ARTICLE
30 August 2023

You Might Want To Think Twice Before Describing Pending Litigation As "without Merit"

CL
Cooley LLP

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There's definitely a lesson to be learned from this recent case from the Massachusetts Federal District Court, City of Fort Lauderdale Police & Firefighters' Ret. Sys. v. Pegasystems Inc.: companies...
United States Intellectual Property

There's definitely a lesson to be learned from this recent case from the Massachusetts Federal District Court, City of Fort Lauderdale Police & Firefighters' Ret. Sys. v. Pegasystems Inc.: companies making public statements about pending litigation should be very cautious when characterizing their views on the merits or prospects of that litigation. There may well be occasions when describing litigation as "without merit" may be, well, merited. But companies should keep in mind that claiming that a complaint against the company is "without merit"-as companies often do-may just shake up a whole new hornets' nest, as it did in this case. (Hat tip to The 10b-5 Daily.)

Background. In prior litigation, the defendant Pegasystems was found to have "willfully and maliciously misappropriate[ed]" the trade secrets of a competitor and ordered to pay $2 billion. The plaintiff shareholders in the present case brought a securities fraud class action under Rule 10b-5 and Section 20(a) of the Exchange Act against Pega, its CEO and CFO, claiming that, although the defendants knowingly engaged in the conduct underlying the earlier litigation, they "failed to disclose that litigation, falsely reassured investors that [the competitor's] claims were 'without merit,' and misleadingly promised never to misappropriate trade secrets." The defendants moved to dismiss. The Court granted the motion dismissing the CFO, as to whom the allegations of scienter were found lacking, but denied the motion as to Pega and the CEO.

As the Court described the facts alleged: For almost a decade, "Pega's senior executives and employees participated in a conspiracy to misappropriate" a competitor's trade secrets, including using a third party to engage an employee of a government contractor to spy on the competitor. The "spy" reported to Pega management at several meetings and the misappropriated information circulated across the company. Subsequently, it was alleged, Pega, under the CEO's direction, engaged in additional corporate espionage, using Pega employees that posed as customers of the competitor to infiltrate its platform. These efforts were even given code names-"Project Crush" and "Teardown." Pega imposed no "formal disciplinary consequences" for the participants in the scheme; instead they received cash bonuses. However, "Pega was aware of the illicit nature of its activities," with the CTO Director often referring to his "spies" and asking the CTO "[w]ho can I ping about legality of using [the competitor's] system?"

After two former Pega employees divulged the scheme to the competitor in 2020, litigation ensued. In its periodic reports filed between 2020 and mid-February 2022, Pega "made no express mention" of the litigation with its competitor, but instead reported only that "[w]e have received, and may in the future receive, notices that claim we have misappropriated, misused, or infringed other parties' intellectual property rights."In mid-February, after the competitor filed an amended complaint for $3 billion-"almost four times Pega's current assets and roughly three times Pega's revenue in 2021"-Pega filed its Form 10-K expressly describing the litigation. The 10-K stated that the competitor's "claims 'are without merit,' Pega has 'strongdefenses to these claims,' and that 'any alleged damages claimed by [the competitor] are not supported by the necessary legal standard.'" Pega's stock price dropped 15%. After a seven-week trial, the jury unanimously found against Pega, concluding that it had "willfully and maliciously misappropriated" the competitor's trade secrets in violation ofstate law and awarding damages of around $2 billion plus millions more in attorneys' fees and interest. Pega's stock price dropped about 28%.

Analysis. Pega moved to dismiss the complaint for "failure to state a claim alleging that Fort Lauderdale has not pled facts with particularity establishing (1) that any of the challenged statements are false or misleading, (2) a strong inference of scienter, and (3) loss causation." As to Pega and the CEO, the Court held that "Pega's arguments miss the mark. The facts alleged in the complaint raise a strong inference that [the CEO] was aware of, involved in, and directed Pega's corporate espionage against [the competitor]. Moreover, the Court said, there was "little doubt" that the CEO "knew or was reckless in not knowing that falsely reassuring investors" that the $3 billion "claim against Pega had no merit-despite his knowledge to the contrary-posed a 'substantial likelihood of misleading a reasonable investor.'" A false denial of the merit of these claims "posed an obvious danger to mislead investors as to the substantial financial risks Pega was facing," establishing scienter for the CEO. That assurance was also "false and misleading according to the standard set forth in the Private Securities Litigation Reform Act ('PSLRA'), as well as causally connected to the drop in value of Pega stock in February and May 2022." Therefore, the motion to dismiss was denied as to Pega and the CEO.

The CEO's statement that the claims were "without merit" was "an actionable opinion statement." Not only did it not "fairly align" with the information in Pega's possession, the Court reasoned, the CEO's "involvement and direction of the conspiracy" called into question his basis for offering the opinion that the claims were without merit. These were not just a few facts that cut the other way. Even framed as an expression of opinion, in this context, the statement was misleading. "Given the way that statement was couched and the identity of the speaker," the Court concluded, "a reasonable investor could justifiably have understood [the CEO's] message that [the competitor's] claims were 'without merit' as a denial of the facts underlying [those] claims-as opposed to a mere statement that Pega had legal defenses against those claims."

But here is the Court's most critical advice: there's a big difference between stating that claims were "without merit," as in this case, effectively denying the underlying facts, and

"a mere statement that Pega had legal defenses against those claims. This does not mean that Pega was under the obligation to 'confess to the wrongdoing' when it disclosed the Virginia Litigation...An issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the claims against it are true. When it decides to do so, however, it must do so with exceptional care, so as not to mislead investors. For example, an issuer may validly assert its intention to oppose the lawsuit... It may also state that it has 'substantial defenses' against it, if it reasonably believes that to be true....An issuer may not, however, 'ma[ke] [(misleading)] substantive declarations regarding its beliefs about themeritsof the . . . litigation.'"

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.

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