Lee v. Active Power, Inc. et al
Filing
33
ORDER DENYING 29 Motion to Dismiss. Signed by Judge Sam Sparks. (td)
FILED
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
DON LEE, INDIVIDUALLY AND ON BEHALF
OF ALL OTHERS SIMILARLY SITUATED,
Plaintiffs,
2014
JUL
2
APt
11:57
CLERK US DSTRCT COURT
VESTERP O$TRICT CF TEXAS
BY____________________
DEPUT ,'
Case No. A-13-CA-797-SS
-vs-
ACTIVE POWER, INC., STEPHEN R. FIFE, and
DOUG MILNER,
Defendants.
I.'.
BE IT REMEMBERED on this day the Court reviewed the file in the above-styled cause, and
specifically Defendants Active Power, Inc., Stephen R. Fife, and Doug Milner's Motion to Dismiss
[#29], Plaintiffs' Response [#31], and Defendants' Reply [#32]. Having considered the documents,
the file as a whole, and the governing law, the Court enters the following opinion and orders
DENYING the motion.
Background1
This is a securities fraud class action on behalf of a class consisting of purchasers of the
common stock of Active Power, Inc. between February 19, 2013, and September 5, 2013 (the Class
Period). Active Power develops, builds, and sells Uninterruptible Power Supply (UPS) products.
Am. Compl. [#26], ¶ 2. Active Power has been selling its products in China since 2005, and in 2010,
it established a regional office in Beijingits fourth regional office
overallto oversee its China
1The following recounting of the nature of this case derives from the Plaintiffs' Amended Complaint [#26] as
the facts alleged therein are taken as true for present purposes. See Leatherman v. Tarrant Cnty. Narcotics Intelligence
& Coordination Unit, 507 U.S. 163, 164 (1993).
V
and Southeast Asia operations. Id., ¶J 3-4. These regional offices control all of the operations
within their respective geographic reach, making them a major investment for Active Power. Id.,
¶ 4. To manage the Beijing office and oversee all of the China operations, Active Power hired Huan
Wang, an industry veteran. Id., ¶ 5. Wang was interviewed along with Active Power's Chief
Financial Officer (CFO) for media articles and quoted in press releases concerning Active Power's
China operations. Id., ¶ 5. The Beijing office disappointed, however, with sales increasing in 2011,
but losing about a third of the gain in 2012. Id., ¶ 7. Profit margins were also lower than in other
regions due to lower prices and increased shipping costs. Id.
On February 19, 2013, Active Power reported it had begun working with a new unnamed
Chinese distribution partner, and this new partnership would reverse Active Power's lagging trends
in China and Asia generally. Id., ¶ 8. On April 30, 2013, Active Power announced in two separate
press releases that the partner was Digital China Information Technology Systems, Inc. (Digital
China), one of China's leading information technology solutions providers and a subsidiary of a $9.1
billion Chinese public company listed in Fortune's China 100. Id. One of the press releases
included a quote from a purported Digital China Vice President touting the partnership. Id. Active
Power also issued a 10-Q reflecting $4. 186 million of purported sales to Digital China. Id., ¶J 8, 70.
In conference calls held on April 30, 2013, Active Power repeatedly advertised its partnership with
Digital China and represented the two companies were already collaborating on specific key
initiatives. Id., ¶ 8. Active Power indicated it planned to release the products of this collaboration
in 2013. Id. Doug Milner, Active Power's Chief Executive Officer (CEO), stated that with Digital
China distributing its products at lower costs, Active Power could compensate for the higher
shipping costs and lower prices previously hampering its profit margins. Id.
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But there was a problem: Active Power never had an agreement with Digital China. Id., ¶ 9.
Rather, the contract was with Qiyuan Network System Limited (Qiyuan), a small Hong Kong firm.
Id. In September 2013, Active Power announced an employee had intentionally lied to it, claiming
Qiyuan was a subsidiary of Digital China when the two actually had no affiliation. Id. The
employee was Wang, and it turns out his wife was a Qiyuan director and held 20% of its shares with
three other directors and an investment fund also each holding 20% and a directorship. Id., ¶ 11.
Due to this falsehood, Active Power had to issue a financial restatement. In previous
statements from quarters ending March 31 and June 30, 2013, it had indicated $4. 186 million in sales
as a result
of this new partnership premised on the notion these sales with Digital China, a major
company, were reasonably assured to be collected under Generally Accepted Accounting Principles.
See
id.,
¶J
52-5 8, 70. The collectability of this $4. 186 million was not reasonably assured with
Qiyuan, a small company with a minimal track record. Id., ¶J 63, 70. Consequently, Active Power
was obligated to issue the restatement. Active Power also indicated Qiyuan had made payments on
some of the product shipped to it and returned the rest of the product to Active Power. Id., ¶ 105.
Plaintiffs filed this lawsuit in September 2013 against Defendants Active Power, Inc., CEO
Doug Milner, and CFO Stephen R. Fife, asserting violations of § 10(b) of the Securities Exchange
Act and Rule lOb-S promulgated thereunder. Id., ¶J 132-41. Plaintiffs also allege the individual
Defendants, Mimer and Fife, had direct control over the activities and public statements of Active
Power, participated in the improper activities and fraudulent statements in question, and are therefore
liable as "control persons" under
§
20(a) of the Securities Exchange Act. Id., ¶J 142-46.
Defendants have now filed the instant motion to dismiss, arguing Plaintiffs have failed to
allege scienter, and therefore the claims should be dismissed pursuant to Federal Rule of Civil
-.3-
Procedure 12(b)(6). Mot. Dismiss [#29], at 1. In essence, Defendants argue Wang was the sole bad
actor in this drama. They do not deny wrongdoing occurred but dispute they were involved or can
be held liable. They claim Wang was a rogue employee who lied to Milner and Fife. They concede
Wang told them about a new distributor agreement with Qiyuan, and Wang told them Qiyuan was
a subsidiary of Digital China. But they claim they did not know Qiyuan actually had no affiliation
with Digital China. While there appears to be no dispute Wang acted with scienter, Defendants
contend the requisite scienter cannot be attributed to any of the Defendants.
As to Active Power, Defendants argue Wang's scienter cannot be imputed because Wang
never actually made the statements on which the suit is based. Id. For this argument, Defendants
rely on a recent Supreme Court opinion, which they construe as altering existing Fifth Circuit law.
id.
According to Defendants, Wang's scienter also cannot be imputed to Active Power because
Wang was acting contrary to Active Power's interests. Id.
As to Milner and Fife, Defendants assert Plaintiffs have failed to allege facts giving rise to
a strong inference
of severe recklessness. Id. Under their view, Milner and Fife reasonably relied
on Wang, a seasoned industry veteran, to manage Active Power's operations in China and provide
honest reports regarding any distributor agreements. Id. Defendants contend Plaintiffs fail to allege
any facts indicating Milner and Fife were aware of the fraudulent scheme or deliberately disregarded
indicators that would have made them aware. Id.
While Defendants primarily focus on the issue of scienter, they make two other arguments
toward the end of their motion seeking partial dismissals. First, they argue the Class Period should
not begin February 19, 2013, because the alleged false statements made by Milner in a conference
call did not even mention Digital China and cannot form the basis of a false statement for securities
fraud purposes. Id. at 17. Second, they request the dismissal of the § 20(a) control-person claim on
the ground Plaintiffs have failed to establish an independent violation of the securities laws from
which liability under § 20(a) could flow. Id. at 18. In other words, Defendants argue the § 10(b) and
Rule 1 Ob-5 claims must be dismissed on scienter grounds, and the § 20(a) claims must be dismissed
because there is no predicate securities fraud offense under
§
10(b).
Analysis
I.
Rule 12(b)(6)Legal Standard
A motion under Federal Rule of Civil Procedure 1 2(b)(6) asks a court to dismiss a complaint
for "failure to state a claim upon which relief can be granted."
FED.
R. Civ. P. 12(b)(6). In deciding
a motion to dismiss under 1 2(b)(6), a court generally accepts as true all factual allegations contained
within the complaint. Leatherman v. Tarrant Cnty. Narcotics Intelligence & Coordination Unit, 507
U.S. 163, 164 (1993). However, a court is not bound to accept legal conclusions couched as factual
allegations. Papasan
v. Allain,
478 U.S. 265, 286 (1986). Although all reasonable inferences will
be resolved in favor of the plaintiff, the plaintiff must plead "specific facts, not mere conclusory
allegations." Tuchman v. DSC Commc'ns Corp., 14 F.3d 1061, 1067 (5th Cir. 1994). Theplaintiff
must plead sufficient facts to state a claim for relief that is facially plausible. Ashcroft v. Iqbal, 556
U.S. 662, 678 (2009); Bell All. Corp.
v.
Twombly, 550 U.S. 544, 570 (2007). "A claim has facial
plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable
inference that the defendant is liable for the misconduct alleged." Jqbal, 556 U.S. at 678. Although
a plaintiffs factual allegations need not establish the defendant is probably liable, they must establish
more than a "sheer possibility" that a defendant has acted unlawfully. Id. Determining plausibility
is a "context-specific task," that must be performed in light of a court's "judicial experience and
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common sense." Id. at 679. In deciding a motion to dismiss, courts may consider the complaint,
as well as other sources courts ordinarily examine when ruling on Rule 1 2(b)(6) motions to dismiss,
such as documents incorporated into the complaint by reference, and matters of which a court may
take judicial notice. Tellabs, Inc.
II.
v.
Makor Issues & Rights, Ltd., 551 U.s. 308, 322 (2007).
Securities FraudLegal Standard and Heightelled Pleading Standard
To state a claim under
§
10(b) and Rule lOb-5, a plaintiff must allege "(1) a misstatement or
omission (2) of a material fact (3) made with scienter (4) on which the plaintiff relied (5) that
proximately caused his injury." Abrams
§
v.
Baker Hughes, Inc., 292 F.3d 424, 430 (5th Cir. 2002). A
10(b) claim is subject to both Federal Rule of Civil Procedure 9(b)'s requirement fraud be pled "with
particularity" and the requirements of the Private Securities Litigation Reform Act (the PSLRA). Id.
The PSLRA "was enacted in response to an increase in securities fraud lawsuits perceived as
frivolous." Newby
v.
Enron Corp., 338 F.3d 467, 471 (5th Cir. 2003). The PSLRA enhanced the
particularity requirements for pleading fraud under Rule 9(b) in two ways. md. Elec. Workers 'Pension
Trust Fund IBE Wv. Shaw Grp., Inc., 537 F.3d 527, 533 (5th Cir. 2008). First, plaintiffs must "specify
each statement alleged to have been misleading, [and] the reason or reasons why the statement is
misleading[,J" 15 U.S.C.
§
78u-4(b)(l)(B), and secondly, for "each act or omission alleged" to be false
or misleading, plaintiffs must "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). The Fifth Circuit has found
the requirements of the PSLRA comport with those of Federal Rule of Civil Procedure 9(b), which
"requires a plaintiff to specify the statements contended to be fraudulent, identify the speaker, state
when and where the statements were made, and explain why the statements were fraudulent." ABC
Arbitrage Plaintffs Grp.
v.
Tchuruk, 291 F.3d 336, 350 (5th Cir. 2002). In short, "the who, what,
when, and where must be laid out before access to the discovery process is granted." Id. at 349
(internal quotations omitted). A district court must dismiss a securities fraud claim failing to satisfy
either the PSLRA's pleading requirements or those of Rule 9(b). Fin. Acquisition Partners LP
v.
Blackwell, 440 F.3d 278, 287 (5th Cir. 2006).
III.
Scienter
The central disputed issue in Defendants' motion to dismiss is whether Plaintiffs adequately
pleaded
scienteri. e., "a mental state embracing intent to deceive, manipulate, or defraud."
Tellabs,
551 U.S. at 319. With respect to Active Power, the issue is not whether Plaintiffs have satisfied the
substantive pleading requirements of scienter but whether Wang's scienter may be imputed to Active
Power, a corporate entity. With respect to Milner and Fife, the issue is whether Plaintiffs have
adequately pleaded scienter for these individual actors. The Court first addresses Active Power's
corporate scienter, and then Milner and Fife's individual scienter.
A.
Wang's scienter may be imputed to Active Power
To hold Active Power liable, Wang's
scienterwhich the parties do not dispute he
possessed, at least for the purposes of the instant
motionmust be imputed
to Active Power.
Defendants argue Wang's scienter cannot be imputed to Active Power for two reasons: (1) Wang
did not "make" any of the alleged false statements at issue; and (2) Wang was acting for his own
purposes and against those of Active Power. The Court addresses both arguments in turn.
1.
Corporate scienter post-Janus
The parties disagree as to the proper legal standard to be applied when imputing scienter from
a corporate employee to the corporation itself Plaintiffs argue Fifth Circuit case law, represented
by the seminal case Southland Sec. Corp.
v.
INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir.
2004), allows for the imputation of scienter from an employee who "makes" a false statement or an
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employee like Wang who "furnished information" used in a false statement. Defendants rely on a
more recent Supreme Court case, Janus Capital Group, Inc.
v.
First Derivative Traders,
131 5. Ct.
2296 (2012), to contend the meaning ofto "make" a statement does not include merely "furnishing"
information. By extension, Defendants argue imputation from a corporate employee is allowed only
where the employee "made" the false statement. Since Wang did not "make" any of the false
statements himself (rather, he "furnished" the false information Milner and Fife used to actually
"make" the false statements), Defendants claim Wang's scienter may not be imputed to Active
Power. For the reasons described below, the Court concludes Southland still is controlling law on
the issue of imputation, and Defendants overstate the impact of Janus on the instant issue.
In Southland, the Fifth Circuit rejected the "group pleading" approach to corporate scienter.
Southland, 365 F.3d at 366. Specifically, the court established the proper standard as follows:
For purposes of determining whether a statement made by the corporation was made
by it with the requisite Rule 10(b) scienter we believe it appropriate to look to the state
of mind of the individual corporate official or officials who make or issue the statement
(or order or approve it or its making or issuance, or who furnish information or
language for inclusion therein, or the like) rather than generally to the collective
knowledge of all the corporation's officers and employees acquired in the course of
their employment. This is consistent with the general common law rule that where,
as in fraud, an essentially subjective state of mind is an element of a cause of action
also involving some sort of conduct, such as a misrepresentation, the required state
of mind must actually exist in the individual making (or being a cause of the making
the misrepresentation, and may not simply be imputed to that individual on
general principles of agency.
of)
Id. at 366 (citations and footnotes omitted) (emphasis added).
In this case, there is no debate Wang told Mimer and Fife Qiyuan was a subsidiary of Digital
China, and he did so knowing this was not true. Mimer and Fife ultimately broadcast this false
information in various statements. In other words, Wang furnished information for inclusion in the
false statements with scienter, and he was a cause of the making of the misrepresentations. Therefore,
under Southland, Wang's scienter may be imputed to Active Power.
Defendants contend "[t]he 'furnish information' language in [Southland] reflected a nowobsolete understanding of who could be sued under § 10(b) and Rule lOb-5." Mot. Dismiss [#29], at
7. Defendants believe
Southland's "furnish information" language is now obsolete based on their
reading of Janus. In Janus, a mutual fund allegedly made false statements in its communications to
investors. Janus, 131 S. Ct. at 2300. The false statements were allegedly drafted by the fund's adviser,
a separate legal entity. Id. at 2300-01. In addressing whether the third party adviser could be held
liable in a private action under § 10(b) and Rule 1 Ob-5, the Court concluded the adviser did not "make"
the mutual fund's statements, and therefore could not be held liable for the allegedly false statements
the mutual fund made to investors. Id. at 2301. The Court held: "For purposes of Rule lOb-5, the
maker of a statement is the person or entity with ultimate authority over the statement, including its
content and whether and how to communicate it." Id. at 2302.
The Court fails to see how Janus makes the "furnish information" language from South land
obsolete as the two cases address distinct issues. Janus defined who "makes" a statement; the "furnish
information" language from Southland defined from whom scienter may be imputed for the purposes
of corporate liability. Put another way, in Janus the issue was the liability of the third party adviser,
and the Court held it could not be held liable because it did not "make" the statement. Rather it
furnished information to the mutual fund, which "made" the statement at issue. In this case, Wang is
analogous to the third party adviser, but the issue here is not whether Wang "made" the statements,
which would make him potentially liable. The issue is if Wang's scienter can be imputed to Active
Power so that Active Power might be held liable. Applying Janus to this case, it may well be true Wang
did not "make" the false
statements.2
But Plaintiffs are not contending Wang "made" the statements.
Instead Plaintiffs are arguing Wang furnished information with scienter, and therefore this scienter can
be imputed to the corporation, Active Power, as established by Southland.
Defendants somehow interpret Janus to have changed Southlandto mean that in order to impute
scienter from a corporate employee to the corporation, the employee must have "made" the statement.
But Janus says no such thing. Southland made clear that in order to impute scienter from a corporate
employee to the corporation, the employee must have "made" the statement, or "ordered or approved
it or its making or issuance," or "furnished" information or language for inclusion therein, or "the like."
See Southland, 365 F.3d at 366. "This is consistent with the general common law rule
that.
.
.
the
required state of mind must actually exist in the individual making (or being a cause of the making
of)
the misrepresentation." Id. (emphasis added). Janus, which simply defines who "makes" a
statement and can therefore be held liable, does not change this holding.
2The Court does not address whether Wang "made" these statements because, as explained, this is not the
Plaintiffs' contention. Nevertheless, the Court notes its concerns as to how Janus would affect this case if it were
applicable. While Janus may suggest Wang did not "make" the statement because he was not "the person or entity with
ultimate authority over the statement, including its content and whether and how to conmrnnicate it," this conclusion is
not obvious. Janus, 131 S. Ct. at 2302. The ambiguity lies in the factual comparison between Janus, which entailed an
investment advisor providing allegedly false information to a separate legal entity in the mutual fund, and this case, which
involves a corporate employee providing allegedly false information to other officers of the company. Indeed, the Court
in Janus emphasized the fact the adviser and the mutual fund were "legally separate entities" that observed corporate
formalities. Id. at 2304. Moreover, Justice Breyer, in his dissent, expressed concerns over the potential applicability
ofthe majority's holding to a corporate insider situation involving the use of innocent intermediarieswhich, according
to Defendants, describes the instant caseand the "loophole" the majority opinion "may well create." Id. at 2310il
(Breyer, J. dissenting). In other words, Janus may apply to such situations, but its holding did not address them. See
id. at 2304 n.10 ("We do not address whether Congress created liability for entities that act through innocent
intermediaries in 15 U.S.C.A. § 78t(b)."). Finally, other courts have rejected attempts to applyJanus to corporate insider
scenarios. See, e.g., In re Pfizer Inc. Sec. Litig., 936 F. Supp. 2d 252, 269 (S.D.N.Y. 2013) ("Janus 'addressed only
whether third parties can be held liable for statements made by their clients. Its logic rested on the distinction between
secondary liability and primary liability. . and has no bearing on how corporate officers who work together in the same
entity can be held jointly responsible on a theory of primary liability.") (quoting City ofPontiac Gen. Employees 'Ret.
Sys. v. Lockheed Martin Corp., 875 F. Supp. 2d 359, 374 (S.D.N.Y. 2012)); In re Merck & Co., Inc. Sec., Derivative,
& ERISA Litig., Nos. 05-1151 (SRC), 05-2367 (SRC), 2011 WL 3444199, at *25 (D.N.J. Aug. 8, 2011) (similar).
.
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This interpretation is consistent with the case law post-Janus. In the only on-point Fifth
Circuit opinion, PipejItters Local No. 636Defined Ben. Plan v. Zale Corp., 499 F. App'x 345 (5th
Cir. 2012) (unpublished), the court implicitly indicated Southland's "furnish information" language
is still controlling law. In Zale, Higgins, the vice-president ofmarketing and a non-party in the case,
made false accounting determinations resulting in incorrect numbers being used in financial
statements, which formed the basis of a class action securities fraud claim against Zale and several
of its chief officers. Id. at 346-48. There was no allegation Higgins "made" any of false statements
herself; rather she furnished the false numbers ultimately used in the financial statements. The
Plaintiffs, however, sought to impute Higgins's scienter to Zale and the individual Defendants. Id.
at 348. The district court dismissed the case because it found the alleged facts did not create a strong
inference Higgins had intended to defraud investors or had acted with severe recklessness. Id. The
district court concluded there were simply not enough facts to say Higgins was obviously aware her
inaccurate accounting could or would eventually result in Zale releasing misleading financial
statements with material errors. Id. The Fifth Circuit affirmed the district court's conclusion and
used the same analysis: "Because Pipefitters has not raised a strong inference that any of the three
Individual Defendants, or any other Zale official responsiblefor the allegedlyfraudulent statements,
acted with scienter, the district court's order dismissing Pipefitters' complaint with prejudice is
affirmed." Id. at 351 (emphasis added).
This opinion indicates, albeit in an unpublished opinion, that Southland's "furnish
information" language is alive and well. Under Defendants' view, the district court (and the Fifth
Circuit) should have never even addressed whether Higgins acted with scienter; since she never
"made" any statement, her scienter could not be imputed to Zale or the individual Defendants
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anyway. The district court (and the Fifth Circuit), however, closely analyzed whether Higgins acted
with scienter, which means imputation is permissible from those who merely "furnish information."
Other district courts have reached the same conclusion. In Kerr
v.
Exobox Technologies
Corp., No. H-10-4221, 2012 WL 201872 (S.D. Tex. Jan. 23, 2012), Judge Ellison addressed this
precise issue and concluded Janus did not alter Southland:
The question thus becomes whether Exobox had scienter when it made the
statements contained in its registration filings and amendments. In determining
whether the Complaint adequately pleads scienter with respect to Exobox, the Court
must look to see if any of the corporate officials who made or prepared the statement
acted with scienter. The standard articulated by the Fifth Circuit in Southland, and
repeated in many subsequent cases, provides that it is appropriate to look at the state
of mind not only of the individual corporate official or officials who made the
statement, but also those who "order or approve it or its making or issuance, or who
furnish information or language for inclusion therein or the like." Id; see also Shaw
Group, 537 F.3d at 533 (repeating this standard post-Stoneridge). The Court finds
no reason to read Janus to limit the liability of the corporation on grounds of scienter.
Exobox "made" the statements contained in the public filings under Janus; Plaintiffs
need only assert that Sonfield furnished the information or language for inclusion in
order to attribute his scienter to Exobox.
Id. at *14. Other courts, while not addressing this precise issue, have continued to use Southland's
"furnish information" language when describing the legal standard applicable to corporate scienter. See
Dawes v. Imperial Sugar Co., 975 F. Supp. 2d 666, 690-9 1 (S.D. Tex. 2013) (Rosenthal, J.); N. Port
Firefighters' PensionLocal Option Plan
v.
Temple Inland, 936 F. Supp. 2d 722, 757 (N.D. Tex.
2013) (Boyle, J.). Finally, the Court notes Defendants have not cited a single case which actually holds
that, in light of Janus, the "furnish information" language from Southland is no longer good law.
In sum, the Court rejects Defendants' view that Wang's scienter cannot be imputed to Active
Power because Wang did not "make" the alleged false statements under Janus as this is not a legal
requirement under Southland. Plaintiffs have sufficiently pleaded Wang furnished false information
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to Mimer and Fife, and Wang furnished this information with scienter. Accordingly, Wang's scienter
may be imputed to Active Power.
2.
Wang did not act adversely to Active Power in the meaning of Kaplan
Defendants next argue Wang's scienter cannot be imputed to Active Power because Wang
was acting adversely to Active Power's interests. To support this contention, Defendants rely on the
Fifth Circuit opinion, Kaplan
v.
Utilicorp United, Inc., 9 F.3d 405 (5th Cir. 1993), and this Court's
previous decision, In re Netsolve, Inc.
v.
Sec. Litig., 185 F. Supp. 2d 684 (W.D. Tex. 2001). In
Netsolve, this Court addressed Kaplan and the principle it supported:
To support its contention that the individual defendants' scienter cannot be imputed
to NetSolve because the defendants plotted to harm the company, Netsolve cites
[Kaplan]. In Kaplan, the Circuit dismissed a securities fraud complaint against the
company, because the two individual defendants had acted to steal money directly
from the company for their personal use. See id. ("[T]he knowledge and actions of
employees acting adversely to the corporate employer cannot be imputed to the
corporation."). Here, however, the plaintiffs allege the individual defendants acted
to artificially raise NetSolve' s stock price, not directly steal money from its coffers.
An artificial raise in the stock price, in most cases, benefits the company. In addition,
the vast majority of securities fraud cases (in this Court, at least) allege that
individual defendants misled the market to artificially raise their company's stock
price, and then sold their shares. If the Court were to accept the defendants'
argument, such causes of action would be eliminated. While this is an appealing
prospect in terms of the Court's workload, it is not a valid application of the federal
securities laws. This ground for dismissal is overruled.
Netsolve, 185 F. Supp. 2d at 697.
The Court applies the same analysis to this case and reaches the same conclusion. In
Kaplan, the corporate officers had misappropriated millions ofdollars for personal use. In this case,
Wang did not misappropriate or steal money from Active Power. Plaintiffs' allegations support a
story with more nuance whereby Wang, while certainly benefitting himself (and his wife) with his
deceit, also benefitted Active Power in its efforts to bolster its perception in the eyes of investors.
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According to Plaintiffs' Amended Complaint, Active Power's China office, which was
established in 2010, was not achieving the results Active Power had promised investors by the end
of 2012. Active Power had made statements like "the China market will account for 20 to 25
percent of our global business within five years," or 2015. Am. Compl. [#26], ¶ 79. Yet all of Asia
accounted for only 8% of Active Power's 2012 revenues. With this backdrop, Plaintiffs depict a
scene where the stakes were high, and Active Power was under tremendous pressure to deliver on
promises made to investors. Specifically, Active Power had to honor its pledge 2013 would be the
year it would focus on China and meet the expectations it had set for itself in the eyes of investors.
The partnership agreement with Qiyuan was supposed to be a huge component of Active
Power's China strategy. Milner and Fife claim they did not know the true nature of Qiyuan and
relied on Wang for the notion Qiyuan was a subsidiary of Digital China. Nonetheless, Wang set
up the deal with Qiyuan and represented Qiyuan as affiliated with Digital China in an effort to
strengthen Active Power's investment profile. While Wang's wife was apparently a 20% owner
ofQiyuan, and Wang perhaps stood to benefit personally from this arrangement, it is simultaneously
true the arrangement served to bolster Active Power. Indeed, the day it announced the Digital China
partnership, Active Power filed a registration statement to sell $50 million of common stock. Id.,
¶ 85. Defendants point out this filing was merely a "shelf registration process" and does not mean
Active Power actually sold any securities out of this $50 million. Defs.' Reply [#32], at 6. The
point, however, is not that Active Power actually benefitted from its representations concerning the
Digital China agreement but rather that the deal was intended to benefit Active Power.
Of course, the Qiyuan deal was predicated, in part, on a lie, and Active Power ended up
suffering negative consequences as a result through, among other things, a drop in its stock price.
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But if defendants could get securities fraud claims dismissed whenever an employee's fraudulent
statements to the market ultimately result in harm to the company, then "the vast majority of
securities fraud cases (in this Court, at least).
. .
would be eliminated. While this is an appealing
prospect in terms of the Court's workload, it is not a valid application of the federal securities laws."
Netsolve, 185
F. Supp. 2d at
697; see
also In
re
Cylink Sec.
Litig.,
178
F. Supp. 2d
1077, 1087
(N,D. Cal. 2001) (observing "chickens have a way of coming home to roost" and noting
"misstatements disseminated to a securities market seldom, if ever, benefit the issuer of the
securities")
In sum, the Court is unconvinced by Defendants' comparison of Wang to the embezzlers
in Kaplan. Falsely promoting a deal which on its face benefits a company but ultimately harms it
upon exposure of the falsehood is not the equivalent of secretly embezzling money from the
company. It is worth noting Qiyuan actually made payments on some of the product it received,
and it returned the rest of the unsold product to Active Power once Active Power apparently
realized Qiyuan was not, in fact, a subsidiary of Digital China. These acts are not consistent with
Defendants' characterization of Wang as stealing from Active Power.
The Court rejects
Defendants' argument Wang's scienter may not be imputed to Active Power because Wang was
acting adversely to Active Power's interests.
B.
Plaintiffs' allegations support a strong inference Mimer and Fife acted with scienter
In contrast to the above discussion involving whether the undisputed scienter of Wang could
be imputed to Active Power, Plaintiffs do not allege Wang's scienter may be imputed to Mimer and
Fife, who were the CEO and CFO respectively during the relevant time period. Instead, Plaintiffs
allege Mimer and Fife possessed scienter themselves in their actions.
-15-
Both intent and "severe recklessness" are sufficient to satisfy the substantive scienter
requirement. Nathenson
v.
Zonagen, Inc., 267 F.3d 400,407-08 (5th Cir. 2001). Severe recklessness
is not mere negligence, but is "limited to those highly unreasonable omissions or misrepresentations
that involve not merely simple or even inexcusable negligence, but an extreme departure from the
standards of ordinary care, and present a danger of misleading
. . .
which is either known to the
defendant or is so obvious that the defendant must have been aware of it." Id. at 408. Under the
PSLRA, a complaint must "state with particularity facts giving rise to a strong inference that the
defendant acted with the required state of mind" in order to avoid dismissal. 15 U.S.C.
§
78u04(b)(2)
(emphasis added); Tellabs, 551 U.S. at 314.
The Supreme Court has detailed a three-step process for reviewing allegations of scienter on
a motion to dismiss pursuant to the PSLRA. See Ind. Elec., 537 F.3d at 533 (citing Tellabs, 551 U.S.
at 322-23). First, the facts alleged in the complaint are to be taken as true. Id. Second, those facts
must be considered holistically, rather than in isolation, to determine whether scienter has been
properly pleaded, as the proper inquiry "is whether all of the facts alleged, taken collectively, give rise
to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets
that standard." Tellabs, 551 U.S. at 323. Finally, in determining whether the pleaded facts give rise
to a "strong" inference of scienter, the court must take into account plausible opposing inferences.
Ind. Elec., 537 F.3d at 533 (citing Tellabs, 551 U.S. at 523). "[T]o qualify as 'strong'
. . .
an inference
of scienter must be more than merely plausible or reasonableit must be cogent and at least as
compelling as any opposing inference of nonfraudulent intent." Tellabs, 551 U.S. at 314. The
inference of scienter need not be irrefutable, but it must be strong in light of other explanations. Id.
Defendants contend Milner and Fife relied on Wang, a seasoned industry veteran, and
trusted him to provide accurate information. While hindsight shows their trust was misplaced,
-16-
Defendants argue this sort of honest reliance does not amount to the sort of severe recklessness
required for scienter. Defendants point out Plaintiffs' allegations repeatedly indicate Wang lied to
Milner and Fife, and these two senior executives relied on Wang for information related to China.
See
Defs.' Reply [#32], at 8. Defendants assert Milner and Fife did not have any motive to
participate in Wang's fraudulent scheme, and they highlight the absence of any allegation Milner
and Fife sold any Active Power Stock after announcing the Digital China distribution agreement.
The Court agrees the alleged facts emphasized by Defendants support plausible inferences of
nonfraudulent intent on the part of Mimer and Fife.
These alleged facts, however, support "cogent and at least as compelling" inferences to the
contrary. Plaintiffs' central contention concerning Milner and Fife's scienter concerns their failure
to disclose to the public Qiyuan as the actual partner at any point during the relevant time period.
In other words, Wang told Milner and Fife he had negotiated a distributor agreement with Qiyuan,
and Qiyuan was a subsidiary of Digital China. As it turns out, Qiyuan was not a subsidiary of
Digital China, but the Plaintiffs do not allege Milner and Fife falsely stated Qiyuan was a subsidiary
of Digital China. Indeed, therein lies the key problem: Milner and Fife never told the investing
public the distributor agreement was with Qiyuan, a subsidiary of Digital China. Instead, Milner
and Fife, without exception, said Active Power had an agreement with Digital China, knowing full
well the deal was with Qiyuan. And Milner and Fife, according to Plaintiffs' allegations, made
numerous statements about their relationship with Digital China (never mentioning Qiyuan),
including that Digital China had dedicated resources to Active Power, that Active Power and Digital
China were holding joint sales calls, and that Active Power had experienced success reselling
-17-
through Digital China's network.
See
Am. Compl. [#26], ¶ 101 (documenting all of the alleged
false statements made by Milner and Fife).
Defendants argue Milner and Fife were merely parroting what Wang told them, and they
cannot be held responsible for doing so. But Mimer and Fife did not just repeat what Wang told
them; they omitted crucial information. If Milner and Fife had merely stated in Active Power's
financial statements and in their investor phone calls what Wang told them, then they would have
reported the fact the distributor agreement was with Qiyuan, a subsidiary of Digital China. If they
had done so, Plaintiffs allege, then the fraud could have been easily discovered by the investment
analysts and other members of the public conducting some basic online research into Qiyuan.
Wang's fraud would have been nipped in the bud, but Milner and Fife continuously represented the
deal was with Digital China, enabling the fraud to persist.
While representing to the public a distributor agreement is with a parent corporation when
the transaction is actually with a subsidiary may not necessarily indicate scienter by itself, Plaintiffs
also allege Mimer and Fife's specific representations about the agreement suggested to the public
Active Power would reap the benefits of working with a large player in China when the reality, as
Milner and Fife claim to have understood it, was they would be working with a small subsidiary in
Qiyuan. For example, when an analyst asked Mimer about Digital China's geographical reach,
Mimer described Digital China's reach without disclosing that Active Power's relationship would
give it access only to those areas accessible to Qiyuan.
See Am.
Compl. [#26], ¶ 82. Perhaps there
is an inference Milner and Fife understood the arrangement with the subsidiary Qiyuan to provide
Active Power access to the parent Digital China's network, but why did Mimer and Fife not just
say so? They could have told the public the deal was actually with the smaller Qiyuan, but they
anticipated having access to Digital China's broader network. Their failure to do so gives rise to
an inference they were hiding the true nature of the relationship with an intent to deceive. As
Plaintiffs portray it, Milner and Fife knew Qiyuan was a small company with a minimal network
compared to Digital China, but they wanted the public to believe the relationship was really with
the parent. Ifthe public knew the relationship was with the comparatively unimpressive subsidiary,
Active Power's needle would not move for investors.
As to motive, Plaintiffs allege Active Power had been promoting for years its intent to
expand operations in China and Southeast Asia. These promises were largely unfulfilled going into
2013. Facing this mounting pressure, Plaintiffs allege Milner and Fife were desperate to latch onto
a Chinese project which might salvage them in 2013, a year in which they announced they were
focusing their efforts on China. A deal with Digital China provided such an outlet; a deal with
Qiyuan did not. Therefore, they only told the public about Digital China because they knew telling
the public about Qiyuan would provide them minimal traction with investors looking for signs of
progress on Active Power's China front.
In sum, taking Plaintiffs' allegations as true and considering them collectively, the Court
balances the competing inferences and ultimately concludes the alleged facts concerning Milner and
Fife give rise to a strong inference of scienter sufficient to satisfy Rule 12 and the PSLRA.
Plaintiffs' central allegations concerning Milner and
Fifetheir failure to
disclose at any point
Qiyuan as the true partner, their failure to identify Qiyuan as a subsidiary of Digital China, and their
decision to broadcast Digital China as the new distributorgive rise to a strong inference these acts
and omissions were "highly unreasonable" and "involve[d] not merely simple or even inexcusable
negligence, but an extreme departure from the standards of ordinary care, and present a danger of
-19-
misleading. . . which is either known to the defendant or is so obvious that the defendant must have
been aware of it."
Nathenson,
267 F.3d at 408. In addition, Plaintiffs' allegations concerning motive
create a strong inference Mimer and Fife were under pressure to deliver immediate results in China,
and this motive plausibly explains Milner and Fife's statements and omissions regarding the true
nature of Active Power's new distributor agreement.
Therefore, the Court DENIES Defendants' motion to dismiss the claims against Milner and
Fife for failure to allege scienter.
IV.
The Class Period should begin February 19, 2013
In addition, and presumably in the alternative, Defendants argue the Class Period should not
begin February 19, 2013, because the alleged false statements made by Milner in a conference call
that day were forward-looking, did not even mention Digital China, and therefore cannot form the
basis of a false statement for securities fraud purposes. Id. at 17. Plaintiffs disagree and contend
Mimer' s statements were false concerning past, present, and future activity.
Although not explicitly mentioned by the Defendants, the Court presumes they are invoking
the PSLRA's safe harbor provision concerning "forward-looking statements."
§
See 15
U.S.C.
78u-5(c)(1)(A). A "forward-looking statement," which can be either written or oral, includes "a
statement of the plans and objectives of management for future operations, including plans or
objectives relating to the products or services of the issuer." 15 U.S.C.
§
77z-2(i)(1)(B).
The statements at issue occurred on February 19,2013, in an earnings conference call when
Mimer responded to a question from an analyst about Active Power's intended strategies in China
and "other non-traditional geographies." Am. Compl. [#26], ¶ 75. Mimer responded as follows:
Sure our intent and we have been working for some time now really setting up an
intelligent distribution system in China. We will use a distribution partner, we intend
-20-
to use a distribution partner that will be our primary fulfillment channel for not just
China but I would say Asia generally. And then that partner will work with our direct
technical sales support people to develop opportunities and close them and they have
been doing that for the past several months that in part is one of the reasons we have
been successful finding or landing our first order for our new CSHD system in China.
So it will be a distribution of fulfillment partner in China that we are having a
network of resellers as resellers will be supported by our technical people on the
ground. And I believe it's going to prove out to be a very efficient system.
Id.
While Milner' s statements were, to some extent, "forward-looking" as he was discussing
Active Power's intended plans and repeatedly uses "will" to describe future actions, he was also
clearly describing past and present actions when he says: "we have been working for some time now
really setting up an intelligent distribution system;" "they [i.e., the "distribution partner" and Active
Power employees] have been [developing opportunities and closing them] for the past several
months;" and this past cooperation partially explains why "we have been successful finding or
landing our first order for our new CSHD system in China." Effectively, he was describing an
already-established, ongoing partnership, which would develop going into the future. Therefore, the
Court rejects Defendants' arguments these statements fall within the "forward-looking" safety harbor
provision.
In addition, the Court concludes Plaintiffs adequately pleaded these statements were false.
While Milner never explicitly identifies this new "distribution partner," as "Digital China," Plaintiffs
argue Defendants were clearly referring to Digital China. Milner describes a "distribution partner
that will be our primary fulfillment channel for not just China but.
. .
Asia generally," and then he
says "that partner" has been working with Active Power employees to develop and close deals.
Indeed, Milner states "that partner" has already been working with Active Power employees to close
-21-
Active Power's first CSHD system order in China. Plaintiffs contend that suggesting the "partner"
could be a primary fulfillment channel for not just China but Asia generally must be a reference to
Digital China, a major company with a broad network. According to Plaintiffs' allegations, creating
the perception Active Power had an agreement with a partner capable of expanding Active Power's
reach across Asia was false. Mimer knew this could not be true because Active Power's deal was
with Qiyuan, a small company incapable of being Active Power's primary fulfillment channel for
China and Asia generally. Similarly, stating Active Power had already worked with such a partner
to close a deal was also false. Mimer knew this could not be true because he knew the deal was with
Qian,
In other words, Plaintiffs allege Milner committed the same fraud with these statements he
committed later on April 30, 2013, with the only difference being he omitted the name "Digital
China." On April 30,2013, Plaintiffs allege Milner perpetrated fraud when he misled the public into
believing Active Power had a partnership agreement with a company capable of being Active
Power's primary fulfillment channel for China and all of Asia by naming "Digital China" as the
partner without ever mentioning the deal was actually with Qiyuan, a subsidiary of Digital China.
On February 19, 2013, Plaintiffs allege Milner perpetrated fraud when he misled the public into
thinking Active Power had a partnership agreement with an unnamed company capable of being
Active Power's primary fulfillment channel for China and all of Asia without ever mentioning the
partner was actually a subsidiary of this unnamed company.
The Court finds these allegations sufficient under the PSLRA and Rule 9, and declines
Defendants' request to push the Class Period's start date from February 19, 2013, to April 30, 2013.
-22-
Plaintiffs' allegations support § 20(a) control-person claims
V.
Finally, Defendants request the dismissal of the § 20(a) control-person claim on the ground
Plaintiffs have failed to establish an independent violation ofthe securities laws from which liability
under
§
20(a) could flow.
See
Defs.' Mot. Dismiss [#29], at 18. Defendants' requested dismissal
of the § 20(a) claims are premised on the Court's dismissal of the § 10(b) and Rule 1 Ob-5 claims for
lack of scienter. As described above, the Court concludes Plaintiffs have adequatelypleaded scienter
and denies Defendants' request to dismiss the
§
10(b) and Rule 1 Ob-5 claims. Accordingly, the
Court also denies Defendants' dependent request to dismiss the § 20(a) claims.
Conclusion
Plaintiffs' allegations in their Amended Complaint satisfy the heightened pleading standards
under the PSLRA and Rule 9. Specifically, Plaintiffs adequately pleaded scienter both with respect
to the corporation, Active Power, and the individuals, Mimer and Fife.
Accordingly,
IT IS ORDERED that Defendants Active Power, Inc., Stephen R. Fife, and Doug
Mimer's Motion to Dismiss [#29] is DENIED.
SIGNED this the
day of July 2014.
UNITED STATES DISTRICT JUDGE
797 mtdordjtw3.wpd
23
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