Appellate victory for XP in securities litigation

On November 22, 2021, Davis Polk secured a full affirmance from the Second Circuit of a district court decision dismissing federal securities claims arising out of the $2 billion IPO of Brazilian fintech XP Inc.(In re: XP Inc. Securities Litigation, 21-903-cv (2d Cir.)). Notably, the Second Circuit’s order concludes, among other things, that mere differences between a parent’s and a foreign subsidiary’s financial statements are not sufficient in and of themselves to materially mislead investors, even in a case governed by the notice-pleading standard of FRCP 8—a ruling that we expect may be helpful in other securities cases against foreign clients going forward.

Davis Polk has now defeated all securities actions filed against XP in connection with its IPO, which was the fourth largest of 2019 and the largest for a Brazilian issuer that year.

The case arose from a March 2020 short seller report that raised a number of allegations concerning purported misstatements in the company’s financial statements. The company promptly responded, demonstrating that the allegations were without merit, including because the short seller was disregarding differences in the accounting standards between XP and its various subsidiaries. Nonetheless, in the days following the report’s publication—which coincided with the arrival of COVID and a broader decline in the Brazilian market—the company’s stock declined by as much as 40%. Although the stock promptly recovered, and has since traded well above its IPO price, the initial drop prompted a number of class action complaints challenging the IPO. Those suits included a first-filed action in the commercial division of the Supreme Court of New York, of which we secured dismissal with prejudice in March 2021. The suits also included a number of federal complaints in the EDNY, which were consolidated, and lead plaintiffs filed an amended complaint on July 29, 2020.

The complaint alleged, among other things, that XP’s IPO offering materials failed to adequately disclose (i) that its principal Brazilian operating subsidiary had incurred approximately R$100 million in expenses stemming from “operating errors” and “system failures” in the years preceding the offering, and (ii) that the Company had experienced a significant increase in intra-quarter civil litigation claims prior to the IPO.

Davis Polk moved to dismiss, and on March 8, 2021, the district court granted the motion and dismissed the complaint in its entirety, substantially adopting each of Davis Polk’s primary arguments.

Plaintiffs appealed, arguing that the district court erred with respect to operating errors/systems failures and civil litigation-based portions of their claims. The Second Circuit (Judges Leval, Cabranes and Chin) heard argument on November 9, 2021.

On November 22, 2021, the Court issued a summary order affirming the district court’s decision in full. It concluded first that plaintiffs failed to allege sufficient facts about the supposed operating errors and system failures to support a plausible inference that the identified difference between the financial statements of XP and its primary Brazilian subsidiary was materially misleading to investors in and of itself or violated any applicable accounting standards. As to the alleged increase in civil litigation claims against XP, the Court agreed with the district court’s determination that the information was legally immaterial, particularly as the incremental claims carried only the risk of “possible” additional litigation losses amounting to less than 3% of XP’s net income for the relevant period. In so holding, it rejected plaintiffs’ arguments that the materiality inquiry should focus on the Company’s total civil litigation exposure (as opposed to the purportedly undisclosed portion thereof, as Davis Polk argued) and that the litigation activity was qualitatively material because it supposedly related to a core aspect of the issuer’s business. 

The Davis Polk litigation team included partner Antonio J. Perez-Marques, who argued the appeal, counsel Daniel J. Schwartz and Craig J. Bergman and associates Esther C. Townes, Brendan Eng and Todd A. Costa. All members of the Davis Polk team are based in the New York office.