(Article from Securities Law Alert, November 2016)
For more information, please visit the Securities Law Alert Resource Center
On November 14, 2016, the Northern District of California held broad optimistic statements concerning the success of post-merger integration efforts are inactionable under the securities laws. Fadia v. FireEye, 2016 WL 6679806 (N.D. Cal. 2016) (Davila, J.). The court explained that “CEOs and executives of companies that merge with or acquire other companies often describe ongoing mergers as smooth, rapid, and successful,” statements “which courts regularly deem corporate puffery” rather than actionable misrepresentations.
The court further held insider stock sales, standing alone, do not raise a strong inference of scienter. Finally, the court found plaintiffs may rely on the core operations theory for scienter purposes only if they provide “detailed and specific allegations about the management’s exposure to factual information within the company.”
Optimistic Generalized Statements Concerning the Progress of Merger Integration Efforts Are Not Actionable Misrepresentations
Plaintiffs alleged that FireEye, a cybersecurity company, “falsely represented” that its post-merger integration efforts with Mandiant Corporation were “progressing successfully.” For example, FireEye stated that the combination was a “natural extension” of a strategic partnership” and that the companies’ product synergies were “very strong.” Plaintiffs claimed that the integration was in fact “going quite poorly.”
The court held the statements at issue were not actionable misrepresentations but rather, “examples of corporate optimism” that fell into the category of inactionable puffery. The court explained that puffery “differs significantly” from a material misrepresentation because puffery is merely “an expression of opinion.” The court noted that under Ninth Circuit precedent, “investors do not rely on puffery when making investment decisions” (citing In re Cutera Sec. Litig., 610 F.3d 1103 (9th Cir. 2010)).
The court found that other courts have similarly rejected securities fraud claims based on optimistic statements concerning merger integration efforts. For example, in In re Level 3 Comm. Sec. Litig., 667 F.3d 1331 (10th Cir. 2012), the Tenth Circuit found “broad claims by defendants regarding integration efforts” to be “non-actionable.” The Tenth Circuit reasoned that “[t]hese are all the kind of rosy affirmations commonly heard from corporate managers . . . that are so vague, so lacking in specificity . . . that no reasonable investor could find them important.”
Defendants’ Stock Sales Did Not Raise a Strong Inference of Scienter
The court rejected plaintiffs’ assertion that defendants’ stock sales were “large and suspicious enough to support an inference of scienter.” The court explained that “[u]nusual or suspicious stock sales by corporate insiders may serve as circumstantial evidence of the requisite scienter . . . only if the insider trading is dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” While the court recognized that stock sales can provide “viable circumstantial evidence of scienter,” the court underscored that “stock sales alone cannot create a strong inference of scienter.”
Here, plaintiffs alleged that three defendants sold stock amounting to 17.6%, 8.7%, and 15% of their respective total holdings. The court found these percentages insufficient to indicate scienter, noting that other “courts have held that higher percentages of stock sales failed to raise a strong inference of scienter.” The court also observed that the Ninth Circuit had previously “caution[ed] against inferring scienter simply because the amount and percentages of the sales [were] large” (citing No. 84 Employer-Teamster Joint Council Pension Trust Fund v. American West Holding, 320 F.3d 920 (9th Cir. 2003)).
In the case before it, the court found it significant that “[d]efendants sold their FireEye stock only during the secondary public offering, had no prior trading history, and retained a majority of their shares.” The court noted that plaintiffs did not allege “accounting irregularities” or “dubious business practices” to support allegations of suspicious stock sales. Moreover, there were “no allegations of GAAP violations, and certainly no evidence that indicate[d] [d]efendants were informed to delay disclosures of their earnings reports.”
Plaintiffs Failed to Raise a Strong Inference of Scienter Under the Core Operations Theory
Finally, the court held plaintiffs “fail[ed] to raise a strong inference of scienter under the core operations theory.” The court explained that under this theory, “the role of corporate officers and their access to information may support a strong inference of scienter” only “if supported by detailed and specific allegations about the management’s exposure to factual information within the company.” The court noted that such “particularized allegations” can only be dispensed with in the “rare circumstances . . . where the nature of the relevant fact is of such prominence that it would be absurd to suggest that management did not have knowledge of it.”
Here, plaintiffs argued that scienter could be inferred from the fact that “[d]efendants were high level corporate officers [who] attended board meetings, had a ‘hands-on’ management style, and could access FireEye’s reports, press releases, public filings, and other statements.” The court deemed these allegations “informative” yet insufficient to establish a strong inference of scienter. The court found that “[a]t a minimum, [p]laintiffs needed to have provided information about precisely what was said by the parties in these meetings, which facts the [d]efendants were exposed to, and why this exposure support[ed] an inference of scienter.” The court further held plaintiffs failed to “provide evidence that suggest[ed] the current circumstances [were] somehow rare, which justifies an inference of scienter without particularized allegations.”