Southern District Of New York Dismisses Putative Class Action Against Digital Services Company For Failure To Adequately Allege Misstatements And Scienter
On August 28, 2019, Judge Lorna G. Schofield of the United States District Court for the Southern District of New York dismissed a putative class action against the digital services and development company Synacor, Inc. and certain of its officers asserting claims under Section 10(b) of the Securities Exchange Act of 1934. Lefkowitz, et al. v. Synacor, Inc., et al., 18-CV-2979 (LGS) (S.D.N.Y. Aug. 28, 2019). Plaintiffs alleged misrepresentations regarding revenue projections relating to a contract with a major customer, the customer’s control over monetizing the contract and weaknesses in the company’s internal controls for financial reporting. The Court held that the alleged misrepresentations in question were either not actionable or were inadequately pleaded with respect to scienter, and therefore dismissed the complaint in its entirety, but granted leave to replead.
Plaintiffs alleged that the company made misrepresentations in SEC filings and public statements regarding a three-year contract to host web and mobile (“portal”) services for a major customer, including revenue projections for the contract and the customer’s control over generating revenue from the portal. Although the company made several statements that it was “on track” to achieve its revenue projections, the revenue generated from the contract ultimately fell short of targets; the company also disclosed material weaknesses in its internal controls regarding financial reporting and ultimately announced that the customer had chosen not to renew the contract. Slip op. at 3-4.
The Court held that the alleged misstatements regarding financial projections were non-actionable as opinion or forward-looking statements. First, the Court reviewed the statements about future revenue growth and the company’s belief that it was “on track” to achieve its projected revenue goals. Id. at 13. The Court held that plaintiffs failed to allege any of the three types of facts necessary to make such statements of opinion actionable. First, the complaint only made conclusory allegations that the individual defendants did not believe their own statements about future revenue. Second, the complaint did not challenge the “supporting facts” defendants supplied in support of the projections. Id. at 14. Third, the Court rejected allegations based on confidential witness statements regarding omissions as to the likelihood of “less customer traffic” due to a shift in web hosting from the prior provider to Synacor; the Court determined that these risks, in fact, “were not hidden” and that Synacor had disclosed that it expected the projected revenues only after “we fully deploy our products and migrate [users of the prior service provider].” Id. at 15.
The Court also rejected plaintiffs’ allegations that the company failed to disclose that the customer controlled monetization. The Court emphasized that the complaint itself alleged facts that the public was aware of the customer’s control, including that a contract attached to an SEC filing—even in the redacted form in which it was publicly disclosed—showed that the customer controlled marketing and would develop the annual marketing plan. Id. at 15-16. In addition, the Court found that plaintiffs failed to plausibly explain how the omission of the monetization fact made the opinion statements at issue regarding revenue projections misleading to a reasonable person. Id. at 16. On similar grounds, the Court rejected allegations regarding weak internal controls, as the Court found that the complaint identified “no connection between weak internal controls and the revenue projections.” Id. at 16-17.
Additionally, the Court noted that the company’s revenue projections fell within the scope of the PSLRA’s “safe harbor” for forward-looking statements. The Court emphasized that financial projections are typical forward-looking statements, and a defendant is not liable if such statements are accompanied by meaningful cautionary language, are immaterial or if plaintiff fails to prove that the statement was made with actual knowledge that it was false or misleading. Id. at 18. Here, the Court concluded that plaintiffs failed to demonstrate that defendants knew or should have known that the revenue projections were false and misleading, because the knowledge that the customer wanted to “prioritize engagement over monetization” and confidential witness statements saying the revenue targets were unrealistic did not equate to knowledge that the projected revenues would not be achieved. Id. at 18.
Finally, the Court rejected allegations of scienter with respect to alleged weaknesses in internal controls. Plaintiffs alleged that the company’s SOX certifications were false in that they certified that the company had disclosed all significant deficiencies in internal controls over financial reporting, but company auditors identified material weaknesses due to a lack of sufficient qualified personnel, a lack of timeliness in executing business process controls, and ineffective monitoring. Plaintiffs argued that defendants knew the company was understaffed, as one officer defendant presided over job cuts to trim costs and a confidential witness claimed that “turnover was terrible” and “financial oversight was poor.” Id. at 20. The Court held that these allegations were insufficient to prove that defendants knew that SOX certifications were false, particularly because an equally plausible inference was that defendants believed any deficiencies were “not so acute as to rise to the level of an internal control weakness.” Id.
While noting that it did not believe the deficiencies in the complaint could be cured, the Court permitted plaintiffs to make a further application to the extent plaintiffs are able to explain how additional allegations would cure the deficiencies identified in the Court’s decision.