On March 23, 2022, Judge Kenneth K. Lee of the United States Court of Appeals for the Ninth Circuit affirmed the United States District Court for the Northern District of California’s dismissal of claims brought under Sections 10(b) and 20(a) of the Securities Exchange Act (the “Exchange Act”) and Rule 10b-5 thereunder against a social media company (the “Company”) and certain of its executive officers. Weston Family Partnership LLLP et al. v. Twitter Inc. et al., No. 20-17465 (9th Cir. Mar. 23, 2022). Plaintiffs alleged that the Company failed to disclose the scope of software issues that led to a loss in advertising revenue, which ultimately caused the Company’s share price to drop. The Court affirmed the district court’s order granting defendants’ motion to dismiss, holding that plaintiffs failed to state a claim because the Company’s statements were not false or materially misleading. The Court stated that “[s]ecurities laws . . . do not require real-time business updates or complete disclosure of all material information whenever a company speaks on a particular topic. To the contrary, a company can speak selectively about its business so long as its statements do not paint a misleading picture. [The Company]’s statements about its advertising program were not false or misleading because they were qualified and factually true. The Company had no duty to disclose any more than it did under federal securities law.”
According to the Court: “[e]very day, millions of people use [the Company] to share and read news, offer (often horrendous) hot takes, and fire off mean [messages. The Company], in turn, mines the personal data of its users to better target advertisements.” In August 2019, the Company revealed that “software bugs” had caused it to inadvertently share with advertisers the personal data of users who had opted out of data-sharing. The Company stated that it had “fixed these issues. In October 2019, the Company disclosed that software bugs had hampered its advertisement customization and that it had suffered a $25 million revenue shortfall. The Company’s share price dropped over 20%.
Plaintiffs are investors who filed a consolidated class action complaint alleging that various statements by the Company were false or materially misleading. Plaintiffs alleged that statements in the July 31, 2019 Form 10-Q—that the Company was “continuing [its] work to increase the stability, performance, and flexibility of [its] ads platform,” but that it was “not there yet”—were misleading because “defendants did not disclose the software bugs allegedly plaguing” their software. Plaintiffs also alleged that warnings in the 10-Q that “the [C]ompany’s products and services ‘may contain undetected software errors, which could harm [its] business and operating results’” were misleading because the Company allegedly knew by then that software bugs were certain to harm its bottom line. In addition to the 10-Q statements, Plaintiffs further alleged that the Company misleadingly claimed it had resolved the software bugs in August 2019—because the Company had in fact allegedly stopped data-sharing altogether rather than fixing the bugs—and that one of the executives made other public statements that glossed over the software bugs. The district court granted defendants’ motion to dismiss, and plaintiffs appealed.
On appeal, the Court first held that plaintiffs failed to state a claim under Section 10(b) because the Company’s statements were not false or materially misleading. The Court disagreed with plaintiffs’ argument that the Company had a legal duty to disclose the software bugs to the investing public, noting that “companies do not have an obligation to offer an instantaneous update of every internal development” under Section 10(b) and Rule 10b-5. The Court held that “[a] company must disclose a negative internal development only if its omission would make other statements materially misleading.” The Court emphasized that to hold otherwise would “inject instability into the securities market, as stocks may wildly gyrate based on even fleeting developments.” With respect to plaintiffs’ allegations that defendants misled investors into believing that work to improve the data-sharing feature was “on track,” the Court found that defendants’ statements were “much more qualified and less definitive,” noting that the 10-Q also stated that the work was “not there yet,” that it was “ongoing,” and that the Company was “still in the middle of that work.” According to the Court, absent a “specific deadline or revenue impact” for the program, the Company’s statements could not be seen as an implied affirmation of any specific target.
The Court next held that plaintiffs did not plausibly allege that the software bugs had materialized and affected revenue in July 2019. The Court stated that “it is simply not enough to assume or implausibly infer” that defendants knew about the bugs in July 2019 based solely on the fact that they disclosed them in August 2019. Moreover, the Court was not persuaded by plaintiffs’ argument that the Company knew about the bugs in August 2019 based on statements in the Company’s July 2019 10-Q filing that the product could contain “undetected software errors.” The Court reiterated that “nothing in the complaint suggest[ed] that the company knew of the bugs in July 2019,” and that plaintiffs merely relied on the assumption that “these types of bugs . . . take three to six months to fix.” Further, the Court rejected plaintiffs’ argument that defendants’ social media post about fixing the bugs in August 2019 “was referring to the fix of the software bugs, and not just a halt to the data-sharing,” noting that the context of the post makes clear that the Company had “‘fixed’ the inadvertent data-sharing; there is no mention of software bugs.”
Finally, the Court held that defendants’ statements in their shareholder letter and 10-Q were forward-looking and “accompanied by very detailed meaningful cautionary language,” and therefore fell within the safe harbor provision of the Exchange Act. Because plaintiffs did not adequately plead a primary violation of Section 10(b) or Rule 10b-5, the Court also affirmed the dismissal of the Section 20(a) claims against the individual defendants.