Northern District Of California Grants Motion To Dismiss Amended Securities Class Action Complaint Against Hearing Aid Company

On August 31, 2023, Judge Charles R. Breyer of the United States District Court for the Northern District of California granted a motion to dismiss a putative securities class action alleging that a hearing aid company (the "Company"), its officers, directors and underwriters, violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 (the "Securities Act") and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"). In re Eargo, Inc. Sec. Litig., No. 21-cv-08597 (N.D. Cal. Aug. 31, 2023). Plaintiffs alleged that the Company misrepresented the Company's revenue and growth opportunities in its offering materials and allegedly downplayed an audit that allegedly led to a Department of Justice investigation in later SEC filings and public statements. We previously covered the Court's decision dismissing the first amended complaint (the "FAC") because plaintiffs failed to sufficiently plead falsity and scienter. The Court held that plaintiffs' second amended complaint (the "SAC") "suffer[ed] from the same pitfalls identified in the Court's prior order" and dismissed the SAC without prejudice.

The Company, which manufactures and sells hearing aids, launched an IPO in October 2020. Whereas hearing aids traditionally require customers to make in-person visits to hearing aid professionals who perform audiological tests, the Company developed a telehealth model that allegedly did not require testing for hearing aids to be prescribed. According to plaintiffs, the Company at first sold its products primarily to customers who paid out-of-pocket but then began servicing customers enrolled in a federal employee health benefits program (the "Federal Program") that provided health benefits through a third-party insurance carrier (the "Insurance Carrier"). According to plaintiffs, the Company's revenue more than doubled after soliciting Federal Program beneficiaries, and, by the end of 2020, insured customers were approximately 45% of the Company's total customer base.

Between March 15 and April 7, 2021, the Company allegedly was notified that it was being audited by the Insurance Carrier and that the Company would be required to supply supporting documentation for all claims submitted, including diagnosis codes based on audiological testing. On May 12, 2021, the Company said that it was "currently subject to a routine audit." According to the SAC, the Company subsequently disclosed on August 12, 2021, that "claims submitted since March 1, 2021 have not been paid." The Company also disclosed that "[r]eimbursement claims submitted to [the Insurance Carrier] are also currently undergoing an audit, and ... it is possible that they may seek recoupments of previous claims paid and deny any future claims." The Company warned that "an unfavorable outcome of the ongoing audits could have a material adverse effect on [its] future financial results[.]" On an August 12, 2021 earnings call, the Company's CFO allegedly stated that "[t]hese kind of audits are—on claims are pretty common, particularly given the growth in our business."

The Court held that plaintiffs "fail[ed] to plead scienter." First, although plaintiffs alleged in the SAC that two of the Company's executives sold stock during the class period, the Court noted that "these sales appear non-discretionary—that is, they were made either to cover tax obligations or under a Rule 10b5-1 trading plan." The Court also noted that these same two executives increased their holdings in the Company's stock during the class period, which "further negate[d] any inference that they sought to avoid losing money before a price decline resulting from the insurance audits."

Second, the Court rejected as insufficient purported statements from a former employee of the Company who stated that the Company's online hearing tool "should have never been used for insurance purposes." According to the Court, "it is not enough, for purpose of pleading a securities fraud claim, that different people have different interpretations of what [an] insurance policy covers." The Court further found that a September 2020 PowerPoint slide labeled "Insurance Risks" created by a senior director at the Company simply identified risks "generally applicable to any entity submitting insurance claims." Similarly, the Court held that alleged communications between the Company's chief legal officer and counsel for the Insurance Carrier concerning the Company's telecare model "simply show[ed] both entities' effort to align [the Company]'s telecare business model with the [Insurance Carrier's] policy requirements." Because plaintiffs failed to plead facts sufficient to give rise to a strong inference of scienter, the Court dismissed the Exchange Act claims.

With respect to plaintiffs' Securities Act claims, the Court held that new allegations regarding an August 2020 email and the September 2020 PowerPoint slide did not establish that the Company's statements in its offering materials about its revenue and growth opportunities were false or misleading. According to plaintiffs, statements in the offering materials were false or misleading because the Company allegedly did not believe that they would receive reimbursement under the Federal Program. The Court held that an alleged August 2020 email from the Company's CFO allegedly asking another employee to "come ready to answer" questions about revenue recognition did not support this claim because it concerned accounting for hearing aids returned by customers at the end of a trial period rather than whether products were eligible for insurance reimbursements. With respect to the PowerPoint slide, the Court again noted that the "slide highlights only general risks with accepting insurance" and did "not establish that those risks, as of September 2020, already materialized insofar that it would render statements in the IPO Offering Documents materially false or misleading." The Court therefore dismissed plaintiffs' Securities Act claims.

In re Eargo, Inc. Sec. Litig.

Originally published October 11, 2023.

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