Pomerantz Wins Ninth Circuit Reversal of Forescout Dismissal

POMERANTZ MONITOR | MARCH APRIL 2023

On March 16, 2023, the Ninth Circuit Court of Appeals reversed, in part, the dismissal of Pomerantz’s securities fraud class action against Forescout Technologies, Inc. and its senior officers. In so doing, the Ninth Circuit also set important precedents that significantly strengthen investor rights.

Forescout specializes in providing network security from malware and potential infiltrators for large computer networks. The operative complaint alleges that the defendants misled investors about the strength of the company’s sales pipeline to falsely support a bullish guidance and otherwise justify poor financial results when the company repeatedly failed to meet its touted objectives.

For its initial public offering in October 2017, Forescout reported growth averaging more than 30% a year in revenues for the fiscal years prior to the IPO. This steady growth continued in fiscal year 2018, with a 32% increase in reported revenues. However, as the company entered FY 2019, it encountered heightened competition from other industry players, primarily because Forescout’s products were not as well suited as theirs to providing solutions for cloud-based cybersecurity and remote working. Nonetheless, defendants provided revenue guidance to investors of 24% annual growth in revenue for FY 2019, despite the fact that a large amount of Forescout’s deals that were identified as “committed” in its sales pipeline had only a 50% chance of closing, according to a confidential witness (“CW”) in the case.

In 2020, Forescout’s alleged deception on the market continued, following its announcement that it had entered into a merger agreement with Advent International, Inc., a private equity firm. Under the terms of the agreement, Advent would acquire Forescout for $33 per share. However, Advent soon learned that the 2020 revenue projections Forescout had provided were inconsistent with the serious deterioration in the sales pipeline that the company had already experienced.

Just three months after Forescout’s announcement of the merger, Advent privately notified the company that it was terminating its acquisition, but defendants withheld these material facts from investors. Following litigation initiated by Forescout to force Advent to proceed with the merger, both parties entered into an agreement providing for Advent to acquire Forescout for $29 per share – a $300 million discount.

In 2021, the U.S. District Court for the Northern District of California dismissed the investors’ securities fraud lawsuit twice, ruling that the plaintiffs had insufficiently alleged that the statements made by the defendants were knowingly or recklessly false and misleading when made.

Plaintiffs appealed that decision to the United States Court of Appeals for the Ninth Circuit. The Court’s decision not only allows the plaintiffs to proceed with their complaint, but it also clarifies and establishes important standards regarding pleading falsity, misleading statements, and the use of information provided by confidential witnesses.

Regarding falsity, the Ninth Circuit’s decision confirms that:

No “dual pleading” standard exists where courts can “comingle” the lower standard for falsity with the higher standard for scienter unless the facts pleaded to support both elements are exactly the same.
Plaintiffs can rely on an expert opinion to bolster allegations of falsity.

Regarding misleading statements, the Ninth Circuit’s decision established that:

Defendants cannot ask courts to disregard the plain words of their own statements at the pleading stage, while instead crediting their attorney’s reimagination of what the statement said or meant.
Concrete” statements of material fact do not need to consist of “hard numbers” and “benchmarks.” Even vague claims like “we have a very large pipeline” can mislead investors, and the law in the Ninth Circuit has not held otherwise since at least the 1990s.
Misleading statements in direct response to specific analyst questions concerning the alleged fraud itself cannot be mischaracterized as puffery.
A defendant cannot rely on the disclosure of hypothetical risks to escape liability for a failure to disclose that he or she already has information suggesting that an event “might not” occur.
A risk does not need to actually materialize for cautionary language to be ineffective. A defendant’s awareness of a “significant likelihood” that the risk would materialize is enough.
Awareness of omitted facts that render a statement misleading is sufficient to demonstrate “actual knowledge” and overcome the PSLRA’s safe harbor.

While investigating the claims in this case, Pomerantz found twenty CWs who provided information that supported the allegations made in the complaint but who had no direct contact with any individual defendant. We successfully argued that this lack of direct contact was not dispositive even though many lower courts had previously dismissed securities class actions on this very ground. As a result, regarding CWs, the Ninth Circuit’s decision clarified that:

In pleading securities fraud, CWs do not need to talk to, hear from, or present information directly to an individual defendant.
When a defendant quibbles that a CW does not provide evidentiary minutia, a plaintiff can cite this decision to state that the defendant is attempting to create an “impossible” standard that the PSLRA never even contemplated.
In securities fraud cases related to misrepresentations regarding sales pipelines, a CW need not provide information about the “guidance” or “corporate level trends.”
Courts can consider even an “estimate” provided by a single CW.
A CW’s factual representations cannot be mischaracterized as presumed “disagreements” of “opinion” with higher level managers when the CW is reporting facts as opposed to merely expressing his or her own beliefs and opinions.
Plaintiffs can rely on a lower-level CW who hears from a third person that a defendant did something wrong or had awareness of certain facts that rendered his or her statements materially misleading.
Plaintiffs can rely on a CW who prepares reports for a mid-level manager, who is then alleged to have provided pertinent information to the individual defendant even if the CW did not directly present the information to the individual defendant or talk to or hear from the individual defendant.
If CWs state that a defendant did something or knew something during the Class Period, it is not necessary for the CWs to state that any of this happened before a particular statement was made.

With the Ninth Circuit holding that plaintiffs adequately stated claims under Section 10(b) and reversing the district court’s dismissal of the Section 20(a) claims for control person liability, Pomerantz’s Forescout class action has been remanded to the district court for further proceedings.

The Firm’s Forescout litigation team is led by Partner Omar Jafri and includes Senior Counsel Patrick V. Dahlstrom and Associate Brian O’Connell.