On February 22, 2019, Judge Kevin McNulty of the United States District Court for the District of New Jersey granted defendants’ motion to dismiss a putative class action against an Israeli-based technology company (“Company”) and its senior officers, asserting violations of Sections 10(b) and 20(a) of the Exchange Act of 1934, and Rule 10b-5. Padgett v. RIT Techs. Ltd., No. 2:16-cv-4579, 2019 WL 913154 (D.N.J. Feb. 22, 2019). Plaintiffs alleged defendants failed to disclose the extent of the Company’s reliance on an agreement with a non-exclusive distributor to provide its products and services in the Commonwealth of Independent States region (“CIS”). The Court dismissed the amended complaint without prejudice, holding that plaintiffs failed to adequately allege how defendants’ public statements and failure to use specific adjectives to characterize the distributor were misleading to investors.
The Company offers intelligent infrastructure management and indoor optical wireless technology solutions to enhance security and network utilization for workspace environments. In its Form 6-K, dated March 3, 2015, the Company announced that it entered into an International Distributor Agreement (the “Agreement”) to improve sales in CIS countries. It explained that the distributor was granted a “non-exclusive right to distribute, sell and/or maintain” the Company’s products in Russia and CIS, and furnished a copy of the Agreement. The Form 6-K disclosed that the distributor was a Russian company affiliated with the Company’s controlling shareholder. The Company then filed a Form 20-F for the 2014 Fiscal Year and listed the Agreement under “Recent Major Business Developments.” In 2016, the Company revealed a delay in payments by the distributor, which adversely impacted its cash flow. Shares of its stock subsequently fell 50% in value. The Company later announced that its collection of overdue debts was moving slowly and expressed doubt over whether its operations could continue, which led its stock price to drop further. The Company was eventually delisted from trading on the NASDAQ, its executives resigned, and a group of employees filed petitions to liquidate the Company. Plaintiffs filed the action, alleging that the Company’s public statements in 2015 were materially false and misleading because defendants downplayed the significance of the Agreement and concealed the Company’s dependence on the controlling shareholder. According to plaintiffs, the Company failed to disclose that the distributor was actually its major distributor in Russia and that the CIS region was vital to its viability.
Defendants’ motion to dismiss was granted. The Court found that plaintiffs failed to adequately plead how defendants’ statements about the Agreement or its relationship with the distributor would have misled investors. For example, plaintiffs pointed to one of the corrective disclosures describing the distribution agreement as “major” to argue that the previous disclosures also should have characterized it as major. The Court rejected this argument, noting that defendants’ failure to use a particular adjective to characterize its distributor does not “equate to an actionable misrepresentation.” It further noted that defendants in any event identified the Agreement as a “major” development and that plaintiffs failed to allege the nature or size of the Company’s other distributors, within or outside CIS, the amount of business the Agreement constituted in relation to other distributors, or how the size of the distributor would be important to investors such that the claim the agreement was major could be evaluated.
In addition, the Court held that plaintiffs failed to raise an inference of scienter because plaintiffs alleged only in a conclusory way that defendants “knew” the statements were false, concluding that an inference of scienter is warranted only when a “fact pattern unambiguously indicates” scienter. The Court explained that the failure to use the word “major” did not “scream fraud.”