Sixth Circuit Affirms District Court's Dismissal Of Putative Securities Class Action Against Car Insurance Company For Failure To State A Claim

Shearman & Sterling LLP


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On April 29, 2024, the United States Court of Appeals for the Sixth Circuit affirmed the dismissal with prejudice of a putative class action asserting claims under the Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 ...
United States Corporate/Commercial Law
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On April 29, 2024, the United States Court of Appeals for the Sixth Circuit affirmed the dismissal with prejudice of a putative class action asserting claims under the Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the "Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 promulgated thereunder, alleging that a car insurance technology company (the "Company"), certain of its officers, and the underwriters of the Company's initial public offering ("IPO") misled investors in the Company's initial public offering materials. Kolominsky v. Root, Inc., No. 23-3392 (6th Cir. Apr. 29, 2024). Reviewing the district court decision de novo, the Court held that the complaint sounded in fraud and that the heightened pleading standard required by Rule 9(b) of the Federal Rules of Civil Procedure applied to the Securities Act claims and that the challenged statements were not actionable because they were based either on past performance and historical data or protected by the "Bespeaks Caution" doctrine.

The Company operated by pricing and quoting insurance through a mobile phone app and used the app to collect driving data from its customers. According to the Company, this strategy enabled it to deliver lower customer-acquisition costs compared to traditional automobile insurers. Appellants alleged in their complaint that the Company's registration statement contained misleading statements and omissions regarding the customer-acquisition costs, including the following that were dismissed and presented on appeal: (i) the Company delivered customer-acquisition costs "below the average cost of doing so through each of the direct and agent channels"; (ii) the efficiency of its customer acquisition strategy resulted in a customer-acquisition costs advantage over using direct and agent channels (including that the Company's average customer-acquisition costs was $332, compared to those of traditional car insurance companies', which averaged between $500 and $800), and (iii) it "may struggle to maintain cost-effective marketing strategies," and its customer-acquisition costs "could rise substantially." Appellants alleged that the Company's customer-acquisition costs had increased by the time of the IPO and that the Company therefore had a duty to update investors and alleged that the statement about the risk of a higher customer-acquisition costs was misleading because that risk already had materialized.

As an initial matter, the Court held that Rule 9(b)'s heightened pleading standard applied to the Securities Act claims because the claims asserted under the Securities Act and the Exchange Act "were all grounded in one fraudulent course of conduct relying on one set of facts." The district court had similarly concluded that Rule 9(b) applied despite appellants disclaimer of fraud in their Securities Act portion of complaint because the statements allegedly were "materially false and misleading," and plaintiff alleged that defendants operated a "fraudulent scheme."

The Court then held that the challenged statements could not give rise to liability. First, the Court noted that the first two challenged statements that the Company delivered below average customer-acquisition costs and that it had a customer-acquisition costs advantage over traditional insurance companies were "historical statements of past performance" and supported by other verifiable data disclosed in its offering documents. Moreover, the statements—when read in context—did not promise that the Company would deliver similar results in the future and were accompanied by a statement that historical data may not be indicative of future results. The Court held that "[t]he disclosure of accurate historical data does not become misleading even if less favorable results might be predictable by the company in the future" and that the Company was not under any duty to update the statements.

Second, the Court held that the Company's statements that it "may struggle to maintain cost-effective marketing strategies" and that its customer-acquisition costs "could rise substantially" were protected by the "Bespeaks Caution" doctrine. Various courts have held that this doctrine, which shields companies from liability when the allegedly misleading statements are forward-looking and accompanied by meaningfully cautionary language, continues to apply to shield companies from liability for certain statements not covered by the PSLRA's Safe Harbor provision. The Court here too "expressly [held] that the Bespeaks Caution doctrine survived the codification of the PSLRA." The Court then rejected appellants' argument that the Company should have stated that its marketing strategy "was" affecting its financial results rather than that it "could." The Court held that the statement was "a cautionary statement, [was] labeled a risk factor, and [was] forward-looking" and that it was "not a sham warning, and a reasonable investor would understand as much." The statement therefore "[fell] squarely within the Bespeaks Caution doctrine's protection."

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