Stadium Capital LLC v. Co-Diagnostics, Inc.

Background

Co-Diagnostics, Inc. makes disease-diagnosis tests. Its revenue increased substantially during the COVID-19 pandemic, but it reported $5 million in revenue for the second quarter of 2022 after reporting at least $20 million per quarter from the second quarter of 2020 through the first quarter of 2022.

Stadium Capital LLC brought a proposed investor class action alleging securities fraud under Section 10(b) of the Securities Exchange Act of 1934, Securities and Exchange Commission Rule 10b-5(b), and Section 20(a). The defendants included Co-Diagnostics, its chief executive officer, Dwight Egan, and its chief financial officer, Brian Brown. Stadium challenged statements made in a May 12, 2022 press release, an earnings call, a quarterly filing, and a June 15, 2022 investor presentation.

Legal standards and outside documents

The court applied the heightened pleading requirements of the Private Securities Litigation Reform Act and Federal Rule of Civil Procedure 9(b). For the alleged misstatements, Stadium had to identify the statements, speakers, locations and dates, and explain why the statements were misleading. It also had to plead particularized facts creating a strong inference that the defendants acted with the required state of mind, known as scienter.

The court considered thirteen documents outside the complaint because they were Securities and Exchange Commission filings, public documents considered only to establish that statements were made, or documents incorporated into or integral to the complaint. The court said those documents made little difference to its decision.

Misleading statements

The court held that Stadium plausibly alleged that some statements were misleading. Statements about restricted near-term visibility, fluctuations in customer orders, and difficulty forecasting demand could have suggested ordinary uncertainty rather than an already rapid decline in demand. The court also found Brown’s response to an analyst’s question—emphasizing order timing and downplaying demand problems—plausibly misleading.

The court rejected the argument that these statements were merely opinions or nonactionable promotional language. It found that at least some statements were determinate and verifiable or contained factual explanations. The court also ruled that the forward-looking-statement safe harbor did not require dismissal because some statements described current conditions and the cautionary language was not meaningful if the warned-of risk had already occurred.

Stadium also plausibly alleged a claim based on Item 303 of Regulation S-K. That provision required disclosure and analysis of known trends or uncertainties reasonably likely to have a material effect on revenue. Stadium alleged that Co-Diagnostics failed to disclose in its May 2022 quarterly filing that federal funding for COVID-19 testing had ended in March 2022. The court found the alleged effect on Co-Diagnostics plausibly material and said the fact that the funding change may have been public did not establish that its effect on the company was known to investors.

The court granted the motion as to other statements. It found that Egan’s June statement about continued demand addressed the relative demand for different tests, not the company’s overall demand. It found that Brown’s adjusted-earnings discussion compared historical first-quarter results and did not describe current demand or future performance. The court also found that Brown’s statement that some demand would remain for the rest of the year did not imply anything about current sales.

Scienter

The court found that Stadium plausibly pleaded a strong inference of scienter based on recklessness. Stadium alleged that Egan and Brown had access to the company’s books and records, that Egan had said the company monitored daily demand, and that Egan later referred to the sales falloff as the second quarter progressed. The court also relied on the importance of the COVID-19 testing product to the company and on the defendants’ references to fluctuations and restricted visibility.

The court concluded that the most compelling inference from the allegations was that Brown and Egan knew sales were down by mid-May 2022 and tried to obscure that fact through vague assurances about timing, fluctuations, and visibility. It reached a similar conclusion regarding the alleged omission of the end of federal funding, relying in part on statements linking that funding change to the later sales decline.

The court rejected arguments based on the defendants’ alleged lack of motive. It found that Co-Diagnostics’ share-repurchase pattern could support an inference that the company knew its stock price was inflated. It also found that Brown and Egan received newly vested restricted stock units for free and sold more than one-third of those units during the class period to cover tax obligations, which could have allowed them to benefit from an inflated share price.

Section 20(a) claim and disposition

The court held that Stadium adequately pleaded that Brown and Egan controlled Co-Diagnostics for purposes of the Section 20(a) claim. Stadium alleged that they were directly and supervisory involved in day-to-day operations, received the challenged statements, and could prevent the statements from being issued or cause them to be corrected.

The court’s conclusion was: “the motion to dismiss is GRANTED IN PART AND DENIED IN PART.” It granted the motion with respect to Stadium’s claims based on paragraphs 47, 51, 53, and 54 of the complaint. It denied the motion with respect to Stadium’s claims based on paragraphs 44, 45, 46, and 50. The clerk was directed to terminate docket entry 32.