The Southern District of New York recently dismissed a putative securities fraud class action complaint predicated on a company’s alleged failure to disclose certain internal sales information. See In re Authentidate Holding Corp. Securities Litigation, No. 05-Civ-5323 (LTS), 2009 WL 755360 (S.D.N.Y. Mar. 23, 2009). The plaintiffs alleged that Authentidate concealed the fact that the company was on the verge of breaching or had already breached an agreement with the United States Postal Service. See id. at *2. Authentidate allegedly knew that weak sales had rendered the company incapable of satisfying certain undisclosed revenue metrics set forth in the agreement with the Postal Service yet failed to disclose this information to its shareholders, thereby artificially inflating the price of the company’s stock. See id.
The defendants moved to dismiss the complaint on the ground that they did not have a duty to disclose the omitted data to Authentidate’s shareholders. The court acknowledged that a duty to disclose can arise in a variety of contexts “including statutorily created disclosure duties, when disclosure is necessary to make prior statements not misleading, when it is necessary to update statements that may have become misleading as the result of intervening events or the passage of time, when an insider seeks to trade on the basis of information known only to her, and the presence of certain fiduciary relationships.” Id. The plaintiffs asserted the existence of a duty to disclose based on (i) Item 303 of SEC Regulation S-K; (2) the company’s February 2004 stock offering; and (iii) an obligation to ensure that prior statements are not subsequently rendered misleading. See id.
The court first rejected the plaintiffs’ argument that Regulation S-K required the company to disclose the omitted data. Item 303 of Regulation S-K is entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and requires that a registrant “describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” Id. Significantly, the instructions for Paragraph 303(a) provide that “[t]he discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.” Id. (emphasis added). Because the plaintiffs had failed to plead particularized factual allegations demonstrating that the omissions rendered the company’s reported financial information misleading, the court found that Item 303 did not create a duty to disclose. See id. at *3.
The plaintiffs’ second argument – that Authentidate was obligated to disclose the omitted information in connection with the company’s February 2004 stock offering – was equally unpersuasive. Pursuant to the company’s agreement with the U.S. Postal Service, Authentidate was to be in compliance with the aforementioned revenue metric no later than July 2004, five months after the February 2004 stock offering. See id. As noted by the court, any statements at that time regarding the company’s sales “during the remaining five-month time period and whether the first revenue metric would be achieved would have been speculative at best.” Id. The plaintiffs similarly failed to identify “any past statement concretely predicting or suggesting that the Company would achieve a certain level of … sales by a specific time period, such that Authentidate’s failure to disclose the levels of sales in February 2004 constituted a material omission.” Id.
The court likewise rejected the plaintiffs’ third and final argument that the defendants were required to disclose the omitted data in order to prevent certain prior statements from becoming misleading. The court found that the factual allegations in the complaint were “insufficient to demonstrate plausibly that any of the cited statements by Defendants were rendered materially misleading as a result of the omissions” and further held that the forward-looking statements cited by the plaintiffs were “merely optimistic expressions of belief of the Company’s potential for improved future performance that are too vague to be material.” Id. at *4.
For all these reasons, the Southern District of New York found that the defendants did not have a duty to disclose the omitted information and dismissed the plaintiffs’ complaint.
