On December 10, 2020, Judge Yvonne Gonzalez Rogers of the Northern District of California granted a motion to dismiss a claim under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 thereunder, as well as Section 20(a) of the Exchange Act, against a social media platform (the “Company”) and certain of its executives.  In re Twitter Securities Litigation, No. 19-cv-07149 (N.D. Cal. Dec. 10, 2020).  Plaintiffs alleged that defendants made materially false and misleading statements concerning the Company's advertising products and revenue predictions that caused the Company's stock price to drop more than 20% when the Company made purportedly corrective disclosures.  The Court granted defendants' motion to dismiss plaintiffs' consolidated class action complaint (the “CCAC”), but granted plaintiffs leave to replead.

According to the CCAC, the Company misrepresented the progress of improvements concerning one of its major advertising products (“MAP”)—an advertising product that is identified as a “primary source of expected revenue” for the Company.  Plaintiffs alleged that defendants made seven misleading statements across three categories during the putative class period: (1) July 2019 statements about “MAP progress and revenue prediction while reporting [the Company's] financial results for the quarter ending June 30, 2019 (Statements 1–4)”; (b) the Company's “August 2019 announcement about software bugs primarily affecting MAP (Statement 5)”; and (c) an individual defendant's “September 2019 statements about MAP progress and Asia's historical focus on MAP during an investor conference following the MAP bug announcement (Statements 6–7).” 

The Court first addressed plaintiffs' allegations that defendants misrepresented the progress of improvements being made to MAP.  Plaintiffs alleged that because MAP was experiencing software bug issues, the alleged statements in July regarding improvements to MAP's stability and performance were misleading because they created the “misimpression that [d]efendants' work to improve MAP was on track” but “in fact [this work was] ‘delayed'” due to the software bugs.  The Court held that plaintiffs failed to adequately plead a material misrepresentation, finding that the alleged misstatements were either vague statements of optimistic puffery that “are not measurable and not tethered to facts that ‘a reasonable person would deem important to a securities investment decision'” or were forward-looking statements that were otherwise protected under the PSLRA's safe harbor.  In particular, the Court observed that certain of the July 2019 projected revenue statements were forward-looking statements “accompanied by meaningful cautionary language,” in addition to the fact the safe harbor applied because plaintiffs did not sufficiently allege that any misstatements were made with the requisite actual knowledge.  The Court also held that statements made by the Company in its Q2 2019 Form 10-Q filing with respect to risk disclosures were not misleading because the potential risks stated on July 31, 2019, were not false when made and had not—as plaintiffs allege—yet materialized.  In so holding, the Court noted that plaintiffs could not plausibly allege that, at the time the risk disclosure was made, defendants' decision to stop sharing user data six days later on August 5, 2019, was already affecting the Company's revenue.  The Court similarly dismissed plaintiffs' allegations that SOX certifications in the Form 10-Q were materially false and misleading, holding that because the Form 10-Q did not contain misleading statements, the SOX claims must similarly fail.

The Court turned next to alleged statements made by the Company in August 2019 regarding issues relating to customer settings and its resolution of the issues.  Plaintiffs alleged that defendants misleadingly omitted information that software bugs “had delayed work on an improved MAP product,” that the Company stopped sharing user data (which is a critical component of the Company's advertising revenue) in response to the bug, that such action created material risk to defendants' business and operating results, and that it negatively affected the Company's ability to target advertising.  The Court rejected plaintiffs' theory of misrepresentation, noting that nowhere in the alleged misstatements did the Company represent that it had resolved the software bugs and further concluding that plaintiffs “conflate[d] the effect (the privacy violations) with the cause (the software bugs themselves).”  The Court further observed that plaintiffs failed to allege with specificity how the improvements to MAP had been delayed at all, and that they also failed “to allege that the omitted information had plausibly occurred at the time of the challenged statements. . . [or even] why the omissions are misleading as opposed to merely incomplete.”

The Court then addressed alleged statements made by an individual defendant in a September 2019 technology conference.  In response to investor questions, the defendant allegedly stated that “MAP work is ongoing” and that the Company “continued to sell the existing MAP product.”  Plaintiffs alleged that these statements were materially false and misleading because they “created the misimpression that defendants' work on an improved MAP product progressed uninterrupted” when “MAP revenue was, in fact, lagging, Key Metrics [such as costs per ad engagement (“CPE”)] and advertising demand for MAP were materially declining.”  The Court rejected each of plaintiffs' arguments in turn, observing that many of these statements were non-actionable “classic forward-looking statements,” and emphasizing that there is no independent duty to disclose every piece of material information with respect to the statements regarding the sale of the existing MAP product.  The Court did note, however, that this alleged misrepresentation was a “closer question” as it is “plausible that investors would have been interested to know that such sales were materially declining, if such were the case.”  However, the Court ultimately held that plaintiffs failed to plausibly allege that MAP revenue was materially declining or that this individual defendant knew as much at the time of his September 4, 2019, statements.

The Court concluded its analysis by addressing the final category of alleged misstatements made by the same individual defendant regarding the Company's international monetization—specifically, that its strength varies across countries and that their Asia market is more MAP-focused.  Plaintiffs alleged that such statements were misleading given that the Company's “MAP product was struggling in Asia . . . as demand for advertising and revenue from MAP had been materially declining.”  The Court held that plaintiffs' claims failed because there were no allegations quantifying the decline in MAP sales in Asia nor any allegations describing when demand for MAP advertising in Asia began to slow. 

While finding that plaintiffs' claims were defective because of the failure to adequately allege any misleading statements or omissions, the Court nevertheless went on to consider whether the CCAC sufficiently pled scienter, holding that it had not.  Plaintiffs alleged two primary theories of scienter—that defendants knew that MAP revenue was materially declining because they received daily reports monitoring key metrics such as CPE, and the “core operations” theory.  The Court dismissed both theories, holding that with respect to the key metrics reports, the allegations were insufficient to draw the required “strong” inference of scienter because they did not describe with particularity the specific contents of the daily summaries and key metrics review such that the Court could infer that the contents of the reports were inconsistent with any of defendants' public statements.  The Court similarly rejected the core operations theory of scienter, holding that simply because MAP and advertising revenue is a “core” or “prominent” aspect of the Company's business, it does not “automatically follow” that each individual defendant was aware of the alleged problems affecting MAP.  The Court noted that MAP was “only one component” of the Company's “suite of advertising products” and further observed that plaintiffs failed to allege facts supporting the inference that the privacy setting change's impact on the company's financials was “so dramatic that it would be absurd to think that [defendants] did not know that something was wrong.”  The Court similarly rejected plaintiffs' other allegations of scienter, holding that plaintiffs failed to plead relevant particularized facts that defendants intended to deceive investors, and that plaintiffs' reliance on one of the individual defendants' alleged stock sales of 10% of his holdings during the putative class period failed both because those sales were not unusual or suspicious and because they were made pursuant to a 10b5-1 plan.  Lastly, the Court held that the timing of defendants' disclosure in August 2019 was insufficient evidence that defendants “knew” in July that software bugs were already affecting MAP.  Instead, the Court found that a more plausible inference negating scienter is that defendants did not discover the MAP software bug issues until after the July statements, as maintained by the August 6 disclosures announcing the recently discovered issues.

Having dismissed the Section 10(b) claims, the Court similarly dismissed plaintiffs' control- person liability claims under Section 20(a), finding no predicate violations of the Exchange Act under which such claims could be established.  Although the Court observed that “it is not apparent that plaintiffs can amend,” it granted plaintiffs leave to further amend “out of an abundance of caution.”

Originally Published by Shearman & Sterling, December 2020

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