Northern District Of California Dismisses Putative Class Action For Failure To Adequately Allege Actionable Misrepresentations Or Scienter
Securities Litigation
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  • Northern District Of California Dismisses Putative Class Action For Failure To Adequately Allege Actionable Misrepresentations Or Scienter

    On August 17, 2021, Judge Beth Labson Freeman of the United States District Court for the Northern District of California dismissed a putative class action asserting claims under the Securities Exchange Act of 1934 against an energy technology company and certain of its executives.  Hurst v. Enphase Energy, Inc., et al., No. 5:20-cv-04036-BLF, slip op. (N.D. Cal. Aug. 17, 2021).  Plaintiff alleged, based on a short seller report released the same day plaintiff’s complaint was filed, that the company misrepresented its revenues, engaged in improper deferred revenue accounting practices, and overstated the growth in its gross margins.  The Court held that plaintiff failed to adequately allege any misrepresentation or scienter and, therefore, dismissed the action, while granting plaintiff leave to amend to attempt to “rectify the defects” identified by the Court.

    As a threshold matter, the Court considered and rejected defendants’ loss causation argument that short seller reports could not serve as corrective disclosures.  To the contrary, the Court held, unlike reports from anonymous short sellers or based on public information, the short seller report in question could be corrective because it was not anonymous and purportedly was the result of an investigation that included interviews with former employees.  Id. at 6-7.

    The Court concluded, however, that plaintiff’s allegations of misrepresentations—which were “far from trivial,” including that revenue was inflated by 47.7%—were backed by “flimsy factual allegations” that were “entirely predicated on the [short seller] [r]eport’s insistence that [the company’s] financial reporting does not add up.”  Id. at 7.  The Court explained that the mere fact that plaintiff or the short seller report could not “reconcile the financials” did not, without more, support a claim for misrepresentation.  Id. at 7-8.  The Court further observed that plaintiff did not allege any accounting restatement or missed earnings revealing the impact of the alleged accounting issues, and that it was “wildly implausible” that such events would not have occurred “[i]n light of the severity of the revenue inflation alleged.”  Id. at 8.

    The Court further held that, while plaintiff alleged that the company improperly deferred revenue, plaintiff failed to plead any facts indicating why that activity was improper under Generally Accepted Accounting Principles (“GAAP”).  Id.  The Court emphasized that GAAP provisions are “subject to interpretation,” and that the factual allegations failed to show why the company’s accounting decision was “not merely the difference between two permissible judgments.”  Id. at 9.

    In addition, the Court determined that plaintiff failed to adequately allege scienter under various theories.  Plaintiff’s contention that scienter could be inferred from “the enormity of [the company’s] GAAP violations” could not survive the Court’s rejection of the GAAP allegations.  Id. at 10.  And while plaintiff pointed to “numerous … red flags,” the Court held that argument lacked “the kind of particularized facts that normally buttress scienter allegations.”  Id.  Moreover, while plaintiff alleged suspicious stock sales, the Court concluded that all but one of the alleged insiders identified by plaintiff were not defendants and their trades were therefore irrelevant to the scienter analysis, and, for the remaining individual, plaintiff’s allegations were “threadbare” and failed to allege the proportion of the individual’s shares that were sold or anything about past trading patterns, or otherwise to explain why the sales were suspicious.  Id. at 11.  Plaintiff’s reliance on anonymous statements by former employees also failed to establish scienter due to the lack of “particularized allegations establishing the employees’ reliability and personal knowledge.”  Id. at 10.