Is calling litigation 'without merit' actually without merit?
“Given the risk, you don't have any big upside in using the expression 'meritless,'" says Matteo Gatti, a professor at Rutgers Law School and a corporate governance expert. “It’s not going to benefit the stock price that much by using it, unless you want to signal that a litigation effort is reckless or a strike suit.” (Image from Shutterstock)
Scan corporate financial filings, and it doesn’t take long to notice that companies often dismiss legal actions brought against them as being “without merit” or “meritless.”
It’s boilerplate text—hardly surprising in annual or quarterly securities filings filled with stock phrases and standard caveats, such as: “Our industry is highly competitive,” or “Our financial results will fluctuate from quarter to quarter.” But a federal court ruling suggests that reliance on such phrases can backfire when it comes to litigation disclosures.
That opinion came in a shareholder class action securities fraud complaint filed in 2023 against Pegasystems Inc., a Cambridge, Massachusetts-based maker of low-code software, after it was ordered to pay more than $2 billion in damages in a prior lawsuit alleging trade secret theft brought by the Appian Corp., its rival.
U.S. District Judge William G. Young of the District of Massachusetts ruled last July that Pegasystems’ portrayal of the trade secrets case as “without merit” in its 2021 10-K annual report was misleading given Pegasystems CEO Alan Trefler’s knowledge of and involvement in the company’s espionage campaign against the Appian Corp.
“Here, Trefler and Pega[systems] categorically denied that Appian’s claims had any merit—despite possessing substantial information about the viability of those claims. [Trefler’s] and Pega[systems]’s opinion statement that Appian’s claims were ‘without merit’ was, therefore, misleading,” according to Young’s opinion on Pegasystems’ motion to dismiss for failure to state a claim.
Citing that decision, at least one major law firm is advising clients to drop the “without merit” language in relation to pending suits. In a December publication on its website about preparing annual 10-K forms for 2023, Gibson, Dunn & Crutcher highlighted the Pegasystems ruling.
“The court’s decision provides a cautionary tale against using boilerplate disclosure language when describing a company’s litigation matters, particularly where those disclosures are contradictory to the actual prospect of an adverse result,” according to the Gibson Dunn publication.
It reasons that litigation often has “at least some merit,” even when a defendant has a strong legal defense.
Without ‘without merit’
That advice could extend well beyond Gibson Dunn’s clientele. A keyword search of “without merit” using the U.S. Securities and Exchange Commission’s EDGAR database of 10-K forms filed in 2023, for instance, returned more than 1,600 results. That includes filings from a range of major U.S. businesses that include Meta Platforms, Philip Morris, Sherwin-Williams and Marathon Oil.
Depending on how many suits that a company faces, “without merit” may appear multiple times within a single 10-K report. Facebook owner Meta Platforms, for instance, uses the phrase several times in relation to different legal matters detailed within the “Legal Proceedings” section of its report filed in early 2023.
So why is it favored as an all-purpose response to litigation?
Michael Titera, a partner in Gibson Dunn’s corporate securities and governance practice, says a terse denial may be seen as preferable to making voluntary disclosures that could later be challenged.
Further, “discussing the merits of a legal proceeding in detail in an SEC filing could suggest to investors or analysts that the proceeding is more important than it actually is,” Titera says.
A succinct statement helps sidestep such potential pitfalls.
But instead of outright declaring a suit “without merit,” the firm recommends alternative language, such as: “We intend to contest this matter vigorously,” or “We have substantial defenses.” That signals that a company is actively addressing a legal action without judging its legitimacy.
In his opinion, Young noted that Pegasystems was not required to admit wrongdoing in its disclosure, and that “an issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the claims against it are true.” But when it does so, it must be done with “exceptional care” to avoid misleading investors.
Matteo Gatti, a professor at Rutgers Law School and a corporate governance expert, supports that approach.
“Given the risk, you don’t have any big upside in using the expression ‘meritless,’” Gatti says. “It’s not going to benefit the stock price that much by using it, unless you want to signal that a litigation effort is reckless or a strike suit.”
Indeed, the class action suit against Pegasystems noted that the company’s stock price decreased 15.6% in February 2022, the day after the company filed the 10-K report for its 2021 fiscal year in where it deemed the Appian Corp. trade secrets claims to be “without merit.” Hardly magic words to ease investor concerns.
But as 10-K filing season kicks off this year, don’t expect the phrase to disappear from company reports or public statements. It’s an entrenched part of the legal disclosure landscape. And Titera acknowledges that using “without merit” won’t necessarily come back to bite companies in most instances. But it’s better to play it safe.
“At the end of the day, whether a company’s description is problematic will depend on the facts. And by avoiding ‘without merit’ altogether, a company can decrease the risk that it will face a suit alleging that its description was materially false or misleading,” Titera says.
Mark F. Walsh is a New York City-based freelance writer. He is a former reporter for American Lawyer Media publications.
