It’s Not Easy Being Green: LeapFrog Execs Dodge Class-Action Over Sales Projections

On August 2, 2016, U.S. District Judge Edward Chen dismissed a shareholder lawsuit brought against children’s educational toymaker LeapFrog Enterprises, Inc. (“LeapFrog”) for failure to adequately plead statements were false or misleading, or made with requisite intent.  Plaintiffs’ suit, which was consolidated in 2015, alleged that LeapFrog and its executives hid demand and inventory problems from investors.  The judge disagreed, finding that the investors had been sufficiently warned of problems with LeapFrog’s product lines and that the allegedly misleading statements were forward-looking and cautionary, and therefore fell within the PSLRA’s safe harbor.  Defendants’ public statements about many of the allegedly misleading topics helped drive home that Plaintiffs’ theory amounted to classic “fraud by hindsight.”

Plaintiffs filed their lawsuit in January 2015, following LeapFrog’s disappointing Q3 FY 2015 earnings, claiming that LeapFrog had falsely inflated its share prices by, among other things, hiding problems with its new LeapTV videogame system and failing to disclose that it was suffering a “retail inventory hangover” of LeapPad products, which were not selling as expected.  Plaintiffs claimed that LeapFrog’s public statements to its shareholders were materially false and misleading and violated Section 10(b) of the Securities Exchange Act.

Following a detailed analysis of numerous LeapFrog statements, the court found that LeapFrog’s CEO and CFO had not tried to hide the company’s problems from investors.  To the contrary, executives had made several public statements tempering financial expectations and warning specifically of possible problems with product rollouts, i.e., the very issues Plaintiffs raised in their suit.  Specifically, executives had warned that sales of LeapTV could suffer due to its late rollout and that there was uncertainty as to whether consumers would respond to another gaming system in the market.  The court noted that many of LeapFrog’s statements were also forward-looking and, therefore subject to the Private Securities Litigation Reform Act’s Safe Harbor.  The court also found that Plaintiffs had not alleged that LeapFrog executives knew or believed that their statements were false at the time, and the executives could not be liable under federal securities laws merely for having predicted wrong.

The court dismissed both the 10(b) and Section 20(a) claims and Plaintiffs were given the opportunity to amend their lawsuit, though the Judge expressed skepticism that they would be able to do so successfully.