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In re Securities Litigation

United States District Court, N.D. California
Dec 22, 2005
No. C 04-03009 JSW (N.D. Cal. Dec. 22, 2005)


No. C 04-03009 JSW.

December 22, 2005


Now before the Court is the motion filed by Defendants, inc. (the "Company"), Marc R. Benioff and Steve Cakebread (collectively, "Defendants") to dismiss the Corrected and Superseding First Amended Class Action Complaint (the "Complaint"). Having carefully reviewed the parties' papers and considered their arguments and the relevant legal authority, and good cause appearing, the Court hereby GRANTS Defendants' motion to dismiss without leave to amend.


In this federal securities class action, Plaintiff Chuo Zhu, representing a purported class of purchasers of the common stock of the Company between June 23, 2004 and July 21, 2004, alleges that the Company's failure to disclose an internal earnings forecast for fiscal year 2005 (ending January 31, 2005), developed prior to the start of the fiscal year and predicting diluted earnings per share ("EPS") of breakeven 3 cents, constitutes a violation of the Securities Exchange Act of 1934.

Founded in 1999, the Company provides on-demand, web-based information management, or customer relationship management ("CRM") solutions, to companies of all sizes on a subscription basis. (Complaint at ¶¶ 2, 35.) The Company went public in a highly publicized initial public offering ("IPO") on June 23, 2004. ( Id. at ¶¶ 6, 57.)

In advance of the IPO, the Company filed with the SEC a Form S-1 Registration Statement and amendments which disclosed the estimated diluted earnings per share by fiscal year. ( See Complaint at ¶ 60; Main Decl., Ex. A at 23, F-4, F-12.) The Registration Statement also disclosed that fiscal year 2004 earnings benefitted from an extraordinary, non-recurring item, the abandonment of office lease space in San Francisco. ( See Declaration of Claudia N. Main ("Main Decl."), Ex. A at 27.) When that non-recurring item is excluded from the calculation, fiscal year 2004 earnings would have been 1 cent.

The IPO price of the Company's stock was $11.00. ( See Complaint at ¶ 57.) After the passage of nearly one month, on July 20, 2004, the stock price was $16.06. ( See id. at ¶ 15.) On July 21, 2004, Defendant Cakebread provided securities analysts with internal guidance of the fiscal years 2005 for the first time. The internal guidance indicated that the Company had predicted a fiscal 2005 net income of breakeven to 3 cents a share and revenue of $160 to $165 million. ( See id. at ¶¶ 10, 78, 80, 81.) Cakebread also indicated that the Company had been using the guidance internally since February 1, 2004. ( See id. at ¶¶ 10, 79, 81.) The next day, the Company's stock price closed at $11.42, reflecting a 29% decline from the previous days' closing price of $16.06. ( See id. at ¶¶ 15, 83.)

On February 17, 2005, the Company announced its actual results for fiscal year 2005. The revenues for the year were $176 million, 84% higher than fiscal year 2004 revenues. (See Main Decl., Exs. B, C at 19, 51.) Diluted earnings per share were 7 cents, or 75% higher than the fiscal year 2004 diluted earnings. ( See id.)

The Court will address other specific facts relevant to this motion as they are pertinent to the analysis.


Rule 10b-5 makes it unlawful for any person to use interstate commerce:

(a) To employ any device, scheme, or artifice to defraud;
(b) To make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or;
(c) To engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
17 C.F.R. § 240.10b-5.

To plead a claim under section 10(b) and Rule 10b-5, a plaintiff must allege (1) a misrepresentation or omission, (2) of material fact, (3) made with scienter, (4) on which the plaintiff justifiably relied, (5) that proximately caused the alleged loss. Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999). Additionally, as in all actions alleging fraud, Plaintiff must state with particularity the circumstances constituting fraud. Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (9th Cir. 1999); Fed.R.Civ.P. 9(b).

Plaintiff also claims that individual defendants, Chief Executive Officer Marc R. Benioff and Chief Financial Officer Steve Cakebread, are liable pursuant to Section 20(a) of the Securities Exchange Act, which provides for derivative liability for those who control others found to be primarily liable under the provisions of that act. In re Ramp Networks, Inc. Sec. Lit., 201 F. Supp. 2d 1051, 1063 (N.D. Cal. 2002). Where a plaintiff asserts a Section 20(a) claim based on an underlying violation of section 10(b), the pleading requirements for both violations are the same. Id.

A. Applicable Pleading Standards.

1. Rule 12(b)(6).

A motion to dismiss is proper under Rule 12(b)(6) where the pleadings fail to state a claim upon which relief can be granted. Fed.R.Civ.P. 12(b)(6). A motion to dismiss should not be granted unless it appears beyond a doubt that a plaintiff can show no set of facts supporting his or her claim. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); see also De La Cruz v. Tormey, 582 F.2d 45, 48 (9th Cir. 1978).

2. Private Securities Litigation Reform Act.

In order to limit the number of frivolous private securities lawsuits, Congress enacted the Private Securities Litigation Reform Act ("PSLRA") in December of 1995, and created heightened pleading standards for such lawsuits. 15 U.S.C. § 78u-4(b). The PSLRA requires that "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement 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)(B). Furthermore, the PSLRA requires that the plaintiff "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 heightened standard set by the PSLRA was intended to put an end to securities fraud lawsuits that plead "fraud by hindsight." In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 988 (9th Cir. 1999). "The PSLRA significantly altered pleading requirements in private securities fraud litigation by requiring that a complaint plead with particularity both falsity and scienter." In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1084 (9th Cir. 2002) (citing Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001)) (emphasis added). "Thus the complaint must allege that the defendant made false or misleading statements either intentionally or with deliberate recklessness or, if the challenged representation is a forward looking statement, with `actual knowledge . . . that the statement was false or misleading.'" Id. at 1085 (citing 15 U.S.C. § 78u-5(c)(1)(B)(I)). This is often accomplished "by pointing to inconsistent contemporaneous statements or information (such as internal reports) made by or available to the defendants." Yourish v. California Amplifier, 191 F.3d 983, 993 (9th Cir. 1999) (quoting In re GlenFed Sec. Lit., 42 F.3d 1541, 1549 (9th Cir. 1991) ( en banc)); see also id. at 994 (discussing insufficiency of plaintiffs' allegations with regard to the non-disclosure of confidential non-public information).

Under the PSLRA, a complaint is still construed in the light most favorable to the non-moving party and all material allegations in the complaint are taken to be true. Silicon Graphics, 183 F.3d at 983. To determine whether Plaintiff has pled a strong inference of scienter, however, "the court must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs." Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir. 2002). The Court "should consider all the allegations in their entirety, together with any reasonable inferences therefrom, in concluding whether, on balance, the plaintiffs' complaint gives rise to the requisite inference of scienter." Id. "Conclusory allegations of law and unwarranted inferences, however, are insufficient to defeat a motion to dismiss." In re Northpoint Communications Group, Inc. Sec. Litig., 221 F. Supp. 2d 1090, 1094 (N.D. Cal. 2002).

Finally, the Court may consider the facts alleged in the complaint, documents attached to the complaint, documents relied upon but not attached to the complaint when the authenticity of those documents is not questioned, and other matters for which the Court can take judicial notice. Id.; see also Silicon Graphics, 183 F.3d at 986.

3. Request for Judicial Notice.

Both Plaintiff and Defendants request that the Court take judicial notice of documents that the Company filed with the SEC, news articles and press releases, and analysts' reports, all of which are either publicly filed documents, or are referenced in the Complaint or are integral to the allegations contained in the complaint. Neither party disputes the accuracy of the documents attached to the other's request, and the requested documents are the types of documents of which this Court properly may take judicial notice. See, e.g., In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 758 (N.D. Cal. 1997); aff'd, 183 F.3d 970 (9th Cir. 1990) (taking judicial notice of publicly available documents filed with the SEC); see also In re Calpine Corp. Sec. Litig., 288 F. Supp. 2d 1054, 1076 (N.D. Cal. 2003) (court "may properly take judicial notice of SEC filings and documents expressly referenced" in a complaint); see also Parrino v. FHP, Inc., 146 F.3d 699, 705-06 (9th Cir. 1998) (granting judicial notice of documents whose authenticity is not contested and which are crucial to the claims although not explicitly incorporated in the complaint). Accordingly, the Court GRANTS both Plaintiff's and Defendants' requests for judicial notice of the attached documents.

B. Alleged Nondisclosure of Internal Forecast is Not Actionable.

1. Alleged Omission of Internal Forecast Was Not Misleading.

To plead a claim under section 10(b) and Rule 10b-5, a plaintiff must allege (1) a misrepresentation or omission, (2) of material fact, (3) made with scienter, (4) on which the plaintiff justifiably relied, (5) that proximately caused the alleged loss. Binder, 184 F.3d at 1063. Here, Plaintiff alleges that the Company's failure to disclose an internal earnings forecast for fiscal year 2005 prior to the IPO was a material omission that caused Plaintiff to purchase stock at an artificially inflated price. To be actionable under Section 10(b) and Rule 10b-5, however, an alleged omission must render some affirmative public statement misleading. In order for an omission to be misleading, "it must affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists." See Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th Cir. 2002) (citing McCormick v. The Fund American Cos., 26 F.3d 869, 880 (9th Cir. 1994)). In order for Plaintiff to survive a motion to dismiss under the pleading standards of the PSLRA, the complaint must specify the reasons why the statements or omissions made by Defendants "were misleading or untrue, not simply why the statements were incomplete." Id. (citing 15 U.S.C. § 78u-4(b)(1); Ronconi, 253 F.3d at 429).

Plaintiff alleges that the earnings per share figures "led investors to believe that the Company was poised to continue the trend of increasing earnings into [fiscal year 2005], ending January 31, 2005." (Opp. at 4.) In addition, Plaintiff alleges that analysts and reporters were forecasting a rise in earnings per share in the fiscal year 2005 based primarily on the Company's past performance. ( Id., citing Complaint at ¶¶ 75, 49.) The core allegation in the Complaint is the Company's omission of the internal forecast gave investors the impression that future earnings would rise in a manner consistent with the Company's historical upward trend in earnings. (Complaint at ¶¶ 9, 58, 59, 62, 63.) However, as Defendants point out, the Company's actual fiscal year 2005 results demonstrated just that — a continuation of the upward trend in earnings. On February 17, 2005, the Company announced its actual results for fiscal year 2005 which indicated that revenues were $176 million, 84% higher than fiscal year 2004. ( See Main Decl., Exs. B., C at 19, 51.) This growth in revenues is comparable to the previous year's increase of 88% in revenues. ( See Complaint at ¶ 60.) Because the actual, existing state of affairs turned out to be an upward trend in earnings, the nondisclosure of the internal forecast portending a decline in revenues, did not affirmatively create an impression of a state of affairs that differed in a material way from the one that actually existed. Therefore, Plaintiff has failed to set forth a legal theory that is actionable based on the nondisclosure of the internal forecast.

2. Defendants Owe No Legal Duty to Disclose the Internal Forecast.

Further, even if the fiscal 2005 forecast announced on July 21, 2004 did reflect a downward departure from an upward trend, Plaintiff could still not state a claim for alleged failure to disclose the forecast. The law imposes no duty to disclose internal forecasts in the context of an initial public offering. See, e.g., In re VeriFone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993) (holding that, absent allegations that the Company withheld financial information from which forecasts are typically derived, the alleged omissions did not render other statement misleading); see also Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980) (holding that the SEC does not require a company to disclose financial projections). The nondisclosure of the internal forecast does not render the Company's disclosure of historical results for the fiscal year 2002 through fiscal year 2004 in the Registration Statement filed before the SEC in preparation for the initial public offering misleading. See In re Convergent Tech. Sec. Litig., 948 F.2d 507, 513 (9th Cir. 1991) (rejecting claim that historical reports of past growth implied future growth); see also In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1406 (9th Cir. 1996) (holding that "a company is not required to forecast future events or to caution `that future prospects [may not be] as bright as past performance.'")

The Court finds the analogy of an IPO to insider trading by the company employed by the First Circuit in Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1203-04 (1st Cir. 1996), to be unhelpful. Here, Plaintiff has not alleged a claim for insider trading, and in any event, if the abstain or disclose rule applied in the context of such a claim, Plaintiff would still bear the burden of pleading and proving that the alleged omission rendered a statement misleading. See, e.g, McCormick, 26 F.3d at 880.

b. Regulation S-K, Item 303, Instruction 7.

Regulation S-K provides that IPO prospectuses and registration statements must contain a section on management's discussion and analysis of financial condition and results of operations in a section called "Management Discussion." See generally 17 C.F.R. § 229.10, et seq. Item 303 addresses what must be included in the Management Discussion and requires, in part, that the section "[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations." 17 C.F.R. § 229.303(a)(3)(ii).

Until its revision in 2003, Instruction 7 to Regulation S-K clearly indicated that registrants were not required to disclose forecasts in their registration statements. See 17 C.F.R. § 229.303(a), inst. 7, 7 Fed. Sec. L. Rep. (CCH) ¶ 71,033, at 61,867-3 (2003) ("Registrants are encouraged, but not required, to supply forward-looking information"); see also VeriFone, 11 F.3d at 870 (holding that the "known trends or uncertainties" language of Item 303 did not include forecasts). In its revisions to the instructions in February 2003, Congress eliminated the sentence regarding the lack of obligation to supply forward-looking information, in order, at least in part, to be consistent with other revisions to the regulations requiring that companies disclose forward-looking information regarding the valuation of assets held in off-balance sheet entities. See Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements and Aggregate Contractual Obligations, Rel. Nos. 33-8182, 34-47264, 68 Fed. Reg. 5982, 5992-93 (February 5, 2003).

Plaintiffs cite a post-revision unpublished case from the Southern District of California in which the court found that "because Section 11 [of the Securities Act] imposes liability if a registrant `omits to state a material fact required to be stated' in the registration statement, `any omission of facts required to be stated' under Item 303 will produce liability under Section 11." In re Surebeam Corp. Sec. Litig., 2004 U.S. Dist. LEXIS 26951, *40 (S.D. Cal. December 30, 2004). The Surebeam court analyzed the issue of omission of information required to be disclosed under Item 303 only with respect to the claim under Section 11. Id. The separate analysis of the 10b-5 claim in that case provides no indication whether the court even considered if a violation of Item 303, standing alone, could support a claim under Rule 10b-5. Id. at *47-51. In any event, the Surebeam court conclusively found that, under their 10b-5 claim, plaintiffs had adequately pleaded with particularity that the prospectus contained "misleading statements and omissions." Id. at *51. Because this Court has found that the omissions alleged were not misleading, the Court does not need to address whether the unpublished interpretation of the applicability of Item 303 to Section 11 claims should apply to Plaintiff's Rule 10b-5 claim. Also, the Court notes that "demonstration of a violation of the disclosure requirements of Item 303 does not lead inevitably to the conclusion that such disclosure would be required under Rule 10b-5. Such a duty to disclose must be separately shown." See Alfus v. Pyramid Tech., 764 F. Supp. 598, 608 (N.D. Cal. 1991); see also In re Caere Corporate Sec. Litig., 837 F. Supp. 1054, 1061 n. 4 (N.D. Cal. 1993) ("The fact that Defendants may or may not have violated Item 303 is irrelevant to Plaintiffs' Rule 10b-5 claims.")

C. Control Person Liability

Section 20(a) of the Securities and Exchange Act provides derivative liability for those who control others found to be primarily liable under the Act. In re Ramp Networks, 201 F. Supp. 2d at 1063. Here, Plaintiff asserts that Benioff and Cakebread are liable under this section because of an underlying violation of Section 10b. Because Plaintiff has not adequately alleged facts to support the underlying 10b-5 violation, the Section 20(a) claim must be dismissed as well. Id.; America West Holding Corp., 320 F.3d at 945.

D. Leave to Amend.

Motions to dismiss are viewed with disfavor and rarely should be granted, and Federal Rule of Civil Procedure 15(a) provides that leave to amend is to be freely given when justice requires. Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1051 (9th Cir. 2003). "Dismissal with prejudice and without leave to amend is not appropriate unless it is clear on de novo review that the complaint could not be saved by amendment." Id. (citing Chang v. Chen, 80 F.3d 1293, 1296 (9th Cir. 1996)). The Ninth Circuit has admonished that because the standards in the PSLRA are high,"[a]dherence to these principles is especially important in the context of the PSLRA." Id. Ultimately, however, it is within the Court's discretion to determine whether to grant a plaintiff leave to amend. Vantive, 283 F.3d at 1097-98.

Here, because the basic facts are alleged and fail to state an actionable claim, the Court concludes that Plaintiff cannot cure the flaws in its pleading. See Lipton v. Pathogenesis Corp. 284 F.3d 1027, 1039 (9th Cir. 2002). Because any amendment would be futile, there is no need to prolong the litigation by permitting further amendment. See Klamath-Lake Pharmaceutical Ass'n v. Klamath Med. Serv. Bureau, 701 F.2d 1276, 1293 (9th Cir. 1983) (futile amendments should not be permitted); Silicon Graphics, 183 F.3d at 991 (denying leave to amend because defects in pleadings could not be cured by amendment).


For the foregoing reasons, Defendants' motion to dismiss is GRANTED without leave to amend. Plaintiff has failed to state a claim upon which relief can be granted under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t(a), and the rules and regulations promulgated thereunder. The Clerk is directed to close the file.


Summaries of

In re Securities Litigation

United States District Court, N.D. California
Dec 22, 2005
No. C 04-03009 JSW (N.D. Cal. Dec. 22, 2005)
Case details for

In re Securities Litigation

Case Details


Court:United States District Court, N.D. California

Date published: Dec 22, 2005


No. C 04-03009 JSW (N.D. Cal. Dec. 22, 2005)