Robb v. Fitbit Inc.

Citations: 216 F. Supp. 3d 1017; 2016 U.S. Dist. LEXIS 149321; 2016 WL 6248896Docket: Case No. 16-cv-00151-SI

Court: District Court, N.D. California; October 26, 2016; Federal District Court

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The Court denies the defendants' motions to dismiss the claims of the Lead Plaintiff, Fitbit Investor Group, as detailed in the Amended Complaint. The allegations concern Fitbit's marketing and the performance of its heart rate tracking devices, specifically the Charge HR and Surge, which featured the proprietary PurePulse optical heart rate technology. Key points include Fitbit's IPO, completed on June 18, 2015, raising approximately $416 million, and a subsequent secondary offering on November 13, 2015, netting about $82.7 million. The rapid sales of these devices significantly contributed to Fitbit's revenue growth in 2015, reaching $1.858 billion, with the Charge HR and Surge identified as primary revenue drivers. However, from January to May 2016, concerns regarding the inaccuracy of the heart rate monitoring features emerged, culminating in a class action lawsuit filed on January 5, 2016, which alleged that the devices posed serious health risks. This led to a significant decline in Fitbit's stock price from $30.96 to $13.99 per share during that period.

Fitbit's devices were alleged to significantly undercount users' heart rates, especially during exercise, posing a risk of dangerous overexertion. On January 5, 2016, Fitbit's stock closed at $24.30, down from a high of $30.96. Following a February 22, 2016, news report about a study revealing a 14 percent average heart rate error in Fitbit's Charge HR, the stock plummeted 27.9 percent to $13.08. An Amended Consolidated Master Class Action Complaint filed on May 19, 2016, included findings from the most comprehensive study on Fitbit heart-rate monitors, stating they do not accurately measure heart rates during moderate to high-intensity exercise. This news led to another drop in stock price to $13.99.

Plaintiff Brian Robb initiated a securities class action lawsuit on January 11, 2016, regarding Fitbit's marketing and initial public offering. The Fitbit Investor Group was named lead plaintiff on May 10, 2016, and the plaintiffs filed an Amended Complaint on July 1, 2016, against Fitbit, its executives, and IPO underwriters. They allege that misleading statements about the accuracy of Fitbit's heart rate tracking led to inflated security prices. Following the revelation of these inaccuracies, plaintiffs claim the stock lost 54.8 percent of its market value, resulting in significant financial losses. 

The plaintiffs assert claims under the Securities Exchange Act of 1934 and the Securities Act of 1933, targeting all individuals who acquired Fitbit securities between June 18, 2015, and May 19, 2016. They allege violations of Section 10(b) of the Exchange Act against Fitbit and specific executives for knowingly or recklessly issuing false statements about heart rate tracking. They also claim control person liability under Section 20(a) of the Exchange Act and violations of Section 11 and Section 15 of the Securities Act against all defendants for issuing misleading statements and failing to disclose vital facts about the devices' inaccuracies.

On July 29, 2016, the Fitbit defendants filed a motion to dismiss (Dkt. No. 107), followed by the Underwriter defendants on August 5, 2016, who joined in the motion regarding the Section 11 claim (Dkt. No. 110). The Court granted the plaintiffs permission to file a single opposition brief limited to 35 pages on August 25, 2016 (Dkt. No. 112).

To withstand a Rule 12(b)(6) motion to dismiss, a plaintiff must present sufficient factual allegations that make their claim plausible, as established in *Bell Atl. Corp. v. Twombly* and *Ashcroft v. Iqbal*. This requires more than mere possibilities or conclusory statements; facts must support legal conclusions. The court evaluates the allegations by accepting them as true and drawing reasonable inferences in favor of the plaintiff, while rejecting conclusory or unwarranted deductions. Generally, the court will not consider materials outside the pleadings unless they are public records, which can be judicially noticed.

If a complaint is dismissed, the court must decide on granting leave to amend, following the principle that leave should be granted unless no potential for amendment exists.

In the discussion regarding the Exchange Act claims, the Fitbit defendants (including Park, Zerella, and Friedman) argue for the dismissal of the plaintiffs' Section 10(b) claim, asserting that the amended complaint inadequately alleges actionable misstatements, scienter, and loss causation. The Section 10(b) of the Exchange Act prohibits manipulative or deceptive practices in securities transactions, requiring plaintiffs to prove six specific elements: a material misrepresentation or omission, scienter, a connection to the transaction, reliance, economic loss, and loss causation, as outlined in *Kelly v. Electronic Arts, Inc.*.

The Private Securities Litigation Reform Act of 1995 mandates that complaints under Section 10(b) must plead falsity and scienter with particularity. Falsity requires specifying each misleading statement, the reasons for its misleading nature, and the factual basis for this belief. Scienter necessitates stating facts that create a strong inference that the defendant acted with intent or deliberate recklessness in making false or misleading statements. Additionally, Federal Rule of Civil Procedure 9(b) requires detailed allegations of fraud or mistake, applicable to securities fraud claims.

In the case at hand, defendants Fitbit, Park, Zerella, and Friedman contend that the statements cited by the plaintiffs are not false or misleading, arguing that they do not assert that PurePulse technology is always accurate and label many statements as mere promotional slogans. They claim that reasonable investors would not rely on promises of perfection in post-IPO statements. In contrast, plaintiffs argue that it was reasonable for investors to interpret the defendants' statements as suggesting consistent accuracy of Fitbit devices, particularly regarding heart rate tracking.

The Amended Complaint alleges that defendants made materially false or misleading statements about the Charge HR and Surge devices, including pre-IPO press releases from October 2014 and January 2015 that misled readers into believing the devices could accurately track heartbeats. Specific statements cited include descriptions of the Charge HR and Surge as providing “continuous, automatic wrist-based heart rate” tracking and using "finely tuned algorithms," as well as claims of "superior heart rate tracking" technology. The plaintiffs assert that these statements misrepresented the actual performance and accuracy of Fitbit’s devices.

Plaintiffs allege that defendant Park's statements during interviews on March 19 and March 27, 2015, misled consumers regarding the heart rate measurement capabilities of the Fitbit Surge. Park suggested that advancements in wearable technology could enhance medical diagnostics and claimed that PurePulse technology was the result of extensive research and development. He also stated that his heart rate was accurately reflected by the device, creating a misleading impression of the device's accuracy, especially given a noted difference of 9 beats per minute. 

The IPO Prospectus claimed that Fitbit's products provided highly accurate measurements and continuous heart rate tracking. However, plaintiffs assert that following the June 18, 2015 IPO, Park continued to make misleading statements about the accuracy of Fitbit's heart rate tracking technology, particularly during high-intensity activities. In a June 25, 2015 interview, Park acknowledged tradeoffs in technology but maintained satisfaction with the optical heart rate tracking of the Surge. Additionally, in an August 5, 2015 earnings call, he implied that PurePulse technology was ready for use as advertised, despite evidence to the contrary regarding its accuracy.

The Secondary Offering Prospectus filed on November 13, 2015, allegedly reiterated false claims from the IPO Prospectus about the accuracy of Fitbit's heart rate monitoring. Lastly, statements made in a November 23, 2015 press release following the Secondary Offering were also claimed to be materially false and misleading.

Fitbit's press releases claimed that its PurePulse heart rate technology was enhanced for improved tracking during high-intensity workouts and asserted its commitment to the accuracy of its wrist-based activity trackers. However, the court found that plaintiffs alleged actionable misstatements under securities law, as outlined by the Ninth Circuit. Misstatements become actionable when the speaker does not believe in the statement, lacks a reasonable basis for belief, or is aware of facts undermining the statement’s accuracy. 

Plaintiffs highlighted false claims in the IPO Prospectus about the accuracy and continuous tracking capabilities of Fitbit devices, asserting that these devices frequently provided inaccurate heart rate readings, especially during exercise. Specific statements from press releases about continuous heart rate tracking were cited as misleading. Furthermore, the Secondary Offering Prospectus continued to describe Fitbit devices as having "highly accurate measurements," despite the alleged inaccuracies.

The court referenced a related case where Fitbit's promotional language about sleep tracking was deemed actionable, emphasizing that specific misdescriptions of product capabilities are subject to fraud allegations, unlike vague assertions of superiority. Plaintiffs contended that Fitbit misrepresented its devices' ability to track heart rates continuously and automatically, arguing that such claims are not mere puffery but specific misstatements that could mislead investors.

Plaintiffs in the case assert that certain statements made by defendant Park, including expressions of optimism about future advancements and personal satisfaction with a product, are non-actionable opinions that reasonable investors would not rely upon. Defendants argue that the complaint lacks sufficient factual support to prove the falsity of Fitbit's claims about its devices. However, the court distinguishes this case from precedents where reliance on customer complaints was insufficient. Unlike those cases, plaintiffs allege that Fitbit’s products failed to perform as advertised, specifically regarding continuous heart rate tracking—a direct claim of product failure. 

Regarding scienter, defendants contend that the complaint does not adequately plead the necessary state of mind. For a strong inference of scienter, the complaint must present particular facts suggesting that the defendants acted with intent or recklessness. The standard requires that all facts collectively lead to a compelling inference of scienter, as opposed to evaluating individual allegations in isolation. The court finds that plaintiffs have sufficiently alleged material misrepresentations or omissions by Fitbit to withstand a motion to dismiss.

The Ninth Circuit employs a dual inquiry to assess allegations of scienter, first evaluating if any individual allegations alone create a strong inference of intent or recklessness, and if not, conducting a holistic review of all allegations collectively. Plaintiffs contend that Fitbit’s management had a motive to misrepresent the accuracy of its PurePulse heart rate monitoring technology during its IPO, as this technology was crucial for significant revenue generation from key products like Charge HR and Surge. However, under the PSLRA's heightened pleading standard, mere allegations of motive and opportunity are insufficient to establish a strong inference of deliberate recklessness. Plaintiffs must provide specific facts demonstrating intent beyond mere motive. While the allegations regarding management’s incentives may be relevant in a broader context, they fail to meet the required standard on their own.

Additionally, plaintiffs assert that individual defendants were aware of the devices' inaccuracies based on their personal use. However, the mere fact of personal use does not sufficiently demonstrate their knowledge of inaccuracies, as the inference of scienter needs to be strong and compelling, not merely reasonable. The defendants' statements about the technology do not provide adequate evidence of knowledge regarding the devices' limitations, and thus, these allegations also do not establish scienter independently.

Plaintiffs allege that on November 2, 2015, during a conference call, Fitbit's CEO Park expressed strong confidence in the company's future, shortly before selling 11% of his Fitbit shares in a secondary offering. While unusual insider stock sales can suggest scienter (intent or knowledge of wrongdoing), such sales are only suspicious if they deviate significantly from prior trading patterns and are timed to capitalize on undisclosed information. Key factors in assessing this include the volume of shares sold, the timing of the sales, and the insider's historical trading behavior. In this case, plaintiffs failed to provide a meaningful trading history for Park, making it difficult to establish scienter based solely on his stock sale.

Furthermore, plaintiffs reference statements from three confidential witnesses (CWs) to support claims of executive awareness regarding inaccuracies in Fitbit's PurePulse devices. To meet the Private Securities Litigation Reform Act (PSLRA) pleading requirements, the CWs must be sufficiently described to demonstrate reliability and personal knowledge. Statements from CW 1, a data scientist contracted by Fitbit, indicate that he provided monthly reports on customer complaints and device failures, highlighting significant heart-rate monitoring issues by mid-2015. These reports were directed to COO Hartmann, and it was noted that Fitbit's testing involved athletes using the devices, with a focus on addressing heart-rate inaccuracies. The details suggest that CW 1's insights contribute to establishing scienter, unlike the allegations surrounding Park’s stock sales.

CW 2 served as a contract fitness tester at Fitbit from April to July 2015, supervising a team of eight to ten testers who logged heart rate results while exercising with Fitbit devices. CW 2 reported to COO Hartmann and claimed that Fitbit's heart-rate monitoring was significantly inaccurate, especially during vigorous exercise and for users with very light or dark skin tones. This personal experience, along with CW 1's similar role, supports their reliability as witnesses regarding the alleged inaccuracies of the Charge HR and Surge devices and indicates potential scienter among Fitbit executives. However, statements from CW 3, an executive assistant during the same period, were deemed insufficient to establish scienter, as they lacked the necessary connection to the specific inaccuracies reported.

The court conducted a holistic review of the allegations per the Tellabs standard, determining that, collectively, they established a strong inference of scienter, as they were as compelling as any innocent alternative explanation. This was particularly relevant given the financial significance of the PurePulse devices to Fitbit's revenue in 2015. 

On the issue of loss causation, defendants argued that the plaintiffs failed to demonstrate a direct link between the alleged deceptive practices and the resulting harm, asserting that previous consumer complaints did not sufficiently reveal that Fitbit's statements were false or misleading. The court noted that to prove loss causation, a clear causal connection must be established between the fraudulent acts and the plaintiff's injuries, referencing legal precedents that outline the necessary criteria for loss causation claims.

A defendant must be notified regarding potential economic loss and the causal link between that loss and the misrepresentation, as established in Metzler Inv. GMBH v. Corinthian Colls. Inc. Plaintiffs need only allege facts that plausibly establish loss causation, as highlighted in In re Gilead Scis. Litig. The Amended Complaint claims that from January 5 to May 19, 2016, revelations about the inaccuracy of Fitbit’s heart-rate tracking devices led to a significant decline in Fitbit’s stock price, dropping from $30.96 to $13.99, a 54.8% loss in value. The Court determined that whether other factors contributed to the stock drop is a factual issue appropriate for summary judgment or trial, not the pleading stage, thus denying the motion to dismiss the Section 10(b) claim. 

Additionally, the plaintiffs assert Section 20(a) claims against defendants Park, Zerella, and Friedman on a control person theory. To prove Section 20(a) liability, a primary violation of Section 10(b) or Rule 10b-5 must first be established. Since plaintiffs adequately alleged such a primary violation, the motion to dismiss the control person liability claim is also denied.

Regarding Securities Act claims under Sections 11 and 15, all defendants challenge the Section 11 claims, arguing that the IPO Registration Statement did not contain materially false or misleading statements and that plaintiffs failed to allege recoverable damages. Section 11 imposes liability for material misstatements or omissions in a registration statement, allowing any person acquiring the security to pursue losses caused by such misstatements. To establish an actionable claim under Section 11, plaintiffs must show that the registration statement contained a misrepresentation or omission that was material enough to mislead a reasonable investor.

Plaintiffs' allegations of false and misleading statements under Section 10(b) of the Exchange Act also pertain to their Section 11 claims regarding the IPO Prospectus. The misleading statements relevant to the Section 11 claim overlap with those in the Section 10(b) claims. The Court finds that risk disclosures in the Registration Statement do not negate these claims. Specifically, a statement in the Prospectus regarding the accuracy of Fitbit's products does not sufficiently indicate to investors that there were known issues with the heart rate monitoring technology at the time of the IPO. Instead, it mentions past claims without disclosing any current inaccuracies. The Court concludes that the Amended Complaint adequately alleges actionable misrepresentations under Section 11.

Regarding loss causation and recoverable damages, defendants argue that plaintiffs failed to show that alleged misstatements caused their damages, pointing out that only one corrective disclosure occurred before the lawsuit, and stock prices remained above the initial offering price afterward. Plaintiffs counter that defendants have not proven negative causation and assert that Fitbit stock traded below the offering price when they filed the lawsuit on January 11, 2016.

Section 11 permits plaintiffs to recover damages reflecting the difference between the purchase price of the security (not exceeding its public offering price) and its value at the time the lawsuit is filed. However, if the defendant demonstrates that any part of the damages is due to factors other than the decline in value caused by the alleged misstatements in the registration statement, those damages cannot be recovered. The burden of proof lies with the defendant, which is considered a "heavy" burden by courts. To succeed, the defendant must show that the stock’s value decrease resulted from reasons unrelated to the claimed material misstatement.

Plaintiffs do not need to plead loss causation in their initial complaints, and courts typically refrain from ruling on this issue during the motion to dismiss stage unless the facts and judicially noticeable documents clearly support the defense. Overcoming a negative causation defense requires that the misrepresentation be linked to the reasons for the investment’s value decline. The court finds that the plaintiffs have adequately alleged that Fitbit’s misrepresentation is connected to the decline in stock value, particularly due to the filing of a consumer lawsuit that allegedly caused a drop in stock prices from the IPO price.

The court is not persuaded by the defendants' arguments for dismissal based on precedent cases. For instance, in one cited case, a corrective disclosure did not include the alleged misstatements, justifying dismissal. In contrast, another case highlighted that the market's reaction was tied to the disclosure of misstatements rather than general poor financial performance, supporting the plaintiffs' claims.

The court found that this case aligns more closely with *Daou* than *Shoretel*, as the plaintiffs successfully demonstrated that the market responded to the McLellan consumer lawsuit, which highlighted alleged inaccuracies in heart rate tracking claims. Consequently, the defendants’ motions to dismiss the plaintiffs’ Section 11 claims were denied. Regarding Section 15, the plaintiffs asserted control person liability claims against defendants Park, Zerella, and Friedman, which were also upheld due to sufficient allegations of a primary violation under Section 11. The court denied all motions to dismiss, emphasizing that the group of plaintiffs includes investors Timothy Flynn, Jesse M. Koth, Kelley Koth, Viet Tran, and Mark Cunningham, and claims are made against Fitbit, Inc. and its executives, as well as several underwriter defendants. Some statements attributed to the defendants may not have originated from them, such as a purported statement by Park that was actually an author's observation. Plaintiffs indicated that Friedman and Zerella sold significant stock during the IPO and expressed willingness to amend their complaint to include these allegations; however, the court deemed such amendments unnecessary as it found sufficient evidence of scienter at this stage. The court also accepted the Fitbit defendants' request for judicial notice of certain public records, including SEC filings, which are permissible in securities fraud actions.