PSLRA Class Action Defense Cases–In re Authentidate Holding: New York Federal Court Grants Motion To Dismiss Securities Class Action Holding Class Action Allegations Failed To Satisfy PSLRA

Apr 9, 2009 | By: Michael J. Hassen

Securities Class Action Warranted Dismissal with Prejudice because Allegations in Second Amended Class Action Complaint Failed to Establish Duty to Disclose New York Federal Court Holds

Plaintiffs filed a class action against Authentidate Holding Corporation and individual defendants (collectively “Authentidate”) alleging violations of federal securities laws; the class action complaint asserted that defendants “failed to make proper disclosures regarding performance metrics in an agreement (‘the Agreement’) the Company had with the United States Postal Service to serve as the preferred provider of the Postal Service’s electronic postmark (‘EPM’), thereby artificially inflating the price of Authentidate common stock in order to, inter alia, attract capital and avoid insolvency.” In re Authentidate Holding Corp. Sec. Litig., ___ F.Supp.2d ___ (S.D.N.Y. March 23, 2009) [Slip Opn., at 1]. The class action alleged that defendants’ misconduct violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5, id. Defense attorneys moved to dismiss the Consolidated Second Amended Securities Class Action Complaint for failure to meet the heightened pleading requirements established by the Private Securities Litigation Reform Act (PSLRA). Id. The district court determined that allegations in the class action complaint failed to satisfy the PSLRA and dismissed the class action with prejudice.

After summarizing the well established law governing Rule 12(b)(6) motions to dismiss securities class action complaints, see In re Authentidate, at 2-3, including Bell Atlantic Corp. v. Twombly, 127 S.Ct. 1955 (2007), the district court turned first to the duty to disclose and noted that for purposes of Section 10(b) “‘[s]ilence, absent a duty to disclose, is not misleading,’ Basic Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988), and an omission is actionable under the securities laws only when the Defendant was subject to a duty to disclose.” Id., at 3 (additional citation omitted). The class action complaint alleged that defendants were under a duty to disclose Authentidate’s “low level of EPM sales and their continuing or likely failure to meet the revenue metrics.” Id. The federal court disagreed. First, it rejected the claim that Item 303 of SEC Regulation S-K (17 C.F.R. § 229.303) created a duty to disclose. See id., at 4-5. Item 303, entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” requires, inter alia, that a registrant “describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 C.F.R. § 229.303(a)(3)(ii). Id., at 4. Plaintiffs’ allegations that “virtually nonexistent EPM sales and the likely failure to meet upcoming revenue metrics were ‘known trends or uncertainties’” were not supported by “any particularized factual allegations making it plausible that these omissions caused any piece of existing ‘reported financial information’ to misleadingly indicate a specific future result or financial condition.” Id., at 5. This was particularly true since EPM sales were not “a significant percentage of the reported monthly revenues.” Id. (citation omitted).

Second, the district court rejected plaintiffs’ claim that Authentidate’s February 2004 Offering that raised $74 million created a duty to disclose “lackluster EPM sales.” See In re Authentidate, at 6. In brief, the federal court concluded that statements concerning the how many EPMs Authentidate might sell in the future “would have been speculative at best,” and the class action contained “no particularized allegations beyond the mere existence of minimal EPM sales” suggesting that slow EPM sales were likely to continue. Id. Additionally, any omission was not material because “even if the level of EPM sales had been disclosed, the public would not have known if the metric had been met or not since the revenue metrics were kept secret.” Id. Thus, the allegations in the class action complaint failed to “plausibly demonstrate the existence of a duty to disclose in connection with the February 2004 offering.” Id., at 7. Third, the federal court rejected plaintiffs’ claim that defendants were obligated to make “prior statements not misleading.” See In re Authentidate, at 7. Plaintiffs argued that defendants were under a duty to update prior statements, but they failed to cite any specific statements made by defendants that “were rendered materially misleading as a result of the omissions.” Id. The district court concluded that this claim, too, failed, see id., at 8-9. Accordingly, the court found that the class action complaint failed to adequately allege a duty to disclose, and granted defendants’ motion to dismiss the class action claims premised on such a theory. Id., at 9.

Finally, the court rejected plaintiffs’ claim that defendants are liable because stock market analysts recommended Authentidate’s stock as a “strong buy.” In re Authentidate, at 10. The claim was speculative, and “nothing in the analyst’s statement explicitly premises its buy recommendation on an estimate by any Defendant that EPM revenues would be high; rather, the recommendation is premised on the nature of the technology and is expressly conditioned on an assumed, rather than a predicted, ‘modest adoption rate.’” Id. Thus, the class action’s Section 10(b) claims failed as a matter of law. And because the Section 10(b) claims had been dismissed, the class action’s Section 20(a) control person claims also had to be dismissed. Id., at 11. Further, leave to amend was not warranted because plaintiffs “have already filed two prior complaints in this action,” id. Accordingly, the district court instructed the clerk to dismiss the class action with prejudice and enter judgment in favor of the defendants, id., at 11-12.

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