Zoumboulaskis v. McGinn et al

Filing 77

ORDER granting 63 Motion to Dismiss third amended complaint. THE CLERK SHALL CLOSE THIS FILE. Signed by Judge Edward J. Davila on 09/22/2017. (ejdlc3S, COURT STAFF) (Filed on 9/22/2017) Modified on 9/22/2017 (ejdlc1S, COURT STAFF).

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UNITED STATES DISTRICT COURT

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NORTHERN DISTRICT OF CALIFORNIA

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SAN JOSE DIVISION

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SOFIA ZOUMBOULAKIS,

Case No. 5:13-cv-02379-EJD

Plaintiff,
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ORDER GRANTING DEFENDANTS’
MOTION TO DISMISS

v.

United States District Court
Northern District of California

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RICHARD A. MCGINN, et al.,

Re: Dkt. No. 63

Defendants.
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I. INTRODUCTION

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Plaintiff Sofia Zoumboulakis (“Plaintiff”) filed the instant shareholder derivative action for

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the benefit of Nominal Defendant VeriFone Systems, Inc. (“VeriFone” or “Company”), against

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certain former and current members of VeriFone’s Board of Directors (the “Board”) and executive

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officers Richard McGinn (“McGinn”), Robert W. Alspaugh (“Alspaugh”), Leslie G. Denend

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(“Denend”), Alex W. Hart (“Hart”), Robert B. Henske (“Henske”), Wenda Harris Millard

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(“Millard), Eitan Raff (“Raff”), Jeffrey E. Stiefler (“Stiefler”), Douglas G. Bergeron (“Bergeron”),

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Robert Dykes (“Dykes”), and Charles R. Rinehart (collectively, “Defendants”), alleging breach of

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fiduciary duties and violation of federal securities laws. Presently before the Court is VeriFone’s

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Motion to Dismiss Plaintiff’s Third Amended Shareholder Derivative Complaint (“TAC”)

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pursuant to Federal Rules of Civil Procedure 12(b)(6) and 23.1 for failure to make a pre-suit

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demand on VeriFone’s Board of Directors. The individual defendants have filed a joinder in

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VeriFone’s motion. Plaintiff contends that she is excused from making a pre-suit demand because

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six of the nine current Board members could not disinterestedly and independently respond to a

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ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS

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demand for action. TAC at ¶83.
The Court found this matter suitable for decision without oral argument pursuant to Civil

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Local Rule 7-1(b), and previously vacated the associated hearing. Having reviewed the parties’

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pleadings, the Court GRANTS Defendants’ Motion to Dismiss.

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II. BACKGROUND

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VeriFone is a global provider of technologies that process electronic payments for goods

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and services. Plaintiff is an owner and holder of VeriFone common stock. Plaintiff alleges that

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since VeriFone went public in 2005, it has been plagued with serious internal control deficiencies.

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TAC at ¶1. She alleges that in 2009, VeriFone was formally charged by the U.S. Securities and
Exchange Commission (“SEC”) with accounting fraud during 2007 that overstated operating

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United States District Court
Northern District of California

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income by 129% and required a significant financial restatement in 2008. Id. A mid-level

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manager allegedly made multiple unsupportable accounting adjustments. Id. According to

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Plaintiff, the SEC alleged that proper controls should have been in place to “prevent the person

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responsible for forecasting financial results from making adjustments which allowed the Company

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to meet the forecast.” Plaintiff alleges that in November 2009, VeriFone consented to the entry of

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a final judgment in the SEC action, which permanently enjoined the Company from violating

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federal securities laws. Id. at ¶3. The judgment also required the company to devise and maintain

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a system of internal accounting controls. Id.

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Plaintiff alleges that although the Board and executive officers were aware that VeriFone’s

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deficient controls had permitted improper manual adjustments to the Company’s internal results,

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they failed to institute sufficient internal controls. Id. at ¶ 4. From 2012 through the beginning of

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2013, the Company’s Chief Financial Officer Robert Dykes (“CFO Dykes”), who had

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responsibility for producing VeriFone’s financial guidance and forecast of future revenues,

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allegedly pressured subordinate employees to inflate revenue, prematurely recognize revenue, and

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adjust revenue in other ways to bring it in line with previously issued forecast guidance. Id. at

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¶¶4, 42. Plaintiff alleges that “[y]et again, the Company’s internal controls failed to prevent ‘the

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person responsible for forecasting financial results from making adjustments which allowed the

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Company to meet the forecasts.” Id. at ¶4. Because of Dyke’s alleged manipulation of the

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Company’s revenue numbers, VeriFone’s quarterly and annual financial disclosures, guidance,

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and proxy statement issued between December 2011 and February 2013 were allegedly misleading

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and inaccurate. Id. at ¶58.

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Plaintiff alleges that in February 2013, the Company announced that CFO Dykes had

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retired, but he was in fact terminated for cause. Id. at ¶6. Two weeks after the new CFO was

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appointed, the Company allegedly disclosed very poor preliminary results for its first fiscal quarter

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of 2013, and repeatedly lowered its forecasts for the rest of 2013. Id. at ¶7. According to

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Plaintiff, as a result, the Company suffered a massive drop in the price of its common stock from a
high of approximately $54 per share in April 2012 to less than $16 per share in the summer of

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United States District Court
Northern District of California

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2013, lost ground against competitors, and lost credibility in the market place. Id. In her Third

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Amended Complaint, Plaintiff asserts the following claims: (1) breach of fiduciary duty; (2) abuse

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of control; (3) violations of §14 of the Securities Exchange Act of 1934; and (4) unjust

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enrichment. See id.

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III. STANDARDS

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Federal Rule of Civil Procedure 8(a) requires a plaintiff to plead each claim with sufficient

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specificity to “give the defendant fair notice of what the . . . claim is and the grounds upon which

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it rests.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (internal quotations omitted).

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Although particular detail is not generally necessary, the factual allegations “must be enough to

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raise a right to relief above the speculative level” such that the claim “is plausible on its face.” Id.

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at 556-57. A complaint which falls short of the Rule 8(a) standard may be dismissed if it fails to

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state a claim upon which relief can be granted. Fed. R. Civ. P. 12(b)(6). “Dismissal under Rule

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12(b)(6) is appropriate only where the complaint lacks a cognizable legal theory or sufficient facts

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to support a cognizable legal theory.” Mendiondo v. Centinela Hosp. Med. Ctr., 521 F.3d 1097,

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1104 (9th Cir. 2008).

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When deciding whether to grant a motion to dismiss, the court usually “may not consider

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any material beyond the pleadings.” Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d

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1542, 1555 n.19 (9th Cir. 1990). However, the court may consider material submitted as part of

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the complaint or relied upon in the complaint, and may also consider material subject to judicial

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notice. See Lee v. City of Los Angeles, 250 F.3d 668, 688-89 (9th Cir. 2001).

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In addition, the court must generally accept as true all “well-pleaded factual allegations.”

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Ashcroft v. Iqbal, 556 U.S. 662, 664 (2009). The court also must construe the alleged facts in the

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light most favorable to the plaintiff. Love v. United States, 915 F.2d 1242, 1245 (9th Cir. 1988).

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But “courts are not bound to accept as true a legal conclusion couched as a factual allegation.”

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Iqbal, 556 U.S. at 678. Nor must the court accept as true “allegations that contradict matters

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properly subject to judicial notice or by exhibit” or “allegations that are merely conclusory,
unwarranted deductions of fact, or unreasonable inferences.” In re Gilead Scis. Sec. Litig., 536

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United States District Court
Northern District of California

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F.3d 1049, 1055 (9th Cir. 2008).

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IV. DISCUSSION
Plaintiff alleges that prior to filing this action, she did not make a demand on the Board

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because making such a demand would have been a futile and useless act. Id. at ¶¶8, 82. Plaintiff

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reasons that a demand would have been futile because a majority of the Board “could not

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disinterestedly and independently respond to a demand for action.” Id. at ¶83. Defendants

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contend that Plaintiff has failed to allege particularized facts showing that a majority of the Board

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is personally interested and unable to consider Plaintiff’s claims. Further, Defendants contend that

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the TAC should now be dismissed with prejudice because Plaintiff has had four opportunities to

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plead that demand upon the Board would have been futile, and has failed to do so.

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A. Federal Rule of Civil Procedure 23.1

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Federal Rule of Civil Procedure 23.1 applies to shareholder derivative actions. Under Rule

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23.1, “a shareholder must either demand action from the corporation’s directors before filing a

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shareholder derivative suit, or plead with particularity the reasons why such demand would have

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been futile.” Arduini v. Hart, 774 F.3d 622, 628 (9th Cir. 2014); see Fed. R. Civ. P. 23.1(b)(3).

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“The purpose of this demand requirement in a derivative suit is to implement the basic principle of

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corporate governance that the decisions of a corporation—including the decision to initiate

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litigation—should be made by the board of directors or the majority of shareholders.”

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Rosenbloom v. Pyott, 765 F.3d 1137, 1148 (9th Cir. 2014) (internal quotations omitted).

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To determine demand futility, courts must look to the substantive law of the entity’s state

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of incorporation to determine whether the demand would have, in fact, been futile. Rosenbloom,

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765 F.3d at 1148. In this case, VeriFone is a Delaware corporation, thus Delaware law applies.

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Under Delaware law, “a shareholder who declines to make a demand on the board of
directors may not bring a derivative action until he has demonstrated, with particularity, the

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reasons why pre-suit demand would be futile.” Id. (internal quotations omitted). Demand futility

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“is gauged by the circumstances existing at the commencement of a derivative suit and concerns

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the board of directors sitting at the time the complaint is filed.” Id. (internal quotations omitted).

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United States District Court
Northern District of California

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The court must determine futility on a case-by-case basis, and “[p]laintiffs are entitled to all

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reasonable factual inferences that logically flow from the particularized facts alleged[.]” Id.

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However, “conclusory allegations are not considered as expressly pleaded facts or factual

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inferences.” Id.

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Delaware law provides a two-pronged test to determine demand futility. First “is whether,

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under the particularized facts alleged, a reasonable doubt is created that the directors are

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disinterested and independent.” Id. at 1149. Second “is whether the pleading creates a reasonable

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doubt that the challenged transaction was otherwise the product of a valid exercise of business

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judgment.” Id. This two-pronged approach is known as the “Aronson test,” pursuant to Aronson

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v. Lewis, 473 A.2d 805, 814 (Del. 1984), and is in the disjunctive. Id. “Therefore, if either prong

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is satisfied, demand is excused.” Id.

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Under the first prong of the Aronson test, “a director’s interest may be shown by

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demonstrating a potential personal benefit or detriment to the director as a result of the decision.”

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Rosenbloom, 765 F.3d at 1149. Thus, “directors who are sued have a disabling interest for pre-

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suit demand purposes when the potential for liability may rise to a substantial likelihood.” Id. In

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a motion to dismiss, “plaintiffs must make a threshold showing, through the allegation of

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particularized facts, that their claims have some merit.” Id. (internal quotations omitted).

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Under the second prong of the Aronson test, “the question is whether the pleading creates a

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reasonable doubt that the challenged transaction was the product of a valid exercise of business

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judgment.” Id. However, “for claims that demand is excused on the ground that a board remained

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consciously inactive when it knew (or should have known) about illegal conduct,” a different test

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is applied—these are considered Caremark claims, pursuant to In re Caremark International Inc.

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Derivative Litigation, 698 A.2d 959, 971 (Del. Ch. 1996), which are tested under Rales v.

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Blasband, 634 A.2d 927 (Del. 1993). Id. at 1150. “Rales requires plaintiffs to allege

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particularized facts establishing a reason to doubt that the board of directors could have properly

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exercised its independent and disinterested business judgment in responding to a demand.” Id.

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United States District Court
Northern District of California

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(internal quotations omitted).
The Ninth Circuit has provided that the difference between the Aronson and Rales tests are

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blurred in cases in which personal liability for breach of fiduciary duties implicates the board’s

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availment of business judgment protections. Id. Thus, it does not matter which test applies. Id.

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“Under either approach, demand is excused if Plaintiffs’ particularized allegations create a

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reasonable doubt as to whether a majority of the board of directors faces a substantial likelihood of

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personal liability for breaching the duty of loyalty.” Id. In turn, the duty of loyalty “is violated

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where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious

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disregard for their responsibilities and failing to discharge the non-exculpable fiduciary duty of

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loyalty in good faith.” Id. (internal quotations omitted).

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C. Five Director Defendants: Alspaugh, Hart, Henske, Millard and Raff

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Plaintiff contends that five Director Defendants, namely Alspaugh, Hart, Henske, Millard,

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and Raff could not disinterestedly and independently consider a demand for action because they

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face a substantial likelihood of liability for their alleged breaches of fiduciary duties. According to

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Plaintiff, these five Director Defendants permitted the Company to function with inadequate

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internal controls and to make inaccurate public statements that conveyed a misleading picture of

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VeriFone’s business in the face of material adverse facts that the Director Defendants knew and

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consciously disregarded. TAC at ¶90. Plaintiff alleges that the material adverse facts known to

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the Director Defendants included the fact that “the same inadequate internal controls that caused

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the 2008 financial restatement were never repaired and continued to be inadequate at least until

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February 2013.” Id. Plaintiff alleges that because the Director Defendants knew and disregarded

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these adverse facts, the Director Defendants face a substantial risk of liability for breach of good

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faith and loyalty, rendering them unable to fairly and objectively evaluate a pre-suit demand. Id.
Knowledge of Alleged Misfeasance Based on SEC Charge

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Like the Second Amended Complaint, the Third Amended Complaint alleges that

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Directors Alspaugh, Hart, Henske, and Raff were on the Board in 2009 when the SEC filed the

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complaint against VeriFone, and that VeriFone consented to a final judgment to resolve the SEC’s
enforcement action. TAC at ¶91. As a result, Alspaugh, Hart, Henske, and Raff allegedly knew

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United States District Court
Northern District of California

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that VeriFone lacked proper controls to prevent manual manipulation of internal financial

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reporting, and to prevent the person responsible for forecasting financial results from making

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adjustments. TAC at ¶91. Alspaugh, Hart, Henske, and Raff, however, allegedly declined to take

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action to strengthen internal controls. Id. Further, Alspaugh, Hart, Henske, and Raff signed the

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Company’s December 23, 2011 Forms 10-K, which allegedly included misleading statements

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regarding the Company’s internal controls and untrue certifications under Sarbanes-Oxley.

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Defendant Millard, together with Alspaugh, Hart, Henske, and Raff, signed the Company’s

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December 19, 2012 Forms 10-K, which also allegedly included similarly misleading statements.

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Id. at ¶92.

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The allegations above may be sufficient to support a reasonable inference that Defendants

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Alspaugh, Hart, Henske, Raff and Millard knew of the internal control deficiencies described in

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the SEC complaint; knew that VeriFone’s internal controls had to be modified in order to prevent

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the person responsible for forecasting financial results from being able to make adjustments to the

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Company’s financials; and knew that the internal controls had to be modified to ensure oversight

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of Defendant Dykes because he was the person responsible for forecasting financial results.

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Critically, however, for the reasons discussed below, Plaintiff has not alleged particularized facts

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identifying any specific deficiency in the internal controls. Nor has Plaintiff alleged particularized

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facts explaining how the internal control was deficient. Further, Plaintiff has not alleged

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particularized facts to show how a purportedly deficient control impacted any financial result or

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statement made by VeriFone. Plaintiff also has not alleged particularized facts to support a

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reasonable inference that the five Director Defendants knew or had reason to know of any

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accounting irregularities linked to an inadequate internal control, and failed to act. Instead,

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Plaintiff relies on the same conclusory allegations previously rejected by the Court.

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“Red Flags” Purportedly Raised by Analyst Reports

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Plaintiff relies on an analyst report issued by Deutsche Bank in April of 2012 that stated, in

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part, that VeriFone’s “organic growth is being inflated through acquisitions.” The Deutsche Bank
report also referred to “poor financial disclosures.” Plaintiff alleges that because the Director

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United States District Court
Northern District of California

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Defendants issued a press release the very same day, it is reasonable to infer the Director

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Defendants were made aware of allegations of accounting impropriety and yet failed to conduct an

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adequate investigation. Plaintiff also relies on an analyst report issued by Wedbush in November

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of 2012 that faulted VeriFone for “opaque” financial reporting as another “red flag” putting the

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Defendant Directors on notice of accounting irregularities. Plaintiff contends that the Defendant

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Directors face a substantial likelihood of liability for failing to investigate after the analyst reports

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were issued, and therefore a pre-suit demand would have been futile.

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Neither the Deutsche Bank nor Wedbush reports, however, explicitly or impliedly refer to

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inadequate internal controls. Nor do these reports contain accusations of accounting manipulation.

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Instead, the Deutsch Bank reflected a difference of opinion about how to report organic growth.

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The Wedbush referred to “opaque” reporting, which is distinct from accounting manipulation.

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Furthermore, Plaintiff’s complaint does not allege sufficient particularized facts to support an

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inference that a majority of the Board knew of the reports and chose not to take action in the face

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of the reports. Therefore, the analyst reports do not provide a basis for raising a reasonable doubt

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as to whether a majority of the Board of Directors faces a substantial likelihood of personal

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liability for breaching the duty of loyalty.

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Committee Membership Allegations

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Plaintiff alleges that demand would have been futile specifically as to Defendants

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Alspaugh and Henske because they face liability for breaches of their duties as members of the

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Audit Committee. Plaintiff alleges that during the time of the alleged wrongdoing, Alspaugh and

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Henske were responsible for, but failed to ensure, the integrity of the Company’s financial

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statements, the Company’s compliance with legal and regulatory requirements, and the

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performance of the Company’s internal audit function. Plaintiff alleges that Alspaugh and Henske

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knew of the precise deficiencies in VeriFone’s internal controls raised by the SEC, but they

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declined to take action to repair those internal controls. Plaintiff also alleges that Alspaugh and
Henske “presided over a complete lack of accountability and a culture where widespread and

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United States District Court
Northern District of California

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pervasively inadequate internal controls were permitted to continue unabated for years.” TAC at

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¶93.

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Plaintiff similarly alleges that demand is futile specifically as to Defendants Alspaugh,

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Hart and Raff because they also face liability for failing to fulfill their responsibilities as members

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of the Corporate Governance and Nominating Committee. Defendants Alspaugh, Hart and Raff

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allegedly breached their fiduciary duties “by permitting the Company to suffer from a widespread

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and pervasive deficiency of internal controls for years, and declining to require truthful

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evaluations of management and the Board, and/or declining to act on evaluations truthfully

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describing the extent of managerial and directorial complicity in the Company’s deficient

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controls.” TAC at ¶94.

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Plaintiff’s conclusory allegations are unsupported by facts. Plaintiff generally refers to the

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integrity of the Company’s financial statements, but fails to identify any specific misstatement or

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omission in a financial statement. Similarly, Plaintiff alleges a general failure to comply with

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legal and regulatory requirements, but fails to identify any specific legal or regulatory requirement

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that was violated. Plaintiff also fails to allege facts relating to the Company’s internal audit

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function. Plaintiff makes sweeping allegations of widespread and pervasive deficiency of internal

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controls, and yet fails to identify a specific deficiency. Thus, Plaintiff has not satisfied its burden

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to plead particularized facts to raise a reasonable doubt as to whether the Director Defendants who

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served on the Audit Committee or the Corporate Governance and Nominating Committee face a

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substantial likelihood of liability for breaches of fiduciary duties.

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Dykes’ Alleged Termination
Plaintiff alleges that demand would have been futile specifically as to Defendants Henske

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and Millard because they face liability for actions they took as members of the Compensation

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Committee. Plaintiff alleges that Henske and Millard “knew of defendant Dykes’ wrongdoing and

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the agreement to refer to his departure as a retirement, and thus consciously concealed the truth of

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Dykes’ wrongdoing and VeriFone’s deficient internal controls from investors.” TAC at ¶95.

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These allegations fail for the same reasons the Court previously stated in dismissing

United States District Court
Northern District of California

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Plaintiff’s Second Amended Complaint. First, Plaintiff has not alleged particularized facts to

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establish that Dykes manipulated the Company’s finances. Plaintiff alleges on information and

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belief that Dykes “directed subordinate employees, at times in writing, to book revenue in

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violation of GAAP that was either being prematurely recognized or that should not have been

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booked as revenue at all” and “implemented an improper accounting change to permit VeriFone to

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recognize gross revenues from certain transactions in VeriFone’s tax payment business when the

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revenues should have been recognized as net revenues.” TAC at ¶¶43-44. These allegations are

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deficient in several respects. Plaintiff does not identify the subordinate employees. Nor does

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Plaintiff allege facts regarding when and how Dykes allegedly directed subordinate employees to

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violate GAAP. There are no facts alleged regarding the amount of the allegedly inflated revenue.

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Nor does Plaintiff allege particularized facts regarding the allegedly improper accounting change

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relating to VeriFone’s tax payment business.

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Second, even if Plaintiff’s allegations were sufficient to support an inference that Dykes

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manipulated the Company’s finances, there are insufficient particularized facts to support an

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inference that the Director Defendants knew of Dyke’s alleged wrongdoing, and made a conscious

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decision not to act. The Defendant Directors’ service on the Compensation Committee and

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knowledge of Dykes’ separation agreement, without more, do not support these inferences.

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Third, Plaintiff has not alleged particularized facts to support a reasonable inference that

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Dykes was terminated. Plaintiff contends that Dyke’s termination can be inferred from the terms

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of his separation agreement, which “forced” him to “forfeit” hundreds of thousands of dollars in

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cash severance in order to maintain his right to outstanding equity awards vesting between

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February and May 2013, equity awards to which he would have been “automatically” entitled had

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he simply retired. TAC at ¶¶49-51. Plaintiff’s complaint makes clear, however, that Dykes

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ceased working in February of 2013, and thus it is not reasonable to assume that Dykes would

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have been “automatically” entitled to have his equity continue to vest for two months more until

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May 2013. In sum, Plaintiff has not alleged particularized facts to create a reasonable doubt as to

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whether Henske, Millard, or any other of the Director Defendants face a substantial likelihood of

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United States District Court
Northern District of California

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liability.

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C. Chief Executive Officer Paul Galant

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Plaintiff alleges that VeriFone’s current Chief Executive officer (“CEO”), Paul Galant

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(“Galant”) 1, lacks independence such that demand upon him would have been futile. Plaintiff

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reasons that Galant is conflicted due to his dual roles as CEO and a director. TAC at ¶84.
Because Plaintiff has not alleged sufficient facts to justify failure to make a pre-suit

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demand on the five Director Defendants, the Court finds it unnecessary to consider Galant’s

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independence.
V. CONCLUSION

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Based on the foregoing, Defendants’ Motion to Dismiss Plaintiff’s Third Amended

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Shareholder Derivative Complaint is GRANTED with prejudice.
IT IS SO ORDERED.

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Dated: September 22, 2017
______________________________________
EDWARD J. DAVILA
United States District Judge

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1

Galant is not named as a defendant because he joined the Company after the alleged wrongdoing
at issue.
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