Introduction

Public companies should be cautious when describing litigation as “without merit” or meritless if they have reason to know otherwise.  It could form the basis of a disclosure claim under the securities laws. A securities fraud putative class action suit in federal court against Pegasystems Inc. (“Pega”) recently survived a motion to dismiss (the ruling can be viewed here) where (1) Pega was sued for trade secret misappropriation, (2)  Pega’s CEO publicly claimed the trade secret lawsuit was “without merit”, (3) thereafter, the trade secret lawsuit returned a judgment against Pega for over $2 billion in damages and (4) sufficient facts were alleged that Pega’s CEO personally participated in the trade secret misappropriation.  As the court in the securities fraud litigation noted, “An issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the complaint are true.  When it decides to do so, however, it must do so with exceptional care, so as not to mislead investors… . An issuer may not … make misleading substantive declarations regarding its beliefs about the merits of the litigation.”

Background

In May 2020, Appian Corp. (“Appian”) sued Pega for, among other things, trade secret misappropriation, alleging a corporate espionage campaign led by Pega’s CEO. Appian initially sought damages of $90 million (less than 10% of Pega’s then reported current assets).¹

In subsequent public filings, Pega included only generic disclosure that, “[w]e have received, and may in the future receive, notices that claim we have misappropriated … [other’s] intellectual property rights.”

In February 2022, Appian filed to increase its claim to approximately $3 billion (four times Pega’s then-current assets and roughly three times its prior year’s annual revenue).  Three business days later, Pega filed its Annual Report on Form 10-K that included new disclosures about the litigation, as well as a statement that the lawsuit was “without merit” and that “any alleged damages claimed by Appian are not supported by the necessary legal standard… .”  The following day, Pega’s stock dropped approximately 16%.

In May 2022, a unanimous jury verdict awarded Appian over $2 billion in damages. Pega’s share price dropped approximately 28% in the following two days.
Shortly thereafter, investors brought a securities fraud class action against Pega, its CEO and its CFO alleging that the defendants, despite knowingly engaging in the conduct underlying Appian’s civil suit, had falsely assured investors that Appian’s claims were meritless. Pega moved to dismiss for failure to state a claim, alleging that the Plaintiff had not sufficiently pled facts establishing, among other things, a strong inference of scienter and that the challenged statements were false or misleading.

Holding

Based on the factual allegations made by the investors, the court denied Pega’s motion to dismiss, except with respect to the CFO.

The allegations of the CEO’s personal involvement in the misconduct underlying the trade secret litigation provided support for the scienter requirement in the securities fraud claim.  The court noted that “[the CEO] knew or was reckless in not knowing that . . . his assurance that Appian's claims were "without merit" posed a substantial danger to mislead investors.” The court further noted that the CEO’s assurances were false and misleading under the Private Securities Litigation Reform Act (the “PSLRA”), as well as causally connected to the drop in value of Pega stock that had occurred in February and May of 2022.  The court explained that a reasonable investor would have expected that the CEO’s statement would have fairly aligned with the information in his possession at that time, when in fact the CEO’s statement did not, as he allegedly had direct involvement in the conspiracy.

Notably, the court stated that “a reasonable investor could justifiably have understood the CEO’s message that Appian's claims were “without merit” as a denial of the facts underlying Appian's claims – as opposed to a mere statement that Pega had legal defenses against those claims.”

Takeaway

Public companies who routinely claim that litigation is “without merit” should pay attention to this case.  While the company is appealing the ruling, it still serves as a good reminder to avoid boilerplate litigation contingency disclosures.

In particular, companies must be cautious where statements by executives regarding ongoing litigation may conflict with the underlying facts, litigation status or written disclosures.  Where the underlying facts and litigation outcome are not known for certain, statements investors may perceive as nullifications of risk (such as claims the litigation is “without merit”) should not be made without thoughtful consideration.

Still, the court was clear that companies need not confess to wrongdoing. Instead companies should consider statements, if true, such as “we plan to vigorously defend ourselves”, “we have substantial defenses”, “we intend to pursue all available administrative and judicial remedies necessary to resolve these matters”, “we intend to dispute these allegations”, “we are confident in our ability to prevail on the merits” — each of which may have the benefit of still being true even where the underlying allegations may be true.  Additionally, qualifications, cautionary language and appropriate PSLRA disclaimers can be significantly helpful.

This ruling does not replace our prior guidance as to how companies should approach litigation contingency disclosures. 

Also, the result in this case may have been different had the alleged facts not met the scienter requirement.  In particular, the facts supported the inference that the executives asserting the trade secret claim was “without merit” were the same individuals perpetrating the trade secret violations. 

Side note: Another noteworthy piece of this securities fraud class action involves a statement in Pega’s Code of Conduct that it would “[n]ever use illegal or questionable means to acquire a competitor’s trade secrets”—the exact misconduct allegedly perpetrated by the CEO in this case.  The court held that the Code of Conduct statement was not merely aspirational but was an actionable commitment to investors to avoid “a specific course of conduct”.  This is a good reminder that companies should routinely review their corporate governance policies to ensure they are complying with the policies and not merely treating the policies as a statement of the company’s goals and aspirations.  Investors and courts will expect companies to adhere to the commitments made in corporate policies.

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