United States: Northern District Of California Denies In Part Motion To Dismiss Securities Act Claims Against A Medical Technology Company, Finding That Plaintiff Adequately Alleged Material Misstatement

On October 18, 2019, Judge Edward J. Davila of the United States District Court for the Northern District of California granted in part and denied in part a motion to dismiss a putative class action asserting claims under Sections 11 and 15 of the Securities Act of 1933 (the "Securities Act") and Item 303 of Regulation S-K against a medical technology company (the "Company") and certain of its executives and directors, venture capital firms, and underwriters.  In re Restoration Robotics, Inc. Securities Litigation, No. 18-cv-03712 (N.D. Cal. Oct. 18, 2019).  Plaintiff alleged that defendants made materially misleading statements and omissions concerning the Company's marketing function, hair transplant technology, product sales and revenue in offering documents in connection with the Company's initial public offering ("IPO").  The Court granted in part and denied in part defendants' motion to dismiss, and granted plaintiff leave to amend to cure the complaint's deficiencies.

The Company develops and markets a hair restoration robotic device and system to assist doctors with "follicular unit extraction surgery," which it sold to physicians internationally through third-party distributors and domestically using a marketing team of sales and clinical trial managers.  The Company earned most of its revenue from sales of the device, the medical procedures it was used to perform, and post-warranty servicing of the device.

Plaintiff alleged in the consolidated amended complaint that the IPO offering documents contained ten materially false and misleading statements, falling within three categories:  (i) statements concerning the Company's marketing function; (ii) statements concerning the quality and design of the robotic system; and (iii) statements concerning the system's "installed base."  Plaintiff cited alleged statements from three confidential witnesses who worked at the Company in marketing teams.

As to the first category of alleged misstatements, concerning the Company's marketing function, defendants argued these were non-actionable statements of corporate optimism and "puffery."  The Court agreed.  The Company allegedly represented that it "provide[d] [physicians with] comprehensive clinical training, practice-based marketing support, as well as patient leads."  The Court found this too generic and vague to state a claim.  The Court similarly found the statement about the Company's "goals . . . to expand the commercialization" of the system, and intention to increase the system's profitability, to be aspirational and forward-looking and thus non-actionable.  Differentiating other cases, the Court observed that these statements "were not made in response to investors['] [direct questions]" but rather were made in the offering documents and merely "generally discussed" the Company's marketing strategy.  With respect to other statements concerning defendants' belief in increasing profitability, the Court noted that the offering materials used "cautionary phrases [that were] repeated throughout" and "honest[ly] disclos[ed]" the Company's lack of commercial success so far.

As to the second category of alleged misstatements—eight statements regarding the Company's relationship with physicians and the quality and design of its robotic system—the Court found that plaintiff failed to plead falsity in all but two instances.  Regarding statements about the Company's strong relationships with customers and coaching provided to physicians, the Court noted that plaintiff admitted that defendants provided clinical training and marketing support to customers, and accordingly found that plaintiff's argument "crumble[d] into an efficacy, but not a falsity, argument" to the extent they took "issue with the methods used" rather than whether or not such services were provided.  The Court similarly rejected plaintiff's arguments that defendants "provided inadequate marketing support because they failed to deliver 'patient leads' as promised," finding that defendants "made no representations as to the quality or quantity of leads" and had warned throughout the offering documents that their "marketing strategy may fail because existing management and personnel 'may not be adequate to support'" future growth.  Regarding statements concerning the ability of physicians to perform hair restoration procedures with less staff when using the robotic system, and other specific statements about what the system allows, the Court again found that plaintiff failed to plead falsity because even under plaintiff's allegations the statements were technically correct.  As for the challenged statement concerning the Company' belief that procedure-based revenue failed to grow proportionally with the increase in installed base sales, the Court observed that plaintiff failed to adequately plead why this statement was actionable, given that defendants "were explicit in that they could not predict success and, in fact, predicted loss of funds."  The Court further noted that this statement was merely, in context, an opinion about a number of non-exhaustive reasons why procedure-based fees were not tracking unit sales and that the Company did not claim that the decline in stock price was due purely to limited use of the system.

The Court did find actionable alleged misrepresentations concerning the robotic device's "targeted precision and a cleanly scored incision" and the Company's "aggregate installed base growth of approximately 34% from December 31, 2015, or 174 to 233 systems."  The Court found that plaintiff had sufficiently alleged adequate facts to infer that the first statement was inaccurate, based principally on alleged statements from a confidential witness.  As to the other alleged statement, plaintiff argued that defendants misrepresented the number of systems that were actually "installed" rather than simply "sold," and the Court agreed that the statement could be misleading to a reasonable investor. 

Finally, the Court dismissed plaintiff's Item 303 claims.  As a threshold matter, the Court rejected defendants' argument that Item 303 is not actionable under Section 11 in light of the Ninth Circuit's decision in In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014) that Item 303 does not create a duty to disclose for the purposes of Section 10(b) and Rule 10b-5 of the Exchange Act of 1934.  The Court stated that the NVIDIA Court was explicit in noting that its prior case law indicating that Section 11 imposes liability if a registrant omits to state a material fact required to be stated in the registration statement is still good law.  However, the Court found that plaintiff had failed to plead facts showing that defendants "failed to disclose known trends and uncertainties" with respect to warehousing by foreign third-party resellers or alleged trends that its physicians were "abandoning" the system and that there was uncertainty "related to physicians stalling purchases" of the device.  The Court found that plaintiff did not adequately plead recurring examples of warehousing, failed to plead that a material impact from any such warehousing trend was "reasonably likely to occur" at the time of the IPO, failed to allege sufficient facts showing that at the time of the IPO­–rather than afterward–physicians were stalling purchases, and failed to adequately allege that defendants were aware of any such purported trends.

For these reasons, the Court found that plaintiff had adequately pled claims under Sections 11 and 15 of the Securities Act against defendants based on just two alleged misstatements, but dismissed all other claims with leave to replead (except as to the statement concerning the ability to perform the procedure with less staff, which it dismissed with prejudice).  

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