS AND HEMP PRACTICE:

Goldberg Segalla is home to nationally recognized cannabis and hemp lawyers and true leaders in cannabis and hemp law, as well as a collaborative culture that allows us to make the most of our diverse practices for clients with complicated needs. Our tailored, cross-practice approach positions us to provide exceptional and comprehensive counsel for clients operating in the cannabis and hemp industries—from producers and product manufacturers to distributors, transportation companies, retailers, investors, and others—handling and advising on virtually any legal need. Whether securing funding for a new business venture, adapting to the industry’s ever-changing regulatory landscape, or defending diverse and complicated claims, clients turn to Goldberg Segalla for the boutique-style attention of our industry-leading cannabis and hemp lawyers, backed by the entire strength of our full-service firm.