Special Situations Fund III QP, L.P. et al v. Marrone Bio Innovations, Inc. et al

Filing 106

MEMORANDUM and ORDER signed by District Judge Morrison C. England, Jr on 3/20/17 ORDERING that EYs Motion to Dismiss 84 is DENIED. (Mena-Sanchez, L)

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1 2 3 4 5 6 7 8 UNITED STATES DISTRICT COURT 9 EASTERN DISTRICT OF CALIFORNIA 10 11 12 SPECIAL SITUATIONS FUND III QP, L.P., et al., Plaintiffs, 13 14 15 v. No. 2:14-cv-02571-MCE-KJN MEMORANDUM AND ORDER MARRONE BIO INNOVATIONS, INC., et al., 16 Defendants. 17 18 Plaintiffs in this consolidated class action charge Defendant Marrone Bio 19 Innovations, Inc. (“Marrone Bio”); certain of its officers and directors; and its public 20 auditor, Ernst & Young (“EY”), with violating federal securities laws. According to 21 Plaintiffs, they were defrauded of millions of investment dollars based on the financial 22 reporting fraud of Marrone Bio and Defendant Hector Absi, its Chief Operating Officer 23 and head of sales. Plaintiffs reached a settlement with Marrone Bio and its officers and 24 directors, and final judgment was entered as to that settlement on September 27, 2016. 25 EY now moves to dismiss the claims against it pursuant to Federal Rule of Civil 26 Procedure 12(b)(6). ECF No. 84. That motion is DENIED.1 27 28 1 Because oral argument would not be of material assistance, the Court order the matter submitted on the briefs. E.D. Cal. Local Rule 230(g). 1 BACKGROUND2 1 2 3 Marrone Bio is a biotech company that provides pest management and plant 4 health products. After completing an initial public offering in August 2013, the 5 company’s stock was traded on the NASDAQ under the ticker symbol “MBII.” At the end 6 of 2013, Marrone Bio filed its 10-K, reporting that its revenues had doubled over the prior 7 year. The company continued to report strong results in the first quarter of 2014, and in 8 June 2014 it undertook a Secondary Offering of 4.575 million shares of common stock at 9 a price of $9.50 per share. That offering was conducted pursuant to a Registration 10 Statement that was filed with the Securities and Exchange Commission (“SEC”), which it 11 declared effective on June 5, 2014. Lead Plaintiffs purchased 140,000 shares directly 12 out of the Secondary Offering. 13 On September 3, 2014, Marrone Bio issued a press release, which was also filed 14 with the SEC, revealing that Marrone’s Audit Committee had discovered documents 15 calling into question the recognition of certain material revenue in the fourth quarter of 16 2013. Following that discovery, the Audit Committee conducted an internal 17 investigation, determining that the financials reported for 2013 and the first half of 2014 18 should not have been relied upon by investors. This revelation purportedly meant that 19 the Registration Statement under which shares had been sold was materially false. 20 Marrone Bio shares thereafter fell in value by at least $2.85 per share. Relevant to the 21 instant motion, Lead Plaintiffs suffered losses in excess of $3 million as a result of this 22 decrease in the value of Marrone Bio’s stock. 23 Various parties brought suit against Marrone Bio as a result of the Audit 24 Committee’s revelation, and the Court consolidated the resultant cases pending in the 25 Eastern District of California. Mem. & Order, ECF No. 18, at 8. The SEC and United 26 States Department of Justice (“DOJ”) have also filed suits in connection with this fraud. 27 28 2 Unless a specific citation is included, the following facts are taken, at times verbatim, from Plaintiffs’ Third Amended Complaint. 2 1 Pls.’ Mot. to Am. Compl., ECF No. 58, at 1. The SEC brought suit against Marrone Bio 2 and Absi for securities violations, while the DOJ indicted Absi on sixteen counts, 3 including counts of securities fraud. Id. Plaintiffs were granted leave to amend their 4 complaint in part because documents filed in connection with the SEC’s and DOJ’s suits 5 provided additional bases for Plaintiffs’ allegations. Mem. & Order, ECF No. 74, at 2. 6 Relevant to the instant motion, EY provided an audit opinion as part of the 7 Registration Statement filed in connection with the Secondary Offering. That audit 8 opinion stated, in part: “In our opinion, the financial statements [in the Registration 9 Statement] present fairly, in all material respects, the consolidated financial position of 10 Marrone Bio Innovations, Inc. . . . in conformity with U.S. generally accepted accounting 11 principles.” EY’s Req. for Judicial Notice (“RJN”), Ex. C, ECF No. 85-3, at 8. Plaintiffs 12 allege that the audit report renders EY liable for any material misstatements of fact 13 contained in the financial statements EY audited, pursuant to § 11 of the Securities Act 14 of 1933. EY, however, contends that the allegations in the Third Amended Complaint 15 (“TAC”), ECF No. 76, are insufficient to set out a claim against it under that section. 16 17 STANDARD 18 19 On a motion to dismiss for failure to state a claim under Federal Rule of Civil 20 Procedure 12(b)(6), all allegations of material fact must be accepted as true and 21 construed in the light most favorable to the nonmoving party. Cahill v. Liberty Mut. Ins. 22 Co., 80 F.3d 336, 337–38 (9th Cir. 1996). Rule 8(a)(2) “requires only ‘a short and plain 23 statement of the claim showing that the pleader is entitled to relief’ in order to ‘give the 24 defendant fair notice of what the . . . claim is and the grounds upon which it rests.’” Bell 25 Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (quoting Conley v. Gibson, 355 U.S. 41, 26 47 (1957)). A complaint attacked by a Rule 12(b)(6) motion to dismiss does not require 27 detailed factual allegations. However, “a plaintiff's obligation to provide the grounds of 28 his entitlement to relief requires more than labels and conclusions, and a formulaic 3 1 recitation of the elements of a cause of action will not do.” Id. (citation omitted). A court 2 is not required to accept as true a “legal conclusion couched as a factual allegation.” 3 Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 555). 4 “Factual allegations must be enough to raise a right to relief above the speculative level.” 5 Twombly, 550 U.S. at 555 (citing 5 Charles Alan Wright & Arthur R. Miller, Federal 6 Practice and Procedure § 1216 (3d ed. 2004) (stating that the pleading must contain 7 something more than “a statement of facts that merely creates a suspicion [of] a legally 8 cognizable right of action”)). 9 Furthermore, “Rule 8(a)(2) . . . requires a showing, rather than a blanket 10 assertion, of entitlement to relief.” Id. at 555 n.3 (citation omitted). Thus, “[w]ithout some 11 factual allegation in the complaint, it is hard to see how a claimant could satisfy the 12 requirements of providing not only ‘fair notice’ of the nature of the claim, but also 13 ‘grounds’ on which the claim rests.” Id. (citing Wright & Miller, supra, at 94–95). A 14 pleading must contain “only enough facts to state a claim to relief that is plausible on its 15 face.” Id. at 570. If the “plaintiffs . . . have not nudged their claims across the line from 16 conceivable to plausible, their complaint must be dismissed.” Id. However, “[a] well- 17 pleaded complaint may proceed even if it strikes a savvy judge that actual proof of those 18 facts is improbable, and ‘that a recovery is very remote and unlikely.’” Id. at 556 (quoting 19 Scheuer v. Rhodes, 416 U.S. 232, 236 (1974)). 20 A court granting a motion to dismiss a complaint must then decide whether to 21 grant leave to amend. Leave to amend should be “freely given” where there is no 22 “undue delay, bad faith or dilatory motive on the part of the movant, . . . undue prejudice 23 to the opposing party by virtue of allowance of the amendment, [or] futility of the 24 amendment . . . .” Foman v. Davis, 371 U.S. 178, 182 (1962); Eminence Capital, LLC v. 25 Aspeon, Inc., 316 F.3d 1048, 1052 (9th Cir. 2003) (listing the Foman factors as those to 26 be considered when deciding whether to grant leave to amend). Not all of these factors 27 merit equal weight. Rather, “the consideration of prejudice to the opposing party . . . 28 carries the greatest weight.” Id. (citing DCD Programs, Ltd. v. Leighton, 833 F.2d 183, 4 1 185 (9th Cir. 1987)). Dismissal without leave to amend is proper only if it is clear that 2 “the complaint could not be saved by any amendment.” Intri-Plex Techs. v. Crest Grp., 3 Inc., 499 F.3d 1048, 1056 (9th Cir. 2007) (citing In re Daou Sys., Inc., 411 F.3d 1006, 4 1013 (9th Cir. 2005); Ascon Props., Inc. v. Mobil Oil Co., 866 F.2d 1149, 1160 (9th Cir. 5 1989) (“Leave need not be granted where the amendment of the complaint . . . 6 constitutes an exercise in futility . . . .”)). 7 8 ANALYSIS 9 10 EY seeks to dismiss the § 11 claim against it on three bases: (1) lack of statutory 11 standing, (2) lack of liability for material misstatements in the financial statements it 12 audited, and (3) negative causation. The Court addresses each in turn. 13 A. 14 Under § 11 of the Securities Act of 1933, codified at 15 U.S.C. § 77k, any person Standing under § 11 of the Securities Act of 1933 15 who purchases a security issued under a materially false or misleading registration 16 statement has standing to sue. For standing to attach, “the person must have 17 purchased a security issued under that, rather than some other, registration statement.” 18 Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999). When a 19 materially false or misleading registration statement was issued in connection with a 20 secondary offering, Plaintiffs “need to prove that the shares they purchased came from 21 the pool of shares issued in the secondary offering, rather than from the pool of 22 previously issued shares.” In re Century Aluminum Co. Sec. Litig., 729 F.3d 1104, 1106 23 (9th Cir. 2013). One method for Plaintiffs to meet this requirement is to allege “that they 24 purchased their shares directly in the secondary offering itself.” Id. Plaintiffs have 25 alleged exactly that. See TAC, ¶¶ 25–26 (alleging that Lead Plaintiffs “purchased MBII 26 securities . . . in the secondary offering”); id., Ex. A (stating that Lead Plaintiffs “directly 27 purchased” 140,000 shares in the secondary offering). 28 /// 5 1 Nonetheless, EY contends that Lead Plaintiffs’ allegations are insufficient to 2 establish standing under § 11 because those allegations are consistent with three 3 distinct possibilities: Lead Plaintiffs purchased their shares: (1) from dealers that held 4 stock originating from the Secondary Offering and the Initial Public Offering (“IPO”); 5 (2) from underwriters that held stock originating from the Secondary offering and the 6 IPO; and (3) from underwriters that held only stock originating from the Secondary 7 Offering.3 EY’s Mem. of P & A in Supp. of Mot. to Dismiss (“MTD”), ECF No. 84-1, at 9. 8 EY contends that Lead Plaintiffs could only have standing under the third possibility. 9 Relying on Century Aluminum, EY claims it “is merely possible rather than plausible” that 10 Lead Plaintiffs bought stock issued under the relevant registration statement, and 11 accordingly, that their allegations are insufficient to establish § 11 standing. Id. at 10 12 (quoting Century Aluminum, 729 F.3d at 1108). 13 EY, however, misapplies Century Aluminum, which addressed the purchase of 14 shares on the open market. None of the plaintiffs in that case alleged that they 15 purchased the relevant shares directly from the secondary offering. Century Aluminum, 16 729 F.3d at 1106 (“Plaintiffs are not arguing here . . . that they bought directly in the 17 secondary offering; they concede that they purchased in the aftermarket.”). Moreover, 18 Lead Plaintiffs’ allegations go even further because they also allege that they purchased 19 their shares on the date of the Secondary Offering at the offering price. EY’s possible 20 alternative origins of Lead Plaintiffs’ stock thus do not demonstrate that the allegations 21 fail to meet the plausibility standards of Twombly and Iqbal. Instead, they are more 22 properly characterized as attempts to negate the factual allegations set out in the TAC. 23 Of course, such attempts are inappropriate at the pleading stage since the Court must 24 accept all factual allegations as true when analyzing a motion to dismiss. See Cahill, 25 80 F.3d at 337–38. 26 /// 27 28 3 It is unclear why, under EY’s logic, there would not be a fourth possibility: purchasing shares from dealers that held stock originating solely from the Secondary Offering. 6 1 The Court notes that EY also cites Thomas v. Magnachip Semiconductor Corp., 2 167 F. Supp. 3d 1029 (N.D. Cal. 2016), and claims it stands for the proposition that it is 3 insufficient to allege merely that one purchased the shares in question on the date of the 4 public offering at the offering price. EY’s Reply, ECF No. 89, at 2. Not only does that 5 case not bind this Court, but there the “Plaintiffs d[id] not argue or allege that they 6 purchased their shares directly from defendants.” Magnachip, 167 F. Supp. 3d at 1055. 7 To the contrary, they alleged only that they acquired the stock “pursuant and/or 8 traceable to” the registration statement in question. Id. As Lead Plaintiffs here have 9 alleged a direct purchase in the Secondary Offering, Magnachip’s analysis (just like 10 Century Aluminum’s) is of limited value. 11 Magnachip does state that allegations of purchasing shares on the date of the 12 offering at the offer price “were rejected by the Ninth Circuit” in Century Aluminum. 13 167 F. Supp. 3d at 1055. However, this Court is not convinced that Magnachip’s reading 14 of Century Aluminum is wholly correct. Century Aluminum did not address allegations 15 that shares were purchased at the offering price. See 729 F.3d at 1106 (“[N]one of the 16 plaintiffs bought shares at the offering price of $4.50 per share.”). Instead, Century 17 Aluminum only addressed “allegations regarding the dates on which and the prices at 18 which” the shares were purchased, “as well as allegations concerning the trading volume 19 of Century Aluminum stock on certain dates.” 729 F.3d at 1108. Contrary to 20 Magnachip, this Court finds that alleging the shares were purchased on the date of the 21 offering at the offer price bolsters the allegation that Lead Plaintiffs purchased their 22 shares directly in the Secondary Offering. 23 Accordingly, Plaintiffs’ allegations are sufficient to establish § 11 standing. See In 24 re CytRx Corp. Sec. Litig., No. CV 14-1956-GHK (PJWx), 2015 WL 5031232, at *15 25 (C.D. Cal. July 13, 2015) (finding allegations that plaintiffs “purchased shares during the 26 offering period at the secondary offering price” sufficient to survive a motion to dismiss 27 for lack of statutory standing). 28 /// 7 1 B. Material Misstatements in the Registration Statement 2 As stated above, § 11 of the Securities Act of 1933 establishes a cause of action 3 for those who purchase securities issued under a materially false or misleading 4 registration statement. Plaintiffs allege that Marrone Bio’s Chief Operating Officer and 5 head of sales Hector Absi orchestrated a fraudulent practice of improperly recognizing 6 revenue to inflate the value of Marrone Bio. TAC, ¶¶ 181, 223. Marrone Bio gave some 7 of its distributors “inventory protection” rights such as the ability to pay Marrone Bio only 8 after the distributor sold the product to an end user. Id. ¶ 181. According to Plaintiffs, 9 the revenue associated with products provided to the distributors under such terms 10 should not have been recognized until the specified contingencies were met (e.g., after 11 the product was sold to an end user and the distributor paid for the product Marrone Bio 12 provided). Pls.’ Opp’n to MTD, ECF No. 88, at 4. Because of this scheme, the financial 13 statements issued in connection with Marrone Bio’s Secondary Offering were allegedly 14 materially false. Plaintiffs allege that EY is liable for these errors because EY “certified” 15 the financial statements. TAC, ¶ 201. They also allege that EY’s opinion on the financial 16 statements were “materially false and misleading.” Id. ¶ 203. Finally, Plaintiffs allege 17 that EY’s “statement that it completed its audit . . . in accordance with [Public Company 18 Accounting Oversight Board (‘]PCAOB[’)] standards was materially false and 19 misleading.” Id. ¶ 204. Under § 11, accountants are liable for errors in “any part of the registration 20 21 statement” that they “prepared or certified.” 15 U.S.C. § 77k(a)(4). Liability can also 22 attach to erroneous opinions under certain circumstances. The Supreme Court set out 23 the framework for analyzing opinions in Omnicare, Inc. v. Laborers District Council 24 Construction Industry Pension Fund, 135 S. Ct. 1318 (2015). Under Omnicare, liability 25 can attach to opinions when (1) the speaker did not honestly hold the stated opinion 26 when he or she said it, (2) the opinion contains “embedded statements of fact” that are 27 untrue, or (3) there are “particular (and material) facts going to the basis for the issuer’s 28 /// 8 1 opinion . . . whose omission makes the opinion statement at issue misleading to a 2 reasonable person reading the statement fairly and in context.” Id. at 1326–27, 1332. 3 EY contends that it did not certify the financial statements at issue and so is not 4 liable under § 11 for material errors in those statements. Instead, EY maintains that it 5 can only be held liable for materially false or misleading statements made in the audit 6 report itself. Furthermore, EY describes its statements in the audit report as opinions, 7 and argues that the audit reports are therefore subject to the opinion analysis outlined in 8 Omnicare. 9 10 11 1. Liability for Material Misstatements in the Financial Statements EY Audited The Court first addresses whether EY certified the allegedly false financial 12 statements. If EY did certify those financial statements, EY can be held liable under 13 § 11 for material errors they contain. See 15 U.S.C. 77k(a). Plaintiffs contend that EY’s 14 audit report constitutes a certification under § 11, relying on what they describe as “[a] 15 long line of precedent applying [§ 11]’s plain language” for the proposition that “an 16 auditor which consents to serve as an accounting expert in connection with a registration 17 statement is liable . . . for the misstatements of material fact contained in the registration 18 statement’s audited financial statements.” Pls.’Opp’n to MTD, at 11; see also In re 19 Lehman Bros. Sec. & ERISA Litig., 131 F. Supp. 3d 241, 260 n.108 (S.D.N.Y. 2015) 20 (collecting cases). That is, Plaintiffs argue that the § 11’s extension of auditor liability to 21 financial statements they certified means that “[a]ccountants may be found liable under 22 Section 11 for portions of registration statements that they audited.” Lehman Bros., 23 131 F. Supp. 3d at 260. 24 EY’s central arguments to the contrary are formalistic: “EY did not certify 25 anything; the word ‘certify’ is not there. . . . [T]he [audit] report . . . states that EY 26 expressed an ‘opinion’ on the financial statements.” EY’s MTD, at 11. This argument is 27 premised on Omnicare’s discussion of the definition of an “opinion.” Omnicare noted 28 that when a speaker uses words such as “I believe,” he or she “admitted th[e] possibility” 9 1 that the opinion was erroneous by the use of those words. 135 S. Ct. 1326. EY argues 2 that the audit report’s prefatory clause, “In our opinion,” similarly admits the possibility 3 that its conclusions were erroneous and thus is subject to Omnicare’s opinion 4 framework. 5 However, Section 11 imposes special liability on those involved in a registration 6 statement, and Omnicare did nothing to upset prior caselaw holding auditors liable for 7 erroneous financial statements in registration statements. It is not a necessary 8 implication from Omnicare’s discussion of opinions that an auditor’s opinion no longer 9 constitutes a certification. Furthermore, audit opinions are not of the same substance as 10 those discussed in Omnicare. The Supreme Court in that case keeps a running 11 hypothetical of a CEO who opines, “I believe . . . the TVs we manufacture have the 12 highest resolution available on the market.” Id. at 1326. These sorts of opinions are 13 qualitatively different from an auditor’s professional opinion about the soundness of a 14 company’s financial statements.4 Thus, no amount of couching an audit report as an 15 opinion obviates the certification effect of those reports when made part of a registration 16 statement. 17 Regardless of Omnicare’s definition of “opinion,” EY also argues that PCAOB 18 standards preclude EY (and all public company auditors) from ever certifying financial 19 statements. Id. at 12 (“[A]uditors cannot certify a company’s financial statements.”). In 20 support, EY cites PCAOB Auditing Standards that state “the auditor’s responsibility for 21 the financial statements he or she has audited is confined to the expression of his or her 22 opinion on them.” EY’s Reply, at 4 (quoting PCAOB Auditing Standards, AS 1001.035). 23 24 25 26 27 4 Omnicare relied primarily on commonsense understanding of the difference between facts and opinions, not the formalism advocated by EY. 135 S. Ct. at 1325 (“[The] difference between [facts and opinions] is so ingrained in our everyday ways of speaking and thinking as to make resort to old dictionaries seem a mite silly.”). This Court similarly relies on the commonsense understanding of the difference between a more ordinary opinion and a professional opinion. Cf. In re Petrobras Sec. Litig., 14cv-9662 (JSR), 2016 WL 1533553, at *3 (S.D.N.Y. Feb. 18, 2016) (“[A]n auditor’s ‘opinion’ is a term of art, the meaning of which may not be entirely synonymous with the more everyday use of the word discussed in Omnicare . . . .”). 5 28 PCAOB Auditing Standards are available at https://pcaobus.org/Standards/Auditing/Pages/ default.aspx and were also provided by EY in their Request for Judicial Notice, Ex. F, ECF No. 85-6. 10 1 However, as Plaintiffs point out, registration statements are required by statute to include 2 both “a balance sheet” and “a profit and loss statement . . . showing earnings and 3 income . . . and the expenses and fixed charges” that have been “certified by an 4 independent public or certified accountant.” 15 U.S.C. § 77aa(25)–(26). The only audit 5 report that the parties have identified in the registration statement is EY’s. The 6 necessary implication is, of course, that EY’s audit report certified the disputed financial 7 statements. “[I]t is difficult to imagine what Congress might have meant by an 8 accountant’s certification if not an audit affirming the accuracy of the documents in 9 question.” Lehman Bros., 131 F. Supp. 3d at 260 (quoting In re OSG Sec. Litig., 971 F. 10 11 Supp. 2d 387, 399 (S.D.N.Y. 2013)). EY explains this apparent contradiction by contending the Security Act of 1933’s 12 references to auditors certifying financials are relics of a bygone era. See EY’s MTD, at 13 13 n.5 (“In 1933, . . . auditors sometimes did certify financial figures. . . . Current 14 professional standards bar auditors from certifying financial statements . . . .”). Taken to 15 its logical conclusions, EY’s argument proves too much. If auditors can never certify the 16 financial statements due to contemporary professional standards, then the SEC has 17 improperly declared effective every public offering filed since those professional 18 standards came into effect. Alternatively, EY’s argument could be construed as 19 contending that the PCAOB has the authority to override federal statutes through the 20 promulgation of accounting standards. Either of these conclusions is untenable and 21 runs contrary to the purposes of both the Securities Act of 1933 and the PCAOB. See 22 Omnicare, 135 S. Ct. at 1323 (“The Securities Act of 1933 protects investors by ensuring 23 companies issuing securities . . . make a ‘full and fair disclosure of information’ relevant 24 to a public offering.” (citation omitted)); Free Enter. Fund v. Pub. Co. Accounting 25 Oversight Bd., 561 U.S. 477, 484 (2010) (“After a series of celebrated accounting 26 debacles, Congress enacted the Sarbanes–Oxley Act of 2002 . . . . Among other 27 measures, the Act introduced tighter regulation of the accounting industry under a new 28 Public Company Accounting Oversight Board.” (emphasis added)). 11 1 EY also relies on cases explaining the relationship between auditors and the 2 companies they audit. See EY’s MTD, at 12–13. Those cases explain that auditors do 3 not “by virtue of auditing a company’s financial statements, somehow make, own[,] or 4 adopt the assertions contained therein.” Special Situations Fund III QP v. Deloitte 5 Touche Tohmatsu CPA, Ltd., 33 F. Supp. 3d 401, 443 (S.D.N.Y. 2014). While it may be 6 generally true that auditors are not liable for errors in financial statements merely by 7 auditing them, none of the cases cited by EY for that proposition consider the strict 8 liability imposed by § 11. For example, the court in Special Situations v. Deloitte 9 considered auditor liability under § 18, which only imposes liability on when “the 10 defendant ‘made or caused to be made’ a false or misleading statement.” Id. at 440 11 (quoting In re Alstom SA, 406 F. Supp. 2d 433, 478 (S.D.N.Y. 2005)). Thus, at issue 12 was whether an auditor “caused” a misleading financial statement to be made by 13 auditing it. Id. at 443. There was no discussion of certification because the context of 14 the audit reports in question was wholly different from the situation here where EY 15 provided an audit report in connection with a registration statement. 16 Finally, EY argues that the line of cases Plaintiffs rely on was rejected by the 17 Second Circuit in the wake of Omnicare. EY’s MTD, at 11–12. In Querub v. Moore 18 Stevens H.K., 649 F. App’x 55 (2d Cir. 2016) (summary order), the Second Circuit 19 stated, “Audit reports, labeled ‘opinions’ and involving considerable subjective judgment, 20 are statements of opinion subject to the Omnicare standard for Section 11 claims,” id. at 21 58. This Court does not find Querub determinative of whether audit reports constitute 22 certifications under § 11 for a number of reasons. 23 First, Querub is a summary order without precedential value. Second, even if 24 Querub had precedential value, that decision would not be binding on this Court. Thus, 25 Querub’s analysis would still only be persuasive authority if it were not a summary order 26 (as are the cases cited by Plaintiffs from the Southern District of New York). Third, and 27 most importantly, Querub did not consider the pertinent question here: whether an audit 28 report included in a registration statement constitutes a certification of the audited 12 1 financial statements. Though the parties addressed such an argument in their briefing 2 before the Second Circuit, see Brief for Plaintiff–Appellants at 45–48, Querub, 649 F. 3 App’x 55 (2d Cir. 2016) (No. 15-2100-cv), the Second Circuit did not. Finally, Querub 4 does not counsel granting EY’s MTD because, as described below, Plaintiffs’ § 11 claim 5 against EY is adequately pleaded even if analyzed under Omnicare’s opinion 6 framework.6 7 Accordingly, Plaintiffs have adequately pleaded a claim against EY under § 11. 8 Plaintiffs allege the financial statements included in Marrone Bio’s secondary offering 9 registration statement were materially false, and § 11 liability attaches to EY because it 10 certified those financial statements. 11 12 2. Liability for Material Misstatements in EY’s Audit Reports As described above, Plaintiffs do not allege that EY is liable under § 11 solely on 13 the basis of its audit report serving as a certification of Marrone Bio’s financial 14 statements. It also alleges that the audit opinion itself was materially false or misleading. 15 Plaintiffs, by analyzing the audit opinion under Omnicare’s framework, implicitly concede 16 that the audit reports themselves are opinions.7 Accordingly, the Court does not need to 17 determine exactly the nature of audit opinions in relation to the kinds of opinions 18 addressed in Omnicare and will analyze the audit report under Omnicare’s guidance. 19 In relevant part, EY’s audit report reads: 20 We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of 21 22 23 24 25 26 6 One court in the Southern District of Texas has adopted EY’s view of Querub, stating that “the holding in that case directly contradicts” the contention that auditors certify financial statements and are therefore liable for material misstatements they contain. Johnson v. CBD Energy Ltd., No. H-15-1668, 2016 WL 3654657, at * 11 (S.D. Tex. July 6, 2016) (citing Querub, 649 F. App’x at 58). For the reasons provided, however, this Court disagrees. 7 27 28 The Court notes that this is not inconsistent with holding EY liable for certifying the registration statement’s financial statements. Regardless of the qualitative difference between the opinions discussed in Omnicare and the professional opinion expressed by an audit report, opinions can still serve as certifications under the Securities Act of 1933. 13 1 2 3 4 5 6 7 8 9 10 the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements . . . present fairly, in all material respects, the consolidated financial position of Marrone Bio Innovations, Inc. . . . in conformity with U.S. generally accepted accounting principles. 11 Marrone Bio Innovations, Inc., Form S-1 Registration Statement, Report of Independent 12 Registered Public Accounting Firm (“Audit Report”), Req. for Judicial Not., Ex. D, F-2, 13 ECF No. 85-4. 14 Under Omnicare, EY can be held liable pursuant to § 11 if (1) it did not honestly 15 hold the opinions set out in the report, (2) the report contains “embedded statements of 16 fact” that are false, or (3) the report omits facts such that the report is misleading. 135 S. 17 Ct. at 1326–27, 1332. Plaintiffs allege liability under the second and third of these. 18 Plaintiffs first argue “EY is . . . liable under Omnicare because the ‘facts of [the] 19 financial statements are embedded in [EY’s] audit opinions.” Pls.’ Opn’n to MTD, at 15 20 (third alteration in original) (quoting In re Petrogras Sec. Litig., 14-cv-9662 (JSR), 21 2016 WL 1533553, at *3–4 (S.D.N.Y. Feb. 18, 2016)). As Plaintiffs note, at least one 22 court has taken this position. This Court, however, disagrees that financial statements 23 are embedded in audit opinions under Omnicare. Here, EY’s audit opinion provides an 24 opinion on the accuracy of the financial statements; it did not use the facts of the 25 financial statements to opine on something else. See Audit Report (“In our opinion, the 26 financial statements . . . present fairly, in all material respects, the consolidated position 27 of Marrone Bio Innovations, Inc.”). Treating the financial statements as embedded facts 28 commits the Sixth Circuit’s error that Omnicare reversed, “conflat[ing] facts and 14 1 opinions.” Omnicare, 135 S. Ct. at 1325 (rejecting a § 11 analysis resting on the idea 2 that “[t]o say ‘we believe X is true’ is often to indicate that ‘X is in fact true’”). Thus, the 3 audit report does not contain the financial statements as “embedded facts” and EY is not 4 liable for errors in the financial statements separate from the liability that attached due to 5 certification described above. 6 Plaintiffs next argue that EY’s statement that it “conducted [its] audits in 7 accordance with the standards of the Public Company Accounting Oversight Board 8 (United States)” is an embedded fact, which was materially false. Specifically, they 9 allege that EY did not adhere to PCAOB standards because it did not “(i) have sufficient 10 information to determine whether or not the terms of the Company’s transactions with its 11 limited number of distributors supported immediate revenue recognition, and (ii) had not 12 acquired sufficient information to accurately state that [Marrone Bio]’s financial 13 statements were prepared in accordance with [generally accepted accounting 14 principles].” TAC, ¶ 190. In support of their allegation that EY did not obtain sufficient 15 information, they also allege that “EY verified [Marrone Bio]’s sales with the Company’s 16 head salesperson as opposed to its handful of customers.” Pls.’ Opp’n to MTD, at 16. 17 EY, for its part, argues that such allegations are “purely conclusory.” EY’s Reply, at 7. 18 EY claims that the SEC complaint forms the sole basis of the relevant allegations, but 19 that the SEC complaint does not support EY’s allegations. Accordingly, EY argues 20 Plaintiffs’ pleading is improper since they “identify no basis for making th[eir] assertion 21 about what EY did or did not do.” EY’s Reply, at 7. 22 EY is incorrect that the SEC’s complaint forms the sole basis of these allegations. 23 Plaintiffs’ TAC states the allegations it contains are based on not just the SEC, but 24 several other sources including “interviews with former [Marrone Bio] employees and 25 other individuals with relevant personal knowledge.” TAC, ¶ 2. Furthermore, Plaintiffs 26 specifically reference the SEC complaint regarding these allegations only by stating that 27 “[t]he SEC has confirmed” them. Id. ¶ 182. EY’s opposition, taken properly, merely 28 contends that Plaintiffs’ allegations are false. See EY’s Reply, at 7 (describing the 15 1 allegation that EY verified sales figures only with Marrone Bio’s head of sales as “wholly 2 untrue”). Again, it is inappropriate to address the truth or falsity of Plaintiffs’ allegations 3 at this stage of the litigation. For purposes of the instant motion, the Court assumes that 4 EY did in fact only rely on Absi’s representations in forming its audit opinion. 5 Accordingly, the relevant question is whether doing so violated PCAOB standards. 6 In their TAC, Plaintiffs cite PCAOB Auditing Standard 2110,8 which, among other 7 things, requires auditors to “[o]btain[] an understanding of the nature of the company.” 8 PCAOB Auditing Standard 2110.10; see also TAC ¶ 170. Plaintiffs also cite Staff Audit 9 Practice Alert No. 12 (Sept. 9, 2014), https://pcaobus.org/Standards/QandA/9-9- 10 14_SAPA_12.pdf, which provides a more detailed explanation of the standard. The 11 portion cited by Plaintiffs reads: 12 Gaining an understanding of the company, its environment, and its internal control over financial reporting includes gaining an understanding of the business, the different types of sales contracts, and the controls over revenue, including the company's development of accounting estimates for revenue. Such an understanding necessarily includes knowledge of the company's key products and services and the contractual terms by which sales are made, such as the key provisions of contractual arrangements and the extent to which contractual terms are standardized across the company. 13 14 15 16 17 18 Id. at 8; see also TAC, ¶ 171. Plaintiffs allege that EY failed to “gain[] an understanding 19 of . . . the different types of sales contracts” employed by Marrone Bio because its audit 20 failed to take into account the fact that several sales contracts contained “inventory 21 protection” rights. TAC, ¶¶ 179–81. 22 23 24 25 26 27 28 These allegations are sufficient to state a claim that the audit report contained a material misstatement in stating EY’s audit comported with PCAOB standards. Plaintiffs 8 Plaintiffs’ TAC refers to this standard as “AU 12.” This is, in part, because the PCAOB Auditing Standards were reorganized on March 31, 2015. See PCAOB, PCOAB Auditing Standards Reorganized and Pre-Reorganized Numbering (Jan. 2017), https://pcaobus.org/Standards/Auditing/Documents/ ReorganizedandPreReorganizedNumbering.pdf (cross-referencing the numbering of PCAOB Auditing Standards under the newer and older systems). The Court also notes that the section “setting forth risk assessment procedures” that Plaintiffs’ intended to cite was previously known as “AS No. 12,” not “AU 12.” See id. (describing the new AS 2110 and old AS No. 12 as “Identifying and Assessing Risks of Material Misstatement”). 16 1 allege that EY failed to adequately gain an understanding of Marrone Bio’s sales 2 contracts because EY only relied on Absi to confirm the terms of Marrone Bio’s 3 contracts. Whether these allegations are true or not, they are sufficient to state a claim. 4 3. Liability for Omissions of Material Facts in EY’s Audit Reports 5 Plaintiffs finally allege that EY is liable for omitting the fact that EY “lacked the 6 basis for making [EY’s statements in the audit report] that a reasonable investor would 7 expect.” Pls.’ Opp’n, at 16 (quoting Omnicare, 135 S. Ct. at 1333). Omnicare directly 8 addressed what a plaintiff must allege in stating such a claim: 9 10 11 12 13 14 The investor must identify particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context. 135 S. Ct. at 1332. EY argues that Plaintiffs must allege facts “indicating the EY’s opinion did not 15 ‘fairly align[] with the information in [its] possession at the time’ it issued its audit report.” 16 EY’s MTD, at 16 (alterations in original) (quoting Omnicare, 135 S. Ct. at 1329). That is, 17 EY argues that its report did not omit any material facts because it did not know that Absi 18 perpetrated fraud. See EY’s MTD, at 17 In essence, EY contends that it cannot be held 19 liable for omitting the fact that its audit was inadequate because its audit was not 20 sufficiently adequate to discover the alleged fraud committed by Absi. Once again, EY’s 21 arguments prove too much. 22 EY’s selective quoting of Omnicare wholly misconstrues the language it cites. 23 Omnicare explicitly states that omission liability can attach due to both “facts about the 24 inquiry the issuer did or did not conduct or the knowledge it did or did not have.” 25 Omnicare, 135 S. Ct. at 1332. The language quoted by EY is properly understood to 26 mean that an investor “expects . . . that [the issuer’s opinion] fairly aligns with the 27 information in the issuer’s possession at the time” and therefore, “if a registration 28 statement omits material facts about the issuer’s inquiry” that show the inquiry was 17 1 inadequate, “then § 11’s omissions clause creates liability.” Id. at 1329. That is, the 2 language quoted by EY stands for almost the exact opposite proposition than EY claims. 3 Plaintiffs identify three alleged failures of EY’s audit that they claim create § 11 4 omissions liability—that is, Plaintiffs allege EY failed to disclose that its audit was 5 inadequate. Plaintiffs allege (1) that EY relied only on Absi to verify the sales terms 6 between Marrone Bio and its distributors; (2) that EY improperly failed to scrutinize a 7 suspicious spike in revenue in winter when there were fewer crops to benefit from 8 Marrone Bio’s products; and (3) that EY failed to take into account Marrone Bio’s internal 9 control environment.9 Pls.’ Opp’n, at 17–18. Taken together, Plaintiffs have alleged 10 sufficient “facts about the inquiry [EY] . . . did not conduct” and “the knowledge it . . . did 11 not have” for omissions liability to attach. Omnicare, 135 S. Ct. at 1332; see also 12 Lehman Bros., 131 F. Supp. 3d at 258–59 (relying on the identification of six “red flags” 13 ignored by EY as creating omission liability under § 11). 14 Despite this, EY claims that no § 11 omissions liability can attach because they 15 “divulge[d] the basis for [its] opinion.” EY’s MTD, at 18 (citing Omnicare, 135 S. Ct. at 16 1332). In support, EY states that it divulged the following bases for its audit report: that 17 “it conducted its audit in accordance with PCAOB standards,” that it “examin[ed] 18 evidence ‘on a test basis,’” and that EY “believe[d] that [its] audits provide a reasonable 19 basis for [its] opinion.” Id. While EY is correct that “to avoid exposure for omissions 20 under § 11 an issuer need only divulge an opinion’s basis,” Omnicare, 135 S. Ct. at 21 1332, EY’s divulgations are here insufficient to escape liability. 22 First, as stated above, Plaintiffs have alleged sufficient facts to state a claim that 23 EY did not conduct its audit in accordance with PCAOB standards and that EY did not 24 examine evidence aside from seeking confirmation from Absi. Second, an auditor 25 26 27 28 9 The Court notes that EY cites to Monroe v. Hughes, 31 F.3d 772 (9th Cir. 1994), for the proposition that no § 11 liability occurs on the basis that an auditor “should have stated in its audit . . . report that it had found deficiencies in internal controls,” id. at 774. EY misreads that case. In Monroe, the auditor did find deficiencies in the company’s internal controls and took those deficiencies into account in performing its audit, but did not disclose the deficiencies. Id. Plaintiffs here do not allege that EY found deficiencies and failed to reveal them; Plaintiffs allege that EY did not take into account the deficiencies of Marrone Bio’s internal controls. Thus, Monroe is inapposite. 18 1 cannot inoculate itself from liability by stating its opinion was based on another opinion. 2 As was aptly stated in Lehman Brothers, “Like philosophy’s apocryphal turtles, EY’s view 3 of auditing is that ‘it’s opinions all the way down.’” 131 F. Supp. 3d at 258. The 4 gravamen of Plaintiffs’ argument is that § 11 omissions liability attaches because EY 5 failed to disclose that it performed an inadequate audit. To escape such liability by 6 divulging the basis for its audit opinion, EY would have had to divulge that it performed a 7 less-than-thorough audit when it opined that Marrone Bio’s financial statements 8 accurately reflected its financial position. 9 C. Negative Causation 10 Lastly, EY seeks to dismiss the claims against it on the basis of an affirmative 11 defense, negative causation. “[A] plaintiff need not demonstrate reliance on a 12 misleading registration statement in order to prevail on a Section 11 claim . . . .” Hildes 13 v. Arthur Andersen LLP, 734 F.3d 854, 860 (9th Cir. 2013). However, “[t]he affirmative 14 defense of negative causation prevents recovery for losses that the defendant proves 15 are not attributable to the alleged misrepresentation or omission in the registration 16 statement.” Id. “As is the case with any affirmative defense, if the facts as alleged by 17 plaintiffs, and documents which the court may take judicial notice of, establish the 18 affirmative defense as a matter of law then the motion to dismiss may be granted.” In re 19 Shoretel Inc. Sec. Litig., No. C 08-00271 CRB, 2009 WL 248326, at *5 (N.D. Cal. Feb. 2, 20 2009). 21 EY argues that negative causation is “apparent from the face of the complaint and 22 judicially noticeable facts.” EY’s MTD, at 19. EY contends that § 11 liability can only 23 result when the revelation of the defendant’s misconduct caused the plaintiff’s losses. 24 Id. at 20 (citing Loos v. Immersion Corp., 762 F.3d 880, 887 (9th Cir. 2014)). 25 Accordingly, EY argues that because the revelation of Absi’s and Marrone Bio’s 26 misconduct caused Plaintiffs’ losses, not the revelation of EY’s deficient audit, EY cannot 27 be held liable for Plaintiffs’ losses. Once again, EY misconstrues the applicable law. 28 /// 19 1 Most of the cases cited by EY address loss causation in the context of § 10(b) 2 cases, in which plaintiffs have the burden of establishing loss causation, and therefore 3 have limited applicability here. See, e.g., Loos, 762 F.3d at 886–887 (listing loss 4 causation as one of the six elements of § 10(b) claims). Furthermore, EY’s view of loss 5 causation is far too narrow. Loss in a § 11 case need not be tied to “a corrective 6 disclosure specifically about EY’s audit opinion.” EY’s MTD, at 20 (emphasis removed). 7 Instead, “[i]f a disclosure reveals adverse information . . . that the misrepresentation had 8 concealed, and this causes a drop in stock price, then the misstatement and the stock 9 decline are causally related and loss causation exists.” In re Wash. Mut., Inc. Sec., 10 Derivative & ERISA Litig., 259 F.R.D. 490, 508 (W.D. Wash. 2009). None of the § 11 11 cases cited by EY are to the contrary. For example, in In re Veltri PLC Securities 12 Litigation, No. 13-cv-03889-WHO, 2015 WL 5736589 (N.D. Cal. Oct. 1, 2015), a 13 negative causation defense was appropriate because the relevant plaintiff sold its shares 14 prior to the corrective disclosures that caused the shares’ value to drop, id. at *29. 15 First, as alleged, because EY certified the financial statements in question, it is 16 responsible for the alleged material misstatements in those financial statements. Thus, 17 negative causation cannot be applicable to liability stemming from material 18 misstatements in those financial statements. Regardless of EY’s liability for material 19 misstatements in the financial statements themselves, negative causation does not bar 20 liability for material misstatements in EY’s audit opinion. When Marrone Bio revealed 21 that it misreported revenue, EY’s opinion that its financial statements accurately 22 represented Marrone Bio’s financial health was proven incorrect. Plaintiffs allege that 23 Marrone Bio’s stock lost value because it was revealed that the financial statements 24 were incorrect—that is, it was revealed that EY’s audit opinion was incorrect. Section 11 25 liability does not require revelation of the specific faults of the false opinion in question 26 as EY urges. 27 The absurdity of EY’s excessively narrow view of loss causation becomes 28 apparent considering the examples of liability given by the Supreme Court in Omnicare. 20 1 Omnicare continues its hypothetical about a CEO that states an opinion that her 2 company’s TV has the highest resolution available. The Court writes that she could be 3 liable under § 11’s omissions provision if “she had recently received information from 4 industry analysts indicating that a new product had surpassed her company’s on this 5 metric” and failed to take that information into account when forming her opinion. 6 Omnicare, 135 S. Ct. at 1329 n.6. Under EY’s interpretation of negative causation, the 7 TV CEO could only be liable if loss were connected to the revelation that she ignored the 8 “recently received information from industry analysts” but not if loss flowed from the 9 revelation that her TVs in fact did not have the highest resolution on the market. 10 A similar absurdity would occur under the Supreme Court’s hypothetical of the TV 11 CEO stating an opinion that her TV had the highest resolution available, when she did 12 not actually hold that belief. See Omnicare, 135 S. Ct. at 1326. Under EY’s 13 interpretation of loss causation, the CEO could only be held liable if loss were connected 14 to a revelation that she did not believe the opinion she gave, but not for loss attributable 15 to a revelation that another TV on the market has a higher resolution. In both these 16 scenarios, EY’s interpretation of loss causation misses the fundamental point. Loss will 17 occur because the opinions were incorrect—the TV did not have the highest resolution 18 on the market—and investors purchased shares in reliance of that incorrect, misleading 19 opinion. Loss causation does not depend on why the opinion was incorrect. 20 Under EY’s version of negative causation, Omnicare’s analysis of opinions would 21 be rendered almost a complete nullity. Companies do not typically lose value because it 22 is revealed that an opinion contained a material misstatement. Companies lose value 23 because it is revealed that an opinion was incorrect. And § 11 imposes liability when the 24 opinion was incorrect because of a material misstatement or omission. 25 Here, the heart of Plaintiffs’ allegations is that Marron Bio’s financial statements 26 were incorrect. The revelation that Marrone Bio improperly recognized revenue 27 allegedly demonstrated that EY’s audit opinion was incorrect. Therefore, EY is liable for 28 /// 21 1 the resulting losses if its opinion contained material misstatements or omissions that led 2 it to incorrectly opine that Marrone Bio’s financial statements were accurate. 3 4 CONCLUSION 5 6 For the foregoing reasons, EY’s Motion to Dismiss, ECF No. 84, is DENIED. 7 Plaintiffs have adequately pleaded § 11 standing, and so EY’s motion premised on that 8 issue fails. Furthermore, EY is liable under § 11 for any material misstatements in the 9 registration statement’s financial statements because it certified those financial 10 statements. Finally, Plaintiffs have adequately pleaded that EY’s audit report contains 11 material misstatements and material omissions under § 11. 12 13 IT IS SO ORDERED. Dated: March 20, 2017 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 22

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