In re Dropbox Securities Litigation

Background

Lead Plaintiff Ognjen Kuraica represented a putative class of investors who purchased or otherwise acquired Dropbox common stock pursuant or traceable to Dropbox’s initial public offering. The plaintiffs sued four groups: Dropbox; the individuals identified in the opinion as the Registration Statement Defendants; the Sequoia Defendants; and the Underwriter Defendants.

The consolidated amended complaint asserted claims under Section 11 of the Securities Act against Dropbox, the Registration Statement Defendants, and the Underwriter Defendants. It asserted claims under Section 15 against the Registration Statement Defendants and the Sequoia Defendants. Section 11 addresses material misstatements or omissions in a registration statement. Section 15 provides potential liability for people or entities that control a primary securities-law violator.

The plaintiffs alleged that Dropbox’s registration statement did not disclose that its rate of converting nonpaying registered users into paying subscribers was slowing or declining. They relied on statements about the number of paying users, the characteristics of users thought more likely to pay, and the performance of user cohorts. They also alleged that Dropbox should have disclosed a material negative trend under Item 303 of Securities and Exchange Commission Regulation S-K.

Rule 12(b)(6) standard

The court evaluated the motions under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint legally states a claim. At this stage, the court generally accepts well-pleaded factual allegations as true and views them favorably to the plaintiff, but it need not accept conclusory allegations, unreasonable inferences, or unsupported deductions.

Section 11 claims

The court granted the motions to dismiss the Section 11 claims. It found that the complaint contained no factual allegation about Dropbox’s user-conversion rate, even though that alleged decline was the central basis for the plaintiffs’ theory. The court rejected the plaintiffs’ attempt to infer a declining conversion rate from disclosed declines in revenue growth and paying-user growth. Those declines could have resulted from Dropbox’s other revenue drivers—new user sign-ups and upgrades or expansions by existing paying users—or from a combination of the three drivers.

The court also held that the plaintiffs had not explained why Dropbox’s omission of the conversion-rate information created a materially different impression of the company’s financial condition. Dropbox disclosed total paying users, revenue, average revenue per paying user, and declining revenue-growth rates. The court said the plaintiffs had not shown that these disclosures were inadequate or that they plausibly implied that one of Dropbox’s three revenue indicators was increasing when the overall disclosed rates were declining.

The court separately discussed Dropbox’s statements about historical data and user characteristics. It said the plaintiffs did not allege that Dropbox’s historical statements were false or that the company’s stated beliefs were not genuinely held. The plaintiffs also did not allege facts about the inquiry Dropbox did or did not conduct, or the knowledge it did or did not have, that would make the opinion statement misleading.

Item 303 claims

The court granted the motions to dismiss the claims based on Item 303 of Regulation S-K. Item 303 requires disclosure of known trends or uncertainties that have had, or that the company reasonably expects will have, a material favorable or unfavorable effect on sales, revenue, or income.

The court found that Dropbox disclosed its revenue and growth rates, and that the declining rate of revenue growth could be calculated from the disclosed figures. The complaint again supplied no factual allegations, data point, or trend line supporting the alleged decline in user conversion. It also did not allege facts showing that the alleged conversion trend materially affected revenue, that the trend was known to the defendants, or that user conversion was more responsible for the revenue-growth decline than Dropbox’s other revenue drivers.

Section 15 claims

The court granted the motions to dismiss the Section 15 claims because the plaintiffs had not adequately established a primary violation of federal securities law. The court therefore did not find the required underlying violation for controlling-person liability.

Statute of limitations

The court also granted the defendants’ motions to dismiss on the alternative ground that the claims were time-barred. Securities Act claims generally must be filed within one year after discovery, or when a reasonably diligent plaintiff should have discovered, the alleged untrue statement or omission.

The plaintiffs filed the initial complaint on October 4, 2019. The defendants argued that the relevant information was available by August 10, 2018, when Dropbox reported its second-quarter 2018 financial results. The plaintiffs argued that they first became aware of their claims after Dropbox’s third-quarter 2018 disclosure on November 9, 2018.

The court stated that the inquiry had to be based on information about revenue and paying-user metrics because the plaintiffs did not plead facts showing that Dropbox had released user-conversion-rate information. It concluded that information available from March through October 2018 was abundant and consistent with the registration statement’s disclosures of slowing revenue and paying-user growth. The court found that the evidence showed the plaintiffs discovered, or should have discovered, the alleged violations at least one year before October 4, 2019.

Disposition

The court granted both motions to dismiss with leave to amend. Although the defendants requested dismissal with prejudice based on the statute of limitations, the court found that amendment was not yet futile. It stated that the plaintiffs would need, at a minimum, to identify a factual circumstance plausibly distinguishing their claims from the information available in Dropbox’s 2018 quarterly report or earlier. The order directed the plaintiffs to file an amended complaint no later than January 6, 2020, as stated in the opinion.