As readers of this blog know, as a follow-on effect to the massive wave of SPAC activity in the U.S., there has also been a surge of securities class action lawsuits involving companies that engaged in SPAC transactions. Many of these suits have only just been filed, so it is too early to tell how they will fare. But some of the cases are now reaching the motion to dismiss stage. If the recent motion to dismiss ruling in the SPAC-related lawsuit against mobile gaming technology company Skillz is any indication, many of these cases could encounter substantial hurdles as they go forward.
Flying Eagle Acquisition Corp. (FEAC) completed its IPO in March 2020. In September 2020, FEAC announced its plans to merge with Skillz, an online gaming platform. The merger transaction was completed in December 2020. Skillz completed a secondary offering in March 2021. In the subsequent securities class action complaint, the plaintiff alleged that the transactions overvalued Skillz because its reported revenue, the complaint alleges, was overstated as bonus incentive payments Skillz pays to users are “recycled” back to Skills in user fees, creating a cyclical flow of funds.
On March 8, 2021, Skillz was the target of a critical research report issued by Wolfpack Research that among other things said that the company’s revenue and user projections at the time of the merger were overstated because revenues from game developers and gaming downloads had declined prior to the transaction. According to the subsequent securities complaint, the company’s share price declined over 10 percent on this news.
Then on April 19, 2021, Eagle Eye Research published an anonymous report on Twitter raising questions about the bonus payments made to users, and the company’s revenue recognition practices, including a question whether the company was recognizing non-cash amounts as revenue. The report suggested that Skillz was effectively giving its users money to spend on the Skillz platform. The securities complaint alleged that the company’s share price declined over 6 percent on this news.
Finally, on May 5, 2021, the company issued its first quarter earnings statement, reflecting a $53 million loss. Among other things, the statement showed that the company’s payments to users had substantially increased. The company’s share price declined more than eight percent on this news.
As discussed here, in May 21, 2021, a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against Skillz, certain of its directors and officers, and the offering underwriters that led the March 2021 offering. The complaint alleged claims under both Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 11 and 12(a) of the Securities Act of 1933. After the plaintiff filed an amended consolidated complaint, the defendants filed motions to dismiss.
The July 5, 2022 Ruling
In a July 5, 2022 order (here), Northern District of California Judge Richard Seeborg granted the defendants’ motion to dismiss, without prejudice. The plaintiffs were given leave of 30 days in which to file an amended complaint.
In granting the motion to dismiss, Judge Seeborg found with respect to each of the seven categories of misrepresentations that the plaintiffs alleged that the plaintiffs had not sufficiently alleged falsity or that the statements were non-actionable forward-looking statements. Judge Seeborg further held that even if the plaintiffs had sufficiently alleged falsity, the plaintiffs’ complaint did not sufficiently allege scienter. Judge Seeborg wrote that “At worst, the statements appear to be poorly worded explanations of what games Skillz offered, rather than a statement made with a mental state embracing intent to deceive, manipulate, or defraud.”
Judge Seeborg also held that the plaintiffs lacked standing to assert the ’33 Act claims, and held further that even if the plaintiffs had standing, their complaint “does not adequately plead untrue statements or omissions of material facts” sufficient to sustain the ’33 Act claims.
The grant of the motion to dismiss here is significant in and of itself, if for no other reason that we are still in the early days of the SPAC-related securities litigation phenomenon, so developments in these cases can be important to the extent they suggest how many of these cases may fare.
There is another way in which the ruling in this case is significant, and that has to do with the fact that in asserting their claims, the plaintiffs here relied heavily on allegations against the company that first appeared in short seller reports. Many of the other SPAC-related securities class action lawsuits that have been filed in the last 18 months have also relied heavily on allegations raise in short seller reports. By my tally, 20 of the 48 SPAC-related securities class action lawsuits that have been filed since January 1, 2021 (about 41%) relied in whole or in part of allegations raised in short-seller reports. The fact that the allegations here were found to be insufficient to sustain the alleged securities liability claims does suggest that the plaintiffs in many of the other SPAC-related suits that have been filed and that relied heavily on short seller reports could also face tough sledding as the cases move to the motion to dismiss stage.
For what it may be worth, Judge Seebold’s skepticism of the plaintiffs’ scienter allegations also seems significant to me. Many of the SPAC-related securities suits may also face difficulty meeting the initial pleading hurdles for scienter.
At the same time, there may be an extent to which this case may not be indicative of how other SPAC-related cases will fare. The allegations in this case all pertain to alleged misrepresentations that allegedly were made after the completion of the SPAC merger transaction. One could say that this case really doesn’t have much to do at all with the fact that operating company did a merger transaction with a SPAC. So it could be argued that the outcome of this case does not have a great deal to say concerning other cases involving alleged misrepresentations made in the runup to the SPAC merger transaction.
Finally, it should be noted that the plaintiffs were given leave to seek to amend their complaint. Although it seems unlikely given Judge Seeborg’s skepticism it is always possible that the plaintiffs will be able to cure the pleading defects in their complaint. To that extent then, any generalizations drawn from this ruling should be tempered in recognition that the last word on this case may not yet have been spoken.