On July 21, 2020, Judge Charles Breyer of the United States District Court for the Northern District of California dismissed a putative class action asserting claims under the Securities Act of 1933 and the Securities Exchange Act of 1934 against an information technology and software company, certain of its executives, and the underwriters for the company's IPO.  In re Pivotal Sec. Litig., No. 3:19-cv-3589, slip op. (N.D. Cal. July 21, 2020), ECF No. 100.  Plaintiffs alleged that the company made misleading statements in IPO offering documents and in subsequent public statements regarding its financial and business condition.  The Court held that plaintiffs failed to adequately allege any actionable misstatement or omission, and further that plaintiffs failed to establish that the alleged misstatements with respect to the Exchange Act claims were made with scienter.  However, the Court granted leave to amend as to certain allegations.

Plaintiffs alleged that the company's public statements "repeatedly tout[ing] the superiority and adoption of its products" were false or misleading because they failed to disclose that the company allegedly "was facing major problems with its sales execution and a complex technology landscape" as well as "the industry's sentiment [having] shifted away from [the company's] principal product, which was incompatible with ... the industry-standard platform."  Slip op. at 4.  Ultimately, the company informed investors that it had "closed fewer deals than ... expected in Q1 due to sales execution and a complex technology landscape that is lengthening [the company's] sales cycle."  Id. 

With respect to the Securities Act claims, the Court first determined that several alleged misstatements in the company's registration statement were not alleged to have been false at the time they were made.  Id. at 9.  For example, plaintiffs alleged that the company's statement that its software was integrated with the industry-standard platform was false because the company's leading product was not integrated in this way.  Id. at 10.  The Court concluded to the contrary that the company's statement was accurate because the company's software contained several components, and plaintiffs alleged only that the statement was false with respect to one product.  Id.  The Court further rejected plaintiffs' allegation that the company's statement that it worked closely with large public cloud providers to "bring [the company's] customers' workloads to their cloud infrastructure" was misleading because the company allegedly competed for clients with the large providers.  Id.  The Court noted that the complaint itself alleged that some cooperation with large providers was occurring, and the company's registration statement also disclosed that it operated in a "highly competitive industry" and that it "currently or in the future may compete" with large providers.  Id. at 11.

The Court further rejected plaintiffs' argument that the company's risk disclosures were misleading because certain of the risks had already materialized at the time of the IPO, for which, the Court emphasized, plaintiffs failed to provide anything beyond conclusory assertions.  Id. at 11.  The Court also explained that various expressions of corporate optimism in the registration statement—including that the company's software was "cutting-edge," "leading," and a "turnkey cloud-native platform"—were nonactionable puffery.  Id. at 12–13.  Finally, while plaintiffs argued that SEC Regulation S-K imposed a duty on the company to disclose that it was experiencing decreased sales and competitive disadvantages, the Court explained that plaintiffs failed to established that any particular trend or uncertainty was known to company management, and that various risks complained of, such as product obsolescence, were in fact adequately disclosed.  Id. at 13–15. 

With respect to the Exchange Act claims, plaintiffs alleged the company made misstatements in the course of four financial earnings calls and one investor conference and listed more than forty alleged misleading statements within excerpted transcripts of those events.  Id. at 18.  The Court, however, emphasized that the complaint failed to explain why each challenged statement was misleading, and instead provided a "conclusory litany of reasons for the statements' falsity that are insufficiently supported by vague accounts from seven [confidential witnesses]."  Id. at 18.  The Court instructed plaintiffs to provide an explanation as to each challenged statement in any amended complaint.

The Court also explained that certain statements of opinion expressed in these corporate events were not actionable because plaintiffs' allegations failed to establish that defendants did not hold the stated beliefs.  Id. at 25.  Moreover, the Court held that challenged statements describing the company's products and business as "uniquely position[ed]," "strong across sectors," "best-in-class," and "industry-leading" were non-actionable corporate puffery.  The Court also explained that various challenged statements were forward-looking statements either regarding plans and objectives for future operations or future economic performance, accompanied by meaningful cautionary language, and therefore fell within the safe harbor provision in the Private Securities Litigation Reform Act ("PSLRA").  Id. at 27-28. 

The Court also held with respect to the Exchange Act claims that plaintiffs' allegations based on statements by confidential witnesses were insufficient to establish scienter.  Id. at 28.  The Court explained that, under the PSLRA, confidential witnesses "must be described with sufficient particularity to establish reliability and personal knowledge" and the statements themselves must be "indicative of scienter," but that plaintiffs failed to satisfy either element.  Id. at 29.  First, the confidential witnesses were at least two reporting levels removed from the company's executives in question and only described generally their attendance at meetings and receipt of regular reports; in addition, the Court held that confidential witness allegations regarding deficiencies in the company's sales strategy did not establish that the company was "deliberately reckless."  Id. at 30-31.

The Court likewise rejected plaintiffs' other theories of scienter.  The Court explained that allegations based on the fact that certain earnings statements were revised soon after issuance amounted to impermissible "fraud by hindsight," and the core operations doctrine—which, as applied within the Ninth Circuit, permits an inference of scienter if the fraud is based on facts critical to a business's core operations, such that key officers would know of those facts—was inapplicable because the complaint failed to contain any details establishing individual defendant's access to information related to the fraud.  Id. at 31.  Indeed, the Court noted that allegations that defendants had general access to sales reports and "occasionally" sat in on regular meetings were insufficient to support application of the core operations doctrine.  Id. at 32.  Finally, the Court considered the complaint in its entirety and found that the allegations, taken collectively, failed to support a compelling inference of scienter, and in fact failed to "offer any coherent theory of fraud."  Id. at 33.

Because plaintiffs indicated that they could plead additional facts supporting falsity and scienter, the Court granted leave to amend.  Id. at 15, 33.  However, the Court emphasized that non-actionable statements should not be included in any amended complaint, highlighting in particular allegations based on what the Court had held constituted corporate puffery or forward-looking statements.  Id. at 15, 25, 28.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.