Heiss v. A123 Systems Inc. et al

Filing 51

Judge Richard G. Stearns: ORDER entered granting 37 Motion to Dismiss, but granting motion to file Second Amended Complaint within twenty-one days of this Order. (Zierk, Marsha)

UNITED STATES DISTRICT COURT
DISTRICT OF MASSACHUSETTS
CIVIL ACTION NO. 12-10591-RGS
IN RE A123 SYSTEMS, INC. SECURITIES LITIGATION

MEMORANDUM AND ORDER ON
DEFENDANTS’ MOTION TO DISMISS
THE CONSOLIDATED AMENDED COMPLAINT
March 14, 2013
STEARNS, D.J.
This putative class action is brought by Suk Cheung, Scott Heiss, and Michael
Zoitas on behalf of all persons and entities who purchased the common stock of A123
Systems, Inc. (A123), between February 28, 2011, and March 26, 2012. The proposed
class was allegedly duped by misrepresentations disseminated by defendants in
violation of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, and
Rule 10b-5. Defendants are former high ranking officers of A123: David P. Vieau,
Chief Executive Officer; David J. Prystash, Chief Financial Officer; and John R.
Granara III, Interim Chief Financial Officer.1 Defendants now move to dismiss the

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A123 Systems, Inc., is named separately as a defendant, but the case against it
was automatically stayed when the company filed for bankruptcy protection. See 11
U.S.C. § 362. On January 29, 2013, A123 Systems LLC, a wholly owned subsidiary
of Wanxiang America Corporation, acquired the non-government business assets of
A123.

Consolidated Amended Complaint on the grounds that it fails to allege: (1) any
actionable omission or misstatement; (2) scienter; or (3) loss-related causation.
BACKGROUND
The facts, in the light most favorable to plaintiffs as the non-moving parties, are
as follows. A123 Systems, Inc. manufactured and sold rechargeable lithium ion
batteries and battery systems. Am. Compl. ¶ 2. The bulk of A123’s sales were in the
transportation sector where its battery systems were designed to power electric
vehicles. Id. ¶ 40; Def.’s Ex. B at 1.2 A123 supplied batteries to BMW, General
Motors, Daimler, and Fisker Automotive, among other manufacturers. Am. Compl. ¶
40; Def.’s Exs. B & C at 1. The A123 “flagship product” was the AMP20 Lithium Ion
Prismatic Cell (prismatic battery). Am. Compl. ¶ 38. Unlike ordinary batteries,
prismatic cell batteries are flat and, as the name implies, shaped like a prism. Id. The
prismatic cells are wired in a series, which are in turn wired in parallel and welded
together. Id. As described by A123, the prismatic battery was “built to deliver high
energy and power density combined” and “demonstrates industry-leading abuse
tolerance coupled with excellent life performance under the most rigorous duty cycles.”
Id. ¶ 39.
In January of 2010, A123 entered into a multi-year contract with Fisker to supply
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The court cites defendants’ exhibits referenced in the Complaint.
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prismatic batteries for the Fisker Karma, a new high-performance sports car. Id. ¶ 42.
Fisker chose A123 as the battery supplier “because of the company’s ability to meet
[its] performance needs and rapidly scale to [its] production volume . . . .” Id.; Def.’s
Ex. D. In tandem with the announcement of the supply agreement, A123 invested over
twenty million dollars in cash and stock in Fisker to “closely align the interests of both
companies.” Def.’s Ex. D. Prior to negotiating the Fisker contract, A123 suffered net
losses of $80 million in 2008, $87 million in 2009, and, in 2010, an even larger loss of
$153 million. Am. Compl. ¶ 45. Against this backdrop, Fisker became A123’s largest
customer, expected by A123 to account for nearly one quarter of its anticipated revenue
in 2011. Id. ¶ 41.

In a press release dated August 4, 2011, defendant Vieau

announced that revenue in the second quarter of 2011 had doubled “due largely to the
fact that [A123] started shipping prismatic modules and packs in volume to Fisker and
Smith Electric Vehicles.” Id. ¶ 88. In a conference call discussing the second quarter
results, A123’s management professed its belief that the partnership with Fisker was
the key to A123’s future growth. Id. ¶¶ 90, 92.
The prismatic batteries were manufactured at A123’s Livonia, Michigan facility.
Id. ¶ 83; Def.’s Ex. D. The Livonia plant, one of two new A123 facilities located in
Michigan, opened on September 13, 2010. Throughout 2010 and 2011, the plant was
in the process of “ramp[ing] up” its prismatic cell production capacity, in part to meet
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the demands of the Fisker supply agreement. Def’s. Br. at 3; Def’s Ex. C at 77.
During this period, the Livonia facility increased battery production from 1,000 to
11,000 cells per day. Am. Compl. ¶ 54.
On November 4, 2011, A123 revised its 2011 revenue guidance downward by
twenty-two percent “due to an unexpected reduction in orders for battery packs from
Fisker for the fourth quarter as it balances inventory levels from all suppliers.” Def.’s
Ex. O. Vieau characterized the reduction as “temporary,” and stated that “[A123’s]
relationship with Fisker remains strong . . . .” Id. A123’s stock price dropped another
ten pecent after the revision was made public. Am. Compl. ¶ 94. On December 21,
2011, the National Highway Transport Safety Association announced that Fisker was
recalling all of the 239 Karma vehicles manufactured between July 1, 2011, and
November 3, 2011, because of a defect in a hose clamp in the A123 battery. Id. ¶ 103.
On March 8, 2012, Consumer Reports issued a critical review of a prototype of
the Fisker Karma, noting that during testing the vehicle’s “dashboard flashed a message
and sounded a ‘bing’ showing a major default,” and that despite attempts at repair, the
Karma proved inoperable and had to be towed. Id. ¶ 108; Def.’s Ex. H. Further
investigation pinpointed the prismatic battery as the cause of the breakdown. Am.
Compl. ¶ 114. On March 26, 2012, A123 issued a press release stating that it had
“discovered that some prismatic cells made in [its] Livonia facility may contain a defect
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which can result in premature failure of a battery pack or module that includes a
defective cell.” Id. The company announced that it had “launched a field campaign to
replace battery modules and packs that may contain defective prismatic cells produced
at A123’s Livonia, Mich. manufacturing facility.” Id. The cost of the recall was
estimated at $55 million, approximately one quarter of A123’s projected annual
revenue for 2012. Id. A123's stock price dropped twelve percent on the day of this
disclosure. Id. ¶ 117. Two days later, the stock fell another thirteen percent after
Deutsche Bank downgraded A123's rating from a “buy” to a “hold.” Id. ¶¶ 118, 119.
This lawsuit was filed one week later.
DISCUSSION
To sustain a claim for securities fraud under Section 10(b) and Rule 10b-5 a
plaintiff must satisfactorily plead six elements: “(1) a material misrepresentation or
omission; (2) scienter, or a wrongful state of mind; (3) a connection with the purchase
or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation.” City of
Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters Corp., 632 F.3d 751, 756
(1st Cir. 2011). In addition to these skeletal requirements, allegations of securities
fraud must also meet the heightened pleading standard set out in the Private Securities
Litigation Reform Act of 1995 (PSLRA) and Federal Rule of Civil Procedure 9(b). The
PSLRA standard is “congruent and consistent” with the First Circuit’s “rigorous”
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interpretation of the pleading requirements of Rule 9(b). Greebel v. FTP Software,
Inc., 194 F.3d 185, 193 (1st Cir. 1999).
A. PSLRA Pleading Requirements
The PSLRA requires that a complaint alleging a material misrepresentation or
omission “specify each statement alleged to have been misleading [and] the reason or
reasons why the statement is misleading.” 15 U.S.C. § 78u-4(b)(1). In explaining why
a statement or omission is misleading, a complaint “must provide some factual support
for the allegations of fraud.” Greebel, 194 F.3d at 193 (internal quotation marks and
citation omitted). This means that a plaintiff must offer “factual allegations that would
support a reasonable inference that adverse circumstances existed at the time of the
offering [of the alleged misrepresentation], and were known and deliberately or
recklessly disregarded by defendants.” Id. at 193-194 (internal quotation marks and
citation omitted).
The PSLRA further requires that a securities fraud complaint “state with
particularity facts giving rise to a strong inference that the defendant acted with the
required state of mind.” 15 U.S.C. §78u-4(b)(2). This required state of mind is known
as scienter, a “mental state embracing intent to deceive, manipulate, or defraud.”
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007) (internal
quotation marks and citation omitted). To make out scienter, a plaintiff must establish
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that “defendants consciously intended to defraud, or that they acted with a high degree
of recklessness.” New Jersey Carpenters Pension & Annuity Funds v. Biogen IDEC
Inc., 537 F.3d 35, 44 (1st Cir. 2008) (internal quotation marks and citation omitted).
Scienter under the recklessness standard requires “a highly unreasonable omission,
involving not merely simple, or even inexcusable, negligence, but an extreme departure
from the standards of ordinary care, and which presents a danger of misleading buyers
or sellers that is either known to the defendant or is so obvious the actor must have
been aware of it.” Greebel, 194 F.3d at 198, quoting Sundstrand Corp. v. Sun Chem.
Corp., 553 F.2d 1033, 1045 (7th Cir. 1977). Moreover, an inference of scienter will
“not survive if [it is] merely reasonable.” Id. at 195. A “strong” inference of scienter
“must be more than merely plausible or reasonable – it must be cogent and at least as
compelling as any opposing inference of nonfraudulent intent.” Tellabs, 551 U.S. at
314.
B. Defendants’ Alleged Misrepresentations
Plaintiffs have identified a number of statements made by defendants that they
allege were materially misleading. The statements fall into three general categories: (1)
those expressing confidence in the market demand for the A123 prismatic batteries; (2)
those touting the superior quality and supposed safety of the A123 battery design; and
(3) those crowing over A123’s partnering with Fisker in the production of the Karma
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electric sports car. A fair sampling of these statements includes:
(1) Vieau’s pronouncement in the February 28, 2011 press release that
A123 “continue[s] to be optimistic about the expected long-term demand
for advanced battery systems, as well as A123’s technology and market
leadership position.” Am. Compl. ¶ 81.
(2) The assertion made in the Form10-K filed by A123 on March 11,
2011, that the Livonia plant “is designed to enable the . . . manufacturing
of high-value components,” and the further representations that: “Our
battery systems are highly engineered to incorporate safety and control
features that extend life and improve performance. Module-level fusing,
temperature sensing and other safety controls provide against containment
safeguards to isolate and protect against cell-level failure. Active
overvoltage protection provides monitoring and balancing of individual
series elements to protect cells from abuse and to extend life.” Id. ¶ 83.
(3) Vieau’s statement in the November 4, 2011 press release announcing
the downward revision of the 2011 revenue guidance attributing the
disappointing results “to an unexpected reduction in orders for battery
packs from Fisker Automotive for the fourth quarter as it balances
inventory levels from all suppliers.” In the same press release, Vieau also
stated: “Our relationship with Fisker remains strong, and we expect that
this reduction in volume is temporary . . . .” Id. ¶¶ 94, 95.
(4) Vieau’s statement in an earnings call on March 8, 2012, following
Fisker’s recall of the Karma vehicles, that the “root cause” of the battery
problems was an incorrectly positioned hose clamp that “certainly had
nothing to do with the integrity of the packs themselves or the cells or the
systems.” Id. ¶ 109.
Plaintiffs contend that all of A123’s statements shared the same fatal defect:
A123 “failed to disclose that the Company’s Prismatic Batteries were flawed; the
process for manufacturing the Prismatic Batteries at its Livonia, Michigan facility was

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flawed; the flawed process resulted in defective Prismatic Batteries; and the defective
nature of the batteries had a significant and material adverse impact on the Company’s
revenue and expenses and jeopardized its relationship with its customers.” Id. ¶¶ 84,
87, 91, 93, 96, 100, 104, 106, 113. According to unnamed sources, the manufacturing
process at the Livonia plant was flawed from the outset. Id. ¶¶ 56, 57. Although the
plant was producing substandard prismatic cells, A123 continued to increase
production to meet Fisker’s demands. Id. ¶ 57. In the attempt to keep pace, the
Livonia facility “ignored and discarded” any semblance of quality control resulting in
a slew of manufacturing errors that ultimately caused the batteries to fail. See id. ¶¶ 5079.
C. Defendants’ Knowledge of the Livonia Plant’s Flawed Manufacturing Process
Assuming for present purposes that plaintiffs’ allegations about the shoddy
manufacturing process at the Livonia facility are true, the dispositive issue is whether
the named defendants had knowledge of (or were recklessly blind to) the impending
quality collapse. “A statement cannot be intentionally misleading if the defendant did
not have sufficient information at the relevant time to form an evaluation that there was
a need to disclose certain information and to form an intent not to disclose it.” New
Jersey Carpenters, 537 F.3d at 45. Whether analyzed in terms of an “actionable
misstatement,” as the parties do here, or as a component of the scienter requirement,
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a viable complaint must establish that defendants were or should have been aware of
the facts making their statements misleading at the time the statements were made.
“Simply pleading that the defendant knew of the falsity, without providing any factual
basis for that knowledge, does not suffice.” Ezra Charitable Trust v. Tyco Int’l Ltd.,
466 F.3d 1, 12-13 (1st Cir. 2006) (citation omitted).
Plaintiffs allege that defendants must have known that the manufacturing process
at the Livonia plant was flawed because the defects “were so obvious and pervasive
that Defendants either had to have known about them, or, at the very least, recklessly
disregarded them.” Pl.’s Br. at 6. According to plaintiffs, the argument for imputed
knowledge is augmented by the fact that the Fisker relationship was crucial to A123’s
survival as a going concern. Id. at 18. Plaintiffs cite a case from this district for the
proposition that “[f]acts critical to a business’s core operations or an important
transaction generally are so apparent that their knowledge may be attributed to the
company and its officers.” Crowell v. Ionics, Inc., 343 F. Supp. 2d 1, 19 (D. Mass.
2004) (Young, J.), citing Epstein v. Itron, Inc., 993 F. Supp. 1314, 1326 (E.D. Wash.
1998).3 Crowell, the only case of which I am aware that relies on the “core operations”
theory to impute knowledge to defendants in a securities case, involved allegations of
3

The proposition also appears as dicta in Chalverus v. Pegasystems, Inc., 59 F.
Supp. 2d 226, 235 (D. Mass. 1999) (Young, J.), but in that case the defendants did not
argue that they were unaware of the facts giving rise to the alleged fraud.
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the improper booking and accounting of fraudulent sales, buttressed by a “plus factor”
– an email pointing to the company’s vice president as the author of the scheme. 343
F. Supp. 2d at 19. Compare Lenartz v. Am. Superconductor Corp., 879 F. Supp. 2d
167, 183 n.9 (D. Mass. 2012) (Young, J.) (finding the core operations theory
inapplicable in an accounting fraud case where the questionable client accounted for
over seventy percent of the company’s revenue because the facts were “less clear”
than the “particularized facts” of Crowell).
Plaintiffs suggest two avenues by which information about the flaws in the
Livonia manufacturing process might have percolated upward to defendants. The first,
however, is merely hypothesized. The anonymous witnesses state that Lou Golato,
A123's Vice-President of Operations, and a member of the company’s executive
committee, had oversight of the Livonia plant and was “well-aware of the defects that
riddled the Prismatic Batteries.” Pl.’s Br. at 11. Because Golato “reported to the
[i]ndividual defendants,” Pl.’s Br. at 4, plaintiffs maintain that they must have been
aware of the escalating problems with the batteries coming out of the Livonia facility.
While the anonymous sources might at best be credited with first-hand information
about what Golato knew, there is no plausible suggestion that they would have known
what Golato (who might have had his own reasons for covering up the problems at
Livonia) may have told the defendants. See In re Vertex Pharm. Inc., Sec. Litig., 357
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F. Supp. 2d 343, 353 (D. Mass. 2005) (plaintiffs’ allegations not pled with particularity
because confidential witnesses did not have personal knowledge of facts alleged); see
also Lirette v. Shiva Corp., 27 F. Supp. 2d 268, 283 (D. Mass. 1998), citing
Maldonado v. Dominguez, 137 F.3d 1, 9 (1st Cir. 1998) (“[G]eneral inferences that the
defendants, by virtue of their position within the company, ‘must have known’ about
the company’s problems when they undertook allegedly fraudulent actions . . . [are]
inadequate to withstand the special pleading requirements in securities fraud cases.”).
The only facts plaintiffs allege suggesting that at least one of the defendants
(Vieau) might have had direct knowledge of the problems at the Livonia plant relate to
a meeting in early 2011 attended by Vieau in which one of the confidential witnesses
“discussed issues concerning the Company’s manufacturing process and made
suggestions to improve those areas . . . .” Pl.’s Br. at 4. As an initial matter, this bland
summary statement that an unnamed person in no specified position of authority “made
suggestions” about the manufacturing process that Vieau may or may not have heard
(or paid attention to) is a meager fount for even a whiff of a fraudulent scheme, much
less a particularization of its details. See In re Cabletron Sys., Inc., 311 F.3d 11, 29-30
(1st Cir. 2002) (whether unattributed facts provide an adequate basis for believing that
a securities defendant’s statements were false requires “an evaluation, inter alia, of the
level of detail provided by the confidential sources”) (emphasis added)); cf. New
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Jersey Carpenters, 537 F.3d at 51 (confidential witnesses must be “described in the
complaint with sufficient particularity to support the probability that a person in the
position occupied by the source would possess the information alleged”). This is
especially so here, where plaintiffs trot out only one instance attributed to an unnamed
witness supporting the proposition that one of the defendants must have known of
incipient problems at the Livonia facility that would not be fully manifest until well over
a year later when the plant’s production lines began to churn. See In re Pharm., Inc.
Sec. Litig., 2007 WL 951695, at *19 n.14 (D. Mass. Mar. 28, 2007) (allegation that a
confidential witness informed management that a pricing structure was flawed did not
adequately plead scienter because “more than that would be needed to support an
allegation that management itself knew the structure to be flawed, as opposed to
knowing simply that someone else (of unclear qualifications) thought that to be the
case”).
In sum, plaintiffs have failed to meet their burden of pleading fraud against the
individual defendants with the particularity demanded by the PSLRA and Fed. R. Civ.
P. 9(b). Consequently, the Section 10(b) claim will be dismissed.
D. Control Person Liability under Section 20(a)
To establish a Section 20(a) claim, a plaintiff must plead: (1) an underlying
violation by a controlled person or entity; and (2) that a defendant controlled the
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violator. Aldridge v. A. T. Cross Corp., 284 F.3d 72, 85 (1st Cir. 2002). Because
plaintiffs have failed to adequately allege a violation of Section 10(b), their derivative
claim under Section 20(a) necessarily fails. See Suna v. Bailey Corp., 107 F.3d 64, 72
(1st Cir. 2002).
E. Leave to Amend Complaint
In the event of dismissal, plaintiffs request leave to further amend the
Consolidated Amended Complaint. “Leave to amend is to be ‘freely given,’ Fed. R.
Civ. P. 15(a), unless it would be futile, or reward, inter alia, undue or intended delay.”
Resolution Trust Corp. v. Gold, 30 F.3d 251, 253 (1st Cir. 1994) (citations omitted).
While futility is a close question given the paucity of detail supporting any allegation
of fraud that plaintiffs have managed thus far to assemble (as evidenced by the meager
allegations in the current Complaint), Rule 15 counsels permitting a third bite at the
apple at this early stage of the litigation. Consequently, the motion for leave to file an
amended complaint will be granted.
ORDER
For the foregoing reasons, defendants’ motion to dismiss the Consolidated
Amended Complaint is ALLOWED. Plaintiffs’ motion to file a Second Amended
Complaint is GRANTED. The Second Amended Complaint will be filed on or
before April 4, 2013.
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SO ORDERED.
/s/ Richard G. Stearns
_______________________________
UNITED STATES DISTRICT JUDGE

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