Northern District Of California Grants In Part Motion To Dismiss Securities Fraud Claims Against Multinational Technology Company, Holding That Plaintiffs Did Not Adequately Allege Falsity, Scienter, Or Loss Causation With Respect To Majority Of Alleged Misstatements
On June 2, 2020, Judge Yvonne Gonzalez Rogers of the Northern District of California granted in part a motion to dismiss a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, against a multinational technology company (the “Company”) and two of its senior executives. In re Apple Securities Litigation, No. 4:19-cv-02033 (N.D. Cal. June 2, 2020). Plaintiffs alleged that defendants made materially false and misleading statements and omissions concerning the Company’s flagship product and its China business. The Court stripped away most of plaintiff’s allegations, holding that those alleged misrepresentations failed to sufficiently allege falsity, scienter, and loss causation, but let remain two alleged misstatements made by the Company’s CEO to analysts that it found to be sufficiently pled.
Plaintiffs alleged that in 2016 the Company received reports that its older smartphones were experiencing battery issues causing them to shut down. In response, the Company released a software update that purportedly addressed the issue in January 2017 but also introduced “throttling”—or a reduction on performance—on these older models as a result of the update, which plaintiff alleged defendants did not initially disclose. According to the amended complaint, after the update in 2017, the Company experienced an increase in sales of newer models “as consumers began buying news phones to replace their slowed-down older” models. Shortly thereafter, the Company allegedly admitted it had deliberately throttled older models and further offered to replace batteries throughout the next year at a substantially lower price than upgrading to a newer model. Plaintiffs alleged that the Company was tracking battery replacements because it was aware that the program could affect sales, and further alleged that such revelations came amid worsening business outlook in China. Plaintiffs further alleged that defendants continued to misleadingly assure investors that the smartphone remained strong in China, that it was not tracking battery replacements, and that it “touted” the Company’s financial strength and growth “without revealing that the positive results were driven by artificially inflated upgrading due to defendants’ throttling of old [phones].” In January 2019, the company’s CEO shared a letter with investors informing them that revenue for Q1 2019 would fall below guidance.
The Court first addressed whether plaintiffs adequately alleged actionable material misstatements. Although the Court largely agreed with defendants’ arguments that the alleged misstatements were inactionable because they were accurate representations of historical facts, forward looking statements protected by the PSLRA, statements of corporate optimism or opinion, or inadequately pled, the Court found that certain statements were, in fact, actionable. In particular, the Court noted that “in a few instances, defendants go beyond representing general historical results and tout specific factors—such as high upgrade rates—that seem to require disclosure of ‘adverse information that cuts against the positive information.’” The Court held that such alleged statements, assumed as true for the purposes of a motion to dismiss, “are affirmatively misleading because they create the impression that the upgrade rate for the throttled phone was the result of ‘ordinary’ factors that ‘bode well’ for future sales.” In so holding, the Court rejected defendants’ argument that these were protected forward looking statements, noting that the statements included “present facts” which are not protected. In particular, the Court held that statements by the CEO “touting high upgrade rates for the throttled [smartphones] creates the misleading impression of organic demand” and the touting of “positive business outlook [in China] mere days before cutting production orders” were misleading statements of present fact and therefore actionable.
The Court further considered defendants’ arguments that many of the statements identified by plaintiffs were inactionable puffery, agreeing that all such statements were inactionable except an alleged misrepresentation on an earnings call regarding the strength of its newest smartphone model. According to the Court, the CEO’s statements that sales were “off to a really great start”—just days before the Company cut production of the model—went beyond puffery and “affirmatively create[d] a positive impression of an area it knows to be doing poorly.” Addressing the statements defendants characterized as opinions, the Court agreed that all but one were inactionable because plaintiffs “failed to allege any facts to show defendants did not hold the beliefs expressed.” The only exception, according to the Court, was the CEO’s alleged statement about the strength of the Company’s market in China, which the Court held was actionable because it contained a fact that was misleading and, even if it were a truthfully held opinion, plaintiffs adequately alleged that the statement “did not align with the information [the CEO] possessed at the time.”
The Court also addressed plaintiffs’ allegations that defendants made false or misleading statements in a letter to Congress in response to the throttling concerns, because the letter falsely represented that defendants considered it “unnecessary” to throttle newer models because they were designed with better hardware. Defendants argued that the statement was not “in connection with” the sale or purchase of a security, and nevertheless that the Noerr-Pennington doctrine provided protection from liability for “petition[s] . . . [to] the government for redress.” The Court rejected defendants’ arguments, holding that there was no evidence that the Company was “seeking any redress from Congress that implicate[d] its First Amendment right to petition.” Separately, the Court agreed with plaintiffs that certain alleged statements regarding the battery replacement program misleadingly suggested that defendants were not tracking or considering the effect of the replacement program on sales and upgrade rates. The Court found that when read in context, these statements created a misleading impression that “defendants possessed no information to suggest that the battery replacement program would hurt demand.”
Having found that plaintiffs sufficiently alleged certain actionable statements—i.e., statements regarding (1) throttling, (2) the battery replacement program, (3) sales and demand for its newest smartphone model, and (4) the strength of the Company and its performance in China—the Court turned to plaintiffs’ scienter allegations. Plaintiffs argued that they had adequately alleged scienter by citing evidence of insider trading by the individual defendants, statements by confidential witnesses, and the “core operations” doctrine. The Court noted that the Ninth Circuit permits dual analysis, which allows the court to first consider allegations separately, then holistically, to determine if scienter was sufficiently pled.
Concerning plaintiffs’ allegations of scienter individually, the Court held that plaintiffs failed to adequately allege unusual or suspicious trading activity, failed to demonstrate that defendants had “contemporaneous knowledge” that rendered their statements about their throttling practices, and the battery replacement program and its effect on demand false or misleading. The Court similarly rejected plaintiffs’ core operation theory, holding that while plaintiffs adequately alleged the importance of the China market to the Company and the importance of the performance of its smartphones to its business model, plaintiffs failed to provide more specific allegations demonstrating these details were relayed to the individual defendants. However, the Court observed that the core operations theory regarding China seemed “more plausible” as defendants would more likely have been kept apprised of the China market and the Company’s performance in China, but added that it is “undermined by the [lack of] specificity of plaintiff’s allegations.”
However, based on a holistic evaluation of plaintiffs’ allegations, the Court determined plaintiffs adequately pled scienter for two alleged misstatements. Specifically, the Court found it “simply implausible that [the CEO] would not have known that the [smartphone] demand in China was falling mere days before cutting production lines” and that it was “implausible [he] was unaware of emerging market issues in China despite admitting two months later that the Company observed worrying signs throughout the quarter.” But the Court held that scienter was not properly pled with respect to other alleged misstatements concerning throttling or the battery replacement program.
Finally, the Court considered and dismissed plaintiffs’ allegations that defendants misled investors regarding the risk that competition from a competitor application was negatively impacting demand for the Company’s smartphones. Holding that such allegations failed to establish loss causation, the Court noted that the complaint itself suggests that this competition risk “was widely reported” and plaintiffs failed to allege that “investors dismissed these concerns based on [the CEO’s] statement[s].”
Because the Court dismissed all but two alleged misrepresentations for failure to establish either falsity, scienter, or loss causation, the Court dismissed the Section 20(a) claim against the individual defendants to the extent plaintiffs failed to establish a predicate violation under Section 10(b).