Securities Regulation Daily Mix-up over mixed statements leads to reversal and remand
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Monday, July 31, 2017

Mix-up over mixed statements leads to reversal and remand

By Rodney F. Tonkovic, J.D.

The dismissal of a securities fraud action has been reversed by a Ninth Circuit panel. The complaint alleged that a software company had real-time sales information that contradicted its public statements denying any decline. The district court dismissed the case, concluding that the challenged statements were either protected forward-looking statements or non-actionable puffery. The appellate court disagreed, however, finding that some of the statements were "mixed" and contained non-forward-looking statements that were materially false or misleading (In re Quality Systems, Inc. Securities Litigation, July 28, 2017, Fletcher, W.).

Pipeline. Quality Systems, Inc. develops and markets software used by medical and dental care providers. During the period at issue, QSI’s growth depended largely on the sales and maintenance of new software systems and associated services to healthcare providers who were adopting electronic systems for the first time. During this time, QSI kept continuous track of its sales "pipeline," which categorized sales by the time-period in which the deal was expected to close.

Wipeout. According to the complaint, the individual defendants, most notably QSI’s CEO, knew, as it was happening, that the market for healthcare software systems was becoming saturated and that sales opportunities to first-time users were decreasing. The investors asserted that QSI misrepresented the state of its current and past sales pipeline to support projections of revenue and earnings growth that lacked any objective basis. The CEO, for example, made a number of statements asserting that the market for new systems was still good and was not "drying up" or "slowing down." In July 2012, QSI issued a press release stating that its business was in steep decline, causing a sharp decline in stock prices.

The district court found that most of the allegedly false or misleading statements were protected forward-looking statements. In reaching this conclusion, the court took judicial notice of PowerPoint slides containing cautionary language that were displayed at health care conferences. The court also found that any statements that were not forward-looking were non-actionable puffery.

First look at mixed statements. The Ninth Circuit panel reversed the district court’s decision and remanded for further proceedings. According to the panel, some of the statements at issue were "mixed statements" that contained both forward-looking statements of projected revenue and earnings and non-forward-looking statements. This issue had not yet been addressed in the Ninth Circuit, but the panel agreed with the First, Second, Third, Fifth, and Seventh Circuits, which have all concluded that non-forward-looking statements are not protected under the PSLRA safe harbor where defendants make mixed statements containing non-forward-looking statements as well as forward-looking statements.

Next, the panel concluded that many of the non-forward-looking statements were materially false and misleading. There were eight separate occasions, the panel said, in which QSI officers made materially false or misleading statements about QSI’s sales pipeline, noting, for example that the pipeline was growing and was expected to continue to do so. The panel found further that these statements were not mere puffery because they went beyond "feel good" optimism and gave concrete descriptions of the past and present states of the pipeline that created an impression of a state of affairs materially different from what actually existed. Additionally, the complaint adequately pleaded scienter by establishing that QSI’s executives had access to, and used, real-time information about the decline in sales during the relevant period.

Finally, the panel found that some of the forward-looking statements were not accompanied by appropriate cautionary language and were made with actual knowledge of their falsity. Here, the individual defendants made mixed statements telling investors that they could rely on predictions of growth because the state of the sales pipeline was consistent with, or better than, its state in previous quarters. Short of an outright admission of falsehood, any cautionary language accompanying the forward-looking part of a mixed statement was not sufficient to correct these misrepresentations, the panel said. It necessarily followed, the panel continued, that the executives had actual knowledge that their forward-looking statements that were unaccompanied by non-forward-looking statements were also false or misleading.

The case is No. 15-55173.

Attorneys: Joseph David Daley (Robbins Geller Rudman & Dowd LLP) for City of Miami Fire Fighters' and Police Officers' Retirement Trust. Andrew Richard Gray (Latham & Watkins) for Quality Systems, Inc.

Companies: City of Miami Fire Fighters' and Police Officers' Retirement Trust; Quality Systems, Inc.

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