On The Case

Uber is a private company. How can investors bring a securities class action?

(Reuters) - A pension fund for Texas firefighters filed a securities class action Tuesday against Uber Technologies and its ousted CEO, Travis Kalanick, in federal court in San Francisco. The complaint, a recitation of all of Uber’s recent scandals, presents the company as quite a juicy target. Uber’s market capitalization has dropped by at least $10 billion in 2017, according to the pension fund’s lawyers at Robbins Geller Rudman & Dowd. They blame the company and Kalanick for fraudulently inducing investors to snap up shares in a company doomed by a toxic culture.

But here’s the thing: Uber shares are not publicly traded. The Texas pension fund that filed the class action does not own Uber stock outright. It owns shares of a Morgan Stanley-managed investment vehicle that, in turn, owns Uber shares. The pension fund nevertheless seeks to serve as a representative plaintiff for all investors supposedly duped into taking a stake in Uber, those who directly bought private Uber shares and those who, like it, invested indirectly.

The complaint presents two interesting questions. First: What’s the cause of action against a private company? And second: Can Uber be liable to indirect investors who don’t even own its shares?

The answer to the first question lies in California’s Corporations Code. Investors in a private company can’t sue under federal securities laws, which address the integrity of public markets. As you know, the legal underpinning for shareholder class actions, 1988’s Basic v. Levinson, assumes a robust, informed public market – not private stock offerings.

But California’s corporations code includes a provision that prohibits false and misleading statements in connection with the sale of securities. The California Supreme Court said in 1993’s Mirkin v. Wasserman that shareholders can bring class actions under that provision. The Mirkin decision involved shares in a public company, but shareholder lawyer Darren Robbins of Robbins Geller said the statute applies to any securities sold in California, public or private.

And according to Robbins, the California provision covers allegedly deceived indirect purchasers as well as those who bought shares directly. That’s the key to his case, since Uber didn’t sell shares to the firefighters’ pension fund Robbins represents. It presumably sold shares to New Riders, the Morgan Stanley investment vehicle in which the firefighters’ fund held shares. Can Uber be liable for allegedly deceiving investors who don’t even own Uber shares?

It can, at least under the reasoning of a federal judge earlier this year in a class action by indirect investors in Theranos. Like the Texas firefighters’ fund in the Uber case, lead plaintiffs in the Theranos class action (who are represented by Robbins Geller and Hagens Berman Sobol Shapiro) held a stake in investment vehicles that directly owned shares in the private company. The Theranos plaintiffs also brought their claim under the California statute barring deceptive securities sales. Theranos moved to dismiss the class action, arguing that it never sold shares to the plaintiffs.

U.S. Magistrate Judge Nathanael Cousins of San Jose denied the Theranos motion last April, holding that the California provision is supposed to prevent fraudulent manipulation of securities markets, not to regulate particular transactions affected by the manipulation. Quoting California state court precedent, Judge Cousins ruled that because the anti-fraud provision focuses on the seller’s deceptive conduct, anyone affected by the fraud can recover damages from the violator, regardless of whether they purchased shares directly or indirectly.

There’s an additional statutory boon for indirect investors in the California anti-fraud law. According to Judge Cousins in the Theranos case – and to the California Supreme Court in the Mirkin case – shareholders do not have to prove they relied on a seller’s false statement in order to claim damages. The state justices were explicit in the Mirkin decision, which said the statutory remedies “do not require plaintiffs to plead or prove actual reliance.”

Reliance can be a class certification obstacle for shareholders of thinly-traded public companies bringing securities class actions under federal law. But Robbins told me he’s confident it’s not going to be a problem under the California statute.

I should point out that not all precedent from the Theranos case cuts in favor of Uber investors. Earlier this month, Judge Cousins agreed with Theranos that direct investors cannot be part of the securities class because their private purchase contracts with the company include limitations, such as a forum-selection clause, that don’t apply to indirect investors. It’s worth noting the only direct Uber investor who has sued the company, the venture capital firm Benchmark, filed its claim in Delaware Chancery Court, not in California.

There are lots of ways, in other words, for Uber to chip away at the investor case. But it would be a mistake to assume that a securities class action by indirect investors in a privately-held company has no shot.

I emailed Uber for comment but didn’t immediately hear back.

Note: This article has been corrected. A previous version incorrectly reported the firefighters’ pension fund that sued Uber is a California fund.