Central District Of California Largely Denies Motion To Dismiss Putative Class Action Regarding Proposed Acquisition Of Space Industry Startup By SPAC
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  • Central District Of California Largely Denies Motion To Dismiss Putative Class Action Regarding Proposed Acquisition Of Space Industry Startup By SPAC
     

    07/20/2022
    On July 13, 2022, the United States District Court for the Central District of California largely denied a motion to dismiss a putative class action asserting claims under the Securities Exchange Act of 1934 against a special purpose acquisition company (SPAC), a space industry startup that was the SPAC’s target, certain executives of both companies, and an investor that served as sponsor of the SPAC.  In re Stable Road Acquisition Sec. Litig., No. 2:21-cv-05744, slip op. (C.D. Cal. July 13, 2022), ECF No. 154.  Plaintiff alleged that the target company made misrepresentations regarding the viability of its technology and the immigration and national security status of its CEO, which the SPAC allegedly repeated without conducting adequate due diligence.  The Court held that plaintiff’s allegations were largely sufficient but that plaintiff failed to adequately allege scienter or control person liability with respect to certain executives.

    Plaintiff alleged that the target company knew but failed to disclose that multiple government agencies had determined that its CEO presented a national security risk, that the government revoked the CEO’s work visa and commenced removal proceedings against him, and that the company’s only test of its core technology had failed — all of which allegedly rendered the company’s financial projections misleading.  Slip op. at 5-6.  Plaintiff further alleged that the SPAC made similar misrepresentations as a result of failing to undertake adequate due diligence.  Id. at 7.  Ultimately, the SEC announced a Cease and Desist Order with respect to the proposed acquisition and the SPAC and the target company agreed to pay civil monetary penalties.  Id. at 5.

    The Court rejected the target company’s arguments that its alleged misstatements and omissions were either nonactionable forward-looking statements of opinion or were accompanied by adequate risk disclosures.  The Court explained that plaintiff “plausibly allege[d] that the [company’s] warnings of risks that might occur [were] misleading to a reasonable investor because the [company] knew that many of those risks had already materialized or very likely would materialize.”  Id. at 12.

    The Court further concluded that plaintiff’s allegations gave rise to a strong inference of scienter with respect to the target company.  Id. at 13.  The Court determined that the allegations “taken as a whole” supported the inference that the company’s executives knew their representations were misleading due to the alleged omission of information regarding the CEO’s status and the test of the company’s core technology.  Id.  Specifically, the Court explained that the allegations were sufficient to show that the company’s Chief Revenue Officer had knowledge of the failed test based on an email she received, and also that she should have known about the failed test and the CEO’s national security and immigration issues based on her leadership role and involvement in revenue projections.  Id.  The Court further observed that the company’s President should have known about the allegedly omitted information because it related to the company’s “core operations,” and also because he gave an interview on the same topics that made it “implausible that [he] would only be aware of the facts he disclosed in his interview and none of the other directly relevant and material information that would have made his statements not misleading.”  Id. at 14.  The Court also noted that the allegations against the CEO himself were “more than sufficient.”  Id.

    With respect to the SPAC defendants, the Court rejected the argument that the allegations against them amounted to mere negligence for repeating information conveyed by the target allegedly without having conducted adequate due diligence.  Id. at 15.  Instead, the Court held that plaintiff adequately alleged scienter based on a theory of deliberate recklessness or willful blindness as to the SPAC and its CEO, who was allegedly responsible for making alleged misstatements regarding the target company and allegedly promoted the SPAC’s “extensive due diligence.”  Id. at 15-16.  However, with respect to other SPAC executives, the Court held plaintiff failed to adequately allege scienter based on their high-level positions and alleged participation in due diligence, without specifically alleging that they were “aware of any red flags to which they turned a blind eye, or that they made any statements that were deliberately reckless because of the failure to investigate those red flags.”  Id. at 16.

    The Court further determined that plaintiff’s control person allegations were adequately alleged as to the SPAC’s CEO and its sponsor.  Id. at 16.  The Court, however, dismissed plaintiff’s control person allegations with respect to the remaining executives of the SPAC and target company.  Id.  The Court explained that plaintiff’s allegations for those defendants regarding their high-level positions or stock ownership were insufficient to show that they actually exercised control over the SPAC or target company “in an effort to induce them to engage in acts that violated the securities laws.”  Id.

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