Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—3d Cir.: REIT shareholders fail to allege statements were false, misleading, or made with scienter, (Oct 16, 2025)

By Rebecca E. Hoffman, J.D.

Statements praising a tenant for its “‘truly distinguished brand,’” and “‘operational expertise driving financial results’” were made before it became aware of the tenant’s fraudulent conduct.

Real estate investment trust Innovative Industrial Properties, Inc. (Innovative), may not have adequately investigated its tenant’s requests for funds to improve its properties—which allegedly turned out to be fraudulent requests—but this does not render Innovative’s laudatory statements about the tenant or the REIT’s due diligence false or misleading, the Third Circuit affirmed Oct. 15 (Handal v. Innovative Industrial Properties, Inc., No. 24-2829 (3d Cir. Oct. 15, 2025)).

Innovative, through its officers and directors, made its money acquiring, owning, and managing industrial properties that it leased to experienced, state-licensed operators to manufacture cannabis. Innovative’s tenant Kings Garden arranged with Innovative—using “draw requests”— for Innovative to finance capital improvement projects at two of Kings Garden’s properties.

However, after Innovative had paid over $48 million toward the draw requests, irregularities came to light, such as that a Kings Garden executive had made the latest request, rather than the general contractor. Further investigation revealed that not all the money was going toward improvements, and Innovative confronted Kings Garden about the issues. Kings Garden ceased paying rent, and Innovative sued Kings Garden in California state court.

Several weeks prior to this, a short-seller put out a report stating, among other things, that Kings Garden and its founder had been sued for fraud. The report also criticized other tenants and stated that Innovative’s stock was overvalued. The company defended itself in a response, indicating that the short-seller did not understand its process for underwriting tenants. Innovative shareholder representatives sued the company, alleging violations of Exchange Act Section 10(b), 20(a), and Rule 10b-5, based on false or misleading statements that caused the stock price to fall. The District of New Jersey dismissed the complaint, and the plaintiffs appealed.

The court noted that Section 10(b) and Rule 10b-5 “do not make it unlawful to do bad business, act negligently, breach fiduciary duties, or otherwise to fail to take care in managing corporate affairs.” Those provisions only prohibit false or misleading statements involving sales of securities. Moreover, a statement is not deemed false or misleading unless it was false or misleading at the time it was made.

Not false or misleading. The plaintiffs challenged Innovative’s statements that its management team conducted due diligence to ensure its tenants were on the up and up. However, the court noted that Innovative never asserted that all purchases followed completed investigations. It said that it had discussed with Kings Garden its financial condition, and the plaintiffs do not allege that this is untrue.

In an annual report, the company stated that “‘in some instances, we monitor our tenants by periodically conducting site visits and meeting with the tenants to discuss their operations.’” But it did not state that it always did this, and thus the statement is not rendered false by Innovative’s failure to visit the Kings Garden sites.

Innovative’s vice president of investments said in February 2022 that Kings Garden “‘has developed a truly distinguished brand in California and consistently ranks as a top producer in sales in a state that represents the largest market in the world.’” This and other statements praising Kings Garden were opinion, the court said, adding that the speakers were not aware that Kings Garden was swindling Innovative until the June 2022 draw request.

Scienter. The court found that one of the challenged statements was plausibly false; namely, a statement in an April 14, 2022 press release hours after the short-seller’s report, that “‘any [Innovative] reimbursements relate only to verified, qualified improvements to the buildings for [infrastructure improvements], and never as funding for any type of “loan” to be utilized for any other purpose.’” The court thus moved to an analysis of whether the statement was made with scienter.

The complaint does not allege that anyone at Innovative knew about Kings Garden’s fraud at that point, and the company’s conduct was not “willfully ignorant,” the court found. “Appellants do not plead that any particular Innovative employee noticed that something was amiss with Kings Garden’s draw requests and then failed to investigate.”

Another theory, from Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242 (3d Cir. 2009), also fails to support an inference of scienter. In that case, the defendant’s CFO was asked “pointed questions,” and the CFO responded by repeatedly denying adverse facts, which was found to be reckless. Here, neither the short-seller’s report nor Innovative’s response directly addresses Kings Garden’s arrangement with Innovative, the court said, and therefore Innovative’s plausibly false statement does not rise to the level of a direct answer that explicitly denies known facts.

The case is No. 24-2829.

Judge: Montgomery-Reeves, T.

Attorneys: Michael A. Cohen (The Rosen Law Firm, P.A.) for Alejandro Handal and Stephen R. Forrester. Christopher A. Degennaro (Foley & Lardner LLP) for Innovative Industrial Properties Inc., Paul Smithers, and Catherine Hastings.

Companies: Innovative Industrial Properties Inc.

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