Bao v. SolarCity Corporation et al

Filing 104

ORDER DENYING 91 DEFENDANTS' MOTION TO AMEND THE JUDGMENT. Signed by Judge Beth Labson Freeman on 3/6/2017. (blflc2S, COURT STAFF) (Filed on 3/6/2017)

1
2
3

UNITED STATES DISTRICT COURT

4

NORTHERN DISTRICT OF CALIFORNIA

5

SAN JOSE DIVISION

6
7

TAI JAN BAO, ET AL.,

8

Plaintiffs,
v.

9
10

SOLARCITY CORPORATION, et al.,
Defendants.

United States District Court
Northern District of California

11

Case No. 14-cv-01435-BLF
ORDER DENYING DEFENDANTS'
MOTION TO AMEND THE
JUDGMENT
[Re: ECF 91]

12
Defendants SolarCity Corporation (“SolarCity” or the “Company”), Lyndon R. Rive, and

13
14

Robert D. Kelly (Rive and Kelly collectively, “Individual Defendants”) (Individual Defendants

15

and Solar City collectively, “Defendants”) request that this Court amend its judgment by imposing

16

sanctions. Mot., ECF 91. Having conducted a careful post-judgment review of the attorneys’

17

conduct for compliance with Federal Rule of Civil Procedure 11(b), the Court finds that Plaintiffs’

18

representations to the court were proper and nonfrivolous, though ultimately unpersuasive. See 15

19

U.S.C. §78(u)-4(c)(1). Because the Court, having conducted the inquiry mandated by the Private

20

Securities Litigation Reform Act of 1995 (“PSLRA”), concludes that sanctions are not warranted,

21

it hereby DENIES Defendants’ motion to amend the judgment.

22
23

I.

BACKGROUND
Lead Plaintiffs James Web and Tai Jan Bao (“Plaintiffs”) brought this suit seeking to

24

represent a putative class of investors who purchased SolarCity securities between December 12,

25

2012, and March 18, 2014 (“Class Period”). Third Am. Compl. (“TAC”) ¶¶ 1, 19, ECF 78.

26

Plaintiffs alleged that during this time, Defendants manipulated an accounting formula to “portray

27

the illusion of profitability” by shifting overhead costs from sales, where they would be

28

recognized immediately, to leases, where they would be amortized over a twenty-year period. Id.

1

¶¶ 58, 71. Specifically, Plaintiffs alleged that Defendants inflated a ratio used to allocate overhead

2

costs to leases (“burden ratio”) by including the prior period’s overhead costs in the numerator, but

3

excluding the prior period’s direct costs from the denominator. Id. ¶¶ 71–72. This formula

4

change did not affect the company’s allocation of direct costs between sales and leases, but did

5

cause an inflated portion of overhead costs to be attributed to leases. Plaintiffs alleged that this

6

error in the burden ratio violated Generally Accepted Accounting Principles (“GAAP”) and

7

enabled Defendants to overstate sales gross margins for seven consecutive quarters. Id. ¶¶ 31–33,

8

61–63.
Plaintiffs filed this suit on March 28, 2014, shortly after SolarCity announced that it had

9

discovered an error in the aforementioned formula and filed its Form 10-K for the fiscal year

11
United States District Court
Northern District of California

10

ending December 31, 2013, which included the restated financials from the relevant periods. See

12

generally Compl., ECF 1. On October 13, 2014, Plaintiffs filed the First Amended Complaint

13

(“FAC”), asserting causes of action for alleged violations of Sections 10(b) and 20(a) of the

14

Securities Exchange Act of 1934 and SEC Rule 10b-5. See generally FAC, ECF 56. Plaintiffs

15

alleged that Defendants had motive and an opportunity to conduct securities fraud. Order

16

Granting Mot. to Dismiss With Leave to Amend (“First Dismissal Order”) 7, ECF 65. Plaintiffs

17

relied primarily on two confidential witnesses (“CWs”), both of whom left SolarCity before the

18

Class Period, to suggest that the Individual Defendants knew of or deliberately disregarded the

19

accounting error. FAC ¶¶ 38, 39. The Court heard arguments on Defendants’ motion to dismiss

20

the FAC on April 16, 2015, and granted Defendants’ motion with leave to amend finding that the

21

FAC lacked adequate factual allegations as to scienter, and thus the Court determined that the

22

FAC did not satisfy the PSLRA’s exacting pleading requirements. ECF 61, First Dismissal Order

23

4–5.

24

Based on this Court’s review of the FAC and consideration of Plaintiffs’ remarks at the

25

critical motion hearing, the Court encouraged Plaintiffs to submit a revised pleading that would

26

incorporate the factual allegations that counsel represented Plaintiffs could allege. Accordingly,

27

Plaintiffs filed the Second Amended Complaint (SAC”) on January 19, 2015. See generally SAC,

28

ECF 66. The SAC missed the mark, but the SAC demonstrated additional investigation and
2

1

submission of eight new CWs to support Plaintiffs’ allegations of scienter. See Order Granting

2

Mot. to Dismiss Second Am. Compl. With Leave to Amend (“Second Dismissal Order”), ECF 77.

3

Those CWs offered additional factual allegations, but still failed adequately to support scienter. In

4

the Court’s view, the SAC was not frivolous.
Acceding to Plaintiffs’ request for one more chance, the Court allowed the Third Amended

5
6

Complaint (“TAC”), which was filed on February 15, 2016. See TAC, ECF 78. The TAC also

7

failed to meet the exacting standards of the PSLRA. In its final order granting the motion to

8

dismiss, the Court noted that the TAC offered few additional factual allegations. Order Granting

9

Mot. to Dismiss Third Am. Compl. With Prejudice (“Third Dismissal Order”) 10, ECF 81.

10

United States District Court
Northern District of California

11

II.

LEGAL STANDARD
Under the PSLRA 15 U.S.C. § 78u–4, “upon final adjudication of the action, the court

12

shall include in the record specific findings regarding compliance by each party and each attorney

13

representing any party with each requirement of Rule 11(b) of the Federal Rules of Civil

14

Procedure as to any complaint, responsive pleading, or dispositive motion.” 15 U.S.C. § 78u–

15

4(c)(1). The Court is required to impose sanctions if it finds that a Rule 11 violation occurred,

16

with the presumptive amount of sanctions for a substantial failure to comply with Rule 11 being

17

the opposing party’s reasonable attorneys’ fees and associated expenses. 15 U.S.C. §§ 78u–

18

4(c)(2)–(3).

19

Rule 11(b), in turn, states that by presenting to the Court any pleading or other filing, an

20

attorney certifies that to the best of the attorney’s knowledge formed after an inquiry reasonable

21

under the circumstances:

22
23
24
25
26

(1) it is not being presented for any improper purpose, such as to
harass, cause unnecessary delay, or needlessly increase the cost of
the litigation;
(2) the claim, defenses, and other legal contentions are warranted by
existing law or by a nonfrivolous argument for extending,
modifying, or reversing existing law or for establishing new law;

27

(3) the factual contentions have evidentiary support or, if
specifically so identified, will likely have evidentiary support after a
reasonable opportunity for further investigation or discovery; and

28

(4) the denials of factual contentions are warranted on the evidence
3

or, if specifically so identified, are reasonably based on belief or a
lack of information.

1
2

Fed. R. Civ. P. 11(b)(1)–(4).

3

III.

DISCUSSION1

4

Defendants’ principal argument is that Plaintiffs’ complaint lacked any factual or

5

evidentiary basis, and that Plaintiffs’ counsel did not conduct a reasonable or competent inquiry

6

into their factual allegations. Mot. 2. When, as here, the Rule 11 inquiry focuses on a complaint,

7

the court “‘must conduct a two-prong inquiry to determine (1) whether the complaint is legally or

8

factually baseless from an objective perspective, and (2) if the attorney has conducted a reasonable

9

and competent inquiry before signing and filing it.’” Holgate v. Baldwin, 425 F.3d 671, 676 (9th
Cir. 2005) (quoting Christian v. Mattel, Inc., 286 F.3d 1118, 1127 (9th Cir. 2002)); Kelter v.

11
United States District Court
Northern District of California

10

Associated Fin. Grp., Inc., 382 Fed. Appx. 632, 633 (9th Cir. 2010) (same, applying standard in

12

PSLRA context). In other words, a finding that a complaint is “frivolous” is appropriate if it “is

13

both baseless and made without a reasonable and competent inquiry.” Holgate, 425 F.3d at 676

14

(quoting Moore v. Keegan Mgmt. Co (In re Keegan Mgmt. Co., Sec. Litig.), 78 F.3d 431, 434 (9th

15

Cir. 1996)). “The reasonableness standard governing a Rule 11 inquiry is objective.” Kelter, 382

16

Fed. Appx. at 633 (citing G.C. and K.B. Invs., Inc. v. Wilson, 326 F.3d 1096, 1109 (9th Cir.

17

2003)).

18

In reviewing the various iterations of the complaint, the Court agreed with SolarCity that

19

Plaintiffs failed to allege facts supporting a strong inference of scienter, and accordingly granted

20

the motions to dismiss. Nevertheless, the Court cannot agree that sanctions are warranted under

21

the PSLRA framework. Although Defendants contend that Plaintiffs’ complaint lacked any

22

factual or evidentiary basis to allege that Defendants were aware of the error in SolarCity’s

23

accounting formula, see Mot. 6, Plaintiffs’ factual contentions were not devoid of evidentiary

24

support. Plaintiffs attempted to present a holistic image of scienter through their use of CWs and

25

facts suggesting both motive and opportunity. See Opp’n 15, ECF 95; see also Cal. Architectural

26

Bldg. Prods. v. Franciscan Ceramics, Inc., 818 F.2d 1466, 1472 (9th Cir. 1997) (finding plaintiff’s

27
1

28

Finding sanctions unwarranted, the Court declines to address whether the safe harbor provision
found in Fed. R. Civ. P. 11 applies in this context. See Opp’n 14; Reply ISO Mot. 2, ECF 99.
4

1

evidence on summary judgment weak, but “not so baseless” and “so lacking in plausibility” that

2

sanctions ought to be imposed). Although the Court concluded that these factual allegations did

3

not, individually or as a whole, “give rise to a strong inference of scienter [that] is as ‘cogent and

4

at least as compelling as any opposing inference of nonfraudulent intent,’” Second Dismissal

5

Order 13 (citation omitted), the Court allowed a third opportunity to correct the identified

6

deficiencies. Plaintiffs’ successive versions of the complaint did not raise the types of objectively

7

baseless and frivolous claims that have been the subject of fee awards. See, e.g., Patton v. Cty. of

8

Kings, 857 F.2d 1379, 1381–82 (9th Cir. 1988) (affirming an award of fees where a plaintiff raised

9

one claim that was directly contrary to established precedent, and a second claim without citing
any authority in support); Song FI, Inc. v. Google, Inc., No. C 14-5080, 2016 WL 4180214 (N.D.

11
United States District Court
Northern District of California

10

Cal. Aug. 8, 2016) (granting in part motion for sanctions under Rule 11 after finding plaintiffs

12

allegations were objectively baseless, plaintiffs presented “no evidence” to support their

13

allegations, and because defendants showed that a reasonable investigation would have uncovered

14

the truth); ITI Internet Servs., Inc. v. Solana Capital Partners, Inc., No. C05-2010Z, 2007 WL

15

666593, at *7 (W.D. Wash. Feb. 27, 2007) (awarding sanctions where plaintiffs claimed the

16

conducted extensive research before filing their complaint but filed no declarations, time sheets, or

17

any other documentation of work effort supporting this assertion). Moreover, the Court is not

18

persuaded that the TAC, or any other iteration of the complaint, was frivolous or offered in bad

19

faith.

20

Finally, Plaintiffs’ counsel have adequately demonstrated that they undertook a reasonable

21

investigation, which included (1) retaining a licensed investigation firm with substantial

22

experience in securities-related investigations to conduct interviews of former SolarCity

23

employees; (2) carefully reviewing the memoranda prepared by the investigative firm, and, where

24

needed, requesting that the investigators seek further information from witnesses; (3) reviewing

25

the Company’s SEC filings and press releases, and news articles, presentations, and analyst

26

reports concerning SolarCity; and (4) retaining experts to review the Company’s restatement and

27

opine on the reasons underlying the restatement. Opp’n 22; Gilmore Decl. ¶ 8; see DeMarco v.

28

Depotech Corp., 131 F. Supp. 2d 1185, 1188 (S.D. Cal. 2001) (finding where a plaintiff’s attorney
5

1

conducts factual research and proffers reasonable arguments that counsel reasonably believed

2

presented a legally redressable harm under the federal securities law, sanctions are improper).

3

Defendants ask the Court to find that “to the extent any investigation was conducted, Plaintiff

4

ignored what that investigation confirmed: that no facts supported his allegations.” Reply ISO

5

Mot. 6. This misconstrues the standard. See, e.g., DeMarco, 131 F. Supp. 2d at 1188; cf. Benedict

6

v. Hewlett- Packard Co., No. 13-cv-119, 2014 WL 234207, at*5 (N.D. Cal. Jan. 21, 2014) (“Rule

7

11 sanctions are appropriate if the allegations and other factual contentions entirely lack

8

evidentiary support.” (citation and internal quotation marks omitted)). Indeed, the factual

9

contentions did not entirely lack evidentiary support; the Court merely concluded that they did not

10

rise to the level required by the PSLRA.
The fact that Plaintiffs’ complaint was unsuccessful is not enough to warrant Rule 11

United States District Court
Northern District of California

11
12

sanctions. See In re Tesla Motors, Inc. Sec. Litig., No. 13-cv-5216, 2015 WL 1306490 (N.D. Cal.

13

Mar. 23, 2015) (denying motion to amend judgment by imposing sanctions despite having granted

14

defendants’ motion to dismiss). Accordingly, the Court DENIES Defendants motion to amend the

15

judgment.2
IT IS SO ORDERED.

16
17
18

Dated: March 6, 2017
______________________________________
BETH LABSON FREEMAN
United States District Judge

19
20
21
22
23
24
25
26
2

27
28

Plaintiffs ask that the Court order Defendants to pay their attorneys’ fees that were incurred in
opposing Defendants’ request for sanctions. Opp’n 23. The Court declines to exercise its
discretion in this manner, finding that Defendants properly presented valid concerns to the Court,
and DENIES Plaintiffs’ request.
6