Opinion
Civil Action No. 02-D-263 (Consolidated with Civil Action No. 02-D-315) (MJW) and Civil Action No. 02-D-345
March 26, 2003
ORDER
THIS MATTER comes before the Court following the January 24, 2003, hearing on Defendants' Motion to Dismiss filed in Civil Action No. 02-D-263 and Plaintiff's Unopposed Motion to Lift Stay filed in Civil Action No. 02-D-345 on February 20, 2003. For the reasons stated on the record at the hearing and as set forth below, the motion to dismiss is denied and the motion to lift the stay in Civil Action No. 02-D-345 is granted subject to the contents of this Order.
I. STANDARD OF REVIEW
Defendants seek to dismiss the Complaint pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act ("PSLRA"). A Rule 12(b)(6) dismissal is appropriate only when it appears plaintiff can prove no set of facts in support of the claims that would entitle it to relief. Grossman v. Novell Inc., 120 F.3d 1112, 1118 (10th Cir. 1997). In considering a Rule 12(b)(6) motion to dismiss, the court must accept all the well-pleaded allegations of the complaint as true and must construe them in the light most favorable to plaintiff. Id. In the securities fraud context, a plaintiff is held to a strict standard of pleading. Id. at 1124.
Under Rule 9(b), a plaintiff is required to "set forth what is false or misleading about a statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading." In 1995, Congress passed the PSLRA in an effort to heighten Rule 9(b)'s pleading standards. "The [PSLRA] imposes even more rigorous pleading requirements on plaintiffs alleging fraud in the securities context." Karacand v. Edwards, 53 F. Supp.2d 1236, 1242 (D. Utah 1999). After the PSLRA, a securities complaint must first specify each statement alleged to have been misleading as well as "the reason or reasons why the statement is misleading." 15 U.S.C. § 78u-4 (b)(1); see also Karacand, 53 F. Supp.2d at 1242.
Further, and of particular significance here, a "complaint shall, . . . state with particularity facts giving rise to a strong inference that the defendant[s] acted with the required state of mind" and must do so with respect to each act or omission alleged to be a violation of the securities laws. 15 U.S.C. § 78u-4 (b)(2); see also Karacand, 53 F. Supp.2d at 1242. To establish that a defendant acted with the requisite state of mind, or scienter, a plaintiff must demonstrate that: "(1) the defendant knew of the potentially material fact, and [that] (2) the defendant knew that failure to reveal the potentially material fact would likely mislead investors." City of Philadelphia v. Fleming Cos., Inc., 264 F.3d 1245, 1261 (10th Cir. 2001).
"To state a claim under § 10(b) of the Securities and Exchange Act of 1934, a plaintiff must allege: (1) a misleading statement or omission of a material fact; (2) made in connection with the purchase or sale of securities; (3) with intent to defraud or recklessness; (4) reliance; and (5) damages." Spiegel v. Tenfold Corp., 192 F. Supp.2d 1261, 1263 (D. Utah 2002). The parties have collapsed this inquiry, for the purposes of the motion to dismiss, into whether under the PSLRA, Plaintiffs plead specific evidentiary facts establishing (1) the reasons why any alleged misstatement was false when made ( 15 U.S.C. § 78u-4 (b)); and (2) the basis for a strong inference that the statement was made with scienter ( 15 U.S.C. § 78u-4 (b)(2)). Accordingly, I will address each group of statements seriatim.
II. LEGAL ANALYSIS
A. ALLEGATIONS THAT DEFENDANT VIOLATED GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP")
(i.) PLAINTIFFS HAVE PLEAD SPECIFIC EVIDENTIARY FACTS ESTABLISHING THE REASONS WHY THE ALLEGED MISSTATEMENTS WERE FALSE WHEN MADE.
The first allegations of fraud concern GAAP violations related to certain transactions between SpectraLink and Lowe's Companies, Inc. Specifically, Plaintiffs allege that SpectraLink violated GAAP by "improperly recogniz[ing] revenue on eleventh-hour sham transactions with Lowe's[.]" (Compl. ¶ 5.) The transactions with Lowe's involved two shipments to Lowe's during the Class Period: (1) a shipment of "5,000 phones (approximately 150 phones per store), eight antennas per store, and two master control units per store" in "the final days of 1 Q 2001" and (2) a shipment of "approximately 600 to 1,000 phones, as well as master control antennas" in "the final days of 2Q 2001." (Complaint, ¶ 39, 49.) Defendants, however, maintain that Plaintiffs' fraud allegations suffer from several defects, each of which is fatal. (Def. Mot, p. 7.)
First, Defendants claim that Plaintiffs failed to sufficiently identify the source of the allegations in the Complaint. The Defendants contend that following vague descriptions of confidential sources are inadequate under the heightened pleading requirements: a former SpectraLink customer services manager; a former SpectraLink manufacturing department supervisor; and a former SpectraLink revenue manager. (Complaint, ¶ 39, 49-51.) Plaintiffs contend that they are not required to name or otherwise identify confidential informants in a PSLRA securities fraud complaint. Further, they maintain that the Complaint describes the confidential source by job title or job description and therefore, together with other facts in the Complaint, they have satisfied their pleading requirements.
It is well settled that Plaintiffs are not required to provide the name of their confidential source in the Complaint. Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000). Rather, in a situation such as the instant case, the confidential sources must be "described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged." Id.; see also In re Secure Computing Corp., 184 F. Supp.2d 980, 988 (N.D.Cal. 2001) ("if Plaintiffs make an allegation that is based on a statement from a witness, they must reveal facts about that witness that were material to the formation of their belief that the witness' statement is accurate").
Here, the first confidential source referred to in the Complaint is described as a former SpectraLink "customer services manager." (Compl., ¶ 39.) The allegations indicate that this source provided information about the first shipment to Lowe's in the final days of 1 Q 2001. According to the Complaint, this source knew that a large sale was needed to meet SpectraLink's sales and earnings projections and that the engineering department informed management that the equipment [that comprised the shipment] was defective." Moreover, the Complaint indicates that another confidential source, described as a `manufacturing department supervisor,' confirmed that Defendants had actual knowledge that the product was defective before shipment and also explained that `as expected, the product failed once installed.'" Id.
The Complaint also identifies a similar transaction occurring between Lowe's and SpectraLink in the final days of 2Q 2001. Again, according to a confidential source identified as a former SpectraLink manufacturing supervisor, SpectraLink shipped product to Lowe's "even though SpectraLink knew the products would be returned a few weeks later." ( Id. at ¶ 49-50.) Notwithstanding the knowledge that these shipments would be returned, the source claims these transactions were entered into so that "SpectraLink [would] meet its quarterly financial projections." ( Id. at ¶ 50.) According to a former SpectraLink revenue manager, Defendants Holland, Hamilton and Cronin had actual knowledge of these transactions and product returns. ( Id. at ¶ 52.)
While it is true that these allegations do not expressly provide how these confidential sources obtained their information, I find it is probable that "a person in the position occupied by the source would possess the information alleged." Novak, 216 F.3d at 314. My finding is based on the level of detail provided by each confidential source and corrobative nature of the each source's information. Whether or not these allegations are true is completely irrelevant to my inquiry at this stage of the proceeding. See Quenn Uno Ltd. P'ship v. Coeur S'Alene Mines Corp., 2 F. Supp.2d 1345, 1352 (D. Colo. 1998) ("[d]ismissal is not appropriate . . . merely because a Court disbelieves a complaint's factual allegations"). In addition, Defendants repeated suggestions that the allegations in the Complaint concerning the Lowe's transactions " are entirely false," are similarly inappropriate for this Court to consider at this stage of the preceding. (Def. Mot, p. 7, n. 6.) Accordingly, I conclude that Plaintiffs have plead specific facts which establish the reason the alleged misstatements were false when made.
As a result of a similar statement located in footnote one of Defendants' Reply brief filed January 8, 2003, Plaintiffs have filed a Motion to Strike such footnote because it improperly refers to extrinsic matters regarding the truth or falsity of the allegations in the Complaint. For the same reasons that I did not consider Defendants'arguments regarding any such falsity at this stage of the proceeding, I also will not consider Defendants' reference to an Affidavit that allegedly confirms the falsity of such allegations. Therefore, Lead Plaintiffs' Motion to Strike is hereby GRANTED. Further, Plaintiffs are not pleading these allegations on information and belief. Rather they are specifically relying on witness testimony to make these allegations. As the Eighth circuit stated in Florida State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645 (8th Cir. 2001),
If the shareholders' attorneys do not have a factual basis for this allegation, they will be subject to Rule 11 sanctions. Therefore, there is already a mechanism in place to deter and punish fabrication. Consequently, there is no need for the name of the money manager to be pleaded in the complaint, although it appears it will soon have to be disclosed under Fed.R.Civ.P. 26(a)(1)(A) if the shareholders intend to make use of it.Id. at 667. Thus, Defendants should subsequently raise this issue at an appropriate time.
(ii.) PLAINTIFFS SUFFICIENTLY PLEAD SPECIFIC EVIDENTIARY FACTS ESTABLISHING THE BASIS FOR A STRONG INFERENCE THAT THE STATEMENTS WERE MADE WITH SCIENTER.
The PSLRA also requires that, "with respect to each act or omission alleged to violate [section 10(b)]," Plaintiffs 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). To establish scienter in a securities fraud case alleging non-disclosure of potentially material facts in this Circuit, Plaintiffs must demonstrate:
(1) the defendant knew of the potentially material fact, and (2) the defendant knew that failure to reveal the potentially material fact would likely mislead investors. The requirement of knowledge in this context may be satisfied under a recklessness standard by the defendant's knowledge of a fact that was so obviously material that the defendant must have been aware both of its materiality and that its non-disclosure would likely mislead investors.City of Philadelphia, 264 F.3d at 1261. In contrast to the case cited in Defendants briefs, this is not a case where accounting irregularities are used to bootstrap an inference that Defendants acted with the requisite state of mind. Rather, Plaintiffs allege that Defendants made affirmative misrepresentations and also allege that former employees with direct knowledge have confirmed Defendants' intentional accounting manipulations. See Section II.A.(i), supra; see also City of Philadelphia, 264 F.3d 1261 ("only where [allegations of GAAP violations] are coupled with evidence that the violations or irregularities were the result of the defendant's fraudulent intent to mislead investors [that] they may be sufficient to state a claim"). Here, I conclude that Plaintiffs have stated with particularity facts giving rise to a strong inference that the Defendants acted recklessly.
B. MARCH 2001 MARKET ANALYSIS REPORT
(i.) PLAINTIFFS HAVE PLEAD SPECIFIC EVIDENTIARY FACTS ESTABLISHING THE REASONS WHY THE ALLEGED MISSTATEMENTS WERE FALSE WHEN MADE
Defendants next argue that this Court should reject Plaintiffs' only other allegation of fraud, which is that Spectra Link's October 17, 2001 announcement of third quarter results and its November 14, 2001 guidance for fiscal 2002 were false or misleading. Plaintiffs allegations of falsity are based on an internal March 2001 market analysis report (the "Report") that predicted a significant negative impact on SpectraLink's overall business, revenue and profits due to a market shift away from one of SpectraLink's products. Defendants make two arguments for rejecting this fraud theory; (1) the Complaint does not plead falsity with the specificity required by the PSLRA; and (2) the Complaint fails to identify any material fact that SpectraLink allegedly had a duty to disclose. (See Def. Mot, p. 8-9.)
Following an internal study in the months preceding March 2001, SpectraLink completed a 35 page comprehensive market analysis which found that SpectraLink's primary market was shifting away from SpectraLink's WTS line toward lower margin 802.11 products. (Compl. ¶ 27-30.)
First, Defendant contends that Plaintiffs' Complaint does not specifywhen the alleged market shift was expected to impact revenue, and therefore, it is not possible to state that SpectraLink's optimistic statements in the October 17, 2001, press release and the November 14, 2001, earnings guidance were "false when made." Further, Defendants argue that Plaintiffs failed to allege that the earnings guidance was inconsistent with the information in the March 2001 report. Accordingly, Defendants claim that SpectraLink could have factored the Report (assuming it existed) into its budgeting process for 2002 and still projected the revenue that it did. However, I agree with Plaintiffs that whether SpectraLink considered this
material in its 2002 budgeting analysis is not relevant to this Court's present analysis. At this stage of the proceeding, I am only concerned with the sufficiency of the pleadings and I find that Plaintiffs have plead specific facts which establish the reason the Report was false when made. The Complaint contains allegations from a former employee that sales figures for the Link WTS systems decreased dramatically from 2000 to 2001. (Compl. ¶ 29, 49.) Further, the Complaint alleges that Defendant Cronin notified sales personnel by conference call and email that it could expect significantly diminished sales and profits in the near term. (Compl. ¶ 30.) Plaintiffs' Complaint provides, with significant detail, that Defendants were aware of both the alleged market shift and its effect on sales of the WTS line. I am therefore satisfied that Plaintiffs Complaint contains the requisite factual allegations that the March 2001 Report was false when made.
(ii.) PLAINTIFFS PLEAD SPECIFIC EVIDENTIARY FACTS ESTABLISHING THE BASIS FOR A STRONG INFERENCE THAT THE REPORT WAS MADE WITH SCIENTER
Without belaboring the issue, I find that Plaintiffs' Complaint states with particularity facts giving rise to a strong inference that Defendants acted with the required state of mind. "One of the classic fact patterns giving rise to a strong inference of scienter is that defendants published statements when they knew facts or had access to information suggesting that their public statements were materially inaccurate." Green Tree, 270 F.3d at 665. Here, the Complaint sets forth information from several former employees that Defendants received the Report, discussed it, commented on its findings, and that Defendant Cronin notified sales personnel to expect diminished sales and profit for the WTS line. (Compl. ¶ 29-30, 59, 62.) Thus, Plaintiffs have alleged that Defendants' published optimistic statements, the October 17, 2001, press release and November 14, 2001, earnings guidance, while they possessed information that SpectraLink's could expect significantly lower revenue, sales and profits in the months and quarters to come. Whether SpectraLink factored the Report into its budgeting analysis is a factual dispute that is not ripe for resolution at this stage of the proceeding. Assuming the truth of the allegations plead with particularity in the Complaint, there is a strong inference of scienter. Accordingly, Defendants' motion to dismiss is DENIED.
III. CONCLUSION
Based on the foregoing, and for the reasons stated on the record at the January 24, 2003, hearing it is
ORDERED that Defendants' Motion to Dismiss the Complaint Pursuant to FED. R. CIV. P. 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act filed on November 1, 2002, is DENIED. It is
FURTHER ORDERED that Defendants' Request for Judicial Notice filed November 11, 2002, is GRANTED IN PART and DENIED IN PART. The request for judicial notice is GRANTED as to Exhibits A-D and DENIED as to Exhibits E, F, G. It is
FURTHER ORDERED that Plaintiffs' Motion to Strike filed January 16, 2003, is DENIED AS MOOT because the Court did not consider Defendants' reference to the Affidavit in denying Defendants' Motion to Dismiss. It is
FURTHER ORDERED that Plaintiff Evie Elennis's Unopposed Motion to Lift Stay filed in Civil Action No. 02-D-345 filed February 20, 2003, is GRANTED and the Defendants' Motion to Dismiss filed May 30, 2002, is STRICKEN so that Plaintiff may file an Amended Complaint within twenty (20) days of receiving this Order or so that the Defendants may refile their motion consistent with the Court's rulings in this Order and at the January 24, 2003, hearing.