Opinion
No. CV-07-02204-PHX-FJM.
January 30, 2009
ORDER
The court has before it five motions to dismiss: (1) one filed by James Ching Hua Li ("Li") and Man Kit (Thomas) Chow ("Chow") (doc. 129) and supporting memorandum (doc. 130); (2) one filed by Vincent F. Sollitto, Jr. ("Sollitto") and Wayne Pratt ("Pratt") (doc. 135); (3) one filed by John S. Hodgson ("Hodgson") (doc. 146); (4) one filed by Brean Murray, Carret Co., LLC, Canaccord Adams Inc., Merrill Lynch, Pierce, Fenner Smith, Inc., Robert W. Baird Co. Inc., and UBS Securities LLC (collectively, "Underwriters") (doc. 143); and (5) one filed by Grobstein Horwath Company LLP ("Grobstein") (doc. 136). We also have before us lead plaintiff City of St. Clair Shores Police and Fire Retirement System ("St. Clair Shores") and named plaintiff City of New Haven Policemen and Firemen's Pension Fund's ("New Haven") (collectively, "plaintiffs") consolidated response to individual defendants Li, Chow, Sollitto, Pratt, and Hodgson's motions to dismiss (doc. 161), consolidated response to Underwriters' and Grobstein's motions to dismiss (doc. 160), and defendants' replies (docs. 167, 165, 168, 166, 164 respectively). The court also has before it Li and Chow's request for judicial notice joined by Pratt, Sollitto, Hodgson, and Underwriters (doc. 133), Grobstein's request for judicial notice (doc. 145), plaintiffs' request for judicial notice (doc. 157), and plaintiffs' reply in support of request for judicial notice and second request (doc. 176).
Also before the court is plaintiffs' motion for leave to amend the consolidated class action complaint, proposed consolidated amended class action complaint, and motion to provisionally seal (docs. 159, 162, 154), responses filed by Li and Chow (doc. 169), Sollitto and Pratt (doc. 170), Hodgson (doc. 173), and Underwriters (doc. 172), plaintiffs' reply to individual defendants Li, Chow, Sollitto, Pratt, and Hodgson (doc. 180), and plaintiffs' reply to Underwriters (doc. 177).
I-Background
Syntax-Brillian Corp. ("Syntax") sells liquid crystal display and high definition televisions. Between November and December 2007, four securities fraud actions were filed in this court against Syntax and various of its officers alleging violations of the Securities Exchange Act of 1934 ("1934 Act"). We consolidated these four actions and appointed St. Clair Shores as lead plaintiff on April 4, 2008 (doc. 51). In February 2008, New Haven brought a fifth action against Syntax under the Securities Act of 1933 ("1933 Act") based on Syntax's May 24, 2007 secondary public offering ("SPO"). New Haven moved for consolidation of its claim and for appointment as lead plaintiff on April 7, 2008 (doc. 52). On June 3, 2008, we granted New Haven's motion to consolidate, but denied their request to be appointed as lead plaintiff (doc. 57). St. Clair Shores filed a consolidated amended complaint on August 25, 2008 (doc. 95) and it is the sufficiency of that complaint which defendants challenge.
Syntax entered bankruptcy proceedings and was voluntarily dismissed as a party on September 9, 2008 (doc. 106).
Plaintiffs allege that defendants overstated profits and financial projections, concealed shortfalls, and otherwise misled investors, causing an artificial inflation of Syntax's stock price. Specifically, plaintiffs claim that defendants made several statements in financial filings, investor calls, and the SPO documents regarding demand for their televisions that were misleading or false. According to plaintiffs, Syntax's financials violated Generally Accepted Accounting Principles ("GAAP") by improperly recording consignment sales to an Asian distributor, South China House of Technology ("SCHOT"), and round-trip "tooling deposits" made to Taiwan Kolin Ltd. ("Kolin").
The complaint contains five counts: (1) violation of Section 11 of the 1933 Act, 15 U.S.C. § 77k, on behalf of named plaintiff against all defendants; (2) violation of Section 12(a)(2) of the 1933 Act, 15 U.S.C. § 771(a)(2), on behalf of named plaintiff against all defendants; (3) violation of Section 15 of the 1933 Act, 15 U.S.C. § 77o, on behalf of named plaintiff against Li, Chow, Sollitto, Pratt, and Hodgson; (4) violation of Section 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against Li, Chow, Sollitto, and Pratt; and (5) violation of Section 20(a) of the 1934 Act, 15 U.S.C. § 78t(a), against Li, Chow, Sollitto, and Pratt. Defendants move to dismiss all claims.
II-Judicial Notice
As an initial matter, we address the parties' requests for judicial notice. "Generally, the scope of review on a motion to dismiss for a failure to state a claim is limited to the contents of the complaint." Marder v. Lopez, 450 F.3d 445, 448 (9th Cir. 2006). We may, however, consider exhibits that are properly attached to the complaint or documents upon which the complaint "necessarily relies" and whose authenticity is not challenged.Id. In addition, we may take judicial notice of "matters of public record" without converting a motion to dismiss into a motion for summary judgment, "as long as the facts noticed are `not subject to reasonable dispute.'" Intri-Plex Tech., Inc. v. Crest Group, Inc., 499 F.3d 1048, 1052 (9th Cir. 2007) (citation omitted).
Li, Chow, Sollitto, Pratt, and Underwriters filed a single request for judicial notice of twenty exhibits lettered A through T. Exhibits A, C, D, E, G, I, J, K, L, N, O, P, R, S, and T are Syntax public disclosures filed with the Securities Exchange Commission ("SEC"). Because these are "matters of public record" not subject to reasonable dispute, we will take notice of all SEC filings attached to the defendants' motion. Exhibits B, F, M, and Q are final transcripts from Syntax earnings conference calls discussed in the complaint. Complaint ¶¶ 143, 185, 154, 169. As these are documents upon which the complaint relies and the authenticity has not been challenged, we will take judicial notice of exhibits B, F, M, and Q. Finally, exhibit H purports to be a chart showing Syntax's stock prices from August 14, 2007 through November 17, 2007. The prices on the chart are consistent with those listed in plaintiffs' complaint and the authenticity of the document has not been challenged. We will, therefore, take judicial notice of the stock prices provided in exhibit H as well.
Grobstein filed a separate request for judicial notice of three Syntax SEC filings. We will take judicial notice of these "matters of public record."
It is unclear why Grobstein chose to file a separate request rather than consolidate its claims with those of the other defendants, particularly as one of the documents included in Grobstein's request is also an exhibit to the motion filed by the remaining defendants. We encourage cooperation between the parties on such matters in the future.
Finally, plaintiffs request judicial notice by two separate motions. They first request that we take judicial notice of three transcripts from the Syntax bankruptcy proceedings on August 20, 2008, October 6, 2008, and October 16, 2008. By reply and "second request" plaintiffs also ask that we take judicial notice of: (1) a complaint filed on November 26, 2008 against Syntax, Li, Chow, Sollitto, Pratt, and Hodgson in the United States Bankruptcy Court for the District of Delaware; and (2) a complaint filed on November 26, 2008 against Li, Chow, Sollitto, Pratt, Hodgson, and Grobstein in Superior Court in Los Angeles County. Defendants do not challenge the authenticity of these documents and we will take judicial notice of them as "matters of public record." See United States v. Wilson, 631 F.2d 118, 119 (9th Cir. 1980); Rothman v. Gregor, 220 F.3d 81, 91-92 (2d Cir. 2000). The court takes notice of these records not as to the truth of the contents contained therein, but as to the existence of the documents and the status of certain proceedings only.
III-Li and Chow
Defendants Li and Chow jointly move to dismiss plaintiffs' complaint for failure to state a claim. Li served as Syntax's president and chief operating officer from 2005 to 2007 and as chief executive officer from October 2007 to June 2008. Chow was the chief procurement officer at Syntax until he resigned in April 2008.
Defendants principally argue that plaintiffs have not sufficiently plead a cause of action under Section 10(b) of the 1934 Act and SEC Rule 10b-5. Section 10(b) prohibits "any person" from using, "in connection with the purchase or sale of any security[,] . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 15 U.S.C. § 78j(b). Rule 10b-5 makes it unlawful for any person
(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in 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(b). The elements of a Rule 10b-5 claim are: "(1) a material misrepresentation or omission of fact; (2) scienter; (3) a connection with the purchase or sale of a security; (4) transaction and loss causation; and (5) economic loss." In re Daou Sys., Inc., 411 F.3d 1006, 1014 (9th Cir. 2005) (citing Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 125 S.Ct. 1627, 1631 (2005)).
Because it sounds in fraud, an action under 10(b) and 10b-5 must meet the heightened pleading requirements of Rule 9(b), Fed.R.Civ.P., which requires plaintiffs to state with particularity "the circumstances constituting fraud or mistake." Plaintiffs' Section 10(b) claim must also meet the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Id. Under the PSLRA, plaintiffs must plead with particularity both misrepresentations by defendants and an intent to defraud. Tellabs, Inc. v. Makor Issues Rights, Ltd., 127 S. Ct. 2499, 2505 (2007).
A. Alleged Misrepresentations
Li and Chow argue that plaintiffs have not sufficiently plead the existence of misrepresentations by defendants. Plaintiffs 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). Plaintiffs allege that defendants used two accounting schemes to overstate Syntax's financial position: (1) consignment sales to SCHOT; and (2) round-trip transactions with Kolin. Defendants claim that plaintiffs have not met the particularity requirements of the PSLRA as to either scheme. We disagree.
First, defendants argue that plaintiffs' allegations regarding consignment sales are insufficient because plaintiffs do not, nor are they able to, show a contemporaneous agreement giving SCHOT a right to return unsold televisions. Plaintiffs have, however, made several specific factual allegations that are sufficient to survive a motion to dismiss under the PSLRA. Plaintiffs allege that Syntax maintained a receivables balance with SCHOT at times in excess of $150 million dollars because payments were not due before merchandise was sold to end-user customers. Complaint ¶ 212. According to plaintiffs, Syntax stopped recording revenue from SCHOT until televisions were sold to end-user customers in the first quarter of fiscal year 2008 (beginning July 1, 2007), which caused a 50% reduction in Syntax's fiscal year 2008 revenue guidance. Id. ¶ 85. In addition, plaintiffs refer to Syntax's April 18, 2008 press release and form 8-K filing announcing that its financial statements from fiscal year 2007 and the first quarter of 2008 may have to be restated and should not be relied upon because "of specified accounting issues, including our tooling deposit accounting and sales transactions with certain of our Asian distributors." Complaint ¶¶ 68-69.
The complaint also contains the report of a confidential witness, the corporate controller and chief accounting officer for Syntax from August 2006 until October 2007, regarding the nature of the SCHOT sales. Complaint ¶ 82 n. 3. Plaintiffs' confidential witness claims that payment terms on SCHOT's receivables balance were habitually extended beyond those disclosed because SCHOT had no obligation to pay Syntax until televisions were resold. Complaint ¶ 83. The witness also claims that from January to June 2007 approximately $100 million worth of 65" televisions were sold to SCHOT with the agreement that SCHOT would not pay Syntax until it has re-sold the televisions.Id. ¶¶ 82-83. Although the revenues for these sales were booked at the beginning of 2007, the televisions were allegedly returned to Syntax between December 2007 and March 2008. Id.
To meet the particularity requirement of the PSLRA, "personal sources of information relied upon in a complaint should 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.'" Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1233 (9th Cir. 2004) (citation omitted). As the corporate controller and chief accounting officer for Syntax, it is reasonable that plaintiffs' confidential witness would have had access to the payment terms of the SCHOT transactions and revenue bookings. Taken together, plaintiffs have adequately stated with particularity the facts upon which their allegations of consignment sales are formed.
Second, defendants argue that plaintiffs have failed to sufficiently support their claim that Syntax's "tooling deposits" with Kolin were round-trip transactions. A round-trip transaction involves a scheme by which parties agree to exchange similar services for similar amounts of money so that the transactions "wash out" without economic substance. Teachers' Ret. Sys. of La. v. Hunter, 477 F.3d 162, 178 (4th Cir. 2007). However, "[t]he mere existence of reciprocal dealing does not suggest `round-tripping.'" Id.
Plaintiffs' complaint alleges that in 2007, Syntax gave Kolin, a related party, between $65 to $150 million in tooling deposits and in return received rebates on televisions purchased from Kolin according to an earn-out schedule. Complaint ¶ 216. According to plaintiffs, these were "sham" transactions for "artificially inflating the Company's profit margin." Id. ¶ 217. Plaintiffs' confidential witness claims that on more than one occasion Syntax wired money to Kolin with no documentation.Complaint ¶ 84 n. 5. The witness also claims that in 2007, Syntax and Kolin extended the "tooling deposit" earn-out schedule instead of properly writing-off the uncredited amounts. Id. ¶ 217. Plaintiffs' confidential witness was in a position to have knowledge of both allegations and we therefore accept them as true for purposes of this motion.
Finally, plaintiffs again rely on Syntax's announcement that previous financial statements should no longer be relied upon because "of specified accounting issues, including our tooling deposit accounting." Id. ¶ 69. Although supported by less evidence than the alleged consignment sales, taking all of plaintiffs' allegations as true, plaintiffs have alleged round-trip transactions with enough particularity to survive a motion to dismiss under the PSLRA.
B. Scienter
Defendants argue that plaintiffs have not sufficiently plead a strong showing of scienter. The PSLRA requires that plaintiffs, "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). Plaintiffs must plead "in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999). "[A]n inference of scienter must be more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, 127 S. Ct. at 2505.
Plaintiffs rely on five allegations to support an inference of scienter: (1) defendants' termination and resignation; (2) defendants' personal financial incentives; (3) statements of confidential witnesses regarding Li's involvement; (4) the nature of the allegedly misleading statements given defendants' positions at Syntax; and (5) defendants' alleged GAAP violations. We must decide whether these five allegations, "`even though individually lacking, are sufficient to create a strong inference' of scienter." Glazer Capital Mgmt. v. Magistri, 549 F.3d 736, 745 (9th Cir. 2008) (citation omitted).
Initially, we find that the personnel changes at Syntax do not support an inference that Li and Chow acted with the required scienter. At most, these changes may provide some indication of negligence by departing parties, but do not give rise to an inference of knowledge or deliberate recklessness. We also find that defendants' executive bonuses are not probative of scienter in this case. See Tachman v. DSC Commc'ns Corp., 14 F.3d 1061, 1068-69 (5th Cir. 1994) ("`[I]ncentive compensation can hardly be the basis on which an allegation of fraud is predicated. On a practical level, were the opposite true, the executives of virtually every corporation in the United States would be subject to fraud allegations.'") (quotation omitted).
Nevertheless, plaintiffs have plead sufficient facts to raise a strong inference of scienter as to Li and Chow. In particular, plaintiffs allege that confidential witnesses who reported to Li claim Li was the "architect" of Syntax's relationship with SCHOT and was "calling the shots" on Syntax's deals with Kolin.Complaint ¶¶ 83 n. 4, 84 n. 5. Plaintiffs also allege that Chow sold a significant amount of stock only one month before Syntax changed the method by which SCHOT sales were recorded and in the quarter immediately preceding Syntax's dramatic revenue drop.
The inference that Li and Chow acted with scienter is also supported by the nature of defendants' alleged misrepresentations given their positions at the company and by their alleged violations of GAAP. See South Ferry LP. #2 v. Killinger, 542 F.3d 776, 785 (9th Cir. 2008) ("[A]llegations regarding management's role in a company may be relevant and help to satisfy the PSLRA scienter requirement . . . along with other allegations that, when read together, raise an inference of scienter that is `cogent and compelling, thus strong in light of other explanations.'") (citation omitted); In re McKesson HBOC, Inc. Sec. Litig., 126 F.Supp.2d 1248, 1273 (N.D. Cal. 2000) ("[W]hen significant GAAP violations are described with particularity in the complaint, they may provide powerful indirect evidence of scienter. After all, books do not cook themselves.").
Although no allegation is sufficient alone, taken together, plaintiffs' allegations sufficiently support an inference that Li and Chow acted with knowledge or deliberate recklessness as to the falsity of their representations. Because plaintiffs have sufficiently plead both material misrepresentations and a strong inference of scienter in accordance with the PSLRA, Li and Chow's motion to dismiss plaintiffs' Section 10(b) claim is denied.
C. Section 11 and Section 12(a)(2) Claims
Plaintiffs' 1933 Act claims are based on representations in the registration statement and prospectus (collectively, "offering documents") for Syntax's SPO. Section 11 creates a private right of action for the purchaser of a security if, "any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). Plaintiffs must show: "(1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment." Daou, 411 F.3d at 1027 (quoting In re Stac Elec. Sees. Litig., 89 F.3d 1399, 1403-04 (9th Cir. 1996)).
Section 12(a)(2) creates liability for any person who sells securities using an instrument containing an untruth or omission to an unaware purchaser. 15 U.S.C. § 771(a)(2). "Section 12(a)(2) is a virtually absolute liability provision that does not require an allegation that defendants possessed scienter." Miller v. Thane Int'l, Inc., 519 F.3d 879, 886 (9th Cir. 2008). However, defendants must have solicited the purchase for their own financial gain. Daou, 411 F.3d at 1029.
Plaintiffs have alleged several misrepresentations contained in and incorporated into the offering documents. These allegations are sufficient to meet the notice pleading requirements of Rule 8, Fed.R.Civ.P. In fact, Defendants Li and Chow do not argue that plaintiffs' Section 11 and Section 12(a)(2) claims fail to meet Rule 8, Fed.R.Civ.P., pleading requirements. Instead, defendants argue that plaintiffs' Section 11 and Section 12(a)(2) claims are subject to the heightened pleading requirements of Rule 9(b), Fed.R.Civ.P., because they sound in fraud. Stac, 89 F.3d at 1403-04. We disagree.
A claim sounds in fraud where plaintiffs allege "a unified course of fraudulent conduct and rely entirely on that course of conduct as the basis of a claim." Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 (9th Cir. 2003). Although plaintiffs rely on the same alleged consignment sales and "tooling deposits" in both their 1933 Act and 1934 Act claims, they have expressly plead only negligence in their Section 11 and Section 12(a)(2) claims. In addition, plaintiffs have carefully crafted the complaint so that their negligence-based claims are wholly separate from their allegations of fraud against Li, Chow, Sollitto, and Pratt. See In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 274 (3d Cir. 2006) ("Because the Section 11 and Section 12(a)(2) claims of the plaintiffs here were expressly negligence-based and pled distinctly in the complaint from the fraud-based claims, it was error for the District Court to hold that they sound in fraud."). Accordingly, we conclude that plaintiffs' Section 11 and Section 12(a)(2) claims do not sound in fraud and are subject to Rule 8, Fed.R.Civ.P., notice pleading requirements.
Because plaintiffs are not subject to a heightened pleading requirement, they have sufficiently alleged a Section 11 and a Section 12(a)(2) claim against Li and Chow.
D. Control Person Liability
Finally, Li and Chow argue that plaintiffs' claims under Section 15 and Section 20(a) should be dismissed because they have not established a primary violation of either the 1933 Act or the 1934 Act. We disagree. For the reasons just discussed, we have concluded that plaintiffs sufficiently plead primary violations of Section 10(b), Section 11, and Section 12(a)(2).
Defendants also contend that, even if plaintiffs have shown a primary violation, their allegations of control person liability are too vague to maintain a cause of action. Whether a party is a "controlling person" is an "intensely factual question." Kaplan v. Rose, 49 F.3d 1363, 1382 (9th Cir. 1994). Plaintiffs specifically allege that defendants had the power and influence to control Syntax, which is sufficient to state a claim at this stage of the litigation. See In re Metawave Commc'n Corp. Sec. Litig., 298 F. Supp. 2d 1056, 1087 (W.D. Wash. 2003) ("At the motion to dismiss stage, general allegations concerning an individual defendant's title and responsibilities are sufficient to establish control."). Therefore, we deny Li and Chow's motion to dismiss plaintiffs' Section 15 and Section 20(a) claims.
IV-Sollitto and Pratt
Defendants Sollitto and Pratt, the former chief executive officer and chief financial officer of Syntax respectively, move to dismiss plaintiffs' complaint on the same primary bases as those argued by Li and Chow. Sollitto and Pratt contend that plaintiffs have not alleged any actionable misstatements or the requisite strong inference of scienter required to bring a claim under Section 10(b).
Defendants argue that their alleged misrepresentations are not actionable because of the "safe harbor" provision of the PSLRA. The PSLRA creates a "safe harbor" for forward-looking projections that are "accompanied by meaningful cautionary statements" and are made without "actual knowledge" of falsity. 15 U.S.C. § 78u-5(c)(1)(A) (B). Defendants isolate three financial projections described by the complaint: (1) on May 10, 2007 estimating the revenue for calendar year 2007; (2) on July 16, 2007 raising the estimated revenue for calendar year 2007; and (3) on September 12, 2007 projecting revenues for the first quarter of fiscal year 2008. Complaint ¶¶ 152, 162, 168. These statements were forward-looking and plaintiffs have not sufficiently plead that Sollitto and Pratt knew they were false when made. As a result, the PSLRA "safe harbor" applies and they are not actionable under Section 10(b).
However, plaintiffs allege several other false or misleading statements contained in Syntax's financial reports, signed by Sollitto and Pratt, which defendants ignore. Complaint ¶¶ 50, 52, 54, 59, 141, 142, 145-47, 154; see also Howard v. Everex Sys., Inc., 228 F.3d 1057, 1061 (9th Cir. 2000) (finding corporate officials may be responsible under Section 10(b) for representations made in corporate and financial documents they signed even if they did not participate in drafting). For the reasons discussed as to Li and Chow, we conclude that plaintiffs have alleged with sufficient particularity that these representations were false or misleading based on the SCHOT and Kolin transactions.
Although plaintiffs have satisfied the first pleading requirement of the PSLRA, they have failed to plead a strong inference that Sollitto and Pratt acted with knowledge or deliberate recklessness. Plaintiffs rely on the same five allegations as those applicable to Li and Chow. However, key differences lessen the inference that Sollitto and Pratt acted with scienter. Unlike Li, plaintiffs have made no specific allegations regarding either Sollitto or Pratt's involvement with the SCHOT or Kolin transactions. In addition, neither Sollitto nor Pratt sold stock during the class period or received any incentive compensation in excess of executive bonuses. Without either one of these specific factors, plaintiffs are left only with two general allegations of scienter-the defendants' positions at the company given the nature of the misrepresentation and alleged GAAP violation-each is insufficient to establish scienter alone and together do not add up to a the required strong inference.
According to plaintiffs, the fact that Sollitto and Pratt signed Sarbanes-Oxley certificates also supports an inference of scienter. We disagree. "Because Congress expressed no intent to alter the pleading requirements of the PSLRA, `Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.'" Glazer, 549 F.3d at 747 (citing Garfield v. NDC Health Corp., 466 F.3d 1255, 1266 (11th Cir. 2006)). Plaintiffs do not allege that defendants were reckless in signing the Sarbanes-Oxley certificates, and the mere fact that Sollitto and Pratt signed the certificates is insufficient to support an inference of scienter.
Plaintiffs' Section 10(b) claim against Sollitto and Pratt is dismissed for a failure to meet the pleading requirements of the PSLRA. In addition, plaintiffs' control persons claim under section 20(a) is also dismissed for failure to allege a primary violation of the 1934 Act. Paracor Fin., Inc. v. General Elec. Capital Corp., 96 F.3d 1151, 1161 (9th Cir. 1996).
Because plaintiffs' 1933 Act claims are subject to only notice pleading requirements, plaintiffs have sufficiently stated a claim against defendants as to those counts. As a result, counts one, two, and three remain as to defendants Sollitto and Pratt. All others are dismissed.
V-Hodgson
John Hodgson was a director at Syntax and served as Syntax's chief financial officer from October 2007 until March 2008. Plaintiffs added Hodgson as a defendant in their amended complaint on August 25, 2008, asserting claims against him under Sections 11, 12(a)(2), and 15 of the 1933 Act. Hodgson moves to dismiss all claims.
First, Hodgson argues that plaintiffs have failed to identify any material misrepresentation contained in the offering documents. We reject Hodgson's arguments. As discussed, plaintiffs allege actionable misstatements contained in the SPO documents sufficient to satisfy notice pleading requirements.
Next, defendant argues that the complaint must be dismissed because it was not filed within the time allowed by the statute of limitations. Claims under Section 11 and Section 12(a)(2) must be "brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence." 15 U.S.C. § 77m. Plaintiffs must plead enough facts in their complaint "to demonstrate conformity with the statute of limitations." Toombs v. Leone, 777 F.2d 465, 468 (9th Cir. 1985). Defendant argues that plaintiffs have not plead facts showing compliance with the statute of limitations. We disagree.
Although not specifically labeled as such, the complaint contains facts demonstrating conformity with the statute of limitations. The complaint describes the events that led to the discovery of allegedly fraudulent behavior and plaintiffs' claims. Complaint ¶¶ 60-67. Plaintiffs claim that they first discovered problems at Syntax through a September 12, 2007 press release warning of lower than projected revenues for the first quarter of fiscal year 2008. Plaintiffs' claims against Hodgson were brought within one year of that date.
Hodgson also contends that plaintiffs' Section 12(a)(2) claim against him must be dismissed because he was not a "seller" of Syntax securities. To establish liability under Section 12(a)(2), plaintiffs "must show that the defendant[] solicited purchase of the securities for [his] own financial gain." Daou, 411 F.3d at 1029. As a director, Hodgson had a financial interest in selling Syntax securities and plaintiffs allege that Hodgson solicited purchasers of Syntax shares. Complaint ¶ 127. This is sufficient to proceed with a Section 12(a)(2) claim against Hodgson. See In re Westinghouse Sec. Litig., 90 F.3d 696, 717 (3d Cir. 1996).
Hodgson also argues that the lead plaintiff cannot state a claim under Section 11 because its Syntax stocks cannot be traced to the SPO. Section 11 requires plaintiffs to show that their Syntax stocks were issued under the challenged offering documents. Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999). Plaintiffs concede that St. Clair Shores cannot trace its shares to the SPO. However, the PSLRA does not require that a lead plaintiff have standing to assert all claims against defendants, but only that they have the greatest financial stake in the action. Hevesi v. Citigroup, Inc., 366 F.3d 70, 82 (2d Cir. 2004). "Nor does anything in the PSLRA prevent the Lead Plaintiffs from constructing a consolidated complaint that brings claims on behalf of a number of named parties besides the Lead Plaintiffs themselves." In re Global Crossing, Ltd. Sec. Litig., 313 F.Supp.2d 189, 204 (S.D.N.Y. 2003). Plaintiffs crafted the complaint such that the Section 11 claim is brought on behalf of named plaintiffs whose shares were allegedly purchased in the SPO. Complaint ¶ 43. As a result, plaintiffs have adequately asserted "traceability" for purposes of a motion to dismiss.
Defendant also contends that plaintiffs lack standing to bring a Section 12(a)(2) claim because they have not shown that their stock purchase took place in the SPO rather than the secondary market. However, the complaint sufficiently alleges that named plaintiff purchased its Syntax shares in the SPO. Complaint ¶ 130.
Finally, defendant moves to dismiss plaintiffs' Section 15 claim on the grounds that plaintiffs failed to allege primary violations of the 1933 Act. Because we have concluded that plaintiffs have sufficiently pled Section 11 and Section 12(a)(2) claims, defendant's motion is denied.
VI-Underwriters
In their August 2008 complaint, plaintiffs also added Section 11 and Section 12(a)(2) claims against the five financial firms that served as underwriters for Syntax's SPO. Underwriters move to dismiss all claims relying on many of the same arguments made by Hodgson. In particular, Underwriters also argue that: (1) plaintiffs cannot trace their shares to the SPO; (2) they were not "sellers" for purposes of a Section 12(a)(2) claim; (3) plaintiffs have failed to allege any actionable misrepresentations; and (4) plaintiffs' claims are barred by the statute of limitations. For those reasons previously discussed, we reject these arguments.
Underwriters also argue that named plaintiff, New Haven, has not been properly added to this action and that, if it wishes to be, we should undertake another class notice according to the PSLRA. We disagree and direct Underwriters to our order dated June 3, 2008 (doc. 57), in which we granted New Haven's motion for consolidation and considered but denied its motion for appointment as lead plaintiff. Because we have already decided the lead plaintiff inquiry as to these plaintiffs, we see no need to repeat this process.
Defendants also argue that, even if sufficiently alleged, the misrepresentations on which plaintiffs rely are not material. However, materiality is generally not decided in a motion to dismiss. SEC v. Phan, 500 F.3d 895, 908 (9th Cir. 2007). Prior to any discovery, we will not determine the materiality of the SCHOT and Kolin transactions as a matter of law.
Finally, Underwriters contend that the complaint must be dismissed because they have established "negative causation." Plaintiffs are not entitled to damages for their Section 11 claim if defendants prove that the loss in value to Syntax securities is attributable to something other than defendants' alleged misrepresentations. 15 U.S.C. § 77k(e). However, "negative causation" is a defense to plaintiffs' Section 11 claim, not a pleading requirement. Id. ("[I]f the defendant proves that any portion or all of such damages represents . . ."). Therefore, we will not determine whether defendant has proved "negative causation" at this stage of the litigation.
VII-Grobstein
Grobstein is an independent accounting firm that provided audit opinions for Syntax's fiscal year 2004, 2005, and 2006 financials. Grobstein also consented to incorporation of their 2005 and 2006 audit reports into Syntax's SPO. Plaintiffs added Grobstein to their August 2008 complaint asserting claims under Section 11 and Section 12(a)(2).
Grobstein asks that plaintiffs' claims be dismissed because plaintiffs do not allege any material misrepresentations made during the period in which Grobstein audited Syntax's financials. But Grobstein had a duty to review information subsequent to the prior-period financial statements for events that affect those financial statements and either modify its audit opinions or withhold its consent. AICPA PROFESSIONAL STANDARDS, Statements on Auditing Standards No. 37, § 711 (Am. Inst. Of Certified Pub. Accountants 1981). According to plaintiffs, a reasonable investigation would have led to discovery of material misrepresentations in the fiscal year 2004, 2005, and 2006 audit reports. Complaint ¶¶ 117-120. Taken as true, plaintiffs' allegations sufficiently establish a prima facie Section 11 claim against Grobstein in its capacity as Syntax's outside auditor for the SPO.
Finally, Grobstein claims that it was not a "seller" of Syntax shares as required by Section 12(a)(2). 15 U.S.C. § 771(a)(2). We agree. Unlike other defendants, Grobstein did not have any financial interest in selling Syntax shares and was not a significant participant therein. Accordingly, plaintiffs' Section 12(a)(2) claim against Grobstein is dismissed.
VIII-Motion for Leave to Amend
Plaintiffs seek leave to amend their complaint. Primarily plaintiffs' proposed amendments incorporate into the complaint the testimony of: (1) Syntax's current CEO Gregory Rayburn; (2) a court-appointed investigator; and (3) the Syntax-appointed investigator from Syntax's ongoing bankruptcy proceedings. All defendants except Grobstein oppose plaintiffs' motion.
Defendants chiefly argue that plaintiffs' proposed amendments should not be allowed because plaintiffs have not shown good cause for modifying our Rule 16 scheduling order and that the changes proposed by plaintiff are futile. We agree. Plaintiffs have already received ample opportunity to amend their complaint and we do not find it necessary to disturb our Rule 16 scheduling order to allow the proposed amendments.
We have reviewed plaintiffs' proposed amendments and have determined that they would have no effect on the outcome of the present motions to dismiss or the litigation as it proceeds. Plaintiffs have not alleged any additional facts that would give rise to a strong inference of scienter as to defendants Sollitto and Pratt. In addition, plaintiffs' proposed amended complaint no longer includes a Section 12(a)(2) claim against Grobstein. Accordingly, we deny plaintiffs' motion for leave to amend. Reddy v. Litton Indus., Inc., 912 F.2d 291,296 (9th Cir. 1990) (citation omitted) ("It is not an abuse of discretion to deny leave to amend when the proposed amendment would be futile.").
We are mindful that allegedly fraudulent misrepresentations upon which plaintiffs' Section 10(b) claim relies must be plead with specificity. However, plaintiffs' proposed amendments neither add nor remove any alleged misstatements of defendants.
IX-Conclusion
Accordingly, IT IS ORDERED DENYING Li and Chow's motion to dismiss (doc. 129).IT IS FURTHER ORDERED GRANTING IN PART AND DENYING IN PART
Sollitto and Pratt's motion to dismiss (doc. 135). Plaintiffs' Section 10(b) and Section 20(a) claims as to Sollitto and Pratt are dismissed, but their Section 11, Section 12(a)(2), and Section 15 claims remain.IT IS FURTHER ORDERED DENYING Hodgson's motion to dismiss (doc. 146).
IT IS FURTHER ORDERED DENYING Underwriters' motion to dismiss (doc. 143).
IT IS FURTHER ORDERED GRANTING IN PART AND DENYING IN PART
Grobstein's motion to dismiss (doc. 136). Plaintiffs' Section 11 claim survives and all other claims against Grobstein are dismissed.
IT IS FURTHER ORDERED DENYING plaintiffs' motion for leave to amend the complaint and modify the court's Rule 16 scheduling order (doc. 159). IT IS FURTHER ORDERED DENYING plaintiffs' motion to provisionally seal (doc. 154), and requiring the clerk to file all lodged documents.
The claims remaining in this case are plaintiffs': (1) Section 11 claim as to all defendants; (2) Section 12(a)(2) claim as to Li, Chow, Sollitto, Pratt, Hodgson, and the Underwriters; (3) Section 15 claim as to Li, Chow, Sollitto, Pratt, and Hodgson; (4) Section 10(b) claim as to Li and Chow; and (5) Section 20(a) claim as to Li and Chow.