On October 21, 2020, Judge Beth Labson Freeman of the United States District Court for the Northern District of California dismissed a putative securities class action against a large online cloud-based storage provider (the “Company”), certain of its officers and directors, certain of its controlling shareholders, and the underwriters of its IPO, for alleged violations of Sections 11 and 15 of the Securities Act of 1933 and Item 303 of SEC Regulation S-K. In re Dropbox Securities Litigation, No. 19-cv-06348 (N.D. Cal. Oct. 21, 2020). Plaintiffs alleged that the offering materials filed in connection with the Company’s IPO omitted to disclose the decelerating rate at which the Company was converting non-paying registered users into paying subscription users, which gave investors a false impression of the Company’s revenue growth. The Court dismissed the complaint with leave to amend because plaintiffs failed to allege the offering materials were false or misleading and because plaintiffs’ claims were time-barred.
The Company provides online cloud-based storage and collaboration services on free and paid subscription bases. The offering materials described a three-pronged business model based on (i) attracting new users (free or paid); (ii) converting free users to paid users; and (iii) upgrading paid user subscriptions. The offering materials also disclosed the numbers of the Company’s registered and paying users at the time of the IPO and that the Company’s revenue growth rate had started to decline. Plaintiffs alleged, however, that the offering materials failed to disclose that the rate of converting non-paying registered users into paying subscription users was decelerating and that this was the cause of a material decline in the Company’s revenue growth.
The Court dismissed these claims. The Court found that plaintiffs did not allege a single fact regarding the Company’s user conversion metrics despite the fact that their entire theory of liability was premised on an alleged declining conversion rate. Accordingly, the Court ruled that plaintiffs’ assertion regarding a declining conversion rate was mere speculation. The Court declined plaintiffs’ invitation to infer a declining conversion rate because the Company disclosed other factors that could have contributed to the declining paying users and revenue, holding that, “[w]hen faced with two possible explanations[,] . . . plaintiffs cannot offer allegations that are ‘merely consistent’ with their favored explanation but are also consistent with the alternative explanation. Something more is needed, such as facts tending to exclude the possibility that the alternative explanation is true.” The Court further held that plaintiffs failed to explain why the Company’s omission of user conversion metrics created an “impression of a state of affairs that differs in a material way from the one that actually exists.” To the contrary, the offering materials disclosed the Company’s declining revenue and paying user rates. The “only plausible inference” from these disclosures was that all drivers of the Company’s revenue—including its conversion rate—were declining.
Finally, the Court held that plaintiffs’ claims were barred by the one-year statute of limitations applicable to Securities Act claims. Plaintiffs—who filed suit on October 4, 2019—contended that they had no notice of the downward trend in the Company’s growth until the Company disclosed its earnings in November 2018. While noting that the motion to dismiss is “usually not the appropriate juncture of the Court to make a conclusion about inquiry notice,” the Court stated that it “is not categorically precluded from doing so,” and that the offering materials filed in March 2018 and the Company’s other financial announcements between March and October 2018 “irrefutably demonstrates [that plaintiffs] discovered or should have discovered the alleged misstatements or omissions at least a year before October 4, 2019.”
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In re Dropbox Securities Litigation