Wallace v. Intralinks Holdings, Inc. et al
Filing
63
OPINION re: 53 MOTION to Dismiss Consolidated Class Action Complaint. filed by Credit Suisse Securites (USA) LLC, Deutsche Bank Securities Inc., Pacific Crest Securities LLC, Lazard Capital Markets LLC, Morgan Stanley & Co. Incorporated, Jef feries & Company, Inc., 43 MOTION to Dismiss (Notice of Motion by Defendants Intralinks Holdings, Inc., The Officer Defendants and the Director Defendants to Dismiss Lead Plaintiff's Consolidated Class Action Complaint). MOTION to Dism iss (Notice of Motion by Defendants Intralinks Holdings, Inc., The Officer Defendants and the Director Defendants to Dismiss Lead Plaintiff's Consolidated Class Action Complaint). filed by Habib Kairouz, Patrick J. Wack, Jr., Robert C. McBride, Thomas Hale, Intralinks Holdings, Inc., Brian J. Conway, Peter Gyenes, Anthony Plesner, Andrew Damico, Harry D. Taylor. For the aforementioned reasons the motion to dismiss is denied.(Signed by Judge Thomas P. Griesa on 5/08/2013) (ama)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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WILLIAM D. WALLACE ET AL.
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:
Plaintiffs,
:
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– against –
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INTRALINKS ET AL.
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Defendants.
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OPINION
11 CV 8861 (TPG)
Plaintiffs bring this federal securities class action against IntraLinks
Holdings, Inc.’s (“IntraLinks”) and IntraLinks’ former CEO and CFO, as well as
the individual signatories and underwriters in IntraLinks’ April 6, 2011
secondary offering. The complaint alleges violations of Sections 10(b) and 20(a)
of the Exchange Act of 1934, and Sections 11, 12(a)(2), and 15 of the Securities
Act of 1933. On July 31, 2012, defendants filed a motion to dismiss the
consolidated class action complaint. 1
Defendants’ motion to dismiss is denied. Plaintiffs state a claim under
all of the causes of action based on the allegation that defendants made false
and misleading statements related to the strength of IntraLinks’ business and
customer satisfaction, without disclosing the impending loss of its largest
customer. However, plaintiffs’ claims that defendants made further false and
The underwriter defendants submitted a separate motion to dismiss on the same day, but the
motion stated it was joining in the other defendants’ motion to dismiss. The two motions to
dismiss will therefore be considered in this opinion as the defendants’ motion to dismiss.
1
1
misleading statements related to overbilling customers and revenue
classification are insufficient to support any of the alleged claims. These latter
allegations fail to state a claim under the Exchange Act of 1934 primarily in
their failure to plead loss causation. The latter allegations are also not alleged
as part of the Securities Act of 1933 claims.
The Complaint
For purposes of deciding the motion to dismiss, the court accepts the
factual allegations in the complaint as true. Ashcroft v. Iqbal, 556 U.S. 662,
678-79 (2009). The defendants challenge many of the allegations based on
information from confidential witnesses. The court however finds that the
complaint provides sufficient information about each confidential witness’s
position and to whom they reported, to support the probability that they
possessed the alleged information. See Novak v. Kasaks, 216 F.3d 300, 314
(2d Cir. 2000). Accordingly, the court also accepts these allegations as true for
the purposes of this motion.
The Parties
The lead plaintiff, Plumbers and Pipefitters National Pension Fund, is a
Taft-Hartley, multiemployer defined benefit pension plan. It brings this federal
securities class action on behalf of itself and all others who purchased or
acquired IntraLinks’ common stock from February 17, 2011 through November
11, 2011 (“class period”), or who purchased IntraLinks’ common stock
2
pursuant to the registration statement governing the April 6, 2011 secondary
offering.
The defendants are divided into two groups according to the causes of
action alleged against them. The “Exchange Act Defendants” include
IntraLinks; Andrew Damico, IntraLinks’ Chief Executive Officer, President, and
director during the class period; and Anthony Plesner, Intralinks’ Chief
Financial Officer and Chief Administrative Officer during the class period. Both
Damcio and Plesner signed all of IntraLinks’ publicly filed documents during
the class period and signed certifications pursuant to the Sarbanes Oxley Act
of 2002, vouching for the truthfulness of IntraLinks’ filings. Damico resigned
from his position on December 15, 2011 and Plesner resigned on May 3, 2012.
The complaint alleges these defendants violated Section 10(b) and 20(a) of the
Exchange Act, and Section 11, 12(a)(2) of Securities Act of 1933.
The “Securities Act Defendants” include IntraLinks and its board
members who signed the registration statement issued for the secondary
offering on April 6, 2011: Chairman of the Board, Patrick Wack, Jr., and
directors Brian Conway, Peter Gyenes, Thomas Hale, Habib Kairouz, Robert
McBride, Harry Taylor, and Damcio. It also includes Plesner, who as CFO and
CAO also signed the registration statement. The complaint alleges these
defendants violated Sections 11 and 12(a)(2) of Securities Act of 1933.
Finally, the “Underwriter Defendants” include all the investment banks
who served as underwriters for IntraLinks’ secondary offering on April 6, 2011:
3
Morgan Stanley & Co. Incorporated, Jefferies & Company, Inc., Lazard Capital
Markets LLC, Credit Suisse Securities (USA) LLC, Deutsche Bank Securities
Inc., and Pacific Crest Securities LLC. The complaint alleges that these
defendants violated Sections 11 and 12(a)(2) of the Securities Act of 1933.
Background on IntraLinks
IntraLinks is a public company with stock trading on the New York Stock
Exchange (“NYSE”). IntraLinks provides “cloud-based” virtual data rooms
(“VDRs”), which are secure web-based workspaces in which customers can
easily share large amounts of sensitive information with specified other
individuals or entities. Historically, IntraLinks’ business was divided between
customers who used VDR services for mergers and acquisitions (“M&A”) and
those who used it for debt capital markets (“DCM”). Its customers were
primarily financial services institutions and banks, and its business model was
based on short-term contracts for project or transaction-specific subscriptions
– typically three to twelve months.
In 2009, with an eye towards a third attempt to take the company
public, 2 IntraLinks sought to diversify its business and seek out larger
corporate clients who had long-term storage needs. It created a new division
called Enterprise which was to include only entities that “used IntraLinks as a
repository, renewing its subscription for longer periods of time.” The
Enterprise division thrived from the outset. In 2009, Enterprise business
2
The complaint alleges that IntraLinks had previously tried two times to take the company public , but was
unsuccessful.
4
represented 40% of IntraLinks’ 2009 revenue. By September 2010, Enterprise
revenue was up 59% year-over-year.
On August 6, 2010, after championing the growth of its Enterprise
business division, IntraLinks went public with an offering of 11 million shares
at a price of $13 per share.
On April 4, 2011, IntraLinks filed a Form S-1/A Registration Statement
with the SEC indicating its intent to sell 7.5 million public shares. On April 6,
2011, IntraLinks filed a prospectus and held a secondary offering where 7.5
million shares were sold at $25.20 per share.
Background on Allegations of Misrepresentations
The complaint alleges that IntraLinks made material misstatements and
omissions relating to three aspects of its business. First, plaintiffs claim that
IntraLinks failed to disclose that its largest customer, the Federal Deposit
Insurance Corporation (“FDIC”), told IntraLinks it would not renew its contract.
Second, plaintiffs allege that IntraLinks misclassified business as Enterprise,
which was more appropriately classified as DCM or M&A. Finally, the
complaint alleges that IntraLinks failed to disclose that it was utilizing
antiquated accounting practices which resulted in overcharging customers by
20-30%.
The facts pertaining to these aspects of IntraLinks’ business, as alleged
in the complaint, will now be described.
5
Loss of FDIC as Customer
In 2000, the FDIC issued a request for proposals (“RFP”) seeking VDR
services. Pursuant to this process, the FDIC selected IntraLinks and signed a
“task order” on October 9, 2000. The task order stated that IntraLinks would
provide the FDIC with VDR services for five years with options to renew.
From 2000 to 2006, the FDIC’s business provided IntraLinks with
revenues between $200,000 and $600,000. Then from 2007 to 2010,
IntraLinks’ revenue from the FDIC dramatically increased to approximately $13
million per year. In 2009, the FDIC was the source of over 23% of revenue in
the Enterprise sector of IntraLinks’ business. In 2010, it was over 15% of
Enterprises’ revenue and over 7% of IntraLinks’ total revenue. In comparison,
the next largest customer constituted less than 2% of IntraLinks’ total revenue.
Given that the FDIC’s use of IntraLinks’ services increased so
dramatically and because IntraLinks was one of the most expensive VDR
providers, the FDIC sought to renegotiate its contract in early 2010, but
IntraLinks refused. Robert Mullen, the Executive Vice President, said there
was “absolutely no way” IntraLinks would renegotiate with the FDIC, and that
IntraLinks was “going to put the screws to them.” The FDIC allegedly
responded by saying they would not renew their contract with IntraLinks.
The FDIC issued a Request for Proposals (“RFP”) in order to find an
alternative VDR provider in July 2010. On November 18, 2010, Plesner signed
a contract modifying task order 16, which stated FDIC was “exercising the final
6
6-month option period” which would extend the original task order to June 9,
2011. However, plaintiffs concede that this was not actually the final 6 month
period, as the task order was amended on May 2011 to extend its effective time
period to March 31, 2012.
On November 7, 2011, the FDIC issued a press release stating that it
would be using a new vendor for its future VDR projects, but would continue
using IntraLinks to wind up existing projects.
Misclassification of Business
Prior to the creation of the Enterprise department, IntraLinks had
classified M&A transactions as M&A revenue and DCM transactions as DCM
revenue. However, with the creation of the Enterprise division, IntraLinks was
no longer properly classifying its revenue streams according to the nature of
the specific business transaction – i.e. M&A, DCM, or Enterprise (longer-term
storage and hosting). Instead, IntraLinks would group a customer’s different
transactions together and classify it as Enterprise, even if one or more of the
transactions were more appropriately considered M&A or DCM. They would
also group multiple DCM or M&A customers together in order to define the
group as Enterprise. Managers were told at many meetings to “group multiple
products under a single account relationship” even if unrelated, solely for the
purpose of classify it as Enterprise. Sometimes an existing customer who
conducted DCM and M&A business would therefore be classified as Enterprise.
7
Ultimately, while Enterprise was supposed to consist of customers who
used IntraLinks for long-term storage, it became the label used for the largest
customers or any cross-departmental relationship.
The most dramatic misclassification involved the FDIC. As described
above, the FDIC was IntraLinks’ largest customer by 2007, and prior to the
creation of Enterprise, its business was classified as DCM. In 2009, although
there was no change in the business relationship between IntraLinks and the
FDIC, the FDIC’s business was reclassified as Enterprise.
The complaint appears to argue that the purpose of this misclassification
was to make IntraLinks appear to be more diversified and able to attract longterm business. According to the complaint, IntraLinks believed this will help
the company be able to conduct a successful initial public offering.
Improper Billing Practices
IntraLinks billed its clients on a cost-per-page basis which worked well
initially when almost all of its business involved scanning and uploading
hardcopy documents. However, in 2009, only around 5% of documents
IntraLinks handled were from scanned hardcopies – the rest were uploaded in
an electronic format. IntraLinks tried to adapt to this change by using
algorithms to estimate how many pages were equivalent to a megabyte, but the
system was disorganized and inaccurate.
In 2009, IntraLinks updated its billing systems and discovered that the
old system had been overbilling customers by 20-30%. This finding was
8
brought to the attention of senior management. However, rather than telling
customers of the overbilling and switching to the new system, IntraLinks
abandoned the new system and made no public disclosures. The complaint
alleges that when employees discussed the issues with Plesner he “would get
threatening if you tried to dig too hard.”
Alleged Misstatements and Omissions
The complaint contains detailed allegations of specific statements issued
or made by the Exchange Act defendants, which plaintiffs claim were materially
false and misleading. Earlier in this opinion the court summarized the three
subjects relating to which the defendants made misrepresentations. The first
is the failure to disclose the problems associated with IntraLinks’ relationship
with the FDIC. The second is the allegation that IntraLinks misclassified
business as Enterprise. The third is the failure to disclose that it was overcharging customers. The complaint alleges that the following quotations of
statements made or issued by the Exchange Act defendants support these
claims of misrepresentation.
The company’s February 17, 2011 Form 8-K and corresponding press
release highlighted the “significant growth in our Enterprise and Mergers and
Acquisitions business.” Intralinks also estimated that revenue for 2011 would
increase between 16-22%, and stated that the company believed it “has the
market opportunity, leadership position and infrastructure to build a large and
9
highly profitable company.” February 17, 2011 is the opening date for the
“class period” covered by this action.
It its March 23, 2011 Form 10-K IntraLinks again attributed its revenue
increases to the growth of its Enterprise business, stating Enterprise was the
company’s “largest and fastest growing market. We believe that we have a
significant opportunity to increase our market share in these core markets.”
The Form 10-K also commended IntraLinks’ strong and stable customer base
stating “We believe our customers have a high level of satisfaction, as
evidenced by the 104% renewal rate . . . for our subscription contracts during
the year ended December 31, 2010.”
The company’s May 11, 2011 Form 8-K stated: “We remain confident
about IntraLinks’ outlook. We continue to see strong market demand.”
IntraLinks projected that for the rest of 2011, “we expect to see a combination
of growth, profitability and cash flow that is a standout in the Software-as-aService sector.” Plesner further stated that that the company would continue
to “capitalize on our multi-billion dollar market opportunity that remains
highly underpenetrated.”
At the conference call of May 11, 2011 to discuss the reported results,
Damico partially revealed a problem in the Enterprise business:
Enterprise business faces a headwind as a result of a single Enterprise
customer whose IntraLinks usage will significantly decrease over the
remainder of the year. The use of IntraLinks is [sic] counter-cyclical and
revolves around the management and exchange of distressed and nonperforming assets. Because of the improving economy, there will be
fewer distressed asset situations going forward, and therefore, we expect
10
that our revenue run-rate with this customer will be reduced by
approximately $2 million per quarter against our expectations.
Damico sought to downplay the significance stating:
We haven’t see any fundamental changes whatsoever in the competitive
landscape, in the sales process, in our pricing, in the competitive
landscape, so we don’t see any fundamental changes to what we shared
with you in the last earnings call.
IntraLinks’ first quarter 2011 Form 10-Q reiterated the strength and
importance of the Enterprise business claiming that the increase in
Enterprise’s revenue “was primarily driven by an increased customer base,
larger contract values for new customers . . . as well as higher exchange
utilization and renewal levels for existing customers.”
IntraLinks’ August 10, 2011 Form 8-K stated that the second quarter
results “reflect a combination of solid growth, profitability and cash flow,” and
described the company as facing a “multi-billion dollar market opportunity.”
The company’s second quarter 2011 Form 10-Q reiterated the
statements made in the first quarter 2011 Form 10-Q, and further stated that
the growth in Enterprise revenue “reflects the wider adoption of our services
across customers’ organizations.”
On November 8, 2011, a day after the FDIC publicly announced it would
not use IntraLinks as its VDR vendor for future projects, IntraLinks filed a
Form 8-K which failed to disclose that FDIC had changed its vendor. Instead,
IntraLinks only disclosed that growth in its Enterprise business was slowing,
with just an 11% increase, as opposed to the 15% increase in the second
quarter and a 33% increase in the first quarter of 2011. And, in a press release
11
Damico stated that “we have not yet gained the momentum I would like to see
in our Enterprise business; however, I am confident that our continuing
investments in sales, customer service and marketing will allow us to achieve
greater momentum going forward.” In the earnings conference call Damico
further stated that “growth in our Enterprise business fell short of
expectations,” and attributed this to deficiencies in the sales force’s quantity,
composition, and tenure.
April 4, 2011 Secondary Offering Materials
IntraLinks’ annual and quarterly filings with the SEC were incorporated
by reference into the Registration Statement, and thus the complaint alleges
that the Registration Statement contained the previously mentioned material
false and misleading statements.
The alleged misstatements and omissions made in the April 4, 2011
Registration Statement are the same as those allegedly made in the March 23,
2011 Form 10-K.
Analysis
Legal Standard – Motion to Dismiss
To survive a motion to dismiss under Fed. R. Civ. P. 12(b)(6), a complaint
must plead sufficient facts to state a claim to relief that is plausible on its face.
Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); Ashcroft v. Iqbal, 556
U.S. 662, (2009). In deciding such a motion, a court must accept as true the
facts alleged in the complaint, but it should not assume the truth of its legal
12
conclusions. Iqbal, 556 U.S. at 678-79. A court must also draw all reasonable
inferences in the plaintiff's favor, and it may consider documents attached to
the complaint, incorporated by reference into the complaint, or known to and
relied on by the plaintiff in bringing the suit. ATSI Commc'ns, Inc. v. Shaar
Fund. Ltd., 493 F.3d 87, 98 (2d Cir. 2007). A court may also consider
documents of which a plaintiff would have had actual notice as he drafted his
complaint and which are integral to the claims set forth within it. Cortec
Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991).
Section 10(b) and Rule 10b-5 of the Exchange Act
In order to state a claim under Section 10(b) and Rule 10b-5 plaintiffs
must allege that defendants “(1) made misstatements or omissions of material
fact; (2) with scienter; (3) in connection with the purchase or sale of securities;
(4) upon which plaintiffs relied; and (5) that plaintiff’s reliance was the
proximate cause of their injury.” In re Int’l Bus. Machs. Corp. Sec. Reg. Litig.,
163 F.3d 102, 106 (2d Cir. 1998); see also 15 U.S.C. § 78j(b); 17 C.F.R. §
240.10b-5.
Claims brought under Section 10(b) and Rule 10b-5 are subject to the
pleading standards of Fed. R. Civ. P. 9(b) and the Private Securities Litigation
Reform Act (“PSLRA”). Rule 9(b) requires that the complaint “state with
particularity the circumstances constituting the fraud.” The PSLRA requires
that plaintiffs “specify each statement alleged to have been misleading [and] the
reason or reasons why the statement is misleading” and “state with
13
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)(1),(2). Defendants claim
that the complaint fails to allege facts establishing a misrepresentation or
omission, scienter, or loss causation.
Misleading Statement or Omission – Risk of Losing the FDIC’s Business
Defendants contend that there was no material misstatement or
omission regarding the loss of IntraLinks’ largest customer, the FDIC.
Specifically, defendants claim IntraLinks never lost the FDIC’s business within
the class period, and even when the FDIC announced it was switching VDR
providers, it still promised to use IntraLinks for existing projects.
Contrary to defendants’ contentions, IntraLinks need not have lost the
FDIC’s business within the class period in order for the statements to have
been misleading. Plaintiffs argue that the failure to disclose that the FDIC
would not renew its contract in the future rendered several statements
misleading. The most significant alleged misleading statements are the
following:
• “We believe that we have a significant opportunity to increase our market
share in these core markets”
• “We believe our customers have a high level of satisfaction, as evidenced
by the 104% renewal rate . . . for our subscription contracts during the
year ended December 31, 2010”
• “We continue to see strong market demand”
• Highlighting the growth in the Enterprise market and attributing it to
“higher exchange utilization and renewal levels for existing customers”
Courts, though in other circuits, have recognized that the failure to
disclose the impending loss of a major customer can render optimistic
14
statements about the company misleading. For example, in Arkansas Pub.
Emps. Ret. Sys. v. GT Solar Int’l, Inc., the court found that statements “about
the market-leading position of the company’s DSS furnace and its promotion of
recurring sales could be considered misleading in light of the undisclosed risk
that the product would very soon lose its spot atop the market, and a large
portion of its recurring sales” as a result of a customer’s impending departure.
08 Cv-312, 2009 WL 3255225 at *9 (D. N.H. Oct. 7, 2009).
Given the circumstances discussed earlier, mainly that the FDIC had
told IntraLinks that it would seek an alternative VDR provider, these
statements touting the customer satisfaction, renewal rate and strong market
demand were misleading for the failure to disclose the impending loss of its
largest customer.
Misleading Statement – Mischaracterization of Enterprise Business
Plaintiffs properly plead that IntraLinks mischaracterized revenue as part
of its Enterprise business when it was more appropriately considered DCM and
M&A business. Accordingly, the plaintiffs properly allege that figures regarding
Enterprise’s growth and revenue, as well as statements that Enterprise was the
“largest and fastest growing” segment of its company were materially false and
misleading.
Misleading Statement – Overbilling Customers
However, plaintiffs fail to properly allege any false or misleading
statement related to IntraLinks’ billing practices that resulted in overbilling
15
customers by 20-30%. The complaint does not identify any statements made
regarding these practices. It is not clear what is meant by IntraLinks’ claims of
having a “high degree of revenue visibility,” and thus it cannot be determined
whether that is misleading.
To the extent the complaint relies upon IntraLinks’ reported revenue and
growth figures, it is not apparent that such figures are misleading based on the
fact that IntraLinks overcharged. While customers may have overpaid, the
complaint does not allege that IntraLinks’ reported revenue failed to match the
amount actually collected. Accordingly, plaintiffs fail to state a claim based on
defendants’ alleged overbilling practices.
Scienter
In order to state a claim under Section 10b and Rule 10b-5 of the
Exchange Act, a plaintiff must “state with particularity facts giving rise to a
strong inference” of scienter, which “must be more than merely plausible or
reasonable – it must be cogent and at least as compelling as any opposing
inference of nonfradulent intent.” Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
551 U.S. 308, 314, 328. A plaintiff can satisfy this requirement by alleging
facts to show “strong circumstantial evidence of conscious misbehavior or
recklessness.” ECA & Local 134 IBEW Joint Pension Trust of Chi. V. JP
Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009).
Reckless conduct is defined as “conduct which is highly unreasonable
and which represents an extreme departure from the standards of ordinary
16
care . . . to the extent that the danger was either known to the defendant or so
obvious that the defendant must have been aware of it.” Novak, 216 F.3d at
308. Recklessness is adequately alleged when a plaintiff claims that “(1)
specific contradictory information was available to the defendants (2) at the
same time they made their misleading statements.” In re Marsh & McLennan
Cos., Inc. Sec. Litig. 501 F. Supp. 2d 452, 484 (S.D.N.Y. 2006) (emphasis
added).
Loss of FDIC’s Future Business
In alleging Damico and Plesner knew it was likely that IntraLinks would
lose the FDIC’s business, the complaint claims that they were involved in the
IntraLinks’ executive policies, which included the decision in 2010 not to
renegotiate the FDIC contract. It also included the execution of the final 6
month extension of the FDIC’s contract in November 2011, which Plesner
himself signed. Defendants argue that this does not establish scienter because
the task order was later further extended. However, the allegation that Damico
and Plesner were involved in a contract which stated it was the final extension,
indicates Damico and Plesner were aware of a significant probability that
IntraLinks would lose the FDIC’s future business. At the motion to dismiss
stage the court must make such reasonable inferences in the plaintiff’s favor.
In addition the complaint alleges that the loss of the FDIC’s business
was discussed at several meetings with management, though the strength of
17
this allegation is undermined by the fact that it is not alleged whether Damico
and Plesner were present at those meetings.
The complaint also provides several other allegations that support
IntraLinks’ scienter due to the scienter of top executives. This includes
Mullen’s refusal to renegotiate the contract with the FDIC, and the FDIC’s
response that it would seek alternative providers.
Core Business
Plaintiffs also allege that it is proper to infer that Damico and Plesner
knew of the likelihood that IntraLinks would lose the FDIC’s business based on
the “core operations” doctrine. This doctrine states that if a complaint pleads
that a defendant made false or misleading statements “when contradictory
facts of critical importance to the company either were apparent or should have
been apparent, an inference arises that high-level officers and directors had
knowledge of those facts by virtue of their positions with the company.” In re
Atlast Air Worldwide Holdings, Inc. Sec. Litig., 324 F. Supp. 2d 474, 489
(S.D.N.Y. 2004). The passage of the PSLRA has threatened the validity of this
doctrine. However, this circuit appears to accept that although the doctrine
cannot provide the sole basis for inferring scienter, it can provide additional
evidence. See New Orleans Emps. Ret. Sys. V. Celestica, Inc., 455 Fed App’x
10, 14 n.3 (2d Cir. 2011); In re Wachovia Equity Sec. Litig., 753 F. Supp. 2d
326, 353 (S.D.N.Y. 2011) (collecting cases).
18
The fact that the FDIC was IntraLinks’ largest customer and a
substantial part of the Enterprise division, which was a key focus of IntraLinks’
revenue reports, provides a basis for the core operations doctrine. The court
finds that there is some additional evidence that Damico and Plesner were
aware that IntraLinks would likely lose the FDIC’s business because as CEO
and CFO they would likely remain informed about developments with a crucial
part of its business. This is not the sole basis for this court finding scienter,
but when added with the previously mentioned allegations, the court finds
there are sufficient allegations of scienter.
Scienter of IntraLinks
A corporate defendant’s scienter is derived from its employees. Suez
Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 101 (2d Cir.
2001). Thus the knowledge of a company’s executives and senior management
can be attributed to a corporate defendant. In re JP Morgan Chase Sec. Litig.,
363 F.Supp.2d 595, 627 (S.D.N.Y. 2005).
Therefore because the complaint sufficiently alleges the scienter of
Plesner and Damico, the CFO and CEO, as well as Mullen, the Executive Vice
President of sales, the complaint also alleges the scienter of IntraLinks.
Scienter - Misclassification of Enterprise Revenue and Overbilling
The complaint properly pleads that Plesner was aware of the overbilling
practice. Specifically, the complaint alleges that sales associates discussed the
issue with Plesner who “would get threatening if you tried to dig too hard.” The
19
allegations regarding Damico’s knowledge of the overbilling practices, and both
Plesner and Damico’s knowledge regarding the misclassification of Enterprise’s
revenue is more general. However, the court need not determine whether they
are sufficient to support scienter, since these claims fail to allege loss
causation, as discussed in the following section of this opinion.
Loss Causation
In order to state a claim for securities fraud a plaintiff must prove “that
the act or omission of the defendant alleged . . . caused the loss for which the
plaintiff seeks to recover damages.” 15 U.S.C. 78u-4(b)(4); see also Dura
Pharm., Inc. v. Broudo, 544 U.S. 366, 346-47 (2005). This can be pled by
“alleging either a corrective disclosure of a previously undisclosed truth that
causes a decline in the stock price or the materialization of a concealed risk
that causes a stock price to decline.” In re American Intern. Group, Inc., 741
F. Supp. 2d 511, 534 (S.D.N.Y. 2010). The pleading of loss causation is
governed by Rule 8 notice pleading, and therefore a complaint only needs to
provide “some indication of the loss and the causal connection that the plaintiff
has in mind.” Dura Pharm., 544 U.S. at 346-47.
Corrective Disclosure - Loss of the FDIC’s Business
It is undisputed that the complaint alleges a corrective disclosure
regarding IntraLinks’ loss of its largest customer the FDIC, which caused a
drop in IntraLinks’ stock price. The first partial corrective disclosure regarding
the loss of FDIC’s business occurred during the earnings conference call on
20
May 11, 2011, when Damico stated that one Enterprise customer was reducing
its usage of IntraLinks’ services. However, Damico did not reveal that this
customer was IntraLinks’ largest, the FDIC, or that the loss entailed an
expiration of its contract, with a substantial risk that it would not be renewed.
Instead, the loss was attributed to the fact that IntraLinks’ business was
countercyclical and the economy was improving. While the stock had closed at
$29.99 per share the day before, after this partial disclosure IntraLinks’ stock
closed at $20.22 per share.
Full disclosure occurred on November 7, 2011 when the FDIC issued a
public statement that “Beginning in November 2011, the FDIC will begin using
the RR Donnelley VDR known as Venue instead of IntraLinks for all new
projects. IntraLinks will host projects initiated before November 2011 until
they are resolved.” The complaint does not indicate the disclosure’s effect on
IntraLinks’ stock price.
Corrective Disclosure Overbilling and Misclassification of Enterprise
Revenue
The complaint fails to allege a corrective disclosure for the alleged
misstatements regarding Enterprise’s revenue recognition practices and
accounting problems. The complaint never claims that the market was
informed of these issues and in fact states that “the Company never disclosed .
. . the issues with their revenue recognition systems or that it was overbilling
customers by twenty or thirty percent.” Plaintiffs rely upon Damico’s
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statements attributing poor financial results to problems in the sales force, but
this does not constitute a disclosure of revenue recognition issues or
accounting problems. See Janbay v. Canadian Solar, Inc., No. 10 Civ. 4430,
2012 WL 1080306, at *15 (S.D.N.Y. Mar. 30, 2012).
The complaint also alleges that there was a disclosure regarding the
SEC investigation, but the complaint itself states that neither the SEC nor
IntraLinks provided any details about the reasons behind this subpoena. The
only publicly available information about the subpoenas was that the SEC was
“requesting certain documents related to the Company’s business from
January 1, 2011 to the present.” An announcement of an SEC subpoena is
itself insufficient to plead loss causation. Id. Even the alleged speculation of
some analysts as to the reasons behind the SEC subpoena is insufficient to
constitute a disclosure of the truth. See In re Omnicom Grp. Inc. Sec. Litig.,
597 F.3d 501, 512 (2d Cir. 2010).
Finally, the fact that IntraLinks revised its earnings projections also does
not indicate that there was a corrective disclosure regarding the revenue
recognition and accounting policies. See In re AOL Time Warner, Inc. Sec.
Litig., 503 F. Supp. 2d 678-79 (S.D.N.Y. 2007).
Materialization of Risk - Misclassification of Enterprise Revenue and
Overbilling
The complaint fails to plead loss causation through a materialization of
risk theory as well. The materialization of risk theory requires that a concealed
22
risk come to light “in a series of revealing events that negatively affect stock
price over time.” In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512,
554 (S.D.N.Y. 2011). The plaintiff must show that the loss is foreseeable and
that the loss was caused by the materialization of the concealed risk. See
Solow v. Citigroup, Inc., 827 F. Supp. 2d 280, 292 (S.D.N.Y. 2011).
Here the theory is presumably that IntraLinks’ failure to disclose that it
was misclassifying Enterprise’s revenue and overbilling clients hid the risk that
IntraLinks’ financial results were not sustainable. The materialization of this
risk would ultimately harm IntraLinks’ share price when revenue inevitably fell.
But the complaint contains no allegation linking the decrease in IntraLinks’
stock price to a materialization of these risks. Although the complaint alleges
that IntraLinks reported weak revenues, it does not claim that this was due to
any changes or revelations about how IntraLinks classified its Enterprise
revenue or billed its clients. Instead, the only allegation is that the poor
financial results were attributed to problems in the quality of the sales force.
Plaintiffs have therefore failed to plead loss causation.
Overall, the claims against the Exchange Act defendants regarding
allegedly false and misleading statements about billing practices and
classification of Enterprise revenue should be dismissed for the failure to plead
loss causation.
23
Reliance
The complaint invokes the fraud-on-the-market presumption in order to
plead reliance. In invoking this presumption, the complaint alleges that
IntraLinks’ common stock traded on the NYSE, an efficient market. The
complaint also states that IntraLinks, as a regulated issuer, filed periodic
public reports with the SEC and NYSE. In addition, several securities analysts
followed IntraLinks and wrote public reports about the company.
Section 11 and 12(a)(2) of the 1933 Act
To state a claim under Section 11 of the Securities Act of 1933 Act, a
plaintiff must allege that he purchased a registered security either directly from
the issuer or in the aftermarket following the offering; that the defendant
participated in the offering in a manner specified by the statute; and that the
registration statement contained an untrue statement of material fact or failed
to state a material fact needed to make the statements therein not misleading.
15 U.S.C. §§ 77k(a).
Section 12(a)(2) of the Securities Act of 1933 provides a similar cause of
action, but requires that the plaintiff allege that the defendant is a “statutory
seller;” that the sale was pursuant to a prospectus or oral communication; and
that the prospectus or oral communication contained a material misstatement
or omission. 15 U.S.C. 77l(a)(2).
Issuers and signatories are subject to strict liability under section 11,
while remaining potential defendants under Sections 11 and 12(a)(2) are
24
subject to liability for negligence. Panther Partners Inc. v. Ikanos Commcn’s
Inc., 681 F.3d 114, 120 (2d Cir. 2012). Scienter, reliance, and loss causation
are not elements of Section 11 or 12(a)(2) claims. Id. However, the heightened
pleading standard of Rule 9(b) applies when those claims are premised on
allegations of fraud. Rombach v. Chang, 355 F.3d 164, 172 (2d Cir. 2004).
The parties dispute whether Rule 9(b) applies to the Section 11 and 12(a)(2)
claims in this case and the implications if it does apply.
Because the grounds for dismissing the Section 11 and 12(a)(2) claims
are premised on the same basis, and the same pleading standard applies, the
court will analyze the claims together.
Law Regarding when Rule 9(b) Applies to Section 11 and 12(a)(2) Claims
Rule 9(b)’s heightened pleading standard applies to Section 11 and
12(a)(2) claims that are premised on allegations of fraud. Id. at 171. In
determining whether to apply Rule 9(b) courts examine whether the gravamen
of the complaint is fraud. Id. The fact that the alleged misstatements
supporting the Section 11 and 12(a)(2) claims are the same as those in the
Section 10(b) claims is not dispositive. See In re IAC/InterActiveCorp. Sec.
Litig., 695 F.Supp.2d 109 (S.D.N.Y. 2010). Furthermore, allegations that
statements were “materially false or misleading” and contained “untrue
statements of material fact” do not necessarily sound in fraud because such
allegations simply track the language of Section 11 and 12(a)(2). See In re
Wachovia Equity Sec. Litig., 753 F. Supp. 2d 326, 375 (S.D.N.Y. 2011). A
25
complaint is allowed to plead Section 10(b) fraud and Section 11 negligence
claims as alternatives, as long as the complaint is organized in a way that
allows the court to determine which allegations support which claim. See In re
Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 632 (S.D.N.Y. 2007).
In this case plaintiffs go beyond merely disclaiming any allegation of
fraud for its Section 11 and 12(a)(2) claims. Plaintiffs have properly separated
their Section 10(b) allegations based on fraud, from their Section 11 and
12(a)(2) allegations based on negligence. The complaint offers a different theory
for liability for the latter claims- that defendants negligently failed in their duty
to investigate and ensure the truth of statements in the registration and
prospectus. Furthermore, the allegations that IntraLinks failed to disclose a
known uncertainty supports the claim of Section 11 and 12(a)(2) liability
pursuant to Regulation S-K, which plaintiffs are able to allege without
requiring the application of Rule 9(b). See Citiline Holdings, Inc. v. iStar
Financial Inc., 701 F.Supp.2d 506, 513 (S.D.N.Y. 2010) (“[T]hat a fact was
known and not disclosed does not mean, as a matter of law, that the
circumstances of the resulting omission sound in fraud.”) (citation omitted).
The Section 11 and 12(a)(2) claims are thus governed by the pleading
standard in Rule 8(a). This rule requires a “short and plain statement of the
claim showing that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a). This
standard does not require “detailed factual allegations,” but it does require
more than “labels and conclusions” or “a formulaic recitation of the elements of
26
a cause of action will not do.” Bell Atlantic Corp. v. Twombly, 550 U.S. 544,
555 (2007).
Overbilling of Customers
The complaint makes no claims regarding IntraLinks’ billing practices in
the portion of the complaint relating the Section 11 and 12(a)(2) claims and as
such the court need not address this issue.
Classification of Enterprise Revenue
To the extent the complaint attempts to assert Section 11 and 12(a)(2)
claims based on the classification of Enterprise revenue, the allegations are
insufficient. Nowhere in the portion of the complaint related to the Section 11
and 12(a)(2) claims is there any allegation that the classification of existing
customers such as the FDIC into the newly created division, Enterprise, was
wrong. Just because a company such as the FDIC was once classified as DCM
or M&A does not preclude them from being properly reclassified when a new
business division is created. The complaint even admits that the Enterprise
classification was for customers who used IntraLinks on a longer term basis,
and that the FDIC was such a customer. Although the complaint claims that
the Enterprise business was not growing as fast as IntraLinks’ claimed, there
are no factual allegations to support this claim. The complaint can therefore
not base any allegations of materially false or misleading statements on how
IntraLinks classified its Enterprise business.
27
Loss of the FDIC as a Customer
Plaintiffs claim that defendants were negligent in failing to investigate the
statements to ensure that they were true and there were no omissions of
material facts. More specifically, plaintiffs appear to allege that defendants
negligently failed to discover that the FDIC’s contract with IntraLinks was
expiring and that the FDIC was unlikely to renew given IntraLinks’ refusal to
renegotiate. According to the complaint, the registration and prospectus
contained materially misleading statements because they failed to disclose
such information or temper positive statements about IntraLinks’ business.
The complaint alleges that the following statements were misleading given the
risk that the FDIC would not renew its contract with the FDIC:
•
•
“this enterprise market is our largest and fastest growing market.
We believe that we have a significant opportunity to increase our
market share in these core markets based on the strength of our
solutions”
“We believe our customers have a high level of satisfaction, as
evidenced by the 104% renewal rate . . . No customer represented
more than 10% of our revenue in 2008, 2009 or 2010.”
Without alleging that Damico Plesner knew of the circumstances, the
complaint repeats allegations that IntraLinks was aware that the FDIC would
likely stop doing business with Intralinks. For example, it alleges that
IntraLinks refused to renegotiate its contract with the FDIC, to which the FDIC
responded that it would seek alternative providers. Given these circumstances,
the complaint properly pleads that the statements were materially false and
misleading.
28
Defendants assert that the statements were not materially false and
misleading because of meaningful cautionary language in the risk factors
section. The section contained statements including:
• “Our business depends substantially on customers renewing and
expanding their subscriptions for our services. Any decline in customer
renewals and expansions would harm our future operating results.”
• “We cannot assure you that any of our customer agreements will be
renewed. Our renewal rates may decline due to a variety of factors
• “If our renewal rates are lower than anticipated or decline for any reason,
or if customers renew on terms less favorable to us, our revenue may
decrease and our profitability and gross margin may be harmed, which
would have a material adverse effect on our business, results of
operations and financial condition.”
When a disclosure contains cautionary language, the court analyses the
fraudulent materials in their entirety to determine whether a reasonable
investor would have been mislead. Halperin v. eBanker USA.com, Inc., 295
F.3d 352, 357 (2d Cir. 2002). The key question is whether the omissions
considered in the context of the whole document would affect the total mix of
information and mislead a reasonable investor regarding the nature of the
securities. Id.
In this case where the allegation is that IntraLinks had specific
information that its largest customer was planning to not renew its contract,
the generic cautionary language is insufficient. When the document is viewed
as a whole the court finds that a reasonable investor would have been misled
where specific statements touting the high customer satisfaction and renewal
rates are made without disclosure that the largest customer is likely to
terminate its business with IntraLinks.
29
Conclusion
For the aforementioned reasons the motion to dismiss is denied.
Dated: New York, New York
May 8,2013
Thomas P. Griesa
U. S. District Judge
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