Ghosts of Christmas Past: WeWork Litigation

Everyone remember the WeWork debacle?  One interesting aspect is that although Adam Neumann is often mentioned in the same breath as Elizabeth Holmes and – these days – Samuel Bankman-Fried, Neumann was never charged with fraud, despite ballyhooed announcements of investigations.  If anything, that’s one of the more amazing things about the story: Neumann was able to incinerate billions of dollars while apparently explaining exactly what he planned to do and how he would do it.

Well, not exactly.  As I blogged in March 2021, one set of WeWork investors brought fraud claims against Neumann and other WeWork officers, namely former shareholders of a company called Prolific Interactive, which WeWork acquired for a combination of cash and WeWork stock.  The former Prolific shareholders claim that they were misled about the value of WeWork stock and sold their company too cheaply.  And, when they filed their complaint, I blogged that I didn’t understand why they had chosen to bring claims solely under Section 10(b) of the federal Exchange Act.  Section 10(b) is a very plaintiff-unfriendly statute.  Among other things, 10(b) claims are subject to the heightened pleading requirements of the PSLRA, and the scope of prohibited behavior is actually quite narrow (aiding and abetting claims, for example, are unavailable, and the definition of a primary violation can be something of a moving target).  Section 10(b) is only preferred by plaintiffs because it allows fraud-on-the-market liability, which most states’ common law does not.  The former Prolific shareholders, however, were not bringing a fraud-on-the-market case, so I didn’t understand why they were advancing claims under 10(b).

Well, on December 23, 2022, the District of Delaware finally dismissed the complaint (with leave to replead), see Emamian v. Neumann, No. 1:21-cv-00414, and from that opinion (as well as by reading some of the briefing), I got my answer.  (Sadly, the opinion is not available on Westlaw or Lexis as of this posting; you have to pull it from the docket).

When the plaintiffs signed the deal to receive WeWork stock in exchange for Prolific stock, the agreement contained a clause that disclaimed reliance on any representations outside of the agreement itself.  That disclaimer of reliance is enforceable under common law (or at least, under Delaware’s common law, see Abry Partners V, L.P. v. F & W Acquisition, 891 A.2d 1032 (Del. Ch. 2006), which likely applies here).  But some federal courts have held that anti-reliance clauses are not enforceable under Section 10(b), as they are too similar to a prohibited waiver of Exchange Act protection.  See AES Corp. v. Dow Chemical Co., 325 F.3d 174 (3d Cir. 2003). But see Cornielsen v. Infinium Capital Management, LLC, 916 F.3d 589 (7th Cir. 2019).

Sidebar: As I’ve previously blogged (here and here and here), the Ninth Circuit is right now considering whether a forum selection bylaw that shunts Exchange Act claims into a forum that has no jurisdiction to hear them is also the equivalent of a prohibited Exchange Act waiver.

In the Emamian case, though the contract disclaimed reliance on external representations, and the plaintiffs based their claims entirely on those.  Since the reliance waiver would have foreclosed claims under common law, they instead brought them under 10(b).

But!

Although some federal courts have been reluctant to give automatic effect to nonreliance clauses in 10(b) cases, they may hold that 10(b) requires plaintiffs to show that their reliance was justifiable, and a nonreliance clause may be evidence – though not dispositive – that any reliance on the disclaimed statements was not justifiable.  See O’Connor v. Cory, 2018 WL 5117197 (N.D. Tex. Oct. 19, 2018) (exploring the caselaw).  Beyond the issue of nonreliance clauses, the caselaw on what counts as “justifiable” reliance is somewhat mixed, especially since doctrines like “puffery” already serve the same function by eliminating any facially unreliable statements.  As a result, some courts have held that, since 10(b) is a fraud statute, plaintiffs have no affirmative duty to investigate defendants’ representations, Teamsters Local 282 Pension Fund v. Angelos, 762 F.2d 522 (7th Cir. 1985). 

The Third Circuit, however, requires some degree of diligence by the plaintiff, and so the Emamian court dismissed plaintiffs’ claims for failure to plead that they conducted a reasonable investigation – especially in light of the nonreliance clause and the length of the negotiations – but gave plaintiffs leave to replead on that issue.

That said, I’ll note something else: Although the court gave lip service to PSLRA pleading standards, it quite demonstrably did not require the same level of detail you’d expect in a fraud-on-the-market case by public company shareholders.  Though the court rejected plaintiffs’ claim that WeWork’s $110-per-share valuation was itself fraudulent for (for failure to plead scienter), the court did hold that plaintiffs had properly alleged that Neumann made false statements, with scienter, about WeWork’s “operations and business prospects.”  Yet the most that plaintiffs alleged along these lines was:

During these meetings [held from December 2018 to March 2019], Neumann discussed how valuable WeWork will be after its IPO as well as WeWork’s purported profitability, cash flow, and supposedly strong balance sheet at the time….

During the meetings and discussions leading up to WeWork’s acquisition of Prolific, Neumann and the other Defendants failed to disclose WeWork’s cash flow problems, massive operating losses, the unsustainable nature of the Company’s business model, Neumann’s self-dealing and erratic behavior, or that Neumann sold or was selling large blocks of his WeWork shares privately.

And, though it’s unclear whether the court considered these to be part of the fraud, Plaintiffs also made general allegations about WeWork’s public statements, such as:

Despite its growth, and the message it was presenting to the investing community that it was a tech start-up that was revolutionizing the workplace by bettering humanity and promoting community “wellness” and “kindness,” as it was later revealed, WeWork was nothing more than a subleasing company that captured the spread between long-term rental costs and short-term subleasing revenues for commercial office space.  WeWork claimed to be selling a membership “experience” that was “powered by technology designed to enable [WeWork’s] members to manage their own space, make connections among each other and access products and services.” But the reality is that WeWork simply offered a trendy desk and chair for monthly rent.

These allegations would never support a Section 10(b) class action against a public company – indeed, reading the complaint, it seems that the plaintiffs’ main claim is that they were defrauded by the $47 billion company valuation (which allegations, again, the court rejected on scienter – not falsity - grounds). Which is probably why we haven’t seen the kinds of government actions surrounding WeWork as we've seen for other high-profile startup collapses; statements of valuation – with nothing more – are extremely hard to prove false, let alone intentionally so.

Which means, we can say that 10(b) cases may formally have tougher pleading standards than common law cases, but judges may be loathe to impose them outside the class action context.