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On August 17, 2021, the Northern District of California dismissed with leave to amend a putative securities fraud class action alleging that a solar energy company and certain executives misrepresented and/or failed to disclose that the company’s revenues were artificially inflated. Hurst v. Enphase Energy, 2021 WL 3633837 (N.D. Cal. 2021) (Freeman, J.). The court held that the complaint failed to plead a material misrepresentation or omission under the heightened pleading standards of the Private Securities Litigation Reform Act (PSLRA). The court noted that the complaint was “entirely predicated on [a short seller’s] Report’s insistence that [the company’s] financial reporting does not add up.” However, the court determined the fact that plaintiff and the short seller could not “reconcile the financials reported by [the company] to their interpretation of the solar market, without more, does not plausibly allege a misstatement.”

Background

Plaintiff claimed that defendants misrepresented and/or failed to disclose to investors that its revenues were inflated and that the company engaged in improper deferred revenue accounting practices. Plaintiff’s allegations were largely derived from a 2020 short seller report. The report stated, among other things, that financial statements filed with the SEC by the company were “fiction” and that, based on their research, the short seller estimated that at least $205.3 million of reported US revenue in FY 2019 was fabricated. Plaintiff alleged that the company’s FY 2019 revenue was artificially inflated “by a whopping 47.7%.” The court stated that the report purported to be based on an analysis of the company’s reported financials along with a private investigation based on interviews with former employees.

The PSLRA Demands More Than Allegations That “Cherry Pick” Financial Data from a Short Seller Report

The court granted defendants’ dismissal motion on the basis that plaintiff failed to plead a material misrepresentation or omission. The court found that plaintiff failed to plausibly allege a misstatement by merely alleging that plaintiff and the short seller could not reconcile the company’s financials to their interpretation of the solar market.

The court also noted that plaintiff did not identify any restatement of the company’s accounting or any missed earnings revealing the impact of alleged accounting fraud. Considering the severity of the revenue inflation alleged—47.7% in FY 2019—the court found “it wildly implausible that neither such event would have occurred in the aftermath of the publication of the [short seller] Report.” Again reiterating that the allegations were directly derived from a short seller report, the court concluded that the PSLRA demands more than allegations that “do little more than cherry pick financial data and present such data in a manner favorable to Plaintiff’s theory.”

Plaintiff Failed to Allege How the Company Violated Its Accounting Standard

Separately, the court found that plaintiff failed to point to any accounting standard that the company misapplied. Specifically, plaintiff alleged that the company adopted the ASC 606 accounting standard in January 2018, but the court found that plaintiff failed to allege how the company ran afoul of this standard. The court stated that the complaint alleged in a “conclusory” fashion that the company began deferring both portions of its revenue after adopting the standard, but did not plead “facts that set out the why this deference was improper under GAAP.” The court concluded that while it is indisputable that “premature revenue recognition is a GAAP violation,” plaintiff must still plead facts supporting the existence of a GAAP violation. Explaining that GAAP provisions are subject to interpretation and “tolerate a range of reasonable treatments, leaving the choice among alternatives to management[,]” the court stated that plaintiff failed to plead any facts showing that the company exercised its judgment in a way that violated GAAP.