District Of New Jersey Discounts Confidential Witness Allegations And Grants Education Company's Motion To Dismiss In Securities Class Action

• Jurisdiction: United States,Federal,New Jersey
• Law Firm: Shearman & Sterling LLP
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Criminal Law, Corporate and Company Law, Class Actions, Securities, White Collar Crime, Anti-Corruption & Fraud
• Author: Shearman & Sterling LLP
• Published date: 03 April 2023

On February 24, 2023, Judge Esther Salas of the United States District Court for the District of New Jersey granted a motion to dismiss a putative class action against a Beijing-based education company (the "Company") and its CEO and CFO (the "Individual Defendants"). The lawsuit alleged that the Company misled investors about its student enrollment figures in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. Wu v. GSX Techedu Inc., No. 20-cv-04457, 2023 WL 2207422 (D.N.J. Feb. 24, 2023). Specifically, plaintiffs alleged that the Company artificially inflated its enrollment figures by creating fake student accounts. In dismissing the action, the Court discounted the import of several purported confidential witness statements, demonstrating the rigor courts apply to such allegations, and held that the complaint failed to allege facts sufficient to give rise to a strong inference of scienter.

The Company, based in China, specializes in online coursework and tutoring for students in grades K-12. Plaintiffs alleged that the Company devised a scheme to overstate the size and growth of its enrollment and revenue using "bots," "that is, fake internet personalities used to boost ... enrollment figures." Plaintiffs additionally alleged that the Company misstated its teachers' qualifications, its process for hiring teachers, the compensation structure for its teachers, and the reasons for differences between its filings with the Securities Exchange Commission ("SEC") and China's State Administration for Industry and Commerce ("SAIC"). Plaintiffs also alleged that the Company failed to disclose that it contracted with related parties to hire employees to falsify student enrollment figures through the use of bots and fake identities. Finally, plaintiffs alleged that the Company falsely denied reports published by a number of short-sellers (the "Short-Seller Reports") that suggested the Company was failing to comply with legal and regulatory requirements.

The Court first held that certain categories of misstatements were not actionable for failure to plead falsity, mainly on the grounds that several confidential witnesses were not alleged to have been in a position to know of the supposed untruths. The Court first held that alleged misstatements about the Company's teacher compensation and hiring process were not supported because the confidential witnesses were not in a position to know about the Company's compensation...