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

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January 20, 2023

Shearman & Sterling LLP

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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 lawsuit asserting claims under the Securities Exchange Act of 1934 against a gambling company and online sports betting company and some of its executives. In re DraftKings Inc. Sec. Litig., 2023 WL 145591 (SDNY 10 Jan. 2023). The plaintiffs alleged that the company made misrepresentations and omissions about whether a target company it acquired had gambling operations in jurisdictions where gambling was illegal. The Court ruled that the plaintiffs failed to adequately allege misrepresentation or actionable evidence.

Initially, the Court explained that where a securities fraud claim is based on alleged underlying violations of law, the target’s allegedly illegal operations in jurisdictions purported to prohibit gambling, the facts of the violation underlying must be pleaded with precision. A plaintiff who is unable to do so cannot discharge his burden of explaining what made the impugned statements false or misleading. Identifier. to *18. And the Court also pointed to what it described as an “overarching deficiency” affecting plaintiffs’ theories of fraud, their claims about Target’s business practices were based almost entirely on a report from a short seller who was , in turn, largely based on unsourced or anonymous sources. allegations. Identifier. Specifically, plaintiffs’ claims from this short seller report were found to be insufficient because (i) the author of the report had an interest in driving down the company’s stock price, requiring the Court to carefully analyze the “factual attributions” of the report and (ii), the sources of the report were “unidentified and unspecified” and, even when the allegations were generally attributed to anonymous former employees, they were “devoid of details amenable to to substantiation”. Identifier. to *1820. Further, the inability of plaintiffs’ counsel to confirm any of the statements in the report with the short seller’s founder or any of the purported sources identified in the report justified the Court rescinds the allegations of the complaint based on the short seller’s report as being ill-litigated. Identifier. to *20.

The Court determined that other allegations also lacked specific details. For example, the plaintiffs alleged that the target was conducting illegal gambling operations in Vietnam, based on statements from alleged former employees and the allegation that the target’s website showed it accepted Vietnamese currency. ; the Court, however, found that the allegations attributed to former employees lacked factual details regarding the positions of these individuals and the source of their knowledge, and, moreover, the mere fact of accepting Vietnamese currency was insufficient to demonstrate illegal activity in Vietnam. Identifier. at *2223. The Court also observed that the plaintiffs had not sufficiently alleged that certain jurisdictions actually prohibited the target’s alleged gambling activities. For example, the Court noted that the plaintiffs pointed to certain websites regarding Indonesian law which the Court found did not categorically show that all gambling activities were illegal. Identifier. at *24.

The court further dismissed claims drawn from analysis by a state lottery commission, which plaintiffs said showed the target operated in Iran in violation of Iranian law and U.S. sanctions. The Court explained that although the lottery commission’s analysis revealed that the target had identified a single instance in which bets had been placed by an Iran-based user, it also explained that the target had immediately taken steps to end its relationship with a sub-licensee who allowed these bets to be placed. Identifier. at *2526. The court found that this behavior did not support a claim that the target had been operating in Iran for nearly five years, or otherwise suggest that the target had failed to comply with US sanctions or Iranian law. Identifier. at *2526, *28. The court also rejected plaintiffs’ widespread claim that the target violated unspecified anti-money laundering provisions. Identifier. at *2829.

The Court also rejected the plaintiffs’ theories of scienter. The plaintiffs first argued that the defendants had a motive and an opportunity to commit fraud because of the alleged trades that the company’s officers made in the company’s stock. But the Court determined that the trades in question were all made by sellers who held on to more shares than they sold (several sellers increasing their position during the relevant period), ten of the trades were made pursuant to Rule 10b5-1 plans, and the other five were entered into under bought deal agreements that preceded the company’s public offerings and provided for sales immediately following a specified lock-up period. The Court therefore concluded that none of these trades justified an inference of scienter. Identifier. at *3335.

The plaintiffs further attempted to argue that the company’s executives understood the target had illegal gambling operations, but the court dismissed those allegations as conclusive. Identifier. to *36. The Court also observed that the elements referenced in the complaint were consistent with the absence of fraudulent intent, as the report of the lottery commission also indicated that the target had retained the services of an attorney to provide him with legal advice. on how to conduct operations in certain jurisdictions. Identifier. to *37. And the Court noted that the company’s response to the short seller report, in which the company said it was “comfortable” with its valuation of the target and declined to “comment on speculation or Allegations made by former “Target employees” do not constitute an admission that Target broke the law. Identifier.

The Court also explained that the complaint’s allegations of violations of Articles 105 and 303 of the SK Regulations were insufficient for reasons similar to those which defeated the plaintiffs’ allegations of misrepresentation, namely, because it did not There were insufficient allegations that the target was operating improperly or that the company was aware of any material risk or uncertainty presented by these allegedly improper operations. Identifier. at *3738.

Since the plaintiffs had already amended the complaint twice, the Court found that further amendment would be futile and dismissed the action with prejudice. Identifier. to *39.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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