Central District of California Dismisses Securities Fraud Claims; Finds Alleged Misstatement Affecting Approximately Five Percent of Defendant’s Gross Merchandise Value Is Not Material
On October 18, 2016, Judge Christina A. Snyder of the United States District Court for the Central District of California dismissed a putative securities class action brought against defendant SouFun Holdings Ltd.“ —a Chinese online real estate business—and certain of its officers. Maresca v. SouFun Holdings Ltd., No. 15 Civ. 8508 (C.D. Cal. Oct. 18, 2016). Plaintiffs alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by making materially misleading statements and omissions regarding the scale and success of SouFun’s new rental brokerage business. The Court dismissed plaintiffs’ claims, concluding that plaintiffs failed to adequately plead materiality or scienter because (i) the brokerage activity at issue was not a significant portion of the company’s overall business and (ii) plaintiffs failed to plead facts from which to infer that senior officers in the company knew about the allegedly fraudulent transactions.
Plaintiffs alleged that, between May and October 2015, defendants made false and misleading statements during earnings calls and in SEC filings by touting rapid growth in SouFun’s new rental brokerage business while failing to disclose that many of its purported rental contracts had been fabricated by SouFun’s brokers to meet internal targets. The Court dismissed the complaint because plaintiffs failed to adequately plead that the allegedly misleading statements were material. In reaching this decision, the Court noted that SouFun’s transactions from its rental brokerage business accounted for only 2.8 to 5.3 percent of the company’s e-commerce business. Based on these facts, the Court ruled that plaintiffs failed to plead that the alleged misstatements and omissions were material because the “falsified rental brokerage transactions made up some unspecified portion of a small portion of, at most, one-half of SouFun’s business.”
The Court also held that plaintiffs failed to plead scienter. Plaintiffs alleged that senior officers at SouFun knew about the allegedly fabricated rental transactions based on the statements of a confidential witness who asserted that the improper transactions were communicated to company headquarters. The Court determined that these allegations were insufficient to plead scienter because plaintiffs offered nothing more than speculation that senior officers “must have known” about the fraudulent transactions based on vague allegations that a “branch manager said something to someone” at company headquarters. The Court ruled that these statements from an unnamed confidential witness were insufficient to give rise to a strong inference of scienter.
The dismissal of plaintiffs’ claims highlights that courts often find an alleged misstatement immaterial when it relates to only a small portion of a company’s business (i.e., typically less than 5 percent). The dismissal also highlights that allegations from confidential witnesses may be insufficient to plead scienter if they do not include facts from which to infer that senior officers at the company knew about the allegedly fraudulent conduct.