Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—S.D.N.Y.: Fraud action dismissed for failure to plead false or misleading statements, (Feb 6, 2019)

By Amy Leisinger, J.D.

Complaint failed to show that a tech company’s comments amounted to more than forward-looking statements, puffery, or opinion.

The Southern District of New York has dismissed a fraud complaint against a cloud computing company and its CEO and CFO for failure to discuss or to make statements taking into account a large customer’s change in use of the company’s technology services. According to the court, the statements made by the company alleged to be false or misleading constituted protected forward-looking statements or puffery, and the plaintiffs failed to show that any statements of opinion were unreasonable or based on false supporting facts. The plaintiffs also failed to adequately allege materiality concerning the changes in the business relationship sufficient to show potential violations of Regulation S-K in SEC filings (City of Warwick Municipal Employees Pension Fund v. Rackspace Hosting, Inc., February 5, 2019, Keenan, J.).

Alleged fraud. Rackspace Hosting, Inc., which offers Internet-based computing, data storage, and related services, entered into a contract with telecommunications company Vodafone (one of its largest customers) in its efforts to launch a mobile phone payment application in Africa. Over time, the application began to experience delays and interruptions because Rackspace was hosting its data in Germany, meaning that transactions had to be relayed between countries. Thereafter, Vodafone begin to migrate the application’s infrastructure from Rackspace’s servers to hosts in Africa. Rackspace later issued a press release announcing its second-quarter results and lowering its full-year 2015 revenue guidance, and its share price fell.

The plaintiffs filed a complaint alleging that, four and a half months before the Vodafone contract expired, the defendants knew that the contract would not be renewed and that the loss of the contract would have a substantial impact on Rackspace’s revenue and growth. The plaintiffs alleged that the defendants intentionally concealed the Vodafone event and its detrimental effects from Rackspace investors and issued false or misleading reassurances and guidance as a result of the failure to disclose.

Forward-looking statements. The court noted that a statement is "forward looking" when it involves a financial projection or is a statement of future economic performance and that forward-looking statements that are accompanied by meaningful cautionary language, or that are immaterial, or that the plaintiff fails to prove were made with actual knowledge of falsity are protected. Rackspace’s statements regarding revenue and growth expectations are projections of future economic performance, the court found. In addition, the court stated, other statements relied on in the complaint are inactionable because the plaintiffs did not adequately plead that the defendants made them with actual knowledge that they were false or misleading. The allegations are not sufficient to support the conclusion that the defendants knew Rackspace’s guidance was necessarily unachievable absent the Vodafone contract, according to the court.

Puffery. The court also agreed with the defendants that several of the statements relied on in the complaint constituted inactionable puffery. The court noted that positive statements may be actionable if they contradict known facts or are worded as guarantees or if the speaker did not genuinely or reasonably believe them but that "statements expressing a general view that ‘things are going well,’ that the company is ‘well positioned,’ or that a year was ‘successful’ are generally not actionable." Rackspace’s CFO’s statements about "good progress" are of the positive type generally found to constitute puffery, the court explained. In addition, the court found, none of the statements necessarily contradict the CFO’s alleged knowledge of the effects of the end of Vodafone contract or are worded as guarantees, and the plaintiffs failed to adequately allege that the officer did not reasonably believe the statements when he made them.

Opinion statements. Statements that Rackspace had limited experience operating in foreign jurisdictions and expected to continue to grow its international operations are inactionable opinions because they express expectations about the future and include the language of opinion, the court found. The plaintiffs made no allegations that the Vodafone event would preclude the possibility that Rackspace’s international operations could grow or that the defendants believed they would not, according to the court. The end of the Vodafone contract does not make the statements misleading as it is not necessarily dispositive on the issue, the court stated.

The court also found that the other statements cited by the plaintiffs were not pleaded with sufficient particularity and that the complaint failed to adequately allege that it was "reasonably likely" that the Vodafone event would have had a "material" effect on Rackspace so as to establish a violation of Regulation S-K in SEC filings. As such, the court dismissed the complaint and the related Section 20(a) control-person claim against the defendants. The plaintiffs may amend the complaint and cure the deficiencies within 30 days.

The case is No. 17 Civ. 3501 (JFK).

Attorneys: Francis Paul McConville (Labaton Sucharow LLP) for City of Warwick Municipal Employees Pension Fund. Jonathan Gardner (Labaton Sucharow LLP) and James M. Hughes (Motley Rice, LLC) for KBC Asset Management NV. Stephen Mark Dollar (Norton Rose Fulbright LLP) for Rackspace Hosting, Inc., William Taylor Rhodes and Karl Pichler.

Companies: Rackspace Hosting, Inc.

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