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Wednesday
Mar012017

The U.S. District Court for the Northern District of California Denies Fitbit’s Motion to Dismiss Investors’ Exchange Act Violation Claims

This post is one of two posts discussing Fitbit’s allegedly false marketing claims regarding its heart rate monitoring devices. This post will specifically focus on claims made under the Securities Exchange Act of 1934 (“Exchange Act”). The other post covers claims made under the Securities Act of 1933.

In Robb v. Fitbit, Inc., et al., No. 16-cv-00151-SI 2016 BL 359028 (N.D. Cal. Oct. 26, 2016), Plaintiff Brian Robb filed a class action lawsuit on behalf of all persons who acquired Fitbit securities prior to the drop in Fitbit’s stock value, which was allegedly caused by inaccuracy of its heart rate monitors. Fitbit Inc. and Fitbit control persons James Park, William Zerella, and Eric Friedman, (collectively “Defendants”) filed a motion to dismiss claims made against them under the Exchange Act in connection with Fitbit’s marketing of its heart rate monitoring devices and its initial public offering (“IPO”). The district court denied the Defendants’ motion to dismiss and determined the plaintiff class (“Plaintiffs”) sufficiently alleged material misrepresentation or omission, scienter, and loss causation actionable under the Exchange Act.

According to the allegations, Fitbit in October 2014 announced its new “heart rate technology” and advertised heavily that it would be featured in two products. A January 2015 press release described the technology as superior tracking that “works no matter what you’re doing.” In June 2015, Fitbit completed its IPO with net proceeds reaching approximately $416 million. The IPO Prospectus described the new products as key revenue drivers. The sales of these devices led Fitbit’s revenues to reach $1.858 billion in 2015, up from $745.4 million in 2014. In August 2015, defendant Park made statements that the heart rate technology took many years to develop and Fitbit only launches products “when we feel they’re ready.” 

On January 5, 2016, Fitbit purchasers filed a class action lawsuit alleging inaccuracy of the heart rate monitoring technology, and on the same day, Fitbit’s stock dropped from $30.96 per share to $24.30 per share. On May 19, 2016 purchasers filed an amended complaint including study findings of the product’s inaccuracy and by that day’s closing Fitbit’s stock fell to $13.99 per share.

Plaintiffs filed the current lawsuit alleging Defendants violated Section 10(b) of the Exchange Act by making, knowingly, or with deliberate recklessness, misstatements and/or failing to disclose information about the technology’s inaccuracy. Plaintiffs asserted the impact of these products on Fitbit’s revenue motivated investment and gave Defendants incentive to inflate the devices’ performance. Two confidential witness statements from Fitbit data contractors reported Fitbit’s internal testing revealed the heart rate technology was inaccurate. Plaintiffs further alleged violations of Section 20(a) of the Exchange Act against the “control persons” by virtue of their roles in the company.

Defendants filed a motion to dismiss both claims on the basis that the Plaintiffs failed to sufficiently allege misstatements, scienter, and loss causation.

Section 10(b) of the Exchange Act prohibits any act or omission resulting in fraud connected with securities transactions. A plaintiff asserting a Section 10(b) claim must adequately allege the defendant’s material misrepresentation or omission, scienter, and loss causation. Section 20(a) of the Exchange Act holds “control persons” liable for violation of Section 10(b).

The court determined the alleged misstatements concerning the accuracy of the Fitbit products made in press releases and by control persons were statements upon which a reasonable investor would rely and were sufficient to state a claim for material misrepresentation. With respect to scienter, the court rejected Plaintiffs assertion that knowledge of the products “limited accuracy” could be inferred from the personal use of the device by some of the Defendants.  “Though defendants may have used the devices to track their own heart rates, there is no indication that they had any metric against which to compare these measurements in order to determine their accuracy. Their mere use of the devices thus fails to establish defendants' knowledge of inaccuracy and, taken individually, does not prove scienter.”

The court did, however, find that the statements by the confidential witnesses were sufficient to plead scienter. “In addressing the first prong of the CW analysis, both CW 1 and CW 2 held positions that exposed them directly to data and consumer complaints on the Charge HR and Surge, establishing their reliability and personal knowledge of the alleged inaccuracies. Second, both CW 1 and CW 2 reported directly to COO . . . indicating scienter by Fitbit executives.”

Finally, the court determined the correlation between the timing of the lawsuit questioning Fitbit’s technology and the drop in stock price was adequate to plausibly establish loss causation. Given these findings, the court held the Plaintiffs sufficiently alleged a claim for violation of Section 10(b), thus the claim for liability under Section 20(a) was also valid. Accordingly, the court denied the dismissal of either claim.

The primary materials for this case can be found on the DU Corporate Governance website.

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