Northern District Of California Dismisses Putative Class Action Against Technology Company For Failure To Adequately Allege Falsity And Scienter
On March 16, 2020, Judge Haywood S. Gilliam, Jr. of the United States District Court for the Northern District of California dismissed a putative class action against a technology company and its executives asserting claims under Section 10(b) of the Securities Exchange Act of 1934. Iron Workers Loc. 580 Jt. Funds v. NVIDIA Corp., No. 18-CV-07669-HSG, 2020 WL 1244936 (N.D. Cal. Mar. 16, 2020). Plaintiffs alleged that the company made misrepresentations regarding its sales of graphic processing units (“GPUs”) for computer gaming and the proportion of such sales that were actually made to cryptocurrency miners—for which demand was allegedly more volatile. The Court dismissed the action, holding that plaintiffs failed to adequately plead that the alleged misstatements were materially false or made with scienter, while permitting plaintiffs to file an amended complaint to attempt to cure these deficiencies.
The crux of plaintiffs’ theory was that the company allegedly falsely represented that revenues for sales of GPUs for computer gaming were largely unrelated to revenues from sales of GPUs to cryptocurrency miners. Id. at *7. With respect to falsity, plaintiffs relied entirely on an expert report that purported to analyze market-wide mining capacity for three cryptocurrencies, and to assign a portion of increased mining capacity to sales of the company’s GPUs in proportion to its market share. Id. at *8.
The Court observed that, contrary to plaintiffs’ argument that the complaint contained the underlying facts on which the expert report relied, the complaint failed to (i) identify the source of data about cryptocurrency mining capacity or detail the report’s assumptions regarding that capacity, (ii) indicate any interaction with current or former company employees or a review of the company’s financial data, or (iii) explain why the company’s mining market share would be the same as its gaming market share. Id. In particular, the Court emphasized that the complaint alleged that cryptocurrency miners preferred a competing company’s GPUs, an allegation that undermined the expert report’s inference that the company’s mining market share would be the same as its gaming market share. Id. The Court thus concluded that plaintiffs’ failure to justify assumptions about GPU market share “precludes [p]laintiffs from meeting the PSLRA’s heightened pleading requirement.” Id. The Court further rejected plaintiffs’ argument that the expert report should be deemed sufficient because it was purportedly “corroborated” by an independent analysis cited in the complaint; the Court noted that this was no substitute for particularized factual allegations and that the independent analysis arrived at a significantly different figure and may have had different assumptions. Id. at *9.
With respect to scienter, plaintiffs attempted to establish an inference of scienter based on statements made by confidential witnesses, the “core operations theory,” and an executive’s stock sales. Id. The Court disagreed. The Court determined that the allegations based on confidential witnesses lacked a sufficient link to the executives accused of wrongdoing. Id. at *10-11. The Court also held that the core operations theory—under which certain corporate officers may be deemed to have knowledge of the critical core operations of the company—would not support an inference of scienter here, given that plaintiffs failed to allege specific facts showing the executives were involved in the minutiae of the company’s operations; further, the conclusory assertion that gaming was the company’s “core business” was insufficient to infer scienter. Id. at *11-12. Finally, the Court rejected plaintiffs’ argument based on an executive’s stock sales, emphasizing that the sales reflected less than 0.5% of the executive’s holdings in the company and that the sales occurred well before the company’s peak price. The Court further reasoned that, while plaintiffs did allege that the sales were “highly unusual” for the executive based on his prior trading patterns, this factor alone was not enough to support an inference of scienter. Id. at *13.
Finally, the Court concluded that plaintiffs sufficiently alleged loss causation by alleging that the truth regarding sales to cryptocurrency miners was revealed in partial corrective disclosures which caused the company’s stock price to drop. In particular, plaintiffs pointed to two alleged corrective disclosures—first, an acknowledgment on an earnings call that it had “probably happened a great deal” that miners had begun buying GPUs through retail gaming channels, and a statement on a subsequent earnings call that demand from miners had led to increased inventory and elevated prices, which “took longer than expected to normalize” when that activity declined. Id. at *13. The Court held that these allegations were sufficient to plead that the company’s prior statements—which allegedly minimized the impact of cryptocurrency mining on gaming revenues—were the proximate cause of plaintiffs’ alleged loss. Id