On July 2, 2024, Judge Haywood S. Gilliam of the United States District Court for the Northern District of California granted a motion to dismiss a putative class action asserting claims under the Securities Exchange Act of 1934 against a cybersecurity company and certain of its officers. In re SentinelOne, Inc. Sec. Litig., No. 23-cv-2786-HSG (N.D. Cal. July 2, 2024). Plaintiff alleged that defendants artificially inflated key business metrics in its SEC filings, necessitating a downward revision of revenue and projection figures. The Court dismissed plaintiff's claims without prejudice, primarily for lack of scienter.
The company provides cybersecurity products to clients on a subscription basis. The subscriptions typically range in length from one to three years. The company recognizes revenue over the term of these contracts in line with Generally Accepted Accounting Principles ("GAAP"). But it allegedly also tracks Annualized Recurring Revenue ("ARR"), a non-GAAP metric. The company allegedly describes ARR in its public filings as the projected yearly revenue it receives from current subscription contracts assuming that its clients renew their contracts without any changes.
In June 2023, the company allegedly announced a significant downward adjustment to its reported ARR figures and its ARR projections. The company purportedly cited two reasons for its ARR adjustment. First, "changing macroeconomic factors" allegedly required the company to remove certain non-guaranteed categories of revenue from the ARR. Second, the company allegedly discovered that it had been double-counting revenue earned from the same subscription contracts in certain circumstances.
Plaintiff alleged that defendants made false and misleading statements in public filings prior to the downward adjustment that undermined the company's stated rationale. In particular, plaintiff alleged that the company defined ARR to exclude the non-guaranteed revenue inputs that the company had announced it was removing from its ARR adjustment. Plaintiff also alleged that the individual defendants certified the accuracy of the incorrect ARR figures and projections when they were published and that this demonstrated that the company controls were inadequate.
The Court first addressed whether plaintiff identified any false or misleading statements. While the Court held that plaintiff adequately alleged the falsity of the ARR figures and projections, it also held that plaintiff failed to plead plausibly any other false or misleading statements. In so holding, the Court concluded that the company's definition of ARR arguably included the non-guaranteed revenue inputs that were subsequently removed in connection with the downward adjustment. Furthermore, the Court rejected plaintiff's inadequate control allegations, finding it to be significant that the controls in place caught some of the errors that necessitated the ARR adjustment.
The Court next addressed scienter. Plaintiff alleged that defendants knew the ARR figures and projections were false, and that defendants only corrected them once it became clear they could no longer hide the truth from the market. To support this theory, plaintiff relied on a confidential witness, the individual defendants' purported trading activity, and the core operations doctrine. The Court held that none—either on its own or considered together—raised a sufficiently strong inference of scienter. The Court found plaintiff's confidential witness allegations unreliable because there were no facts to suggest the confidential witness was in a position to have insight into individual defendants' state of mind. The Court further concluded that it could not infer scienter from plaintiff's allegation that individual defendants traded company stock several months before the ARR revisions because plaintiff did not provide any meaningful trading history against which it could compare the trades. Finally, the Court found that plaintiff could not rely upon a core operations doctrine because they did not allege the individual defendants played any role in calculating ARR or that they were otherwise informed of inaccuracies in ARR.
The Court granted plaintiff leave to file a further amended complaint but directed that any such complaint be accompanied by a detailed statement-by-statement chart specifically identifying each challenged statement and plaintiff's basis for contending that the statement was false or misleading and made with the requisite scienter.
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