District Of Massachusetts Denies Motion To Dismiss Claims Based On Statements That A Lawsuit Against The Company Was “Without Merit”
 

On July 24, 2023, Judge William G. Young of the United States District Court for the District of Massachusetts granted in part, and denied in part, a motion to dismiss a putative class action brought against a software company (the “Company”) and two of its executives for violations of Sections 10(b) and 20(A) of the Securities Exchange Act of 1934.  City of Fort Lauderdale Police & Firefighters’ Ret. Sys. V. Pegasystems Inc., No. CV 22-11220-WGY, 2023 WL 4706741 (D. Mass. July 24, 2023).  The class action followed a decision in a separate civil trade secret case in which the Company was found to have maliciously misappropriated another software company’s trade secrets in violation of Virginia law.  Plaintiffs alleged that statements that the claims in the lawsuit were “without merit” were false and misleading, as were provisions in its Code of Conduct promising to not misappropriate trade secrets, because the Company allegedly was engaged knowingly in wrongdoing.  The Court denied the Company’s motion to dismiss the claims against the Company and its CEO, finding sufficient factual basis for the allegations, but granted the motion to dismiss the claims against the CFO for lack of scienter. While the outcome on the motion to dismiss was highly context-specific, it is important precedent to review given that companies routinely offer the opinion that litigation claims are “without merit.”

The Company develops software for customer relationship management and business process management.  Plaintiffs allege that the Company engaged in a two-part conspiracy to misappropriate the trade secrets of another company, which also developed software for business process management, to enhance its own software and win business over its competitor.  Plaintiffs allege that, from 2012 to 2014, the Company engaged an employee of a U.S. government contractor to share information on the functions of the competitor’s platform and associated documentation.  Additionally, according to plaintiffs, the Company spied on its competitor from 2019 to 2022 by having several of its employees create fake companies to gain access to its competitor’s software.  The competitor learned of the Company’s activities and brought an action for misappropriation of trade secrets on May 29, 2020.

Plaintiffs alleged that, on February 16, 2022, the Company made “express and detailed mention” of the trade secret litigation.  Specifically, plaintiffs alleged that the Company and CEO stated that the trade secret allegations were “without merit,” that the Company had “strong defenses to these claims,” and that the damages sought were “not supported by the necessary legal standard.”  The Company’s SEC filings also directed investors to the Company’s Code of Conduct, which indicated that the Company would “[n]ever use illegal or questionable means to acquire a competitor’s trade secrets.”  In May 2022, the Circuit Court of Fairfax County, Virginia, found that the Company had willfully and maliciously misappropriated its competitor’s trade secrets and ordered the Company to pay damages of more than $2 billion.  After the verdict, plaintiffs alleged that the Company’s share price dropped approximately 28%.

The Court held that plaintiffs adequately pled falsity.  The Court concluded that the “never use illegal or questionable means” statement in the company’s Code of Conduct was not “aspirational,” but instead described “with specificity a course of conduct that [the Company] promised to abjure.”  Especially in light of allegations that the espionage campaign against the Company’s competitor was “orchestrated and directed” by the Company’s senior executives, the Court held that the complaint sufficiently alleged that the statement was misleading to investors.

As to the statement that the trade secret litigation was “without merit,” the Court found that the complaint sufficiently alleged that the statement did not “fairly align” with the CEO’s alleged “awareness of, involvement in, and direction of [the Company’s] espionage campaign.”  Moreover, the Court found that “a reasonable investor could justifiably have understood [the CEO’s] message that [the] claims were ‘without merit’ as a denial of the facts underlying [the] claims – as opposed to a mere statement that [the Company] had legal defenses against those claims.”  As the Court explained, “[a]n issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the complaint are true.  When it decides to do so, however, it must do so with exceptional care, so as not to mislead investors.  For example, an issuer may validly assert its intention to oppose the lawsuit.  It also may state that is has ‘substantial defenses’ against it, if it reasonably believes that to be true.  An issuer may not, however, make misleading substantive declarations regarding its beliefs about the merits of the litigation.”

The Court also held that the facts alleged in the complaint raised a strong inference of scienter against the Company and its CEO.  The Court found that the complaint sufficiently alleged a detailed scheme to misappropriate trade secrets and that the CEO was aware of and personally involved in the scheme, providing direction and referring to the involved employees as “spies.”  The Court found that the allegations, if true, left “little doubt” that the CEO knew or was reckless in not knowing that his and the Company’s statements posed a “substantial danger” of misleading investors.  With respect to the CFO, however, the Court held that allegations that he “must have known” about the espionage scheme were “mere speculation” and an “extension of the ‘scienter by status’ theory, which has been uniformly rejected.”  The Court therefore dismissed the claims against the CFO without prejudice.