On March 4, 2024, the Supreme Court received appeal requests in two putative securities fraud class actions – Facebook, Inc. v. Amalgamated Bank (No. 23-980) and NVIDIA Corp. v. E. Ohman J:OR Fonder AB (No. 23-970). The defendants in each matter asked the Court to overturn a decision from the Ninth Circuit Court of Appeals, declining to dismiss claims against them under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
On June 10 and June 17, the Supreme Court agreed to hear both appeals, but with respect to the Facebook appeal the Court certified for review only one of the questions presented. Both appeals present issues that commonly arise in securities fraud cases and are litigated every day by public companies and their directors and officers. The outcome of these appeals, thus, has the potential to have broad impact and make it harder for plaintiffs to plead securities fraud claims.
We believe that the plaintiffs in each case have failed to plead how the defendants’ statements were false or misleading, and/or failed to plead sufficient facts to give rise to a “strong inference” of fraudulent intent or “scienter.” Both deficiencies are fatal to securities fraud claims and should result in reversal by the Supreme Court.
The Facebook Appeal
Although the defendants in Facebook asked the Supreme Court to consider two questions, the Court granted certiorari as to only one question – namely, what public companies must disclose in the “risk factors” section of their 10-Ks. The plaintiffs had alleged that Facebook’s statement in its 10-K on possible harm to the company arising from the risk of improper third-party access to and disclosure of user data was false and misleading because it was presented as a “hypothetical risk” when, in the past, Facebook had already experienced improper access and use of its data by a third party.1 The Ninth Circuit held that the plaintiffs had sufficiently alleged this statement was false and misleading because, at the time the statement was made, Facebook supposedly knew this risk had already “materialized” based on this past incident.2
On appeal, Facebook argues that a risk factor is forward-looking in nature and cannot reasonably be read by investors as a representation that the thing warned of has never occurred in the past. According to Facebook, the Ninth Circuit’s iteration of the standard for pleading falsity for risk factors should be overturned because it would require companies to disclose a past event, even though there is no known threat of ongoing or future harm to the company associated with that past event.
Also, it is important to bear in mind that companies are required to include risk factors in their 10-Ks and the ability to plead falsity for such disclosures has to be based on something more than simply pointing to the fact that the risk warning later came to fruition. If the rule were otherwise, it would be far too easy for plaintiffs to argue, with the benefit of hindsight, that the company “must have known” the risk had already moved from theoretical to actual at the time of the 10-K.
Facebook also makes the practical point that the Ninth Circuit’s ruling would lead to more burdensome and unworkable disclosure requirements for SEC filings that would reduce the usefulness of risk factor disclosures by drowning inventors in irrelevant information. Facebook explains that, under the Ninth Circuit’s ruling, companies would be burdened with chronicling long-past events, which have no foreseeable impact on the company, or risk being sued if the event turns out to present larger issues than reasonably anticipated.
It is very common in securities cases for plaintiffs to allege, as in Facebook, that a company’s risk factors are themselves misleading. Facebook, therefore, has the potential to impact a large number of cases where similar claims have been brought. Risk factors are designed to help investors in assessing their risk tolerance and should not be turned into a “gotcha” moment for the plaintiffs’ bar whenever a company is forced to announce bad news.
The NVIDIA Appeal
The NVIDIA appeal addresses a common pleading tactic whereby the plaintiffs are fed information about the existence of internal reports within a company by unnamed former employees. At the motion to dismiss stage, the plaintiffs will argue that the required fraudulent intent for an executive can be shown through allegations of regular reports being circulated. The plaintiffs will claim that those reports must have put the executives on notice of the bad facts the plaintiffs contend were concealed from investors. Often, the plaintiffs then double down on the speculation and claim that the executives must have read the available reports because they were very “detail-oriented” or “hands-on” as to all aspects of the company. This is the pleading tactic that allowed the plaintiffs to prevail as to one executive in NVIDIA case.3
NVIDIA has asked the Supreme Court to address whether the plaintiffs who seek to rely on allegations of internal reports must plead with particularity the contents of those documents or face dismissal. The answer to that question should be that further detail is required because every company is going to generate some internal reports on issues of importance to the company’s financial health and future demand for its products. The mere existence of internal reports standing alone cannot be sufficient because that would mean the plaintiffs would automatically satisfy the requirement of pleading fraudulent intent on the part of executives.
The critical distinguishing fact that many courts have recognized is that the plaintiffs must be able to plead particular facts about the actual contents of those reports and not rely on speculation about what they might have said. In other words, they must plead facts showing that the reports seen by the executives actually contained information contrary to the company’s public statements. Only through such a showing can plaintiffs successfully plead the required strong inference of fraudulent intent on the part of a specific person at a specific point in time.
NVIDIA contends on appeal that the internal report allegations that were found to be sufficient to plead scienter against one of its executives were of the type that would have been rejected by other courts. As if in tacit acknowledgement of this fact, the plaintiffs in NVIDIA took the unusual step of hiring an expert who attempted to reverse engineer from public data what internal reports at NVIDIA must have shown at particular points in time.4 NVIDIA argues that the court erred in allowing a bought-and-paid-for expert’s opinions to shore up otherwise deficient allegations of internal reports. NVIDIA has asked the Supreme Court to rule that plaintiffs cannot use an outside expert to overcome the absence of particularized facts regarding the actual contents of internal reports.
NVIDIA has the better side of the argument. The expert in NVIDIA was a complete stranger to the company and its executives. Accordingly, the expert could not know and did not claim to know any actual facts regarding what was known, when, and by whom within the company. Unadorned speculation on what an expert suspects might have been known by someone within the company is no substitute for the requirement of pleading particularized facts regarding a specific individual accused of violating the law.
We will continue to follow both appeals and report on further developments.
1Sec. Litig. v. Facebook, Inc. (In re Facebook, Inc.), 87 F.4th 934, 949 (9th Cir. 2023).
2Id. at 949-50.
3E. Ohman J. v. NVIDIA Corp., 81 F.4th 918, 938-40 (9th Cir. 2023).
4Id. at 930-32.
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