Background. Public companies routinely disclose information about threatened or ongoing litigation in investor materials and Securities and Exchange Commission filings. Those disclosures often include the status of lawsuits as well as boilerplate statements that the company disputes the allegations. But a new decision in the United States district court for the district of Massachusetts is a stark reminder that companies should issue these statements with caution and attention to accuracy.
The case, City of Fort Lauderdale Police & Firefighters’ Retirement System v. Pegasystems Inc., No. 22-11220-WGY (D. Mass. July 24, 2023), stems from a different lawsuit in Virginia state court, in which a jury found Pegasystems Inc. (Pega) liable for willfully and maliciously misappropriating trade secrets from another company, Appian Corp. Pega was ordered to pay more than $2 billion in damages.
The Virginia case concerned a yearslong effort by Pega and its executives to misappropriate trade secrets from its competitor, Appian, and to use those secrets to improve its own products. That effort allegedly included a meeting with a Pega’s CEO Alan Trefler (later named as a defendant in the securities case), during which the CEO was shown “how to use Appian’s platform” and was given answers to “detailed technical questions about Appian’s software.” The CEO allegedly directed an effort to spy on Appian, including having Pega employees pose as Appian customers to gather information. Pega allegedly knew these activities were illicit – another executive referred to Pega’s use of “spies” and asked employees to keep the activities “STRICTLY INTERNAL.” Pega also allegedly paid cash bonuses to employees who participated in the conspiracy.
The securities lawsuit. Following the verdict in the Virginia case, Pega’s share price dropped about 28 percent. As is common following event-based stock drops, certain investors sued Pega for violations of section 10(b) of the Securities Exchange Act of 1934. The suit, a putative class action, alleged that Pega falsely characterized the Virginia lawsuit as “without merit” and falsely promised never to misappropriate trade secrets.
The alleged false statements appeared in Pega’s 2021 10-K form filed with the SEC and signed by Pega’s CEO. The disclosure identified the Virginia lawsuit, which at the time included a pending claim for $3 billion. In it, Pega stated that Appian’s claims “are without merit,” that Pega had “strong defenses to these claims,” and “that any alleged damages by Appian are not supported by the necessary legal standard.” Pega also disclosed its Code of Conduct, which stated that Pega would “[n]ever use illegal or questionable means to acquire a competitor’s trade secrets or other confidential information.”
Pega moved to dismiss the lead plaintiff’s claims for failure to sufficiently plead (1) that Pega’s alleged statements were false or misleading; (2) a strong inference of scienter – that is, that Pega knew the statements were false (or that Pega was reckless in not knowing); and (3) that the challenged statements caused the drop in Pega’s stock price.
District Court Judge William G. Young denied Pega’s motion to dismiss the plaintiff’s claims against the company and its CEO. On the question of whether Pega’s challenged statements were false or misleading, the court found the company’s representation that the Virginia lawsuit was “without merit” to be misleading because a reasonable investor would expect that even a statement of opinion would fairly align with information in the company’s possession – and it was clear that the company knew that the lawsuit had at least some merit. The court emphasized that the statements were not couched in terms of mere legal defenses; the disclosures set apart the “without merit” statement as a stand-alone declaration. Pega’s Code of Conduct was similarly misleading because it “describes with specificity a course of conduct that Pega promised to abjure.”
At the same time, the court stressed that its holding does not mean that companies must “confess to the wrongdoing” in public filings. Pega could have validly stated, for instance, that it opposed the Virginia lawsuit or that it had substantial defenses against it, assuming it reasonably believed those statements to be true.
Turning to the defendants’ state of mind, the court found that Pega and its CEO had acted with the required scienter under the Private Securities Litigation Reform Act because its CEO knew (or was reckless in not knowing) that stating that the Virginia suit had no merit would be substantially likely to mislead a reasonable investor. Pega’s CEO’s close involvement with wrongdoing – he directed the conspiracy, attended meetings reporting on that effort, and was included on emails suggesting the company was engaging in wrongdoing – meant that “there is little doubt” that he knew or was reckless in not knowing that the company’s statements were misleading. The CEO’s knowledge was also imputed to Pega as a company.
The court did grant, without prejudice, the motion to dismiss as it related to Pega’s chief financial officer’s scienter, because the plaintiff’s allegations as to the CFO relied on mere speculation that he would have learned about the wrongdoing given his position at Pega. The order paves the way for the remaining claims against Pega and its CEO to proceed to class certification, discovery, and trial (assuming no settlement is reached).
Key takeaways:
- This case is a reminder that companies should take care that all public statements about pending or threatened litigation are accurate and not misleading – even when the company vigorously disputes the asserted claims.
- In disclosures about litigation, companies should avoid categorical statements or denials of wrongdoing. Instead, companies should take a just-the-facts approach, focusing on verifiable events in the litigation (for instance, “we have moved to dismiss the complaint”) or on reasonable statements of legal defenses (“we believe we have substantial defenses to the allegations”).
- In publicly disclosed codes of conduct, companies should focus on best practices and efforts, rather than stating categorically that the company “never” engages in a particular course of conduct, as Pega did in its Code of Conduct.
Client Alert 2023-183
