The news late last week that London’s transport authority had stripped ride-hailing firm Uber of its ride-hire license on the grounds that it was “unfit to operate” in the U.K. capital was merely the latest blow to the company, following a string of scandals, probes, and damaging revelations. Now the company – which, despite its enormous size, is still a privately held firm — has been hit with a federal court securities class action lawsuit, the most recent instance where one of the high-flying “unicorn” companies has been hit with a securities fraud lawsuit after a decline in fortune. The new lawsuit has a number of interesting features, discussed below.
As noted in Greg Bensinger’s September 26, 2017 Wall Street Journal article (here), on September 26, 2017 an Uber investor filed class action lawsuit in the Northern District of California against Uber and its former CEO, Travis Kalanick. The complaint, which was filed on behalf of the Irving, Texas firefighters’ retirement fund, purports to be filed on behalf of a class of investors who purchased an interest in Uber securities between June 6, 2014 and September 22, 2017. (The class period ending date coincides with the date on which the news about that the London transport authority had revoked the firm’s license.)
The complaint, a copy of which can be found here, contains a detailed description of Uber’s rapid and dramatic growth and of the company’s more recent reverses. The company alleges that beginning in 2014 the defendants conducted a “mass media campaign designed to induce investors to invest billions of dollars in the company.” The campaign included statements about the benefits to consumers from the company’s business model’s disruptive impact. The complaint also refers to Kalanick’s statements as a part of the campaign about the company’s “values” and “principles.”
The campaign, the complaint alleges, was “a resounding success,” as, by 2016 directly or through investment vehicles raised more than $10 billion from investors and by mid-2016, the company had reached a valuation of over $70 billion, a level greater than some of the country’s most venerable industrial firms. However, the complaint alleges, the defendants failed to disclose that the company’s rapid growth and its skyrocketing valuation were inflated by illicit conduct and that the company’s business prospects were subject to numerous undisclosed legal, reputational, and operational risks.
In 2017, the complaint alleges, “defendants’ story began to unravel.” In a short span, “a shocking litany of corporate misconduct came to the fore” and investors “learned startling truths about the willingness of C-Suite executives to flout local, national, and international law, stifle competition, misappropriate trade secrets, and seek vengeance against detractors.”
The complaint lists what it calls “just some the Company scandals, including: news that the FBI is investigating the company’s use of the “Hell” software app to monitor drivers who worked for both Uber and Lyft; inquiries concerning a covert program called “Grayball” that allowed the company to mislead regulators and evade detection in jurisdictions in which it was operating illegally or had faced opposition; news that the company had schemed to steal self-driving car technology from Waymo; disclosure that the company is under investigation for possible Foreign Corrupt Practices Act violations; revelations of allegedly rampant gender discrimination and sexual harassment. The complaint alleges further that as a result of these scandals Kalanick was forced to resign, as were as many as 14 other executives.
These revelations, the complaint alleges, caused the valuation of the company’s securities to “plummet.” The complaint alleges that investors have been forced to mark their securities down as much as 15%, which translates to as much as $10 billion in 2017 alone. Many of these write-downs took place before even more recent revelations which allegedly caused valuations to decline further, allegedly bring cumulative valuation declines to as much as $18 billion.
The complaint alleges that the defendants’ false and misleading statements about the company violated California Corporations Code Sections 24500(d) and the complaint seeks the recovery of damages pursuant to California Corporations Code Section 25500.
There are a number of interesting things about this securities class action lawsuit, the most important of which to me is that it has been brought against not a publicly traded company whose share are traded on a public securities exchange, but rather against a privately held company whose shares were purchased in a series of private placement transactions. A lawsuit of this kind against a private company is not entirely unprecedented; as discussed here, in late 2016, investors filed a securities fraud lawsuit against the blood testing firm Theranos and certain of its executives. So investors filing a securities fraud lawsuit against a private company is not unprecedented, but it is still noteworthy.
It is also interesting to me that the plaintiff has chosen to file its claim exclusively under the California state securities laws, rather than under the federal securities laws. I suspect that the tactical decision to file state law claims only was an effort to avoid hurdles or obstacles the plaintiffs’ lawyers anticipated that a claim under the federal securities laws might face. (I encourage readers to contact me to suggest what some of those hurdles or barriers might be.)
The plaintiffs will face other obstacles. Showing how investors were misled presents some interesting challenges. As a private company, Uber made relatively few disclosures as a company, and those were within the controlled environment of the private placement offerings. The complaint attempts to supplement these offering disclosure with various public statements the company and Kalanick made. The plaintiffs will not only need to show that the defendants made misleading statements but also that the plaintiffs relied on the statement. (The defendants will argue that because Uber’s shares do not trade on an efficient market, the plaintiffs cannot rely on the fraud on the market theory.)
The plaintiffs will face another challenge owing to the fact that the company’s shares were not publicly traded. The plaintiffs will have to establish that the misrepresentations inflated the company’s share price and that the revelations of the truth caused the company’s share price to decline. The magnitude of the inflation represents one challenge, and the causation of the loss will present another challenge. Without a daily share price to use as a measurement, plaintiffs will face difficulties showing that specific disclosure caused specific loss in an identifiable amount.
It is of course not news that a private company has been sued by investors on the basis of alleged misrepresentations. It is not even news that a private company has been sued for securities fraud. What is news is that the lawsuit was filed in the form of a securities class action. Given the magnitude of Uber’s valuation prior to the alleged valuation decline, the range of potential damages also is noteworthy, again given that Uber is a privately held company.
As I noted at the time of the Theranos lawsuit, the advent of securities class action litigation against private companies, particularly litigation that potentially involves the magnitude of losses allegedly involved here, represents a significant new development for the D&O insurance industry. The industry has tended to view private company liability exposures and public company liability exposures as two distinct and separate classes. However, this new lawsuit and in particular the potential magnitude of the damages have attributes that more typically would have characterized the public company risk class and not the private company risk class. Clearly, with the arrival of these kinds of lawsuits, the perceived division between these two risk classes may be breaking down. Indeed, with the recent rise of private companies with valuations in excess of $1 billion, the perceived distinction between the two classes already was becoming blurred.
The challenge for the industry is that because of the past categorical distinction between the two risk classes, the industry offered two distinct types of policies, one for privately held companies and one for publicly traded companies. There are numerous distinctions between the two types of policies but among the most salient derived from the perception that publicly traded companies had liabilities under the securities laws, while private companies do not. The lawsuit filed against Uber, and the earlier lawsuit against Theranos, highlights the fact that private companies can face liability under the securities laws.
The possibility of this kind of private company lawsuit has numerous implications, including among things, for the amount of insurance that a private company might seek to buy. Private companies with these enormous valuations already should have been thinking about increased limits, but the possibility of securities class action litigation underscores the need for these kinds of companies to reconsider the amount of insurance that they buy.
In any event, it will be interesting to see how this latest lawsuit progresses. As a more general matter, it will be interesting to see if others of the so-called unicorn companies face significant setbacks if more of these private company securities lawsuits follow.
Added Note: If you have read this far, you absolutely must also read Alison Frankel’s September 27, 2017 post about the Uber lawsuit on her On the Case blog (here). She answered all of the questions I posed above but failed to answer, and she adds more, for example an explanation why reliance will not be an issue.