The Supreme Court DIGs securities cases, leaving important questions unanswered

The Supreme Court DIGs securities cases, leaving important questions unanswered

January 06, 2025 – This term, the Supreme Court was poised to decide a securities case involving Facebook and another involving NVIDIA. Both cases raised recurring and important issues that arise in securities class action litigation. Following oral argument, the Court issued so-called “DIG” orders — orders indicating that the Court dismissed the cases as “improvidently granted,” referring to the decisions to grant review of the cases.

The Supreme Court issues DIG orders after granting certiorari when, for example, justices realize the case before it is not the best vehicle to rule on an issue, where parties’ merits arguments diverge from those that they urged when seeking Supreme Court review, or where a majority of justices cannot reach a consensus.

In the wake of these two DIG orders, questions regarding when allegedly false risk factor disclosures are actionable and whether and under what circumstances plaintiffs can rely on expert reports to satisfy the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA) will remain open. This article discusses the cases left undecided and the potential implications of the Supreme Court’s silence on these issues.

Plaintiffs’ lawyers increasingly target the risk factor disclosures in annual reports when bringing securities fraud claims. Because companies’ risk disclosures must address all material factors that could make an investment in the company risky, there is almost always an on-point risk factor that relates to the subject matter of some subsequent, adverse event disclosed by the company. When that adverse event happens, Plaintiffs will claim in hindsight that the company knew of that event when the risk factor was published but failed to disclose it.

Plaintiffs relied on a variation of that playbook in Facebook, Inc. v. Amalgamated Bank, Case No. 23-98. In Facebook, the Supreme Court was asked to decide whether risk disclosures are false or misleading when they do not disclose that a risk has materialized in the past, even if that past event presents no currently known risk of ongoing or future business harm. Following argument, the Supreme Court issued its DIG order, which let the 9th U.S. Circuit Court of Appeals’ ruling in Facebook stand.

The Supreme Court’s decision not to rule in the Facebook case will allow a circuit-split to persist. In the case that had been under review, the 9th Circuit reversed dismissal of a securities fraud claim against Facebook. The plaintiffs in that case alleged that Facebook’s risk disclosures in its annual report (mandated by Item 105 of Regulation S-K) were materially misleading for failing to disclose that its data had been improperly harvested by Cambridge Analytica in connection with political campaigns in 2016.

In a split decision, the 9th Circuit reversed in relevant part. The majority opinion criticized Facebook for representing the risk of improper access to or disclosure of Facebook data

A reasonable investor, the majority opinion concluded,

As purely hypothetical when that exact risk had already transpired.

“would have understood the risk of a third party accessing and utilizing Facebook user data improperly to be merely conjectural.”

The majority opinion reasoned that it was irrelevant that Facebook

By Cambridge Analytica,

Did not yet know the extent of the reputational harm it would suffer as a result of the breach

In conflict with the 9th Circuit’s materialized risk standard, the 1st, 2nd, and 10th Circuits have adopted a “virtual certainty test.” Under that test, risk disclosures only imply that the company is unaware of any previous occurrence of a triggering event if that event is almost certain to cause the warned-of harm to the company’s business. That rule makes it harder (but not impossible) for plaintiffs to bring viable claims based on allegedly misleading risk factor disclosures.

In light of the Supreme Court’s decision not to rule in Facebook, it is likely that courts around the country will continue to take distinctly different approaches when ruling on risk factor claims. In the absence of a clear, uniform rule, public companies will need to proceed with caution in the face of a circuit split relating to the circumstances that will trigger securities fraud liability for statements and alleged omissions in risk factor disclosures. Companies will need to decide whether more or less risk disclosure creates a greater risk of being sued down the road.

The NVIDIA case and the use of expert reports at the pleading stage

In NVIDIA Corp. v. E. Ohman J:or Fonder AB, Case No. 23-970, the Supreme Court was asked to decide two related issues: 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; and whether plaintiffs can satisfy the PSLRA’s falsity requirement by relying on an expert opinion to substitute for particularized allegations of fact. The expert question became the focus of the case at the Supreme Court.

Like the Facebook case, the Supreme Court issued its DIG order shortly after oral argument when justices expressed skepticism towards NVIDIA’s arguments and even questioned why the Court agreed to review the case when it sounded like NVIDIA was merely seeking “error correction,” rather than a categorical rule regarding expert reports.

The NVIDIA case arose from a recurring pattern in securities litigation: the announcement of disappointing revenue results and downward guidance revisions following a sustained period of success. The plaintiffs alleged that NVIDIA fraudulently understated the extent to which its revenues for its graphics processing units (GPUs) depended on sales for crypto mining, rather than for gaming. When cryptocurrency prices fell in 2018, demand for GPUs declined, and NVIDIA’s stock price also declined. In the wake of the stock price decline, the plaintiffs filed a putative securities class action.

In support of their securities fraud claim, plaintiffs alleged that contemporaneous internal NVIDIA reports regarding GPU sales contradicted public statements about them. Plaintiffs did not, however, allege the contents of any internal NVIDIA report. Instead, Plaintiffs sought to bolster their fraud claims by retaining an expert firm, the Prysm Group, which purported to estimate the amount by which NVIDIA’s quarterly gaming revenues were driven by cryptocurrency miners, rather than gamers.

Using generic market research, Prysm estimated the overall amount of computing power needed during the relevant time period to mine cryptocurrencies, estimated how many GPUs that would require, estimated NVIDIA’s market share, and then multiplied the number of units implied by that market share times an estimated revenue per unit. Plaintiffs alleged that the amount by which the estimated revenue exceeded the amount NVIDIA reported in its OEM segment for sales of its crypto-specific GPU product was the amount by which NVIDIA fraudulently understated its exposure to cryptocurrency mining demand.

After the district court dismissed the securities fraud claim, a divided panel of the 9th Circuit reversed in relevant part. The panel majority held that falsity was sufficiently alleged based on the revenue estimates generated by Prysm. As for the element of scienter, the panel majority held that there was a strong inference of scienter because internal NVIDIA documents “would have” reflected Prysm’s post hoc calculations and that NVIDIA’s CEO “would have” known about those internal documents given allegations about his “detail oriented” and “meticulous” oversight of company operations.

The panel majority credited the Prysm report’s conclusion that NVIDIA underreported its crypto revenues by $1.126 billion, observing that a

CEO who does not know the source of $1.126 billion is unlikely to exist.

In the wake of the Supreme Court’s decision not to rule in NVIDIA, the 9th Circuit’s decision will stand. Some have argued that the 9th Circuit’s purportedly permissive standard will give plaintiffs a roadmap to evade the PSLRA’s heightened pleading requirements. That may lead to forum shopping by plaintiffs lawyers who may try to avoid filing their securities cases in circuits that do not credit expert reports at the pleading stage.

That is the state of play in the Second Circuit, which has ruled that expert opinions “cannot substitute for facts under the PSLRA” unless the opinion “was based on particularized facts sufficient to state a claim for fraud.” Arkansas Pub. Emps. Ret. Sys. v. Bristol-Myers Squib Co., 28 F. 4th 343, 354 (2d Cir. 2022).

The 5th Circuit has similarly held that “opinions cannot substitute for facts under the PSLRA.” Fin. Acquisition Partners LP v. Blackwell, 440 F.3d 278, 285-86 (5th Cir. 2006). Courts have also referenced evidentiary complications relating to the admission of expert reports in connection with a pleading stage analysis to support their rejection of expert report allegations.

Plaintiffs may seize upon the Supreme Court’s decision not to decide NVIDIA as an invitation to use expert reports more frequently and more aggressively. If that happens, expert reports may become a focal point of motions to dismiss, leading to extensive litigation over such things as the purported expertise of offered experts, the reliability of the opinions reached, the reasonableness of assumptions used by experts, the failure of plaintiffs to disclose the assumptions used by experts, the level of details plaintiffs must allege about an expert’s opinions and methodologies, and whether and when an expert’s opinions will be treated as facts sufficient to meet the PSLRA’s requirement that plaintiffs expert report’s conclusions will be construed as “facts” that satisfy the PSLRA’s heightened requirements for pleading falsity and a “strong inference” of scienter.

Without a uniform rule, it is likely that there will be litigation for years to come over these recurring and important questions. Perhaps then a suitable case will be ripe for the Supreme Court to provide much-needed guidance to lower courts and litigants.

Virginia Milstead is a regular contributing columnist on securities law and litigation for Reuters Legal News and Westlaw Today.

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