Luo v. Sogou Inc.

Background

Sogou completed an initial public offering of American Depositary Shares in November 2017 and filed a registration statement and prospectus with the Securities and Exchange Commission. The plaintiffs purchased shares issued in or traceable to that offering. They alleged that the offering documents contained material misstatements and omissions in violation of Section 11 of the Securities Act of 1933, and that certain defendants were also liable under Section 15 as controlling persons.

The plaintiffs focused on two subjects. First, they alleged that Sogou failed to disclose that its systems for screening advertising content were inadequate under Chinese regulations. Their allegations relied in part on a 2018 investigation involving advertisements that made jokes about Qiu Shaoyun, a Chinese war hero. After that investigation, Sogou was fined, ordered to disgorge advertising income, and directed to revise its advertising policies and audit procedures. Second, the plaintiffs alleged that Sogou failed to disclose a change in its smart-hardware strategy and misleadingly suggested that its hardware products used artificial-intelligence capabilities.

Sogou, Sohu, and the IPO underwriters moved to dismiss the Third Amended Complaint under Federal Rules of Civil Procedure 9(b) and 12(b)(6). Rule 12(b)(6) allows dismissal when a complaint does not state a legally sufficient claim, and Rule 9(b) requires fraud allegations to be pleaded with particular detail.

Court’s analysis

The court held that the plaintiffs did not identify a false or misleading statement about Sogou’s content controls when the registration statement became effective. The offering documents described Sogou’s obligation to police its Internet platforms and warned that the company might have difficulty determining what content could create liability. They did not promise that Sogou’s procedures would guarantee compliance with Chinese law or prevent all illegal content.

The court distinguished a prior decision involving detailed descriptions of environmental compliance measures that allegedly were already failing. Here, the disclosures about Sogou’s compliance efforts were general, and the plaintiffs did not allege that Sogou was violating Chinese law or that its controls were deficient at the time of the IPO. The law concerning heroes and martyrs that led to the investigation had not yet been enacted. The court also stated that the offering documents warned investors about the possibility of new Chinese laws, difficulty policing prohibited content, and resulting effects on Sogou’s operations and revenue.

The court separately rejected the hardware allegations. Although Sogou had begun developing new artificial-intelligence-related hardware before the IPO, the court found that the complaint and incorporated documents showed that the decision to accelerate the new hardware strategy and phase out older products occurred after the IPO, following successful product launches in March and May 2018. The court also found that the registration statement did not say that all Sogou smart hardware was artificial-intelligence enabled; it described artificial-intelligence features for the Teemo Hero Watch but did not make that statement about the older Teemo Watch.

Disposition

The court concluded that the plaintiffs failed to state a Section 11 claim. Because Section 15 liability requires an underlying Section 11 violation, the Section 15 claim also failed. Judge Lewis J. Liman granted the motions to dismiss and dismissed the Third Amended Complaint with prejudice. The court explained that this was the plaintiffs’ fourth attempt to state a claim, that the defects were fundamental, that the plaintiffs did not request another opportunity to amend, and that they identified no additional facts that could cure the defects.

Result

The motions to dismiss filed by Sogou, Sohu, and the underwriters were granted. The action was dismissed with prejudice.