On September 30, 2018, Judge Andrea R. Wood of the United States District Court for the Northern District of Illinois dismissed a putative shareholder class action against VASCO Data Security International, Inc. and certain of its officers. Plaintiff asserted claims under Sections 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Rossbach v. VASCO Data Sec., Int’l, 2018 WL 4699796, (N.D. Ill. Sept. 30, 2018). Plaintiff alleged that VASCO made a number of misstatements suggesting that revenue sources other than the company’s largest client were stronger than they really were. When the company disclosed that the revenue associated with those other products and services remained essentially flat, the stock price allegedly fell. The Court held that plaintiff’s amended complaint failed to adequately allege a false statement or scienter. Plaintiff was, however, granted leave to file a second amended complaint.

The Court first held that plaintiff failed to plead with particularity how any statements were false or misleading. The Court emphasized that plaintiff had the burden to “properly pinpoint” which statements were allegedly false or misleading and to provide a specific explanation as to why each such statement was false or misleading. Id. at *6. The Court therefore determined that plaintiff’s allegations “fail at the outset for lack of specificity” because they relied on block quotes and general references, and cautioned that there “should not be any guesswork in identifying what statements are at issue in this case.” Id.

The Court nevertheless examined whether those quotes and references might establish an actionable misstatement or omission. The Court rejected plaintiff’s claim based on statements on an earnings call about VASCO’s “strong pipeline of potential new orders,” holding that this was essentially a statement concerning new business, not a forecast of revenue at any particular time. Id. Moreover, any inference that this new business would exclude VASCO’s largest customer was contradicted by statements on the same earnings call that VASCO planned to rely on its existing customers to generate that “pipeline” of new business. Id. Separately, the Court determined that a statement on the earnings call regarding the company’s ability to create a “continuing sustainable repeatable revenue stream” was taken out of context by plaintiff and merely referred to VASCO’s business strategy of generating revenue from existing customers. Id. at *7. Moreover, the Court held that statements comparing revenue between two prior quarters were not actionable because they were not alleged to be inaccurate with respect to the prior quarters and did not forecast future revenue. Id. While the Court did find that certain allegations might be potentially actionable — references to a “pipeline” of potential business, “demand” for future products, “expect[ations] for future orders,” “reception” to certain products, and “interest in future products” — the Court held that the complaint failed to allege with specificity that these amounted to material misstatements. Id.

The Court also held that plaintiff failed to adequately allege scienter. The Court emphasized that plaintiff’s allegations were based almost entirely on events occurring after the class period — subsequent stock movement, corporate disclosures, and financial results — which courts have found to be improper “fraud in hindsight.” Id. at *8. In particular, the bulk of plaintiff’s allegations were based on executives’ stock sales. One executive, however, sold no stock during the class period, and the Court rejected plaintiff’s argument that any inference could be drawn from the fact that the executive did not purchase any stock during the period either. Id. at *9. Two other executives sold 23.1% and 68.1% of their respective holdings during the class period, but the Court emphasized that these sales were made several months before the alleged stock drop, at lower prices than before the alleged misstatements were made, and that the stock price continued to rise substantially after the sales. Id. The Court observed that, if the corporate executives “were engaging in insider trading based on false and misleading information, one would have to infer that they were doing a particularly incompetent job at it.” Id. at *10. The only contemporaneous allegation in support of scienter was a single reference on an earnings call to “greater visibility” in deals for “traditional and new products” — which the Court determined was a “far cry” from showing defendants knew there was not a strong pipeline for potential business at the time. Id. at *9. These allegations thus failed to establish the required strong inference of scienter.

This decision is a reminder that allegations of misstatements and omissions must be alleged with specificity and allegations of scienter based on the timing of stock trades will be scrutinized in reference to the stock’s price movements.

Rossbach v. VASCO Data Sec., Int’l