US Supreme Court Agrees to Review Securities Fraud Pleading Standards

The US Supreme Court granted certiorari in NVIDIA Corp. v. E. Ohman J:or Fonder AB on June 17, 2024, agreeing to consider the standards for pleading under the federal securities laws that statements are false and made with scienter, potentially resolving two “circuit splits.” The Court’s forthcoming decision is likely to have a significant impact on the future adjudication of securities fraud claims.

BACKGROUND

The US Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA) to deter “baseless and extortionate securities lawsuits”[1] —i.e., “suits whose nuisance value outweighs their merits,” thereby injuring “the entire U.S. economy.” [2] To achieve this goal, the PSLRA imposes heightened pleading standards on securities fraud complaints; to avoid dismissal, securities fraud complaints must “state with particularity . . . the facts constituting the alleged violation”—including the falsity of the allegedly false statements—and the “acts giving rise to a strong inference that the defendant acted with the required state of mind”—i.e., scienter. [3]

Interpreting the PSLRA in 2007, the Supreme Court held that a “strong inference” of scienter is one that is “cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” [4]

The NVIDIA certiorari petition presents two questions:

1. As to scienter: “Whether plaintiffs seeking to allege scienter under the PSLRA based on allegations about internal company documents must plead with particularity the contents of those documents.” [5]
2. As to falsity: “Whether plaintiffs can satisfy the PSLRA’s falsity requirement by relying on an expert opinion to substitute for particularized allegations of fact.” [6]

THE NVIDIA PLAINTIFFS’ ALLEGATIONS AND DISTRICT COURT DECISION

The plaintiffs in NVIDIA alleged that NVIDIA and several of its officers intentionally misrepresented the extent to which revenues of one of NVIDIA’s products, GeForce graphics processing units (GPUs), were attributable to purchases by video gamers rather than cryptocurrency miners. [7] Plaintiffs attempted to plead the required “strong inference” of scienter by alleging that the defendants had access to what plaintiffs speculated would have been sources of information internal to NVIDIA that reflected relatively high demand for GeForce GPUs from cryptocurrency miners. [8] While plaintiffs alleged some specifics surrounding the documents, including the names of regular internal reports and data sources and how often they were distributed, they did not allege any specific information that any particular internal report or data source contained.

Judge Haywood Gilliam of the US District Court for the Northern District of California dismissed the plaintiffs’ complaint for failure to plead a strong inference of scienter against any of the defendants. Specifically, Judge Gilliam found that, while plaintiffs pled the existence of various internal records, “Plaintiffs do not adequately tie the specific contents of any of these data sources to particular statements so as to plausibly show that the Defendant who made each specified statement knowingly or recklessly spoke falsely.”[9]

THE NINTH CIRCUIT’S DECISION

In a split-panel ruling, the US Court of Appeals for the Ninth Circuit reversed in part the US District Court for the Northern District of California’s dismissal of the suit. [10]

The majority held that plaintiffs had sufficiently pled scienter as to the CEO by citing statements from two confidential former employees to support the allegation that the CEO had access to detailed sales data and frequently reviewed sales reports. [11] The majority found that “[the CEO]’s detail-oriented management style would have led him to become aware of the source of more than one billion dollars in company revenue during a fifteen or eighteen-month period.”[12]

In addition, reaching an issue the District Court had not, the majority concluded that the plaintiffs had pled with particularity that defendants’ statements concerning GeForce GPU revenue derived from cryptocurrency miners were false in light of the company’s actual revenue attributable to cryptocurrency miners. To support their falsity allegations, plaintiffs relied on the work of an expert consulting firm they had retained to analyze NVIDIA’s alleged GeForce GPU revenue derived from cryptocurrency miners.[13] The majority held that the expert’s analysis could be considered because it was reliable and supported by other allegations, including public analyses, witness statements, and corroborating market events.[14]

JUDGE SANCHEZ’S DISSENT

Judge Gabriel Sanchez disagreed with the majority, observing that the complaint’s central falsity allegation was based entirely on a post hoc analysis by the plaintiffs’ outside expert that relied on generic market research and unreliable or undisclosed assumptions.[15] Further, like the District Court decision, Judge Sanchez noted that the complaint did not identify the content of any internal report or data source that would have put executives on notice that their statements were false or misleading when made, finding that the allegations did not raise a strong inference of scienter.[16]

NVIDIA ASKS THE SUPREME COURT TO RESOLVE TWO ‘CIRCUIT SPLITS’

First, NVIDIA’s certiorari petition argues that the Ninth Circuit’s opinion deepens a split between several circuits “on the requirements for pleading scienter under the PSLRA based on internal company documents.”[17]

On the one hand, the US Courts of Appeals for the Second, Third, Fifth, Seventh, and Tenth Circuits have required plaintiffs attempting to plead scienter based on internal company documents to plead with particularity the actual contents of those documents. [18] As those courts have held, simply alleging that a defendant had access to internal reports that would have contained information on the same subject of defendants statements is insufficient to plead a strong inference of scienter.[19] Without allegations regarding the contents of internal reports, those courts have held that a complaint does not support a strong inference of scienter that defendants were privy to information contrary to their public statements.[20]

On the other hand, NVIDIA argues that the First Circuit,[21] and now the Ninth Circuit, have held that plaintiffs may defeat motions to dismiss based on allegations that internal company reports existed, combined with speculative allegations about what those reports might have said.

Second, NVIDIA’s certiorari petition argues that “the Ninth Circuit’s decision created a second circuit split with respect to whether a plaintiff can plead falsity based on allegations about the after-the-fact opinion of an expert.”[22]

Both the Second Circuit and the Fifth Circuit have held that a plaintiff’s expert’s opinion could not substitute for particularized factual allegations of falsity, holding that “[a]though it is permissible for a plaintiff to bolster a complaint by including a nonconclusory opinion to which an expert may potentially testify,” such “‘opinions cannot substitute for facts under the PSLRA.’” [23] NVIDIA argues that the Ninth Circuit’s reliance on plaintiffs’ expert analysis concerning the source of GeForce GPU revenue diverges from those other Circuits’ holdings in this regard.

As noted, on June 17, 2024, the US Supreme Court granted NVIDIA’s certiorari petition.

CONCLUSION

Because securities fraud plaintiffs almost invariably allege that internal reports available to defendants contained information contrary to their public statements, the Supreme Court’s forthcoming decision on NVIDIA’s first question presented will be watched closely by both the plaintiff and defense bars. As NVIDIA correctly notes, the issue “affects nearly every securities fraud case across the country.” [24]

The second question arises less frequently, but a decision by the Supreme Court giving credence to the use of expert analyses in support of securities fraud complaints could spur more plaintiffs to rely on that tactic.