Lu v. Align Technology, Inc.

Background

This was a proposed securities class action brought by lead plaintiff SEB Investment Management AB on behalf of people and entities that purchased or acquired Align Technology common stock during the stated class period. The defendants were Align Technology, Inc.; Joseph M. Hogan; John F. Morici; Raphael S. Pascaud; and Emory M. Wright.

The complaint alleged that Align and its executives made six false or misleading statements or omissions between April 25, 2018, and September 5, 2018. According to the complaint, the statements downplayed competition following the expiration of Align’s patents, concealed price cuts and promotional programs, and failed to disclose that Align’s strategies were inadequate to address competitive pressure. The complaint focused in part on changes to Align’s Advantage Program and a later discount promotion. It alleged that Align’s third-quarter average sale price fell by approximately $85 and that Align’s stock price declined nearly $59 per share after the company disclosed its third-quarter results.

The complaint asserted three causes of action: securities fraud under Section 10(b) of the Securities Exchange Act and Rule 10b-5; control-person liability under Section 20(a); and insider trading under Sections 10(b) and 20A and Rule 10b-5 against Hogan and Morici.

Legal standard

The defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which permits dismissal for failure to state a legally sufficient claim. Because the claims alleged securities fraud, the complaint also had to satisfy heightened pleading requirements under Rule 9(b) and the Private Securities Litigation Reform Act. Those rules required the plaintiff to identify the allegedly misleading statements, explain why each was false or misleading when made, and plead particular facts supporting a strong inference that the defendants acted intentionally or with deliberate recklessness.

Court’s analysis

For the Section 10(b) and Rule 10b-5 claim, the court first found that the complaint was an impermissible “puzzle pleading.” It quoted lengthy statements, marked some portions with emphasis, and then supplied generalized reasons why the statements allegedly were misleading. The plaintiff later acknowledged that several quoted paragraphs were included only for context, but did not clearly identify which statements were actionable. The court concluded that it could not determine which specific statements the plaintiff alleged were false or misleading.

The court also held that the complaint failed to plead falsity with the required particularity. It found that the plaintiff selectively quoted the defendants’ statements, including statements that acknowledged competition and Align’s response to it. The plaintiff’s repeated allegations that executives discussed competition, warned employees about patent expirations, changed the Advantage Program, and knew the program might be insufficient did not adequately connect those facts to the specific statements or show why the statements were false when made.

The court further found that the complaint did not plead the effect of competition on Align’s business with enough specificity. The complaint attributed only about $30 of the approximately $85 average-sale-price decline to promotions and did not allege that the other explanations for the decline were false. It also alleged that shipments had increased. The court concluded that the complaint did not sufficiently show that post-patent-expiration competition caused the reported results or that competition materially harmed Align.

Although the court had already found grounds to dismiss the primary securities-fraud claim, it also discussed scienter, meaning the required state of mind for securities fraud, in anticipation of an amended complaint. The court found that statements from former employees did not show that the defendants intentionally or deliberately recklessly made false statements. It also found that the complaint did not identify specific data showing what the defendants knew about competition’s effect on Align. Finally, the allegations about insider stock sales did not establish scienter because the complaint did not adequately address the timing of the sales or the defendants’ prior trading histories, and the sales occurred before the later stock-price decline alleged in the complaint.

For the Section 20(a) control-person claim, the court granted the motion to dismiss because that claim required an underlying securities-law violation, and the plaintiff had not adequately pleaded one.

For the insider-trading claim under Sections 10(b) and 20A and Rule 10b-5, the court found that the plaintiff had not adequately pleaded a predicate securities-law violation or shown that Hogan and Morici traded while possessing material, nonpublic information. The court also found that the plaintiff failed to allege contemporaneous trading at least as to Hogan’s June 1, 2018 trades because the plaintiff’s purchases on May 30 and May 31 preceded Hogan’s sale.

Disposition

Judge Koh granted the defendants’ motion to dismiss the complaint in its entirety and granted the plaintiff leave to amend. The plaintiff had 30 days to file an amended complaint. The order stated that failure to amend, or failure to cure the identified deficiencies, would result in dismissal of the deficient claims with prejudice. The court also granted the defendants’ request for judicial notice and incorporation by reference, while limiting judicial notice to the fact that documents had been filed and not accepting disputed facts in those documents as true.