finding support for scienter where corporate officers' resignations "occurred as [the company]'s financials were being restated and as [the company] was conducting its own internal investigation."Summary of this case from In re Salix Pharms., Ltd.
No. C 01-1092 SC
April 2, 2002
ORDER DENYING DEFENDANTS' MOTION TO DISMISS
This is a class action filed on behalf of all purchasers ("Plaintiffs") of the publicly-traded securities of Adaptive Broadband Corporation ("Adaptive") against Adaptive and four of its officers: Frederick D. Lawrence ("Lawrence"), Adaptive's former Chief Executive Officer and Chairman of the Board of Directors; Donna S. Birks ("Birks"), Adaptive's former Chief Financial Officer; Daniel Scharre ("Scharre"), Adaptive's former President and Chief Operating Officer and, later, its President, CEO and Director; and Peter J. Maloney ("Maloney"), Adaptive's former Senior Vice President of Finance and later, its Chief Financial Officer (collectively "Defendants"). On October 23, 2001 Plaintiffs filed a Corrected Consolidated Complaint for violations of the Securities and Exchange Act of 1934. Specifically, Plaintiffs allege all Defendants violated Sections 10(b) of the 1934 Act and Securities and Exchange Commission ("SEC") Rule 10b-S and that the Individual Defendants violated Section 20(a) of the 1934 Act. Now before the Court are the Individual Defendants' Motion to Dismiss and Request for Judicial Notice. For the following reasons, the Individual Defendants' Motion to Dismiss is denied and their Request for Judicial Notice is granted in part and denied in part.
Adaptive is a Delaware corporation based in San Jose, California. Before it filed for bankruptcy protection on July 26, 2001, Adaptive supplied equipment related to broadband wireless communication over the Internet. As a result of its bankruptcy filing, all proceedings against Adaptive in this Court are stayed pursuant to 11 U.S.C. § 362 (a).
Prior to its bankruptcy filing and throughout the class period, Adaptive common stock was traded on the NASDAQ National Market System under the symbol "ADAP." Changes were made to senior management on or around January 11, 2001. Prior to January 11, 2001 Defendant Lawrence was Adaptive's Chairman and CEO, Defendant Birks was its CFO, Defendant Scharre was its President and COO and Defendant Maloney was the Senior Vice President of Finance. After January 11, 2001, Defenants Lawrence and Birks resigned, Defendant Scharre became the CEO, President and Director and Defendant Maloney became the CFO.
The facts in this case are complicated slightly by the fact that Adaptive switched operating calendars around the time the class period began. As of June 2000, Adaptive operated on a fiscal calendar year ending June 30. The company later transitioned to a calendar ending December 31. For ease of reference, the Court, like the parties, will refer to a quarter by the month in which it ended, i.e., June 2000 Quarter, etc.
The class period in this case extends from August 10, 2000 through March 15, 2001. Plaintiffs allege that the Individual Defendants either participated in directly or sanctioned by virtue of their authority in the company a scheme to improperly recognize revenue in violation of Generally Accepted Accounting Principles (GAAP). According to Plaintiffs, Defendants were motivated by a desire to bolster the company's economic outlook in order to attract a merger partner. Specifically, Plaintiffs allege that the Individual Defendants overrode accounting methods and internal company policies to extend credit to customers with questionable credit histories and to "ship" products to Adaptive's own warehouse in an attempt to move them off the books. According to Plaintiffs, contemporaneously with these maneuvers, the Individual Defendants were reporting to the investing public grossly overinflated revenue in order to maintain or raise the price of Adaptive's securities.
Plaintiffs describe statements from four confidential witnesses who have reported details of Defendants' alleged fraud. Confidential witness 1 ("CW1") is a 15-year employee of Adaptive and its predecessor, California Microwave. CW1 was a manager in charge of Adaptive's order fulfillment department in 2000 until approximately July 2001. Id. at ¶ 41. CW1 claims that Adaptive had specific policies for Revenue Recognition Procedure, Order Entry Procedure and Commercial Booking Policy, all of which were incorporated into an Oracle database housing Adaptive's general ledger. Id. at ¶ 43.
Confidential witness 2 ("CW2") began work at Adaptive in 1999. In 2000, and until approximately July 2001, CW2 worked in Adaptive's finance division and reported directly to Defendant Maloney. CW2 generated regular reports for senior management, including a "BBB Customer Report" detailing billings, bookings and backlog. Id. at ¶ 42. These reports, which were generated from Adaptive's Oracle database, were used by senior management to support Adaptive's SEC filings and its reports to the investing public and securities analysts. Id.
Confidential witness 3 ("CW3") worked for Adaptive and its predecessor company for 10 years. Id. at ¶ 60. In 2000 and until approximately July 2001, CW3 was a department head-level information officer in Adaptive's Rochester, New York offices, the hub of Adaptive's sales and order administration department. Id. reported to Adaptive's Chief Information Officer, Steve Bringham ("Bringham").
Confidential witness 4 ("CW4") was an administrative assistant who worked for Defendants Lawrence and Birks between July 2000 and February 2001. Id. at ¶ 63.
For the purposes of a motion to dismiss, the Court takes all of Plaintiffs' allegations as true. They allege the following misleading statements:
The Announcement of Fiscal Year 2000 Results
On the first day of the class period, August 10, 2000, Adaptive issued a press release "prepared by defendants" and signed by Defendant Lawrence describing financial information and results of operations. Id. at ¶¶ 33, 89. ("August 2000 release") These same statements were included in an August 29, 2000 Annual Report on Form 10-K filed with the SEC. Id. at ¶ 33.
In the August 2000 release, Adaptive claimed a 106 percent increase in revenue for the June 2000 Quarter as compared to the previous quarter.Id. at ¶ 34. Defendants Lawrence, Scharre and Birks were quoted in the release touting the company's success. Id. at ¶¶ 35-37. These same three defendants signed the Form 10-K, filed August 29, 2000 for FY2000 which repeated figures detailed in the August 2000 Release. In the FY2000 10-K, Adaptive reported that it generally recognizes revenue upon shipment to a credit-worthy customer." Id. at ¶ 38.
Plaintiff's claim this statement was false and misleading because Adaptive falsified its financial results by improperly recognizing revenue. According to CW1, Defendant Maloney overrode these procedures frequently in 2000 to ship products to companies that did not meet Adaptive's own creditworthiness standards, or to companies that had canceled orders or never placed orders in the first place. Id. at ¶ 45. CW1 reported that Defendants Lawrence and Birks "knew what [Maloney] was doing" and "consented to his actions." Id. CW1 reported that "no one trusted [Maloney]" when it came to compliance with internal order procedures. Id.
In particular, CW1 reported that at the end of June 2000, Defendant Maloney overrode Adaptive's procedures for several transactions and created a second set of accounting records for transactions that violated the procedures and were recommended for rejection by Adaptive's Order Administration Department. Id. at ¶ 46. According to CW1, Defendant Maloney kept a separate accounting sheet for a $4 million purchase from a customer called BroadbandNow, which became the subject of arguments between Defendant Maloney and employees in the order administration department and finance division. Id. at ¶ 47. CW1 told Defendant Maloney that the $4 million transaction was not supported by a purchase order. Id. Defendant Maloney responded that a purchase order would be forthcoming, but CW1 reports it never was. Id. CW1 discussed this issue with the manager-level head of Adaptive's accounting department, who agreed that recording the transaction was improper. CW1 reported that Defendant Maloney was confronted about the transaction by CW1 and the accounting department manager. Id. In addition, CW1 reported that email correspondence from June 2000 between Defendant Maloney and the order administration department chronicled admonitions to Defendant Maloney about his actions. CW1 and the accounting manager "jokingly" gave Defendant a Monopoly-esque "get-out-of-jail-free card" in recognition of their view that what he was doing was improper. Id.
CW1 reported another alleged improper transaction in the June 2000 Quarter, this one with Cybertech Wireless Inc. ("Cybertech"). Id. at ¶ 48. Cybertech canceled its June 2000 order and was in debt to Adaptive, having failed to pay for a prior shipment. Id. A customer support representative, after calling Cybertech to confirm that it had canceled its order, recommended that Adaptive not ship it. Id. According to CW1, Defendant Maloney extended Cybertech's credit line, overrode the order entry procedures and directed Adaptive to ship the product to Cybertech anyway. Id. Cybertech refused the shipment and Adaptive refused the return until December 2000 when it was re-inputted into the Adaptive accounting system. Id.
CW1 describes another transaction with TESSCO Technologies, Inc. ("TESSCO"), also reflected in the June 2000 Quarter results. Id. at ¶ 49. Adaptive received TESSCO's order by email at approximately 11:00 p.m. on a Saturday night from a TESSCO engineer. Id. This was unusual since all prior (and subsequent) orders came via purchase orders on TESSCO letterhead, as specified by Adaptive's Order Entry procedure.Id. Adaptive's order administration department contacted TESSCO about the order and was informed that the TESSCO engineer had not been authorized to make the purchase and that TESSCO did not want the product. Id. According to CW1, Defendant Maloney overrode usual procedure and directed Adaptive to ship the product to TESSCO. TESSCO refused to accept it. Id.
According to Plaintiffs, all of these transactions were reflected in the June 2000 Quarter financial statements. Id. at ¶¶ 39, 48, 49.
On March 15, 2001 Adaptive admitted it wrongfully recorded the Broadband Now transaction. Id. at ¶ 50. On July 5, 2001, Adaptive admitted that it had wrongfully recorded a total of $4.8 million in revenue, or over 20 percent of the year's total. Id. In its July 5, 2001 Annual Report on Form 10-K, Adaptive told the SEC that the results reported in the August release were overstated because of "two additional revenue transactions, one relating to an unauthorized shipment and the other to the inappropriate recognition of a customer deposit, both recorded in the [June 2000 Quarter], which have also been restated." Id. at ¶ 51.
Defendant Lawrence's Statements Relating to the Fuzion Deal
Prior to the class period, on July 18, 2000, Adaptive issued a press release describing an agreement it had entered with Fuzion Wireless Communications ("Fuzion") for the joint development of new technology for wireless broadband networks. Id. at ¶ 53. On September 22, 2000, Adaptive issued another press release announcing a $100 million contract with Fuzion. Id. Also on September 22, 2000, Bloomberg quoted Defendant Lawrence's statements about the Fuzion deal. Id. at ¶ 55. Defendant Lawrence noted that "[t]he contract goes over a multiple-year period, but there is immediate revenue for the current and 2 15 following quarters. . . . This will hit our top-line growth over the next five years, and when you add up our customer list, you'll see over 50 names and $1.5 billion in contracts." Id.
According to Plaintiffs, Lawrence's statement that revenue would be reflected in the immediate quarter was false and misleading because Defendants knew that Fuzion could not place or accept any orders from Adaptive before the close of the September 2000 Quarter. Id. at ¶ 56. Nonetheless, in an attempt to rush the order through, Defendants demanded that the order administration department fulfill a $13 million order from Fuzion before the close of the quarter. Id. at ¶ 57. According to CW2, Adaptive never received a purchase order from Fuzion.Id. at ¶ 58. Moreover, CW2 reported that Fuzion had previously defaulted on an earlier, $12 million order, which under normal procedures would preclude its being issued further credit. Id. Nonetheless, according to Plaintiffs, Adaptive "senior management" extended Fuzion's credit to allow for another shipment. Id.
CWl reported that Fuzion could not accept products shipped under the new order. Id. According to CW1, Defendants Maloney, Lawrence and Birks devised a scheme whereby Fuzion could "lease" storage space at Adaptive's Sunnyvale, California headquarters. Id. at ¶ 59. Id. CW1 told Defendant Maloney that Adaptive could not ship to its own warehouse without a written lease agreement. Id. CW1 reported that Defendant Maloney overrode procedure and ordered Adaptive to "ship" the order, consisting of eight or nine tractor loads, to its own warehouse. Id.
CW3 confirmed the informal arrangement between Fuzion and Adaptive. CW3 reported that he visited Adaptive's Sunnyvale, California headquarters in early July 2000 and noticed 15 pallets of 600 units of merchandise in an Adaptive warehouse. Id. at ¶ 61. According to CW3, this struck him as unusual, and when he asked Bringham about it, he was told that the products belonged to Fuzion. Id.
CW3 reported that the Fuzion relationship was handled in part by Defendant Scharre. Id. at ¶ 62. According to CW3, when the Fuzion/Adaptive partnership was announced on July 18, 2000, Defendant Scharre directed Adaptive employees to provide Fuzion employees with access to Adaptive's technical information. Id. As an example, CW3 reported that Fuzion was granted the right to provide wireless services to Adaptive's Rochester office. Id. CW3 reported that Adaptive employees were subsequently ordered to terminate all contact with Fuzion, and that questions from Fuzion employees were to be referred to Adaptive's counsel. Id. CW3 then contacted Scharre to determine whether he should continue to provide a Fuzion employee with access to the Rochester facility. Id. Defendant Scharre told CW3 to stall the Fuzion employee, and not to connect him to Adaptive's systems. Id. CW3 reported that Fuzion had refused to pay Adaptive, and was experiencing financial difficulties. Id.
CW4 confirmed that the products Adaptive sold to Fuzion were stored at Adaptive's Sunnyvale, California headquarters. Id. CW2 reported that Adaptive's general ledger did not record the Fuzion order in the first quarter of FY01 because the order was never received, nor were the products shipped. Id. at ¶ 64. CW2 generated the BBB Customer Report for senior management to review. Id. CW2 reported that senior management falsely altered the report to reflect the first quarter Fuzion sale. Id.
Announcement of September Quarter 2000 Results
On October 23, 2000, Adaptive released its financial statements and results of operations for the September 2000 Quarter in a press release disseminated to investors. Id. at ¶ 65 ("October 2000 release"). On November 3, 2000, Adaptive filed a quarterly report with the SEC on Form 10-Q reporting these same revenue figures. Id. The October 2000 release reported revenue for the first quarter of FY2001 of $24.2 million, a 42 percent increase from the previous quarter. Id. at ¶ 66. It also contains statements from Defendants Lawrence, Birks and Scharre, making glowing predictions for Adaptive's future. Id. at ¶ 67. Defendant Birks predicted a 30 percent or greater quarter-to-quarter growth rate, and that gross margins would increase by 10 percent to 40 percent by the March 2001 quarter. Id. The October 2000 release announced a recorded net income of $1.7 million in the September 2000 Quarter compared to a net loss of $15.9 million for the June 2000 Quarter and a net loss of $3.9 million for the comparable quarter of the previous year. Id. at ¶ 68.
The Form 10-Q report was signed by Birks. Id. at ¶ 69. It read, in part, "In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (all of which are normal and recurring in nature) necessary to present fairly the financial position, results of operations and cash flows for the periods presented." Id. at ¶ 89.
Plaintiffs allege that the Fuzion order, worth $13 million, was improperly included in the September 2000 Quarter results, rendering the October 2000 release and the FY01 Form 10-Q false and misleading. Id. at ¶ 70. On July 5, 2001, Adaptive admitted that its September 2000 Quarter revenues were overstated by 981.6 percent; $21.4 million of the $23.6 million in revenue was wrongly recorded. Id.
Adaptive also reported in the October 23, 2000 release that it had backlog orders at the close of the September 2000 Quarter totaling $72.4 million. Id. at ¶ 66. According to Plaintiffs, Adaptive's reported backlog of orders was falsely inflated. Adaptive's invoicing system was based on 30-day net payment terms. Id. at ¶ 72. If a customer was 90-days past due or more, it was red-flagged for review by Defendant Maloney. Id. CW1 reported that purchase orders received prior to the close of FY2000 with shipment dates between January and March 2001 that were red-flagged were reported nonetheless. Id. CW2 reported that in the first and second quarters of FY2001 certain orders were shipped and never paid for and never returned, but were recorded by Defendant Maloney as having been returned to inventory anyway. Id. at ¶ 73.
Announcement of December 2000 Quarter Results
On January 25, 2001, Adaptive issued a press release detailing its results for the December 2000 Quarter. Id. at ¶ 77. ("January 2001 Release"). It reported revenue of $8.4 million and $21.4 million in backlog, after a $55 million backlog adjustment "due to softness in the U.S. Competitive Local Exchange Carrier." Id. It also admitted Fuzion's default on a $12.4 million receivable and Adaptive's deferral of $13 million in additional shipments. Id. Adaptive's Recognition of Accounting Errors
This part of Plaintiffs' Complaint is difficult to follow. 25 According to Plaintiffs, Adaptive eventually admitted that the December 2000 revenue figures were overstated by 158.3 percent and 26 that an initial net loss of $62.6 million turned out to be $98.9 million. Id. at ¶ 79. But Plaintiffs fail to direct the Court's attention to when and where this later admission was made.
On March 15, 2001, the last day of the class period, Adaptive issued a press release admitting it had wrongfully recorded $4 million in June 2000 Quarter revenue for a single, major customer, BroadbandNow. Id. at ¶ 80. The $4 million in question represented 23.4 percent of the $17.1 million in revenue reported for the June Quarter 2000. Id. at ¶ 39.
In an April 18, 2001 press release, Adaptive announced that Defendant Maloney had been replaced as its CFO. Id. at ¶ 81. On May 22, 2001, Adaptive issued a press release announcing its securities had been delivered by the NASDAQ. Id. at ¶ 83.
On July 5, 2001, Adaptive filed its Annual Report on Form 10-K with the SEC for the transition period July 1, 2000 to December 31, 2000 ("FY2001 10-K"). Id. at ¶¶ 51, 84. On the form, Adaptive for the first time disclosed the June 2000 "financing commitment" side letter for the $4 million sale to BroadbandNow. Id. Adaptive told the SEC that it would reverse the transaction, which had been reflected in the June 2000 quarter. Id. Adaptive also revealed it was restating "two additional revenue transactions, one relating to an authorized shipment and the other to the inappropriate recognition of a customer deposit," both recorded in the June 2000 quarter. Id. (quoting FY2001 10-K).
Upon discovering the side letter, Adaptive established a Special Investigation Committee and retained independent special counsel. Id. at ¶ 84. The committee's counsel reviewed sales transactions from April 1, 2000 to December 31, 2000. Id. As a result, Adaptive determined that extension of credit to certain customers in the latter part of 2000 was not supportable, and decided to restate or reverse revenues recorded in the June, September, and December 2000 quarters. Id. The FY2001 10-K also disclosed that severance payments to Defendants Lawrence and Birks were suspended in May 2001. Id.
On July 26, 2001, Adaptive filed for federal bankruptcy protection in the San Jose Division of the Northern District of California Federal Bankruptcy Court. Id. at ¶ 86. Adaptive has yet to file a restated annual report for FY2000 and a restated quarterly report for the first quarter of FY2001 Id.
Adaptive's Proposed Merger with Western Multiplex
The individual defendants owned at least 844, 703 shares of Adaptive stock during the class period. (Mem. of PA's in Supp. of Defs.' Mot. to Dis. at 2:24). Plaintiffs do not allege that any of the Individual Defendants sold securities during the class period. Rather, Plaintiffs allege that the individual defendants were attempting artificially inflate the price of the company's stock in an attempt to attract a merger partner. Plaintiffs support this hypothesis with certain facts about a potential merger proposed during the class period.
On November 13, 2000, Adaptive issued a press release announcing a merger agreement under which it would be acquired by Western Multiplex Corporation ("Western Multiplex"). Id. at ¶ 74. Under the agreement, Western Multiplex would issue $645 million in stock to acquire Adaptive, and Defendants Lawrence and Scharre would join the Board of Directors with Scharre also acting as President and COO. Id.
On January 10, 2001, Adaptive issued a press release announcing that the merger had been called off due to unfavorable market conditions. Id. at ¶ 75. The release also announced that Defendants Lawrence and Birks were retiring from Adaptive, and that Defendant Scharre had been promoted to CEO and that Defendant Maloney had been promoted to CFO. Id. at ¶ 75. As noted above, Defendant Maloney was relieved of the CFO position in April 2001. Id. at ¶ 81.
III. LEGAL STANDARD
A. Motion to Dismiss
A motion to dismiss will be denied unless it appears that the plaintiff can prove no set of facts which would entitle her to relief. Fed.R.Civ.Pro. 12(b)(6); Conley v. Gibson, 355 U.S. 41, 45-46 (1957);Gilligan v. Jamco Dev. Corp., 108 F.3d 246 (9th Cir. 1997); Fidelity Financial Corp. v. Federal Home Loan Bank of San Francisco, 792 F.2d 1432, 1435 (9th Cir. 1986). All material allegations in the complaint are accepted as true and construed in the light most favorable to the non-moving party. NL Industries, Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986).
B. Securities Fraud
Rule 9(b) provides that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). The allegations must be "specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong." Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985).
Rule 9(b) applies to actions brought under the federal securities laws. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994) (en banc). In 1995, Congress enacted the Private Securities Litigation Reform Act, ("PSLRA"), to clarify and strengthen the particularity requirements of Rule 9(b) in the context of federal securities class actions. In the Ninth Circuit, this requirement has been interpreted and explained by In re Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir. 1999).
Section 10(b) of the Securities Exchange Act of 1934 provides, in relevant part, that it shall be unlawful "[t]o 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). Exchange Commission Rule 10-5, issued by the SEC to implement Section 10(b), 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 a 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. A plaintiff bringing a claim under these sections must show: (1) a false and misleading statement or omission of material fact; (2) reliance; (3) scienter; and (4) resulting damage.Paracor Fin., Inc. v. General Elec. Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996).
The PSLRA places additional pleading requirements on a plaintiff in a securities fraud action. To state a claim under the PSLRA, for each defendant, a plaintiff 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 . . . [to] state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4 (b)(1). The plaintiff must also "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 PSLRA further requires that a district court, upon motion of the defendant, "shall" dismiss any complaint that does not meet these requirements. 15 U.S.C. § 78u-4 (b)(3)(A).
C. Control Person Liability
Rule 20(a) of the 1934 Act defines control persons as: "Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder. . . ." 15 U.S.C. § 78t(a). Such a person "shall also be liable jointly and severally with and to the same extent as such controlled to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." Id.
D. Judicial Notice
A party requesting judicial notice must show that the fact in question is not subject to reasonable dispute because it is generally known in the community or "capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned." Fed.R.Evid. 201(b). In ruling on a motion to dismiss, a district court may take judicial notice of a document if the plaintiff relies upon it in her complaint and its authenticity is not questioned. Parrino v. FHP, Inc., 146 F.3d 699, 706 (9th Cir. 1998). A court may consider SEC filings incorporated by reference in a complaint. Ronconi v. Larkin, 253 F.3d 423, 427 (9th Cir. 2001); In re Silicon Graphics, 183 F.3d at 986.
In this securities class action, Plaintiffs claim that Adaptive falsely reported financial results by improperly recording revenue in an attempt to inflate its stock price. According to Plaintiffs, revenue overstatement and inadequate loss recognition was effected by violating generally-accepted accounting principles ("GAAP") and Adaptive's own internal policies. As a result, FY2000 and FY2001 financial results were materially false and misleading when made. Plaintiff's claim they would not have purchased Adaptive stock at the prices they paid, or at all, if they had known that the market price had been inflated by Defendants' alleged fraud.
Plaintiffs allege violations of Section 10(b) of the 1934 Act and SEC Rule 10b-S against all defendants and violations of Section 20(a) of 1934 Act against the individual defendants. They request class damages, interest and costs and any other equitable/injunctive relief as the Court deems just and proper.
The Court will first address whether the Complaint states facts sufficient to support fraud generally under the PSLRA's heightened pleading standards. The Court will next address whether the Complaint's allegations are sufficient to support the claim that the individual defendants were control persons under Section 20(a).
A. Section 10(b) and SEC Rule 10b-5
Plaintiffs allege that Defendants engaged in a series of conscious decisions to falsify financial statements in order to attract a merger partner and to profit personally thereby. To support these allegations, Plaintiffs cite reports from four confidential witnesses from inside the company. They also cite to Adaptive's own public admission that it had misstated its financials, the NASDAQ's decision to delist Adaptive's stock, reshuffling (and replacement) of top executives and a failed merger attempt as evidence that Adaptive knowingly, or at least with deliberate recklessness, defrauded them by engaging in questionable business practices. Defendants dispute Plaintiffs' contention that their Complaint pleads securities fraud with the necessary particularity.
Under the PSLRA and Rule 9(b), a plaintiff must show that an alleged false statement was false when made, and must also plead specific facts creating a strong inference that the fraud was committed with deliberate recklessness. In re Silicon Graphics, 183 F.3d at 974; Ronconi, 253 F.3d at 429. If an allegation regarding a statement or omission is made on information and belief, the complaint must state with particularity all facts on which that belief is based. 15 U.S.C. § 78u-4 (b)(1). Allegations are presumed to have been made on information and belief unless and until the plaintiffs demonstrate they have personal knowledge of the facts. In re Vantive Corp. Sec. Litig., No. 00-16136, 2002 WL 398498, at *2 n. 3 (9th Cir. March 15, 2002).
The first prong of the Silicon Graphics formula is satisfied here; Defendants do not contest that financial statements for the June, September and December 2000 Quarters were false when made. In their Motion to Dismiss, however, the Individual Defendants deny these results were knowingly false when made; that is, they argue that Plaintiffs' complaint is fatally flawed for failure to plead the required level of scienter. They explain the readjustment of Adaptive's financial disclosures as the combined result of the discovery that some transactions had been improperly recorded and the collapse in the market for Adaptive's product which made prior credit extensions to certain customers insupportable.
In the Ninth Circuit, the required state of mind in a securities fraud case is actual knowledge or "deliberate recklessness," or if the statement is forward-looking, "actual knowledge . . . that the statement was false or misleading." 15 U.S.C. § 78u-5 (c)(1)(B)(i);Ronconi, 253 F.3d at 429. This stricter standard was codified in an attempt to prevent cases based upon "fraud by hindsight." In re Silicon Graphics, 183 F.3d at 988 (internal citations omitted)
A securities fraud complaint need not be dismissed for relying on circumstantial evidence, as long as that evidence meets the "strong inference" standard. In re Silicon Graphics, 183 F.3d at 996; In re Northpoint Comm. Group, Inc. Sec. Litig., 184 F. Supp.2d 991, 997 (N.D. Cal. 2001). In order to adequately plead that statements were intentionally false, misleading or made with deliberate recklessness, the complaint must allege specific "contemporaneous statement or conditions" demonstrating the deliberately reckless or intentional nature of the statements at the time they were made. Ronconi, 253 F.3d at 432; In re Vantive, 2002 WL 398498 at *7 In assessing whether a complaint sufficiently pleads scienter, it must be read in its entirety. In re Silicon Graphics, 183 F.3d at 985.
Plaintiffs argue scienter on many different levels. First, they argue that GAAP violations in and of themselves support an inference of scienter. They also argue that by restating its financials, Adaptive effectively admitted that its original filings and releases were knowingly false when made. But most importantly, Plaintiffs point to a series of deliberate transactions by corporate executives designed to override standard accounting procedures in an effort to attract a potential buyer for the company. Plaintiffs argue that collectively, these transactions and the deliberateness with which they were entered into support the necessary inference that the fraud alleged was knowing, or at least deliberately reckless.
1. Unnamed Sources
As an initial matter, the Court will addres concern over Plaintiffs' use of confidential witnesses. Defendants claim the use of unnamed sources violates the PSLRA's particularity requirement. Defendants demand that Plaintiffs should be required to at least provide the witnesses' names and titles, or more facts establishing that they are likely to possess the information attributed to them. Defendants note in particular that the Complaint is vague as to the starting dates of three of the four witnesses, suggesting that they may not have been working at the jobs that gave them access to the knowledge they are supposed to have until after the events happened.
The credibility to be attributed to an anonymous source should be evaluated on a case-by-case basis. In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp.2d 1248, 1271 (N.D. Cal. 2000). The failure to name sources may reduce the weight to be allocated to their testimony when evaluating the complaint's ability to meet the strict requirements for pleading scienter. Id. at 1272. But the failure to name sources will not doom an otherwise well-plead securities complaint. According to Silicon Graphics, a plaintiff need only "mention . . . the sources of [plaintiff's] information." 183 F.3d at 985. This has been interpreted to mean that "[i]t is possible to identify sources and provide other corroborating details without disclosing names of sources." In re McKesson, 126 F. Supp. 2d at 1271.
Plaintiffs' Complaint would be more credible if their sources were named, since, in the context of pleading securities fraud, the more detail the better. But their refusal to provide this detail is not fatal. Plaintiffs allege that CW1 was a 15-year employee of Adaptive and its predecessor, California Microwave, and that in 2000 until approximately July 2001 the witness was a manager in charge of Adaptive's order fulfillment department. (Compl. at ¶ 41.) Plaintiff's claim that CW2 began work at Adaptive in 1999 and from 2000 to July 2001 worked in Adaptive's finance division and reported directly to Defendant Maloney. CW2's responsibilities included generating regular reports for senior management, including a "BBB Customer Report" detailing billings, bookings and backlog. Id. at ¶ 42. CW3 worked for Adaptive and its predecessor company for 10 years. Id. at ¶ 60. In 2000 and until approximately July 2001, CW3 was a department head-level information officer in Adaptive's Rochester, New York office, the hub of Adaptive's sales and order administration department. Id. CW3 reported to Adaptive's Chief Information Officer. Finally, CW4 is described as an administrative assistant who worked for Defendants Lawrence and Birks between July 2000 and February 2001. Id. at ¶ 63.
Defendants correctly note that Plaintiffs are vague as to the dates witnesses one through three began work in their positions. And it is indeed odd that employees whose descriptions give away so much of their identities would not let their names be used. But the Court finds that the failure to name them is more than compensated for by the fact that the witnesses are long-term employees whose positions are described in detail.
Defendants cite to In re Northpoint, a case in which the use of eight confidential witnesses could not overcome the PSLRA's particularity requirement. 184 F. Supp. 2d at 1001. But the Court finds that case to be distinguishable. There, Judge Alsup noted that the complaint never described the witnesses' duties, nor did it discuss how they came to learn of the information in the complaint. Id. Here, by contrast, Plaintiffs provide much more that the four witnesses' titles. For example, they describe that CW1 had first-hand knowledge of Defendant Maloney's decision to extend credit to certain customers and to override internal accounting procedures in the process. They describe how CW2 generated reports and knew first-hand that a report had been altered to reflect the Fuzion deal. They describe how CW3 saw for himself the Fuzion's supposedly completed order stored in Adaptive's Sunnyvale warehouse, a scheme later confirmed by his supervisor. While less concrete, the information provided by CW4 confirms the Fuzion warehouse deal.
This is not to say that everything attributable to these witnesses is acceptable. CW1's allegations that Defendants Lawrence and Birks actually "knew what Peter was doing" and "consented to his actions," and that "no one trusted [Maloney]" are far too vague. (Compl. ¶ 45). The same goes for CW2's allegations that "[c]ertain orders during [the first and second quarters of FY2001] had been shipped to customers, never paid for, and never returned." Id. at ¶ 73. But the places where the complaint suffers for vagueness are counterbalanced by detailed allegations elsewhere. The Court is persuaded that on the whole, Plaintiffs have provided sufficient detail as to the job descriptions and responsibilities of their confidential sources, and the ways in which they came to know the information pleaded in Plaintiffs' complaint. The fact that they are not named, while not ideal, does not prove fatal to Plaintiffs' complaint.
The Court notes that while the hard numbers falsely reported in press releases announcing financial results and corresponding SEC filings are actionable, the vast majority of the statements made by the individual defendants to the media are not. Reasonable investors do not take heed of puffery when making investment decisions. In re Northpoint, 184 F. Supp. 2d at 1005 (citing Raab v. General Physics Corp., 4 F.3d 286, 288-90 (4th Cir. 1990)).
a. SEC Filings/Press Releases Announcing Financial Results
Plaintiffs argue that a series of SEC filings and press releases announcing financial results were false when made, and were made with the intent to deceive or with a deliberately reckless regard for the truth. They attempt to show scienter with a variety of corroborating circumstantial evidence, the sufficiency of which the Court will presently address.
1) GAAP violations
Plaintiffs claim that in their zeal to prop up Adaptive's financial health, Defendants deliberately failed to follow the SEC's admonition that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate. 17 C.F.R. § 210.4-01 (a)(1) ("SEC Reg. S-X"). According to Plaintiffs, a failure to follow GAAP demonstrates deliberate recklessness in reporting financial results, and thus, scienter. Defendants disagree.
While it is true that conclusory allegations of GAAP violations standing alone cannot be used to prove intentional or reckless misconduct, if pled in detail and read in context, GAAP violations may support an inference of scienter. In re McKesson, 126 F. Supp. 2d at 1273 ("After all, books do not cook themselves."); In re Cylink Sec. Litig., 178 F. Supp.2d 1077, 1082 (N.D. Cal. 2001); compare In re Northpoint, 184 F. Supp. 2d at 998 (finding GAAP violations alone to be insufficient proof of scienter)
GAAP violations are particularly credible evidence where a plaintiff provides specific amounts by which revenue was overstated, dates of transactions and/or the identities of the customers or company employees involved. In re McKesson, 126 F. Supp. 2d at 1273; compare In re Vantive, 2002 WL 398498 at *7 (finding an allegation of revenue overstatement insufficient where the amount of overstatement was not specified). Such information is adequately supplied here. The Broadband Now transaction in and of itself is specific as to amount ($4 million), approximate date (June 2000 Quarter) and customer. In addition, Plaintiffs provide specific evidence that there was an internal debate at Adaptive as to whether to override internal policies and GAAP restrictions and book the transaction. Plaintiffs also provide specific detail as to the TESSCO and Cybertech transactions, both recorded in the June 2000 Quarter.
The Court finds similarly sufficient detail in Plaintiffs' description of the September 2000 Quarter Fuzion deal for $13 million. There is detailed evidence to suggest the customer, amount and approximate date of the Fuzion transaction, which was booked despite Fuzion's faulty credit status and the questionable arrangement to "ship" the order to Adaptive's own warehouse. See In re Secure Computing Corp. Sec. Litig., 184 F. Supp.2d 980, 988-89 (N.D. Cal. 2001) ("Secure II") (finding allegations about a scheme to warehouse unfinished products for which the government would not accept delivery and treating it as delivered for accounting purposes to support a strong inference of deliberate recklessness under the PSLRA); compare In re Guess?, Inc. Sec. Litig., 174 F. Supp.2d 1067, 1077 (C.D. Cal. 2001) (failing to find sufficient evidence of scienter allegations that did not amount to anything as "egregious and the booking of entirely contingent contracts as sales, followed by hiding the side letters that established the contingencies").
Defendants' suggestion that these transactions might somehow have been mismanagement, overconfidence or "growing pains" is best raised on a motion for summary judgment or at trial. At this stage in the litigation, by corroborating GAAP violations with detailed evidence of the contemporaneous decision-making behind the accounting errors, Plaintiffs have set forth sufficient circumstantial evidence that the statements released to the SEC and the investing public were known to be false at the time they were made. Ronconi, 253 F.3d at 432 (holding that allegations of deliberate recklessness must be supported by "contemporaneous statements or conditions" of knowing falsity). Defendant Maloney's actions alone — ignoring basic accounting principles and refusing to heed warnings from the accounting department about the propriety of his actions in overriding company policy — are sufficient to suggest that he knew what he was doing would lead to falsified financial results.
2) Financial Restatements
Plaintiffs allege that the fact that financials had to be restated at all supports an inference that they were knowingly false when made. Again, Defendants disagree, citing In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 553-54 (6th Cir. 1999).
While it is true that a one-time restatement, without more, probably does not create the necessary strong inference of scienter, In re Northpoint, 184 F. Supp. 2d at 1003, there is at least one case from the Northern District of California supporting Plaintiffs' position. In In re Cylink, the Court noted that "the mere fact that the statements were restated at all supports . . . an inference [of scienter]." 178 F. Supp. 2d at 1084. Given the fact that Adaptive was forced to announce restatements at least twice — once on March 15, 2001 and again on July 5, 2001 the Court finds that while they would be insufficient to support a scienter inference on their own, when coupled with the strong evidence of deliberately reckless accounting, these restatements shore up and place in context the allegations of fraud.
3) Corporate Reshuffling
As Adaptive's financial difficulties were coming to light, three of the named individual defendants either left the company or were moved to new positions. On January 11, 2001 Defendants Lawrence and Birks resigned. In April 2001, Adaptive Defendant Maloney was replaced as CFO and reassigned. In addition, in May 2001, severance payments to Defendants Lawrence and Birks were suspended. Plaintiffs suggest that these changes provide further support for an inference of scienter.
As with the restatement of Adaptive's financials, these changes, taken alone, would not support scienter. But because the changes occurred as Adaptive's financials were being restated and as Adaptive was conducting its own internal investigation (which resulted in a determination that the extension of credit to certain customers was unsupportable), they add one more piece to the scienter puzzle. This comports with In re McKesson, where the court inferred that the corporation had a factual basis for firing employees for cause because they "knew or should have known" of accounting improprieties. 126 F. Supp. 2d at 1274. While Adaptive's actions do not rise to such a level in this case (no one was publicly fired), the fact that the CFO was moved and former executives' severance payments were discontinued is highly suspicious, especially given the additional allegations in the Complaint.
4) Internal Reports
Defendants take issue with Plaintiffs' reference to internal BBB Reports to support a scienter inference, because while named, their contents are not alleged in sufficient detail. Plaintiffs counter that the details in their Complaint are sufficient; they allege that CW2 drafted some of them (BBB) and that the Fuzion order was specifically left out of at least one of them. Plaintiffs also claim that the existence of the BBB reports is corroborated by their witnesses.
Defendants are correct that In re Silicon Graphics explicitly rejected a plaintiff's attempt to ground scienter on general, uncorroborated allegations that defendants had received internal reports. 183 F.3d at 984, 985, 988. To overcome In re Silicon Graphic's proscription against vague references to a defendant's access to internal reports, details such as dates and contents of the reports in question are required. In re Vantive, 2002 WL 398498 at *5.
Plaintiffs actually make few if any references to company internal reports; their complaint rests on details wholly unrelated to what company executives were seeing or should have been seeing in internal memoranda. Unlike those cases in which scienter failed because it could not be shown that executives should have known something because they had access to internal documents detailing failing company prospects, this case rests on other evidence, most notably, witness reports that Defendants were deliberately violating accounting rules with side agreements and insupportable credit extensions. Indeed, the premise of Plaintiffs' theory of the case is that Defendants perpetrated a scheme more notable for what was not in the BBB reports generated from Adaptive's general ledger. In other words, it would not even matter what the internal documents said, because according to Plaintiffs, they were doctored. Defendants' argument about the use of internal reports as it relates to scienter is therefore unavailing.
5) Motive/Stock sales
Finally, Defendants argue that Plaintiffs' complaint is fatally flawed in that it fails to allege that any of the Individual Defendants made any stock sales during the class period. The Court interprets Defendants' argument to mean that the Complaint fails to demonstrate a motive for the alleged fraud.
Defendants have requested that the Court take judicial notice of the fact that Defendant Scharre's purchased 10,000 shares of Adaptive stock between January 30, 2001 and February 5, 2001. (Defs. Req. for Judicial Notice, Ex. C). Plaintiffs oppose the request because the issue of stock sales was not raised in their Complaint. In the alternative, Plaintiffs argue that Defendant Scharre's purchase only supports their theory; he wanted more shares so that he could sell more shares post-merger. Because the Court denies the Request for Judicial Notice,see section IV C, infra, neither argument will be addressed in this Order.
Plaintiffs counter that Defendants sought to profit personally from the proposed Western Multiplex merger because their stock holdings, if sold to an acquiring company, were collectively worth $14 million. Plaintiffs hypothesize that a merger with Western Multiplex would have allowed Defendants to sell all of their stock to the acquiring company without raising suspicion of insider trading.
Defendants dismiss this argument as boilerplate and conclusory. They argue that in addition to Plaintiffs' failure to make it in the original complaint, if this argument were persuasive, every potential merger would create an inference of scienter. Morever, Defendants contend that the stock they were holding after the merger would have been devalued once the financials were restated. In support, Defendants cite Florida State Bd. of Admin. v. Green Tree Fin. Corp, 270 F.3d 645 (8th Cir. 2001), for the proposition that a motive to overstate revenue to make a company more attractive to potential buyers is "too thin a reed on which to hang an inference of scienter. . . ." Id. at 664; see also In re McKesson, 126 F. Supp. 2d at 1274 n. 14 (recognizing that incentive compensation has been consistently rejected as a motive for fraud, for if this was enough it "would effectively eliminate the state of mind requirement as to all corporate officers and defendants" (quoting Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994)).
It is true that insider trading, if contemporaneous with knowingly false statements, tends to directly support the inference that a defendant knew that a statement she made was false at the time she made it. Ronconi, 253 F.3d at 434. But other motive evidence, while not as persuasive, is not necessarily unpersuasive if coupled with other allegations of fraud. See, e.g., Howard v. Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000) (holding on summary judgment that a desire to raise company financing combined with other "red-flags" of a company's financial condition can be probative of a motive to defraud investors); In re Imperial Credit Indus. Sec. Litig., No. CV 98-8842 SVW, 2000 WL 1049320, at *3 (C.D. Cal. Feb. 22, 2000) (finding allegations of motive to attract a buyer "before the company fell apart entirely," while not sufficient to support an inference of scienter on their own, "still probative to the inquiry").
The $645 million merger agreement would have made Defendants Lawrence and Scharre members of Western Multiplex's board of directors, and Scharre would have become President and COO. (Compl. ¶ 74). The merger was called off on January 10, 2001, and a little over six months later, Adaptive filed for bankruptcy. Id. at ¶¶ 75, 86. While these facts are not persuasive on their own, when read in light of the facts supporting the deliberately reckless accounting violations, the Court finds that they support an inference that the individual defendants were falsifying Adaptive's revenue in an attempt to bail the company out and save and perhaps increase the value of their shares. In the process, many investors, including plaintiffs, could have also been misled.
The Court recognizes that in isolation, this evidence would not come close to the level required to strongly infer scienter; as Defendants note, preserving a merger may provide "an incentive to feign success," but on its own, a fraud case it does not make. In re Northpoint, 184 F. Supp. 2d at 1003. But under the circumstances, when Plaintiffs relied on the misstated revenues and purchased stock at inflated prices, the fact that Defendants did not sell their own stock matters little. In re Nuko Info. Sys., Inc. Sec. Litig., 199 F.R.D. 338, 344-45 (N.D. Cal. 2000).
Plaintiffs are only obliged to state some set of facts giving rise to a strong inference of deliberate recklessness. If they have done so, it is irrelevant whether another, different set of facts might have accomplished the same thing. In re Cylink, 178 F. Supp. 2d at 1083. Therefore, given the sufficiency of the facts supporting the deliberately reckless GAAP violations, it makes no difference that there were no stock sales, or that the Complaint only alludes to internal company reports. These additional facts provide a backdrop for a portrait of fraud, painted in sufficient detail to satisfy the Court that the case is not one of the "fishing expeditions" the PSLRA was designed to discourage. At this stage, taken as true, Plaintiffs' pleadings are sufficient to suggest egregious GAAP violations in necessary detail to support a scienter inference, and therefore a violation of federal securities laws.
In sum, the Court finds that the statements made about Adaptive's revenue and loss in the June, September and December 2000 Quarters may very well have been made with a deliberately reckless regard for the truth. The Complaint provides specific details about a scheme to overinflate revenue in clear violation of internal policy and federal guidelines. Coupled with a formal admission that the revenues were overstated in the form of financial restatements filed with the SEC, public admonition of those involved and the results of Adaptive's own internal investigation, Plaintiffs have provided sufficient evidence to survive a motion to dismiss.
3. Allegations as to Each Individual Participant
Aside from proving whether the statements themselves were made with the requisite scienter, Plaintiffs must also satisfy the Court that it can prove who is liable for making them. Plaintiff's claim Section 10(b) violations against Adaptive and Defendants Lawrence, Birks, Scharre and Maloney. In addition to arguing that Plaintiffs have failed to allege scienter generally, Defendants also argue that Plaintiffs have failed to allege scienter separately as to each of these individual defendants.
As an initial matter, the Court is convinced that the allegations pertaining to Defendant Maloney are specific enough to infer that he acted at least with deliberate recklessness. Plaintiffs allege that he overrode internal revenue recognition policies and refused to reverse his decision even after being confronted by accounting staff. (Compl. ¶ 47.) In response, CW1 and another accounting department staffer jokingly gave Defendant Maloney a "get-out-of-jail free" card in recognition that he had acted inappropriately. Id. Defendant Maloney is also alleged to have overridden an internal policy that orders could not be shipped to Adaptive's own warehouse without a written lease agreement. Id. at ¶ 59. Again, Defendant Maloney was confronted with the policy and ignored it. Together these allegations are detailed enough to pinpoint an inference of scienter as to Defendant Maloney.
As to Defendants Lawrence, Birks and Scharre, Plaintiffs' allegations amount to a series of suggestions that they "knew" about events, devised the fraudulent schemes, or spoke publicly about revenue figures they knew were false. Plaintiffs rely on the group publication doctrine and the core operations inference to support their allegations of securities fraud against all individual defendants, but as the Court has already determined that the specific allegations as to Defendant Maloney stand on their own, it will only address the doctrine's application to the remaining three: Lawrence, Birks and Scharre.
a. Group Published Information Doctrine
Defendants take issue with Plaintiffs' reliance on group published information doctrine, which Defendants argue has not survived the passage of the PSLRA. The doctrine, described in Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir. 1987), states that a defendant's participation in securities fraud can be shown by reference to that defendant's position, since false statements are the collective acts of officers:
In cases of corporate fraud where the false and misleading information is conveyed in prospectuses, registration statements, annual reports, press releases or other "group-published information," it is reasonable to presume that these are the collective actions of the officers. Under such circumstances, a plaintiff fulfills the particularity requirement of Rule 9(b) by pleading the misrepresentations with particularity and where possible the roles of the individual defendants in the misrepresentations.818 F.2d at 440; see also In re Glenfed Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995) (citing Wool with approval)
Both Wool and In re Glenfed were decided before the enactment of the PSLRA. According to Defendants, the PSLRA now requires that falsity and scienter be pled as to each defendant. 15 U.S.C. § 78u-4 (b) (1)-(2). Defendants acknowledge that the Ninth Circuit has yet to tackle head-on whether the group published information doctrine survives the PSLRA, but claim that it is clear that "its historical underpinnings have been destroyed." (Mem. PA's in Supp. of Defs.' Mot. to Dis., 11:21-22.)
Plaintiffs cite numerous cases from the Ninth Circuit affirming the viability of the group publication doctrine even after the passage of the PLSRA. See, e.g., In re Guess?, 174 F. Supp. 2d at 1079-80 (recognizing the viability of the doctrine); In re Secure Computing Corp. Sec. Litig., 120 F. Supp.2d 810, 821-22 (N.D. Cal. 2000) ("Secure I") (collecting Ninth Circuit cases recognizing the doctrine). The Court agrees that the doctrine has not been specifically abrogated, and is still good law in this Circuit.
In this case, Plaintiffs rely on statements published in press releases and SEC filings, both of which are subject to the group publication doctrine. Wool, 818 F.2d at 440. Defendants Lawrence, Birks and Scharre signed the August 2000 10-K SEC report, which Plaintiffs allege reported knowingly false revenue results for the June 2000 Quarter. The same three Defendants were quoted in the October 2000 release announcing Adaptive's September 2000 Quarter financial results, which Plaintiffs allege falsely overstated revenue by nearly 981 percent. (Compl. ¶¶ 38, 66-67, 70.) Under the group publication doctrine, the statements are presumed to be the collective acts of Adaptive's officers. At the time of the August 2000 release, Defendant Lawrence was the CEO and Chairman of the Board, Defendant Birks was the CFO and Defendant Scharre was the President and COO of Adaptive. These were not just officers of the company, they were the highest ranking officers, and the Court has no trouble inferring that the press releases and SEC filings that contain the false statements were issued with their blessing.
In the alternative, Plaintiffs rely on the core operations inference, which states that if a proper factual foundation is laid, "it may be inferred that facts critical to a business's core operations or an important transaction are known to a company's key officers." In re Northpoint, 184 F. Supp. 2d at 998. This requires a minimal showing that the critical facts were "actually known within the company." Id. Plaintiffs allege that Adaptive consciously focused its efforts on their AB-Access products, and that the importance of this niche supports the inference that the corporate officers would have been well aware of important transactions relating to it, including the Fuzion and Broadband Now deals. (Compl. ¶¶ 18, 25, 27, 39, 53, 67). Because the Court finds the group publication doctrine applicable to this case, it need not address Plaintiffs' core operations inference.
The Court's conclusion is supported by the Ninth Circuit's recognition in Howard that when corporate officers sign documents, they attest to their accuracy. 228 F.3d at 1061 ("When a corporate officer signs a document on behalf of the corporation, that signature will be rendered meaningless unless the officer believes that the statements in the document are true."). While it is true that a plaintiff cannot make general references to a defendant's attendance at a meeting or her "hands-on" managerial style in an attempt to prove scienter, In re Vantive, 2002 WL 398498 at *4, it is a different matter when an officer signs a document. In the latter case, the officer is effectively making a statement herself.
Here, Plaintiffs allege that the FY00 Form 10-K was signed by Defendants Lawrence, Birks and Scharre and that the Form 10-Q Report of September 2000 Quarter results was signed by Birks. By signing the forms, which are alleged to contain deliberately reckless and false report of FY2000 revenue, these Defendants have themselves become liable for securities fraud.
B. Control Person Liability: Section 20(a)
Plaintiffs hold the individual defendants responsible for the alleged fraud as control persons under Section 20(a) of the 1934 Act. The 1934 Act defines a control person as someone "who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder . . . ." 15 U.S.C. § 78t(a). Such a person "shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." Id.
To successfully plead control person liability, Plaintiffs must show a primary violation of the federal securities laws and that each defendant "directly or indirectly" controlled the violator. Paracor Fin., Inc. v. General Elec. Capital, 96 F.3d 1151, 1161 (9th Cir. 1996); Hollinger v. Titan Capital. Corp, 914 F.2d 1564, 1575 (9th Cir. 1990). According to Defendants, Plaintiffs have not pled control person liability with particularity. Defendants contend that Plaintiffs must allege specific facts to support each defendant's control over the transaction or activity that gave rise to the primary violation.
According to Plaintiffs, the fact that the named individual defendants held important positions in the company is sufficient at the pleadings stage. The Court agrees. While it is true that the identification of a control person is "intensely factual," it is also true that a control person need not be a "culpable participant" in the alleged fraud. Howard, 228 F.3d at 1065 (citing Hollinger, 914 F.2d at 1575; Paracor, 96 F.3d at 1161). Indeed, at least one court has determined that allegations that individual defendants, by virtue of their executive and managerial positions, could control and influence the company and did so, are sufficient at the pleadings stage. In re Cylink, 178 F. Supp. 2d at 1089 ("[P]laintiffs need not allege that the individual defendants actually participated in the wrongful conduct or exercised actual power to be derivatively liable under section 20(a).")
The Court finds that the allegations that the Individual Defendants held the highest offices in the corporation, spoke frequently on its behalf, and made key decisions in how to present its financial results are sufficient to survive Defendants' contention that the Complaint lacks specificity as to control person liability. Later in the proceedings, when and if Plaintiffs present evidence of such control, Defendants will have the opportunity to assert a good faith defense of lack of participation.Howard, 228 F.3d at 1065; In re Cylink, 178 F. Supp. 2d at 1089. Defendants' Motion to Dismiss the control person liability claims against Defendants Birks, Maloney, Scharre and Lawrence is therefore denied. C. Judicial Notice
As an aside, the Court notes that the Second Claim for Relief in Plaintiffs' Complaint alleges that the individual defendants are liable under Section 20(a) only for their control over Adaptive, not for their liability for their collective acts as corporate executives; that is, for their control over each other. The fact that the case is stayed against Adaptive's pending bankruptcy may be problematic, since Plaintiffs cannot prove that Adaptive has committed a primary violation of federal securities laws until the stay is lifted. As noted, the establishment of a primary violation is a threshold inquiry in determining control person liability. Howard, 228 F.3d at 1065. The parties do not address this in their papers, but the Court assumes that since the individual defendants themselves are named as Section 10(b) violators, the above analysis applies. According to the 1934 Act, joint and several liability can be imposed upon anyone who "controls any person liable under any provision" of the Act. U.S.C. § 78t(a).
Defendants request that the Court take judicial notice of the following documents: 1) Adaptive's Form 10-K for the transition period July 1, 2000 to December 31, 2000 filed with the SEC on July 5, 2001 attached to the Request at Exhibit A; 2) Adaptive's Schedule 14A, Proxy Statement filed with the SEC on October 2, 2000 attached as Exhibit B to their Request; 3) Two statements of Changes in Beneficial Ownership ("Form 4s")filed on behalf of Defendant Scharre with the SEC on February 7, 2001 and March 9, 2001, reflecting Defendant Scharre's purchases of Adaptive stock, attached as Exhibit C to the Request. Plaintiffs oppose the Request, arguing that judicial notice of the truth of documents referred to in a complaint is not allowed.
Federal Rule of Evidence 201(b) requires a party requesting judicial notice to show that the fact in question not be subject to reasonable dispute because it is "generally known in the community" or "capable of ready determination by resort to sources whose accuracy cannot reasonably be questioned." Fed.R.Evid. 201(b). In ruling on a motion to dismiss, a district court may consider a document, including an SEC filing, if the plaintiff relies upon it in her complaint and its authenticity is not questioned. Parrino, 146 F.3d at 705-06; Ronconi, 253 F.3d at 427; In re Silicon Graphics, 970 F. Supp. 746, 751-52 (N.D. Cal. 1997) (noting that the document must be "referenced in plaintiff's complaint" and "`central' to plaintiff's claim"). Importantly, if facts contained in a document are disputed, a court may only consider the document for the limited purpose of recognizing the fact that the document exists. Lee v. City of LA, 250 F.3d 668, 688-90 (9th Cir. 2001).
Plaintiffs properly concede that the Form 10-K attached as Exhibit A was referenced in the Complaint. The Court therefore takes judicial notice the fact that the statements therein were made, but does not take judicial notice of their truth. Lee, 250 F.3d at 690.
As to Exhibits B and C, Plaintiffs argue they are not subject to judicial notice at all because they are not referenced or relied upon in the Complaint. According to Plaintiffs, judicially noticing these documents would improperly convert the motion to dismiss into a motion for summary judgment. Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994)
Defendants allege that Plaintiffs must have relied on the Proxy Statement in Exhibit B in order to come up with the Defendants' exact stock holdings. As far as the Court can tell, however, Defendants were the first to mention this number in their Motion to Dismiss. See Mem. PA in Supp. of Defs.' Mot. to Dis., 17:15. The Court cannot see any other relevance for it, thus it will not be judicially noticed or incorporated by reference into the Complaint.
As to Exhibit C, Defendant Scharre's Form 4s, Defendants say that as an SEC filing, under In re Silicon Graphics, it is indisputable that it can be judicially noticed. Defendants allege, moreover, that Plaintiffs necessarily relied on it in their Complaint when they put forth their theory about Adaptive's motive to inflate the stock price.
The Court disagrees that there is no dispute as to whether the Form 4s can be judicially noticed. If the parties dispute its authenticity or the form is not referenced in a plaintiff's complaint, it will not be noticed. Here, there is no dispute that Defendant Scharre sold stock, and the document was filed publicly. But Plaintiffs never refer to stock sales by any defendant in their Complaint. Plaintiffs only raised their theory about motive in response to Defendants' Motion to Dismiss, which explicitly referred to a lack of stock sales. Therefore, the Court declines to take judicial notice of the Form 43.
For the above-mentioned reasons, Defendants' Motion to Dismiss is hereby DENIED. Defendants' Request for Judicial Notice is GPANTED as to Exhibit A, and DENIED as to Exhibits B and C. The parties shall appear for a status conference on Friday, April 12, 2002 at 10:00 a.m. in Courtroom 1, San Francisco Division. The parties shall file one joint statement seven days prior to the status conference.
IT IS SO ORDERED.