There are reasons to believe that the Atkins SEC may be less inclined than its predecessor to bring enforcement actions based on “hypothetical risk factors,” but the same can’t be said for private plaintiffs. In that regard, the 2nd Circuit’s recent decision in City of Hialeah Employees’ Retirement System v. Peloton Interactive (2d. Cir; 8/25) to revive fraud claims premised on hypothetical risk factor disclosure is likely to bolster their appeal to members of the plaintiffs’ bar.
In that case, the 2nd Circuit overruled the SDNY’s prior decision and reinstated Rule 10b-5 claims against Peloton arising out of, among other things, hypothetical risk factor disclosure concerning excess inventory levels. Here’s an excerpt from the Court’s opinion:
In its SEC filings of May 7, August 26, and November 4, 2021, Peloton warned: “If we fail to accurately forecast consumer demand, we may experience excess inventory levels or a shortage of products available for sale. Inventory levels in excess of consumer demand may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would cause our gross margins to suffer.”
We agree with the district court that the risk disclosure in the Form 10-Q of May 2021 was not actionable. But the risk disclosures in the Form 10-K and the Form 10-Q of August and November 2021 were plausibly false or misleading. The SAC plausibly alleged that by August 26, 2021, the specific financial consequences described in these disclosures were not merely hypothetical “but had already materialized and resulted in significant disruption to [Peloton’s] business.” Teladoc, 2024 WL 4274362, at *5.
The SAC alleged that following the earnings call on August 26, 2021, Peloton reduced the price of the original Bike by $400. See App’x 237 (¶ 187). According to CW1, this reduced price was a direct response to Peloton’s “excess inventory.” Id. at 184 (¶ 31). Moreover, on November 4, 2021, Peloton disclosed that 91 percent of its inventory was unsold and reduced its earnings guidance by approximately $1 billion. See id. at 178 (¶ 7); id. at 252-53 (¶¶ 219-23). In other words, Peloton was already engaging in “the sale of excess inventory at discounted prices.” Id. at 424.
The Court concluded that, accepting the plaintiffs’ allegations as true, the presentation of these inventory-related risks as hypothetical in Peloton’s August and November 2021 SEC filings was potentially misleading.
– John Jenkins
Dual class capital structures remain common in IPOs, but in response to investor pressure, many companies have opted to include a time-based sunset provision in their charter documents that will eventually eliminate the high-vote class of stock. When the ride sharing company Lyft went public in 2019, it took some heat from the CII for turbo-charging its high vote stock (20 votes per share v. the typical 10) and for failing to include sunset provisions in its charter. Last month, Lyft and its founders decided to unwind that structure.
That move came in connection with the departure of the company’s two founding shareholders from the board and was effectuated by their decision to convert their high-vote Class B common stock into low-vote Class A common stock. Here’s an excerpt from Lyft’s press release:
Lyft, Inc. (Nasdaq: LYFT) today announced that its co-founders, Logan Green, Chair of the Board, and John Zimmer, Vice Chair of the Board, intend to step down from the Lyft Board of Directors (the “Board”) on August 14, 2025, marking the successful completion of a two-year transition plan. Green and Zimmer will also convert all shares of Lyft Class B common stock to Lyft Class A common stock on August 15, 2025. Following the conversion, all holders of Lyft common stock will hold Class A common stock with equal voting rights, and Green and Zimmer will collectively own approximately 9.69 million shares of Lyft Class A common stock.
According to a recent ValueEdge Advisors blog, Green and Zimmer’s decision to convert their Class B shares reduced their voting power in the company from 30% to under 2%. The Class A common stock’s price popped by over 8% on the day after the announcement and has tacked on another 2.5% since then.
– John Jenkins
Last month, a Texas federal court refused to dismiss the state’s antitrust claims against BlackRock, Vanguard and State Street associated with their engagement with portfolio companies on ESG-related matters. This Cleary memo says that the Court’s decision is going to add another layer of complexity to engagements between companies and shareholders. This excerpt lays out why companies and shareholders are likely to proceed even more cautiously as a result of the decision:
Companies may be taking on greater risk when they take an action advocated by one or more shareholders (or other climate change advocates) that are also lobbying for actions at competing firms. Companies should avoid engaging with their competitors and overlapping shareholders in a group setting, or taking action because shareholders promise that they will also pressure competing firms to act similarly. The Texas case provides new contours to risk of a finding of collective action through industry or other groups, by including shareholders as a nexus to potential coordination.
Similarly, we expect shareholders may also refresh their engagement effort strategies in light of this case and take a more conservative, thoughtful and tailored approach to outreach with each company to avoid any optics of coordination among themselves or among their portfolio companies.
The blog contends that the potential for conspiracy liability raised by this decision together with the SEC’s guidance narrowing the path for major investors to file short form Schedule 13G beneficial ownership disclosures may have a cooling effect on the frequency of shareholder engagements and reduce the pressure placed on companies to make changes in line with investor policies.
As we previously blogged, the DOJ and FTC submitted a Statement of Interest in the Texas lawsuit. While the antitrust agencies weren’t supportive of the defendants on most of the issues raised by the lawsuit, they did clarify that engagements on governance topics wouldn’t typically jeopardize shareholders’ status as passive investors for purposes of the antitrust laws.
– John Jenkins
