Southern District of New York Dismisses Putative Class Action Against Online Sports Gaming Company for Failure to Allege Actionable Misrepresentations or Scienter

USA (January 18, 2023) — On January 10, 2023, Judge Paul Engelmayer of the United States District Court for the Southern District of New York dismissed with prejudice a putative class action asserting claims under the Securities Exchange Act of 1934 against an online sports gaming and betting company and certain of its executives.  In re DraftKings Inc. Sec. Litig., 2023 WL 145591 (S.D.N.Y. Jan. 10, 2023).  Plaintiffs alleged that the company made misrepresentations and omissions regarding whether a target company it acquired had gambling operations in jurisdictions where gambling was illegal.  The Court held that plaintiffs failed to adequately allege actionable misrepresentations or scienter.

At the outset, the Court explained that when a securities fraud claim is premised on alleged predicate violations of law—here, the target’s allegedly illegal operations in jurisdictions that supposedly prohibited gambling—the facts of the underlying violation must be pleaded with particularity.  A plaintiff who is unable to do so cannot meet its burden of explaining what rendered the challenged statements false or misleading.  Id. at *18.  And the Court also stressed what it described as a “global deficiency” affecting plaintiffs’ theories of fraud—their claims regarding the target’s business practices were based virtually entirely on a short-seller’s report that was, in turn, largely based on unsourced or anonymously-sourced allegations.  Id.  More specifically, plaintiffs’ allegations derived from that short-seller report were held insufficient because (i) the report’s author had an interest in driving down the company’s stock price, requiring the Court to carefully analyze the report’s “factual attributions,” and (ii) the report’s sources were “unidentified and unspecified” and, even where allegations were generally attributed to unnamed former employees, they were “devoid of details lending themselves to corroboration.”  Id. at *18–20.  Moreover, the plaintiff’s counsel’s inability to confirm any of the statements in the report with either the short-seller’s founder or any of the purported sources identified in the report warranted the Court putting aside the complaint’s allegations based on the short-seller report as ill-pled.  Id. at *20.

The Court determined that other allegations also lacked particularized detail.  For example, plaintiffs alleged that the target was conducting illegal gambling operations in Vietnam, based on statements by purported former employees and the allegation that the target’s website showed that it accepted Vietnamese currency; the Court, however, concluded that allegations attributed to former employees lacked factual detail regarding those individuals’ positions and the source of their knowledge, and, further, merely accepting Vietnamese currency was insufficient to show illegal activity in Vietnam.  Id. at *22–23.  The Court also observed that plaintiffs had not sufficiently alleged that certain jurisdictions actually prohibited the target’s alleged gambling activities.  For example, the Court noted that plaintiffs pointed to certain websites regarding Indonesian law that the Court determined did not categorically show that all gambling activities were illegal.  Id. at *24.

The Court further rejected allegations derived from the analysis of a state lottery commission, which plaintiffs argued showed that the target had operated in Iran in violation of Iranian law and United States sanctions.  The Court explained that while the lottery commission’s analysis revealed that the target had identified a single instance in which wagers had been placed by a user based in Iran, it also explained that the target had immediately taken steps to end its relationship with a sublicensee that had allowed those wagers to be placed.  Id. at *25–26.  The Court found this conduct did not support an allegation that the target had been operating in Iran for nearly five years, nor otherwise suggest that the target had not complied with United States sanctions or Iranian law.  Id. at *25–26, *28.  The Court similarly rejected the plaintiffs’ generalized contention that the target violated unspecified anti-money laundering provisions.  Id. at *28–29.

The Court also rejected plaintiffs’ theories of scienter.  Plaintiffs first contended defendants had a motive and opportunity to commit fraud due to alleged trades the company’s executives made in the company’s stock.  But the Court determined that the trades in question were all made by sellers who retained more shares than they sold (with several sellers increasing their position during the relevant period), ten of the transactions were made pursuant to Rule 10b5-1 plans, and the remaining five were made pursuant to underwriting agreements that preceded the company’s public offerings and provided for sales immediately following a specified lock-up period.  The Court accordingly concluded that none of these trades supported an inference of scienter.  Id. at *33–35.

Plaintiffs otherwise attempted to argue that the company’s executives understood that the target had illegal gambling operations, but the Court rejected such allegations as conclusory.  Id. at *36.  The Court also observed that materials referenced in the complaint were consistent with the absence of fraudulent intent, as the lottery commission report also noted the target had retained counsel to provide it with legal advice about how to conduct operations in certain jurisdictions.  Id. at *37.  And the Court noted that the company’s response to the short-seller report, in which the company stated it was “comfortable” with its assessment of the target and declined to “comment on speculation or allegations made by former” employees of the target, did not constitute an admission that the target had violated the law.  Id.

The Court also explained that the complaint’s allegations of violations of Items 105 and 303 of Regulation S-K were insufficient for reasons similar to those that defeated plaintiffs’ misrepresentation claims, namely, because there were insufficient allegations that the target operated improperly or that the company knew of a material risk or uncertainty presented by those purportedly improper operations.  Id. at *37–38.

Because plaintiffs already had amended the complaint twice, the Court concluded that further amendment would be futile and dismissed the action with prejudice.  Id. at *39.

SOURCE: Shearman & Sterling LLP   / Lexology.