U.S. Supreme Court to Clarify Securities Fraud Pleading Requirements for Falsity and Scienter During 2024–2025 Term

On June 17, 2024, the U.S. Supreme Court granted certiorari in Nvidia Corp. v. E. Ohman J:or Fonder AB [No. 23-970]. The Supreme Court’s decision is expected to address, for the first time in over a decade, the exacting pleading requirements civil plaintiffs must overcome in securities fraud class actions brought under the Securities Exchange Act of 1934 (the “Exchange Act”). The Supreme Court agreed to answer two significant questions, both of which have very real consequences for businesses facing securities fraud litigation: (1) whether plaintiffs seeking to allege a strong inference of scienter under the Private Securities Litigation Reform Act (PSLRA)—a rigorous and formidable burden—based on allegations about internal company documents must plead the contents of those documents with particularity; and (2) whether plaintiffs can satisfy the PSLRA’s particularized falsity requirement by relying on an expert opinion as a substitute for specific allegations of fact in a complaint.

Background

The underlying litigation began in the Northern District of California, where investors sued NVIDIA and three of its officers, alleging that they knowingly or recklessly made materially false or misleading statements about the proportion of one of NVIDIA’s products that were purchased for crypto mining purposes. The putative class of shareholders brought a securities fraud class action complaint under Rule 10b-5 and Section 10(b) of the Exchange Act, claiming that NVIDIA’s chief officers downplayed NVIDIA’s sales of GeForce graphics processing units (GPUs) to crypto miners, and instead attributed its strong revenue growth to its video game purchase partners, which were less susceptible to swings in the crypto market. To meet the element of scienter, the plaintiffs alleged that NVIDIA and its officers had access to what the plaintiffs speculated would have been sources of information internal to NVIDIA that reflected relatively high demand for GPUs from cryptocurrency miners.

District Court’s Holding

The district court dismissed the complaint with prejudice, holding that the plaintiffs failed to allege facts giving rise to a strong inference of scienter against NVIDIA and its officers. The district court concluded that the plaintiffs’ mere reference to various internal records was not enough to plead scienter in order to survive the pleadings stage. Specifically, the plaintiffs failed to “adequately tie the specific contents of any of these data sources to particular statements so as to plausibly show that the Defendant who made each specified statement knowingly or recklessly spoke falsely.”

9th Circuit’s Holding

On appeal, the 9th Circuit Court of Appeals reversed in part, holding that the complaint adequately alleged a claim under Section 10(b) and Rule 10b-5 against NVIDIA and its CEO. In a divided decision, the 9th Circuit held—over the staunch dissent of Judge Sanchez—that the complaint adequately alleged scienter. The 9th Circuit relied on testimony of anonymous former employees stating that NVIDIA maintained a detailed sales database showing which end users were driving sales. Further, the majority reasoned that the CEO’s “detail-oriented management style would have led him to become aware of the source of more than a billion dollars in company revenue during a fifteen- or eighteen-month period.”

On the element of falsity—which the district court did not need to reach—the 9th Circuit held that the plaintiffs had adequately alleged that NVIDIA’s statements concerning GeForce GPU revenue derived from cryptocurrency miners were false in light of the company’s actual revenue attributable to cryptocurrency miners. Notably, the plaintiffs did not have access to the actual GeForce GPU revenue attributable to cryptocurrency miners. Thus, to support their falsity allegations, the plaintiffs relied instead on an expert consulting firm to analyze NVIDIA’s alleged GeForce GPU revenue derived from cryptocurrency miners based on publicly available data. The 9th Circuit considered this expert opinion because, in its view, it was reliable and supported by other allegations, including public analyses, witness statements and corroborating market events.

Petition for Writ of Certiorari

NVIDIA filed a petition for a writ of certiorari with the U.S. Supreme Court, identifying a circuit split regarding the level of particularity with which plaintiffs must allege on the content of internal company documents that allegedly contradict public statements. The 2nd, 3rd, 5th, 7th and 10th Circuits have held that the PSLRA requires that a plaintiff allege the actual contents of such internal documents with particularity, whereas the 1st and the 9th Circuits permit speculating about what might be in a company’s internal documents at the pleadings stage.

NVIDIA also pointed to a circuit split on the question of whether investors can rely on hired experts to prove that a company’s representations are false. The 2nd and 5th Circuits have held that plaintiffs cannot allege falsity by substituting an expert opinion for particularized allegations of fact. The 9th Circuit has, by contrast, now effectively allowed securities plaintiffs to substitute expert opinions for allegations of fact.

On June 17, 2024, the Supreme Court granted NVIDIA’s petition on both questions. The case will be heard during the Supreme Court’s 2024–2025 term.

Takeaways

By enacting the PSLRA in 1995, Congress memorialized exacting pleading requirements for litigants bringing securities fraud actions against businesses and their executives. The PSLRA also imposes a stay of all discovery unless and until a complaint is sustained over defendants’ motion to dismiss. This automatic discovery stay was intended to prevent plaintiffs from leveraging the threat of costly discovery to force defendants into settlements of meritless securities lawsuits.

Since the PSLRA’s passage, lower courts have wrestled with applying the heightened pleading requirements for claims arising under Section 10(b) and Rule 10b-5 of the Exchange Act. As a result, circuit splits have emerged on both the element of falsity, i.e., whether the facts alleged misrepresentations or omissions with particularity, and the element of scienter, i.e., whether the facts alleged give rise to a strong inference that the defendant acted knowingly or with severe recklessness. The Supreme Court’s forthcoming decision will likely resolve these circuit splits and bring much-needed clarity to the adjudication of securities fraud class actions.

The Supreme Court also has the rare opportunity to ensure that the PSLRA’s pleading requirements remain robust in courts across the country. Indeed, motions to dismiss in securities class actions often challenge the adequacy of allegations on the elements of scienter and falsity. And plaintiffs regularly seek to prove scienter by alleging that internal company documents contradict company executives’ public statements. Further, the 9th Circuit’s ruling, if not overruled, would sanction the practice of retaining expert witnesses to support otherwise unsupported allegations of falsity in securities fraud class actions. As a result, the Supreme Court’s decision will have exceptionally significant consequences for businesses facing the threat of securities litigation, especially against the backdrop of the PSLRA’s automatic discovery stay and the exorbitant costs of defending against securities class actions.