Blue Coat Systems, Inc. was a web security firm that, in 2008, tried to break into the growing field of wide-area network optimization by acquiring a company called Packeteer, Inc. The move was supposed to secure long-term growth, but arguably had the opposite effect.

On May 27, 2010, Blue Coat issued some financial results and held a conference call with industry analysts. While Blue Coat had met its its previous financial projections, its forward- looking guidance was not as optimistic as in previous calls. The analysts (and their readers) apparently worried, because the next day Blue Coat shares lost a quarter of their value after unusually heavy trading. (In other words, investors stampeded to sell the stock.)

And, as sure as the elimination of redundant data transfers follows deduplication, that drop in value was followed by a class action complaint. The problem, in this case, was that Blue Coat had hit its financial projections; it had just reported a less-rosy future than it had described before.

The plaintiffs responded to that dilemma by contending that:

an inference can be drawn that Blue Coat had intentionally misled the market by making unduly positive statements about its business and prospects, with knowledge that actual conditions were less favorable.

The defendants moved to dismiss, posing the question: can you bring a securities class action based only on forward-looking statements? According to the Northern District of California in Scandlon v. Blue Coat Sys., Inc., No. C-11-4293, 2013 U.S. Dist. LEXIS 10433 (N.D. Cal. Jan. 25, 2013), the answer seems to be "no."

The court specifically held that the plaintiffs had not pled sufficient factual allegations to meet the heightened standards of the PSLRA. But, as a quick look at the three deficiencies the court identified shows, most attempts to sue only on forward-looking statements would founder on the same problems:

Falsity – The court found it difficult to determine exactly what statements the plaintiffs claimed were misrepresentations. This was complicated by the facts that a number of the statements the plaintiffs pointed to were non-actionable "puffery," and that

Businesses are entitled, however, to synthesize and analyze the available information, and to reach judgments as to how "rosy" things are or are not. Not every detail that informs the overall opinions expressed must be disclosed to avoid committing fraud, even if some of the judgments subsequently turn out to have been wrong.

Scienter – The PSLRA requires a specific allegation that the defendants had the state of mind to commit fraud. Here, the court noted that the plaintiffs had pled themselves into a corner. To justify their focus on forward-looking statements, the plaintiffs had stressed the theme that management had made a bad decision by buying Packeteer. But alleging that management might not be competent businessmen was inconsistent with an inference of scienter:

In essence, plaintiff is alleging that Blue Coat made bad business judgments and poorly executed its changes in strategy after the Packeteer acquisition. While plaintiff is trying to argue that Blue Coat management had become aware of such shortcomings by the time it was making the generally positive public statements in issue, an equally plausible inference is that to the extent any statements were unduly positive, that was merely another aspect of management’s failure to understand and respond well to business conditions. 

Loss causation – As the court succinctly pointed out, if the plaintiffs could not allege that any of Blue Coat’s statements were false, there was no way they could demonstrate that a false statement caused their financial loss.

So what is the takeaway here? The most effective motions to dismiss are the ones that really test whether the plaintiffs’ allegations hang together as a whole. If a court can’t reconcile the plaintiffs’ theory of the case, it’s not going to go forward, especially when it has to meet a heightened standard of pleading like Rule 9(b) or the PSLRA.