Summary
In Omnivision, a technology company moved to dismiss a securities claim for insider trading because alleged accounting violations actually resulted in a large understatement of revenue rather than an overstatement of revenue.
Summary of this case from In re Medicis Pharmaceutical Corp. Securities LitigationOpinion
No. C-04-2297 SC.
July 29, 2005
ORDER RE: DEFENDANTS' MOTION TO DISMISS THE SECOND CONSOLIDATED AMENDED COMPLAINT
I. INTRODUCTION
Lead Plaintiffs ("Plaintiffs") have brought this class action against Defendant OmniVision Technologies, Inc. ("OmniVision") and Individual Defendants Shaw Hong, Raymond Wu, H. Gene McCown, and John Rossi ("Individual Defendants"). Defendants seek dismissal of the Second Consolidated Amended Complaint ("SCAC") in its entirety pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4 ("PSLRA"). For the reasons described herein, the Court hereby DENIES the Motion in its entirety.
II. BACKGROUND
OmniVision is a Delaware corporation headquartered in Sunnyvale, California. Motion at 3. OmniVision develops and sells semiconductor image sensor devices used in mobile phones, digital still cameras, and video game consoles. Id. Individual Defendants are directors and officers at OmniVision. Id.
On June 9, 2004, OmniVision announced that it was carrying out a review of previously released financial results. Id. The review dealt with improper revenue recognition methods. Although the review was expected to lead to an upward revision of the financial results for certain quarters, damage to confidence in OmniVision's accounting practices led to a sharp sell-off in its stock. Opposition at 2. OmniVision eventually restated its financial results for the quarters ended July 31, 2003; October 31, 2003; and January 31, 2004. Motion at 4.
The class period runs from June 11, 2003 to June 9, 2004. SCAC at 1. Plaintiffs allege that over this period preceding the June 9, 2004 announcement, Defendants deliberately delayed recognition of certain revenues and income so as to smooth out OmniVision's earnings and mask the impact of competition on its growth rate.Id. Plaintiffs also allege that the Individual Defendants sold significant amounts of stock at prices that were artificially inflated because of the earnings manipulation. Id. at 2.
The Second Consolidated Amended Complaint puts forth two causes of action. The first is brought against all Defendants pursuant to Section 10(b) of the Securities Exchange Act of 1934. The second is brought against the Individual Defendants pursuant to Section 20(a) of the Act.
III. LEGAL STANDARD
Under Rule 12(b)(6) of the Federal Rules of Civil Procedure, a party may move for dismissal "for failure to state a claim upon which relief can be granted." When presented with a motion to dismiss, "[a]ll allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party." Jacobellis v. State Farm Fire Cas. Co., 120 F.3d 171, 172 (9th Cir. 1997). "[A] complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); see also Gompper v. VISX, Inc., 298 F.3d 893, 896 (9th Cir. 2002).
Defendants also rely on Rule 9 of the Federal Rules of Civil Procedure to support their Motion. Rule 9 states, "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity."
Plaintiffs' claims are brought pursuant to Sections 10(b) and 20(a) of the Exchange Act. The PSLRA controls the pleading standards for these claims. In re Silicon Graphics, 183 F.3d 970, 973 (9th Cir. 1999). Under the PSLRA, a plaintiff "must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." Id. at 974. More specifically, a plaintiff "is required to state with particularity all facts giving rise to a `strong inference' of the required state of mind." Id. at 983.
The Court notes that "an inevitable tension arises between the customary latitude granted the plaintiff on a motion to dismiss under Fed.R.Civ.P. 12(b)(6), and the heightened pleading standard set forth under the PSLRA." Gompper, 298 F.3d at 896. The Ninth Circuit, resolving this tension with a tilt toward the heightened pleading standard of the PSLRA, has stated that "to consider only inferences favorable to [plaintiffs'] position would be to eviscerate the PSLRA's strong inference requirement." Id. at 896. Rather than considering only inferences in favor of plaintiffs, "the court must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs." (emphasis in original)Id. at 897. In other words, "[t]he heightened pleading requirements of the Private Securities Litigation Reform Act are an unusual deviation from the usually lenient requirements of federal rules pleading." Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir. 2001). As stated in Ronconi, "[f]or a securities fraud case based on false statements to survive a motion [to dismiss], the pleading has to state particularized facts that, taken as a whole, raise a strong inference that defendants intentionally or with deliberate recklessness made false or misleading statements to investors." Id. IV. DISCUSSION
"To avoid dismissal under the PSLRA, the Complaint must specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading . . ." Nursing Home Pension Fund v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir. 2004) (internal citations and quotations omitted). "In addition, the PSLRA requires that the Complaint state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind, or scienter." Id. (internal citations and quotations omitted). A complaint must be dismissed if either of these two prongs are not met. Id. Defendants assert that Plaintiffs have failed to meet both prongs. Furthermore, Defendants assert that the individual defendants are not liable for any statements that they did not make. Finally, Defendants assert that Plaintiffs failed to allege that their economic losses were caused by OmniVision's restatements. The Court will consider each of these arguments in turn.
A. Whether the Complaint describes misleading statements
It is undisputed that OmniVision engaged in revenue recognition practices which resulted in a restatement of revenues and earnings for the financial reporting periods covered by the class period. Motion at 3-5. OmniVision eventually restated earnings results for the quarters ended July 31, 2003; October 31, 2003; and January 31, 2004. Motion at 4. Given that the financial results for these periods were restated, the originally announced results were clearly misleading. "Properly pled, overstating of revenues may state a claim for securities fraud . . ." Hockey v. Medhekar, 30 F. Supp. 2d 1209, 1216 (N.D. Cal. 1998). Here, the allegations concern understating of revenue, but Defendants' argument that there is a distinction between overstatements and understatements of revenue is simply not credible. The one third drop in OmniVision's stock price on June 9, 2004 overwhelmingly demonstrates that the investing community finds improper revenue recognition incidents to be serious matters regardless of the direction of the improper recognition. Therefore, this Court holds that Plaintiffs have sufficiently plead facts showing that Defendants issued misleading statements. Of course, this alone cannot defeat dismissal. "[T]he mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter." Provenz v. Miller, 102 F.3d 1478, 1490 (9th Cir. 1996) (internal citations and quotations omitted). As discussed in the following section, the Court finds that the allegations of scienter are sufficient to defeat dismissal.
B. Whether the Complaint alleges scienter
As a preliminary matter, the Court notes the connection between a § 10(b) claim and a § 20(a) claim. "Scienter is an essential element of a § 10(b) or Rule 10b-5 claim. And to prevail on their claims for violations of § 20(a) . . ., plaintiffs must first allege a violation of § 10(b) or Rule 10b-5. Absent pleading scienter with particularity, there can be no liability" on either the § 10(b) claim or the § 20(a) claim. Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1035 (9th Cir. 2002) (internal citations and quotations omitted). In other words, dismissal of the § 10(b) claim necessitates dismissal of the § 20(a) claim as well. Similarly, allegations sufficient to support a § 10(b) claim provide strong support for a corresponding § 20(a) claim. Therefore, the Court will focus its analysis on the § 10(b) claim.
Turning to the legal definition of the element of scienter applicable here, the PSLRA's "required state of mind," in 15 U.S.C. § 78u-4(b)(2), "refers to the scienter requirement applicable to [a section 10b claim]." In re Silicon Graphics, 183 F.3d at 975. The PSLRA states, "In any private action arising under this title in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall . . . state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). The Ninth Circuit has held that "the PSLRA language that the particular facts must give rise to a strong inference of the required state of mind [means] that the evidence must create a strong inference of, at a minimum, `deliberate recklessness.'" In re Silicon Graphics, 183 F.3d at 977 (internal quotations omitted). A plaintiff bringing a claim controlled by the PSLRA, as Plaintiffs do here, "can no longer aver intent in general terms of mere `motive and opportunity' or `recklessness,' but rather, must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent." Id. at 979.
"Scienter can be established by direct or circumstantial evidence." Provenz, 102 F.3d at 1490. The preferable way for a plaintiff to show scienter is by putting forth contemporanous reports or data which contradict the allegedly misleading statements. Nursing Home Pension Fund, 380 F.3d at 1230. Plaintiffs here have put forth a variety of arguments to support their allegations of scienter. For example, Plaintiffs allege that "the restatement and GAAP violations create an inference of scienter." Opposition at 10. However, as stated above, "the mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter."Provenz, 102 F.3d at 1490. Alternatively, Plaintiffs suggest that OmniVision's muddled explanations of its improper accounting at the time of the restatement and its unstable upper management ranks during the class period support an inference of scienter. Opposition at 14-16. However, the Court finds these arguments to be insufficient under the heightened pleading requirements of the PSLRA.
An alternative method of showing an inference of scienter involves insider trading data. "[I]nsider trading in suspicious amounts or at suspicious times is probative of scienter."Provenz, 102 F.3d at 1491 (internal citations and quotations omitted). Generally speaking, under Ninth Circuit law, "[s]tock trades are only suspicious when dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information." Nursing Home Pension Fund, 380 F.3d at 1232 (internal citations and quotation omitted). "To evaluate suspiciousness of stock sales, [a court considers] three factors: (1) the amount and percentage of shares sold; (2) timing of the sales; and (3) consistency with prior trading history." Id.
Plaintiffs have detailed a series of stock sales by the Individual Defendants. For example Defendant Hong sold 18% of his shares during the class period, but only 7% of his shares in the year earlier period. SCAC at 43. Defendant Wu sold 64% of his shares in the class period, but only 29% of his shares in the year earlier period. Id. Defendants McCown and Rossi sold 100% of their shares during the class period. Id. at 44. These percentages, the timing, and the inconsistency with prior trading history all support a finding of an inference of scienter for purposes of this Motion. In particular, two of the Individual Defendants more than doubled the relative proportion of their shares they sold during the class period. The other two simply sold all of their shares. The Court finds that these sales meet the "dramatically out of line" standard described in Nursing Home Pension Fund.
The Court recognizes that "credible and wholly innocent explanations for stock sales, ranging from long-standing programs of periodic divestment, to the need to free cash to meet matured tax liabilities [if unrebutted] are sufficient to defeat any inference of bad faith." Provenz, 102 F.3d at 1491 (internal citations and quotations omitted). Tellingly, Defendants have offered no such explanations. Reply at 12-13. Rather, Defendants rely on their misconstrued theory that because this case involves earnings understatements, instead of overstatements, insider sales are not indicative of scienter. For example, Defendants state, "If, in fact, defendants were causing financial results (and hence OmniVision's stock price) to be artificially deflated in the current period, so that it would be higher in future periods, there would be no reason to sell stock in the current period." Reply at 12. This statement is a dramatic misconception of how stock markets function as demonstrated by the movement of OmniVision's stock on June 9, 2004. Clearly, the investing community does not view improper revenue recognition resulting in understated earnings in the same light as Defendants because the share price of OmniVision fell by approximately one third on June 9, 2004 when the company first announced its accounting problems.
In light of the above, the Court finds that Plaintiffs have demonstrated an inference of scienter sufficient to meet the heightened pleading requirements of the PSLRA and defeat this Motion to Dismiss.
C. Individual defendants' liability for others' statements
The parties disagree over the applicability and extent of the "group pleading doctrine." Under the group pleading doctrine, there is "a presumption that the allegedly false and misleading `group published information' complained of is the collective action of officers and directors." Berry v. Valence Tech., Inc. 175 F.3d 699, 706 (9th Cir. 1999). The Court has found no case law to suggest that this doctrine does not apply here. It is true that the Ninth Circuit has limited the doctrine in cases of directors' liability to situations where a director participated in day-to-day corporate control or had some other special relationship with the corporation. Id. However, this limitation is moot here since all four Individual Defendants were executives with day-to-day responsibilities at OmniVision. Therefore, the Court holds that at this time the group pleading doctrine does apply. However, with respect to Defendants McCown and Rossi, who were CFOs of OmniVision for different sub-periods of the class period, the Court cautions Plaintiffs that the potential liability of an Individual Defendant for statements attributable to the corporation or other individuals is limited by when that defendant served in a position encompassed by the group pleading doctrine.
As to the attempt to limit Defendant Wu's liability, the argument put forward by Defendants is at best unclear. Defendants state, "Contrary to the [Complaint], with the exception of the 2003 10-K and the secondary offering documents, Mr. Wu did not sign any of the SEC filings challenged by plaintiffs." Motion at 23. These are two rather large exceptions. While the Court recognizes that the 2003 10-K concerned past results which did not fall within the class period, clearly the secondary offering documents were concerned with revenue recognition methods during the class period.
D. Whether complaint alleges economic losses
On April 20, 2005, Defendants' original Motion to Dismiss was vacated by this Court subsequent to the Supreme Court's holding in Dura Pharmaceuticals, Inc. v. Broudo, 125 S. Ct. 1627, 161 L. Ed. 2d 577, 2005 U.S. LEXIS 3478 (April 19, 2005), that plaintiffs in a securities fraud action must show that they "suffered actual economic loss." An "`artificially inflated purchase price' is not itself a relevant economic loss." Id. *19. Rather, where the facts suggest that false or misleading statements led to an artificially inflated purchase price, the complaint cannot fail to allege that the "share price fell significantly after the truth became known." Id.
Plaintiffs' Amended Complaint of November 23, 2004 merely alleged that "members of the Class acquired OmniVision securities during the Class Period at artificially high prices and were damaged thereby." Consolidated Complaint at 42. This was insufficient under Broudo. The Second Consolidated Amended Complaint now before the Court alleges, "Plaintiffs purchased OmniVision securities at artificially inflated prices and suffered damages when revelation of the true facts caused a decline in the value of their investments." SCAC at 49. The Court finds this to be a sufficient allegation of economic loss as required under theBroudo standard described above.
V. CONCLUSION
The PSLRA and Rule 9(b) of the Federal Rules of Civil Procedure require a heightened standard of pleading and particularity with regard to securities class actions. Here, these pleading requirements are met by the Second Consolidated Amended Complaint. It is uncontested that Defendant OmniVision engaged in accounting procedures which led to earnings restatements for several periods. It is also uncontested that the executives in charge at the time engaged in a pattern of share sales that was distinguishable from earlier sales. While these facts alone do not prove by themselves any liability on the part of the entity or Individual Defendants, the Court holds them to be sufficient to defeat the instant Motion. Therefore, the Court DENIES Defendant's Motion to Dismiss in its entirety. It is further ordered that the parties are to appear on September 16, 2005 at 10 a.m. in Courtroom Number 1 for a status conference. The parties are to file one joint status conference statement 7 days prior to the conference.
IT IS SO ORDERED.