On August 23, 2022, the United States Court of Appeals for the Tenth Circuit unanimously reversed the dismissal of a putative securities class action lawsuit against an online education company (the “Company”) ), alleging violations of Section 10(b) of the Securities Exchange. Act of 1934 (the “Exchange Act”), SEC Rule 10b-5, Section 20A of the Exchange Act and Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 (the “Securities Act”). Plaintiffs alleged that the company made false and misleading statements about the size and productivity of the company’s sales force. The district court dismissed the Exchange Act claims because the plaintiffs failed to plead a strong inference of scienter and dismissed the Exchange Act and Securities Act claims for failure to plead a violation of the Section 303 of SEC SK. On appeal, the Tenth Circuit reversed and remanded, finding that (i) the Exchange Act allegations “support[ed] a knowing inference at least as compelling as any not guilty inference” and (ii) the District Court relied on “erroneous reasoning” to dismiss the Exchange Act and Securities Act claims based on the alleged violation of Section 303.
The plaintiffs alleged that the company, which was not profitable, touted the growth of its “invoicing” to attract investors. The Company has defined “billing” as “total revenue plus the change in deferred revenue during the period”. The plaintiffs alleged the company gave assurances about the accuracy with which it tracked billings, calling it a “key business metric”. According to the plaintiffs, the Company informed investors and analysts that its sales force — “including both the number of its sales representatives and their productivity” — was the primary driver of the Company’s billing growth. The plaintiffs alleged that the company artificially inflated its stock price, including through a secondary public offering in March 2019, when it made false and misleading statements about the size and productivity of its workforce. sale. Specifically, plaintiffs alleged that in January 2019, the company’s chief financial officer spoke at an annual conference and highlighted the size and efficiency of the company’s sales force. In a Q&A session with analysts and investors, the CFO explained that the company’s sales force had grown from 80 to around 250 “quota-wearing” sales reps over the course of several years. which would be untrue as the company only had about 200. direct sales to focus on commercial sales” and that she had “been able to generate substantial increases in the productivity and efficiency of [its] sales staff.” The plaintiffs also alleged that the company violated Section 303, which requires disclosure of “known trends” reasonably likely to have a material impact on net sales, by failing to disclose that the company “was months behind on its sales ramp capacity plan, which was likely negatively impacting its billing.
In dismissing the Exchange Act claims, the district court found the CFO’s statement that “today we have about 250” sales representatives subject to quota to be false. That would have been wrong because the company would have had only about 200, but the district court found plaintiffs failed to plead a “strong and compelling inference of scienter” as required by Private Securities Law. Litigation Reform Act of 1995. In dismissing the Section 303 claims, the district court held that the plaintiffs had not sufficiently alleged that the company was aware that the alleged capacity gap would have a material impact on the growth of billings, as the company experienced “strong growth in billings in the first quarter of 2019 despite the alleged sales capacity gap.”
The Tenth Circuit reversed the district court’s ruling that the complaint did not raise a strong inference of scienter. With respect to the statement of the company’s former CFO that “we now have approximately 250” sales representatives subject to quota, the Court noted that the plaintiffs’ allegations, including that the CFO admitted he was aware of a capacity gap during an earnings call, which the CFO said he was watching the company’s sales force numbers closely and had emphasized that the ability of the sales force to generate billings was central to the company’s business model: “Strongly supporting[ed] the inference that [the CFO] knew that his January 16, 2019 statement was false or misleading when he made it. The Court therefore concluded that the District Court erred in concluding that there was no strong inference of scienter with respect to this statement.
The Tenth Circuit then ruled that, on remand, the district court should reconsider the plaintiffs’ claims that the company violated Section 303. The court explained that, according to the complaint, the company “relyed heavily on agreements that had taken several months to close, and thus, the quarterly billings primarily reflected transactions initiated in a previous quarter. As a result, the Court noted that the plaintiffs “plausibly alleged [the Company] knew that the growth in billings in the first quarter did not mean that the gap in sales capacity would not affect future billings. The Court held that the district court’s finding – that the failure to disclose the sales ability gap was not misleading – was “not supported by the allegations in the complaint” and could not ” form the basis for dismissing the violation of Section 303″. On remand, the Court instructed the District Court to “consider at first instance whether two months of delay on an internal sales ramp capacity plan constitutes a ‘trend’ within the meaning of Section 303.”
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