On July 13, 2022, the United States District Court for the
Central District of California largely denied a motion to dismiss a
putative class action asserting claims under the Securities
Exchange Act of 1934 against a special purpose acquisition company
(SPAC), a space industry startup that was the SPAC's target,
certain executives of both companies, and an investor that served
as sponsor of the SPAC. In re Stable Road Acquisition Sec.
Litig., No. 2:21-cv-05744, slip op. (C.D. Cal. July 13, 2022),
ECF No. 154. Plaintiff alleged that the target company made
misrepresentations regarding the viability of its technology and
the immigration and national security status of its CEO, which the
SPAC allegedly repeated without conducting adequate due diligence.
The Court held that plaintiff's allegations were largely
sufficient but that plaintiff failed to adequately allege scienter
or control person liability with respect to certain
executives.
Plaintiff alleged that the target company knew but failed to
disclose that multiple government agencies had determined that its
CEO presented a national security risk, that the government revoked
the CEO's work visa and commenced removal proceedings against
him, and that the company's only test of its core technology
had failed — all of which allegedly rendered the
company's financial projections misleading. Slip op. at 5-6.
Plaintiff further alleged that the SPAC made similar
misrepresentations as a result of failing to undertake adequate due
diligence. Id. at 7. Ultimately, the SEC announced a Cease
and Desist Order with respect to the proposed acquisition and the
SPAC and the target company agreed to pay civil monetary penalties.
Id. at 5.
The Court rejected the target company's arguments that its
alleged misstatements and omissions were either nonactionable
forward-looking statements of opinion or were accompanied by
adequate risk disclosures. The Court explained that plaintiff
"plausibly allege[d] that the [company's] warnings of
risks that might occur [were] misleading to a reasonable investor
because the [company] knew that many of those risks had already
materialized or very likely would materialize." Id.
at 12.
The Court further concluded that plaintiff's allegations gave
rise to a strong inference of scienter with respect to the target
company. Id. at 13. The Court determined that the
allegations "taken as a whole" supported the inference
that the company's executives knew their representations were
misleading due to the alleged omission of information regarding the
CEO's status and the test of the company's core technology.
Id. Specifically, the Court explained that the allegations
were sufficient to show that the company's Chief Revenue
Officer had knowledge of the failed test based on an email she
received, and also that she should have known about the failed test
and the CEO's national security and immigration issues based on
her leadership role and involvement in revenue projections.
Id. The Court further observed that the company's
President should have known about the allegedly omitted information
because it related to the company's "core
operations," and also because he gave an interview on the same
topics that made it "implausible that [he] would only be aware
of the facts he disclosed in his interview and none of the other
directly relevant and material information that would have made his
statements not misleading." Id. at 14. The Court also
noted that the allegations against the CEO himself were "more
than sufficient." Id.
With respect to the SPAC defendants, the Court rejected the
argument that the allegations against them amounted to mere
negligence for repeating information conveyed by the target
allegedly without having conducted adequate due diligence.
Id. at 15. Instead, the Court held that plaintiff
adequately alleged scienter based on a theory of deliberate
recklessness or willful blindness as to the SPAC and its CEO, who
was allegedly responsible for making alleged misstatements
regarding the target company and allegedly promoted the SPAC's
"extensive due diligence." Id. at 15-16.
However, with respect to other SPAC executives, the Court held
plaintiff failed to adequately allege scienter based on their
high-level positions and alleged participation in due diligence,
without specifically alleging that they were "aware of any red
flags to which they turned a blind eye, or that they made any
statements that were deliberately reckless because of the failure
to investigate those red flags." Id. at 16.
The Court further determined that plaintiff's control person
allegations were adequately alleged as to the SPAC's CEO and
its sponsor. Id. at 16. The Court, however, dismissed
plaintiff's control person allegations with respect to the
remaining executives of the SPAC and target company. Id.
The Court explained that plaintiff's allegations for those
defendants regarding their high-level positions or stock ownership
were insufficient to show that they actually exercised control over
the SPAC or target company "in an effort to induce them to
engage in acts that violated the securities laws."
Id.
In re Stable Road Acquisition Sec. Litig.
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