Cronos Group Inc. (NASDAQ: CRON) got some good news from U.S. District Judge Eric N. Vitaliano when he dismissed the investor lawsuit against the cannabis company.
The lead plaintiff in the case, Keith Norman, alleged that Cronos Group knew it mislabeled some transactions that it recorded as sales. Cronos acknowledged its error and corrected the accounting.
Despite lots of evidence of the mislabeled transactions, Norman couldn’t prove to the judge that Cronos executives knew that what they were doing was wrong.
The judge suggested if there had been a warning from an accountant pointing out the error, which the executives ignored, then there would maybe be a case. However, just making an accounting mistake and then later correcting it wasn’t enough evidence to point out they knowingly misled investors.
The case hinged on a specific set of transactions between Cronos Group and MediPharm Labs. In 2019, Cronos made a deal to send its dried cannabis to MediPharm, which MediPharm would turn it into bulk resin. The contract was called a Tolling Agreement, and in that contract, the transactions were described as fees.
However, Cronos instead treated the transfer as sales. In other words, when Cronos sent the cannabis to MediPharm, it reported that MediPharm bought the cannabis, which made it look like Cronos’ revenue was growing.
It also recorded the resin as a purchase it made from MediPharm. Norman alleged these were “roundtrip” transactions that were used to artificially inflate the company’s revenue.
A year after the transactions began, the Cronos board audit committee found fault with the accounting. This led to delayed earnings releases and a restatement of the financials, which caused the stock to drop in value.
Proof of Bad Behavior
The judge noted that Norman needed to prove that Cronos Group had a motive for the poor accounting and was aware the company was being reckless.
Norman noted that the top executives were seasoned professionals who should have been aware of the issue, but the judge clapped back that picking bits from executive resumes wouldn’t cut it. Norman was unable to prove the executives had any advance notice of fraudulent reporting.
“Plaintiff concedes that the amended complaint does not allege motive-and-opportunity scienter,” the decision stated.
The judge also told Norman that the size of the accounting errors and the acknowledgement of weak internal accounting controls wasn’t enough to prove the company willfully tried to fake sales.