On November 29, 2021, the Delaware Court of Chancery in In re Mindbody, Inc., Stockholder Litigation denied a joint motion to dismiss by investment firm Vista Equity Partners Management, LLC, Torreys Parent, LLC, and Torreys Merger Sub, Inc. (collectively, “Vista”) concerning claims that Vista aided and abetted breaches of fiduciary duty in connection with a proxy statement for its 2018 purchase of Mindbody Inc.
The case arises out of Vista’s $1.9 billion acquisition of Mindbody in 2018, which stockholder plaintiffs contend was unfair and tilted in Vista’s favor by three Mindbody officers laboring under conflicts of interest. Specifically, plaintiffs allege that Vista aided and abetted two categories of disclosure violations: Mindbody’s failure to include sufficient detail regarding interactions between Vista and Mindbody’s then-Chief Executive Officer Rick Stollmeyer in the proxy statement, and Mindbody’s decision not to disclose its preliminary fourth quarter revenue results.
With respect to the first category of alleged disclosure issues, Chancellor Kathaleen St. Jude McCormick cited to the investment firm’s contractual entitlement to review the proxy and its obligation to inform Mindbody of any deficiencies to find that Vista knew the proxy failed to disclose information about its own dealings with Stollmeyer, and thus, participated in the disclosure violation. As to the second category of alleged disclosure violations, the court noted an absence of any similar “contractual hook” implicating Vista’s involvement, but nonetheless found it reasonable to infer from the facts alleged — specifically, that Vista raised “concerns” to Mindbody regarding its press release announcing fourth quarter preliminary revenue results —that Mindbody did not disclose those results at Vista’s request. As such, the court found Vista’s knowing participation as to both categories of alleged disclosure violations to be adequately pleaded.
The case represents another victory for the plaintiff stockholders, with the court largely denying a motion to dismiss in October 2020, and allowing plaintiffs to amend their complaint in July 2021 to re-assert claims against a previously dismissed Mindbody outside director.
Delaware Chancery Court Dismisses Majority of Claims Alleging that California Biotech Firm Profited from Nonpublic Information About Vaccine Development Efforts
On December 1, 2021, Delaware’s Chancery Court dismissed three of five claims against California biotech firm Vaxart, Inc. and its one-time majority shareholder Armistice Capital LLC, finding plaintiffs had failed to demonstrate that (1) Armistice Capital was a controlling shareholder at the time of the transaction, or (2) a majority of the board of directors had conflicts of interests or acted in bad faith.
The case stems from a complaint filed by Vaxart’s stockholders, which alleged that the company’s board of directors and former majority shareholder Armistice Capital wrongfully profited from nonpublic information about the company’s efforts to develop a COVID-19 vaccine. In May 2020, the board approved two warrant agreements between the company and Armistice Capital, enabling Armistice to own a greater number of shares upon exercise of the warrants and dispose of shares more quickly than under the original terms. The board also voted to amend the company’s incentive compensation plan to increase the number of shares eligible for grant. A few weeks later, Vaxart publicly announced that it had been selected to participate in a study sponsored by Operation Warp Speed, the federal government’s initiative to accelerate the development of a COVID-19 vaccine. The company’s stock price rose significantly following the announcement.
As a result of the stock price increase, plaintiffs alleged that the board knew of Vaxart’s impending selection for Operation Warp Speed when it approved the warrant agreements and equity incentive plan, but withheld disclosure of that information until after the announcement to benefit themselves and Armistice Capital. Plaintiffs brought claims for breach of fiduciary duty, unjust enrichment, and aiding and abetting against both the Vaxart directors and Armistice Capital, alleging that Armistice Capital was a controlling shareholder at all relevant times.
The Delaware Chancery Court rejected three of the five counts in the suit, including all claims against Armistice Capital, and in so doing, declined to apply entire fairness review, opting instead for the more lenient business judgment rule. With Armistice Capital’s ownership of Vaxart’s voting power in steady decline for years, reaching less than ten percent at the time of the challenged transaction, the court found that it was not a controlling shareholder, despite plaintiffs’ attempts to “cobble together” allegations of disparate actions suggesting control. The court further found no conflict of interest or bad faith with respect to the warrant agreements, noting that the warrant agreements were “hardly a gift” and would in fact allow the company to increase its cash on hand by roughly $5 million. The court rejected any argument that the company could have raised capital “in better ways” as exactly the kind of “second-guessing” precluded by the business judgment rule.
The two remaining claims, not substantively addressed in the Chancery Court opinion, will be subject to further briefing.
Fourth Circuit Declines to Revive Shareholder Class Action
On December 1, 2021, a Fourth Circuit panel affirmed the dismissal of a securities fraud lawsuit against DXC Technology Company and its top executives. The case stems from a class action brought by plaintiffs KBC Asset Management NV and Arbejdsmarkedets Tillagspension, alleging that the company and its executives made false and misleading statements about the company’s financial health, causing plaintiffs to purchase DXC stock at inflated prices.
DXC, a publicly-traded information technology company, was formed in 2017 after a merger between Computer Science Corporation and Hewlett Packard Enterprise Company. The company enjoyed financial success in its first year and, on February 8, 2018, issued a press release announcing continued success and positive revenue projections. On November 6, 2018, DXC had to revise its projected revenue guidance to shareholders to approximately $800 million less than previously reported, following declines it attributed to a stronger dollar, the completion of several large transformation projects, and slower-than-expected ramp up on key digital contracts, as well as delayed client migrations to cloud environments.
Plaintiffs represent a class of stockholders who acquired DXC stock between February 8, 2018, and November 6, 2018, alleging they suffered losses totaling roughly $2 billion when DXC stock prices plummeted following news of revenue shortfalls and layoffs. Plaintiffs further alleged that defendants fraudulently induced them to buy DXC stock within that time period by falsely representing that the company was in good financial health, despite knowing that cost-cutting measures implemented in 2018 would undermine the company’s ability to generate revenue by detracting from any focus on growth and making it difficult to deliver on client contracts.
The district court dismissed the complaint on the grounds that plaintiffs failed to allege actionable false or misleading statements and failed to allege facts from which scienter could be inferred. The Fourth Circuit agreed with the district court that the statements cited by plaintiffs were either forward-looking statements or non-actionable puffery. The circuit court further affirmed the district court’s finding that the complaint failed to allege scienter, noting that, while plaintiffs relied on five categories of allegations in an attempt to demonstrate scienter —allegations made by a former executive in a separate lawsuit, statements of unnamed former employees, stock sales by certain executives during the class period, the core-operations theory, and the temporal proximity between the company’s challenged revenue projections and its ultimate admission that those forecasts had been overly optimistic — the “non-fraudulent inference” that the company simply “stumbled” as a result of greater-than-expected operational difficulties was more compelling than the inference of scienter.
In upholding the district court’s dismissal, the Fourth Circuit specifically took note of the fact that DXC promptly announced the drop in revenue and disclosed its initial mistakes to investors in its November 6, 2018 announcement.
California District Court Finds Electric Truck Company’s Statements About Potential Contracts Give Rise to Actionable Claims
On December 2, 2021, the U.S. District Court for the Central District of California ruled that stockholder plaintiffs adequately pleaded claims that electronic truck manufacturer Workhorse, Inc. violated the Securities Exchange Act of 1934 in making statements regarding its production capabilities and chances at securing a major government contract.
The case arises out of Workhorse’s unsuccessful attempts to secure large contracts with the United States Postal Service (“USPS”) and the United Parcel Service, Inc. (“UPS”) for fleets of its electric package delivery vehicle. Workhorse was among six electric-vehicle suppliers competing to win a multibillion dollar contract with USPS to replace roughly 165,000 aging trucks. Plaintiffs allege that Workhorse encountered numerous issues during the bidding process and that USPS told the company its proposal had a number of weaknesses, but that Workhorse nonetheless continued to represent to investors it was a viable contender for the contract. Plaintiffs similarly allege that Workhorse overstated its agreement with UPS by indicating to investors that it was about to fulfill a UPS order for 950 vehicles when UPS had offered no indication that it was moving forward with the contract. In February 2021, USPS announced that it had awarded the contract to a different company, with Workhorse’s stock price plummeting after this news, and plaintiffs’ lawsuit followed.
Judge Cormac J. Carney rejected Workhorse and its officer-defendants’ arguments that statements regarding the company’s chances of winning and capability of fulfilling the USPS contract were protected by the Private Securities Litigation Reform Act’s safe harbor as nonactionable forward-looking statements. Specifically, the court pointed to alleged undisclosed issues in prototype testing (including a parking brake failure resulting in the hospitalization of a USPS driver), confidential witness statements concerning Workhorse’s lack of production capabilities, and multiple emails from USPS listing deficiencies in the company’s proposal in sustaining plaintiffs’ claims. The court found that such allegations plausibly stated a claim for relief, where they evidenced defendants could not have genuinely believed that Workhorse had a real chance at winning the contract and that defendants knew Workhorse did not have the infrastructure in place to fulfill a contract of that scale.
The court also rejected Workhorse’s argument that its statements about having a “backlog” of vehicle orders from UPS were not false or misleading in light of the company’s disclosure that the order was not guaranteed. Examining the allegations as a whole, the court again held that plaintiff had plausibly alleged that defendants could not reasonably have believed that UPS would be taking delivery of the order given its public announcement that it had ordered 10,000 electric delivery vehicles from a UK-based start-up. Once Workhorse chose to “tout” its backlog, Workhorse was “bound to do so in a manner that wouldn’t mislead investors as to what the backlog consisted of,” the court stated.
The court sided with Workhorse, however, on plaintiffs’ additional allegation that Workhorse made false statements regarding its use of Paycheck Protection Program (“PPP”) funds by representing that they would be used “primarily for payroll costs” when they were, in fact, used to pay executive bonuses. The court found these allegations insufficiently pleaded as they were supported by only one confidential witness who, as plaintiff pled, did not assist with payroll, prompting the court to question how that confidential witness could have personal knowledge regarding application of the PPP funds. The court separately concluded plaintiffs alleged no facts indicating that the statements concerning application of the funds were false when made. The court therefore dismissed plaintiffs’ claims based on this category of alleged misrepresentations, while permitting plaintiffs leave to amend.
Kate E. MacLeman
Kate E. MacLemanPartner