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Eastern District Of New York Court Grants In Part Motion To Dismiss Putative Securities Class Action Brought Against Space Exploration Company
11/15/2022On November 7, 2022, Judge Allyne R. Ross of the United States District Court for the Eastern District of New York granted in part a motion to dismiss a putative securities class action against a space exploration company (the “Company”), its founder, and certain of its current and former executives. Kusnier and Scheele v. Virgin Galactic Holdings, Inc., et al, No. 21-cv-03070-ARR (E.D.N.Y. Nov. 7, 2022). Plaintiffs alleged that defendants violated Section 10(b) of the Securities Exchange Act (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Sections 20(a) and 20A of the Exchange Act, by making materially false and misleading statements regarding the safety history and functioning capabilities of the Company’s spacecraft. The Court granted the motion in part but found sufficient at the pleading stage certain alleged misstatements.
According to the amended complaint (“Complaint”), the Company was founded in 2004 and is in the business of taking customers to space. Plaintiffs alleged that during the putative class period, the Company utilized a two-part system wherein Eve, the carrier spacecraft, took Unity, the shuttle, to 45,000 feet and then released the shuttle which activates its own engine and flies to 275,000 feet, thereby meeting the definition of “space” under U.S. law. According to plaintiffs, the Company’s testing of its spacecrafts revealed safety issues and design flaws. Plaintiffs further alleged that following additional testing, in February 2019, the Company sent its first non-pilot “astronaut” to space, and that during the flight, Unity “suffered critical damage” which was so extensive that one employee allegedly told a journalist “I don’t know how we didn’t lose the vehicle and kill three people.” According to the Complaint, the Company did not disclose this incident in its post-flight press release, and the Company did not disclose the damage to Unity caused by the February 2019 flight in its SEC filings or others; instead the Washington Post allegedly broke the news in a February 1, 2021 article. Additionally, plaintiffs alleged that the Company’s spacecrafts “suffered from a series of design, engineering, and inspection flaws,” which the Company allegedly compounded by “failing to consistently keep track of the modifications it was making” as a result of these flaws. Relying on confidential witnesses, plaintiffs alleged that the Company’s system tracking for modifications was “a chaotic mess,” that inspections and processes could not reliably detect problems, that inspectors signed off on inspections that were not conducted, and that such inspectors had conflicts of interest, were not adequately trained, and the technicians were not certified under the FAA or industry guidelines.
The Complaint alleged 35 statements made by defendants during the putative class period that plaintiffs alleged were materially misleading. The Court dismissed most of the alleged misstatements—such as the statement that the Company “believes it has not reached an inflection point in its development as it progresses towards launching commercial operations”—as inactionable opinion statements of opinion under Omnicare. The Court held, however, that plaintiffs sufficiently alleged that certain statements by the Company—such as the alleged statement that it had “demonstrated the repeatability of the full flight profile” and “ha[d] overcome a substantial number of the technical hurdles required to make the company a viable and profitable commercial service”—were actionable because the Company “lacked a reasonable basis” for those statements at the time they were made.
The Court next considered statements that defendants identified as forward-looking and therefore protected under the PSLRA’s safe harbor. Plaintiffs contended that no statement was forward-looking because each “purported to represent the then-current state of [the Company’s] test flight program,” and highlighted that the statements were in the present, rather than future, tense. The Court rejected plaintiffs’ arguments, finding that each of the statements identified by defendants was “a statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer” and therefore “forward-looking” within the meaning of the PSLRA. The Court further found that the Company included appropriate cautionary warnings regarding these statements and that plaintiffs did not identify what had ceased to be “hypothetical” about defendants’ warnings. The Court also emphasized that plaintiffs’ claims that the PSLRA safe harbor does not apply fail for the independent reason that plaintiffs have failed to plead “actual knowledge” on the part of any defendant.
The Court then turned to defendants’ argument that the alleged misstatements constituted “mere puffery” and therefore were inactionable. The Court largely agreed with defendants, holding that many of the purportedly misleading statements amounted to mere “puffery,” with the exception of certain statements, such as that the Company “clear[ed] the huge technical milestone which came from demonstrating Unity’s full flight profile with two trips to space.” The Court found that alleged statement to be material and misleading at the pleading stage because “[a] reasonable investor would be interested in the progress of a commercial spaceflight company’s testing program, and these statements are not so generic as to be ignored.” Likewise, the Court noted that certain alleged statements describing the flight the Company’s founder had taken to space as “successful,” “perfect,” and “flawless” all attributed the success of the flight to the Company’s “incredibly safety diligent program . . . [which is] anchored in safety experience” and that the flight was devoid of “major technical issues.” The Court held that these statements fall within the line of cases finding statements relating to safety are not puffery where repeated emphasis on safety as a priority “‘put[s] the topic at issue such that [I] cannot say that, as a matter of law, investors would not find certain representations material.’” (citation omitted).
The Court further addressed plaintiffs’ claims pursuant to Items 303 and 105 of SEC Regulation S-K, which imposes a duty to disclose where a trend, demand, commitment, event, or uncertainty is both (1) presently known to management and (2) reasonably likely to have material effects on the registrant’s financial condition or results of operations. The Court held that plaintiffs failed to allege a claim pursuant to Items 303 or 105 because the Company “disclosed the risk that an accident could cause a material adverse effect on its business” and that this was “the exact risk plaintiffs contend was not disclosed to the market.”
Having found that plaintiffs sufficiently alleged certain material misstatements, the Court considered the remaining elements of plaintiffs’ 10b-5 claim. First addressing the issue of loss causation, the Court held that plaintiffs adequately pleaded loss causation with respect to statements touting the success of the February 2019 flight, as the Company’s stock price declined upon the disclosure of the issues related to the February 2019 flight. The Court further held that plaintiffs sufficiently alleged loss causation as it related to statements describing a July 2021 flight by the founder as “successful,” “perfect,” and “flawless,” as a subsequent drop in the stock price was “adequately alleged to be caused by the revelation of the fact that the July 2021 flight left its landing cone.” The Court, however, held plaintiffs did not sufficiently allege loss causation for the remaining alleged misstatements.
Second, with regard to the issue of scienter, the Court noted that the founder’s alleged “sale of 100% of his available stock is unusual and contributes to an inference of scienter,” but that it was “not persuaded that volume and percentage alone are sufficient on these facts.” Accordingly, the Court declined to find a “per se rule” that the founder acted with scienter “solely” because he allegedly sold a considerable volume and percentage of his shares. The Court did, however, find that plaintiffs sufficiently pled scienter as to the statements regarding the success of the founder’s July 2021 flight, because the founder allegedly sold over ten million shares of stock for total proceeds of nearly $300 million in August 2021, just weeks before it was publicly revealed that Unity had strayed from its landing cone and risked a crash landing, resulting in a decline in the Company’s stock price. The Court further found that plaintiffs adequately pled scienter regarding the founder’s alleged statement made in a publicly-filed letter in advance of the de-SPAC transaction that formed the Company, from which the founder earned $123 million. According to the Court, although the letter was filed in July 2019, three months before the transaction, the founder had no other means of selling the shares before the de-SPAC was completed, and also in light of the timing and amount of this stock sale, plaintiffs adequately pled scienter with respect to that alleged statement. The Court found that plaintiffs failed to sufficiently plead scienter as to alleged misstatements regarding the other individual defendants.
Finally, turning to plaintiffs’ section 20(a) and 20A claims, the Court held that since it had “found primary violations of the securities laws only with respect to [the founder]” and that plaintiffs “failed to allege that any individual defendant had control over [the founder] during the Class Period,” it dismissed plaintiffs’ section 20(a) claims against all individual defendants. The Court dismissed the section 20A claims against the founder insofar as they relied on his alleged sales other than those made between August 10-12, 2021, which the Court found were sufficiently “contemporaneous” under Second Circuit precedent to support a claim under Section 20A.
