Securities Regulation Daily Most alleged Apple disclosures found clean, not rotten
Wednesday, June 3, 2020

Most alleged Apple disclosures found clean, not rotten

By Jay Fishman, J.D.

Plaintiff investor does not win on most fraud claim theories against Apple but enough to avoid total complaint dismissal with permission to file an amendment.

California’s Northern District Court found most fraud claims against Apple Inc., its CEO and senior vice president to be in-actionable but granted the class action plaintiffs leave to amend upon determining that two defendant disclosures and one scienter theory met the Federal Civil Procedure Rule 9(b) and Private Securities Litigation Reform Act (PSLRA) standard to be actionable as fraud under Exchange Act, Section 10(b)/Rule 10b-5 (In Re Apple Inc., Securities Litigation, June 2, 2020, Rogers, Y.).

Pension fund seeks class action certification. The plaintiff, a California pension fund, filed a jury demand seeking class action certification, compensatory damages, cost and expenses, and other equitable relief against the defendants collectively under Section 10(b)/Rule 10b-5 and against the CEO and senior vice president, individually, as "control persons" under Exchange Act, Section 20(a). The plaintiff alleged that between August 2, 2017, and January 2, 2019, the defendants made false and misleading statements in connection with consumer demand for iPhones, particularly in Greater China (Hong Kong, Taiwan and Mainland China), which led to a $74 billion one-day slide in Apple’s market value once the CEO and senior vice president revealed declining sales in that region after first touting positive growth (City of Roseville Employees Retirement System v. Apple Inc., April 16, 2019).

The court reviews the disputed fraud elements. The district court examined the three Rule 10b-5 fraud elements in dispute: (1) material misrepresentation or omission; (2) scienter; and (3) loss causation.

Material misrepresentation or omission.The defendants contended that the complaint comprised "puzzle pleading" whereby a plaintiff sets down the facts and fraud theories but asks the court to match them up instead of the plaintiff doing so as required. The defendants secondly argued that the complaint failed to allege any actionable material misstatement or omission. The court debunked the puzzle pleading contention, finding that the complaint cohesively set forth the defendants’ various disclosures made throughout the relevant period followed by specific allegations of how the disclosures were fraudulent.

The defendants next proclaimed that their disclosures were in-actionable by being either statements of historical results, forward looking statements, puffery, statements of opinion or belief, or risk disclosures. Regarding historical result statements, the court found that most of the disclosures were in-actionable because the defendants did not go beyond describing Apple’s historical results, but that some disclosures were actionable because the defendants went beyond historical fact descriptions to touting specific factors that drove those results. In these instances, said the court, a defendant is required to disclose negative information about those factors. Here, the defendants: (1) touted high iPhone upgrade rates without disclosing adverse information that cut against the positive information; and (2) made statements about positive iPhone growth in Greater China which contradicted declining iPhone sales and low market share in the region which occurred soon after the positive statements were made. Using the "reasonable investor" standard, the court determined that a reasonable investor would want to know the contradictory information before investing in Apple.

The court similarly found most of the defendants’ forward-looking statements to be in-actionable under the PSLRA because they talked exclusively of the future or consisted solely of future projections. A few of the statements, however, contained both future projections mixed with data about Apple’s present or past condition and were, therefore, considered actionable. As with the historical result statement found actionable, these actionable forward-looking statements were those that pertained to high iPhone upgrade rates and positive iPhone growth in Greater China.

Regarding puffery, most of the defendants’ disclosures were again in-actionable because a reasonable investor would know to discount the defendant company’s overly optimistic statements, which contain phrases like "everything is going fine" or "we’re very happy." But the few defendant optimistic statements about great iPhone sales which contradicted the defendants’ knowledge that those sales were, in fact, declining were actionable statements alleged as fraudulent by the plaintiff.

On the opinion statement or belief theory, only one alleged statement was actionable, namely the defendants’ statement about emerging market issues in relation to China: "I would not put China in that category. Our business in China was very strong last quarter iPhone, in particular, was very strong double-digit growth." The court acknowledged the defendants’ contention that the statement was literally true because it concerned "last quarter," but declared that the statement’s context suggests that business in China continues to be strong while Apple admitted only two months later that it "saw" troubling signs coming from China, as well as emerging market issues "as the quarter went on" that were particularly bad in November," when the statement was made.

Lastly, on the market risk issue, the court found all defendant risk disclosures to be in-actionable because the alleged statements all pertained to interest rate and foreign currency risks rather than the risks of throttling and economic downturn in the Greater China market upon which the complaint was based.

Other statements considered actionable. In addition to actionable statements surrounding iPhone upgrades and false touts about the growth of iPhones in China, the court additionally found actionable the defendant disclosures about tracking and replacing the batteries in old non-working iPhone models, as well as an Apple response to a 2018 letter from U.S. Senator John Thune asking whether Apple planned to throttle new phones. Apple responded that it did not intend to do so because hardware updates made throttling unnecessary, but the plaintiff correctly alleged that Apple continued to throttle new iPhones as recently as 2019.

Scienter. The plaintiff failed on an insider trading theory of scienter, said the court, because the CEO’s and senior vice president’s allegedly suspicious disposal of large amounts of Apple shares during the relevant period is actually something that company executives typically do after announcing positive earnings. The court similarly found the plaintiff’s confidential witness theory of scienter in-actionable because it requires the witnesses to document with detail their interactions with the executives to have first-hand knowledge of the fraud. The plaintiff could not show that the witnesses knew of the CEO’s and senior vice president’s day-to-day transactions with this level of detail. Similarly, the plaintiff failed on a core operations theory of scienter by not producing evidence to show that the Apple executives received information about the battery replacement program or the program’s effect on iPhone demand.

The court, however, determined that the plaintiff succeeded on an "inference of scienter" theory because of the close timing between when the defendants made positive statements and when they had to retract those statements. Specifically, the plaintiff alleged that on November 1, 2018, the CEO positively represented in a call that certain iPhone models "got off to a really great start," thereby causing analysts to walk away believing from the call that demand trends were "solid." But four days later, a Chinese publication reported that Apple told its biggest manufacturers to "halt plans for additional production lines" for these iPhones. Then, on January 2, 2019, the CEO admitted to investors that Apple failed to meet guidance due to declining demand, stating "we did not foresee the magnitude of the economic declaration, particularly in Greater China."

Loss causation. The court dismissed the loss causation claim. Here, the plaintiff alleged that competition from Chinese iPhone manufacturers reduced the need for customers in China to buy iPhones from Apple, and that the capability of accessing Chinese iPhone accounts from competitor phones, but not from Apple’s iPhone, drove down the demand for the iPhone. But the court said that the plaintiff failed to allege or show any evidence that Chinese competition led to lowered guidance or missed earnings to cause the stock price decline that financially victimized the plaintiffs.

Control person liability. The court also dismissed the plaintiff’s Section 20(a) control person liability claim because the plaintiff could not show corresponding culpability against the CEO or the senior vice president under Section 10(b)/Rule 10b-5.

The case is No. 19-cv-02033-YGR.

Attorneys: Mary K. Blasy (Robbins Geller Rudman & Dowd LLP) for City of Roseville Employees' Retirement System. Alexander K. Talarides (Orrick Herrington & Sutcliffe LLP) for Apple Inc.

Companies: City of Roseville Employees' Retirement System; Apple Inc.

MainStory: TopStory DirectorsOfficers FraudManipulation GCNNews InternationalNews NewLawsuitsNews PublicCompanyReportingDisclosure CaliforniaNews

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