By Rodney F. Tonkovic, J.D.
A Fourth Circuit panel gave a complaint against an educational services company an "F" for failing to adequately plead scienter. The plaintiff shareholders claimed that in an effort to boost share prices, the company's CEO misrepresented the business opportunity presented by COVID-related school closures and the status of a deal with a school district. The panel found that the bulk of the alleged false statements were not material and that the statements concerning the school district failed to show scienter. The district court's dismissal of the plaintiff's claims was accordingly affirmed (Boykin v. K12, Inc., November 22, 2022, Wilkinson, J.).
K12, Inc., now known as "Stride, Inc.," is a Virginia-based company providing various support services to schools. While K12 grossed over $1 billion in revenue during the fiscal year ending in June 2020, the plaintiff shareholders assert that K12 and its CEO and CFO made a number of false statements in a fraudulent effort to boost the company's share price. But, the share price declined in late 2020 after it became known that school districts were ending their partnership with K12.
COVID opportunity. The complaint pointed to 23 statements made by the defendants. Eleven statements occurred surrounding an April 2020 quarterly earnings release. At the time, K12's CEO observed that school closures in response to COVID-19 would be a major business opportunity for K12 because its "core competency" is in online learning. K12's share price climbed over the following months, reaching an all-time high in August.
Another 12 allegedly misleading statements were made on or around an August 2020 earnings release. At that time, the CEO, for example, affirmed that K12 was meeting the needs of its school customers and students. Moreover, the CEO said that Miami-Dade County Public Schools, the fourth largest school district in the nation, would be purchasing K12's content and curriculum. Later that month, however, news reports indicated that the relationship between K12 and Miami-Dade was faltering, and that no contract had been signed. In September, Miami-Dade terminated the partnership, and K12's stock dropped further shortly thereafter on news that another school district was ending its partnership.
Scienter not pleaded. In the fall of 2020, shareholders brought suits alleging fraud under the Exchange Act. The district court, however, concluded that the plaintiffs failed to plead falsity and scienter, and granted K12's motion to dismiss.
The panel first concluded that the bulk of the alleged misstatements were not actionable. First, a number of statements concerning K12's competencies were nonactionable puffery. Several other statements amounted to opinions and either reflected the beliefs of the speaker or were made in an SEC filing, where investors had ample disclosures to provide context. More statements were protected as forward-looking under the PSLRA safe harbor as projections of future economic performance.
The remaining statements centered around K12's relationship with Miami-Dade. The court acknowledged that the proposed $15.35 million partnership could have factored into the run-up of K12 shares but added that materiality is just one component of a fraud claim. Specifically, the plaintiffs argued that K12's CEO misled investors into believing that there was a contract with Miami-Dade when there was not. The panel pointed out that while the CEO's statement was imprecise, there were no allegations that he unambiguously said there was a signed agreement. At the time, a contract was well on its way after a long series of negotiations, and it was over three weeks since the CEO's last statement that Miami-Dade called off its deal.
Ultimately, the plaintiffs failed to plead an inference of scienter that was cogent and at least as compelling as any opposing inference of nonfraudulent intent. The court said that there was no statement of clear falsity and that the CEO's statements were consistent with his anticipation of a consummated deal—even if the CEO knew Miami-Dade had misgivings, he may have believed they would be smoothed over. All the plaintiffs could point to was a wish to "boost" K12's share price, but this was a generalized motive shared by all companies. The most the plaintiffs could demonstrate, the court said, was that the CEO spoke in a loose way. The more cogent inference was that K12 believed that it would profit from pandemic-related disruptions and that it would secure the Miami-Dade deal.
The case is No. 21-2351.