Steven Taormina v. Annie's, Inc. et al

Filing 58

ORDER GRANTING 37 MOTION TO DISMISS WITH LEAVE TO AMEND; AND GRANTING 49 MOTION TO STRIKE. Signed by Judge Beth Labson Freeman on 4/16/2015. (blflc1, COURT STAFF) (Filed on 4/16/2015)

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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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STEVEN TAORMINA, et al.,

Case No. 14-cv-02711-BLF

Plaintiffs,
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v.
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ANNIE’S, INC., et al.,
Defendants.

ORDER GRANTING MOTION TO
DISMISS WITH LEAVE TO AMEND;
AND GRANTING MOTION TO STRIKE
[Re: ECF 37, 49]

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United States District Court
Northern District of California

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Before the Court are (1) Defendants’ motion to dismiss Plaintiffs’ consolidated class action

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complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) and (2) Plaintiffs’ motion to strike

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the supplemental declaration of Meaghan Banks-Innes filed in support of Defendants’ reply to

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Plaintiffs’ opposition to the motion to dismiss. The Court has considered the briefing and the oral

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argument presented at the hearing on March 26, 2015. For the reasons discussed below, the

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motion to dismiss is GRANTED WITH LEAVE TO AMEND and the motion to strike is

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GRANTED.

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I.

BACKGROUND
Lead Plaintiffs Vladislav Kandinov and Enhanced Life Partnership bring this securities

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fraud class action on behalf of those who purchased stock in Defendant Annie’s, Inc. (“the

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Company”) between June 10, 2013 and June 3, 2014 (“the Class Period”). Consol. Compl. ¶ 1.

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The Company manufactures, markets, and distributes organic food products. Id. ¶ 2. It became

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publicly listed on the New York Stock Exchange on March 28, 2012 and traded under the ticker

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symbol “BNNY.” Defendant John Foraker (“Foraker”) was the Chief Executive Officer (“CEO”)

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and a director of the Company during the Class Period; Defendant Kelly Kennedy (“Kennedy”)

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was the Chief Financial Officer (“CFO”) until November 12, 2013; and Defendant Zahir Ibrahim

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(“Ibrahim”) was the CFO from November 13, 2013 through the end of the Class Period. Id. ¶¶ 16-

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Plaintiffs claim that Defendants’ public statements and filings with the Securities and

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Exchange Commission (“SEC”) contained false and misleading statements of material fact and

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omitted other material facts relating to (1) the Company’s accounting practices regarding

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promotional incentives and (2) the adequacy of its internal controls over financial reporting.

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Consol. Compl. ¶ 22. Those claims are based upon the following allegations: the Company used

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promotional programs, targeted around the back-to-school and spring seasons, in which the

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Company offered its customers incentives such as price discounts, consumer coupons, volume

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rebates, cooperative marketing programs, slotting fees, and in-store displays. Id. ¶ 29. In its
quarterly and annual financial reports filed with the SEC, the Company represented that it

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accounted for the cost of its promotional programs by estimating those costs and recording them

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as a reduction of sales. Id. ¶ 31. In fact, the Company’s methodology failed to capture all trade

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promotion costs. Id. ¶ 32. As a result, the Company’s financial statements were false and

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misleading because they failed to provide the Company’s true net income. Id. ¶¶ 50, 56, 59, 65,

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68, 74, 77, 83. The financial statements also were false and misleading because they represented

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that the Company’s internal controls over financial reporting were reliable when in fact they were

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not. Id. ¶¶ 56, 65, 74, 83. The Company’s accounting practices with respect to recognizing trade

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promotion costs violated generally accepted accounting principles (GAAP”). Id. ¶ 3.
The Company’s misstatements and omissions were made public in a press release issued

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May 29, 2014, an earnings conference call later in the day on May 29, 2014, and SEC filings

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submitted between June 2, 2014 and June 14, 2014.1 Consol. Compl. ¶¶ 84-104. In particular,

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Plaintiffs point to the Company’s statements that: its historical methodology for estimating certain

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trade expenses had not taken into account trade promotional activities conducted by customers

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after quarter end but related to sales activities occurring prior to quarter end; the methodology had

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been revised; and the revision of the methodology had resulted in higher trade expenses that were

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The Court notes that a number of those disclosures occurred before the end of the Class Period,
which is alleged to be June 10, 2013 through June 3, 2014.
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reflected as a reduction in net sales. Id. ¶¶ 84-85, 88, 91. The Company stated that it did not

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consider the financial impact of the change in methodology to be material to any prior financial

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statements under accounting guidelines, but that the change in methodology resulted in audit

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adjustments and immaterial revisions to the Company’s quarterly and year-end financial

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statements for 2012, 2013, and 2014. Id. The Company acknowledged that there was a “material

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weakness” in its internal control over financial reporting, and stated that it had taken remedial

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steps to address the issues that gave rise to the material weakness classification, including

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engaging an external audit firm to assist with the Company’s internal audit and internal controls

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function, and establishing a controls committee that would include board members and senior

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management. Id. The Company also stated that its outside auditor, PricewaterhouseCoopers

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Northern District of California

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(“PwC”), would be resigning effective August 11, 2014 or upon completion of the Company’s

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filing of its Form 10-Q for the period ending June 30, 2014, whichever was earlier. Id. ¶ 103.
This class action was filed on June 11, 2014 and the operative Consolidated Complaint was

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filed on October 22, 2014. Plaintiffs assert claims for (1) securities fraud under § 10(b) of the

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Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 of the Securities and

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Exchange Commission (“SEC”) and (2) controlling person liability under § 20(a) of the Exchange

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Act.

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II.

LEGAL STANDARD

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A.

Rule 12(b)(6)

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“A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a

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claim upon which relief can be granted ‘tests the legal sufficiency of a claim.’” Conservation

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Force v. Salazar, 646 F.3d 1240, 1241-42 (9th Cir. 2011) (quoting Navarro v. Block, 250 F.3d

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729, 732 (9th Cir. 2001)). When determining whether a claim has been stated, the Court accepts

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as true all well-pled factual allegations and construes them in the light most favorable to the

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plaintiff. Reese v. BP Exploration (Alaska) Inc., 643 F.3d 681, 690 (9th Cir. 2011). However, the

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Court need not “accept as true allegations that contradict matters properly subject to judicial

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notice” or “allegations that are merely conclusory, unwarranted deductions of fact, or

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unreasonable inferences.” In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008)
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(internal quotation marks and citations omitted). While a complaint need not contain detailed

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factual allegations, it “must contain sufficient factual matter, accepted as true, to ‘state a claim to

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relief that is plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl.

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Corp. v. Twombly, 550 U.S. 544, 570 (2007)). A claim is facially plausible when it “allows the

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court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id.

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B.

Rule 9(b) and PSLRA

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In addition to the pleading standards discussed above, a plaintiff asserting a private

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securities fraud action must meet the heightened pleading requirements imposed by Federal Rule

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of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 (“PSLRA”). In
re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694, 701 (9th Cir. 2012). Rule 9(b) requires a

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plaintiff to “state with particularity the circumstances constituting fraud. . . .” Fed. R. Civ. P. 9(b);

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see also In re VeriFone Holdings, 704 F.3d at 701. The PSLRA requires that “the complaint shall

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specify each statement alleged to have been misleading, [and] the reason or reasons why the

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statement is misleading. . . .” 15 U.S.C. § 78u–4(b)(1)(B). The PSLRA further requires that the

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complaint “state with particularity facts giving rise to a strong inference that the defendant acted

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with the required state of mind.” 15 U.S.C. § 78u–4(b)(2)(A). “To satisfy the requisite state of

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mind element, a complaint must allege that the defendant[ ] made false or misleading statements

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either intentionally or with deliberate recklessness.” In re VeriFone Holdings, 704 F.3d at 701

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(internal quotation marks and citation omitted) (alteration in original). The scienter allegations

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must give rise not only to a plausible inference of scienter, but to an inference of scienter that is

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“cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs,

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Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007).

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III.

DISCUSSION
Defendants move to dismiss the Consolidated Complaint for failure to meet the pleading

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requirements for both the § 10(b) claim and the § 20(a) claim. The Court indicated at the hearing

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that it would grant the motion to dismiss with leave to amend based upon the lack of adequate

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factual allegations on the key issue of scienter. The Court granted Plaintiffs until May 29, 2015 –

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approximately sixty days from the date of the hearing – within which to file an amended pleading.
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Plaintiffs’ counsel indicated that he understood the Court’s comments and stated that he could

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provide additional factual allegations. This order is intended to highlight the areas of primary

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concern to the Court.

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A.

Claim 1 - Section 10(b) and Rule 10b-5

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“To state a securities fraud claim, plaintiff must plead: (1) a material misrepresentation or

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omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or

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omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or

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omission; (5) economic loss; and (6) loss causation.” Reese v. Malone, 747 F.3d 557, 567 (9th

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Cir. 2014) (internal quotation marks and citation omitted). Defendants contend that Plaintiffs have

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not alleged facts adequate to satisfy the first two elements.
With respect to the first element, the “materiality requirement is satisfied when there is a

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substantial likelihood that the disclosure of the omitted fact would have been viewed by the

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reasonable investor as having significantly altered the total mix of information made available.”

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Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1318 (2011) (internal quotation marks and

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citation omitted). Based upon Plaintiffs’ allegations, the Company’s true net income for the

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relevant quarters, using the Company’s revised methodology for recognizing promotional

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expenses, was approximately: 8.7% less than reported for the fourth quarter of fiscal year 2013;

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7% more than reported for the first quarter of fiscal year 2014; 6% less than reported for the

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second quarter of fiscal year 2014; and 0.7% less than reported for the third quarter of fiscal year

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2014. Consol. Compl. ¶¶ 50, 56, 59, 65, 68, 74, 77, 83. Defendants argue that those discrepancies

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are so minor that they would not have significantly altered the total mix of information, especially

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in light of other revisions to the Company’s financials. “Determining materiality in securities

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fraud cases should ordinarily be left to the trier of fact.” SEC v. Phan, 500 F.3d 895, 908 (9th Cir.

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2007) (internal quotation marks and citation omitted). The Court cannot conclude as a matter of

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law that a reasonable investor would not have viewed the alleged discrepancies to be material.

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With respect to the alleged misstatements regarding the adequacy of the Company’s

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internal control over financial reporting and compliance with GAAP, Defendants argue that the

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statements are couched as opinions and thus that they must be analyzed in light of the United
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States Supreme Court’s recent decision, Omnicare, Inc. v. Laborers Dist. Council Const. Indus.

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Pension Fund, 135 S. Ct. 1318 (2015). In Omnicare, the Supreme Court, reviewing § 11 of the

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Securities Act of 1933, clarified the circumstances under which a company can be liable for

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statements of opinion contained in a registration statement. The Supreme Court held that “a

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statement of opinion is not misleading just because external facts show the opinion to be

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incorrect” so long as the opinion is honestly believed. Id. at 1328. The discussion of materiality

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in Omnicare was limited to the second prong of § 11 regarding omissions. Thus while the Court

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agrees with Defendants that some of the statements regarding the Company’s financial controls

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were couched as opinions, the Court cannot conclude at this stage in the proceedings that the
statements were not materially misleading. Plaintiffs may amend to address the concerns raised in

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Omnicare.

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Turning to the second element, scienter, the Court finds Defendants’ factual allegations to

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be inadequate. The Court agrees with Defendants that as presently pled this case is

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indistinguishable in all relevant respects from Zucco Partners, LLC v. Digimarc Corp., 552 F.3d

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981 (2009). As noted at the hearing, the Court was surprised by Plaintiffs’ failure to address

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Defendants’ moving arguments based upon Zucco in their opposition to the motion to dismiss.

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The Court trusts that in amending their pleading, Plaintiffs will supply factual allegations that

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address the pleading requirements outlined in Zucco.

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As in Zucco, Plaintiffs here rely heavily upon information obtained from confidential

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witnesses (“CWs”). However, while some of Plaintiffs’ CWs are “described with sufficient

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particularity to establish their reliability and personal knowledge,” see Zucco, 552 F.3d at 995, as

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in Zucco the statements reported by the CWs are not themselves indicative of scienter, see id. For

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example, while CW5 is described as Vice President of Finance and Accounting, reporting directly

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to Foraker and Kennedy, Consol. Compl. ¶ 38, CW5’s statements that “Defendants Foraker and

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Kennedy had full knowledge of BNNY’s accounting and finance controls,” id., are too vague and

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general to give rise to a strong inference that Defendants made false or misleading statements

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either intentionally or with deliberate recklessness. See Zucco, 552 F.3d at 998.

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Nor do Plaintiffs’ allegations regarding revised financials give rise to the necessary strong
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inference of scienter. See Zucco, 552 F.3d at 1000 (“In general, the mere publication of a

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restatement is not enough to create a strong inference of scienter.”). Plaintiffs do not allege any

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contemporaneous facts suggesting that the Individual Defendants believed at the time that the

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methodology used to account for promotional costs was inappropriate, or that the Company’s

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internal controls were insufficient.

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Plaintiffs’ allegations regarding the resignations of Kennedy and PwC likewise are

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insufficient to suggest the requisite mental state. “Although resignations, terminations, and other

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allegations of corporate reshuffling may in some circumstances be indicative of scienter, . . .

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“[w]here a resignation occurs slightly before or after the defendant corporation issues a
restatement, a plaintiff must plead facts refuting the reasonable assumption that the resignation

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occurred as a result of restatement’s issuance itself in order for a resignation to be strongly

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indicative of scienter.” Zucco, 553 F.3d at 1002. As the court observed in Zucco, “the resignation

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of KPMG as Digimarc’s independent accounting firm a month after the restatement was issued is

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not surprising – it had just been partially responsible for the corporation’s failure to adequately

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control its accounting procedures.” Id. Plaintiffs have not alleged facts suggesting that PwC did

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not have a similar motive for resignation in the present case. They likewise have failed to allege

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facts suggesting a suspicious reason for Kennedy’s resignation. See id. (“For other resignations

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occurring during the relevant time period, a plaintiff must allege sufficient information to

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differentiate between a suspicious change in personnel and a benign one.”).

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Nor do the Individual Defendants’ stock sales suggest the requisite mental state. Although

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Plaintiffs allege that the Individual Defendants sold stock at “artificially inflated prices” during the

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Class Period, Consol. Compl. ¶ 142, Plaintiffs do not allege facts showing that those sales were

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“dramatically out of line with prior trading practices at times calculated to maximize the personal

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benefit from undisclosed inside information,” Police Ret. Sys. of St. Louis v. Intuitive Surgical,

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Inc., 759 F.3d 1051, 1063 (9th Cir. 2014) (internal quotation marks and citation omitted). With

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respect to Plaintiffs’ allegations that Foraker and Kennedy were motivated to make the alleged

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misrepresentations in order to receive bonuses, it is unclear from the allegations in the

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Consolidated Complaint that they obtained substantially greater bonuses than they would have
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absent the alleged misrepresentations.

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The Court notes that Defendants’ supplemental declaration of Meaghan E. Banks-Innes,

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containing mathematical calculations regarding the bonuses, is the subject of a motion to strike

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brought by Plaintiffs. The supplemental declaration is procedurally improper, as it constitutes

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evidence and/or additional argument. The motion to strike the declaration likewise is procedurally

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improper, as it was filed late. Because the material in the declaration is inappropriate for

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consideration on a Rule 12(b)(6) motion, the Court hereby GRANTS the motion to strike despite

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the fact that it was not timely filed.
In summary, the Court concludes that even viewed holistically as required under Tellabs,

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Plaintiffs’ allegations do not give rise to a strong inference of scienter that is at least as compelling

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as an inference of nonfraudulent conduct. Accordingly, the Court hereby GRANTS the motion to

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dismiss with leave to amend.

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B.

Section 20(a) (Claim 2)

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Section 20(a) provides that “[e]very person who, directly or indirectly, controls any person

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liable under any provision of this chapter or of any rule or regulation thereunder shall also be

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liable jointly and severally with and to the same extent as such controlled person.” A plaintiff

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suing under § 20(a) must demonstrate: (1) “a primary violation of federal securities laws” and (2)

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“that the defendant exercised actual power or control over the primary violator.” Howard v.

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Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). Because Plaintiffs have failed to state a

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claim for a primary violation of the securities laws, they likewise have failed to state a claim for

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violation of § 20(a) of the Exchange Act.

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IV.

ORDER

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For the foregoing reasons, IT IS HEREBY ORDERED that:

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(1)

The motion to dismiss is GRANTED WITH LEAVE TO AMEND;

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(2)

Any amended complaint shall be filed on or before May 29, 2015; and

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(3)

The motion to strike is GRANTED.

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Dated: April 16, 2015

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BETH LABSON FREEMAN
United States District Judge
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