Newett v. Leapfrog Enterprises, Inc. et al

Filing 117

ORDER by Judge Edward M. Chen Granting in Part and Denying in Part 100 Defendants' Motion to Dismiss. Case Management Conference set for 4/6/2017 09:30 AM. Joint Case Management Conference Statement due 3/30/2017. (emcsec, COURT STAFF) (Filed on 2/24/2017)

Download PDF
1 2 3 4 UNITED STATES DISTRICT COURT 5 NORTHERN DISTRICT OF CALIFORNIA 6 IN RE LEAPFROG ENTERPRISE, INC. SECURITIES LITIGATION, ___________________________________/ 7 8 9 This Document Relates to: 10 All Actions. ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS’ MOTION TO DISMISS Docket No. 100 12 For the Northern District of California United States District Court 11 Case No. 15-cv-00347-EMC Plaintiffs have filed a securities class action against Defendant Leapfrog Enterprises, Inc. 13 14 (“LF”) and two of its executive officers, John Barbour (CEO) and Raymond L. Arthur. Since 15 appointment of lead plaintiff and lead counsel, and their filing of a consolidated class action 16 complaint, Defendants have repeatedly challenged the sufficiency of Plaintiffs‟ pleadings. This 17 Court previously dismissed the original consolidated class action complaint as well as the first 18 amended complaint. See Docket No. 63 (minutes); Docket No. 88 (order). The current operative 19 complaint is the second amended consolidated class action complaint (“SAC”). In that pleading, 20 Plaintiffs allege that Defendants violated federal securities law, including § 10(b) and related Rule 21 10b-5, because they falsely represented that accounting write-offs did not need to be taken when, 22 in fact, they did as required by generally accepted accounting principles (“GAAP”). Currently 23 pending before the Court is Defendants‟ motion to dismiss the SAC pursuant to Federal Rule of 24 Civil Procedure 12(b)(6). Having considered the parties briefs, as well as their accompanying submissions where 25 26 appropriate,1 the Court hereby GRANTS in part and DENIES in part Defendants‟ motion. 27 1 28 Defendants have asked the Court to take judicial notice of various documents and KBC has objected to most of the requests. The Court addresses only those objections that are pertinent to I. 1 FACTUAL & PROCEDURAL BACKGROUND 2 In their complaint, Plaintiffs allege as follows. 3 LF “is a developer of educational entertainment for children.” SAC ¶ 32. It “has 4 developed a number of learning platforms, including the LeapPad learning tablets.” SAC ¶ 32. 5 Mr. Barbour was, during the relevant period, LF‟s CEO, and Mr. Arthur was LF‟s CFO. See SAC 6 ¶¶ 29-30. For the relevant period, LF‟s fiscal years started in April and ended in March. Thus, for 7 8 fiscal year 2015: F1Q15 lasted from April 1, 2014, to June 30, 2014;  F2Q15 lasted from July 1, 2014, to September 30, 2014; 11  F3Q15 lasted from October 1, 2014, to December 1, 2014; and 12 For the Northern District of California  10 United States District Court 9  F4Q15 lasted from January 1, 2015, to March 31, 2015. 13 See SAC at 1 n.2. Prior to F1Q15, LF‟s “quarters aligned more closely to the calendar year, with 14 1Q ending March 31, 2Q ending June 30, 3Q ending September 30 and 4Q ending December 31.” 15 SAC at 1 n.2. At the end of the 2013 fiscal year, LF had disappointing results, due at least in part to the 16 17 poor sales of the LeapPad tablet. See SAC ¶ 35 (noting that LF was “facing aggressive 18 competition in the tablet market from other manufacturers, which forced LeapFrog to cut the price 19 of its LeapPad offerings and disappointing 2013 and F4Q13 results”). LF issued what analysts 20 considered weak guidance for fiscal year 2014, based in part on a carryover inventory problem 21 with the LeapPad product.2 See SAC ¶¶ 37, 40 (stating that, in a press release, Defendants 22 “discussed their expectations that LeapPad inventory build, due to poor sales and difficult retail 23 conditions, would reduce expectations for net sales throughout 2014”; also stating that, “[a]s a 24 result of LeapFrog‟s poor 2013 performance, the Company faced a substantial retail inventory 25 26 resolution of the motion. 2 27 28 Carryover inventory is a problem because “„[t]he longer [a] product sits in back rooms and on shelf, the less willing retailers will be to bring in new product, both for space and risk reasons, and the more they are likely to want in sales allowances.‟” SAC ¶ 116 (quoting analysts at BMO Capital Markets). 2 1 hangover of LeapPad tablets from 2013 that management knew would impact both margins and 2 sales heading into 2014”). “To generate sales in 2014, . . . Defendants sought to move up the 3 release of what they described as a „major‟ new product, LeapTV, to a calendar 2014 release.” 4 SAC ¶ 40. Problems, however, persisted in 2014, with LF‟s “results continu[ing] to be affected by a 5 informed “investors that LeapTV would not ship until September 2014, with [the product] „hitting 8 stores in October.‟ Defendants acknowledged that this would restrict LeapTV sales during the 9 quarter ending December 31, 2014 [i.e., F3Q15].” SAC ¶ 44. This is because the “anticipated 10 September 2014 shipment date would result in LeapTV hitting shelves at least two months later 11 than most competing holiday items.” SAC ¶ 44 (noting that “major retailers like Wal-Mart 12 For the Northern District of California „tough‟ retail market and LeapPad carryover inventory.” SAC ¶ 42. In June 2014, Defendants 7 United States District Court 6 typically put holiday items on their shelves in August and that to do so, the retailers would have to 13 receive items at their distribution centers by the end of July”). F1Q15 (i.e., April through June 2014) continued the downward trend, and, in August 2014, 14 15 LF reduced its fiscal year 2015 guidance. See SAC ¶¶ 45-46, 51. Thus, according to Plaintiffs, 16 prior to the end of F2Q15 (i.e., September 30, 2014), Defendants knew that LF 17 faced serious problems as a company and . . . even Defendants‟ own future expectations for the Company were tempered by these problems, including: (i) the late shipment of LeapTV and limitations in the ability to sell the product given the late shipment; (ii) indefinite deferral of its consumer electronics tablet; (iii) carryover inventory; and (iv) the cannibalizing LeapPad sales and profits. 18 19 20 21 SAC ¶ 52. The gist of the SAC is that, subsequently, Defendants made false statements about LF‟s 22 23 F2Q15 financial results and its F3Q15 financial results – more specifically, those results were 24 based on accounting that violated GAAP provisions relating to goodwill and long-lived assets. 25 A. 26 2Q: No Write-Off for Goodwill Impairment According to Plaintiffs, Defendants falsely stated that no goodwill impairment testing was 27 necessary after the end of F2Q15, when in fact such testing was not only necessary and but also 28 such testing would have led to a 100% writedown for goodwill impairment for 2Q. 3 1 “Goodwill represents the excess of the purchase price over the fair value of the net assets 2 acquired in a business combination.” SAC ¶ 71. Under GAAP, goodwill “„[i]mpairment is the 3 condition that exists when the carrying amount [or book value] of goodwill exceeds its implied 4 fair value.‟” SAC ¶ 73. 5 Under GAAP, there is a two-step test for goodwill impairment. See SAC ¶ 74. However, such testing is needed in the first place. That “qualitative assessment” is referred to as “step zero.” 8 SAC ¶ 74. “Step zero . . . requires impairment testing for any quarter when certain triggering 9 events are present „that would more likely than not reduce the fair value of a reporting unit below 10 its carrying amount.‟” SAC ¶ 75. Examples of triggering events include (but are not limited to) a 11 negative or declining overall financial performance, a sustained decrease in share price, an 12 For the Northern District of California before a company must engage in that two-step test, it first makes an assessment as to whether 7 United States District Court 6 increased competitive environment, and a change in the market for an entity‟s products or 13 services. See SAC ¶ 75. 14 According to Plaintiffs, for 2Q (the quarter ending September 30, 2014), there were 15 various triggering circumstances that “indicated . . . it was objectively and overwhelmingly more 16 likely than not [that] LeapFrog‟s goodwill was impaired,” SAC ¶ 68, such that Defendants should 17 have tested for goodwill impairment. Plaintiffs point to, e.g.: 18  a decline in overall financial performance, see, e.g., SAC ¶ 80 (alleging that, “[f]or 19 five consecutive quarters, from F2Q14 through F2Q15, [LF] reported weak 20 financial results or substantially lowered guidance”); 21  increased competition and a change in the market for LF‟s products, see, e.g., SAC 22 ¶ 83 (referring to “a tough retail environment and competition,” including but not 23 limited to the carryover inventory problem); and 24  a sustained decrease in share price (and corresponding decline in market 25 capitalization). See, e.g., SAC ¶ 92 (alleging that LF‟s “stock price decline lasted 26 57 days of the [F2Q15] quarter – 62% of F2Q15”). 27 28 Plaintiffs assert that, even though it was obvious that goodwill impairment testing was necessary (step zero), Defendants falsely claimed, in November 2014 (i.e., shortly after 2Q 4 1 ended), that such testing was not necessary. Most notably, in its 10-Q for 2Q (filed in November 2 2014), LF stated: 3 As of September 30, 2014 [i.e., the end of 2Q], based on its assessment of various qualitative factors and projection of future operating results, the Company does not believe that sufficient indicators of impairment of its goodwill currently exist that would require performing step one of the two-step test for goodwill impairment. 4 5 6 7 Defs.‟ RJN, Ex. 16, at 9 (LF‟s 10-Q for 2Q). Plaintiffs further assert that, if Defendants had conducted goodwill impairment testing for 8 9 2Q (as they should have), then they would have determined that goodwill was in fact impaired overstated LF‟s financial results for 2Q by not making the necessary deduction for goodwill 12 For the Northern District of California under the GAAP two-step test for impairment. Thus, according to Plaintiffs, Defendants falsely 11 United States District Court 10 impairment. Plaintiffs admit that, in the next quarter, Q3, Defendants ultimately did make a goodwill 13 14 impairment adjustment – a write-off of approximately $19.5 million (100% of its value). But, 15 according to Plaintiffs, this was one quarter too late. 16 B. 17 3Q: No Write-Off for Long-Lived Asset Impairment According to Plaintiffs, Defendants also falsely represented that LF‟s long-lived assets 18 were not impaired as of F3Q15. See SAC ¶ 158 (alleging that LF‟s “long-lived assets consisted of 19 property and equipment, capitalized content costs, and other intangible assets that the Company 20 expected to retain for at least a year to generate cash flows”). 21 Similar to above, under GAAP, there is a two-step test for impairment to a long-lived 22 asset, but, before a company engages in that test, it must first determine (step zero) that such 23 testing is necessary. See SAC ¶ 158. At step zero, a long-lived asset is to be tested for impairment 24 “„whenever events or changes in circumstances indicate that [the] carrying amount [i.e., book 25 value] may not be recoverable.‟” SAC ¶ 158. Events or changes in circumstances indicating 26 long-lived asset impairment include: a significant decrease in the market price of a long-lived 27 asset; a significant adverse change in the extent or manner in which a long-lived asset is being 28 used or in its physical condition; a significant adverse change in legal factors or in the business 5 1 climate that could affect the value of a long-lived asset; and a current-period operating or cash 2 flow loss combined with a history of operating or cash flow losses or a projection or forecast that 3 demonstrates continuing losses associated with the use of a long-lived asset. See SAC ¶ 159. 4 In the instant case, there is no dispute that, for 3Q (ending on December 31, 2014), 5 Defendants did conclude that testing for long-lived asset impairment was necessary and did 6 conduct such testing. See RJN, Ex. 19, at 9 (LF‟s 10-Q for 3Q) (stating that “the Company 7 determined that testing for recoverability of its long-lived assets . . . was required”). In the 10-Q 8 for 3Q, Defendants indicated that testing was necessary based on “the Company‟s performance 9 during the 2014 holiday season being significantly lower than anticipated,” “the underperformance trading values of the Company‟s stock and corresponding decline in the Company‟s market 12 For the Northern District of California of products and product lines newly introduced to the market,” and “the continuing decrease in 11 United States District Court 10 capitalization.” Id. 13 At step one, however, Defendants went on to find that there was no long-lived asset 14 impairment. At step, “one must determine whether the carrying amount of a long-lived asset (or 15 asset group) exceeds the sum of the undiscounted cash flows expected to result from the use and 16 the eventual disposition of the asset.” SAC ¶ 160. According to Defendants, “its long-lived assets 17 were not impaired as of December 31, 2014 [i.e., the end of 3Q]” because “their carrying value did 18 not exceed the cumulative undiscounted future cash flows.” Id. (adding that “[t]he principal 19 assumptions used in the Company‟s undiscounted cash flow analyses consisted of projections of 20 future net cash flows”). 21 According to Plaintiffs, Defendants falsely represented that its long-lived assets were not 22 impaired as of 3Q. Plaintiffs admit (similar to above) that Defendants ultimately did make an 23 adjustment for long-lived asset impairment in the following quarter, i.e., 4Q – more specifically a 24 write-down of $36.5 million which constituted 96% of the value of the long-lived assets. But 25 Plaintiffs maintain (similar to above) that this adjustment was one quarter too late. Plaintiffs note 26 that, when Defendants did find impairment at 4Q, they indicated that this was “primarily due to 27 the significant decline of the trading value of the Company‟s Class A common stock and the 28 corresponding market capitalization.” Defs.‟ RJN, Ex. 22, at 58-59 (LF‟s 10-K for fiscal year 6 1 2015) (note 9). But, according to Plaintiffs, there already was a significant decline in LF‟s stock 2 value as of 3Q – or at least, there was a significant decline by January 23, 2015, when LF‟s stock 3 was worth only $2.55, compared to $4.72 at the end of December 31, 2014.3 See SAC ¶ 175; see 4 also SAC ¶ 16 (alleging that the average stock price from January 23, 2015, through the end of 5 4Q, i.e., March 31, 2015, was $2.44). Thus, according to Plaintiffs, the long-lived asset 6 impairment write-off of $36.5 million (96% of its value), which was taken in 4Q, should have 7 been taken in 3Q. See SAC ¶ 170 (alleging that “the „weak financial results‟ that necessitated the 8 impairment charge of $36.5 million or 96% of the Company‟s long-lived assets [in 4Q] had 9 already occurred as of December 31, 2014 [i.e., 3Q]”) (emphasis in original). II. 10 A. Legal Standard As the Court has before it a 12(b)(6) motion to dismiss, the Twombly/Iqbal standard is 12 For the Northern District of California United States District Court 11 DISCUSSION 13 applicable. That is, the Court must evaluate the SAC for plausibility. See Ashcroft v. Iqbal, 556 14 U.S. 662, 678 (2009) (stating that, “[t]o survive a motion to dismiss, a complaint must contain 15 sufficient factual matter, accepted as true, to „state a claim to relief that is plausible on its face‟”) 16 (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). 17 A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. The plausibility standard is not akin to a “probability requirement,” but it asks for more than a sheer possibility that a defendant has acted unlawfully. Where a complaint pleads facts that are “merely consistent with” a defendant‟s liability, it “stops short of the line between possibility and plausibility of „entitlement to relief.‟“ 18 19 20 21 22 Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 556-57). However, because Plaintiffs‟ claims are predicated on securities fraud, more than just the 23 24 Twombly/Iqbal standard must be met. More demanding requirements must be satisfied, as 25 codified in Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act 26 3 27 28 Although January 23, 2015, technically falls within 4Q, Plaintiffs point out that LF‟s 10-Q for 3Q was not filed with the SEC until after that date (i.e., on February 9, 2015), and, under GAAP, Defendants were required to take into account “„subsequent events that provide[d] additional evidence about conditions that existed [at the end of 3Q, i.e., December 31, 2014].‟” SAC ¶ 178. 7 1 2 (“PSLRA”). Under Rule 9(b), “[i]n alleging fraud . . . , a party must state with particularity the 3 circumstances constituting fraud.” Fed. R. Civ. P. 9(b); see also Cafasso v. Gen. Dynamics C4 4 Sys., 637 F.3d 1047, 1055 (9th Cir. 2011) (stating that “[t]o satisfy Rule 9(b), a pleading must 5 identify „the who, what, when, where, and how of the misconduct charged,‟ as well as „what is 6 false or misleading about [the purportedly fraudulent] statement, and why it is false‟”). 7 The PSLRA has a similar requirement. See Janas v. McCracken (in Re Silicon Graphics 8 Sec. Litig.), 183 F.3d 970, 996 (9th Cir. 1999) (noting that, under the PSLRA, “a securities fraud 9 complaint shall identify: (1) each statement alleged to have been misleading; (2) the reason or reasons why the statement is misleading; and (3) all facts on which that belief is formed”; citing 11 15 U.S.C. § 78u-4(b)(1)). 12 For the Northern District of California United States District Court 10 Moreover, the PSLRA has an additional requirement – i.e., that a securities fraud plaintiff 13 must “state with particularity facts giving rise to a strong inference that the defendant acted with 14 the required state of mind.” 15 U.S.C. § 78u-4(b)(2)(A). For a § 10/Rule 10b-5 claim, “a private 15 securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute 16 strong circumstantial evidence of deliberately reckless or conscious misconduct.” Silicon 17 Graphics, 183 F.3d at 974. “Deliberate recklessness means that the reckless conduct „reflects 18 some degree of intentional or conscious misconduct.‟” Reese v. Malone, 747 F.3d 557, 569 (9th 19 Cir. 2014). For example, “„[a]n actor is [deliberately] reckless if he had reasonable grounds to 20 believe material facts existed that were misstated or omitted, but nonetheless failed to obtain and 21 disclose such facts although he could have done so without extraordinary effort.‟” Id. 22 23 24 25 26 27 28 To qualify as a “strong inference,” the Supreme Court has held, “an inference of scienter must be more than merely plausible or reasonable.” Tellabs, 551 U.S. at 314. When determining whether there are sufficient allegations of scienter, courts “must consider the complaint in its entirety . . . [and inquire] whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.” Id. at 322-23. Moreover, courts must take into account plausible opposing inferences. Id. at 323. A complaint will survive a motion to dismiss “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” Id. at 324. 8 1 In re Rigel Pharms., Inc. Secs. Litig., 697 F.3d 869, 882-83 (9th Cir. 2012). 2 B. 3 2Q: No Write-Off for Goodwill Impairment Defendants argue that Plaintiffs‟ claims based on the failure to take the goodwill 4 impairment in 2Q must be dismissed because (1) Plaintiffs have failed to adequately allege 5 scienter and (2) Plaintiffs have failed to adequately allege falsity. As discussed below, the Court 6 agrees that allegations on scienter are lacking. 7 Plaintiffs contend that they have sufficiently pled scienter largely based on two reasons: (1) 8 because the impairment to goodwill was obvious in 2Q, see In re Cardinal Health, Inc. Sec. 9 Litigs., 426 F. Supp. 2d 688, 719-20 (S.D. Ohio 2006) (noting that an “inference of knowledge or and pervasive in nature, and so great in magnitude, that they should have been obvious to a 12 For the Northern District of California recklessness may be drawn from allegations of accounting violations that are so „simple, basic, 11 United States District Court 10 defendant‟”); and (2) because, effectively “overnight” (i.e., from 2Q to 3Q), Defendants wrote off 13 100% of goodwill, which amounted to a sizeable $19.5 million. See Dudley v. Haub, No. 2-11-cv- 14 05196 (WJM), 2013 U.S. Dist. LEXIS 61386, at *30-31 (D.N.J. Apr. 30, 2013) (noting that “the 15 magnitude of the impairment suggests that it should have been recorded earlier[;] [g]oodwill does 16 not go from being unimpaired to fully impaired overnight”). Neither argument is convincing, 17 particularly in light of Plaintiffs‟ obligation to state with particularity facts giving rise to a strong 18 inference of scienter. 19 As an initial matter, even if it were obvious that LF had suffered a decline in overall 20 financial performance, that there was increased competition and a change in the market for LF‟s 21 products, and that there had been a sustained decrease in LF‟s share price – i.e., that certain 22 “triggering events” existed – that does not mean that it was obvious that those triggering events 23 “„would more likely than not reduce the fair value of a reporting unit below its carrying amount.‟” 24 SAC ¶ 75 (emphasis added). This is especially true given that, by the end of 2Q (September 30, 25 2014), the holiday season was still upcoming. It is undisputed that the holiday season is a highly 26 significant period for LF, a time where a major portion of its annual sales are made. Plaintiffs 27 admit as much in their complaint. See, e.g., SAC ¶ 81 (chart reflecting largest sales for the quarter 28 ending on December 31). Given that circumstance, even with the triggering events alleged by 9 1 Plaintiffs, it may not have been obvious that goodwill impairment testing was warranted as the end 2 of F2Q15 – prior to the big holiday season. See City of Dearborn Heights Act 345 Police & Fire 3 Ret. Sys. v. Align Tech., Inc., No. 12-cv-06039-WHO, 2013 U.S. Dist. LEXIS 172841, at *26, 32 4 (N.D. Cal. Dec. 9, 2013) (taking into account that “a goodwill evaluation is based on several 5 factors present at the time the assessment is made „which are not matters of objective fact‟”; 6 adding that “„[a] plaintiff arguing for a quicker write down of goodwill would have to explain 7 how, in a given quarter, the company‟s optimism about that market was not just wrong . . . but so 8 wholly unfounded that it was fraudulent‟”); City of Omaha v. CBS Corp., No. 08 Civ. 10816 9 (PKC), 2010 U.S. Dist. LEXIS 25497, at *30 (S.D.N.Y. Mar. 16, 2010) (noting that “SFAS 142 – not‟ that that a reporting unit‟s fair value had fallen below its carrying amount, based on, among 12 For the Northern District of California upon which plaintiffs base their fraud theory – requires testing only once it is „more likely than 11 United States District Court 10 other things, adverse changes in market conditions[;] [t]his formulation necessarily involves 13 judgment and discretion on the part of a company in deciding whether to undertake an intra-year 14 impairment test”), affirmed on appeal in 679 F.3d 64 (2d Cir. 2012); In re Radian Sec. Litig., 612 15 F. Supp. 2d 594, 615 (E.D. Pa. 2009) (noting that, “[e]ven if an impairment of [the company‟s] 16 investment did occur at some point earlier than [the company] ultimately stated, the plaintiffs do 17 not allege facts to show that [the company‟s] decision not to report whatever impairment may 18 have existed until July 2007 involved not merely simple, or even inexcusable negligence, but an 19 extreme departure from the range of reasonable business treatments permitted under GAAP”); see 20 also SEC v. Todd, 642 F.3d 1207, 1216 (9th Cir. 2011) (“recogniz[ing] that GAAP „tolerate[s] a 21 range of “reasonable” [accounting] treatments, leaving the choice among alternatives to 22 management‟”). 23 In fact, in LF‟s 10-Q for 2Q, Defendants expressly pointed to the upcoming holiday season 24 in addressing why it was not testing for goodwill impairment at that point in time. See Defs.‟ 25 RJN, Ex. 16, at 9 (LF‟s 10-Q, filed in November 2014, covering F2Q15) (stating there were 26 insufficient indicators to do goodwill impairment testing; noting that “[i]ndicators of impairment 27 considered by the Company include . . . overall financial operating results which depend in large 28 part on the strength of the Company’s performance during the holiday season”) (emphasis added). 10 during the holiday season are weaker than anticipated, the Company may be required to perform 3 step one of the two-step test for goodwill impairment.” Id. The fact that Defendants disclosed this 4 information to the public and expressly warned of the consequences of a poor holiday season 5 further weighs against an inference of scienter. See Iron Workers Local No. 25 Pension Fund v. 6 Oshkosh Corp., No. 08-C-797, 2010 U.S. Dist. LEXIS 30693, at *63 (E.D. Wis. Mar. 30, 2010) 7 (explaining that, if the defendants intended to defraud, they would likely have used stronger 8 language – not just express cautious optimism; defendants would not “have repeatedly warned 9 about the possibility of an impairment charge” – defendants “teed up the issue and flagged the 10 question of an impairment so that investors could make their own judgments”); see also In re 11 NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1065 (9th Cir. 2014) (finding no strong inference of 12 For the Northern District of California Moreover, in the 10-Q, Defendants went on to warn that, “[t]o the extent the Company‟s results 2 United States District Court 1 scienter based on, inter alia, company‟s warning to investors of possible product flaws and 13 “set[ting] aside a reserve to account for costs related to those flaws”). As it turns out, the fact that 14 the holiday season was not the boon anticipated by Defendants provides an explanation was to 15 why there was the “overnight” decision to do goodwill impairment testing for 3Q and to find a 16 sizeable impairment. Finally, strongly weighing against scienter is the fact that “[Mr.] Barbour and [Mr.] Arthur 17 18 each purchased [LF] stock within days after the challenged November [2014] disclosures 19 [regarding goodwill], adding to their significant holdings.” Mot. at 5 (citing Foster Decl. ¶ 26 & 20 Exs. 28-29).4 Plaintiffs have objected to judicial notice of the individual defendants‟ stock 21 purchases, see Docket No. 106 (Obj. at 3) (arguing that the documents are not relevant), but, in a 22 different case, the Court rejected a similar objection.5 See Westley v. Oclaro, Inc., 897 F. Supp. 2d 23 4 24 25 26 27 28 See, e.g., Defs.‟ RJN, Ex. 28, at 11 (Mr. Barbour‟s Form 4 regarding November 5, 2014, transaction) (indicating that Mr. Barbour acquired 20,000 shares of common stock on that date); RJN, Ex. 28, at 12 (Mr. Barbour‟s Form 4 regarding November 7, 2014, transaction) (indicating that Mr. Barbour acquired 3,125 shares of common stock on that date); Defs.‟ RJN, Ex. 29, at 7 (Mr. Arthur‟s Form 4 regarding November 10, 2014, transaction) (indicating that Mr. Arthur acquired 21,000 shares of common stock on that date). 5 Plaintiffs argue that, if the Court does take judicial notice of the acquisition of stock, it should also take judicial notice of an article that criticizes LF management for not buying or holding stock. See Pls.‟ RJN at 2 (quoting article as stating: “„If they believed in the long run success of 11 1 902, 929 (N.D. Cal. 2012) (noting “obligat[ion] to take a „holistic approach‟ in evaluating 2 scienter” and stating that, as “the Court may take judicial notice of the individual defendants‟ 3 Oclaro stock sales (as reflected in the SEC Forms 4 which are public records), the presence or 4 absence of insider trading is a fact that could be considered by the Court as a part of its holistic 5 approach”); cf. In re Rigel Pharms., Inc. Secs. Litig., 697 F.3d 869, 884-85 (9th Cir. 2012) (noting 6 that “the individuals‟ conduct concerning their stock is inconsistent with Plaintiff‟s theory that 7 financial motive establishes scienter here[;] [t]he complaint alleges that individual defendants 8 knew that the value of their stock options would increase if Rigel reported positive results from 9 the clinical trial” but, “because none of the defendants sold stock during the period between the the period during which they would have benefitted from any allegedly fraudulent statements, the 12 For the Northern District of California allegedly fraudulent statements and the subsequent public disclosure of the detailed data, which is 11 United States District Court 10 value of the stock and stock options does not support an inference of scienter”). Plaintiffs do not 13 dispute that these stock purchases were in fact made. Taking into account the above, the Court concludes that, as to Defendants‟ failure to take a 14 15 write-off for goodwill impairment in 2Q, Plaintiffs have failed to plead facts supporting a strong 16 inference of scienter. 17 C. 18 3Q: No Write-Off for Long-Lived Asset Impairment Similar to above, Defendants argue that Plaintiffs have not sufficiently alleged either 19 scienter or falsity with respect to their claims that Defendants improperly failed to take a write-off 20 in 3Q for long-lived asset impairment. Here, the Court reaches a different conclusion than that 21 reached as to goodwill impairment. 22 As to scienter, the Court acknowledges that Plaintiffs‟ contentions are similar to above – 23 i.e., scienter may reasonably be inferred on the part of Defendants because (1) it was obvious that 24 the impairment for long-lived assets needed to be taken and (2) 96% of LF‟s long-lived assets, for 25 26 27 28 the company as much as I do, they would probably be buying up shares of LF‟”). Plaintiffs‟ point here seems to be that Mr. Barbour and Mr. Arthur acquired stock in response to this criticism and not because they truly believed in the value of the stock. But the missing link in Plaintiffs‟ analysis is that, even if the article was in the public realm (and thus judicially noticeable), that does not mean that Mr. Barbour or Mr. Arthur read or knew about the article, which then (allegedly) prompted them to purchase LF stock. 12 1 a total of $36.5 million, were effectively written off “overnight” (in F4Q15 as opposed to F3Q15). 2 These arguments have resonance in respect to long-lived asset impairment. The Court recognizes that Defendants actually tested for long-lived asset impairment (i.e., 3 4 they concluded step zero was met) and that the long-lived asset impairment determination is 5 somewhat of a subjective assessment. As Plaintiffs expressly admitted in their SAC: 6  “[s]tep one of the long-lived assets determination required Defendants to determine 7 whether the carrying amount of the assets exceeded the sum of the undiscounted cash 8 flows expected to result from the use and eventual disposition of the asset,” SAC ¶ 172; 9 and 10  “[t]he projected changes to current free cash flows is a subjective, speculative factor involving considerations including: performance year-to-date, trends in free cash flows 12 For the Northern District of California United States District Court 11 over time, the competitive landscape, management track records, acquisitions, new 13 products and other considerations bearing on a company‟s future performance.” SAC ¶ 14 56(c) (emphasis added). 15 To be sure, inferring scienter can be challenging where an alleged GAAP violation is 16 complicated and not obvious. See, e.g., MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 636 17 (E.D. Va. 2000) (noting that, “if the GAAP rules and [company] accounting policies Defendants 18 are alleged to have violated are relatively simple, it is more likely that the Defendants were aware 19 of the violations and consciously or intentionally implemented or supported them, or were reckless 20 in this regard”); see also SEC v. Todd, 642 F.3d 1207, 1216 (9th Cir. 2011) (“recogniz[ing] that 21 GAAP „tolerate[s] a range of “reasonable” [accounting] treatments, leaving the choice among 22 alternatives to management‟”). Nevertheless, Plaintiffs‟ argument that the need to take the 23 impairment was obvious in this case is supported by specific allegations in the complaint. 24 Plaintiffs point out that, when Defendants did make the adjustment for impairment in 4Q (rather 25 than 3Q), they justified it based on a significant stock decline (and not, e.g., on changed cash flow 26 projections). See Defs.‟ RJN, Ex. 22, at 58-59 (LF‟s 10-K for fiscal year 2015) (note 9) 27 (indicating that there was impairment at 4Q “primarily due to the significant decline of the trading 28 value of the Company‟s Class A common stock and the corresponding market capitalization”). 13 1 The bulk of the stock decline, however, had already happened in 3Q or at least by January 23, 2 2015, when the price fell to $2.55 (a 46.3% fall from its price of $4.75 on December 31, 2014). 3 See SAC ¶ 175 (noting that LF‟s stock was worth $4.75 at the end of December 31, 2014, but that 4 it declined to $2.55 by January 23, 2015); SAC ¶ 16 (adding that the average stock price from 5 January 23, 2015, through the end of 4Q (March 31, 2015) was $2.44). After January 23, 2015, 6 the stock fell further by the end of 4Q15, but the bulk of the price reduction during the quarter 7 occurred before January 23, 2015. See SAC ¶ 16 (alleging that the average stock price from 8 January 23, 2015, through March 31, 2015, was $2.44 – i.e., only $0.11 less). Although January 9 23, 2015, technically falls in 4Q rather than 3Q, LF‟s 10-Q for 3Q was filed on February 9, 2015, GAAP. See SAC ¶ 178 (alleging that, under GAAP, Defendants were required to take into 12 For the Northern District of California and therefore should have taken into account the January 23, 2015, price drop, as required by 11 United States District Court 10 account “„subsequent events that provide[d] additional evidence about conditions that existed [at 13 the end of 3Q, i.e., December 31, 2014]‟”). In short, as Defendants justified the long-lived 14 impairment write-off in 4Q based on an obvious stock decline, but that stock decline was obvious 15 as of 3Q or shortly thereafter. Accordingly, Plaintiffs‟ obviousness argument in support of 16 scienter has merit. 17 A strong inference of scienter arises because not only are there Plaintiffs‟ obviousness 18 allegations but also their allegations related to the timing and size of the impairment, which further 19 support scienter. As Plaintiffs have alleged, Defendants knew that the LF stock price had dropped 20 to $2.55 by January 23, 2015, but did not claim any impairment to long-lived assets for 3Q; then, 21 just two months later, i.e., March 31, 2015, for the end of 4Q, Defendants claimed an impairment 22 of $36.5 million, which represented 96% of LF‟s long-lived assets. Defendants have failed to 23 explain why, in just two months, they changed their view on long-lived assets from no impairment 24 to a 96% impairment. This is in contrast to the analysis of the failure to take a goodwill 25 impairment in F2Q15; in that case, there was a significant intervening event that could have 26 altered Defendants‟ expectations between F2Q15 and F3Q15 – the disappointing holiday sales. 27 No such intervening event explains the difference between F3Q15 and F4Q15. 28 Defendants point out that they did give a warning about the possibility of an impairment to 14 1 long-lived assets in the 10-K for LF‟s 3Q. See Defs.‟ RJN, Ex. 19, at 28 (LF‟s 10-Q for 3Q) 2 (stating that, “[i]f impairment testing shows that the carrying value of our long-lived assets 3 exceeds their estimated fair values, we would be required to record a non-cash impairment charge, 4 which would decrease the carrying value of our long-lived assets, as the case may be, and our 5 results of operations would be adversely affected”). While this warning is given some 6 consideration, the fact that it is general in nature, i.e., lacking in specifics, particularly in 7 comparison to the specificity of the warning regarding goodwill impairment, renders its impact on 8 scienter of less consequence. 9 At the end of the day, Plaintiffs‟ allegations regarding scienter are more than merely in light of the lack of any explanation as to why, in just two months, Defendants recognized an 12 For the Northern District of California plausible; the inference of scienter is at least as compelling as any opposing inference, especially 11 United States District Court 10 impairment of the size claimed despite the absence of a significant intervening change in 13 circumstances. 14 At the hearing, Defendants suggested for the first time that the long-lived impairment may 15 not have been taken at 3Q because, e.g., costs were going to be brought down (which would affect 16 the cash flows of the company). See Defs. RJN, Ex. 18 (LF earnings call for Q3, held on February 17 5, 2015) (stating that “yesterday we announced internally a reduction of 95 full term positions 18 across our business, which represents over 16% of our organization”). While, based on timing, 19 reduction-in-workforce costs may well have been a consideration for 3Q, see SAC ¶ 178 (alleging 20 that, under GAAP, Defendants were required to take into account “„subsequent events that 21 provide[d] additional evidence about conditions that existed [at the end of 3Q, i.e., December 31, 22 2014]‟”), that same consideration, based on timing, should have affected 4Q as well. Thus, as the 23 Court asked at the hearing, the question is what changed between 3Q and 4Q that caused 24 Defendants to take the impairment at 4Q but not 3Q? As nothing has been identified for the 25 Court, it concludes that there is a strong inference of scienter. 26 Defendants protest that, even if the Court is inclined to find sufficient allegations of 27 scienter, Plaintiffs have still failed to allege falsity. According to Defendants, because an 28 assessment of long-lived asset impairment depends on expected cash flows, see SAC ¶ 160 15 1 (alleging that, at step one, “one must determine whether the carrying amount of a long-lived asset 2 (or asset group) exceeds the sum of the undiscounted cash flows expected to result from the use 3 and the eventual disposition of the asset”), and Plaintiffs have not made any allegations about 4 what cash flow analysis Defendants actually did (i.e., what was wrong with that analysis), the 5 falsity allegations are lacking. The Court is not persuaded. Plaintiffs have adequately pled falsity 6 based on the allegations that Defendants justified the long-lived asset impairment determination 7 based on a significant stock decline, but that stock decline had primarily taken place at 3Q (or 8 shortly thereafter, i.e., by January 23, 2015). Plaintiffs have alleged enough to survive the motion 9 to dismiss. III. 10 For the foregoing reasons, the Court grants in part and denies in part Defendants‟ motion 11 12 For the Northern District of California United States District Court CONCLUSION to dismiss the SAC. The motion is granted to the extent Plaintiffs‟ claims are based on 13 Defendants‟ failure to take a write-off for goodwill impairment in 2Q. The motion is denied to the 14 extent Plaintiffs‟ claims are based on Defendants‟ failure to take a write-off for long-lived asset 15 impairment in 3Q. Defendants shall file their answer to the SAC, with claims limited by the Court‟s ruling 16 17 herein, within four (4) weeks of the date of this order. The Court will hold a Case Management 18 Conference on April 6, 2017 at 9:30 a.m. to set dates in connection with Plaintiffs‟ motion to 19 certify the class. A Joint Case Management Conference statement shall be filed by March 30, 20 2017. 21 This order disposes of Docket No. 100. 22 23 IT IS SO ORDERED. 24 25 26 27 Dated: February 24, 2017 ______________________________________ EDWARD M. CHEN United States District Judge 28 16

Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.

Why Is My Information Online?