First Circuit Revives Putative Class Action Against Software Company
On December 22, 2021, the United States Court of Appeals for the First Circuit reversed the dismissal of a putative class action asserting claims against a software company and certain of its current and former executives under the Securities Exchange Act. Constr. Indus. and Laborers Jt. Pension Tr. v. Carbonite, Inc., —F.4th—, 2021 WL 6062622 (1st Cir. 2021). Plaintiffs alleged that the company misleadingly touted the capabilities of a new cloud-based data backup product, even though defendants knew that the product did not work. The district court dismissed the action for failure to adequately allege scienter, but the First Circuit reversed, holding that plaintiffs adequately alleged scienter and that the challenged statements were actionable.
The Court first assessed whether the challenged statements, which were made on conference calls with investors, were actionable statements of fact or nonactionable opinion statements. With respect to the CEO’s statement that he believed the new product “improves our performance for backing up virtual environments and makes us really competitive,” the Court explained that this statement could be “reasonably construed in context as a statement of fact” because it implied improved performance for a product that allegedly did not work at all. Id. at *4. Further, the Court noted that while the CFO presented one statement in the form of an opinion—that the company had “put something out that we think is just completely competitive and just a super strong product”—this statement also plausibly conveyed the following facts, one or all of which could be false if he knew that the product did not in fact work: that the CFO actually believed in the strength and competitiveness of the product; that his opinion fairly aligned with information he possessed; and that his opinion was based on reasonable inquiry. Id. The Court also rejected defendants’ argument that the CFO’s statement should be deemed a non-actionable “opinion about future potential,” explaining that the statement was in the present tense and described the existing status of a product that had already been “put out.” Id. The Court further concluded that the challenged statements were material, given that, for example, the CFO had described the new product as “a really important product for us” and the company’s executives promoted it as enabling the company to compete in a major market segment that had been historically weaker for the company. Id. at *5.
In addition, the Court held that plaintiffs adequately alleged scienter under the theories that, because senior executives stated that the product was important to the company, they would either have known that the product was not functional or were reckless in not knowing that it did not work. Id. at *5. The Court emphasized that the key allegation in the complaint was that the company thought the product was important enough to warrant attention from senior management, which supported a strong inference that the executives touting the product would have paid some attention to the product’s status. Id. at *6. The Court further concluded that the complaint adequately alleged that these statements were knowingly false or required further investigation because “it does not require a PhD to know that a product cannot be ‘super strong’ if it has never once done what it is supposed to do.” Id. The Court also noted that internal reports before the product launched made clear that it was not then functional. Id. While defendants suggested that the Court should not infer that the product was one to which they paid attention simply because they spoke about it on earnings calls, the Court rejected that contention and again emphasized that these statements were framed in the present tense suggesting that the statements were “not projections of hoped-for future performance” but instead “were flat-out claims about the product as it then stood.” Id.