Monday, March 29, 2021

Cybersecurity company executives did not mislead in rosy statements

By Lene Powell, J.D.

The Northern District of California dismissed an investor class action suit alleging that a cybersecurity company made misleading statements and failed to disclose damaging adverse facts in order to conceal financial struggles. The court found that most statements were puffery or forward-looking statements protected by the PSLRA safe harbor, and evidence from confidential witnesses was not detailed enough to show that other statements were made with actual knowledge of falsity (Sayce v. Forescout Technologies, Inc., March 25, 2021, Illston, S.).

Optimistic opinions or fraud? Forescout Technologies, Inc. provides cybersecurity services and technology to businesses and government agencies. The plaintiffs alleged that the company and several senior executives undertook a variety of tactics to project a misleading positive image of the company’s financial condition, including engaging in a channel stuffing scheme by artificially closing deals, falsely blaming the COVID-19 pandemic for missed revenue projections, and falsely downplaying workforce issues. The court appointed co-lead plaintiffs and class counsel in November 2020.

No actionable misstatements. The court concluded that although the company’s stock price dropped after the company disclosed a failure to meet revenue projections, the plaintiffs did not establish any actionable misrepresentations. Many statements were forward-looking, including statements about Forescout’s sales productivity, pipeline, and deals. Some statements contained concrete factual assertions about Forescout’s operations and reasons why the company would meet revenue projections. For example, one speaker said, "[W]e feel like we are tracking very well against our sales productivity, the investment levels that we have been making. [follow] that path to profitability and investing at levels below where our top line is growing." However, the plaintiffs failed to show that the statements were made with actual knowledge of falsity, so the statements were protected by the PSLRA’s safe harbor provision, the court found.

Knowledge of falsity was also not shown for some current statements. For example, Forescout’s CEO claimed that the sales force was "maturing and ramping nicely trending in the right direction," and that the company was "hiring like crazy" and had "increased visibility" into the sales pipeline. Evidence from confidential witnesses, all former employees, demonstrated that in fact Forescout’s sales department struggled to meet sales quotas, a significant number of sales representatives left, and the company imposed a hiring freeze. However, the witnesses did not allege that the CEO had knowledge of any employee departures or the hiring freeze, so knowledge of falsity was not established. Further, the statement about the sales force "maturing and ramping nicely" was inactionable puffery, too vague for investors to rely upon.

Similarly, the evidence from witnesses was too vague to establish that deals were artificially listed as "closed" or "committed," or how the inclusion of these deals would render financial forecasts false. The plaintiffs also failed to show that Forescout’s declines in earnings or financial performance were not caused by the COVID-19 pandemic, as the company claimed.

Scienter. The plaintiffs also failed to show scienter. Evidence from the 15 confidential witnesses lacked detail to establish either the reliability of their statements or that the statements were indicative of scienter. None of the CWs reported to individual defendants about their experiences with sales and hiring,or personally heard individual defendants speak about sales productivity, the pipeline, or Forescout’s deals.

Motive was also not shown. All of the defendants’ stock sales during the class period were made pursuant to Rule 10b5-1 trading plans, and the plaintiffs did not show that the stock sales were dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information. Further, generic financial motives arising from a potential acquisition were insufficient to establish a strong inference of scienter, and not enough detail was given about statements that the acquisition was going forward when in fact it was being terminated.

The complaint was dismissed with leave to amend.

This is case No. 20-cv-00076-SI.