Central District Of California Dismisses Putative Class Action Against Software Developer For Failure To Adequately Allege Falsity Or Scienter
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  • Central District Of California Dismisses Putative Class Action Against Software Developer For Failure To Adequately Allege Falsity Or Scienter

    On April 18, 2022, the United States District Court for the Central District of California dismissed without prejudice a putative class action asserting claims under the Securities Exchange Act of 1934 against a computer game development company and certain of its executives.  Cheng v. Activision Blizzard, Inc., No. 21-cv-6240, slip op. (C.D. Cal. Apr. 18, 2022), ECF No. 75.  Plaintiffs alleged the company made statements that were misleading because they failed to disclose certain government investigations and the prevalence of sexual harassment and gender-based discrimination at the company.  The Court held that plaintiffs failed to identify any actionable misrepresentations or to adequately raise an inference of scienter but granted plaintiffs leave to replead.

    Relying on allegations in complaints filed by the California Department of Fair Employment and Housing and the U.S. Equal Employment Opportunity Commission, as well as on various media reports and confidential witnesses, plaintiffs alleged that certain company statements regarding its legal exposure, code of conduct, and policy against retaliation were misleading.  Id. at 6–8.  Plaintiffs also argued that the company had an affirmative duty to disclose the pending investigations.  Id. at 7.

    The Court first held that plaintiffs failed to plead facts sufficient to establish that any of the challenged statements were false.  First, plaintiffs argued that the company’s “legal proceedings” disclosure in SEC filings—that the company was party to “routine” investigations and other proceedings in the ordinary course of business that were “not significant” and that the company “had no reasonable basis to believe” would have a “material adverse effect”—were false or misleading for not disclosing purportedly “widespread illegal conduct.”  Id. at 12.  The Court declined to rule “[a]t this stage of the litigation” as to whether such statements were protected by the safe-harbor provision in the PSLRA regarding forward-looking statements accompanied by meaningful cautionary language.  Id. at 12-13.  The Court determined, however, that plaintiffs had failed to identify specific facts that would render those statements false in any event.  Id.  The Court also held that, to the extent investigations into the company received media coverage after the fact, that did not in itself indicate that there had been anything unusual about the investigations warranting further disclosure.  Id. at 13.  Moreover, the Court rejected plaintiffs’ argument that the company had a duty to disclose further information because it “spoke about [the company’s] ongoing investigations” in its SEC filings, holding that “[t]he mere mention of ‘investigations’ does not, alone, trigger an introduction of the topic.”  Id. at 14.

    With respect to the company’s statements regarding adherence to its code of conduct—which indicated that the company did not tolerate harassment, retaliation, and discrimination—the Court rejected plaintiffs’ argument that these constituted “verifiable statements” contradicted by the government complaints and other sources.  Id. at 14-15.  Rather, the Court observed that a company’s “promotion of business ethics” was not unusual and that, in this context, plaintiffs “would have to establish that [the company] ‘took no action at all in the face of blatant and pervasive violations of its’ [c]ode.’”  Id. at 15.

    Finally, with respect to statements in the company’s Environmental, Social, and Governance report indicating that the company did not tolerate retaliation, the Court rejected plaintiffs’ argument that such statements “were materially false and misleading because … retaliation against female employees … who made sexual harassment and discrimination claims was rampant and tolerated by the [c]ompany.”  Id.  The Court explained that these “bare bones assertions” failed to satisfy the heightened pleading standard of the PSLRA.  Id.

    In addition, the Court held that plaintiffs failed to establish that the company had an affirmative duty to disclose the information allegedly omitted.  The Court rejected the suggestion that Item 103 of Regulation S-K, regarding the disclosure of “legal proceedings … known to be contemplated by government authorities,” required disclosure, determining that a government investigation alone is not a “legal proceeding” under Item 103.  Id. at 13-14.

    With respect to scienter, the Court rejected plaintiffs’ argument that scienter was established by investigations into the company, public knowledge concerning the company’s culture, and stock sales by the individual defendants.  Id. at 16.  The Court explained that plaintiffs had not pled particularized facts showing that defendants knew the company’s statements regarding investigations were inaccurate.  Id.  Although plaintiffs argued that government allegations that the company had obstructed its investigation showed that the company was aware that the investigation posed a “serious threat,” the Court determined that this was a “speculative conclusion” and would not, in any event, have shown that defendants “lied” in their prior statements.  Id.  Moreover, the Court rejected plaintiffs’ argument that the context of the “#MeToo” movement created an inference that defendants were reckless in not recognizing the significance of the government investigations and purported “ongoing misconduct” because this theory was “too vague a concept to raise a strong inference of scienter.”  Id.

    Further, the Court determined that the company’s disclosure of one government investigation—and statement that “[i]f we experience prolonged periods of adverse publicity, significantly reduced productivity or other negative consequences relating to this matter, our business likely would be adversely impacted”—did not give rise to a sufficient inference of scienter.  The Court emphasized that the words “if” and “likely” implied a “conditional assessment and thus a malicious inference is not as compelling as any opposing innocent inference.”  Id. at 17.  The Court also rejected, for lack of particularized factual allegations, plaintiffs’ argument that defendants “must have known” that the alleged harassment and discrimination were “endemic” due to their positions at the company.  Id.

    The Court also rejected plaintiffs’ argument that scienter should be inferred based on the compensation structure for the company’s CEO, which included bonus incentives based on the company’s stock price.  Id. at 18-19.  The Court explained that plaintiffs alleged “no facts to connect any clear financial incentive … to alleged misstatements by [the CEO].”  Id. at 18.  Finally, regarding plaintiffs’ allegations based on certain executives’ stock sales, the Court concluded that plaintiffs failed to provide factual information regarding the executives’ prior trading history from which a comparison could be drawn to the period before the investigations were announced, without which “no inference of scienter can be gleaned.”  Id. at 19.