Southern District Of New York Dismisses Putative Class Action Against Software Application Developer With Prejudice
On July 16, 2020, Judge Jesse Furman of the United States District Court for the Southern District of New York dismissed a putative class action against a Chinese computer application developer and certain of its executives asserting claims under the Securities Exchange Act of 1934. Marcu v. Cheetah Mobile Inc., No. 18-CV-11184 (JMF), 2020 WL 4016645 (S.D.N.Y. July 16, 2020). Plaintiffs asserted an “omissions case”; i.e., they alleged that the company made statements regarding its revenue, the popularity of its applications, and the importance of the Google Play store to its business model that were rendered misleading because the company did not disclose an alleged scheme through which the company earned improper referral bonuses on application downloads. The Court held that plaintiffs failed to adequately allege that the challenged statements were false or misleading or made with scienter. Because plaintiffs had previously been granted leave to amend their complaint, and the Court found nothing to suggest that the deficiencies identified could be cured, the Court denied leave to amend.
The Court held that plaintiffs had failed to plead falsity because they had not pleaded with sufficient specificity how “the alleged omissions are sufficiently connected to [d]efendants’ existing disclosures to make those public statements misleading.” Id. at *3. For example, the Court noted that many of challenged statements described a user’s experience with the company’s applications, which were unaffected by plaintiffs’ assertion that those same applications were also used to manipulate the referral bonuses. Id. at *4.
In addition, the Court rejected plaintiffs’ argument that statements regarding the company’s revenue or profit were misleading. The Court emphasized that many of the challenged statements “did nothing more than accurately characterize … statistical facts,” and were not rendered misleading by the omission of the alleged misconduct because they “did not put the source of [the company’s] success at issue.” Id. at *5. While the Court noted that certain statements came closer to being actionable, such as statements that the company “generate[d] online marketing revenues primarily by referring user traffic and selling advertisements on our mobile and PC platforms” and listing the “most significant factors affecting revenues from online marketing,” the Court held that those statements did not rule out the possibility that other factors contributed to revenue and plaintiffs alleged no facts regarding the significance of the alleged scheme to the company’s overall revenues. Id.
Moreover, the Court held that challenged statements regarding the company’s risk disclosures—including statements that the company’s business could be adversely affected by evolving data protection regulations or if Google Play terminated its relationship with the company—were not actionable because plaintiffs’ allegations failed to establish that the statements were false when made or that the risks had already materialized. Id. at *6. Because plaintiffs had not established that any existing statements were rendered misleading by the alleged omissions, and in light of the fact that there was no affirmative duty to disclose that information, the Court held that plaintiffs had not alleged an actionable falsity.
The Court also held that plaintiffs failed to allege facts adequately supporting scienter. Plaintiffs relied on several allegations to support a strong inference of scienter: (1) that individual defendants were senior executives or a controlling shareholder when the statements were made; (2) that the individuals had knowledge of the applications implicated in the alleged scheme as well as of the company’s revenues generally; (3) that the company owned a separate “software development kit” that was used to facilitate the scheme; (4) that confidential witnesses stated that the company “valued clicks and revenue above all else, including integrity”; (5) that the applications in question were core offerings; and (6) that the company had been accused of advertising fraud previously. Id. at *7.
The Court rejected each of these arguments. The Court noted that a defendant’s position alone cannot establish that he or she was aware of information contradicting an alleged misrepresentation, and that plaintiffs failed to identify any specific basis to support an inference that defendants had information contradicting the statements at issue. Id. The Court further held that plaintiffs failed to explain why the company’s ownership of the “software development kit” would suggest that particular individuals were aware that the software caused false referrals, and the Court held that the confidential witnesses did not state that the individuals in question possessed the requisite knowledge that the statements were false. Id.
The Court further observed that plaintiffs’ allegation that the company’s applications were “core offerings” appeared to be an effort to invoke the core operations doctrine, which permits an inference that a company’s senior executives have knowledge of information regarding the business’s core operations. The Court concluded, however, that even if the core operations doctrine was valid in the Second Circuit following the adoption for the Private Securities Litigation Reform Act, which is not clear, it could only be used to supplement other allegations of scienter and not to establish scienter independently. Id. at *8. Finally, with respect to previous allegations of fraud levied against the company, the Court explained that the mere fact that the company had been sued previously regarding other allegedly fraudulent advertising practices did not establish that defendants knew that the alleged misstatements were false when made. Id.