Category Archives: Motion To Dismiss Monitor

When faced with litigation, companies often publicly opine that the case is “without merit.”  But if the company loses the litigation, can investors then bring a securities class action alleging that opinion was false?

In City of Fort Lauderdale Police and Firefighters’ Retirement Sys. v. Pegasystems, Inc., 2023 WL 4706741 (D. Mass. July 24, 2023), the court considered a securities class action brought in the wake of a civil decision requiring Pegasystems to pay $2 billion for willfully and maliciously misappropriating trade secrets.  The decision led to a stock price decline.  The plaintiffs in the securities case alleged that Pegasystems deceived investors when it previously stated (a) it would “[n]ever use illegal or questionable means to acquire a competitor’s trade secrets,” and (b) that the trade secrets case was “without merit.”

The court held that the plaintiffs had adequately plead falsity as to both statements.  While the  “never use illegal or questionable means” statement was contained in the company’s Code of Conduct, the court concluded that it was not “aspirational,” but instead described “with specificity a course of conduct that Pega promised to abjure.”  Given that the espionage campaign against its competitor allegedly was “orchestrated and directed” by the company’s senior executives, the statement was misleading to investors.

As to the opinion that the trade secrets litigation was “without merit,” the court found that the statement did not “fairly align” with the CEO’s “awareness of, involvement in, and direction of Pega’s espionage campaign.”  Moreover, “a reasonable investor could justifiably have understood [the CEO’s] message that [the] claims were ‘without merit’ as a denial of the facts underlying [the] claims – as opposed to a mere statement that Pega had legal defenses against those claims.”

Holding: Motion to dismiss denied.

Quote of note: “An issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the complaint 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, make misleading substantive declarations regarding its beliefs about the merits of the litigation.”

Securities class actions involving Special Purpose Acquisition Companies (SPACs) can raise interesting issues.  A SPAC is a publicly traded shell company created to merge with an existing privately held business so as to allow the target company to go public without the time, expense, and regulatory scrutiny of an initial public offering.  If the privately held business makes material misstatements that affect the SPAC’s stock price prior to the merger, can that company and its officers be liable for securities fraud?

The U.S. District Court for the Northern District of California recently considered that question in In re CCIV/Lucid Motors Sec. Litig., 2023 WL 325252 (N.D. Cal. Jan. 11, 2023).  CCIV is a SPAC that acquired Lucid Motors, an electric car manufacturer, in February 2021.  CCIV’s shareholders brought a securities class action alleging that in the weeks prior to the announcement of the merger, Lucid had made false and misleading statements about its production capacity and production start date that caused CCIV’s stock price to artificially increase because there were market rumors about a possible merger.  Once the merger was entered into, Lucid disclosed that its factory was not yet built and production would not begin in spring 2021, leading to a 36% decline in CCIV’s stock price.

In their motion to dismiss, the defendants argued that CCIV’s shareholders did not have standing to sue Lucid and its officers because the alleged misstatements were about Lucid, not CCIV.  The defendants relied heavily on a pair of Second Circuit decisions (Nortel and Menora) holding that stockholders do not have standing when the company whose stock they purchased is negatively impacted by the material misstatements of another company.  The district court did not find those decisions persuasive, noting that they appeared to rely on an overly restrictive reading of Supreme Court precedent.  Moreover, while other courts outside the Second Circuit have adopted the same approach, some decisions have suggested that there might be an exception to the general rule if the two companies have a direct relationship, as in a merger.  Nor did the district court find that there was any public policy rationale for limiting standing in this situation, noting that the Supreme Court has rejected proposed limitations on the Section 10(b) private right of action in the past.

Despite finding that standing existed, the district court ultimately dismissed the claims for lack of materiality.  In particular, the district court found that “[t]o show information regarding a potential merger is material plaintiffs must be able to allege that the merger was likely to occur at the time they relied on defendants’ misrepresentations.”  In this case, however, the alleged misrepresentations were made at a time “when Lucid and CCIV had not even publicly acknowledged that a merger was being considered.”  Under these circumstances, the district court held, alleged misstatements about Lucid could not have been material to CCIV’s investors.

Holding: Motion to dismiss granted with leave to amend.

Quote of note:  “Here, plaintiffs purchased securities in CCIV and seek to hold Lucid and its CEO Rawlinson liable for inducing them to make those purchases through misrepresentations and omissions about the value of Lucid itself which CCIV then acquired.  Thus, plaintiffs purchased securities, have identified specific alleged misconduct, and the alleged loss is discernible.  The Court finds plaintiffs have standing.”

Investors frequently bring securities class actions against drug development companies, typically asserting that the company failed to adequately disclose information about its clinical trials.  In Lehmann v OHR Pharmaceutical, Inc.,  2019 WL 452765 (S.D.N.Y. Sept. 20, 2019), the company was developing a drug for the treatment of a degenerative eye disease called Wet Age-Related Macular Degeneration (“Wet AMD”).  The plaintiffs claimed that OHR, in disclosing the results of its Phase II clinical trial, failed to disclose that its control arm results were inconsistent with previous trials (which allegedly made the Phase II trial appear more successful than it really was).  Ultimately, the company announced disappointing results for its subsequent Phase III clinical trial and the stock price declined 81%.

The court found that OHR’s disclosures were accurate and the company was not required to provide more context around its Phase II trial results.  Indeed, the court questioned the entire premise of the case, noting that “[o]n Plaintiffs’ account, it is unclear whether the Company should have embarked on the phase III study after the success of the phase II study – should the Company have ignored what Plaintiffs say were aberrant results, or should it have investigated further?”  The court came down firmly on the side of further investigation, noting “that the law does not abide attempts at using the judiciary to stifle the risk-taking that undergirds scientific achievement and human progress.”

Holding: Motion to dismiss granted (also based on the plaintiffs’ failure to adequately plead scienter).

Quote of note:  “This Court will not adopt a rule that discourages free scientific inquiry in the name of shielding investors from the risks of failure.  Science is risky.  Science advances through those willing to take those risks and break with consensus.  With science suffering from a replication crisis, this Court is happy to report that the law does not abide attempts to use the judiciary to stifle the risk-taking that undergirds scientific advancement and human progress.  The answer to bad science is more science, not this Court’s acting as the Southern District for the Inquisition.”

To what extent can plaintiffs use allegations from a retained expert in a securities fraud complaint?  In Sgarlata v. Paypal Holdings, Inc., 2019 WL 4479562 (N.D. Cal. Sept. 18, 2019), the plaintiffs claimed that PayPal had failed to adequately disclose a cybersecurity breach.  To bolster their scienter (i.e., fraudulent intent) allegations, the plaintiffs engaged a cybersecurity expert to determine what information about the breach likely was available to the company at the time the breach was discovered and provided the expert’s opinions in the complaint.

In its motion to dismiss decision, the court found that it could consider the expert’s statements, but only if they satisfied the same standard applied to confidential witnesses, i.e., (1) the statements must be described with sufficient particularity to establish the expert’s reliability and personal knowledge; and (2) the statements must themselves be indicative of scienter.  The cybersecurity expert had extensive experience in the field and opined that the company must have known more about the breach than it disclosed.

The court noted, however, that there was no allegation in the complaint that the expert “was familiar with, much less had knowledge of, the specific security architecture of Defendants’ privacy network.”  Moreover, the expert “did not actually talk to employees . . . nor did he review documents that – in and of themselves – demonstrate inconsistencies that were available” to the company at the time of its disclosure.  Even considered holistically with the entire complaint, the court found that the expert’s opinions did not support a finding of scienter.

Holding: Motion to dismiss granted.

It is common for a securities class action to follow an announcement that a company has engaged in Foreign Corrupt Practices Act (FCPA) violations.  Plaintiffs typically allege that the company’s statements about its legal compliance, internal controls, and/or financial results were rendered false or misleading by the failure to disclose that certain revenues were obtained through corruption.

In Doshi v. General Cable Corp., 2019 WL 1965159 (E.D. Ky. April 30, 2019), General Cable entered into settlements with the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) over FCPA violations.  As part of a non-prosecution agreement with the DOJ, the company admitted that it knew about certain corrupt payments and “knowingly and willfully failed to implement and maintain an adequate system of internal accounting controls designed to detect and prevent corruption or other illegal payments by its agents.”  The court’s motion to dismiss ruling contains three interesting holdings.

First, there is a two-year statute of limitations for federal securities fraud claims, which begins to run when the “plaintiff did discover or a reasonably diligent plaintiff would have discovered the the facts constituting the violation.”  Although the complaint was filed more than two years after General Cable first disclosed the possibility of FCPA violations, the court held that the claims were not barred by the statute of limitations because there was no available evidence of scienter (i.e., fraudulent intent) until the company entered into the government settlements.

Second, the court found that the only actionable misstatements made by General Cable related to its statements concerning the effectiveness of its internal controls over financial reporting (including SOX certifications).  The company’s disclosure that it had a FCPA compliance program was not rendered false or misleading by the fact that the program was not effective.  The company also had no obligation to disclose a theoretical risk that its overseas operations might fail if it could not rely on corrupt business practices.

Finally, despite its holdings regarding the statute of limitations and the existence of actionable misstatements, the court concluded that the plaintiffs had failed to adequately plead scienter.  The company’s settlements with the government established that “GC knew it did not have controls that provided a sufficient framework for dealing with third-parties in the identified subsidiaries and GC knew that this allowed it to violate the FCPA in particular countries.”  However, the court held, “this does not mean that GC knew its overall internal controls over financial reporting were not effective, nor does it mean that GC knew its SOX certifications – which do not specifically relate to the FCPA – were false.”  In other words, the court found that the “most plausible inference” was that GC believed that its overall financial reporting system was “sound despite a specific FCPA-related issue.”

Holding: Motion to dismiss granted.

Among other reforms, the Private Securities Litigation Reform Act of 1995 (“PSLRA”) requires that upon “final adjudication” of a federal securities action, the court shall include in the record “specific findings regarding compliance” with the federal rule providing that attorneys’ must present accurate and non-frivolous pleadings to the court.  If the court finds the rule has been violated, it must impose sanctions on the offending party or attorney.

The PSLRA’s required sanctions review is more honored in the breach than the observance, with federal judges generally declining to provide the specific findings unless prompted by a party.  In turn, parties rarely make these requests because they believe there is a slim likelihood of sanctions being imposed.

That said, if a plaintiff is worried about a possible sanction, can it avoid the mandatory review by voluntarily dismissing its claim?  In Rezvani v. Jones, 2019 WL 1100149 (C.D. Cal. March 6, 2019), the plaintiff voluntarily dismissed his case with prejudice after he failed to amend his complaint and the court indicated that it found dismissal with prejudice appropriate.  The court held that for purposes of determining whether the dismissal was a “final adjudication” under the PSLRA, the key factor was that the dismissal was with prejudice (not whether it was voluntary or involuntary).  A dismissal with prejudice – no matter the exact circumstances – closes the district court case file, constitutes a “final adjudication,” and leads to the required sanctions review.

However, the court also found that sanctions against the plaintiff were not warranted.  The securities claim had “little merit,” but the court accepted counsel’s representation that he had researched his client’s claims and the case had been brought in good faith.  In addition, the court credited the plaintiff for dropping his securities claim “once the Court identified its deficiencies.”

Holding: Defendant’s motion for sanctions denied.

If an individual defendant’s stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan that was entered into before the outset of the alleged fraud, the use of the trading plan may undermine any inference that the trades were “suspicious” for purposes of assessing scienter (i.e., fraudulent intent).  As part of this analysis, however, does a court have to accept that the beginning of the class period constitutes the outset of the alleged fraud?

In Harrington v. Tetraphase Pharma., Inc., 2017 WL 1946305 (D. Mass. May 9, 2017), the plaintiffs claimed that the company “knew that the drug they were testing would fail long before that information was released to the public.”  The alleged timeline was that the class period began on March 5, 2015, two of the individual defendants entered into Rule 10b5-1 trading plans on March 13, 2015, and the company became aware of the results of its clinical testing as of late April or early May 2015.  In assessing the impact of the Rule 10b5-1 trading plans on its scienter analysis, the court noted that the plans “were executed before even Plaintiffs argue that defendants possessed results from the pivotal portion of the [clinical trial].”   Accordingly, the court rejected the idea that it was forced to accept, for purposes of analyzing the impact of the trading plans, that the alleged fraud began at the beginning of the class period.  Instead, the court concluded that the “reasonable inference from the alleged facts” was that the fraud began after the two individual defendants entered into their trading plans and, as a result, their subsequent trading was not suspicious.

Holding: Motion to dismiss granted (on the basis that the plaintiffs had failed to establish a strong inference of scienter as to any of the defendants).

Can a company face securities fraud liability for describing a lawsuit brought against it as “meritless” if the plaintiff goes on to win a big verdict?  In Grobler v. Neovasc, Inc., 2016 WL 6897760 (D. Mass. Nov. 22, 2016), Neovasc was hit with a $70 million verdict in a case alleging that it stole intellectual property, its stock price declined by 75 percent when the verdict was announced, and investors brought a securities class action.  The investors alleged that Neovasc had lied when it repeatedly told them that the intellectual property case was “without merit” and “baseless.”

The district court concluded that the PSLRA’s safe harbor for forward-looking statements applied to Neovasc’s statements.  First, the statements “were predictions about the future outcome of the pending litigation, and could only be invalidated by reference to the ultimate outcome of the case.”  Second, the statements were accompanied by meaningful cautionary language that “included detailed and specific warnings about the possibility and the consequences of losing” the intellectual property case.  Finally, whether Neovasc actually believed that it was likely to lose the intellectual property case was irrelevant because “examining an alleged present belief apart from the forward-looking aspects of the statement requires an inquiry into the state of mind of the defendant—something that the first prong of the safe harbor provision is written to ignore.”  Accordingly, the court found that the alleged false statements were inactionable.

Holding: Motion to dismiss granted with prejudice.