SolarCity Mistake Escapes Class-Action Burn

The U.S. Ninth Circuit Court of Appeals spared Solar City an embarrassing loss, but also said it was a "mismanaged organization in need of closer financial oversight."

The decision scrolls back to the company's initial public offering in 2012, when it raised more than $92 million. It put the company up in a big way, later leading Tesla to buy it for $2.6 billion in 2016.

But there were those investors who lost money. In Webb v. SolarCity Corporation, they sued because the stock price dropped almost 30 percent in a month due to company accounting errors.

No Scienter

The class action plaintiffs claimed fraud, alleging the company intentionally manipulated its books to show higher profits. A trial judge dismissed the case, however, saying the plaintiffs could not show the defendants intended to do anything wrong.

On appeal, the Ninth Circuit agreed. It was more a case of a "mismanaged organization in need of closer financial oversight that made a minute error at a critical stage in its development."

The appeals court recognized the "strong incentive to present an appearance of profitability and to keep stock prices high in the months immediately preceding and following a company's IPO. However, these facts do not give rise to an inference of scienter that is at least as compelling as the inference of an honest mistake."

The accounting mistake was serious, the judges acknowledged, but not an "extreme departure from the standards of ordinary care."

Hidden Costs

Solar City did not hide its error, but also did not realize it until 2014. The company then "announced that it discovered tens of millions in overhead expenses that it had incorrectly classified."

"This error inflated the gross margins of the company's sales, which led the company to report profits inaccurately for both sales and leases," the judges observed.

The impact on the stock market was quick. SolarCity's shares declined by $1.70 per share -- just over 2 percent -- that day. Then there was a second announcement, leading to more losses. In March that year, SolarCity's share price fell by $23.58, or 27.8 percent.

In the meantime, Tesla laid off SolarCity employees around the country last year. The stock is trading for about $20.34 now.

Related Resources:

• 'Stairway to Heaven' Lawsuit Plays Out in Ninth Circuit (FindLaw's U.S. Ninth Circuit Blog)
• Naked Violinist Appeals to the Ninth Circuit (FindLaw's U.S. Ninth Circuit Blog)
• United States Ninth Circuit Cases (FindLaw's Cases & Codes)