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Northern District Of California Dismisses Exchange Act And Securities Act Claims, Addressing Sufficiency Of Scienter And Standing Allegations
01/23/2017On January 17, 2017, Judge Beth Labson Freeman of the United States District Court for the Northern District of California dismissed with leave to amend a putative securities class action against TriNet Group, Inc. (“TriNet”), its officers and directors, a former controlling shareholder, and the underwriters of TriNet’s initial public offering (“IPO”) and a secondary offering (“SPO”). Welgus v. TriNet, — F. Supp. 3d —, 2017 WL 167708 (N.D.Cal. 2017). The Court held that plaintiff had not adequately alleged facts showing that the officer defendants knowingly made false statements in violation of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) or facts sufficient to establish control person liability against TriNet’s controlling shareholder under Section 20 of the Exchange Act. Nor had plaintiff stated a claim under Sections 11 and 12(a)(2) of the Securities Act of 1933 (the “Securities Act”) because, among other things, plaintiff had not sufficiently alleged that its shares were traceable to the IPO or SPO.
TriNet offers outsourced human resources services and derives revenues, in part, by contracting with insurers to provide coverage under TriNet-sponsored plans to TriNet’s client’s employees. Tri-Net collects premiums from those employees and passes most of them on to the insurers, but retains a portion of the premiums, along with some secondary exposure to claims after a deductible amount has been exhausted. Plaintiff alleged that TriNet’s IPO and SPO registration documents and subsequent financial disclosures misstated such things as TriNet’s (1) risk management capabilities, (2) access to insurance claims data, and (3) assessment of individual claims. When TriNet subsequently disclosed in a series of public statements starting in March 2015 that it faced a higher than expected number of insurance claims, the stock dropped from a high of $37.88 to a low of $12.28.
The Court held that plaintiff failed to state a Section 10(b) claim against TriNet and its CEO and CFO (the “Officer Defendants”) because plaintiff had not adequately alleged any false statements or that the Officer Defendants had acted with fraudulent intent. For example, while the Officer Defendants had repeatedly assured investors that risk management was a “core competency” of TriNet, plaintiff failed to “identify any contemporaneous evidence” showing that these statements were false when made and pleaded no facts showing that the Officer Defendants knew the alleged misstatements were false when made. The Court explained that plaintiff’s reliance on statements made after TriNet’s stock drop were insufficient because plaintiff did not plead particularized facts supporting an assertion that, at the time the challenged statements were made, TriNet either did not have in place sufficient risk policies and personnel or knew that those policies and personnel were deficient. Absent such facts, plaintiff’s allegations established, at best, bad judgment, which is not enough to create a strong inference of scienter. The Court also rejected plaintiff’s attempt to invoke the “core operations” doctrine (according to which scienter may be proven by allegations showing that “it would be absurd to suggest that management was without knowledge of the matter”), because the complaint did not allege that the Officer Defendants had actual access to information contradicting the challenged statements at the time they were made or that they were “hands-on” managers who were “monitoring” every aspect of the company, let alone its relevant systems and data. On independent grounds, the Court also dismissed plaintiff’s Section 20(a) claim against TriNet’s controlling shareholder. The Court held that plaintiff’s allegations regarding the shareholder’s involvement in the drafting and/or approval of the challenged communications were insufficient absent factual allegations regarding the shareholder’s authority to exercise decision-making power or it day-to-day involvement in the operation of the company.
The Court also dismissed plaintiff’s Securities Act claims. The Court held that plaintiff’s Securities Act claims were subject to Rule 9(b), and that in order to establish Section 11 standing, plaintiff was therefore required to specifically allege facts sufficient to demonstrate that his shares were traceable to either the IPO or SPO registration statements. The Court also noted that if plaintiff could not establish statutory standing under Section 11, he could not seek relief on behalf of himself or any member of the proposed class. Similarly, plaintiff also failed to state a Section 12(a)(2) claim because, among other things, he did not allege that he had bought shares “pursuant to” the IPO or SPO registration statements, as opposed to in the secondary market.
The Court also held that plaintiff’s Securities Act claims against the underwriter defendants were time-barred, because plaintiff was on notice of potential misstatements in the IPO and SPO registration statements regarding TriNet’s exposure to insurance claims by March 2015, when TriNet first announced that it had encountered more such claims than previously anticipated. Because plaintiff did not assert any claims against the underwriters until April 2016, the Court held that these claims were barred by the Securities Act’s one-year statute of limitations.
Although the Court granted plaintiff leave to amend, this decision underscores the importance of pleading particularized facts demonstrating falsity and knowledge of falsity to state a securities fraud claim, as well as facts sufficient to demonstrate statutory standing under the Securities Act.
