In November, the U.S. Supreme Court will hear two cases from the Ninth Circuit Court of Appeals that will implicate the ability of investors to bring securities fraud claims. The most worrisome – NVIDIA Corp. v. E. Ohman J:or Fonder AB, No. 23-970 – will address a fundamental question about the pleading standards for securities fraud cases, which are already heightened under the Private Securities Litigation Reform Act of 1995 (PSLRA). The other – Facebook v. Amalgamated Bank, No. 23-980 – will expound upon whether publicly listed companies must disclose past known risks that do not pose ongoing or future risks. Both cases are scheduled to be heard during the upcoming 2024-2025 term.

NVIDIA: Pleading Standards for Scienter and Falsity

In NVIDIA, shareholders brought a putative class action lawsuit under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission (SEC) Rule 10b-5, alleging that NVIDIA and several of its officers intentionally misrepresented the extent to which the computing company’s gaming-segment revenues were driven by selling its graphic processing units (GPU) to cryptocurrency miners rather than to gamers. Plaintiffs allege that defendants tracked mining-related sales in multiple ways and had access to documents that demonstrated the high demand and use of NVIDIA GPUs among cryptocurrency miners, a conclusion plaintiffs based partly on interviews with former employees. Unlike in most securities fraud class actions, the plaintiffs were even able to allege a number of specifics relating to the documents to which defendants had access, including detailed descriptions of the contents of the documents, the names of regular internal reports, and the frequency with which the reports were distributed. The plaintiffs also relied on an RBC Capital Markets report and independent expert analysis of public data to demonstrate that NVIDIA had generated over a billion dollars more in mining-related revenues than had previously been disclosed.

The U.S. District Court for the Northern District of California dismissed the complaint, concluding that the plaintiffs were not able to point to any specific information in NVIDIA’s internal documents to support an inference of scienter (defendants acting either recklessly or with knowledge that their own actions were wrong), which is required under the PSLRA. A divided panel of the Ninth Circuit reversed in part and remanded, disagreeing with the district court and finding that plaintiffs adequately showed scienter based on the employee interviews, at least as to the CEO. In addition, considering an issue the district court had not broached, the majority concluded that the expert report sufficiently supported plaintiffs’ falsity claims.

On June 17, 2024, the Supreme Court granted certiorari to hear two questions, the first relating to scienter and the second relating to falsity: (1) “Whether plaintiffs seeking to allege scienter under the PSLRA based on allegations about internal company documents must plead with particularity the contents of those documents. . .” and (2) “Whether plaintiffs can satisfy the PSLRA’s falsity requirement by relying on an expert opinion to substitute for particularized allegations of fact.”

Facebook: Disclosure of Previously Materialized Risks

In Facebook, shareholders brought a putative class action lawsuit, also under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, alleging that Facebook failed to disclose materialized business risks related to Cambridge Analytica’s access to and misuse of Facebook user data, instead describing such risks as merely hypothetical. While the District Court for the Northern District of California granted defendants’ motion to dismiss, the Ninth Circuit reversed. The divided panel held that Facebook could be held liable for securities fraud for disclosing in its filings that security breaches and improper third-party access to user data “could harm” its business, given that Facebook was aware of the Cambridge Analytica breach.

On June 10, 2024, the Supreme Court granted certiorari to consider one of the two questions from the Facebook petition: “Are risk disclosures false or misleading when they do not disclose that a risk has materialized in the past, even if that past event presents no known risk of ongoing or future business harm?”

Implications

Both the NVIDIA and Facebook cases are bound to affect the ability of investors to successfully pursue securities class action lawsuits.

The first question presented in the NVIDIA case, in particular, could serve as a serious impediment to bringing securities fraud claims. The PSLRA, as interpreted by the Supreme Court nearly two decades ago, already provides a heightened standard for pleading scienter – much higher than in any other area of law. If the Supreme Court decides NVIDIA in favor of defendant-appellants, it will make bringing securities fraud cases even more difficult by requiring plaintiffs to plead in great detail the specific contents of internal documents for the case to proceed. It is nearly impossible to imagine how plaintiffs can clear this hurdle, since the PSLRA imposes an automatic stay on discovery, meaning defendants are not required to produce any internal documents until after the complaint survives a motion to dismiss. This also would encourage the problematic practice of company insiders stealing company documents and turning them over to lawyers. The second NVIDIA question is important but will likely have less of an impact, since pleading based on expert testimony is relatively rare. And when there is expert testimony, it is not typically a “substitute for particularized allegations of fact,” but rather a tool to opine on protocol in a given industry or to analyze public data.

Resolution of the Facebook question is less likely than NVIDIA to be devastating to securities cases, but a decision in favor of the appellants could still have significant repercussions. If a past event presents no risk of “ongoing or future business harm,” then it is not material – i.e. something that a reasonable investor would consider important in deciding whether to buy or sell a security – and a court likely will not sustain a securities fraud case on that basis. Moreover, the Facebook question will not affect the majority of securities fraud claims, since investors typically bring such claims only when known risks were indeed material. However, contrary to the way defendants in Facebook framed the question to the Supreme Court, the known risk at issue was in fact material to investors and to Facebook – indeed, Facebook agreed to pay $5.1 billion in civil penalties to settle charges by the Federal Trade Commission and the SEC over the scandal.

Regardless of the cases’ outcomes, the fact that the Justices will hear two securities fraud cases next term is a testament to the Supreme Court’s increasingly active role in this area.

This post comes to us from Cohen Milstein Sellers & Toll PLLC. It is based on an article in the firm’s Shareholder Advocate, Summer 2024, dated July 31, 2024.