In a 2-1 split, the United States Court of Appeals for the Ninth Circuit revived securities fraud claims under Section 10(b) and Rule 10b-5 against chip maker NVIDIA and its CEO, Jensen Huang – claims previously dismissed by the Northern District of California.
In their amended complaint, class action plaintiffs alleged that during the Class Period (May 10, 2017, through November 14, 2018), NVIDIA and three of its officers, including Huang, knowingly or recklessly made materially misleading or false statements regarding the impact of cryptocurrency sales on NVIDIA's financial performance in order to minimize the extent to which NVIDIA's gaming segment depended on the notoriously volatile demand for cryptocurrency. The district court dismissed both Plaintiffs’ first complaint and amended complaint on the basis that Plaintiffs failed to sufficiently plead that NVIDIA and its officers’ false or misleading statements were made knowingly or recklessly. Plaintiffs appealed.
On appeal, the Ninth Circuit reversed, in part, holding that Plaintiffs adequately alleged that (1) Huang made materially false or misleading statements and (2) Huang made those statements with the required scienter.
Falsity Allegations: Although the sufficiency of Plaintiffs’ falsity allegations was not addressed by the district court, the majority opinion placed particular importance on the fact that Plaintiffs’ outside expert arrived at the same conclusion as an independent investigation regarding crypto-related revenue during the Class Period. Both concluded NVIDIA understated its crypto-related revenues by about $1.1 billion from May 1, 2017, to July 31, 2018. Plaintiffs pointed to multiple occasions where Huang affirmatively stated that NVIDIA’s crypto-related revenues were $150 million for a quarter – actual revenue from crypto-related sales was nearly $350 million for that quarter.
Because Huang’s statements on quarterly earnings calls and subsequent interviews substantially downplayed crypto-related revenue during the Class Period, the Ninth Circuit concluded this led “investors and analysts to believe that NVIDIA’s crypto-related revenues were much smaller than they actually were.” When NVIDIA’s subsequent earnings disclosures revealed it was significantly more dependent on crypto sales than Huang previously expressed, its stock price dropped 28.5%.
The dissent was critical of the majority’s approach, pointing out that the Ninth Circuit has never allowed an outside expert to serve as the primary source of falsity allegations under the Private Securities Litigation Reform Act (PSLRA). Moreover, the dissent noted that plaintiffs’ expert did not rely on NVIDIA’s internal data or documents, but instead relied almost exclusively on generic market research and post hoc calculations.
Scienter Requirement: The Ninth Circuit majority then concluded that Plaintiffs sufficiently pled scienter under the PSLRA with respect to Huang’s statements. Here, the majority relied on confidential statements from former NVIDIA employees, who “confirmed that Huang personally reviewed NVIDIA’s sales data through [NVIDIA’s] centralized sales database” and that “Huang was the most intimately involved CEO he had ever experienced.” On this basis, Plaintiffs’ amended petition provided sufficient particularity to support the probability that a person in the position occupied by the former employees would possess the information alleged. Accordingly, the Ninth Circuit held that plaintiffs sufficiently stated a claim for relief under Section 10(b) and Rule 10b-5 against Huang and NVIDIA. The majority further reasoned that “[w]hile the PSLRA significantly altered pleading requirements in private securities fraud litigation, it did not impose an insurmountable standard.”
Going Forward: NVIDIA’s dominant position in the A.I. chip market and the promise of generative A.I.’s future development has contributed to NVIDIA’s recent $1 trillion market capitalization. In fact, NVIDIA’s stock price has increased by over 11,000% during the last ten years. Given this Ninth Circuit reversal at the pleadings stage, investors will likely fix a keen eye on how NVIDIA categorizes and discloses its revenue from A.I.-related sales.