Courtney v. Avid Technology, Inc.
1:13-cv-10686 | D. Mass. | Jun 27, 2014
UNITED STATES DISTRICT COURT
DISTRICT OF MASSACHUSETTS
WASHTENAW COUNTY EMPLOYEES
RETIREMENT SYSTEM, and
MICHAEL COURTNEY, Individually
and on Behalf of All Other
Persons Similarly Situated,
Plaintiffs,
CIVIL ACTION
v. NO. l3-lO686-WGY
AVID TECHNOLOGY, INC.,
GARY G. GREENFIELD, KENNETH A.
SEXTON, LOUIS HERNANDEZ, and
ERNST & YOUNG LLP,
Defendants.
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YOUNG, D.J. June 27, 2014
MEMORANDUM AND ORDER
I. INTRODUCTION
This is a putative class action filed by Michael Courtney
(“Courtney”) and Washtenaw County Employees Retirement System
(“Washtenaw”) (collectively, the “Plaintiffs”) against Avid
Technology, Inc. (“Avid,” or the “Company”), certain of its
officers (the “Individual Defendants”) (collectively with Avid,
the “Avid Defendants”), and Ernst & Young LLP (“Ernst & Young”)
(collectively with the Avid Defendants, the “Defendants”),
seeking remedies for violations of the federal securities laws
pursuant to the Securities Exchange Act of 1934, Pub. L. No. 73-
291, 48 Stat. 881 (codified as amended at 15 U.S.C. §§ 78a-78pp)
(the “Exchange Act”). This securities class action is brought
by the Plaintiffs on behalf of purchasers of Avid common stock
on the NASDAQ Stock Market (“NASDAQ”) between October 23, 2008,
and March 20, 2013, inclusive (the “Class Period”).
The Plaintiffs’ core contention is that the Defendants took
actions to present false and misleading financial statements,
which artificially inflated Avid's stock price. Those actions
involved the knowing violation of established accounting
principles, the manipulation of accounting reserves, and the
withholding of true and essential information regarding the
Company's business. As a result, when the truth was revealed to
the market, Avid's stock price plummeted.
The present lawsuit is the result of a consolidation of two
class actions separately filed by the two Plaintiffs. After the
consolidation, the Defendants moved to dismiss the lawsuit under
Federal Rule of Civil Procedure 12(b)(6) (“Rule 12(b)(6)”),
attacking the legal sufficiency of the complaint in light of the
heightened pleading requirements under the Private Securities
Litigation Reform Act, Pub. L. No. 104-67, 109 Stat. 737
(codified as amended in scattered sections of 15 U.S.C.) (the
“Reform Act”), and under Federal Rule of Civil Procedure 9(b)
(“Rule 9(b)”). At a motion session held on February 11, 2014,
this Court allowed the motion to dismiss as to the claims of
fraud related to the restructuring of the Company and also those
related to the European sales operation, and took under
advisement the fraud claim pertaining to post-contractual
customer support.
A. Procedural Posture
Courtney filed a complaint in this Court on March 25, 2013.
Class Action Compl., ECF No. 1. On May 24, 2013, Washtenaw,
which had filed a related lawsuit, also in this session of the
Court, moved to consolidate these cases, appoint a lead
plaintiff, and approve the selection of counsel. Washtenaw
l
Cnty. Emps. Retirement Sys.'s Mot. Consolidation, Appointment
Lead Pl. & Approval Selection Counsel, ECF No. 6. On June 11,
2013, this Court allowed the motion to consolidate and set for
hearing the motion to appoint lead counsel. Elec. Order, June
11, 2013, ECF No. 18. At a motion hearing held on July 31,
2013, this Court allowed the stipulation of the parties as to
lead counsel and granted the Plaintiffs forty-five days to file
a joint complaint. Elec. Clerk's Notes, July 31, 2013, ECF No.
25. The joint amended complaint was filed on September 16,
2013. Am. Compl., ECF No. 26.
On October 31, 2013, the Avid Defendants filed a motion to
dismiss accompanied by a supporting memorandum of law. Defs.
Avid Tech., lnc., Louis Hernandez, Gary G. Greenfield, & Kenneth
A. Sexton's Mot. Dismiss Pls.' Am. Compl., ECF No. 33; Mem. Law
Supp. Defs. Avid Tech., lnc., Louis Hernandez, Gary G.
Greenfield, & Kenneth A. Sexton’s Mot. Dismiss Pls.’ Am. Compl.
(“Avid’s Mem.”), ECF No. 34. On the same day, Ernst & Young
also filed a motion to dismiss along a supporting memorandum of
law. Ernst & Young LLP’s Mot. Dismiss, ECF No. 36; Mem. Supp.
Ernst & Young LLP’s Mot. Dismiss (“Ernst & Young’s Mem.”), ECF
No. 37. On December 16, 2013, the Plaintiffs opposed both
motions to dismiss. Lead Pls.’ Mem. Law Opp’n Avid Defs.’ Mot.
Dismiss (“Pls.’ Opp’n Avid”), ECF No. 44; Lead Pls.' Mem. Law
Opp’n Def. Ernst & Young LLP’s Mot. Dismiss (“Pls.’ Opp’n Ernst
& Young”), ECF No. 46. The Defendants filed their reply briefs
on January 22, 2014. Reply Mem. Law Further Supp. Defs. Avid
Tech., Inc., Louis Hernandez, Gary G. Greenfield, & Kenneth A.
Sexton’s Mot. Dismiss Pls.’ Am. Compl. (“Avid’s Reply”), ECF No.
50; Ernst & Young LLP’s Reply Br. Supp. Mot. Dismiss (“Ernst &
Young’s Reply”), ECF No. 51.
At the motion hearing on February 11, 2014, the Court
allowed the motion to dismiss as to the claims of fraud related
to the Company restructuring and also as to the European sales
operation, while taking under advisement the fraud claim
pertaining to post-contractual customer support. §§e Hr’g Tr.
18:12-22, Feb. 11, 2014, ECF No. 57.
B. Facts Alleged1
1.Parties
The Plaintiffs purchased Avid’s securities at purportedly
artificially inflated prices during the Class Period, and they
were then damaged because of the price drop after the Company
announced the corrective measures. Am. Compl. 1 14.
Avid is a Delaware corporation with its principal place of
business in Burlington, Massachusetts. 1§; 1 15. Avid is a
leading provider of software systems and hardware products used
to create and manipulate digital media content. §§; 11 2, 22.
Its products are used by professionals to produce feature films,
television programming, live performances, and recorded music.
Avid’s Mem. 2. Avid’s common stock trades on NASDAQ. Am.
Compl. 1 15.
Gary G. Greenfield (“Greenfield”) was Avid’s Chief
Executive Officer (“CEO”), President, and Chairman of the Board
during almost the entire Class Period, having resigned on
February ll, 2013, just over a month before the end of the Class
Period. §e§ id; 1 16. Kenneth A. Sexton (“Sexton”) was Avid’s
Chief Financial Officer (“CFO”), Executive Vice President, and
1 Considering the heightened pleading requirements in
securities fraud cases, it is necessary to describe the facts
that the Plaintiffs alleged in the amended complaint in greater
detail than would normally be required in a motion to dismiss.
Also, because this is a motion to dismiss, the Court takes the
facts alleged by the Plaintiffs as true. Tellabs, Inc. v. Makor
lssues & Rights, Ltd., 551 U.S. 308" date_filed="2007-06-21" court="SCOTUS" case_name="Tellabs, Inc. v. Makor Issues & Rights, Ltd.">551 U.S. 308, 322 (2007).
Chief Accounting Officer throughout the entire Class Period.
ld; 1 17. Louis Hernandez (“Hernandez”) is the current
President and CEO of Avid, and was appointed immediately after
Greenfield’s resignation. ld; 1 114.
Ernst & Young served as Avid’s independent registered
public accounting firm throughout the Class Period. 1§; 1 21.
Accordingly, “[Ernst & Young] audited and issued unqualified
audit opinions on Avid’s financial statements and its system of
internal controls over financial reporting for the years [2008
through 2011].” 1d.
2.Avid's Purported Fraudulent Schemes
The Plaintiffs generally allege that “[t]hroughout the
Class Period, [the] Defendants engaged in a wide ranging scheme
to materially inflate [Avid’s] reported financial statements.”
1§; 1 3. More specifically, the Plaintiffs identify three
instances where the fraud took place: (1) Avid recognized
revenues generated from software updates “immediately upon the
commencement of a licensing agreement with a customer, as
opposed to ratably over the term of the contract” - the manner
provided by the Generally Accepted Accounting Principles
(“GAAP”). ld; 1 4. As a result of this accounting tweak, the
Company's results were artificially inflated, which were
reflected in the stock price, see id;; (2) Avid “manipulated
accounting reserves associated with the four restructuring
initiatives during the Class Period in order to inflate its
earnings, and by extension the stock price,” id; 1 5 (emphasis
omitted); (3) After touting Avid’s increasing operating
efficiency for many quarterly reports, the Company finally
disclosed “that its centralized sales structure in Europe was
failing and that its scheme to increase prices in order to
offset lost sales was equally ineffective.” ld; 1 7. As a
result of the disclosure, Avid’s stock price plummeted. ld;
The Plaintiffs further claim that, “during the Class Period, the
Individual Defendants engaged in insider trading, improperly
benefiting from their financial shenanigans and Avid’s
artificially inflated stock price, by selling shares of Avid
common stock.” ld; 1 20.
According to the Plaintiffs, the first two events could
only have taken place with the “cooperation and imprimatur” of
Ernst & Young, who ignored “fundamental accounting principle[s]”
and allowed the fraud to Occur. ld; 1 6. To better understand
the issues involved, the Court breaks down the three fraudulent
schemes alleged by the Plaintiffs.
a.Improper Recognition of Revenue from Post-
Contract Customer Support
The first -- and strongest -- allegation by the Plaintiffs
regards Avid’s accounting treatment of the revenue originated by
post-contract customer support (“PCS”). Before going over the
Plaintiffs' arguments, a brief overview of PCS and its
accounting treatment is in order.
“PCS is the right to receive services or unspecified
product upgrades or enhancements offered to users or resellers,
after the software license begins, or after another time as
provided for by the post-contract customer support arrangement."
l§; 1 25. The purveyance of PCS is a common practice in the
software business: besides delivering the software, the
producers “provide their customers with other elements such as
additional software products, training, installation,
consulting, telephone support, and future upgrades or
enhancements after the delivery of the initial software.” Id.
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Importantly, [b]ecause PCS is considered a separate element in
a software arrangement,” GAAP precludes the recognition of PCS
revenue upon the immediate delivery of the software, and
“requires that companies record PCS revenue ratably in financial
statements over the term of the contract." ld;
The Court makes two distinctions at this point. First,
PCS-type services (or “upgrades”) are distinct from mere “bug
fixes.” While the former constitute some sort of enhancement to
the product,2 the latter merely fix some coding defect or error.
2 According to the Accounting Standards Codification, an
upgrade is “[a]n improvement to an existing product that is
intended to extend the life or improve significantly the
marketability of the original product through added
Avid’s Mem. 2. As a result, for accounting purposes, there is a
substantial difference between PCS and bug fixes: under GAAP,
revenue on software sold without PCS -- i;e;, with only “bug
fixes” supplied after the sale -- is recognized fully upon the
sale. §ee id; at 2-3. Conversely, revenue from software sold
with PCS -- i.e., with enhancements available in the future --
is recognized ratably over the life of the period in which the
support is offered. See Accounting Standards Codification
(“ASC”) 985-605-25-103; Avid’s Mem. 2-3. In addition, a
“pattern[] of regularly providing . . . certain kinds of
customers with . . . unspecified upgrades or enhancements” can
result in “implied [PCS],” ASC 985-605-25-66, that also triggers
ratable revenue recognition over the “implied” support period.
The second distinction regards the accounting of the so-
called “multiple element arrangements,” where both software and
PCS are provided pursuant to separate contractual components.4
functionality, enhanced performance, or both. The terms upgrade
and enhancement are used interchangeably to describe
improvements to software products . . . .” Accounting Standards
Codification 985-605-20.
3 The accounting rules which compose GAAP are published by
the Financial Accounting Standards Board, and are available at
https://asc.fasb.org.
4 “Software arrangements may provide licenses for multiple
software deliverables (for example, software products, upgrades
or enhancements, postcontract customer support, or services),
which are termed multiple elements.” ACS 985~605-25-5,
available at https://asc.fasb.org.
In such cases, the various elements of the contract must be
allocated according to GAAP’s revenue recognition criteria. §ee
generally ASC 985-605-25-5 to 25-11. For instance, while the
software sale and delivery are accounted immediately, the PCS
element must be accounted ratably over the term of the contract.
§ee Am. Compl. 1 27. The value assessment of each element is
“based on vendor subjective objective evidence of fair value.”
ld; Accordingly, “the fair value of the PCS [is] determined by
reference to the price the customer would be required to pay
when it is sold separately.” ld; If, however, the company is
unable to determine the value of the separate elements of the
arrangement and the only undelivered element is PCS, revenues
for the entire licensing arrangement should be recognized
ratably, and not up front. §e§ ASC 905-685-25-70.
According to the Plaintiffs, during the entire Class
Period, Avid sold software that included explicit or implied
promises to provide software updates, which the Plaintiffs argue
was a type of PCS. §ee Am. Compl. 1 24. Accordingly, each and
every Avid Annual Report on Form 10-K filed with the U.S.
Securities and Exchange Commission (“SEC”) since at least 2008
stated that the Company complies with GAAP by deferring the fair
value of PCS and recognizing the related revenue ratably over
the span of the service period. Id. 11 26*30.
10
On February 25, 2013, however, based on an internal review
of its accounting practices, Avid announced that it would delay
the release of its fourth quarter and fiscal year 2012 financial
results because “it needed additional time ‘to evaluate its
current and historical accounting treatment related to bug
fixes, upgrades and enhancements to certain products which the
Company has provided to certain customers.'” 1§; 1 116 (quoting
Avid Tech. 8-K, issued Feb. 25, 2013).
Subsequently, on March 19, 2013, Avid announced its intent
to restate previous financial statements based on its failure
“‘to recognize [revenues] ratably over the estimated PCS service
period.'” Pls.' Opp'n Avid 4 (alteration in the original). The
failure was related to implied PCS that should have been
accounted ratably but was instead accounted up front. Am.
Compl. 1 124 (“The Company expects that the timing of revenue
recognition for the impacted customer arrangements will change
from the historical presentation in the Company's financial
statements pursuant to which revenue was recognized up front,
generally to being recognized ratably over the estimated implied
PCS service period.”) (quoting Avid Tech. 8-K, issued May 17,
2013). According to Avid's disclosure, “the ‘primary focus' of
the Company's still ongoing review of its accounting treatment
for Software Upgrades ‘ha[d] been to determine whether no-charge
bug fixes previously made available by the Company to its
11
customers included upgrades or enhancements and if so, whether
such upgrades or enhancements met the definition of [PCS] under
[GAAP]'”. ld; 1 141 (first alteration in the original) (quoting
Avid Tech. NT 10-K, issued Mar. 19, 2013).
The Plaintiffs allege that the price of Avid's stock
dropped as a result of these disclosures. Id. 11 140-42, 144.
tx Manipulation of Restructuring Expenses
The second fraud alleged by the Plaintiffs regards the
manipulation of expenses incurred with Avid's restructuring.
Between 2008 and 2012, the Company went through four
restructuring initiatives. ld. 1 35. For each of these
initiatives, the company recorded restructuring charges in its
quarterly and annual forms. Id.
ln 2012, however, Avid announced in its first quarter Form
10-Q that it had identified errors in previous financial
statements. ld. 11 36, 100. Through the revised financial
statements:
[T]he Company increased its 2011 net restructuring
costs by $1.3 million (or 14.7%) and reduced its 2010
net restructuring costs by $1.6 million (or 7.7%).
The Company increased its first quarter 2011 net
recovery of previously expensed restructuring costs by
$740,000 (or 33.4%), reduced its second quarter 2011
net recovery of previously expensed restructuring
costs by $325,000 (or 199.4%) and increased its fourth
quarter 2011 net restructuring costs by $240,000 (or
2.8%).
12
ld; 1 37 (citing Avid Tech. 10-Q, issued May 10, 2012).
According to the Plaintiffs, Avid’s stock price immediately
dropped as a result of this announcement, and “continued to drop
precipitously for several days thereafter on heavy trading
volume.” ld; 1 101. Likewise, on May 21, 2013, Avid disclosed
it had overstated restructuring expenses related to the second
and third quarters of 2012, ld; 1 124.
The Plaintiffs claim that the Avid Defendants “used the
above restructuring accounting shenanigans to manipulate the
Company's earnings by setting up excess reserves in prior
periods and then releasing the reserves into earnings in
A
subsequent periods, creating phantom income.” Id. 1 38.
c.Decline in European Sales Resulting in
Restructuring Charges
The third instance of fraud alleged by the Plaintiffs
regards the changes made to the European operation of the
Company. According to the Plaintiffs, for some period of time
since 2008, the Avid Defendants “touted the Company's increasing
operating efficiency with respect to its sales force . . . ,
increasing sales revenues, and positive company-wide growth in
the prior reporting periods.” 1§; 1 43. On July 21, 2011,
however, the Avid Defendants “disclosed that the Company badly
missed sales revenues targets they had led investors to expect,
revealing for the first time that significant deficiencies in
13
the structure of Avid’s European sales force required a
restructuring of the entire division.” ld; 1 41. The
disclosure immediately caused a sharp drop in Avid stock price,
which traded in unusually high volume the following day. 1§;
1 87. The Plaintiffs allege that the Avid Defendants made
misstatements promoting the Company's efficiency while knowing
their falsity as to the European operation, See id. 1 7.
II. ANALYSIS
A. Jurisdiction and Venue
This Court has jurisdiction under 28 U.S.C. § 1331, and
under Section 27 of the Exchange Act, codified at 15 U.S.C.
§ 78aa, as the claims in this action arise under and pursuant to
Sections 10(b) and 20(a) of the Exchange Act, codified at 15
U.S.C. §§ 78j(b) and 78t(a), respectively, and Rule 10b~5,
promulgated thereunder by the SEC, 17 C.F.R. § 240.10b-5. The
Plaintiffs have adequately alleged that Avid made use of the
means and instrumentalities of interstate commerce in committing
the acts of which the Plaintiffs complain. Venue is proper
under 15 U.S.C. § 78aa and 28 U.S.C. § 1391(b).
B. Standard of Review - Generally
To survive a motion to dismiss under Rule 12(b)(6), a
complaint must allege facts sufficient to state a facially
plausible claim for relief. See Bell Atl. Corp. v. Twombly, 550
14
U.S. 544, 570 (2007) (setting out the standard of review for
Rule 12(b)(6) motions to dismiss). Nevertheless, a defendant's
burden of persuasion “is a heavy one when a motion to dismiss is
filed.” Stein v. Smith, 270 F. Supp. 2d 157" date_filed="2003-07-03" court="D. Mass." case_name="Stein v. Smith">270 F. Supp. 2d 157, 164 (D. Mass.
2003) (Lindsay, J.). 1n its consideration of a motion to
dismiss, the Court is instructed to “accept as true all well-
pleaded facts in the complaint and draw all reasonable
inferences in favor of the plaintiffs.” Gargano v. Liberty
Int'l Underwriters, Inc., 572 F.3d 45" date_filed="2009-07-14" court="1st Cir." case_name="Gargano v. Liberty International Underwriters, Inc.">572 F.3d 45, 48 (1st Cir. 2009). In
other words, a motion to dismiss does not measure the
complaint's probability of success, but rather its legal
adequacy. Reisman v. KPMG Peat Marwick LLP, 965 F. Supp. 165" date_filed="1997-02-28" court="D. Mass." case_name="Reisman v. KPMG PEAT MARWICK LLP">965 F. Supp. 165,
170 (D. Mass. 1997).
C. Pleading Standards - Securities Action
“To state a claim under Rule 10b-5, ‘a plaintiff must
allege that: (1) in connection with the purchase or sale of
securities, (2) the defendant made a false statement or omitted
a material fact, (3) with the requisite scienter, and that (4)
plaintiff relied on the statement or omission, (5) with
resultant injury.'” Crowell v. lonics, lnc., 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d 1,
12 (D. Mass. 2004) (quoting In re Boston Tech., Inc. Sec.
Litig., 8 F. Supp. 2d 43" date_filed="1998-02-05" court="D. Mass." case_name="In Re Boston Technology, Inc. Securities Litigation">8 F. Supp. 2d 43, 52 (D. Mass. 1998) (Lasker, J.)). The
dispute in the present motions revolves around the second and
third requirements. A brief overview is in order.
15
l.Misrepresentation or Omission of a Material Fact
ln order to qualify as a material misrepresentation or
omission, the plaintiff must indicate that a reasonable investor
would have viewed the information as “having significantly
altered the total mix of information made available.” §a§ic
lnc; v. Levinson, 485 U.S. 224" date_filed="1988-03-07" court="SCOTUS" case_name="Basic Inc. v. Levinson">485 U.S. 224, 232 (1988) (quoting TSC lndus.,
lnc; v. Northway, lnc., 426 U.S. 438" date_filed="1976-06-14" court="SCOTUS" case_name="TSC Industries, Inc. v. Northway, Inc.">426 U.S. 438, 449 (1976)) (internal
quotation marks omitted).
Rule 9(b) provides that “[i]n alleging fraud . . . a party
must state with particularity the circumstances constituting
fraud.” Fed. R. Civ. P. 9(b). lt has long been established
that “[t]he First Circuit is ‘especially strict in demanding
l
adherence to Rule 9(b) in the securities context.” Crowell,
343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 12 (quoting Gross v. Summa Four, Inc., 93
F.3d 987, 991 (1st Cir. 1996)).5 Thus, it is the plaintiff’s
duty to point to “specific facts that make it reasonable tol
believe that the defendant knew a statement was materially false
or misleading. The rule requires that the particular times,
dates, places, or other details of the alleged fraudulent
involvement of the actors be alleged.” ld; (quoting §ro§§, 93
F.3d at 991). ln other words, “[t]o survive a motion to
dismiss, a complaint alleging fraud must specify (1) the
5 As this Court observed in Crowell, Gross has been
partially superseded on other grounds by the Reform Act.
Crowell, 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 12 n.6.
16
statements that the plaintiff contends were fraudulent; (2) the
identity of the speaker; (3) where and when the statements were
made; and (4) why the statements were fraudulent.” Fitzer v.
Sec. Dynamics Techs., Inc., 119 F. Supp. 2d 12" date_filed="2000-09-28" court="D. Mass." case_name="Fitzer v. Security Dynamics Technologies, Inc.">119 F. Supp. 2d 12, 18 (D. Mass.
2000).
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Accordingly, [p]leadings based on information and belief,
without specifying the source of the information and the reasons
for the belief, do not pass muster under the First Circuit‘s
interpretation of Rule 9(b).” Id.; see also Romani v. Shearson
Lehman Hutton, 929 F.2d 875" date_filed="1991-04-08" court="1st Cir." case_name="Richard Romani v. Shearson Lehman Hutton">929 F.2d 875, 878 (1st Cir. 1991), superseded by
statute on other grounds, Reform Act. Finally, the allegations
must create a strong inference of fraudulent intent, rather than
a reasonable one. Crowell, 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 12~13. As a
result, “exaggerated, vague, or loosely optimistic statements
about a company are not actionable under Rule 10b-5.” ln_re
Boston Tech., 8 F. Supp. 2d 43" date_filed="1998-02-05" court="D. Mass." case_name="In Re Boston Technology, Inc. Securities Litigation">8 F. Supp. 2d at 54.
2. Scienter
As for scienter, “the plaintiff must plead a mental state
embracing [an] intent to deceive, manipulate, or defraud.
Scienter can be proved by showing either knowledge that the
statements at issue were materially false or misleading, or
recklessness in that regard, and the complaint must so plead.”
Lenartz v. Am. Superconductor Corp., 879 F. Supp. 2d 167" date_filed="2012-07-26" court="D. Mass." case_name="Lenartz v. American Superconductor Corp.">879 F. Supp. 2d 167, 181
(D. Mass. 2012) (alteration in original) (internal quotations
17
and citations omitted). The First Circuit has long followed the
Seventh Circuit's narrow definition of recklessness: “the
definition of ‘reckless behavior' should not be a liberal one
lest any discernible distinction between ‘scienter' and
‘negligence' be obliterated for these purposes. We believe
‘reckless' in these circumstances comes closer to being a lesser
form of intent than merely a greater degree of ordinary
negligence. We perceive it to be not just a difference in
degree, but also in kind.” Sanders v. John Nuveen & Co., lnc.,
554 F.2d 790" date_filed="1977-06-08" court="7th Cir." case_name="Fed. Sec. L. Rep. P 96,030 Henry T. Sanders v. John Nuveen & Co., Inc.">554 F.2d 790, 793 (7th Cir. 1977); see also Greebel v. FTP
Software, lnc., 194 F.3d 185" date_filed="1999-10-08" court="1st Cir." case_name="Greebel v. FTP Software, Inc.">194 F.3d 185, 199 (1st Cir. 1999) (quoting with
approval the standard set by the Seventh Circuit in Sanders and
noting that “[the First Circuit] explicitly rejected a
formulation of recklessness as mere negligence, finding it had
to come closer to being a lesser form of intent than merely a
greater degree of ordinary negligence”).
Accordingly, the First Circuit requires:
A highly unreasonable omission, involving not merely
simple, or even inexcusable, negligence, but an
extreme departure from the standards of ordinary care,
and which presents a danger of luisleading buyers or
sellers that is either known to the defendant or is so
obvious the actor must have been aware of it.
Greebel, 194 F.3d 185" date_filed="1999-10-08" court="1st Cir." case_name="Greebel v. FTP Software, Inc.">194 F.3d at 198 (quoting Sundstrand Corp. v. Sun Chem.
Corp., 553 F.2d 1033" date_filed="1977-04-18" court="7th Cir." case_name="Fed. Sec. L. Rep. P 95,887 Sundstrand Corporation v. Sun Chemical Corporation">553 F.2d 1033, 1045 (7th Cir. 1977)). Finally, “[i]n
making the scienter determination, courts consider the totality
18
of the circumstances, rather than examining each alleged
omission or misstatement in isolation.” Crowell, 343 F. Supp.
2d at 13.
D. The Merits
1.The Amended Complaint Alleges a Misstatement with
Particularity, only as to the PCS-related Claim
The Avid Defendants assert that the Plaintiffs have failed
to allege a misstatement with the particularity required by the
Reform Act and Rule 9(b) as to all the three purported instances
of fraud. Avid's Mem. 8.
a.The Improper Recognition of PCS Revenue
As to the first episode of fraud ~- concerning the improper
recognition of PCS revenue -- the Avid Defendants claim that
“[t]he pleading simply quotes the revenue reports, labels them
wrong, and emphasizes Avid's accounting policy to recognize
revenue for explicit PCS ratably and consistent with GAAP's
guidance," id. at 9, and as such the complaint “fail[s] to
demonstrate any misstatement . . . with the specificity for
accounting fraud required by the [Reform Act],” id. at 10.
At its core, the Avid Defendants’ contention is that the
Plaintiffs make a broad allegation of accounting fraud, without
pointing to any specific transactions that should be accounted
for in a different manner. In other words, the amended
complaint arguably relies solely on Avid's own disclosure of
19
errors, instead of identifying the particular transactions where
the purported fraud actually took place. As the Avid Defendants
put it:
[T]he Amended Complaint provides no detail at all
about any update, much less any decision to
characterize an update as a mere “bug fix” or an
actual “upgrade” that may have constituted implied
PCS. There is not one fact identifying any software
release where Avid ndsapplied its accounting policy.
The Amended Complaint does not mention any release
characterized as a “bug fix” that should have been
labeled an “upgrade” or point to “significant
added functionality or performance enhancements[]” for
any release. And it does not even address the
decision making process used to determine how to treat
any “update” for accounting purposes.
Id. at 10 (alterations in original) (emphasis omitted).
The Plaintiffs, on the other hand, insist that “the
Complaint particularizes the Avid Defendants' materially false
and misleading statements and omissions related to the Company's
accounting practices regarding implied PCS by specifically
identifying: ‘what' statements are alleged to be false and
misleading; ‘who' made the statements . . . ; ‘when' they were
made; and ‘where' they were made . . . . Further, the Complaint
also explains ‘why' the Avid Defendants' statements were
materially false and misleading.” Pls.' Opp'n Avid 9 (internal
citations omitted).
The parties rely on different lines of cases to support
their arguments, and they disagree about what constitutes a
sufficiently particularized misstatement pleading.
20
The Avid Defendants rely on this Court’s decisions in
Fitzer, 119 F. Supp. 2d 12" date_filed="2000-09-28" court="D. Mass." case_name="Fitzer v. Security Dynamics Technologies, Inc.">119 F. Supp. 2d 12, and in Orton v. Parametric
Technology Corp., 344 F. Supp. 2d 290" date_filed="2004-11-03" court="D. Mass." case_name="Orton v. Parametric Technology Corp.">344 F. Supp. 2d 290 (D. Mass. 2004), where
this Court ruled that the plaintiffs’ pleading failed on the
particularity requirement. As observed in Fitzer:
This Court has previously required significant
specificity when a securities fraud claim is based on
improper revenue recognition. “To adequately plead
financial fraud based on improper revenue recognition,
Plaintiffs must allege, at minimum, some particular
transactions where revenues were improperly recorded,
including the names of the customers, the terms of
specific transactions, when the transactions occurred,
and the approximate amount of the fraudulent
transactions.”
Fitzer, 119 F. Supp. 2d 12" date_filed="2000-09-28" court="D. Mass." case_name="Fitzer v. Security Dynamics Technologies, Inc.">119 F. Supp. 2d at 35 (quoting Lirette v. Shiva Corp.,
27 F. Supp. 2d 268" date_filed="1998-11-19" court="D. Mass." case_name="Lirette v. Shiva Corp.">27 F. Supp. 2d 268, 277 (D. Mass. 1998)); see also Qrton, 344 F.
Supp. 2d at 304-05.
On the other hand, as this Court has also observed, “the
rigorous standards for pleading securities fraud do not require
a plaintiff to plead evidence.” Crowell, 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 21
(quoting ln re Cabletron Sys., lnc., 311 F.3d 11" date_filed="2002-11-12" court="1st Cir." case_name="Mesko v. Cabletron System, Inc.">311 F.3d 11, 33 (1st Cir.
2002)). ln Crowell, this Court relied on the First Circuit’s
decision in Cabletron, “which makes clear that the question
whether a complaint satisfies the [Reform Act] is fact-specific,
and that not every question regarding relevant transactions must
be answered at the pleading stage.” ld; at 21 (citing
Cabletron, 311 F.3d 11" date_filed="2002-11-12" court="1st Cir." case_name="Mesko v. Cabletron System, Inc.">311 F.3d at 32).
21
In Crowell, this Court had the opportunity to analyze the
case in light of both Fitzer and Cabletron, Succinctly, in
Crowell the plaintiff alleged that the defendant company “had
schemed to inflate [a] product[’s] sales and customer base
artificially,” by ordering the product's “sales force to deliver
hundreds of thousands of unordered and unwanted [units] to [the]
retail customers, one extra [unit] per customer.” ld; at 6.
When the discussion focused on the particularity
requirement, the defendants in Crowell argued that the plaintiff
had the duty to “allege who the customers that received excess
[products] were, as well as the time, terms, and amount of the
specific transactions.” ld; at 21. This Court, however, ruled
that the plaintiff had pleaded the misstatement with sufficient
particularity, because he “alleged a specific type of scheme,
taking place over a specified time period, for a specified
reason, with specified results, based on testimony of multiple
witnesses with personal knowledge, and on reasonable inferences
from the later downward adjustment in [the product]'s sales
price.”6 ld;
Having the benefit of analyzing the present case with these
precedents in mind, this Court views this case as closer to
6 ln Fitzer, on the other hand, the plaintiff failed on the
particularity requirement, because although she “ha[d] made
general allegations relating to channel stuffing activity
she ha[d] not supplied any of the details required to meet her
pleading burden.” Fitzer, 119 F. Supp. 2d 12" date_filed="2000-09-28" court="D. Mass." case_name="Fitzer v. Security Dynamics Technologies, Inc.">119 F. Supp. 2d at 36.
22
Crowell than to Fitzer. Here, the Plaintiffs (i) pointed to the
statements they claim to be false or misleading (the many press
releases and financial reports presenting financial revenues
artificially inflated by accounting upfront revenue that should
have been accounted ratably); (ii) identified the speakers
responsible for such statements (broadly, the Avid Defendants,
but each statement is attributed to one or more of them); (iii)
defined where and when such statements were made (providing
dates and context); and (iv) provided the reasons why each
statement was fraudulent (broadly, to inflate the Company's
revenue).
Now, while it is true that the Plaintiffs cannot allege by
exactly how much the revenues were inflated, this ought not
prevent them from surviving the motion to dismiss. Once more,
because they do not have the benefit of discovery, the
Plaintiffs are not required to plead evidence, as long as the
misstatements are pled with enough particularity to comply with
the heightened standards aforementioned. See Mississippi Pub.
Emps.' Ret. Sys. v. Boston Scientific Corp., 523 F.3d 75" date_filed="2008-04-16" court="1st Cir." case_name="Mississippi Public Employees' Retirement System v. Boston Scientific Corp.">523 F.3d 75, 90
(lst Cir. 2008) (“[T]his court has held that ‘in determining the
adequacy of a complaint . . . we cannot hold plaintiffs to a
standard that would effectively require them, pre-discovery, to
plead evidence.' The law ‘proscribes the pleading of ‘fraud by
hindsight,' but neither can plaintiffs be expected to plead
23
fraud with complete insight.’”) (quoting Shaw v. Digital Equip.
Corp., 82 F.3d 1194" date_filed="1996-05-07" court="1st Cir." case_name="Shaw v. Digital Equipment Corp.">82 F.3d 1194, 1225 (1st Cir. 1996), superseded by statute
on other grounds, Reform Act).
In the end, this is not a strong case, such as Crowell.
Here, one can argue that the Plaintiffs rely too much on Avid’s
voluntary disclosure of errors. This should not lead, however,
to the dismissal of the case, See In re Polaroid Corp. Sec.
Litig., 134 F. Supp. 2d 176" date_filed="2001-03-21" court="D. Mass." case_name="In Re Polaroid Corp. Securities Litigation">134 F. Supp. 2d 176, 186~87 (D. Mass. 2001) (Saris, J.)
(“‘[A] plaintiff may rely on the defendant's own disclosures
about a revenue restatement to allege that previously-made
statements about revenue were materially false or misleading.’
Pursuant to Regulation S~X, 17 CFR 210.4-01(a)(1), ‘[f]inancial
statements filed with the [SEC] which are not prepared in
accordance with generally accepted accounting principles will be
presumed to be misleading or inaccurate . . . .’ 17 C.F.R.
210.4-01(a)(1).”) (second, third and fourth alterations in
original) (internal citation omitted) (quoting Chalverus v.
Pegasystems, Inc., 59 F. Supp. 2d 226" date_filed="1999-07-30" court="D. Mass." case_name="Chalverus v. Pegasystems, Inc.">59 F. Supp. 2d 226, 233 (D. Mass. 1999)).
Besides, there is not much more the Plaintiffs can do right
now, considering that, after almost a year since the Company
announced the restatements, they have not yet been published,
preventing the Plaintiffs from ascertaining the amount by which
the revenues were previously inflated, §§e Pls.’ Mem. Opp’n
Avid 10 (“[E]ven after ten months, [Avid] has still yet to
24
complete its restatement and provide investors with an accurate
set of financial statements.”).
All in all, while this is not a textbook case for a
successful fraud pleading, the misstatements regarding the
improper recognition of PCS revenue were pled with sufficient
particularity to survive the motion to dismiss. The same,
however, cannot be said about the other two instances of fraud
alleged in the amended complaint.
tx The Manipulation of Restructuring Expenses7
7 This claim was not part of the original complaint filed by
Courtney, see Class Action Compl., ECF No. 1, although it was
part of Washtenaw's original complaint, Compl. 1 92, Washtenaw
Cnty. Emps.’ Retirement Sys. v. Avid Tech., Inc., No. 13-cv-
10686-WGY, ECF No. 1. The Avid Defendants argue this claim
exists solely to justify Washtenaw's presence as a plaintiff in
the case, As the Avid Defendants put it, “[Washtenaw] was so
eager to sue in response to Avid's disclosure promising a
restatement that it rushed to court even though it had not
purchased a single share of Avid stock _- and had in fact sold
its entire position -- fully eighteen months before Avid's
announcement. Called out for seeking to represent a class it
did not belong to, that plaintiff had to invent an entirely new
claim. So the Amended Complaint accuses Avid of taking ‘big
bath’ restructuring reserves in 2010 and 2011 so they would be
available to leak back into earnings later.” Avid’s Reply 1
(internal citations omitted). Despite the Plaintiffs’ silence,
this explanation seems to make sense. Without the present (and
the following) claim, it is hard to see how Washtenaw could
establish loss causation for itself, considering it sold its
position on Avid more than a year before the supposed truth
about the improper recognition of PCS revenue -- Courtney's
original claim -- hit the market. §ee Decl. Theodore M. Hess-
Mahan Supp. Mot. Washtenaw Cnty. Emps.’ Retirement Sys.
Consolidation, Appointment Lead Pl. & Approval Selection
Counsel, Ex. B, Certification Named Pl. Fed. Sec. Laws, ECF No.
8-3 (showing that Washtenaw acquired Avid stocks in March and
25
As to the second episode of fraud -- related to the
manipulation of restructuring expenses -- the Avid Defendants
claim that “[t]he complaint does not allege how or why the
restructuring charges were false when made. lnstead, it says
only that Avid’s charges were ‘false’ because” they were
restated in later years. Avid’s Mem. 12. According to the Avid
Defendants, the lack of particularity in the Plaintiffs’
pleading prevents the Court from “assess[ing] whether the
restructuring charges were legitimate, erroneous, or
purposefully inflated.” ld; at 13.
The Plaintiffs affirm the sufficiency of the amended
complaint, however, because it “alleges that the Avid Defendants
improperly manipulated Avid’s earnings by setting up excess
reserves in prior periods, and then releasing the reserves into
earnings in subsequent periods.” Pls.’ Opp’n Avid 13.
As explained supra, the discussion here concerns the four
restructuring initiatives that Avid underwent between 2008 and
2012, and the later admission by the Company that it had
identified errors in its previous financial statements regarding
the restructuring expenses. Through the revised financial
statements:
[T]he Company increased its 2011 net restructuring
costs by $1.3 million (or 14.7%) and reduced its 2010
April of 2011 and sold them in July and August of that same
year).
26
net restructuring costs by $1.6 million (or 7.7%).
The Company increased its first quarter 2011 net
recovery of previously expensed restructuring costs by
$740,000 (or 33.4%), reduced its second quarter 2011
net recovery of previously expensed restructuring
costs by $325,000 (or 199.4%) and increased its fourth
quarter 2011 net restructuring costs by $240,000 (or
2.8%).
Am. Compl. 1 37. The Plaintiffs' argument is that, given the
“magnitude, pervasiveness, and repetitiveness of the
restatements,” it would be “reasonable to infer that these
restructuring costs were manipulated.” Pls.' Opp’n Avid 13
(citing In re MicroStrategy lnc. Sec. Litig., 115 F. Supp. 2d
620, 635-37 (E.D. Va. 2000)).
There seems to be a leap of logic here. The fact that the
restructuring costs were restated does not automatically lead to
the conclusion that they were manipulated. This simply is not a
reasonable inference.
Here, the Plaintiffs rely solely on Avid's voluntary
disclosure of errors to ascertain the fraud. Again, while this
is not a problem per se, the particularity requirement makes it
impossible for this claim to survive because there is simply not
enough information about the alleged fraud. As the Avid
Defendants observed:
The pleading does not identify the cost associated
with any restructuring activity; and it does not say
that Avid's expectations for those costs were off
base. The [P]laintiffs do not claim that any
assumption underlying Avid's estimates was invalid, or
that the company's projections were not made in good
27
faith. ln short, there is nothing in the document
to even hint that Avid did not honestly believe
its charges to be reasonable estimates when taken.
Avid’s Mem. 13.
lnterestingly enough, some of the restatements increased
past restructuring costs, while others decreased such costs,8
Even from one quarter to the next, in the same year, this
“inconsistency” occurred,9 These undisputed facts do not seem to
be in line with the Plaintiffs’ argument that the manipulation
sought to set up excess reserves in prior periods, to
subsequently release them into earnings.
One cannot forget that restructuring expenses are by their
very essence an estimate, an anticipation of costs, and, as
such, inexact. lmportantly, as the Avid Defendants do not fail
to observe, the Company disclosed in its reports “the inexact
nature of such estimates, stating that ‘restructuring charges
and accruals require significant estimates and assumptions,
including sub-lease income assumptions.’” Avid’s Mem. 13 n.5
(quoting Avid Tech. 10-K, issued Mar. 16, 2009).
Accordingly, this claim does not meet the heightened
standards of fraud pleading, see Crowell, 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 12
8 Per the restatements, Avid reduced its 2010 net
restructuring costs, while increasing such costs for 2011. Am.
Compl. 1 37.
9 E.g., Avid increased its first quarter 2011 net recovery
of previously expensed restructuring costs, while reducing its
second quarter 2011 net recovery. Am. Compl. 1 37.
28
(quoting Gross, 93 F.3d at 991 (1st Cir. 1996)), and, as a
result, dismissal followed.
c.The Decline of the European Operation
As to the third episode of fraud, the Avid Defendants claim
they had no affirmative duty to disclose information about the
decline of the Company's European Operation. Avid’s Mem. 14.
Alternatively, the Avid Defendants claim that any prior
statement about future prospects of Avid’s operation were non-
actionable puffery. ld; at 15.
The Plaintiffs' argument here is that for consecutive
reports since at least 2008, the Avid Defendants had been
misleading the market by “tout[ing] the Company's increasing
operating efficiency with respect to its sales force . . .,
increasing sales revenues, and positive company-wide growth in
the prior reporting periods.” Am. Compl. 1 43. On July 21,
2011, however, the Avid Defendants “disclosed that the Company
badly missed sales revenues targets they had led investors to
expect, revealing for the first time that significant
deficiencies in the structure of Avid’s European sales force
required a restructuring of the entire division." ld; 1 41.
The Plaintiffs allege that the pre-July 2011 statements
were clearly false. Furthermore, “[t]he need to restructure an
entire division’s sales force was material to shareholders.
While companies do not have to disclose all information that
29
may affect stock prices, ‘[w]hen a corporation does make a
disclosure - whether it be voluntary or required - there is a
duty to make it complete and accurate.’” Pls.’ Opp’n Avid 15
(second alteration in original) (quoting Rosenbaum Capital
L.L.C. v. Boston Commc’n Grp., Inc., 445 F. Supp. 2d 170" date_filed="2006-08-20" court="D. Mass." case_name="Rosenbaum Capital LLC v. Boston Communications Group, Inc.">445 F. Supp. 2d 170, 175-76
(D. Mass. 2006)).
Before assessing the viability of the present claim, two
aspects of the law must be described. The first regards
“puffery.” As the First Circuit has explained, “courts have
demonstrated a willingness to find immaterial as a matter of law
a certain kind of rosy affirmation commonly heard from corporate
managers and numbingly familiar to the marketplace - loosely
optimistic statements that are so vague, so lacking in
specificity, or so clearly constituting the opinions of the
speaker, that no reasonable investor could find them important
to the total mix of information available.” §haw v. Digital
E ui . Cor ., 82 F.3d 1194" date_filed="1996-05-07" court="1st Cir." case_name="Shaw v. Digital Equipment Corp.">82 F.3d 1194, 1217 (lst Cir. 1996), superseded by
statute on other grounds, Reform Act.
The second concerns mismanagement claims. As this Court
observed in Fitzer, “management problems . . . are not, on their
own, actionable as fraud. These include allegations of
disruption and dissension in the sales force . . . . Although
these allegations, if true, certainly could disappoint an
investor who may have believed that [the company] could have
30
succeeded, poor management is a risk that every investor takes.
Damages flowing therefrom are not actionable under the
securities laws.” Fitzer, 119 F. Supp. 2d. at 31 (internal
citation omitted).
ln the present case, the claims regarding the decline of
Avid's European Operation are a result both of puffery and
mismanagement and are, therefore, non-actionable.
Going back to the allegedly false statements, they are no
more than the garden-variety puffery. The example cited by the
Plaintiffs in their amended complaint is very illustrative:
These results show that we’re seeing the benefits of
focusing on our strategic principles and continuing to
improve our operational efficiency. Back in July of
2008 we laid out a three-stage transformational plan
for the company; to get healthy, build momentum in the
core business and unlock new sources of growth. While
we will continue to be diligent in managing our cost
structure, we feel that we’re moving beyond the get-
healthy phase of our transformation and can be even
more focused on continuing' to build_ momentunl in our
core business while looking at other potential
alternatives to improve our revenue growth.
Am. Compl. 1 44 (emphasis in original) (quoting Avid Press
Release on February 4, 2011).10 This statement is very similar
to those analyzed by this Court in Fitzer, where the defendant
company released statements mentioning the acceleration of
m The Plaintiffs also point to another statement, made by
Sexton, the CFO, according to which “[the Company] had growth in
products and services across all major geographies.” 1§; 1 82.
This statement essentially follows the same line of the one
quoted above.
31
efforts and abilities to better position the company in the
market. These are the typical rosy statements insufficient to
mislead a reasonable investor. §ee Fitzer, 119 F. Supp. 2d at
30 (“These statements indicat[ing] that the integration
‘accelerated’ [the company's] efforts and abilities, and that
the result would be a `preferred' product and would `position
[the company] to be the first to offer such a solution . . . are
no more than corporate ‘puffery' that cannot be said to have
misled investors.”). The fact that the statements promoting
Avid's efficiency were repetitive, and endured for years, does
not change the analysis.
The Plaintiffs also rely on a confidential witness in order
to claim that “the European problems did not develop overnight,
and it was [the CEO] Greenfield's lack of understanding
regarding retail that caused the European issues.” Pls.’ Opp’n
Avid 15. Or, as stated in the Amended Complaint, “the issue in
Europe was caused by Greenfield's decision to restructure
inappropriately and raise prices that were in set price points.
Thus, according to [the confidential witness], the lack of
understanding of retail . . . killed the European retail
business.” Am. Compl. 1 45.
As sad as it may be, this is a case of alleged
mismanagement, which cannot be claimed as securities fraud.
Greenfield's alleged “lack of retail experience,” with the
32
consequent failure of Avid's European Operation, standing alone,
does not amount to fraud, and the fact that the Company touted
its efficiency while having operational challenges does not
change that,
All in all, puffery and mismanagement, although
disappointing to investors, are not sufficient to survive a
motion to dismiss in a securities fraud action.
After the analysis of the material misstatement
requirement, only the first claim of fraud, related to the
improper recognition of PCS revenue, survives. But this claim
is also attacked by the Avid Defendants as to the scienter
requirement. An analysis of this argument follows.
2.The Amended Complaint Raises a “Strong Inference”
of Scienter
\\
As mentioned §upra, [s]cienter can be proved by showing
either knowledge that the statements at issue were materially
false or misleading, or recklessness in that regard, and the
complaint must so plead.” Lenartz, 879 F. Supp. 2d 167" date_filed="2012-07-26" court="D. Mass." case_name="Lenartz v. American Superconductor Corp.">879 F. Supp. 2d at 181.
\\
In the present case, the Avid Defendants argue that not
one allegation in the Amended Complaint identifies a specific
document, meeting, or accounting transaction that supports an
inference that any Avid Defendant knew of any accounting error
related to a software update.” Avid’s Mem. 16.
33
The Plaintiffs plead scienter by pointing at a series of
facts, in tune with the First Circuit’s “fact-specific inquiry”
approach to scienter, Greebel, 194 F.3d 185" date_filed="1999-10-08" court="1st Cir." case_name="Greebel v. FTP Software, Inc.">194 F.3d at 196. The amended
complaint presents a series of facts as the basis for the
Plaintiffs' allegations of scienter, Considered holistically,
the facts set forth by the Plaintiffs add up to a strong
inference of scienter, as is required under the Reform Act. §ee
idy
First, the Plaintiffs claim that Greenfield personally
decided to take the PCS revenue up front, instead of ratably.
Am. Compl. 1 34. The allegation is supported by a confidential
witness and is described with sufficient particularity to
support a securities fraud claim. §ee Fitzer, 119 F. Supp. 2d
at 22 (“[W]here plaintiffs rely on confidential personal sources
but also on other facts, they need not name their sources as
long as the latter facts provide an adequate basis for believing
that the defendants' statements were false. Moreover, even if
personal sources must be identified, there is no requirement
that they be named, provided they are described in the complaint
with sufficient particularity to support the probability that a
person in the position occupied by the source would possess the
information alleged.”) (quoting §pyak v. Kasaks, 216 F.3d 300" date_filed="2000-06-21" court="2d Cir." case_name="Carol Novak v. Sally Frame Kasaks">216 F.3d 300,
314 (2d Cir. 2000)).
34
Here, the Plaintiffs allege that “Greenfield demonstrated
his knowledge of GAAP's revenue recognition criteria” and the
Company repeatedly stated it followed GAAP requirements. §ee
Am. Compl. 1 28 (quoting Avid's Form 10-K for the year 2011 for
the proposition that the Company followed GAAP criteria); id;
1 31 (quoting Greenfield's statement in a conference call in
2012, explaining that the Company recognized revenue upon
implementation). The Plaintiffs further argue that, despite his
demonstrated knowledge, Greenfield decided to recognize PCS
revenue up front. 1§; 1 34. This allegation is supported by a
confidential witness, who was a vice president of Video and
Enterprise at the Company and attended weekly meetings with
Greenfield during the Class Period. Id. As described in the
\\
amended complaint, [a]ccording to [the confidential witness],
certain management opted to take revenue sooner, and the service
revenue would be built in so the company could take the revenue
up front. According to [the confidential witness], it was
Greenfield's and [Beth] Martinko'sll decision to do it this way.”
ldy The amended complaint is thus clear about the fact that,
not only did Greenfield know that the PCS revenue was
inappropriately accounted up front, but he actually decided to
do so.
n Beth Martinko, then vice-president at Avid, is not a
defendant in this lawsuit.
35
The Plaintiffs also claim insider trading. See id. 1 131.
According to them:
[D]uring the Class Period, while the Company's share
price was artificially inflated due to Defendants'
materially false and misleading statements and
omissions, Company insiders, including Defendants
Greenfield and Sexton, unloaded 70,275 shares of their
Avid stock for proceeds of $771,306.18.
Significantly, Defendant Greenfield's largest sale of
Avid stock (16,151 shares for $126,947) came only a
little over a week before the Company announced the
need to restate its financials.
As the First Circuit has already observed, “[i]nsider
trading cannot establish scienter on its own, but it can be used
to do so in combination with other evidence. lnsider trading in
suspicious amounts or at suspicious times may be probative of
scienter.” Mississippi Pub. Emps.’ Ret. Sys., 523 F.3d 75" date_filed="2008-04-16" court="1st Cir." case_name="Mississippi Public Employees' Retirement System v. Boston Scientific Corp.">523 F.3d at 92
(internal citations omitted).
The Plaintiffs, however, fail to provide the Court with
enough information to support their claim of suspicious insider
trading. As this Court observed in Lenartz, the plaintiff
“bears the burden of showing that insider sales were in fact
unusual or suspicious in timing or amount. Such a showing
requires the plaintiff to provide information on the defendant's
trading both before and after the class period, so the court can
assess the sales in context.” Lenartz, 879 F. Supp. 2d 167" date_filed="2012-07-26" court="D. Mass." case_name="Lenartz v. American Superconductor Corp.">879 F. Supp. 2d at 186
(internal citations omitted).
36
Here, the Plaintiffs merely allege suspicious insider
trading by Greenfield and Sexton, without providing any context.
The Plaintiffs solely present a list of transactions made by
Greenfield and Sexton during the Class Period, Am. Compl. 1 20,
but there is no basis to compare such trading with other
periods. As a result, the Court cannot fully appreciate the
allegation, and thus the insider trading allegation is not of
much help to the Piaintiffs.lz
Next, the Plaintiffs point to the resignations of the
Company's senior executives. According to the Plaintiffs:
Greenfield resigned two weeks prior to the
announcement that Avid was unable to timely report its
financial results for the fourth quarter of 2012, as
it needed additional time to review certain
transactions. Further, a month prior to the final
announcement regarding the restatement, Avid disclosed
that Sexton was being relieved of his duties.
Pls.’ Opp’n Avid 19 (internal citations omitted).
The Plaintiffs do not point to any precedent from the First
Circuit deriving scienter from the resignation of a company's
senior executives; they rely instead on decisions from the
Southern District of New York. Id. ln one of those cases, the
court noted that “[the executive]’s resignation by itself is
w The Avid Defendants also argue that the sale of stocks by
Greenfield and Sexton was made pursuant to “a non-discretionary
withholding of shares by Avid to satisfy tax withholding
obligations upon a vesting event.” Avid’s Mem. 20. Because of
its conclusion that the insider trading claim does not support
the scienter inference, the Court need not engage with this
argument.
37
insufficient to support an allegation of scienter because ‘there
are any number of reasons that an executive might resign.’
However, when considered in conjunction with the rest of
Plaintiffs' allegations, a strong inference of scienter has been
1113
stated with particularity. §§ v. Duoyuan Global Water, lnc.,
887 F. Supp. 2d 547" date_filed="2012-08-24" court="S.D.N.Y." case_name="Ho v. Duoyuan Global Water, Inc.">887 F. Supp. 2d 547, 575 (S.D.N.Y. 2012) (internal citation
omitted) (quoting ln re BISYS Sec. Litig., 397 F. Supp. 2d 430" date_filed="2005-10-28" court="S.D.N.Y." case_name="In Re BISYS Securities Litigation">397 F. Supp. 2d 430,
446 (S.D.N.Y. 2005)).
The problem with the Plaintiffs' allegation is that they
bring no other facts to support the conclusion that the
resignations indicate scienter. The Plaintiffs rely solely on
the timing of the resignations - close to the Company's
disclosure of the misstatements. This is not enough to build up
the scienter inference. §§e ln re BISYS, 397 F. Supp. 2d at
446-47 (“Plaintiffs claim that the resignations of [the
executives] ‘shortly before and/or coterminous with [the
company's] disclosures of financial shortfalls, financial
charges, improper accounting and financial restatements' support
an inference of scienter. Plaintiffs, however, have alleged no
facts linking the resignation of [the executives] to the
accounting improprieties at [the company]. ln reality, there
are any number of reasons that an executive might resign, most
w The other case cited by the Plaintiffs, In re Sadia, S.A.
Sec. Litig., 643 F. Supp. 2d 521" date_filed="2009-07-29" court="S.D.N.Y." case_name="In Re Sadia, S.A. Securities Litigation">643 F. Supp. 2d 521, 534 (S.D.N.Y. 2009), does not
really discuss this issue.
38
of which are not related to fraud. . . . Accordingly, absent any
alleged facts linking the two resignations and the alleged
fraud, the resignations of [the executives] do not support an
inference of conscious misbehavior or recklessness.”).
Moving on, the Plaintiffs point to the length and magnitude
of the restatement as an indication of scienter. According to
the Plaintiffs, the restatement covers “a large number of
transactions over the past five years.” Pls.’ Opp’n Avid 19-20.
Not only that, “the restatement covers fundamental accounting
rules applicable to software, Avid’s core business - a violation
that ‘suggest[s] a conscious choice to recognize revenue in a
manner alleged to be improper.’” ldy at 20 (alteration in
original) (quoting ln re Baan Co. Sec. Litig., 103 F. Supp. 2d
1, 21 (D.D.C. 2000)).
Courts in this District have often given some weight to the
magnitude and frequency of the restatements in supporting an
inference of scienter. See ln re Raytheon Sec. Litig., 157 F.
Supp. 2d 131, 147 (D. Mass. 2001) (Saris, J.) (including “the
magnitude of the accounting overstatement” among the
circumstances indicative of fraudulent intent); see also Gelfer
v. Pegasystems, lnc., 96 F. Supp. 2d 10" date_filed="2000-01-27" court="D. Mass." case_name="Gelfer v. Pegasystems, Inc.">96 F. Supp. 2d 10, 16 (D. Mass. 2000)
(Tauro, J.) (“The magnitude and frequency of the restatements
create a strong inference of scienter.”).
39
ln the present case, the magnitude of the restatement is
evinced by the fact that after almost one year since it was
announced, the restatement is still not complete. The magnitude
is also emphasized by Avid’s recently filed Form 8-K, where it
informs that, “given the scope of the review,” the Company will
probably fail to regain compliance with its SEC filing
requirements for continued listing of its common stock on NASDAQ
before the deadline set by the NASDAQ Listing Qualifications
Panel.14 Lead Pls.’ First Req. Judicial Not. Opp’n Defs.’ Mot.
Dismiss, Ex. A, Form 8-K, Dec. 31, 2013, at 6, ECF No. 53-1.
M Avid further states in the Form 8-K:
Avid Technology, lnc. . . . has determined that it is
unlikely that it will be able to regain compliance with its
SEC filing requirements for continued listing of its common
stock on [NASDAQ] by the previously reported March 14, 2014
deadline set by the NASDAQ Listing Qualifications Panel.
As previously reported, the Company is in the process of
restating its financial statements for the fiscal years
ended December 31, 2011, 2010 and 2009 and for its
quarterly periods ended September 30, 2012 and 2011, June
30, 2012 and 2011, and March 31, 2012 and 2011. The
restatement relates to the Company's accounting' treatment
of certain upgrades, enhancements and compatibility
extensions (collectively “Software Updates”) it previously
made available to certain of its customers at no-charge.
The Company has determined that such Software Updates
should have been accounted for as implied [PCS] under
[GAAP]. As a result of the pending restatement of prior
financial results, the Company is not current in its
periodic report filing requirements with the SEC.
While the Company has been working diligently to complete
the restatement and regain compliance with its reporting
requirements, the Company has determined that, given the
scope of the review, it will be unlikely to achieve these
objectives prior to the March 14, 2014 deadline.
40
Accordingly, it is as yet unknown what the impact of such a
restatement will be, but that cannot impair the Plaintiffs’
claim. The length and magnitude of the restatement here leads
to a strong inference of scienter, indeed suggesting a conscious
choice by the Defendants, or at least an extreme departure from
the standards of ordinary care.
Another fact that contributes to the strong inference of
scienter comes from Avid’s systemic failure to maintain adequate
internal controls. The Plaintiffs describe in detail the many
instances where the Company acknowledged internal control
deficiencies. §§e Pls.’ Opp’n Avid 7 (listing the repeated
admissions of such flaws and concluding that “since the outset
of the Class Period, Avid was forced to admit to its haphazard
internal controls on at least five separate occasions, raising
glaring red flags regarding the integrity of its financial
statements”).
Taken together with the magnitude of the restatement, the
consistent failure as to the internal controls makes the
scienter inference more compelling. See Crowell, 343 F. Supp.
As a result . . . the Company's shares of common stock may
be suspended from trading and delisted from [NASDAQ].
Following a possible suspension of trading in the Company's
common stock on NASDAQ, the Company expects that its shares
would trade on the OTC Markets - OTC Pink Tier while the
Company works to finalize the restatement,
Lead Pls.’ First Req. Judicial Not. Opp’n Defs.’ Mot. Dismiss,
Ex. A, Form 8-K, Dec. 31, 2013, at 6, ECF No. 53-1.
41
2d at 16 (“The way in which the allegedly fraudulent acts
[including fraudulent contract accounting and failure to
maintain adequate internal controls] fit together and reinforce
one another strongly suggests a conscious course of conduct.”).
Finally, the Plaintiffs refer to government investigations
as a support for an inference of scienter. According to the
Plaintiffs, “[s]hortly following the Company's February 25, 2013
announcement regarding the delayed financials, the Company
received a document preservation request from the SEC and a
federal grand jury subpoena from the [Department of Justice]
related to its accounting practices and procedures, including
the accounting treatment related to Software Updates.” Pls.'
Opp’n Avid 20. The Plaintiffs believe this investigation
“add[s] to the overall picture.” ld;
The Plaintiffs cannot cite to precedents from this District
or the First Circuit in this regard; it is true, however, that
courts in other circuits have concluded that governmental
investigation can be considered in an analysis of scienter,
although it is insufficient in and of itself, See ln re Gentiva
Sec. Litig., 932 F. Supp. 2d 352" date_filed="2013-03-25" court="E.D.N.Y" case_name="In re Gentiva Securities Litigation">932 F. Supp. 2d 352, 380 (E.D.N.Y. 2013)
(“Certainly, courts have considered a governmental investigation
as one piece of the puzzle when taking a ‘holistic' view of the
purported facts as they relate to scienter. The Court agrees
that while the existence of an investigation alone is not
42
sufficient to give rise to a requisite cogent and compelling
inference of scienter, it may be considered by the Court as part
of its analysis.”) (internal citation omitted); see also
Chamberlain v. Reddy lce Holdings, lnc., 757 F. Supp. 2d 683" date_filed="2010-12-06" court="E.D. Mich." case_name="Chamberlain v. Reddy Ice Holdings, Inc.">757 F. Supp. 2d 683,
713 n.8 (E.D. Mich. 2010) (attaching relevance to the existence
of government investigations, albeit noting its insufficiency,
standing alone, to support a strong inference of scienter); §§
re Bristol Myers Squibb Co. Sec. Litig., 586 F. Supp. 2d 148" date_filed="2008-08-20" court="S.D.N.Y." case_name="In Re Bristol Myers Squibb Co. Securities Litigation">586 F. Supp. 2d 148,
168 (S.D.N.Y. 2008) (including an investigation by the
Department of Justice as one of the elements in the scienter
analysis); In re Enron Corp. Sec., Derivative & ERISA Litig.,
235 F. Supp. 2d 549" date_filed="2002-12-19" court="S.D. Tex." case_name="In Re Enron Corp. Securities, Derivative & ERISA Lit.">235 F. Supp. 2d 549, 688 (S.D. Tex. 2002) (including facts
“unearthed in current investigations by the SEC” in the scienter
analysis).
Here, the government investigation can be seen as one more
piece of the puzzle, a series of circumstances that add up to a
strong inference of scienter. As the Supreme Court explained in
Tellabs, lnc. v. Makor lssues & Rights, Ltd., 551 U.S. 308" date_filed="2007-06-21" court="SCOTUS" case_name="Tellabs, Inc. v. Makor Issues & Rights, Ltd.">551 U.S. 308
(2007) “[t]he 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.” ld; at 322-23. Accordingly, the fact
that a circumstance is not sufficient per se to establish the
43
requisite scienter ought not control the outcome, lest we see
the trees but miss the forest.lE
Among the Avid individual Defendants, this Court can infer
(for the purposes of this motion) that Greenfield -- as the
Company's CEO, President, and Chairman of the Board -- and
Sexton -- as the Company's CFO, Executive Vice President, and
Chief Accounting Officer -- knew or should have known of Avid’s
practices of improperly recognizing revenue, because their
positions during the Class Period gave them unfettered access to
the information. §ee Crowell, 343 F. Supp. 2d 1" date_filed="2004-11-03" court="D. Mass." case_name="Crowell v. Ionics, Inc.">343 F. Supp. 2d at 17-18. The
Plaintiffs also mention the confidential witness's statement
that the accounting classification was a deliberate choice made
by Greenfield. Accordingly, there is a strong inference of
scienter as to these two defendants.
The same, however, cannot be said of Hernandez, who was
appointed as Avid’s CEO and President immediately after
Greenfield's resignation, i;e;, after all of the alleged
misstatements had occurred, There is not a single claim against
Hernandez in the amended complaint, and he is not even mentioned
in the “Parties” section of the complaint - or in any other part
w Or, as once put by this Court, “[a]lthough none of the
general allegations proffered by the [plaintiffs] in their
Complaint is determinative on its own, this Court may consider
them together as indicative of fraudulent intent. In
determining scienter, courts can look to the totality of the
circumstances, rather than examining each alleged omission or
misstatement in isolation.” Orton, 344 F. Supp. 2d 290" date_filed="2004-11-03" court="D. Mass." case_name="Orton v. Parametric Technology Corp.">344 F. Supp. 2d at 307.
44
of it other than the caption. Accordingly, the Court allows his
motion to dismiss.
As things stand, this is not a strong case of securities
fraud. All in all, however, the Plaintiffs manage to survive
the Avid Defendants' motion to dismiss as to the PCS-related
claim. Hernandez, however, ought be off the hook.
E. Ernst & Young
Ernst & Young's motion to dismiss focuses solely on the
scienter requirement.16 1ts essential contention is that the
Plaintiffs failed to plead sufficient facts to meet the
particularly high standard of scienter required against
independent auditors. Ernst & Young's Mem. 5-8.
lnitially, this Court acknowledges that “[c]ourts assessing
claims against independent accountants and auditors under the
[Reform Act] have placed the bar high.” ln re Raytheon, 157 F.
Supp. 2d at 154; see id; (“For recklessness on the part of a
non-fiduciary accountant to satisfy securities fraud scienter,
such recklessness must be conduct that is highly unreasonable,
representing an extreme departure from the standards of ordinary
care. lt must, in fact, approximate an actual intent to aid in
the fraud being perpetrated by the audited company.”) (quoting
Rothman v. Gregor, 220 F.3d 81" date_filed="2000-07-11" court="2d Cir." case_name="Joel Rothman v. Andrew Gregor">220 F.3d 81, 98 (2d Cir. 2000)).
w Ernst & Young's motion to dismiss is now limited to the
PCS-related claim of fraud because, as explained above, the
other two claims are dismissed.
45
Here, once again, the Plaintiffs rely on a series of facts
to build up a strong inference of scienter. These alleged facts
mostly parallel those assessed in resolving the Avid Defendants'
motion to dismiss, but there are also a couple of specific
allegations related solely to Ernst & Young. In short, this is
what the Plaintiffs point to: “(i) the audit's deficiency; (ii)
the magnitude of the accounting error;” (iii) some red flags
that should have demanded further inquiry from Ernst & Young;
“(iv) the repeated violations of GAAP, [Generally Accepted
Auditing Standards (“GAAS”)], and internal audit procedures; (v)
the desire to protect profits, and the longstanding nature of
the relationship between Ernst & Young and Avid;” and (vi) the
findings of a report by the Public Company Accounting Oversight
Board (the “Oversight Board”), showing deficiencies in Ernst &
Young's “audit system of quality control.” Pls.' Opp’n Ernst &
Young 20.
In the analysis of Avid’s motion to dismiss, the Court
mentioned that the length and magnitude of the accounting error
was an important piece of the puzzle, The same was said about
Avid's systemic failure to maintain adequate internal controls.
Importantly, as the Plaintiffs argue in their opposition to
Ernst & Young's motion, the longstanding relationship between
Ernst & Young and Avid enabled the former to acquire great
knowledge of the latter's auditing system over time, See id. at
46
9. Accordingly, Ernst & Young presumably knew about Avid’s
consistent internal controls’ failures.
Ernst & Young insists that the revelations about Avid’s
flawed internal controls came only after Ernst & Young had
presented the audit opinions at issue here. Ernst & Young’s
Mem. 16-17; Ernst & Young’s Reply 6. While it is true that
Avid’s voluntary disclosure of such shortcomings came only after
Ernst & Young’s final audit opinion, dated February 29, 2012,
this does not mean that the shortcomings were unknown to both
companies before the opinion was filed. As the Plaintiffs
explain:
[Ernst & Young]’s argument is nothing more than an
effort to shift the focus to when Avid made the
disclosures; the timing of when Avid revealed the
existence of the internal control deficiencies is not
relevant to [Ernst & Young]’s culpability. What is
relevant is that Avid’s disclosures revealed that the
deficiencies existed and were known to the Company and
[Ernst & Young] at the end of 2011. For example, in
its Form_ 10-Q for the first quarter of 2012, Avid
acknowledged “previously identified internal control
deficiencies in [its] assessment of internal control
over financial reporting as of December 31, 2011,”
thereby admitting that such deficiencies were known by
both Avid and [Ernst & Young] at the time of the
issuance of Avid’s 2011 Form 10-K.
Pls.’ Opp’n Ernst & Young 15 n.6 (penultimate alteration in
original) (emphasis omitted).
As observed in dismissing Avid’s motion, the scienter
analysis is very fact-intensive; as a result, precedents can
only go so far in marking a path for the scienter analysis.
47
Considering the longstanding relationship between Avid and Ernst
& Young, the length and magnitude of the restatements, and the
repeated failure by Avid to maintain adequate internal controls,
a strong inference of scienter can be drawn. At least the
Plaintiffs successfully plead an egregious degree of
recklessness by Ernst & Young.
In this context, the Plaintiffs’ claim that Ernst & Young
turned a blind eye to Avid’s bad practices, aiming to protect a
profitable relationship, id. at 17, helps build up the scienter
inference. As the First Circuit observed:
[S]such a profit motive could contribute to an
auditor's decision to turn a blind eye to a
corporation's misleading accounting. Such allegations
can thus strengthen an inference of scienter
predicated on other facts, possibly adding sufficient
strength to satisfy the strong-inference requirement
of [the Reform Act]. On the other hand, absent truly
extraordinary circumstances, an auditor's motivation
to continue a profitable business relationship is not
sufficient by itself to support a strong inference of
scienter.
ln re Stone & Webster, 1nc., Sec. Litig;, 414 F.3d 187" date_filed="2005-07-14" court="1st Cir." case_name="Brody v. Stone & Webster, Inc.">414 F.3d 187, 215 (lst
Cir. 2005) (internal citations and quotation marks omitted).
ln Stone & Webster, the First Circuit held scienter was not
adequately pled because, besides the allegation of profit
protection, “there was virtually nothing else.” ldy Still, the
framework laid out by the First Circuit stands true, and here
the profit protection allegation adds to an already consistent
scienter pleading. 1n fact, the Plaintiffs point to the length
48
and magnitude of the accounting error, to Avid's systemic
failure to maintain adequate internal controls, and finally to
the profit protection motivation.17
Thus, adopting the holistic approach established in
Tellabs, the Plaintiffs meet, albeit barely, the high threshold
for a successful scienter pleading against Ernst & Young.
Accordingly, the Plaintiffs manage to survive Ernst & Young's
motion to dismiss, at least as to the PCS-related claim.
III. CONCLUSION
For the aforementioned reasons, this Court ALLOWED both
motions to dismiss as to the second and third fraud claims,
related to the restructuring of the Company and the European
w The remaining argument presented by the Plaintiffs --
regarding the findings of a report by the Oversight Board,
showing deficiencies in Ernst & Young's audit system of quality
control -- does not help the Plaintiffs' case.
According to the Plaintiffs, the report “found that [Ernst
& Young] failed to remediate deficiencies in its audit system of
quality control, dating as far back as 2009. The report noted
that certain of the deficiencies were ‘audit failures,' stating
that ‘certain of the identified deficiencies were of such
significance that it appeared that [Ernst & Young], at the time
it issued its audit report, had failed to obtain sufficient
appropriate audit evidence to support its audit opinion on the
financial statements and/or on the effectiveness of internal
control over financial reporting.” Pls.' Opp’n Ernst & Young
19-20 (internal citations omitted).
The report's conclusion has nothing to do with fraud or
extreme recklessness. On the contrary, it relates to alleged
incompetency by Ernst & Young, which adds nothing to a scienter
inference. Furthermore, the report does not concern Ernst &
Young’s body of work at Avid, but rather other audit procedures
made by the auditing firm. §ee Ernst & Young's Mem. 17-18.
Accordingly, the report's conclusions are not relevant to the
outcome of the present case.
49
sales operation, and now DENIES both motions as to the first
fraud claim, pertaining to post-contractual customer support.
As to the defendant Louis Hernandez, the motion to dismiss is
ALLOWED.
The case is ordered onto the running trial list for March
2015. The parties shall have 14 days from the date of this
order to submit a joint case management schedule.
SO ORDERED.
DISTRICT JUD
50