Opinion
No. C 01-0988 MJJ.
March 24, 2003.
Donald M. Falk, Esq., Mayer Brown Rowe Maw, Palo Alto, CA.
Nicole Lavallee, Esq., Berman DeValerio Pease Tabacco Burt Pucillo, San Francisco, CA.
ORDER GRANTING DEFENDANTS' MOTION TO DISMISS
INTRODUCTION
Before the Court is Defendants Oracle Corporation, Lawrence J. Ellison, Jeffery O. Henley, and Edward J. Sanderson's (collectively "Oracle" or "Defendants") Motion To Dismiss Second Amended Complaint ("MTD") for failure to state a claim upon which relief can be granted. Coupled with this motion are Plaintiff's Motion To Amend Second Amended Complaint and Plaintiff's Motion To Strike.
Considering first plaintiff's motion to amend the Second Amended Complaint and to file a Revised Second Amended Complaint, defendants do not oppose such a revision, and the proposed revisions are relatively minor. Therefore, the Court GRANTS this motion. For this reason, the motion to dismiss the second amended complaint shall be considered as a motion to dismiss the Revised Second Amended Complaint ("RSAC").
With regard to the motion to dismiss, the Court has twice found that plaintiffs have failed to meet the heightened pleading requirements in securities cases established by the Private Securities Litigation Reform Act ("PSLRA"), Section 10(b) of the Securities Exchange Act, and SEC Rule 10b-5. Defendants' motion to dismiss the initial Consolidated Complaint was granted through this Court's March 13, 2002 Order ("1st. Ord."), and the First Amended Consolidated Complaint was also ordered dismissed on September 11, 2002. ("2nd Ord.") In both Orders, the Court held that plaintiffs failed to allege with sufficient detail facts supporting their allegations and that their pleadings did not rise to the high standard required by the PSLRA. While it adds several new allegations, the Revised Second Amended Complaint fails to cure the deficiencies of its predecessors. Therefore, defendants' motion to dismiss is GRANTED, without leave to amend.
The Court did not rely upon defendants' Appendix of Allegations and Appendix of Confidential Witness Allegations, so plaintiffs' motion to strike these appendices is therefore moot.
FACTUAL BACKGROUND
Like the pleadings before it, plaintiffs' Revised Second Amended Complaint alleges securities fraud in violation of Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. The complaint is brought on behalf of a class of private and public investors who purchased Oracle stock between December 15, 2000 and March 1, 2001. The complaint alleges that during that period (the Class Period), Oracle and its top executives, Chief Executive Officer Larry Ellison, Chief Financial Officer Jeffery Henley, and Executive Vice President Edward Sanderson, made false and misleading statements concerning Oracle's projected third quarter earnings and the overall viability and efficiency of its new flagship product, the 11i Suite.Oracle is the second-largest software company in the world, designing and selling software for business information management. In the arena of database management systems, Oracle has been the market leader since the 1980s. Responding to the market's need for fully integrated software applications, Oracle developed the 11i Suite, a product designed to enable companies to manage the financial, manufacturing, sales, logistics, e-commerce, and supplier components of their business in a single software package, eliminating the need to purchase separate software for each function.
As with the initial Consolidated Complaint and the First Amended Consolidated Complaint, the bulk of plaintiffs' claims in the Revised Second Amended Complaint ("RSAC") center on alleged problems with the implementation of the 11i Suite. Plaintiffs allege that Oracle, through executives Ellison, Henley and Sanderson, made several misrepresentations about the overall viability and efficiency of the 11i Suite. Specifically, plaintiffs allege that in the spring of 2000, Ellison and others began marketing the 11i Suite as a fully integrated and interoperable platform that obviated the need for businesses to buy and integrate a number of separate applications. However, plaintiffs claim that the software was anything but integrated and interoperable. Plaintiffs allege that Oracle knew that its statements concerning the interoperability of the 11i Suite were false because Ellison and other company executives were aware of the product's massive defects. This awareness was created by strong customer dissatisfaction with the product and the need for substantial programming adjustments and systems integration in order for the Suite to function. Plaintiffs allege that on December 15, 2000, January 5 and 8, and February 3, 2001, Ellison and Sanderson made false statements about the financial savings Oracle enjoyed as a result of its internal use of the 11i Suite. Plaintiffs allege that Ellison and Sanderson knew that their statements to the public concerning the savings claim were false because the product was "always down" and because it did not work even within Oracle.
Plaintiffs allege that defendants falsely assured investors that demand for the 11i Suite was so strong that the slowing economy would not impair Oracle's projected financial growth. Plaintiffs allege that on February 9, 2001, Oracle falsely insisted that the "slowdown is going to provide new opportunities for Oracle." Plaintiffs also claim that on February 13, 2001, Sanderson denied speculation that Oracle would fall short of its 3Q01 projections, falsely claiming that its pipeline for applications and database products has "never been stronger." According to plaintiffs, these allegedly false statements were often coupled with Oracle's lofty growth projections, attributing the Plaintiffs allege that Oracle knew that its statements projecting software applications growth of 75%, earnings per share (EPS) growth of $0.12, and revenues of $2.9 billion for 3Q01 were false when made because applications and 11i Suite sales had steadily diminished since "early summer 2000."
The "pipeline" refers to a database of possible sales opportunities, ranging from contacts with potential customers to contracts about to be signed. As a given opportunity becomes closer to a sale, it is moved along the pipeline, and sales projections are based on the probability of items in the pipeline resulting in revenue.
Plaintiffs seek to substantiate these allegations with confidential witnesses who claim that Oracle knew that the statements of its executives during the Class Period were false when made because Henley, Ellison, and Sanderson were all aware of internal reports, and informed through Oracle's internal databases, that there was "a severe and continuous decline in product sales from June 2000 to March 2001." Plaintiffs allege that the market relied on the allegedly false statements, and that the price of Oracle's stock was thereby kept artificially high. Plaintiffs assert that when Oracle announced on March 1, 2001 that revenue and earnings per share were lower in 3Q01 than it had predicted, the stock price dropped accordingly. Plaintiffs claim that Ellison and Henley fraudulently benefitted from the artificially inflated stock by selling $925 million worth of Oracle stock two months before the announcement of its 3Q01 earnings.
On March 1, 2001, Oracle announced its 3Q01 results: (1) $2.7 billion in revenue (as opposed to its projected $2.9 billion); (2) EPS growth of 10 cents per share (as opposed to its projected 12 cents); and (3) applications growth of 25% (as opposed to its projected 75%). As a result of the announcements, Oracle stock dropped from $19.375 to $16.875 the following day.
New to the RSAC is a claim of improper revenue recognition. Based on information from a confidential witness, plaintiffs allege that Oracle improperly converted money from customer overpayments to revenue, in violation of GAAP. This money, in the hundreds of millions of dollars, was originally held in an "unapplied cash account" for each customer that had overpaid. However, plaintiffs allege that in a series of transactions in November of 2000, the money in the unapplied cash account was converted into "debit memos," and these debit memos were in turn improperly recognized as revenue. The RSAC claims that these transactions artificially inflated Oracle's revenue by at least $228 million. Based on this allegation, plaintiffs assert that defendants' statements regarding Oracle's performance in 2Q01 and its projections for 3Q01 were materially false when made.
Defendants maintain that these new allegations suffer the same fatal defects as the allegations in the first two complaints: namely, that they fail to meet the stringent pleading requirements of the PSLRA. For the reasons outlined below, the Court agrees.
LEGAL STANDARDS
1) Rule 12(b)(6)
A court may dismiss a complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for either lack of a cognizable legal theory or the pleading of insufficient facts under an adequate theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir. 1984). When deciding upon a motion to dismiss for failure to state a claim upon which relief can be granted pursuant to FRCP 12(b)(6), a court must take all of the material allegations in plaintiff s complaint as true, and construe them in the light most favorable to plaintiff. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995). Moreover, a complaint should not be dismissed unless a plaintiff could prove no set of facts in support of his claim that would entitle him to relief. Id.
In the context of a motion to dismiss, review is limited to the contents in the complaint. Allarcom Pay Television, Ltd. v. General Instrument Corp., 69 F.3d 381, 385 (9th Cir. 1995). When matters outside the pleading are presented to and accepted by the court, the motion to dismiss is converted into one for summary judgment. Where such a conversion takes place, all parties must be given an opportunity to present all material made pertinent to such a motion by Rule 56. In re Pacific Gateway Exchange, Inc. Securities Litigation, 169 F. Supp.2d 1160, 1164 (N.D.Cal. 2001); see also Fed.R.Civ.P. 12(b). However, matters properly presented to the court, such as those attached to the complaint and incorporated within its allegations, may be considered as part of the motion to dismiss. See Hal Roach Studios, Inc. v. Richard Feiner Co., 896 F.2d 1542, 1555 n. 19 (9th Cir. 1989). Where a plaintiff fails to attach to the complaint documents referred to in it, and upon which the complaint is premised, a defendant may attach to the motion to dismiss such documents in order to show that they do not support plaintiff s claim. See Pacific Gateway Exchange, 169 F. Supp.2d at 1164; Branch v. Tunnell, 14 F.3d 449, 44 (9th Cir. 1994), cert denied, 512 U.S. 1219 (1997). Thus, the district court may consider the full texts of documents that the complaint only quotes in part. See In re Stac Electronics Securities Litigation, 89 F.3d 1399, 1405 n. 4 (1996), cert denied, 520 U.S. 1103 (1997). This rule precludes plaintiffs "from surviving a Rule 12(b)(6) motion by deliberately omitting references to documents upon which their claims are based." Parrino v. FHP, Inc., 146 F.3d 699, 705 (9th Cir. 1998).
2) Section 10(b) and Rule 10b-5
Section 10(b) of the Securities Exchange Act provides, in part, that it is unlawful "to use or employ in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b).
Rule 10b-5 makes it unlawful for any person to use interstate commerce
(a) To employ any device, scheme, or artifice to defraud.
(b) To make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.17 C.F.R. § 240.10b-5
To be actionable under section 10(b) and Rule 10b-5, a plaintiff must allege (1) a misrepresentation or omission (2) of material fact (3) made with scienter (4) on which the plaintiff justifiably relied (5) that proximately caused the alleged loss. See Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999). Additionally, in actions alleging fraud, plaintiffs must state with particularity the circumstances constituting fraud. Fed.R.Civ.P. 9(b).
3) Private Securities Litigation Reform Act
In 1995, Congress enacted the Private Securities Litigation Reform Act to provide "protections to discourage frivolous [securities] litigation." H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 32 (1995)) (Nov. 28, 1995). The PSLRA strengthened the pleading requirements of Rules 8(a) and 9(b). Actions based on allegations of material misstatements or omissions under the PSLRA must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1).
The PSLRA also heightened the pleading threshold for causes of action brought under Section 10(b) and Rule 10b-5. Specifically, the PSLRA imposed strict requirements for pleading scienter. A complaint under the PSLRA must "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, in interpreting the PSLRA, has held that "a private securities plaintiff proceeding under the [PSLRA] must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics Inc., 183 F.3d 970, 974 (9th Cir. 1999). If the complaint does not satisfy the pleading requirements of the PSLRA, upon motion by the defendant, the court must dismiss the complaint. See 15 U.S.C. § 78u-4(b)(1).
ANALYSIS
1) Differences Between the RSAC and the FACC
The Court has already given thorough consideration to the allegations in the FACC and the Consolidated Complaint. To the extent that the RSAC reincorporates the same allegations, the Court's rulings in its two prior Orders still stand. Comparing the RSAC to the dismissed FACC reveals remarkable similarity between the two complaints. ( See Defendants' Request For Judicial Notice, Ex. 37 ("DX").) The core of the RSAC is summed up in Plaintiffs Opposition To Defendants' Motion to Dismiss Second Amended Complaint ("Opp."), where plaintiffs state:
DX 37 is a redlined copy of the RSAC, highlighting changes from the FACC. While plaintiffs object to many of the exhibits contained in the Request For Judicial Notice, ( see Plaintiff's Response To Defendants' Request For Judicial Notice), they have no objections to DX 37. "The redlined Complaint, DX 37, is very helpful in identifying plaintiffs' new allegations." (Id. at 1:24-25).
Here, plaintiffs plead that (i) 48 witnesses saw a declining economy, declining sales and product defects in the second and third quarters; (ii) defendants made continuing false statements about these issues up to five days before the truthful disclosures; (iii) defendants made an astonishing amount of stock sales only four or five weeks before the disclosures; and (iv) defendants admit they had access to the same information the witnesses saw.
(Opp. at 21:9-13.) The RSAC adds to the allegations in four areas: 1) brand-new allegations of improper revenue recognition; 2) new allegations concerning defendants Ellison and Henley's insider trading; 3) new allegations regarding slumping sales and defendants' knowledge of this decline; and 4) new allegations of problems with the 11i Suite and Oracle's knowledge of these issues. The allegations completely new to the RSAC, concerning improper revenue recognition, will be more fully discussed below.
RSAC ¶¶ 8 and following.
RSAC ¶¶ 21, 23.
RSAC ¶¶ 35, 47, 48, and 49.
RSAC ¶¶ 52, 53, 64, and 66.
a) Allegations of Insider Trading
The insider trading allegations are essentially identical to the claims of insider trading present in the FACC, allegations that were dismissed by the Order of September 11, 2002. Despite their dismissal, these claims are resurrected in the RSAC, with the only changes being additional information concerning the price at which Ellison and Henley purchased their shares and a refutation of the Court's determination that defendants suffered the same loss as plaintiffs when the stock price fell on March 2, 2002. These changes are insufficient to alter the Court's analysis in its prior Order that plaintiffs fail to allege a claim for insider trading. As plaintiffs have not altered their allegations of insider trading from the FACC in any meaningful way, but have chosen to repeat practically the same claims in the RSAC, the Court repeats its dismissal of those allegations.
Similarly, Plaintiffs' claim that Ellison and Henley's stock trades prior to the March 1 announcement provide a strong inference of scienter is unpersuasive. "`Only unusual' or `suspicious' stock sales by corporate insiders may constitute circumstantial evidence of scienter." Silicon Graphics, 183 F.3d at 986. Courts consider (1) the amount and percentage of shares sold by insiders, (2) the timing of the sales, and (3) whether the sales were consistent with the insider's prior trading history." Id. Additionally, percentages of a trader's total portfolio become more significant in cases where insider trading is the only circumstance left in the case to show scienter. Id. at 987-88. Plaintiffs allege that defendants Ellison and Henley's stock sales totaling $925 million shortly after "inflating" the stock with alleged falsehoods provide[an] additional stronger inference of scienter and a motive for fraud. In the Ninth Circuit, stock sales alone ("motive and opportunity") cannot provide a strong basis for scienter. In re Splash, 160 F. Supp.2d 1059, 1081 (N.D.Cal. 2001). Moreover, Plaintiffs claim that the timing of Ellison and Henley's stock trades were highly suspicious is unpersuasive. "[I]nsider trading is suspicious only when it is "dramatically out of line with prior trading practice at times calculated to maximize the personal benefit from undisclosed inside information." Ronconi v. Larkin, 253 F.3d 423, 435 (9th Cir. 1991).
Plaintiffs' allegations are not borne out by the facts. First, Plaintiffs have not proven that Ellison or Henley was aware of any undisclosed inside information. Second, Plaintiffs do not provide the Court with any information about Henley's prior trading. Third, Plaintiffs cannot get around the fact that Ellison sold only 2.1% of his holdings, retaining approximately 98% of his holdings and Henley sold only 7% of his holdings. Thus, both Ellison and Henley "incurred the same large losses as did the Plaintiffs." Worlds of Wonder, 35 F.3d at 1425. Additionally, neither defendants' sales were at suspicious times, both occurring two months prior to Oracle's announcement of its third quarter results. Therefore, because both Ellison and Henley "retained the vast majority of [their] holdings and none of the sales occurred at suspicious times, such as immediately before a negative announcement," the Court finds that Ellison and Henley's stock trades do not support a strong inference of scienter. Wenger, 2 F. Supp.2d at 1251.
(2nd Ord. at 19:19-20:23.) These determinations from the second Order apply with equal force to the allegations of insider trading in the RSAC.
b) Allegations Regarding Declines in Sales
Plaintiffs attempt to bolster their allegations that sales during 3Q01 were in serious decline, thus rendering the optimistic statements of defendants false when made, by adding allegations from new confidential witnesses. CW 47, a former Vice President of Field Sales, described a "pipeline collapse" in 2Q01, and that "very little remained in the pipeline in the western states territory" in 3Q01 and 4Q01. (¶ 47(j).) CW 37 reported scarce sales and a slowdown in business in the distributor channel in 2001, "which developed into a complete collapse by February 2001." (¶ 47(v).) CW 19 stated that no deals closed in the federal government sector of his organization between June 2000 and December 2000. (¶ 47(y).) According to CW 26, there was a 1Q01 slowdown in the Southern Internet Services Division, where "lli sales were not taking hold." (¶ 47(aa).) CW 40 "reports that the number of consulting deals between January 2001 and February 2001 went to zero[.]" (¶ 48(1).)
Citations using "T" by itself refer to paragraphs in the RSAC.
New allegations by plaintiffs maintain that Ellison was well aware of these negative reports by keeping track of deals through an internal website. (¶ 48(k) (CW30).) CW 47 stated that Ellison was also using Oracle Sales Online to monitor every sale, and the Oracle White Paper stated that all sales representatives were using this same database for pipeline management and forecasting. (¶¶ 49(a) (CW 47), 49(b).) Thus, plaintiffs repeat their claim in the FACC that Ellison must have been aware of the phenomenon of declining sales, and that he would therefore have known that Oracle could not meet its 3Q01 projections.
Oracle Sales Online is an internal database through which Ellison had access to up-to-the-minute information about current sales and revenue, future projections, and a host of other information about Oracle's financial performance.
In dismissing the FACC, the Court held that the failure to allege what the database Ellison consulted actually contained was a fatal flaw in the pleading.
Although Plaintiffs contend that several confidential witnesses (CW's 1-4, 6, 16, 19, 28, 31, 32, 36 and 44) had access to Oracle's comprehensive, global database, Oracle Sales Online, and knew that the database contained references to every sales opportunity, its amount and its progress to closing, the FACC does not allege overall sales figures, revenue or pipeline figures. However, none of these confidential witnesses offer any information that would prove any statement false when made. As this Court has previously stated in dismissing Plaintiff's initial complaint, Plaintiffs fail to "allege what the reports in the OASIS database said nor d[id] Plaintiffs provide any other basis from which the Court could infer knowing falsity." Order at 9. [1st Ord.] Providing the Court with information that Sanderson or Ellison had access to "up to the minute" global roll-ups without providing what the details actually were cannot satisfy the pleading requirements of the PSLRA. Nor does the fact that these confidential witnesses, from their knowledge of the several regional, national, or global databases, thought that sales "went dead," "fizzled out," "dried up," and "stopped" establish that Ellison, Sanderson or Henley knew of this information or thought the same thoughts.
(2nd Ord. at 13:12-28 (emphasis original).) It is not sufficient simply to allege that given statements about growth in sales or pipeline status were false; plaintiffs must also allege what sales the performance actually was, and what the pipeline actually contained. Ronconi v. Larkin, 253 F.3d 423, 431 (9th Cir. 2001) (upholding dismissal where "[t]he complaint fails to describe, chart or graph what sales actually did"). This very problem was raised in the September 11, 2002 Order dismissing the FACC.
Plaintiffs also would also have to provide this Court with information showing that as of a specific date Oracle knew about a specific amount or volume of sales. Then, Plaintiffs would have to demonstrate that Oracle's knowledge of the sales volume would have made its predictive statements false when made. Plaintiffs could accomplish this by comparing the specific sales volume figures with prior quarters or some other comparative factor. This Court has no such numbers to work with.
(2nd Ord. at 16:11-19). The Court still lacks these figures, and therefore, this deficiency has not been rectified in the RSAC.
The need to allege what Ellison knew about the global sales picture for Oracle stems from the company's massive size, considerable volume of sales, and wide geographic reach. Oracle is a company with over $10 billion in annual revenue, roughly half of which comes from overseas. (DX 6 at 9, 5.) The company employs over 7,000 sales people, who are located in 60 different countries and organized within seven global business units. (PX 38 at 39.) While plaintiffs furnish reports from a number of confidential witnesses who describe declining sales across a number of Oracle's product lines and domestic markets, these witnesses afford only a limited view of the financial health and sales performance of the company during 3Q01. Plaintiffs fail to allege that these reports, when coupled with reports from other sectors within North America and throughout the rest of the world, led defendants to know that the statements about sales performance, pipeline strength, and earnings projections were false when made. A useful analogy is provided by the court in In re Federal Mogul Corp. Securities Litig., 166 F. Supp.2d 559 (E.D.Mich. 2001).
Plaintiffs have no objection to Exhibit 6 in Defendants' Request for Judicial Notice. See Plaintiff's Response To Defendants' Request For Judicial Notice at 1:24.
"PX" refers to exhibits contained in plaintiff's Corrected Appendix Of Exhibits To Plaintiffs' Second Amended Complaint.
For an argument about the breadth of information about Oracle's performance to which the confidential witnesses had access, see defendants' Reply In Support Of Motion To Dismiss ("Reply") at 12, n. 9.
If during World War II, General George C. Marshall had reported that the Allied offensive was going well, but a private at the front reported that the war looked pretty bad to him, there would not be a strong inference from the private's comments that General Marshall was lying about the overall success of the military strategy.Id. at 564. While plaintiffs present a number of confidential witness reports that detail sales problems, in the absence of allegations relating what the overall sales and pipeline figures were for Oracle as a whole, it is impossible for the Court to determine that the scope of the alleged problems was sufficient to render defendants' optimistic statements about Oracle's performance false when made.
See Reply at 12:4-6.
In addition, plaintiffs fail to establish that the allegations in the RSAC give rise to a strong inference that defendants acted with the required state of mind, or that the positive statements about 3Q01 performance were false when made. See 15 U.S.C. § 78u-4(b)(2); see also Silicon Graphics, 183 F.3d at 974. While one may infer from the confidential witness reports that Ellison and the other defendants were aware of the sales decline and that their statements were false, it does not raise a strong inference. See Federal Mogul, 166 F. Supp.2d at 564. Nor is it the only inference that may be drawn from plaintiffs' allegations.
When considering whether plaintiffs meet the heightened pleading requirements of private securities actions, the Court is not limited to accept only inferences favorable to plaintiffs. Rather, "when determining whether plaintiffs have shown a strong inference of scienter, the court must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs." Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir. 2002) (emphasis original). Based on the information in plaintiff's complaint and the documents attached to it, it is also reasonable to infer that reports of declining sales from some Oracle salespeople, managers, and executives in North America, when combined with reports of sales from other sectors of North America, as well as the rest of the world, did not make Oracle's positive statements about sales and optimistic projections for 3Q01 false when made.
In light of the lack of any pleadings by the plaintiffs as to sales figures for Oracle as a whole, or concerning the status of the pipeline for the entire company, the Court finds that "plaintiffs have not established that Oracle knew of hard, contemporaneous and contradictory facts when it made its 3Q01 projections." (2nd Ord. at 18:10.) Thus, the new allegations of pipeline difficulties and a slowdown in sales do not change the Court's prior determination that plaintiffs have failed to allege a strong inference that defendants knew the favorable statements at issue in the complaint were false when made.
c) Allegations Concerning Problems With the 11i Suite
The RSAC contains a number of new allegations involving confidential witness reports of problems with the performance and implementation of the 11i Suite, Oracle's flagship product. However, these new allegations utterly fail to address the concerns expressed by this Court in its prior Order.
Although Plaintiffs have included several paragraphs regarding the functionality of the 11i Suite [in the FACC], Plaintiffs do not establish how Oracle's alleged difficulty implementing the 11i Suite affected the revenue projections made prior to the close of 3Q01. Finally, and most importantly, Plaintiffs' FACC fails to account for Oracle's financial success in the two quarters which immediately followed the release of the 11i Suite. . . . Essentially, Plaintiffs argue that although most of the alleged defects in the 11i Suite occurred during two successful quarters which followed the product's introduction, these same defects are attributable to Oracle's missed 3Q01 predictions and therefore establish that Oracle knew that its 3Q01 predictive statements were false when made. Yet, Plaintiffs have not [pled] anything that would have made it unreasonable for Oracle to expect that the financial success it enjoyed during the two quarters following the product's release (despite the alleged product defect claims) would also obtain in 3Q01.
(2nd Or. at 17-19.) As the Court has previously found the product defect allegations insufficient to support a claim for securities fraud, and as the new allegations in the RSAC add little to what had been pled in the FACC, the Court's finding that the FACC fails to plead the requisite particularity is extended to the RSAC.
2) RSAC's Allegations of Improper Revenue Recognition
The claims in the RSAC that are completely new to the case are plaintiffs' allegations that Oracle committed accounting fraud by improperly recognizing revenue in 2Q01. Relying largely on information from an outside financial analyst, CW 46, plaintiffs contend that defendants maintained an account of "unapplied cash" that contained customer overpayments. ( See ¶¶ 36-44.) Rather than refund these customer overpayments, Oracle kept the money in various unapplied cash accounts. (¶ 36(c).) As an outside analyst hired by some of Oracle's customers, CW 46 investigated the status of the unapplied cash. She learned that on November 17, 2000, defendants conducted an internal process to "clean up" these accounts by creating over 46,000 "debit memos" that were later credited as revenue, (¶ 41(c) (discussing CW 49's corroboration of CW 46's report).) Plaintiffs assert that this process resulted in the improper recognition of over $228 million in revenue, artificially inflating defendant's reported revenue for 2Q01 and making its earnings and financial reports for that quarter false when made. (¶ 43.)
Defendants argue that the transactions that resulted in the creation and rectification of these debit memos did not result in any recognition of revenue, and more importantly, that there is no basis for plaintiffs to allege that these internal transactions resulted in revenue recognition. Were the Court to accept defendants' characterization of the creation of the debit memos, it would be considering factual challenges to the complaint, which is not permitted in the context of a motion to dismiss. See Lee v. City of Los Angeles, 250 F.3d 668, 688 (9th Cir. 2001). However, in determining whether there is a son inference that statements were false when made, and that defendants knew they were false or were deliberately reckless as to their truth, the Court may consider whether there is a basis for the allegations made in the complaint. See 15 U.S.C. § 78u-4(b)(1) (". . . if an allegation is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed."); 15 U.S.C. § 78u-4(b)(2) (". . . the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."). In the case of the allegations of improper recognition of revenue, the Court may consider whether the plaintiffs allege that the confidential witnesses have a basis to know that the debit memos were, in fact, recognized as revenue. Nowhere in the Complaint do plaintiffs allege information sufficient to satisfy the Court that the confidential witnesses upon whom plaintiffs rely were in a position to know Oracle's accounting treatment of the debit memos.
Confidential witness 46 is "a former Financial Analyst for a global recovery, audit, and cost containment firm. . . . As a financial analyst, CW 46 reviewed the billing and payment histories of 17 separate Oracle customers and spoke directly with Oracle employees concerning customer overpayment and credits." (¶ 27(tt).) Plaintiffs repeatedly rely upon CW 46 for their claim that the debit memos were treated as revenue.
According to CW 46, the financial impact of a "550" debit memo was the same as the creation of an actual invoice for a real product sale. In these 760 instances, however, there were no real sales.
(¶ 37(b).)
The amount of the debit invoice was for $15,582.55. According to CW 46, his/her investigation revealed that the exact same amount was overpaid by [Eli] Lilly to Oracle on June 23, 1997. Lilly's billing history also revealed that Oracle created a $15,582.55 credit for the overpayment on June 23, 1997, but did not notify Lilly of the credit and did not refund the money. On November 17, 2000, however, Oracle created the phony "550" invoice and applied the 1997 overpayment to satisfy the phony invoice and booked the $15,582.55 as revenue.
(¶ 38(a) (citations omitted).)
CW 46 further researched the transaction [Household International debit memo] and determined that the January 4, 1991 check from Household was an inadvertent overpayment. Oracle never informed Household and had not refunded the money. . . . Therefore [through creation and rectification of a debit memo], Household's unapplied cash remained at Oracle for nearly 10 years, then it was used to satisfy a phony invoice booked as revenue.
(¶ 38(c).) There is nothing to indicate how CW 46, an outside analyst, working for Oracle's clients, would have knowledge of the internal accounting practices of Oracle or the specific treatment of the transactions involving the debit memos.
Plaintiffs attempt to overcome this hurdle by offering "corroboration" from Oracle employees. This corroboration, however, offers no more basis to establish that the debit memos were improperly recognized as revenue than do CW 46's reports standing alone. CW 48, a former Collections Analyst at Oracle's Rocklin, California office, states that there was a "huge sweep of old cash" on November 17, 2000. (¶¶ 38(e), (f).) There is no corroboration through CW 48 that the debit memos were recognized as revenue. Plaintiffs also rely upon assertions made by CW 19, a former Oracle Finance Director and Manager of Revenue Accounting who offers only that the 11i Suite suffered technical problems that turned many support agreements into money losing engagements, and that "we had a fund we could pull from" to compensate Oracle for these unprofitable agreement. (¶ 38(g).) There is utterly no linkage to the debit memos in plaintiffs' presentation of CW 19's report.
In fact, the sole source within Oracle to support CW 46's claim, as set forth in the RSAC, is CW 49, a former Oracle Senior Manager of Global Process in Oracle's Rocklin, California office. He alleges that there was pressure from Oracle Senior Vice President of Finance of Operations Jennifer Minton to "clean up" the unapplied cash upon other employees, and that they created the debit memos and improperly recognized $230 million as revenue. (¶¶ 41(a)-(d).) This lone allegation from a person who might have a basis to know the internal accounting treatment of the debit memos is insufficient to support a strong inference that improper recognition of revenue has taken place, notwithstanding the assertions contained in ¶ 41(d).
CW 49 further disclosed that at that time (November 2000), he voiced his concern to his superiors, including [Vice President of Revenue Accounting Mike] Quinn, about recognizing revenue on the basis of customers' unapplied cash. Quinn then told CW 49 that he/she should not worry about the matter because it was none of CW 49's concern.
(Id.) While plaintiffs aver that this reflects an attempt to cover up improper recognition of revenue, the Court is troubled by the lack of detail concerning the basis of CW 49's personal knowledge. The RSAC does not furnish any basis to conclude that a "Process Manager" had the ability to know that the creation of debit memos for the unapplied cash resulted in the improper recognition of revenue. The pleading does not inform the Court what the duties of a "Manager of Global Process" are or how broad their scope extends.
The Court also notes the similarity to In re Northpoint Communications Group, Inc., where this Court expressed concerns with a complaint's ability to satisfy the PSLRA when it is unclear what the basis of a witness's knowledge is for the allegations she puts forward. See id., 221 F. Supp.2d 1090, 1098 (N.D.Cal. 2002). In this case, as in Northpoint, plaintiffs offer no information to establish that CW 49 had " firsthand knowledge of the information attributed to [him]." Id. at 1097-98 (emphasis original). Thus, plaintiffs do not meet the requirement that a strong inference of scienter be raised in a private securities action.
In addition to failing to provide facts sufficient to produce a strong inference that improper revenue recognition took place, a second fatal flaw of the RSAC is that it neglects to establish that even if such accounting improprieties were present in 2Q01, defendants were aware of them. The only allegation of scienter regarding revenue recognition flows from defendants' alleged micro-management of Oracle operations.
As alleged in ¶¶ 16, 34, 49(d) and 79, defendants Ellison, Sanderson and Henley admitted that they micro-managed and were aware of all aspects of Oracle's business, sales and earnings, which supports a strong reference [ sic] that they were aware of and authorized the recognition of $228 million in revenue in 2Q01 — a substantial component of Oracle's quarterly earnings, without which the Company would have missed its forecast.
(¶ 44.) The Court disagrees that in this case, allegations of micro-management are sufficient to establish the strong inference of scienter required by the PSLRA. See In re Vantive Corp. Securities Litig., 283 F.3d 1079, 1087 (9th Cir. 2002) (holding that allegations of a "hands-on" management style, attendance at meetings, and receipt of numerous reports are insufficient to establish knowledge). Plaintiffs' claims of micro-management do not furnish the type of "critical details" necessary to support an inference that defendants knew about the accounting treatment of the debit memos. Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1038 (9th Cir. 2002). While plaintiffs may rely upon circumstantial evidence if it creates a strong inference of fraud, and "it may be inferred that facts critical to a business's core operations or to an important transaction are known to a company's responsible officers," Northpoint, 221 F. Supp.2d at 1104, the circumstantial evidence that defendants were "hands-on" managers is not sufficient in this case. Further, while plaintiffs attempt to link up one of the amounts they allege was improperly recognized in 2Q01 with the amount Oracle was shy in terms of its 3Q01 projections, there is no sufficient allegation that this accounting transaction was critical to Oracle's core operations or was an important transaction. Thus, plaintiffs cannot impute knowledge of the treatment of the debit memos to defendants through the circumstantial evidence of their nature as micro-managers. Once again, even assuming that knowledge of the creation of debit memos out of customer overpayments could be imputed to Ellison, Henley, and Sanderson, plaintiffs fail to establish that this accounting treatment actually resulted in the improper recognition of revenue.
While keeping customer overpayments may constitute a questionable business practice, plaintiffs have failed to allege facts and circumstances that rise to the level the court required in Silicon Graphics. Oracle customers may be curious indeed to learn what happened to their overpayments, but plaintiffs' allegations do not raise a strong inference of improper revenue recognition or that defendants' statements concerning the sales performance, pipeline status, and revenue projections were false when made. This matter is not an action to collect customer overpayments; it is a case of securities fraud under the PSLRA. As such, plaintiffs' pleadings must meet the rigorous pleading requirements imposed by the Act. As with the Consolidated Complaint and the First Amended Consolidated Complaint, plaintiffs' Revised Second Amended Complaint fails to do so.
CONCLUSION
For the reasons outlined above, the Court makes the following rulings; plaintiffs' Motion To Amend Complaint is GRANTED; defendants' Motion To Dismiss is GRANTED, without leave to amend; and plaintiff's Motion To Strike is considered MOOT.
IT IS SO ORDERED.