Northern District Of California Dismisses Putative Class Action Against Large IT Services Provider

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Shearman & Sterling LLPOn July 27, 2020, United States District Judge Beth Labson Freeman of the United States District Court for the Northern District of California dismissed, with leave to amend, a putative class action asserting violations of Sections 11 and 15 of the Securities Act of 1933 (the “Securities Act”) against a large IT services provider (the “Company”), certain of its officers, and its largest shareholder. Costanzo v. DXC Tech. Co., No. 19-cv-05794-BLF, 2020 WL 4284838 (N.D. Cal. July 27, 2020). Plaintiffs alleged that the Company’s prospectus and registration statement (the “Registration Statement”), issued in connection with the merger that created the Company, mislead investors about the true scale of, and the risks associated with, the Company’s plan to reduce its workforce costs. The Court granted defendants’ motion to dismiss because plaintiffs failed to allege that the statements in the Company’s Registration Statement were false and because the alleged misstatements were protected by the Private Securities Litigation Reform Act’s (“PSLRA”) safe harbor.

In April 2017, two IT services providers executed a “Reverse Morris Trust” merger. One of the IT service providers spun off a division into a new company, which then purchased the second IT service provider to form the Company. The second IT service provider’s company stock was then converted to the Company’s stock on a one-to-one basis. The Company filed a draft Registration Statement to register the Company’s shares that were issued and exchanged in the merger, which was declared effective in February 2017. A few days after the completion of the merger, the Company’s shares began trading on the New York Stock Exchange.

The Registration Statement announced that the Company expected to produce first-year “cost synergies” of $1 billion that would be achieved, in large part, through a “workforce optimization” plan that would eliminate duplicative roles and costs. Relying on allegations in a separate breach of contract suit against the Company brought by a former senior executive, who had been terminated a year after the merger, plaintiffs alleged that defendants failed to disclose that (i) the Company in fact intended to make $2.7 billion in workforce cuts, nearly triple what it had announced; (ii) the workforce cuts were made to inflate reported earnings and other financial metrics; and (iii) the scale and speed of these cuts would essentially cripple the Company’s workforce infrastructure, impeding its ability to deliver on client contracts and driving down its revenue.

The Court was unpersuaded. The Court, agreeing with its sister court in the Eastern District of Virginia, which had dismissed a similar suit against the Company, found that the allegations in the former executive’s complaint, even assuming that they were true, made clear that the $2.7 billion internal cost-cutting target was nothing more than an “aspirational goal” that was used to “reduce internal debate” within the Company. Because the plaintiffs had not alleged that the Company actually cut costs beyond the disclosed $1 billion—and, indeed, alleged no facts outside of those set forth in the former executive’s complaint—the Court held that plaintiffs had not alleged that the Registration Statement contained any false or misleading statements. According to the Court, the use of an internal aspirational goal as a tool to silence internal debate was “simply a business decision without any consequence to the investor.”

The Court also addressed defendants’ argument that the complaint should be dismissed because the alleged misstatements were forward-looking and therefore protected by the PSLRA’s safe harbor. The Court agreed with defendants, rejecting plaintiffs’ argument that the alleged misstatements were made in connection with an initial public offering (“IPO”) and therefore exempt from the PSLRA’s safe harbor. Although plaintiffs conceded that the merger was not a “vanilla IPO,” they argued that it should nevertheless be treated as an IPO because the Company had issued “a brand new, never before publicly traded security of a new and thus previously non-reporting company.” While the Court acknowledged that the PSLRA’s safe harbor does not extend to statements made in connection with an IPO, the Court was unpersuaded that the merger should be treated as an IPO. The Court found it particularly noteworthy that plaintiffs had not alleged that the Registration Statement referred to the stock issuance as an IPO or indicated that the stock had never before publicly traded.

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Costanzo v. DXC Tech. Co.

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