On October 16, 2019, Judge Jorge L. Alonso of the United States District Court for the Northern District of Illinois Eastern Division dismissed a putative securities class action against an in-flight internet connectivity services provider (the “Company”) and some of its current and former executives. Pierrelouis v. Gogo Inc., et al., No. 18-cv-04473 (N.D. Ill. Oct. 16, 2019). Plaintiffs, who brought claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, alleged that defendants misrepresented the Company’s financial health and the performance and reliability of its in-flight internet services by failing to disclose the extent of a de-icing fluid issue that was affecting its ability to provide those services, and that the eventual disclosure of the issue caused the Company’s stock price to decline. The Court held that plaintiffs failed to plead a material misrepresentation or omission and also failed to adequately allege a strong inference of scienter, and therefore dismissed the amended complaint without prejudice.
According to the amended complaint, in 2016 the Company launched a new antenna-and-satellite-based internet system, known as the “2Ku system”, to deliver faster in-flight internet connectivity. However, according to plaintiffs, the systems were installed in such a manner that de-icing fluid could interfere with it while the plane was de-icing, causing the systems to malfunction. A major airline experienced service issues as a result of this process at the end of 2017 and the Company and its repair teams made attempts to fix the malfunction, but the issue persisted. Plaintiffs claimed that repairs would often be delayed for weeks as airline clients were unable to take their planes out of service for an extended period of time for repairs, which negatively impacted the Company’s average revenue per aircraft (“ARPA”), a key accounting metric that shareholders allegedly relied upon in evaluating the Company’s financial performance. Plaintiffs allege that between 2017 and 2018, the Company failed to “fully disclose that a defect in the 2Ku system or its installation was inhibiting its performance” and that the Company “described any stagnation of ARPA as a short-term problem caused by ‘dilution’” from new installations. According to plaintiffs, defendants misled investors and analysts by marketing the 2Ku systems’ advantages as “15-plus megabits per second speed to connect the passengers [,] 98% coverage of global flight hours[,] and 98% service availability.” Plaintiffs alleged that this description was materially misleading because it suggested that 2Ku’s systems “were already achieving [this] level of performance . . . when in reality the de-icing fluid infiltration problem was negatively affecting the system’s performance and requiring costly repairs” and that its service ability was not at 98% as a result of all the issues. Defendants argued that plaintiffs had not “alleged with particularity that the de-icing fluid problem had yet manifested itself in such a serious way as to permit a factfinder to reasonably conclude” that the statements were misleading at the time they were made.
The Court first considered plaintiffs’ arguments that the issues with 2Ku’s systems “must have been apparent long before” its disclosure in May 2018 and even before its partial disclosure in February 2018. According to plaintiffs, certain individual defendants “publicly touted” the Company’s “ability to track and respond” to outages and, therefore, “the problem must have manifested” by late 2017 based on the major airline’s complaints. The Court rejected plaintiffs’ arguments and found that these examples “do not amount to sufficiently particularized factual allegations to support a reasonable belief that defendants’ statements were false or misleading at the time they were made.” Rather, according to the Court, the examples cited by plaintiffs—(i) that the Company “could and did track service outages,” (ii) that defendants “had access to outage reports” and (iii) that at some time prior to May 4, 2018, during or after the “winter,” the 2Ku systems’ availability “plunged” down to the mid 80s’—failed to “provide sufficiently specific and particularized information about when the data revealed that the de-icing problem had caused a precipitous drop in availability, or when it became clear that costly remediation efforts were necessary.” Accordingly, the Court found that plaintiffs “have not made sufficiently particularized allegations to make plausible, rather than merely possible, that defendants’ statements were misleading when made.”
Although the Court held that plaintiffs failed to adequately allege a material misstatement or omission, it nonetheless proceeded to consider, and reject, the sufficiency of plaintiffs’ scienter allegations. The Court observed that, again, mere allegations of the Company’s ability to track service outages, its management’s access to outage reports, and a drop in service availability failed to satisfy PSLRA’s particularity requirements because they did not “answer the critical question of when defendants had sufficient knowledge to put them on notice that there was at least a substantial risk that [the Company] would have to incur considerable remediation costs to prevent service outages due to de-icing fluid infiltration.” According to the Court, an inference of scienter based on an allegation that defendants were monitoring data because the numbers were so important is “weak at best.” Moreover, according to the Court, separate and apart from the particularity requirement, plaintiffs’ allegations did not support a strong inference of scienter that is “cogent and at least as compelling as any opposing inference of nonfraudulent intent,” as required by the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). The Court found that “[b]ecause plaintiffs have not alleged that, before or during the class period, defendants were presented with any specific information that demonstrated the scope and magnitude of the de-icing problem, the inference that defendants recklessly disregarded a serious problem in omitting to disclose it to investors is not ‘cogent and compelling’ in light of opposing, nonfraudulent inferences,” such as the outages being “caused by other factors apart from the de-icing fluid that were easier to fix,” the defendants not knowing “how expensive and difficult the necessary repairs would be at first,” or the weather being “different from what they expected, preventing the problem from revealing itself right away or worsening it once it did.”
Finding that plaintiffs failed to sufficiently plead either a material misrepresentation or scienter, the Court did not consider plaintiffs’ claims under Section 20(a) because there was no predicate violation of the Exchange Act under which a control-person violation could be established. The Court, therefore, granted defendants’ motion to dismiss and granted plaintiffs leave to amend.