On March 16, 2017, District Judge Ann M. Donnelly of the United States District Court for the Eastern District of New York dismissed with prejudice a putative class action against Etsy, Inc., its CEO, CFO, certain of its directors, and the underwriters of its initial public offering (“IPO”).  Altayyar, et al., v. Etsy, Inc., et al., No. 1:15-cv-2785 (E.D.N.Y. March 16, 2017).  Plaintiffs alleged that the company and the individual defendants violated Section 10(b) of the Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, by artificially inflating Etsy’s stock price through misrepresentations leading up to Etsy’s IPO, causing plaintiffs to suffer losses when additional information was revealed and the company’s stock price dropped.  Plaintiffs also brought claims under Sections 11 and 12(a)(2) of the Securities Act of 1933 (the “Securities Act”) against all defendants, as well as claims under Section 15 of the Securities Act and Section 20(a) of the Exchange Act against the individual defendants.  In dismissing the complaint in its entirety, the Court found that plaintiffs had failed to establish that the company’s statements were objectively false, intentionally inaccurate, or materially misleading when made.

Etsy operates a website that connects buyers and sellers of handmade and vintage goods, as well as craft supplies. Plaintiffs—investors in Etsy’s April 16, 2015, IPO—alleged that the prospectus and registration statements filed in support of the IPO contained false and misleading information regarding the company’s “values,” including its commitment to working with artisans, entrepreneurs, and small-batch manufacturers; its business operations; and its performance metrics.  According to plaintiffs, who sought to bolster their allegations with statements from six confidential witnesses who were former employees of the company, the company’s offering materials omitted that its marketplace included mass-producers of counterfeit goods, overstated its performance metrics because it did not discount sales relating to counterfeit sellers, and, contrary to the company’s representations, maintained a “lax” approach to compliance, doing “the bare minimum” to address ongoing infringement issues. 

Judge Donnelly disagreed.  In addition to finding that statements about the company’s culture were inactionable puffery, the Court found that the company’s use of words like “mindful,” “humane,” “genuine,” and “authentic” to describe its marketplace were not quantifiable or factual, but rather were statements of opinion that, under Omnicare, were subject to interpretation and were not actionable as fraud.  Regarding allegations concerning the company’s financial performance, the Court found that Etsy had sufficiently explained its methodology for the calculation of its financial metrics and had supplied investors with all the necessary information to assess the reported financial results.  Lastly, the Court agreed with defendants that plaintiffs had not alleged facts sufficient to suggest that the company’s CEO was deliberately lying in asserting that he “believed” Etsy’s compliance system “was working.”  Notably, the Court determined that while plaintiffs’ allegations “might show that Etsy’s compliance practices were imperfect—perhaps even awful—and that its managers knew of ongoing infringement problems,” plaintiffs had not established that Etsy’s statements were “objectively false or disbelieved” when made.  Finding no misstatement or intent to deceive, the Court dismissed the fraud claim.

Further, after first determining that Plaintiffs’ Section 11 and 12(a)(2) claims should be subject to the standard Rule 8 pleading requirements because those claims sounded in negligence rather than fraud, the Court dismissed those claims, finding that, for the same reasons why the Exchange Act claims were defective, plaintiffs had failed to plead any actionable material misstatements or omissions, even under Rule 8.  Finding that plaintiffs failed to allege primary liability under either the Securities Act or the Exchange Act, the Court dismissed the control person liability claims under Sections 15 and 20(a) thereof, respectively, against the individual defendants. 

The decision serves as a reminder of the high pleading standard that plaintiffs must meet in alleging Section 10(b) or Section 11 and 12(a)(2) claims, even when the complaint is supported by numerous confidential witness statements.  The decision also reinforces that courts will carefully distinguish between aspirational or opinionated statements that are not actionable under the Exchange Act or Securities Act, on the one hand, and factual assertions that may provide the basis for liability under the securities laws, on the other.