The global economy is still adapting to the advent of the Artificial Intelligence (AI) era. It remains unclear what AI ultimately will mean for economies and businesses, and many businesses are struggling to adjust in real time. The firms experiencing these struggles also include companies in the business of providing AI products and services. In many cases, these companies’ struggles can translate into securities litigation. A lawsuit filed earlier this week against Netherland-domiciled AI services company Elastic illustrates the ways securities litigation can arise from AI companies’ business struggles. A copy of the February 11, 2025, complaint filed against Elastic can be found here.
Background
Elastic, whose shares trade on the NYSE, describes itself as “the Search AI Company.” Its platform, which is available both as a cloud-hosted, managed service or as a self-managed software, allows customers to “find insights and drive AI and machine learning use cases from large amounts of data.” The company’s sales teams are organized geographically. The company’s Americas business has consistently accounted for the largest proportion of the Company’s revenues.
On May 30, 2024, Elastic released its fourth quarter and FY 2024 financial results. Among other things, the company also provided financial guidance for FY 2025, among other things projecting revenue of $1.468 billion to $1.48 billion, representing 16% year-over-year growth at the midpoint of the projected revenue range. Among other things in the May earnings call with analysts, company management, according to the subsequently filed securities suit assured investors that “Elastic’s sales operations were working, stable, and helping the company thrive, even though Defendants knew at the time that they had recently made significant changes that had impacted basically the Company’s entire Americas sales operation.”
On August 29, 2024, Elastic announced its financial results for the first quarter of FY 2025. Among other things, the company announced that it was reducing its FY 2025 revenue guidance; as the subsequently filed securities lawsuit complaint put it, the company reduced its guidance “to a range of $1.436 billion to $1.444 billion, representing 14% year-over-year growth at the midpoint – significantly down from their prior FY 2025 guidance of $1.468 to $1.48 billion, or 16% year-over-year growth at the midpoint.”
In explaining this reduction in its FY 2025 guidance, the company cited “a slower start to the year with the volume of customer commitments impacted by segmentation changes that we made at the beginning of the year, which are taking longer than expected to settle.” In a call with analysts, company management said, among other things, that while they had anticipated some degree of change associated with the segmentation alterations, the magnitude of the change was larger than anticipated, and that it might take a couple of quarters to work through.
According to the complaint, the company’s share price fell over 26% on the news.
The Lawsuit
On February 11, 2025, a plaintiff shareholder filed a securities class action lawsuit against Elastic; the company’s CEO; and the company’s CFO. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between May 31, 2024 (that is, the day after its fourth quarter and FY 2024 year-end financial release) and August 29, 2024 (that is, the day of the company’s 1Q25 financial release).
The complaint alleges that during the class period, the defendants made false and/or misleading statements and/or failed to disclose that: “(i) Elastic has implemented significant changes to its sales operations, particularly with respect to its customer segments in the Americas; (ii) the foregoing changes were likely to, and did, disrupt Elastic’s sales operations during the first quarter of FY 2025; (iii) accordingly, Defendants had overstated the stability of Elastic’s sales operations; (iv) as a result of all the foregoing, Elastic was unlikely to meet its own previously issued revenue guidance for its FY 2025; and (v) as a result, Defendants’ public statements were materially false and misleading at all relevant times.”
The complaint also alleges that during the class period the CEO sold 28,483 shares of his personal holdings in Elastic stock for total proceeds of over $3 million, and that the CFO sold 10,011 shares of Elastic stock for total proceeds of over $ million. The complaint does not state what percentage of the individuals’ total holdings of Elastic stock that the sales represented.
The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the class.
Discussion
Elastic is an AI-based company. But does this lawsuit against Elastic qualify as “AI-related”?
On the one hand, the kind of allegations here could have been made against any company. The company implemented some sales segmentation changes that had a larger impact than the company anticipated, as a result of which it lowered its fiscal year guidance, as a result of which its share price declined. There is nothing about this sequence of events that is unique to an AI-based company. Indeed, it could be argued that this sequence of events really has nothing at all to do with AI as such.
On the other hand, let’s step back and look at what happened here. This company is not losing money; indeed, even at the lower guidance level, this company was projecting that its revenue would increase by double-digits — that is, that its revenue would increase by nearly a billion and a half dollars. Not only that, but it reduced its projected revenue growth for the fiscal year by only two percentage points. It would be tempting to argue that this was a de minimus change in guidance – except for the fact that in response to the reduction in guidance, the company’s market capitalization lost over a quarter of its value.
Pretty clearly prior to the company’s guidance reduction its share price was priced for perfection. The company’s share price undoubtedly was at sky high levels, as its market valuation reflected the AI-related premium that all AI-adjacent companies were enjoying at the time. Even a bobble as slight as a two-percentage point reduction in the company’s projected revenue growth was enough to undercut the company’s share price by over a quarter.
I will leave it to others to argue about whether or not in the end this case qualifies for the category of “AI-related” cases. But there is no doubt that what happened here, and in particular what happened to the company’s share price, happened because the company was an AI company whose share price reflected the peculiarities of market valuations for AI companies.
There is a point I am trying to make here for my friends on the D&O underwriting side. The point has to do with how to view AI companies from a D&O underwriting perspective. It is apparent that because of the peculiarities of the way the market is valuing AI companies, the companies’ share prices may be subject to an inherent volatility risk. And, as this case demonstrates, with the prospect of the volatility comes the prospect of corporate and securities litigation risk.
As a result of the advent of AI, it is in many ways a whole new world out there. As AI integrates itself into the economy and into business plans and prospects, the way that these developments translate into risk will change as well.