On August 26, 2024, Judge Araceli Martínez-Olguin of the United States District Court for the Northern District of California granted a motion to dismiss a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 against a financial technology company (the “Company”) and certain of its officers. In re Affirm Holdings, Inc. Sec. Litig., 22-cv-07770-AMO (N.D. Cal. Aug. 26, 2024). Plaintiff alleged that the Company made false and misleading statements regarding its ability to manage interest rate risks and the impact of rising interest rates on its business. The Court held that plaintiff failed to allege facts that raised a strong inference that defendants made those alleged misstatements with scienter and dismissed plaintiff’s claims without prejudice.
The Company allegedly generates a significant portion of its revenue by providing credit to borrowers with low or “subprime” credit ratings. According to plaintiff, the Company principally relies on funding from three sources: (1) warehouse lending facilities with certain banks; (2) forward-flow arrangements to sell loans to wholesale buyers, thereby offloading the economic interest in the loan to those buyers but continuing to earn servicing fees; and (3) bundling and selling loans through asset-backed securities. When, in March 2022, the Federal Reserve undertook the first of a series of interest rate-hikes, the Company’s funding sources began to diminish because its loans became riskier to its bank partners, wholesale buyers, and investors alike. Through March 2023, the Company’s stock declined repeatedly after missing analyst expectations and reporting poor financial results, as interest rates continued to rise.
Plaintiff filed a second amended complaint on January 19, 2024, alleging that the Company, through its chief executive and financial officers, made numerous public statements that misrepresented the Company’s preparedness for interest rate hikes and the extent to which rising rates would impact the Company’s funding and financial performance. Plaintiff proffered several theories in support of scienter, including: (1) certain statements by the Company’s officers identified in the opposition brief; (2) the core operations doctrine; (3) confidential-witness allegations; (4) supplemental allegations concerning statements made by the Company after the litigation commenced purportedly demonstrating requisite state of mind; and (5) the proximity of the alleged misstatements to the Company’s corrective disclosures.
The Court found that even assuming the falsity of the 11 purported misstatements identified in the complaint, plaintiff’s failure to proffer facts sufficient to raise a strong inference of scienter was independently fatal to plaintiff’s claims. The Court disposed of plaintiff’s first two theories on the ground that it relied upon facts not alleged in the complaint, but rather on facts improperly introduced through plaintiff’s opposition brief. The Court then turned to plaintiff’s confidential witness allegations. It found that two of three witnesses—one of whom alleged that his superior notified certain of the Company’s officers about interest rate risks, and the other of whom alleged that he and members of his team did not believe certain officers were being truthful when they spoke about interest rate risks—lacked requisite personal knowledge about defendants’ state of mind. Meanwhile, the Court found that the third confidential witness’s allegations that he had personally notified defendants about risks relating to rising interest rates enabled only a reasonable inference that there was internal disagreement at the Company regarding the impact of the Federal Reserve’s hikes, not a strong inference that defendants acted with scienter.
Next, the Court addressed plaintiff’s supplemental allegations that defendants began to admit the extent of the risks posed by interest rate risks in approximately February 2023. The Court disagreed that this theory raised a requisite inference of scienter because plaintiff failed to allege facts showing defendants’ earlier statements were inaccurate at the time they were made. Thus, those statements were wholly reconcilable with defendants’ subsequent acknowledgment of rising interest rates’ impact on the Company’s business. Finally, the Court found that plaintiff could not rely on the temporal proximity between the alleged misstatements and the Company’s corrective disclosures, standing alone, to plead scienter.
The Court dismissed plaintiff’s claims under Section 20(a) for failure to allege a primary violation. The Court granted plaintiff leave to file a third amended complaint.
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