The 9th Circuit has upheld a district court’s dismissal of a class-action lawsuit against Align Technology that alleged the orthodontic technology company misled investors about its 2011 acquisition of Cadent, a provider of 3D digital scanning solutions for orthodontics.
The lawsuit, which had the City of Dearborn Heights Police and Fire Retirement System as its lead plaintiff, claimed that Align made false and misleading statements concerning its goodwill valuation of Cadent. It alleged that the company deliberately overvalued the goodwill of Cadent’s computer-aided design and manufacturing and scanner unit when Align conducted its 2011 annual goodwill impairment.
The plaintiffs argued that the $187.6 million purchase price for Cadent, which was justified in part on Cadent’s 2010 revenues, was artificially inflated. They cited former Cadent employees as confidential sources, who said Cadent “offered substantial and unprecedented discounts to its customers in the last quarter of 2010” in an attempt to make itself “appear more valuable to an acquirer.”
The suit claimed the practice, known as channel stuffing, resulted in an unsustainable 147% increase in scanner sales by Cadent for the 2010 fiscal year. It also alleged Align had knowledge of Cadent’s channel stuffing because it would have been “readily apparent” from Align’s due diligence, and direct access to Cadent’s financial reports and company documents through a data room that Cadent made available during the acquisition process. Align allegedly used Cadent’s artificially inflated 2010 revenue as the basis for projecting a 20% sales growth rate, and 50% gross margins for the unit.
Although the unit’s revenue increased sequentially from the fourth quarter of 2011 to the second quarter of 2012, it never met the projected 20% growth rate in any quarter following the acquisition. The unit’s gross margins also failed to meet the 50% projection, and instead ranged from 24% to 36%.
The circuit court panel affirmed the district court’s dismissal for failure to adequately plead falsity or scienter (intent or knowledge of wrongdoing) of a securities fraud action under the Securities Exchange Act of 1934 and SEC Rule 10b-5. The panel said the plaintiffs failed to sufficiently plead falsity under any of the three Omnicare standards, which were established by the Supreme Court’s 2015 decision in Omnicare Inc., v. Laborers District Council Construction Industry Pension Fund.
The three standards are:
- When a plaintiff relies on a theory of material misrepresentation, the plaintiff must allege both that the speaker did not hold the belief she professed, and that the belief is objectively untrue.
- When a plaintiff relies on a theory that a statement of fact contained within an opinion statement is materially misleading, the plaintiff must allege that the supporting fact the speaker supplied is untrue.
- When a plaintiff relies on a theory of omission, the plaintiff must allege facts going to the basis for the issuer’s opinion, whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.