In re 2U, Inc.
| Decision Date | 05 August 2021 |
| Docket Number | Civil Action TDC-19-3455,TDC-20-1006 |
| Parties | IN RE 2U, INC. SECURITIES CLASS ACTION |
| Court | U.S. District Court — District of Maryland |
Plaintiffs Fiyyaz Pirani and the Oklahoma City Employees Retirement System (“OKCERS”) have filed this consolidated civil class action against Defendant 2U, Inc. (“2U”) and several of its officers, directors and underwriters, in which they allege violations of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-qq (2018) (“the Exchange Act”), and the Securities Act of 1933, 15 U.S.C. § 77a-aa (“the Securities Act”). Pending before the Court is Defendants' Motion to Dismiss, which is fully briefed. Having reviewed the submitted materials, the Court finds that no hearing is necessary. See D. Md. Local R. 105.6. For the reasons set forth below, Defendants' Motion will be GRANTED IN PART and DENIED IN PART.
Established in 2008, 2U provides online education programs to students and has common stock that trades on the NASDAQ stock exchange under the symbol “TWOU.” Am. Compl. ¶ 50 ECF No. 92. From 2017 through 2019, Defendant Christopher J. Paucek, a co-founder of 2U, served as 2U's Chief Executive Officer (“CEO”) and was a member of its Board of Directors. Defendant Catherine A. Graham served as 2U's Chief Financial Officer (“CFO”) throughout 2018 and until her resignation on August 22, 2019. Defendant Harsha Mokkarala served as 2U's Chief Marketing Officer from January 2016 to April 2018 and became its Chief Revenue Officer in April 2018.
Throughout its existence, a major portion of 2U's business has been its Graduate Division, or “Domestic Graduate Programs” (“DGP”), which partners with colleges and universities to offer online education programs that culminate in the institution conferring a graduate degree on the student. During the events at issue in this case, 2U marketed the programs to potential students and shepherded them through the application process, while the universities retained full control of the admissions process and decided which students to admit. 2U conceived of its process for finding potential customers and converting them to actual enrollments as a sales or marketing “funnel” in which the very beginning of the process-the wide top of the funnel-progressed down to the end of the process-the narrow bottom of the funnel-at which point a student was actually paying tuition for a graduate program. Id. ¶¶ 15, 69, 75. The top of the funnel consisted of 2U's digital advertising, which reached a large audience. 2U described the top of the funnel as a data-driven marketing system through which it targeted an audience of potential customers who were likely to seek out graduate programs, rather than just a random sample of the population. When individuals clicked on an advertisement or were otherwise identified by 2U as a “leads, ” or good candidates for further recruiting efforts, they were considered to be in the middle of the funnel. Id. ¶ 108. There, a salesperson, called an “admissions counselor, ” would contact the potential customers, pitch specific programs, and assist them with completing the application, in what executives called a “high-touch” model. Id. ¶ 15. Further down the funnel were the customers who completed and submitted applications to graduate programs. At the bottom of the funnel were customers who were admitted and then, finally, enrolled in the programs. The goal was to generate sufficient leads at the top of the funnel and convert those leads into applications started, applications submitted, and ultimately enrolled students paying tuition. Under 2U's agreements with universities, 2U bore the costs of employing this marketing strategy, finding potential customers, converting them to enrolled students, and providing the digital infrastructure for the online classes; in exchange, it received the lion's share of the revenue, aiming for 60 percent of the total tuition and fees paid by a student.
When 2U was founded in 2008, it provided one program at one university. It then rapidly expanded to increase the number of its graduate programs and partner universities. In 2017 alone, it added 10 new graduate programs, for a total of 37 graduate programs by the end of that year. 2U finished 2017 with over 1, 800 full-time employees and total revenue of $286.8 million, but it had total expenses of $316.9 million, with marketing and sales costs accounting for $150.9 million of that amount.
Though 2U also offered courses as part of a “Short Course Segment, ” id. ¶ 56, its Graduate Division provided the vast majority of 2U's revenue, accounting for 84.6 percent of revenue in 2018 and 80 percent of revenue in the first half of 2019. Out of 2U's 24 graduate program partners, a handful provided a disproportionate amount of revenue within the Graduate Division. For example, during 2017, programs at the University of Southern California (“U.S.C.”) provided 27 percent of 2U's revenue, those at Simmons College provided 17 percent, and those at the University of North Carolina provided 10 percent. 2U identified graduate programs by the type of degree they provided, such as a Master of Business Administration (“MBA”) or Master of Social Work, and described each degree category as a “multi-program vertical” or “MPV.” Id. ¶ 80. Because much of 2U's revenue came from the Graduate Division and that revenue was received only when a student had enrolled in a program and had paid tuition or fees, enrollments in graduate programs were a primary driver of overall revenue. 2U closely monitored enrollments and reported aggregate data on enrollment to investors.
As 2U grew, it added more programs from different universities to its MPVs. Programs within an MPV could have widely different tuition costs. 2U argued that this price differentiation within an MPV increased marketing efficiency because prospective customers who sought out a particular type of degree could be pitched on different programs within the same MPV and may prefer one program or its cost over another.
2U's central narrative to investors was that, although its business was not yet profitable, it had expanded rapidly and would continue to do so, with sustained annual revenue growth exceeding 30 percent, until it reached a “steady state” of over 190 programs with hundreds of students enrolling each year, garnering $3 billion in annual revenue, at which point it would become profitable. Id. ¶ 10. Economies of scale played a key role in potential profitability: as 2U grew larger, it would collect more data from prospective and actual customers across the funnel, which would make its advertising more efficient and less expensive and would help it to develop MPVs that ensured that a larger portion of students at the top of the funnel ultimately enrolled in a program at the bottom. Because its projected growth rate significantly exceeded that of other online education programs, 2U was highly rated by investment analysts.
As part of its effort to monitor the Graduate Division, 2U worked to forecast its growth, including in enrollments, based on “seasonality and demand from quarterly reports of past numbers of enrollments and degrees received by students, lead generations and historical sales, ” as well as based on data from the sales funnel, including the number of applications completed and students who had paid deposits. Id. ¶¶ 88-89. These enrollment forecasts were conducted six months in advance and were provided to Mokkarala, who then reported the data to Paucek. Graham also received enrollment forecasts from the finance team. According to a former 2U employee, referenced by Plaintiffs as FE-2, who led a team responsible for forecasting, “enrollment projections began to slowly stall in 2017, and the problem worsened in 2018 and 2019.” Id. ¶ 89. FE-2 has alleged that Mokkarala “often wanted to see forecast numbers earlier than they were due” and became “stressed about enrollment numbers” in 2017, id., and that Paucek was “unhappy with the dropping numbers, ” id. ¶ 357. She has also alleged that “2U was not spending enough money to make sales in 2017 through 2019.” Id. ¶ 88.
According to FE-2, by February 2018, 2U's sales goals had become unreachable. Also in February 2018, according to allegations from an employee in the office of the CEO, referenced as FE-1, “concern about low enrollment” became “a topic and remain[ed] one, ” and Paucek himself “mention[ed] concern about enrollment not too far into 2018.” Id. ¶ 86. FE-1 has also alleged that Paucek and Mokkarala were “working closely . . . to figure out how to enroll more students.” Id. Another former employee, FE-8, has alleged that while admissions counselors typically received reports containing projections for individual programs, 2U abruptly stopped sending them those reports in late 2017 or early 2018. Id. ¶ 350.
Also in February 2018, Paucek publicly announced that 2U projected its annual revenue to grow by 30 percent or more per year for the “foreseeable future” until it reached 193 graduate programs and annual revenue of $3 billion. Id. ¶ 10. Paucek also announced that in addition to 14 new graduate programs to be started in 2018 it would launch 16 more graduate programs in 2019. Then, on February 27, 2018, Paucek and Graham certified 2U's Securities and Exchange Commission (“SEC”) Form 10-K annual report for the year ending December 31, 2017 (“the 2017 Form 10-K”). In the 2017 Form 10-K, 2U stated that its “core strategy is to launch graduate programs and short courses with new and existing university clients and to increase student enrollments across our portfolio, ” and that adding more graduate programs and increasing student enrollments...
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