As I noted in my recent year-end wrap up, one of the top D&O stories of 2021 was the surge of SPAC-related securities litigation during the year. Most of these SPAC-related lawsuits have only just been filed, and it remains to be seen how they will fare. However, in a development that may represent an early sign concerning the prospects for these cases, on January 14, 2022, a federal district court substantially denied the motion to dismiss in the securities class action lawsuit filed last year against electric vehicle battery developer and manufacturer, QuantumScape. As discussed below, the court’s dismissal motion ruling has several noteworthy features. Northern District of California Judge William H. Orrick’s January 14, 2022 in the QuantumScape case can be found here.
QuantumScape was founded in 2010 and makes solid-state batteries for use in electric vehicles. Most electric vehicles use lithium-ion batteries. Solid-state batteries are a technological alternative to lithium-ion batteries. Solid-state batteries are thought to be safer than lithium-ion batteries. However, solid-state batteries have long been though to be subject to shortcomings compared to lithium-ion batteries, including charge duration and operating capabilities are low and high temperatures. Solid-state batteries are also known to be prone to the formation of “dendrites” (cell formations that interfere with battery performance).
QuantumScape Corporation because a publicly traded company as a result of its November 25, 2020 merger with Kensington Capital Acquisition Company, a special purpose acquisition company (SPAC). In the transaction, QuantumScape merged into Kensington, and the surviving company took on QuantumScape’s name.
According to the subsequently filed securities class action complaint, in a series of statements in late 2020 and early 2021, QuantumScape made a number of representations about its batteries’ capabilities, the results of various tests of its batteries, and about the extent to which its batteries addressed the long-understood concerns about solid-state batteries.
Thus, for example, On December 8, 2020, QuantumScape issued a press release announcing performance data for its solid-state battery technology. Among other things, the press release claimed that the data showed that the company’s technology “addresses fundamental issues holding back widespread adoption of high-energy density solid state batteries.” The press release contained data concerning charge time, cycle life, safety, and operating temperature.
On December 17, 2020, QuantumScape filed a registration statement for the sale of company securities held by insiders. Among other things, the registration statement contained a risk factor noting that the company faces “significant barriers to our attempts to produce a solid-state battery cell and may not be able to successfully develop our solid-state battery cell.” The risk factor goes on to detail the barriers and the consequences for the company if the barriers are not overcome. The registration statement elsewhere identifies the “significant benefits” that its battery technology could enable, including such issues as “battery capacity, life, safety, and fast charging.”
On January 4, 2021, before markets opened, Seeking Alpha published an article pointing to several risks with QuantumScape’s solid state batteries that make it “completely unacceptable for real world field electric vehicles,” stating among other things that the battery’s power means that it ‘will only last for 260 cycles or about 75,000 miles of aggressive driving” and that due to the batteries’ temperature sensitivity “the power and cycle tests at 30 and 45 degrees above would have been significantly worse if run even a few degrees lower.” The company’s share price fell more than 40% on the news.
On April 15, 2020, short-seller Scorpion Capital issued an even more critical article about QuantumScape entitled “A Pump and Dump SPAC Scam by Silicon Valley Celebrities, That Makes Theranos Look Like Amateurs.” The report asserted, among other things, that many of QuantumScape’s claims about its batteries were false, including that the batteries resisted dendrites, performed well in low temperatures, reached 80 percent charge in 15 minutes, and long life. The Scorpion Capital reportedly relied on statements from several QuantumScape employees who questioned the company’s management’s statements about the company’s battery technology’s performance under test conditions. The company’s share price declined more than 12 percent on the news.
As discussed here, on January 4, 2021, shortly after the Seeking Alpha article’s publication a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against QuantumScape. The lead plaintiff in the action subsequently filed an amended consolidated complaint (here), which named as defendants the company itself; and its CEO, Chief Technology Officer, and Chief Financial Officer. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between November 27, 2020 (that is, shortly after the SPAC merger was completed) and April 14, 2021 (that is, the day before the Scorpion Capital article).
As later summarized by the court in the securities lawsuit, the amended complaint alleges that during the class period, the defendants made a series of misrepresentations about the company’s battery technology, including with respect to the batteries: “(i) power, (ii) range, (iii) low temperature operation, (iv) low temperature life, and (v) energy density,” and omitted material information related to “(vi) dendrites, (vii) safety and (viii) cost.”
The defendants moved to dismiss the plaintiff’s amended complaint, contending that none of the statements on which the plaintiff relies are false or misleading; some of them are protected by the safe harbor; some are opinions or corporate puffery; that the plaintiff had not adequately alleged scienter; and that the two supposed corrective disclosure cannot be relied upon.
The January 14, 2022 Opinion
In his January 14, 2022 opinion, Judge Orrick denied the defedants’ motion to dismiss except with respect to one of the statements on which the plaintiff sought to rely, which Judge Orrick found to constitute unactionable puffery.
In otherwise denying the motion to dismiss, Judge Orrick rejected the argument that the two critical articles about the company cannot be relied upon to establish misrepresentation or falsity. Judge Orrick considered the defendants’ contention that the Seeking Alpha article could not be relied upon because it was written by a competitor of QuantumScape; while this objection “certainly would diminish [the author’s] credibility, I cannot say it does so to such an extent as to require dismissing his findings at the pleading stage,” adding that the article was “littered with factual assertions.” Likewise, Judge Orrick rejected the defendants’ contention that the Scorpion Capital article could not be relied upon to establish falsity, because it was written by a short-seller. Noting that the article relied on interviews with nine former QuantumScape employees, he noted that the article had “the minimum indicia of reliability to make it past the pleading stage.”
Judge Orrick also concluded that the plaintiff had also adequately alleged falsity with respect to the statements on which the plaintiff sought to rely purporting to show that QuantumScape had solved the historical challenges associated with solid-state batteries and that the batteries were ready for commercialization. The defendants contended that all the relevant testing methodology, conditions and data on which it relied were adequately disclosed. Judge Orrick said that while the company’s disclosures were “certainly extensive and may well weaken or even defeat plaintiffs’ case at a later stage,” he said that he cannot at this stage “conclude that the adequacy of the disclosure is so obvious that reasonable minds could not differ” about whether the statements were misleading. In particular, he said that he cannot say that the “technical and narrow disclosures on which Quantumscape relies” rendered the company’s “more categorical statements” about the battery’s performance and readiness for commercialization not misleading.
Judge Orrick also concluded that the plaintiff had adequately alleged scienter, noting that on the plaintiffs’ theory, the defendants “must at least have intended to deceive investors,” as “the statements that the defendants made over and over were, according to the plaintiffs’ allegations, verifiable falsehoods.” Judge Orrick also said that the plaintiff had alleged a sufficient motivation, in that the company “had spent a decade developing its product and it went public just before the class period,” adding that during the period of the alleged misrepresentations, the company “raised hundreds of millions of dollars,” more than it had spent during its previous decade of existence.” It is therefore “plausible,” Judge Orrick said, that the defendants had “a financial incentive to represent that it batteries were farther along and less risky than they actually were.”
Finally, Judge Orrick concluded that the plaintiff had adequately alleged loss causation, noting that “it is plausible that the Seeking Alpha article and Scorpion Capital report cause the stock price to drop due to their timing; taking as true the allegations, that means that the revelation of alleged fraud was at least a substantial cause of the loss of value.”
This case counts as being “SPAC-related” because it involves a company that suffered a significant stock price decline and that was hit with a securities class action lawsuit shortly after the operating company merged with the SPAC. However, it is a strange sort of SPAC-related lawsuit. Not only are none of the former directors or officers of the SPAC named as a defendant (as was the case with roughly two-thirds of the SPAC-related lawsuits filed in 2021), but none of the alleged misrepresentations on which the plaintiff sought to rely allegedly were made prior to the SPAC merger transaction; all of the alleged misrepresentation are alleged to have taken place after the transaction.
In other words, this case is only formally a SPAC-related lawsuit, given that it involves a company’s conduct immediately after the completion of a SPAC merger. It is otherwise and entirely conventional lawsuit, and the court’s analysis of the sustainability of the plaintiff’s allegations has almost nothing to do with the fact that the company merged with a SPAC immediately prior to the class period.
About the only consideration Judge Orrick gave to the SPAC merger in his analysis was in his discussion with respect to the scienter issue, in which he noted, in concluding that plaintiff had presented “motive allegations,” given that the company had just gone public after a decade of existence and was in the process of raising hundreds of millions of dollars of capital. The suggestion is that the company was straining to establish the legitimacy of its new public listing.
That said, there are a number of features of this case and of Judge Orrick’s analysis that may be relevant to other SPAC-related lawsuits. For starters, the allegations in this lawsuit, as is the case in a substantial number of the SPAC-related lawsuits, rely upon supposed disclosures in short-seller reports. The defendants in those other lawsuits, like the defendants in this lawsuit, may well try to contend that the short-seller’s financially motivated statements are inherently unreliable and in particular should not be relied upon for purposes of evaluating allegations of falsity. Judge Orrick rejected the defendants’ contention that, because they are financially motived, the short-seller’s contentions are inherently unreliable. In this case, Judge Orrick (referring to the fact that the short-seller relied on statements from nine former QuantumScape employees) rejected the defendants’ contention that the short-seller’s report was inherently unreliable. This of course does not mean that the plaintiffs in other cases will also be able to rely on short-seller reports to establish misrepresentation or falsity; however, it does suggest that in at least some of these other cases made in reliance on short-seller reports, the defendants may not be successful in having the short-seller-based allegations entirely disregarded.
One other feature of this case that resembles many of the other SPAC-related securities lawsuits filed in 2021 is that it relates to a company involved in the electric vehicle industry. By my count, 9 of the 31 SPAC-related securities lawsuits filed in 2021 involved companies in the electric vehicle industry. Like QuantumScape, many of the defendant companies in the other EV-related lawsuits are relying on innovative but untested technologies; investor interest in the promise of EV technology has driven valuations for many of the companies upward, putting the companies in the position that their share prices may drop significantly on reports questioning the companies’ technologies. While the outcome of the QuantumScape dismissal motion does not mean that companies in other EV cases may not be able to get their cases dismissed; however, Judge Orrick’s consideration of the issues does show the scrutiny that these companies and their statements will face.
It is worth noting that in many instances, Judge Orrick noted that the defendants’ objections to the plaintiffs’ allegation may well be relevant at later stages of the proceedings in this case. The plaintiff has managed to survive the initial pleading hurdle but there are a number of questions in Judge Orrick’s opinion raising questions about whether the plaintiff may ultimately be able to prevail.