ORDER RULING ON PENDING MOTIONS;
[Doc. Nos. 173, 194, 263, 308, 310, 336]
DISMISSING CASE WITH PREJUDICE
Currently pending before the Court are four summary judgment motions and several evidentiary motions in these consolidated securities fraud cases against Defendants REMEC, Inc., Ronald E. Ragland, and Winston E. Hickman. In sum, for the reasons stated below, and because the Court finds that Defendants are entitled to summary judgment on the element of scienter, judgment shall be entered in favor of Defendants and the case shall be dismissed with prejudice. 1
1. Background
A. Basic Facts
Defendant REMEC, Inc. (“REMEC”) designed and manufactured “high frequency subsystems used in the transmission of voice, video and data traffic over wireless communications networks and in space and defense electronics applications.” FAC
2
¶2. This action concerns REMEC’s Commercial segment (also known as the Wireless Systems division).
3
Defendant Ronald
Plaintiffs accuse REMEC of materially overstating its financial results by failing to recognize millions of dollars in losses related to goodwill impairment. See e.g., FAC ¶¶ 3-6, 139-225. Although the heart of Plaintiffs’ case concerns impaired goodwill, Plaintiffs allege REMEC engaged in other deceptive accounting practices such as inflating revenue by overstating the value of excess, obsolete inventory and by failing to disclose significant internal control deficiencies. See e.g., FAC ¶¶ 8, 11, & 14. 4
The FAC contains two causes of action. REMEC, Ragland, and Hickman are named in the first cause of action for securities fraud pursuant to § 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. Plaintiffs’ second claim alleges control person liability against Ragland and Hickman under § 20 of the Securities Exchange Act of 1934.
The Court certified a class of plaintiffs who purchased or otherwise acquired RE-MEC securities between September 8, 2003 and September 8, 2004. Fed.R.Civ.P. 23(a) & (b)(3); Order Granting Pis.’ Mo. for Class Certification. [Doc. No. 103.]
B. Defining Goodwill Impairment Testing
Plaintiffs’ case primarily involves an accounting method to test the value of goodwill, which is calculated and reported on a company’s financial statement. Goodwill is an intangible asset that reflects the “excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed.” Williams Decl. Ex. 1 at 105.
5
In other words, goodwill, though it is an intangible asset, must be measured. If the value of the goodwill is “impaired,” the company
Goodwill is customarily acquired when an existing company purchases another company. With each acquisition, goodwill is recorded on the company’s financial statement. In this case, Plaintiffs allege that REMEC pursued an aggressive strategy of buying companies and recording inflated goodwill values in a scheme to mask the true financial condition. See e.g., FAC ¶ 87. Under Ragland’s command, part of REMEC’s business strategy was to expand by buying other specialized technology companies that would complement REMEC’s product offerings. Williams Decl. Ex. 2 at 8-9 (FY02 Form 10-K at 6-7 describes strategy to pursue acquisitions); Williams Decl. Ex. 56 at 10 (FY03 Form 10-K). 6 Beginning in 1999, RE-MEC’s Commercial unit acquired several companies. REMEC recorded the acquired goodwill as an asset on its financial statements in most of those transactions. 7 For example, in November 2003, during the class period, REMEC bought Paradigm Wireless (Hickman’s former employer) and recorded $17 million on its financial statement as goodwill, or 81 % of the $21 million purchase price. See Pis.’ Opp. Br., Attachment 3; Fraser Decl. Ex. 4 at 1 (Hinkle mem. dated 2/19/04). Plaintiffs calculate that REMEC recorded goodwill totaling $55.9 million from the Commercial Wireless’s four main acquisitions (or 64% of the $87 million purchase prices). See Pis.’ Scienter Opp. Br., Attachment 3.
As mentioned, companies must test the value of goodwill using generally accepted accounting procedures (“GAAP”). The Financial Accounting Standard (“FAS”) Board changed the rules governing the valuation of intangible assets in 2002. Under the prior rule, companies accounted for goodwill by amortizing the value over a period of years as a long-term asset. Brownlie Decl. Ex. D (FAS 121). The prior rule instructed companies to account for and disclose impaired goodwill “whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recovered.” Id. at 84.
The statement of FAS 142 eliminated the prior method of amortizing goodwill. Williams Decl. Ex. 1. Instead, FAS 142 uses a two-step test to identify potential goodwill impairment and to measure the amount of loss.
Id.
at 12 (¶ 18). The first
The accounting method to value goodwill involves predictions of future results and other uncertain variables. The language of FAS 142 states that it measures a “reasonable estimate of the value of goodwill.” Williams Decl. Ex. 1 at 12 & 108 (¶ 18 n. 13). “Unlike many other assets that are tested for impairment, goodwill does not have a set of cash flows uniquely associated with it. Instead, the cash flows associated with acquired goodwill usually are intermingled with those associated with internally generated goodwill and other assets because entities generally enter into business combinations to reduce costs and achieve synergies, which entails integrating the acquired entity with the acquiring entity.” Id. at 50 (App.B84); id. at 54 (App. B96 & B97); id. at 61-62 (App.B127) (“a goodwill impairment test by its very nature will include some level of imprecision”). As the definition states, goodwill measures amorphous concepts like the “synergy” created by merging two companies. Goodwill is measured in large part on predictions, such as predictions of future sales and estimates of the cost savings that will be achieved by combining two entities (e.g., reductions in duplicative labor and facilities).
The prediction of gross profit margin is central to Plaintiffs’ suit against REMEC. These types of business judgments should not be invalidated merely because, in hindsight, they proved wrong.
FAS 142 also changed the timing of goodwill testing. It required companies to test the value of goodwill every fiscal year. In addition to the annual test, certain conditions “that would more likely than not reduce the fair value” of an acquisition could trigger a requirement to perform an interim test. Id. at 15 ¶ 28.
REMEC implemented the new FAS 142 rule in early 2002 and first reported its compliance after its FY03 ended on January 31, 2003.
See
Williams Decl. Ex. 2 at 28; Katsell Supp. Decl. Ex A at 12 & 16.
8
The first test conducted under the new rule is called the transitional test. RE-ME C’s transitional test applied “as of’ the beginning of REMEC’s fiscal year, and the company had six months to complete it. Williams Decl. Ex. 1 at 23 (¶ 55). The annual test must be conducted the “same time every year,”
id.
at 14 (¶ 26), and REMEC elected to measure goodwill im
In its Securities and Exchange Commission (“SEC”) filings, REMEC told investors that it tested goodwill and found no impairment. See e.g., Williams Decl. Ex. 56 at 33 (FY03 Form 10-K at 27) (‘We did not recognize any goodwill impairment as a result of performing this annual test.”). Plaintiffs dispute the accuracy of those statements. Plaintiffs allege Defendants falsely assured the market it used assumptions that were “consistent with the plans and estimates that we use to manage the underlying business” to calculate its goodwill. FAC ¶¶ 5 & 151. Plaintiffs further allege that REMEC used unreasonable assumptions to test the goodwill and should have conducted interim goodwill impairment tests. FAC ¶¶ 9-10. Of particular importance to Plaintiffs’ case, REMEC assumed, for purposes of its annual impairment analyses in FY03 and FY04, that its gross profits in future years would range from a low of 24% to a high of 38%. Williams Decl. Ex. 56 at 33 (FY03 Form 10-K at 27); id. Ex. 5 at 25 (draft FY04 Form 10-K at 22). 9 Plaintiffs emphasize that REMEC’s actual performance had been much worse: 7.1 % in FY02, 10.2% in FY03, and 12.3% in FY04. In short, Plaintiffs accuse REMEC of using numbers that crossed the line from optimism to manipulation.
In reviewing the accounting claims at issue in this lawsuit, the Court bears in mind that measuring goodwill entails the exercise of professional judgment. See e.g.,. Katsell MSJ Decl. Ex. E (Minstein Dep. at 27); Regan Rebuttal Report at 12-15; Katsell Decl. to Mot. to Strike Ex. 2 at 8, 14, & 17 (hereinafter “Holder Rebuttal Report”). Professional judgment is involved in accounting for goodwill in general because it is an intangible asset and specifically because it depends upon predictions of future results. See e.g., Williams Decl. Ex. 1 at 6 (the two-step process “begins with an estimation of the fair value of a reporting unit”); id. (¶ 18 n. 13) (“The fair value of goodwill can be measured only as a residual and cannot be measured directly.”); id. at 13 (¶ 23) (defining fair value as the amount for which willing parties could buy or sell the asset); id. at 67 (App.B153) (allowing “latitude” to measure fair value).
“Accountants have long recognized that ‘generally accepted accounting principles’ are far from being a canonical set of rules that will ensure identical accounting treatment of identical transactions. ‘Generally accepted accounting principles,’ rather, tolerate a range of ‘reasonable’ treatments, leaving the choice among alternatives to management.”
Thor Power Tool Co. v. C.I.R.,
FAS 142 also gives management discretion to make reasonable estimates in the totality of circumstances.
See e.g.,
Williams Decl. Ex. 1 (“some consideration
With these principles in mind, the Court turns to the pending motions.
II. Summary Judgment Standard
Summary judgment is appropriate when the “pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(c);
Celotex Corp. v. Catrett,
Plaintiffs bear the burden of proving these elements: (1) a material (2) misrepresentation of fact; (3) scienter; (4) connection with the purchase or sale of a security; (5) reliance (also known as transaction causation); (6) loss causation; and (7) economic loss.
Dura Pharm., Inc. v. Broudo,
Plaintiffs must come forward with “specific facts showing that there is a genuine issue for trial.”
Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
The Court must construe the evidence and draw justifiable inferences in favor of the non-moving party.
Anderson v. Liberty Lobby, Inc.,
“Where the record taken as a whole could not lead a rational trier of fact to find for the nonmoving party, there is no ‘genuine issue for trial.’ ”
Matsushita,
III. Cross Motions for Summary Judgment on False or Misleading Statements
The parties filed cross motions to determine whether or not certain statements were false or misleading as a matter of law.
In a securities fraud case, “Pliability depend[s] on the plaintiffs’ success in demonstrating that one of the statements made by the company was actually false or misleading.”
In re Convergent Tech. Sec. Litig.,
“The fact that an allegedly fraudulent statement and a later statement are
different
does not necessarily” establish falsity because the statement must be evaluated at the time it was made and not by hindsight.
In re GlenFed, Inc. Sec. Litig.,
A. Plaintiffs’Accounting Expert Witnesses’ Opinions are Admissible under Daubert
Plaintiffs rely on expert testimony from two CPAs as evidence that REMEC’s goodwill impairment tests were manipulated by using unrealistic assumptions. Defendants move to exclude the expert opinions of Andrew G. Minstein and D. Paul Regan. Fed.R.Evid. 702. Defendants argue that Minstein and Regan did not use a reliable methodology in forming their opinions, but simply substituted their own subjective judgments.
In
Daubert v. Merrell Dow Pharms., Inc.,
Having reviewed the expert reports and declarations, the Court overrules Defendants’ objections because their arguments bear on the weight of the evidence.
1. Minstein Expert Report
Defendants complain that Minstein’s analysis is conclusory. Defs.’ Mot. to Strike at 3-4 (“Minstein simply substitutes his judgment for that of REMEC’s, and concludes that REMEC was wrong.”);
Daubert,
a) FY03 and FY04 Goodwill Impairment Tests
The Court finds that Minstein’s expert opinions are sufficiently reliable to be admissible evidence because his declaration elucidates the basis of his conclusions. His expert report supports Plaintiffs’ claims that REMEC made false and misleading statements that its goodwill was
Minstein concludes that REMEC’s analysis of goodwill impairment was conducted in violation of GAAP in both FY03 and FY04. See e.g., Minstein Decl. ¶¶ 24(b), 26-29, & 31-33. Minstein opines that the assumptions REMEC used to project gross profit margins and operating expenses as a percentage of revenue were inappropriate and indefensible. Minstein bases his opinion on factors such as RE-MEC’s low performance in recent years, continuing pressure from competitors, the slow progress of moving manufacturing operations from Finland to China, and poor selection of guideline companies. Minstein Report at 4-10 & 17-21. Min-stein notes that these conditions existed both when REMEC reported goodwill and when it took the writeoff. Minstein Decl. ¶ 6. He points to facts that support his conclusion, such as the small margins in the FY03 and FY04 tests, the small percentage of the calculated fair value in contrast to the carrying value, and the impact that small changes had on REMEC’s continued losses. Id. ¶ 24(b).
Minstein also explains how he chose the assumptions he used in his computer model. Minstein uses actual data from Andrew Corporation — one of the guideline companies that REMEC used. See e.g., Williams Decl. Ex. 12 at 8 (listing Andrew as guideline company). Although Andrew consistently outperformed REMEC, Min-stein states that he gave REMEC the benefit of doubt that it could achieve similar numbers. Minstein Decl. ¶¶ 19, 21(d), & 41(b), (c), & (e). He applied an across-the-board 10% revenue growth rate in each of the last eight years of the projection based on “industry and company expectations.” Minstein Report at 19 & Ex. 18; Minstein Decl. ¶¶ 21(a) & 41(a). He explains how he arrived at a gross profit margin of 30% after allowing for a 15% margin in the first year. Minstein Report at 19 & Ex. 19; Minstein Decl. ¶¶ 21(b) & 41(b). He also contrasts the different gross profit margin assumptions that RE-MEC used in two tests in the same year. Minstein Decl. ¶ 4.
In sum, the Court concludes Minstein explains the steps of his analysis and justifies the numbers he used; consequently, his expert opinion is admissible.
Defendants point to various weaknesses in Minstein’s analysis. These include such matters as (1) his professional judgment (e.g., his assertion that “Powerwave is the better indicator of expected REMEC com
Defendants may explore these perceived deficiencies through cross examination.
Primiano v. Cook,
For the present purpose of ruling on the summary judgment motion, the Court OVERRULES Defendants’ laundry list of evidentiary objections to Minstein’s report. Defs.’ Evid. Obj. [Doc. No. 339-2],
b) Interim Tests
The Court SUSTAINS Defendants’ objection to Minstein’s expert opinion on whether REMEC failed to conduct necessary interim tests between its annual tests. Minstein concludes that REMEC should have conducted interim tests for the quarters ending May 2, 2003 and October 31, 2003. Minstein Report at 3,15-17.
FAS 142 provides that “[gjoodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.” Williams Decl. Ex. 1 (FAS 142 ¶ 28). The standard gives examples of such events or circumstances, such as “a loss of key personnel.”
The Court agrees with Defendants that Minstein does not explain his reasons and does not conduct any analysis under the standard — he simply jumps to conclusions. Minstein identifies the events that, in his opinion, triggered the duty to conduct an interim test. For example, Minstein claims that the loss of key personnel, namely Morash as CFO in September 2003 and Ragland as CEO in February 2004, qualify as triggering events. Minstein Decl. ¶ 22-24 (interim); Minstein Report at 16. What is lacking, however, is any analysis of the language in FAS 142 that states the event
“would more likely than not reduce the fair value of a reporting unit below its carrying amount.”
When asked about his analysis at his deposition, Minstein admitted that he had not performed an impairment test to demonstrate that the identified events would have reduced the fair value of the Commercial wireless segment below its carrying value. Katsell MSJ Decl. Ex. E (Minstein Dep. at 302-03). As such, his opinion rests on his
c) Scienter
The Court agrees with Defendants that Minstein exceeded his role as an expert witness on accounting when he gave his opinions about the Defendants’ mental state. The Court discusses that issue in the scienter section below.
2. Regan Rebuttal Report
Plaintiffs offer Regan’s expert report to rebut the report by Defendant’s expert William W. Holder. Rogers Decl. Ex. 1 (Regan Decl. Ex. A.) (hereinafter “Regan Rebuttal Report”). [Doc. No. 252.]
Defendants first contend the rebuttal report was untimely filed in relation to Plaintiffs’ opposition brief. This procedural objection is overruled. The pretrial schedule was extended to allow the parties to exchange the rebuttal reports on February 3, 2009. Plaintiffs submitted the report as soon as it was available on February 9, 2009. The Court observes that Defendants filed their expert’s rebuttal report on the same day. [Doc. No. 254.] The Court prefers to resolve summary judgment motions on a complete record.
Next, Defendants argue Regan’s report exceeds the scope of a proper rebuttal brief because Regan conducted his own goodwill impairment analysis whereas Defendants’ expert Holder did not undertake that task. The Court OVERRULES this objection because Regan’s analysis contradicts Holder’s opinion on the same subject matter, specifically, whether RE-MEC used assumptions, estimates, and forecasts to evaluate goodwill that complied with GAAP. Compare Regan Rebuttal Report at 17-26 with Holder Rebuttal Report at 8-9 & 13-18. Regan also addressed Holder’s reliance on the Ernst & Young audit work papers and the analysis by the successor Certified Public Accountant (“CPA”). Id.
Defendants’ substantive argument is that Regan ignored the relevant legal standard and completely failed to explain or justify how or why the assumptions he made are more appropriate than the assumptions REMEC used to value goodwill.
The Court OVERRULES the objection because the allegations are belied by the report itself. Regan explains precisely why he believes REMEC used inappropriate assumptions and then supports his reasons for selecting alternative inputs.
See e.g.,
Regan Rebuttal Report at 17-25. As the Ninth Circuit observed on remand from the Supreme Court, “the test of
Daubert
is not the correctness of the expert’s conclusions but the soundness of his methodology.”
Daubert v. Merrell Dow Pharms., Inc.,
For the present purpose of ruling on the summary judgment motion, the Court OVERRULES Defendants’ laundry list of evidentiary objections to Regan’s report. Defs.’ Evid. Obj. [Doc. No. 339],
B. Statements Before and During Class Period
The cross motions for summary judgment involve these statements: (1) RE-MEC performed a goodwill impairment test in' February 2002; (2) REMEC’s goodwill for FY03 was not impaired (particularly the gross profit margin assumptions); (3) REMEC would soon return to profitability; (4) Ragland “retired” as CEO; (5) the “China Ramp” was “on plan”; and (6) other accounting practices and financial performance.
1. Factual Issues Remain on the Falsity of the Statement that REMEC conducted a Transitional Goodwill Impairment Test as of February 1, 2002
Plaintiffs contend that Defendants falsely told investors that REMEC “performed its transitional goodwill impairment test as of February 1, 2002.” Fraser Deck Ex. 9 at 12 (Q3 04 Form 10-Q filed Dee. 13, 2003) (“REMEC did not recognize any goodwill impairment as a result of performing this transitional test.”); accord Williams Deck Ex. 56 at 33 (FY03 Form 10-K at 27) (R887571) (same, pre-class statement). They seek summary adjudication on this issue. Pis.’ MSJ Br. at 17-20.
Defendants counter that the company did perform that transitional test, which was the first test conducted under the new standard in FAS 142, but cannot locate the actual document. Plaintiffs argue that the fact that REMEC cannot produce, when ordered to do so, the 2002 test demonstrates that it does not exist. See Order Granting in part and Denying in part Pis.’ Mot. Compel Production of Docs, and Interrog. Resp. [# 193]; Order Granting Mot. to Compel Dep. Answers. [#270]. 11
After Plaintiffs’ motion was fully briefed, the Court permitted Defendants to file a supplemental brief because they located documents reflecting that the transitional test had been performed. Defendants now rely on circumstantial evidence from their accountant to show that the test was conducted.
The Court concludes that Plaintiffs are not entitled to a partial summary judgment that REMEC did not conduct its transitional test in February 2002. Defendants submitted evidence that REMEC’s independent auditor reviewed that initial test during its audit in April 2003. Katsell Supp. Deck Ex. A (Ernst & Young Audit Results).
12
The auditor’s statement that it “reviewed” the initial test “performed by the Company” on the Commercial segment which used the “discounted cash flow analysis” for both segments “as of February 1, 2002” is circumstantial evidence that RE-MEC did conduct the transitional impairment test as stated in its Form 10-K.
Id.
at 12 (R1928030). Ernst & Young reviewed Arthur Andersen’s valuation of Solitra, including the fair value of goodwill, as a part of the audit.
Id.
(noting its review of the Oct. 2001 Solitra analysis);
In their supplemental brief, Defendants further argue that REMEC properly tested the goodwill by relying on third-party valuations of recent acquisitions. Defendants argue that the accounting standards permit this approach because the acquired entities constituted a “significant portion” of the Commercial Wireless segment. Defs.’ Supp. Opp. Br. at 2-3; Williams Decl. Ex. 1 (FAS 142, App. B ¶ 155); Furukawa Surreply Decl. Ex. B at 52-55 (Sackett Dep. at 125-29). Plaintiffs objected to the new issue, but responded in their own supplemental brief by disputing whether the transitional test, as reported in the corroborating documents, complied with the accounting standard to value the “reporting unit as a whole.” Williams Decl. Ex. 1 (FAS 142 ¶23). Plaintiffs contend that REMEC improperly substituted an analysis of one acquisition (Solitra) by an outside accounting firm instead of conducting a complete test of the Commercial segment’s goodwill.
The Court declines to address this new issue — whether the transitional test, assuming it exists, complied with FAS 142 — because it was not part of either party’s original motion for summary judgment.
See Martinez v. Ylst,
2. FY03 Goodwill Impairment Test
The next statement concerns the first annual test of goodwill that REMEC conducted under the new FAS 142 accounting standard.
One introductory caveat is appropriate. REMEC filed its Form 10-K in April 2003
before
the class period commenced in September of that year. Statements made
before
the class period can be relevant evidence on this issue of
scienter
because “they may provide insight into what the defendant knew during the class period.”
DeMarco v. DepoTech Corp.,
The Form 10-K included the following language on the valuation of REMEC’s goodwill for the fiscal year that ended on January 31, 2003.
The required goodwill impairment test was performed as of December 27, 2002. Our impairment review process is based on a discounted future cash flow approach that uses our estimates of revenue for the reporting units, driven by assumed market growth rates and assumed market segment share, and estimated costs as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage the underlying business. The estimates we used assume that we will gain market segment share in the future and the Commercial segment will experience recovery and a return to growth and profitability from the current trends. We may incur charges for goodwill impairment in the future, if the products fail to gain expected market acceptance or if we fail to achieve our assumed revenue growth rates or assumed gross margins. In performing the fiscal 2003 annual test for the Commercial segment, we assumed sales growth rates ranging from 5%-15%; gross profit margins ranging from 30%-38% (excluding depreciation); an income tax rate of 18% and a discount rate of 20% .... We did not recognize any goodwill impairment as a result of performing this annual test.
Williams Decl. Ex. 56 at 33 (Form 10-K at 27) (emphasis added).
Plaintiffs allege that REMEC falsely stated that its goodwill was not impaired for FY03 (measured “as of’ Dec. 27, 2002). They argue that REMEC used inflated and unreasonable gross profit margins to perform that test. Specifically, they seek summary adjudication that REMEC falsely stated that the gross profit margin “estimates are consistent with the plans and estimates we use to manage the underlying businesses.” Id.; Pis.’ MSJ Br. at 14-17 n. 17. 13
In contrast to the narrow question that Plaintiffs raise, Defendants raise a broader issue. In their competing motion, Defendants move for summary adjudication that there is no evidence that the company’s goodwill impairment analysis for FY03 was improper, misleading, or fraudulent.
(a) A Jury Must Decide Whether RE-MEC’s FY03 Assumptions of Future Gross Profít Margins of 30% to 38% were “Consistent” with its Business Plan
In conducting its FY03 goodwill impairment test, REMEC assumed gross profit margins of 30% for FY04, 35% for FY05, and 38% for the next seven years. Williams Decl. Ex. 56 at 33 (Form 10-K at 27); Katsell Opp. Decl. Ex. J at 298. 14
In opposition, Defendants’ witnesses explained that the figure in the budget includes depreciation; by contrast, the goodwill impairment analysis excludes depreciation. Katsell MSJ Decl. Ex. L at 283-84 (Hinkle Dep. at 158-59); Katsell Opp. Decl. Ex. N at 405-06 (Gray Dep. at 35-36); see Katsell Opp. Decl. Ex. J at 299 (“Gross margin excludes depreciation”). Defendants argue that if the 5% depreciation figure is deducted from the 30% assumption for FY04, it shows that REMEC used consistent gross profit margins in its internal budget and its public statements about goodwill impairment test.
Plaintiffs challenge this logic. Even taking into account a 5% difference for depreciation leaves a disparity of 4.3% in FY04.
As further evidence, Plaintiffs cite to the Internal Control and Fraud Considerations form that Ernst & Young completed to prepare for its audit of REMEC’s FY03 books. Plaintiffs’ brief states that Ernst & Young “called the GPM assumptions ‘aggressive and unrealistic’ ” as if the auditor specifically identified the gross profit margin assumptions in REMEC’s goodwill impairment analysis. Pis. MSJ Br. at 16. This is a mischaracterization. The memo actually states a concern with “[m]anagement’s commitment to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts.” Nonetheless, Ernst & Young’s observation does state its general opinion that REMEC had used unrealistic forecasts.
Plaintiffs also cite a draft of a three-year strategic plan to support their motion. Williams Decl. Ex. 10 at 1. The plan forecasts gross margins for the Commercial segment of 25.9% for FY04, 28% for FY05, and 30% for FY06.
Id.
at 63 (R001319). Plaintiffs argue that these in-house assumptions are inconsistent with the higher
Defendants raise two objections to the admissibility of the August 2003 Three Year Strategic Plan exhibit that Plaintiffs submitted. Williams Decl. Ex. 10. First, Defendants argue the exhibit has not been authenticated. The Court overrules this objection because it is clear that REMEC created the August draft and a proper foundation easily can be laid by a person with personal knowledge that the document is what it is purported to be.
Hal Roach Studios v. Feiner & Co.,
The Court’s review of the record leads to the conclusion that Defendants have raised questions of fact that defeat Plaintiffs’ motion as to the falsity of this preclass period statement. First, Defendants cite a budget for FY04, which began on February 1, 2003. Katsell Opp. Decl. Ex. K. That budget, which is dated March 13, 2003, forecast a 25.12% gross profit margin for the Commercial segment. Id. at 2 (R315180). Adding back the 5% for depreciation makes the assumption 30.12%, which is the same as the 30% assumption that REMEC stated it would achieve in FY04.
Second, the budget had been prepared with estimates provided by the product line managers and then consolidated at the corporate level. Defendants argue this “bottom up” approach protected the budget from manipulation by executives.
Third, Defendants point to testimony that the company used the information it had available and the results that it expected to achieve. Katsell Reply Decl. Ex. 4 at 103-05 (Ernst & Young Partner Niki Krutop Dep.); Katsell Reply Decl. Ex. 7 at 182-84 (CFO Morash Dep.).
Fourth, Defendants cite evidence to explain the higher figures REMEC used for FY05 to FY10. Morash defended using projections of 35% to 38% gross profit margins after FY04 because “[w]e thought things were going to continue to improve, and so, we add a modest improvement on top of that.” Katsell Opp. Decl. Ex. C at 245 (Morash Dep. at 110). In particular, Morash believed that once the manufacturing operations were completely located in China, REMEC’s costs would reduce from “$40 an hour to 40$ an hour.” Id. “So, if that doesn’t improve your gross margin, then I don’t know what does.” Id. Morash also testified that he discussed the assumptions with Ernst & Young during the audit, and the CPA approved them. Katsell Scienter Decl. Ex. A (Morash Dep. at 72).
Fifth, REMEC’s independent auditor reviewed the FY03 goodwill impairment testing assumptions as part of its annual audit of the financial statements, and found they were “in line with managements forecasts and expectations of the relative segments’ performance in subsequent years.” Katsell Supp. Decl. at 12 (Audit Results, Report to the Audit Comm, of the Bd. of Directors) (dated Apr. 17, 2003). This included the gross profit margins used by the Commercial segment.
The Court concludes that a reasonable jury could accept Defendants’ explanation and take the 5% depreciation into account to reconcile the different figures in the current budget and the goodwill impairment test. There is certainly room for the parties to argue whether these numbers fall within the definition of the word “consistent.” Because a jury could find that REMEC used gross profit margin figures that were the same as its internal projections, Plaintiffs are not entitled to summary adjudication on the falsity of the challenged statement.
One further observation: Plaintiffs criticize the use of a budget dated March 13, 2003 to evaluate a goodwill impairment test “as of’ December 27, 2002. Plaintiffs argue that the Defendants’ evidence is irrelevant because the document was “dated 2^ months after the date as of which RE-MEC publicly reported it conducted the test” and “could not possibly be a document used to run the business at the time the test was performed.” Pis. Reply Br. at 7 (emphasis in original). Plaintiffs appear to believe that the “as of’ date is the date on which the goodwill impairment test was “performed.” They also argue that documents prepared closer in time to December 27 are more reliable than those created later. For example, Plaintiffs argue that the version of the budget printed on February 3, 2003 is better evidence than a version prepared in March 2003. Id. at 8 (“While Plaintiffs’ evidence is dated approximately one month after the date the test was conducted “as of,” it was the budget nearest in-time to the testing that Plaintiffs could find in Defendants’ production.”).
This- is inaccurate. The “as of’ date is selected by a company to measure goodwill; the company uses the same date in every annual test. REMEC selected the last business day of December for its annual test. Although REMEC’s goodwill was valued “as of’ December 27, 2002, the impairment test itself is performed over many weeks. See generally Williams Decl. Ex. 1 at 81-82 (FAS 142, App. B ¶¶ B142, B204 & B210) (discussing amount of work involved in impairment testing and allowing six months for companies to complete initial test under new method). The test can rely on information available during that time period. 15 During that same time period, REMEC would have been closing its fiscal year end books to prepare its SEC filings and Ernst & Young would have been conducting its annual audit of REMEC’s financial statements.
By necessity, a test is conducted “as of’ a date selected by the company even though the books for that period have not yet been closed and the budget for the new year has not yet been finalized. Katsell Reply Decl. Ex. 4 (Krutop Dep. at 103-04) (“the period that is selected is not the period that all the information has to be available ... if you do it, say as of December 27, ... your books for that period, by definition, wouldn’t be closed, nor would you have a budget from that period forward as of that date”). As Defendants point out, REMEC created a “working build” document and then revised the budget several times thereafter. Williams Decl. Ex. 51 at 2 (R000172) (same as Fraser Decl. Ex. 24); Defs.’ Opp. Br. at 3 n. 6. The early versions, including the one dated February 3, 2003, were subject to modification. Katsell Opp. Decl. Ex. C at 245-46 (Morash Dep. at 110-11) (referring to
Moreover, a goodwill impairment test necessarily refers to estimates, forecasts, and projections of future events. It is natural to expect these figures would be modified and refined as the company solidified its strategy for the coming years.
Plaintiffs’ complaint that the March 13, 2003 budget was created “one day after E & Y signed off on the impairment analysis” also fails. Pis.’ Reply Br. at 7 (emphasis is original); Williams Decl. Ex. 44 (Ernst & Young initialed “3/12/03”). The budget was available to REMEC during the time it was analyzing the value of its goodwill. To the extent that Defendants rely on Ernst & Young’s approval of the assumptions, the original memorandum was dated January 30, 2003; was written by Kristen Janis, Senior Manager at Ernst & Young; and disclosed that REMEC assumed a 38% gross margin rate for the commercial segment. Williams Decl. Ex. 44 at 1.
The Court further notes that Plaintiffs also rely .on documents created after the “as of’ date of December 27, 2003 to support their own motion. Plaintiffs cite three documents that were created well after REMEC announced the goodwill impairment test for FY03. First, they rely on the “Internal Control and Fraud Considerations” form that Ernst & Young prepared in connection with its annual audit in the subsequent year (FY04). Pis.’ MSJ Br. at 16 (citing Fraser Decl. Ex. 23, which is same as Williams Decl. Ex. 26 (EYE-008934)). The form is not dated but the footer contains the date “08/03.” Second, Plaintiffs rely on a version of the three-year strategic plan, dated August 2003. Id. at 17 & n. 19 (citing Fraser Decl. Ex 25, which is same as Williams Decl. Ex. 10 (R001266)). Third, Plaintiffs cite a three-year forecast created in August 2003. Id. (citing Fraser Decl. Ex. 26).
(b) A Jury Must Decide Whether RE-MEC’s Goodwill Impairment Analyses were False or Misleading
Defendants move for summary adjudication in their favor as to Plaintiffs’ goodwill claims. Their motion covers Plaintiffs’ allegations about the annual goodwill impairment tests for both FY03 and FY04, as well as allegations that RE-MEC should have conducted interim tests on the Commercial Wireless division. Defs.’ MSJ Br. at 6-16. Defendants argue that Plaintiffs have not presented evidence sufficient to support a verdict in their favor on the element of falsity.
Celotex,
Defendants’ motion is based entirely on their argument that Plaintiffs’ experts’ reports are unreliable and are therefore inadmissible under
Dauberb.
Defs.’ Br. at 10-12 (FY03), 13-14 (interim), & 15-16 (FY04). The Court, however, has concluded that the expert opinions are admissible in so far as they pertain to the annual impairment tests. Consequently, there are competing expert opinions as to whether REMEC’s valuation of goodwill violated GAAP.
Compare
Minstein Report at 18 (“The projected gross margins exceeded what REMEC had historically achieved or would reasonably be expected to achieve.”),
id.
at 13 & Ex. 13 (calculating a goodwill impairment charge of $133.9 million for FY03),
id.
at 19 & Ex. 19 (using 25% gross margin — a number in line with REMEC’s internal information but still optimistic about future growth—
(c) Plaintiffs’ Claim on Interim Testing Fails as a Matter of Law
Defendants also move for summary judgment on Plaintiffs’ related claim that REMEC’s failure to conduct interim tests violated GAAP. Plaintiffs contend REMEC falsely stated, both before and during the class period, that there were no impairment indicators. See e.g., Brownlie Decl. Ex. H (2Q04 Form 10-Q at 19) (“Through August 1, 2003, there have been no such indicators.”). Plaintiffs’ only evidence on this issue was Minstein’s expert testimony. The Court has stricken the relevant portions of Minstein’s testimony because he offers unsupported and unreliable conclusions. Without that evidence, Plaintiffs have not created a genuine issue of fact as to whether certain events triggered RE-MEC’s obligation to conduct interim evaluations of goodwill. As such, the Court GRANTS Defendants’ motion, as to that issue.
C. Ragland’s Optimistic Statements about Future
Plaintiffs contend that Ragland misled the market by making overly optimistic statements in December 2003. 17 Pis.’ MSJ Br. at 6-13; Pis.’ Reply Br. at 4 n. 3. Defendants filed a cross motion on the December statements and they seek partial summary judgment that similar statements in September were not misleading as a matter of law. Defs.’ MSJ Br. at 17-19.
“Projections and general expressions of optimism may be actionable under the federal securities laws.”
In re Apple Computer Sec. Litig.,
“[A]s opposed to simple representations of historic fact,” an optimistic prediction of future growth, profit, or success “presents more subjective issues.”
Apple Computer,
1. September 2003 Statements
REMEC issued a press release on September 8, 2003 to announce the results of its second quarter of FY04. Williams Deck Ex. 24. REMEC reported the hard financial data, including net sales, net loss, and gross profit. The last paragraph quotes Ragland in his role as CEO as follows:
Continued improvement in sales and gross margins, as well as reduction in operating expenses and critical competitive wins, supports our confidence in REMEC’s game plan to exit FY'04 with sustainable growth and profitability. In addition to continued strong market share gains, we believe that the OEM and service provider customers are again spending on wireless infrastructure. Our Defense and Space Group continues to perform at record levels, while we continue to improve the performance of our Commercial Group The acquisition of Himark expands our ability to serve the China market and provides important momentum and competitive advantage in achieving our goal of a near term return to profitability and a strong second half performance.
Id. 18
Defendants argue that these statements are the type of soft information
A close look at Ragland’s statement shows that part of it concerned the entire company. When Ragland spoke in general terms of factors that supported “confidence” in the “game plan” to achieve profitability by the end of the fiscal year on January 31, 2004, he was predicting the consolidated results for both segments of the company. Id. Defendants point to the record to show that shortly before Ragland made that public prediction, REMEC internally forecast that its consolidated operations would earn a profit in the third and fourth quarters. Williams Decl. Ex. 7 at 65 (R001426) (forecasting $1.7 and $1.6 million net income in third and fourth quarters, respectively, for entire company); Katsell Opp. Decl. Ex. C at 247 (Morash Dep. at 219) (the entire company “was expecting a small profit” in third quarter); Fraser Decl. Ex. 11 (Morash Dep. at 215-17). Plaintiffs’ expert criticizes Ragland’s statements because he did not disclose that REMEC’s internal forecast for the operating income (as compared to net income) predicted consolidated losses of $2.2 million and $700,000, respectively. Min-stein Report at 23; Minstein Decl. at 23. Plaintiffs’ expert opines that Ragland’s predictions were misleading because RE-MEC had large operating losses and the forecast of net income was “only possible with substantial income from non-recurring items unrelated to operations,” Min-stein Decl. at 24, ¶¶ 42, 43, & 44(b), namely, a $2 million gain from an executed trade of foreign exchange. Williams Decl. Ex. 7 at 56 (R001417).
The last part of Ragland’s statement concerns the Commercial Wireless Segment. Ragland stated that the performance of that separate segment had been improving in comparison to prior quarters. He identified the acquisition of Himark as a factor that supported his optimism that REMEC would be “achieving our goal of a near term return to profitability.” Williams Decl. Ex. 24. Plaintiffs’ expert notes that this prediction of profit is contradicted by the internal forecast of large net losses in both the third and fourth quarters for the Commercial segment. Minstein Decl. at 23, ¶ 44(a) & (b)(i); Williams Decl. Ex. 7 at 66 (R001427) (forecasting $4.9 and $3.5 million losses in third and fourth quarters). 19
The Court DENIES Defendants’ motion as to the September 2003 statements. Al
2. December 2003 Statements
REMEC announced its third quarter results on December 8, 2003. Ragland predicted that REMEC would make a profit soon. In the press release, Ragland said, “we believe we are on track to achieve profitability in the near term.” Williams Deck Ex. 30 at 3 (R2601287). In the conference call that same day, Ragland stated, “we are quite convinced that we’re still steadily in the growth mode.” Williams Deck Ex. 31 at R2601287. Rag-land described his expectations as being “quite upbeat.” Id. at R2601286; id. at R2601290 (“I happen to be pretty damn optimistic about the way the marketplace looks.”). After Ragland commented on some of the positive indications and his confidence in the development, management, and sales teams at REMEC, he then said, “[o]ur goal is to breakeven for the quarter.” Id. at R2601287; id. at R2601292 (setting goal for gross margin in coming year).
The parties dispute whether Ragland falsely described REMEC’s financial situation in the press release and earnings conference call. 20 Plaintiffs contend that when Ragland announced on December 8, 2003 that REMEC would soon return to profitability, the company faced extreme pricing pressures and REMEC’s internal projections contradicted any belief of profit by the end of FY04. Pis.’ MSJ Br. at 7. In their cross motion, Defendants argue that “[w]ith two months to go in the quarter and the internal forecast being so close to breakeven, these numbers do not show that a breakeven fourth quarter was impossible to achieve.” Defs. MSJ Br. at 18.
Like his predictions in September 2003, Ragland’s December statements are optimistic statements that usually are not actionable as securities fraud.
Copper Mountain,
As support, Plaintiffs rely on the presentation at a Board of Directors meeting on December 5, 2003 when REMEC forecast-ed a net loss of $600,000 for the fourth quarter and estimated a net loss of $15.4 million for FY04. Williams Deck Ex. 8 at 33 (R001619). That presentation also informed Ragland that the expected savings from the “China ramp” had not yet come to fruition because of delays in getting out of Finland. Indeed, the delay was costing
In addition, Plaintiffs note that REMEC did not have a track record of meeting its forecasts. For example, at the September 2003 Board of Directors meeting, REMEC had predicted it would earn a profit in the third quarter. Williams Decl. Ex. 8 at 33 (R001426). That goal was not met. Instead of earning a $1.7 million profit, RE-MEC suffered a net loss of $4.1 million that quarter. Compare Williams Decl. Ex. 7 at 65 (R001426) (Sept. 5, 2003 forecast for Q3) with Williams Decl. Ex. 8 at 33 (Q3 actual result). Plaintiffs argue that because the actual result was a loss twice as large as the early forecast, Ragland must have known his prediction for the fourth quarter was equally doomed to fail.
Plaintiffs also note that others with the same information doubted that REMEC would quickly return to profitability. 22 First, Plaintiffs rely on Hickman’s testimony that he “would not have said that” REMEC’s goal was to breakeven in the fourth quarter. Fraser Decl. Ex. 10 (Hickman Dep. at 123). Second, a member of the Board of Directors had been concerned with REMEC’s “lack of profitability and sales growth” throughout his tenure. Fraser Decl. Ex. 12 (Hughes Dep. at 85-86). Third, Plaintiffs state that Ernst & Young did not believe REMEC would achieve the goal of profitability given its consistent losses in the first three quarters of FY04. The basis of this inference is that Rag-land’s statement that REMEC would return to profitability caused the auditor to be on the lookout for overstating revenues when it conducted the annual audit.
Defendants argue the internal forecast did not seriously undermine Ragland’s optimism for improvement during the two remaining months of the fourth quarter because it was a small number. It was not impossible that REMEC would eliminate the projected loss of $600,000 and breakeven. They minimize the significance of RE-MEC’s past performance. In the recent past, REMEC’s actual results showed increased sales in the first, second, and third quarters as well as a declining net loss. Williams Decl. Ex. 8 at 33 (R001619) (sales increased from $81 to $86 to $104 million in the three prior quarters, while the net loss of $7.1 million in the first quarter was reduced to a $4.1 million loss in the third). Defendants further argue Ragland genuinely believed REMEC’s forecasts were reasonable. Prior to the third quarter, the company had expected to earn a “small profit.” Katsell Opp. Decl. Ex. C at 247 (Morash Dep. at 219) (CFO, at that time, testified REMEC forecast a little better than break even). REMEC’s budget for FY04 projected net income of $2.2 million. D’s Opp. p. 1. Finally, Defendants argue the company had a plan to increase gross profit margins over the near term in order to meet the target. Katsell Opp. Decl. Ex.
On this record, the Court concludes that triable issues of fact exist and DENIES the cross motions as to the falsity of the December 2003 projection.
Hanon,
D. Statement of Ragland’s Reason for Leaving REMEC
On February 10, 2004, REMEC issued a press release stating that “Ronald E. Ragland, 62, has announced his retirement from REMEC, Inc.” Fraser Decl. Ex. 31 (emphasis added).
Plaintiffs move for summary judgment that the announcement that Ragland “retired” was false. They argue the record is clear that Ragland was forced out of the company for poor performance, therefore, REMEC’s public statement portraying his departure solely as a personal decision to retire was misleading.
“To be actionable under the securities laws, an omission must be misleading; in other words it must affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists.”
Brody v. Transitional Hospitals Corp.,
Plaintiffs have shown the statement was false because the actual circumstances under which Ragland left REMEC cannot be characterized as “retirement.” First, the minutes of the January 30, 2004 meeting of the independent Board of Directors states:
After an extensive discussion of the financial condition of the Company and management’s inability to satisfactorily improve the financial performance of the business, upon motion duly made, seconded and unanimously carried it was decided that Ronald E. Ragland was to be removed immediately as Chief Executive Officer of the Company. Messrs. Shaner and Nash were appointed to offer Mr. Ragland the opportunity to retire and to negotiate an appropriate transition agreement with Mr. Ragland.
Fraser Decl. Ex. 6. Second, three Directors testified in their depositions that Ragland was asked to resign because of his poor performance.
Id.
Ex. 12 at 4 (Harold Hughes Dep. at 215);
Id.
Ex. 15 at 3 (Thomas Waechter Dep. at 52);
Id.
Ex. 30 at 4 (William Gibbs Dep. at 216-17). Ragland confirmed in his deposition that the Board used the “art form” of being “encouraged to retire.”
Id.
Ex. 7 at 3 (Ragland Dep. at 132-33) (“The board of directors asked me to retire from RE-MEC.”). The press release did not disclose that Ragland “was to be removed immediately” and as a result he agreed to accept the Board’s offer to retire.
Id.
Ex. 30 at 5 (William Gibbs Dep. at 219-20) (Board decided to give Ragland opportunity to retire to avoid any wrongful termination litigation, and “[a]fter some negotiation, he took the agreement.”);
GlenFed,
Another piece of incriminating evidence is that REMEC drafted a script to answer questions regarding Ragland’s departure:
Why did Ron Ragland step down? Was Ragland forced to resign? Was Ragland’s retirement a direct result of the poor financial results?
After founding REMEC in 1983 and leading the company for over 20 years, Ron Ragland took the personal decision that at the age of 62, he wanted to finally retire.
Did Ron’s resignation come as a surprise?
There was no surprise or spur of the minute decision. The board was fully aware of Ron’s intentions and beforeleaving, he had agreed to assist the company, at its request.
Did the board try to prevent Ron from retiring?
Retirement is a completely personal decision and therefore the board completely respected Ron’s wishes.
Fraser Decl. Ex. 32 at 1.
Plaintiffs’ evidence shows that REMEC portrayed a “fagade that Ragland was leaving the company of his own volition.” Pis.’ Br. at 23. In fact, Ragland described the experience as feeling “like my beloved mother had just told me I was a bastard.” Fraser Decl. Ex. 7 (Ragland Dep. at 133).
Defendants oppose the motion on the ground that the omission was not material, however, materiality is a separate element distinct from falsity. Defs.’ Opp. Br. at 11-12;
TSC Indus., Inc. v. Northway, Inc.,
Defendants also argue REMEC followed a standard business practice not to reveal that Ragland retired only because he had been asked to retire. E.g., Katsell Opp. Decl. Ex. S at 501 (Horn Dep. at 267) (“When people retire, it is not the practice — I’ve never seen any announcement saying, ‘Mr. X has retired because he was asked to retire.’ This is not the way things are done in business.”). That such omissions are common however does not immunize them from being misleading.
The Court concludes that Plaintiffs’ evidence demonstrates the absence of a genuine issue of fact as to the misleading nature of the statement in the February 10, 2004 press release that Ragland retired.
Celotex,
E. Statement that “China Ramp” was On Schedule
REMEC manufactured its wireless products and components worldwide, but decided to close its Finland operations and build new manufacturing plants in China. See Williams Decl. Ex. 56 at 10 (10-K at 4). The goal was to reduce costs. This project was called the “China ramp.” On December 8, 2003, REMEC issued a press release that quoted Ragland as saying that “our China ramp is proceeding on plan.” Fraser Decl. Ex. 13 at 3. The parties filed cross motions as to whether this statement is false or misleading.
Defendants argue that the statement that the relocation of REMEC’s manufacturing to China was “on plan” is not actionable as a matter of law. Defs.’ Br. at 16-17. Defendants argue the statement constitutes an amorphous, soft forecast of optimism.
In re Dot Hill Sys. Corp. Sec. Litig.,
The Court does not agree with Defendants’ characterization of the statement as forward-looking; instead, the statement describes a current business condition.
In re Secure Computing Corp. Sec. Litig.,
In their motion, Plaintiffs seek partial summary judgment that the statement was false because, at the time it was made, Ragland knew the project was suffering costly delays. Pis. Br. at 2. Specifically, three days before REMEC made its public statement, the Board of Directors learned that one challenge REMEC had faced in the third quarter was that the “China ramp too slow, costing $3-$5M/Quarter.” Fraser Decl. Ex. 2 at 70 (R001656) (Dec. 5, 2003 presentation). Plaintiffs note that this was not new information. When the Board of Directors held its June 2003 meeting, the China ramp was “3 months behind original plan.” Fraser Decl. Ex. 3 at 14 (R001087). Similarly, at the September 5, 2003 Board of Directors meeting, REMEC reported that “[s]lower than planned phase-down of Finland manufacturing causing $2.5M/qtr budget overrun.” Fraser Decl. Ex. 8 at 13 (R001374) (noting delay in setting up supply chain of “China manufacturing ramp”).
One executive testified that the three or four months of delay “was not [an] insignificant amount of time.” Fraser Decl. Ex. 15 at 4 (Thomas Waechter, Chief Operating Officer, Dep. at 82). Plaintiffs emphasize that REMEC depended upon the transition out of Finland and into China to achieve considerable cost savings that would overcome the pricing pressures facing the wireless industry. Id. (Dep. at 84) (“with the pricing pressures we had and the importance of getting to lower cost products, yes, [the delay] was significant”); Fraser Decl. Ex. 18 (Jon Opalski Dep. at 207) (a transition to lower cost manufacturing “was the only idea that was going to make our company profitable”).
One industry analyst concurred and concluded that the “eventual transition of the company’s Finland-based manufacturing to China ... should enable the company to show gross margin improvement ■ in its next fiscal year.” Fraser Decl. Ex. 17 at 1. The analyst reported that, as of September 2003, REMEC was incurring $2.5 million per quarter of costs by operating duplicate manufacturing facilities in Finland and China. Those costs were expected to increase in the third quarter, and then to decrease upon a complete transition to China. Id. at 1-2.
Defendants contend that Ragland’s December 8, 2003 statement is consistent with the internal reports and therefore is not misleading. H. Clark Hickock, Vice President of Global Operations, testified that the statement was accurate when it was made during the fourth quarter. Katsell MSJ Decl. Ex. K at 276 (Hickock Dep. at 118). Plaintiffs point to the weakness of Hickock’s assertion, however, since he based his opinion on REMEC’s press release, rather than personal knowledge of how the company had been performing. Furukawa Reply Decl. Ex. A (Hickock Dep. at 119).
Defendants also rely on Ragland’s deposition testimony that “China was performing the plan and the ramp was too slow. They’re not mutually exclusive.... [W]e were not getting out of Europe as fast as we liked. So we were performing the plan, but we’d like to be performing a lot faster.” Katsell MSJ Decl. Ex. V (Rag-land Dep. at 209).
The Court DENIES Plaintiffs’ motion to find the statement — “our China ramp is proceeding on plan” — false as a matter of
F. “Other” Accounting Practices and Historic Financial Performance
Plaintiffs allege that REMEC’s financial reports were false and misleading because, aside from the valuation of goodwill, the company artificially inflated its reported earnings by reducing its inventory reserves in the second and third quarters of FY04. FAC ¶ 8 (“manipulating inventory reserves to artificially improve profits”). Defendants move for summary adjudication of this allegation because Plaintiffs have failed to present any evidence to substantiate it.
The Court agrees. Plaintiffs oppose the motion with attorney argument but without any evidentiary support. Pis.’ Opp. Br. at 18 & 23-24. They cite one page of a two-hundred page document without any testimony to explain how it relates to their fraud theory. Fraser Decl. Ex. MM (U.S. Amps as of 10/31/03). Plaintiffs offer no evidence to defend allegations in the complaint that REMEC over-valued inventory or sold “zero value” inventory. FAC ¶ 11(a) & (b). Further, Plaintiffs also fail to cite even a “scintilla” of evidence that supports their allegation that REMEC falsely stated its historic results regarding sales and revenue. FAC ¶¶ 3 & 8. Accordingly, to the extent that the Plaintiffs allege REMEC committed other types of accounting fraud, the Court GRANTS Defendants’ motion for summary adjudication.
Matsushita,
IV. Scienter
Defendants seek summary judgment on the scienter element of the first cause of action which alleges a violation of § 10(b). 23 15 U.S.C. § 78j; SAC ¶¶ 382-92.
In order to prevail at trial on a § 10(b) claim, a plaintiff must establish that each defendant made the allegedly false or misleading statements with scienter.
Kaplan v. Rose,
“Generally, scienter should
not
be resolved by summary judgment.”
Provenz,
“To establish scienter, plaintiffs must show that defendants had ‘a mental state embracing an intent to deceive, manipulate, or defraud.’ ”
Id.
(quoting
In re Worlds of Wonder Sec. Litig.,
35
“ ‘[T]he proof of scienter in fraud cases is often a matter of inference from circumstantial evidence.’ ”
In re Software Toolworks, Inc.,
Before applying the summary judgment standard, the Court makes an initial observation. Counsel for Plaintiffs are skilled litigators, and they have ably and zealously argued their interpretation of the facts at hand. Plaintiffs’ opposition brief is written such that one might readily accept their conclusion that “Ragland and Hickman were directly involved and knew the goodwill test assumptions were false and misleading.” Pis.’ Opp. Br. at 14 (heading). In resolving the pending motions, however, the Court must separate rhetoric from evidence. The Court repeatedly examined the evidence underlying the generous characterizations in Plaintiffs’ briefs and found faint, if any, support.
At the pleading stage, the Court held that Plaintiffs alleged sufficient facts to create a strong inference of scienter in large part because the FAC quoted several Confidential Witnesses stating that Rag-land and Hickman were directly involved in critical events and had personal knowledge of key facts. Compare Order Granting Mo. to Dismiss [SAC] at 16-17 with Order Denying Mo. to Dismiss FAC at 6 (citing FAC ¶¶ 99-126). None of those allegations are supported by the proof presented. After a taxing and thorough discovery process, Plaintiffs did not submit a deposition or declaration from a single Confidential Witness to substantiate the FAC’s allegations regarding the executives’ knowledge or personal involvement. See e.g., FAC ¶¶ 128 & 136 (alleging Rag-land “issued his directives” to reduce manufacturing costs “in a futile attempt to improve gross profit margins”); id. ¶¶ 102 (alleging “Hickman personally adjusted this forecast”), 112-13, 117, & 134-35 (alleging Hickman was “definitely involved” and “intensely debated” gross profit margins with independent auditors).
The Court is mindful that “credibility determinations, the weighing of evidence, and the drawing of legitimate inferences from the facts are jury functions, not those of a judge when he is ruling on a motion for summary judgment.”
Anderson,
Despite their impressive stack of exhibits (the 81 consolidated exhibits on the scienter and reliance motions exceed 3,000 pages [Doc. Nos. 286-98]), Plaintiffs have not produced evidence sufficient to raise a question of fact of an intent to deceive.
Anderson,
This case involves a complicated accounting analysis that is infused with the exercise of professional judgment. All of the experts in this case agree that professional judgment is applied throughout goodwill impairment testing. Katsell MSJ Decl. Ex. E (Minstein Dep. at 27, 29, 37, 52, 226, 234-35,
&
269). Professional judgment is exercised when predicting future results, for example, assessing the company’s plans and whether its goals are achievable.
Id.
(Minstein Dep. at 235 & 258). Goodwill impairment analysis does not produce an absolute, black-or-white, definitive result.
In re Actema Corp. See. Litig.,
At best, Plaintiffs produce evidence of corporate mismanagement.
Santa Fe Indus., Inc. v. Green,
Defendant Ragland seeks summary judgment on scienter and submits a sworn declaration to demonstrate the absence of evidence to support Plaintiffs’ claim against him. “As CEO of REMEC, I did not make any decisions and did not participate in the making of any decisions regarding ... goodwill, goodwill impairment, interim impairment testing or any other accounting matters.” Ragland Decl. ¶ 5. Ragland relied on the accounting department to make those decisions. Id. “While I was certainly apprised of significant accounting decisions, they were not mine to make and I never overruled or changed any accounting decisions made by our accounting department, CFO, or Audit Committee.” Id. He states that he had a good faith belief that the financial statements were true and in compliance with GAAP; he did not make any statement about RE-MEC with the intent to deceive; and he relied on the staff accountants as well as outside auditors to prepare accurate financial reports. Decl. Ragland ¶¶ 6-10.
Plaintiffs’ opposition brief asserts that Ragland was “directly involved” in accounting matters, “reviewed the assumptions used,” and “knew the goodwill test assumptions were false and misleading.” Pis.’ Opp. Br. at 14-15. The Court read each document Plaintiffs cite to support their broad allegations. The Court carefully examined the record and found that most of Plaintiffs’ allegations lack substance.
Anderson,
As to the very weak inference that can be drawn from certain evidence, Defendants have rebutted it with substantial evidence that Ragland lacked the intent to defraud investors, including a lack of motive and opportunity.
Vucinich v. Paine, Webber, Jackson & Curtis, Inc.,
1. Ragland’s Statements
Plaintiffs identify several statements, that may or may not be false, that are attributable to Ragland. One was made before the class period began, i.e., the statement that REMEC’s goodwill was not impaired for FY03. During the class period, Plaintiffs challenge whether REMEC conducted a transitional goodwill test in February 2002; Ragland’s prediction that REMEC would return to profitability; and his comment that the China ramp was on plan. Ragland left REMEC on February 10, 2004 — statements after that date are not attributable to him. Factual issues remain as to the misleading nature of these statements. In regard to the scienter element, the precise question is whether Ragland knew or recklessly disregarded the alleged falsity at the time he made the challenged statement.
Plaintiffs argue Ragland was aware REMEC could not meet the inflated expectations, yet he knowingly continued to report misleading positive news. They contend that the egregious deficiencies in REMEC’s accounting practices raise a genuine issue of material fact with regard to the intent to deceive the public. As support for this theory, Plaintiffs make the following points. Ragland discussed and reviewed the assumptions used in the FY03 test and Plaintiffs’ experts conclude that the goodwill impairment analyses violated GAAP; Ernst & Young identified a potential risk of fraud in Ragland’s public statements about REMEC’s return to profitability.
The memo does not, as Plaintiffs urge, demonstrate the Ragland “must have known, or was reckless in disregarding, the fact that the GPM estimates used in the impairment test were much higher than internal estimates ‘used to run the business,’ contrary to what they told the public.” Pis. Opp. Br. at 15;
Kaplan,
A related piece of evidence is Ragland’s testimony that he reviewed the estimates, assumptions, and financial statements. Ragland Decl. ¶ 5. Ragland states he “did not prepare [the goodwill impairment testing] estimates and forecasts, but I did review them and was familiar with them.” Id. ¶ 8.
Plaintiffs jump on Ragland’s “admission” that he “reviewed” the relevant financial documents as proof of his opportunity to manipulate the outcome. In their motion on REMEC’s allegedly false and misleading statements concerning the FY03 goodwill impairment test, Plaintiffs conclude that Ragland must have known that assuming gross profit margins of 30% to 38% in future years was false. Pis.’ MSJ Falsity Br. p. 16-17. Plaintiffs speculate that Ragland told the market they were the same as those used to run the business to “bolster” their legitimacy because he knew the market would be skeptical of such high numbers. Id.
The evidence does not support this sweeping allegation. All of the evidence
In relation to the calculations of goodwill, which is the cornerstone of Plaintiffs’ fraud allegations, Ragland states that he “did not make any decisions” and “did not participate” in any accounting matters. Ragland Deck ¶ 5. As CEO, Ragland “was certainly apprised of significant accounting decisions,” but he never changed those decisions. Id. The accounting department, CFO, and Audit Committee made the decisions regarding goodwill impairment and Ragland relied in good faith on their competence and expertise, as well as the outside auditors Ernst & Young. Id. ¶¶ 5-7.
Plaintiffs rely on William Gibbs’ deposition as evidence that Ragland was “responsible for the impairment testing.” Pis.’ Opp. Br. at 15. Gibbs’ actual testimony does not support that characterization. Gibbs, a member of the Board of Directors and its Audit Committee, testified during his deposition as follows:
Q. Do you know who is responsible for the oversight of the goodwill testing in determining an impairment existed?
A. Ultimately, the CEO and then the CFO. Q. Do they share the responsibility?
A. Well, the buck stops at the CEO. He delegates it to the CFO, so it’s the CFO’s primary responsibility.
Q. And is it your understanding the CFO makes a determination, but the CEO would review that determination? [objection omitted]
A. I don’t know.
Q. You said the CEO delegates it to the CFO so it’s the CFO’s primary responsibility; however, you said the ultimate responsibility was the CEO[’s], correct?
A. That doesn’t mean he reviews everything. The buck stops there.
Williams Deck Ex. 37 at 3 (Gibbs Dep. at 150).
This testimony describes nothing more than a CEO’s responsibility to oversee the business.
See Vantive,
As noted, Plaintiffs have not produced a witness to testify to the truth of the aspersions recited in the complaint. Instead, the witnesses who were deposed testified that Ragland was not involved in the impairment testing. Patrick Gray, who served as Corporate Controller before taking a higher position, testified that he “spearheaded” the analysis and did “not recall whether Ron [Ragland] was involved” in the goodwill testing process or in creating the assumptions used in the test. Katsell MSJ Deck Ex. G at 216 & 220 (Gray Dep. at 12 & 18); Katsell Scienter Deck Ex. D at 22-23 (Gray Dep. at 34). Similarly, David Hinkle, who took over as REMEC’s Corporate Controller when Gray was reassigned, testified that he was responsible for conducting the impairment testing. Katsell Scienter Deck Ex. C. Hinkle did not recall any discussions with Ragland about the goodwill impairment analysis. 25 Id. at 14 & 17 (Hinkle Dep. at 345 & 394).
Moreover, Plaintiffs’ rank speculation is wholly discredited by Ragland’s sworn declaration. He states his subjective belief that “the estimates used in the goodwill impairment testing were based on and, in fact, were the same as the estimates and forecasts that management used to run REMEC’s business.” Ragland Decl. ¶ 8. Ragland understood the “forecasts for earnings, profitability and margins exceeded our actual performance at that time” but he explains the specific reasons behind the optimism. Id. These include the fact that REMEC’s sales and revenues had been increasing; that the transfer of manufacturing to Costa Rica, the Philippines, and China would be successful; and the industry was poised for a resurgence, both in national and international markets, in the products that REMEC manufactured. Id.
Plaintiffs rely on their expert, Minstein, as support that the goodwill impairment test conducted during Ragland’s tenure was so flawed that the magnitude of the accounting errors creates an inference that the report was deliberately manipulated to defraud investors. Minstein opines that REMEC’s assumptions for the Commercial segment were flawed, unsupported, and unrealistic. REMEC assumed 30% to 38% gross profit margins for the FY03 impairment test at a time when its internal forecast was 21.7% and its recent actual performance for FY02 was approximately 7%. 26
The Court agrees with Defendants that Minstein’s testimony at times crosses into impropriety when he offers his opinions as to Defendants’ mental state.
Elsayed Mukhtar v. Cal. State Univ.,
This argument fails for three reasons. First, Plaintiffs’ assertion, like that in the
Kaplan
case, is that the “statements are so false that defendants must have known they were false and must have intended to mislead the public.”
Kaplan,
Second, at best, Plaintiffs’ inference — that Ragland must have known the gross margin assumption was too high— leads to a conclusion that there was a violation of GAAP. “[E]ven deliberate GAAP violations do not by themselves establish scienter.”
Wet Seal,
Furthermore, the evidence shows Rag-land was fired for poor performance. Williams Deck Ex. 41 at 2, 4 (Audit Committee member Harold Hughes recalls discussing Ragland’s performance at every Directors meeting; the reviews were “negative”; and Ragland was fired because “his strategic vision was not working effectively”). While Plaintiffs may have shown mismanagement, they have not presented evidence on which a jury could find that Ragland was acting with the scienter that is necessary to impose personal liability for securities fraud.
Santa Fe,
Any negative inference created by Ernst & Young’s concern is largely negated by Ernst & Young’s explanation of the function of the form and Defendants’ affirmative evidence to the contrary. The planning document does not conclude that anyone at REMEC committed fraud; rather, it simply alerts the audit team to certain issues to ensure a complete and effective audit. Katsell Opp. Decl. Ex. M (Krutop Dep. at 274); id. Ex. L (Janis Dep. at 404). Ernst & Young prepares the standard form before it conducts an audit so that each member of the team is alert to potential fraud issues in the client’s financial papers. Id. at 1. The purpose of the form is to help Ernst & Young decide “the nature, timing, and extent of our audit procedures.” Id. The form further states: “We expect one or more fraud risks will be identified for most engagements. In addition, there is a presumption that we will identify one or more fraud risks relating to revenue recognition.” Id. at 6.
Patrick Gray, the Controller at the time, explicitly denied that Ragland pressured the business units to forecast certain figures. Katsell Scienter Decl. Ex. D at 20 (Gray Dep. at 30) (“I believe there were targets and goals mutually — mutually developed. But that to my knowledge, there was no undue pressure related to the business units to meet a certain number that year.”); id. at 21 (Dep. at 31) (same as to gross margin projections).
Plaintiffs do not present any evidence to show Ragland had reason to believe that REMEC had not conducted the transitional goodwill impairment test in February 2002.
ICN Pharm.,
Plaintiffs also rely on Ragland’s prediction that REMEC soon would return to profitability. As discussed above, factual issues exist as to whether Ragland’s optimistic statements in September and December 2003 were false. In evaluating the scienter element, the question is whether Ragland’s optimism was grounded on an objectively reasonable basis and a genuine personal belief.
Rubke,
Plaintiffs rely on Hickman’s testimony that he “would not have said that” RE-MEC’s goal was to breakeven in the fourth quarter as circumstantial evidence that Ragland made the statement with deceptive intent. The rest of Hickman’s testimony, however, defeats any such inference. Hickman’s complete statement was “but I wasn’t the CEO either.” Fraser Decl. Ex. 10 (Hickman Dep. at 123). Hickman explained that his job as CFO dictated that he take positions that other executives would consider “too conservative,” and he denied having any “real conflicts” about Ragland’s performance. Id.
Aside from Hickman’s view that the glass was half-empty, Plaintiffs have not presented evidence that Ragland knowingly misled investors; rather, the evidence shows Ragland genuinely believed the company would prosper. Williams Decl. Ex. 30 at R2601290 (“I happen to be pretty damn optimistic about the way the marketplace looks.”). Ragland focused on the positive signs of growth. Ragland Decl. ¶ 8; see, e.g., Williams Decl. Ex. 7 (Sept.2003 BOD presentation showed REMEC’s consolidated rate losses had slowed over three quarters, and forecasts for third and fourth quarters predicted profits and earnings per share). Similarly, Ragland articulated his reason for believing that the relocation of manufacturing facilities from Finland to China was “on plan” but needed to go faster.
2. Defendants Produce Affirmative Evidence that Conclusively Negates any Inference that Ragland Acted with Scienter
Even if Plaintiffs presented evidence that could give rise to an inference in their favor, Defendants have rebutted that inference with affirmative evidence of good faith.
Plaintiffs’ speculation that Ragland knew the company’s goodwill was impaired in FY03 is negated by Ernst & Young’s opinion that the assumptions were reasonable. Acting as REMEC’s outside auditor, Ernst & Young reviewed the goodwill analyses for FY03, and expressly concurred in the conclusion that goodwill was not impaired.
See e.g.,
Katsell Reply Decl. Ex. 2 (FY03 audit work papers).
28
The partner, Niki Krutop, and the senior manager, Kristen Jams, of the audit team testified that they “evaluated” goodwill and concluded REMEC “had come to a reasonable conclusion that goodwill had not been impaired as of the fiscal year ended 2003.” Katsell MSJ Decl. Ex. O;
id.
Ex. T (Janis Dep. at 226, 418-28) (describing audit of assumptions and goodwill test); Katsell Reply Decl. Ex. 4 at 96 (Krutop Dep. at 96) (explaining her analysis of was RE-MEC’s projected gross margins were “reasonable”). Ernst & Young evaluated the 38% figure and did not advise REMEC to change it. “While gross margins historically have been approximately 25% management represents that the historical gross margins include only 30-50% capaci
Moreover, as Defendants correctly argue, the level of transparency also serves to negate an inference that Ragland had a scheme to defraud investors. Defendants showed that Ernst & Young had full access to conduct a thorough, professional, and independent audit while Ragland was CEO.
Worlds of Wonder,
In addition, Ernst & Young reviewed REMEC’s third quarter financial report, which ended in October 2003. Katsell Reply Deck Ex. 12 (“we performed analytical review procedures” of matters including gross margins). It considered whether any indicators of impairment had arisen since the year end so as to require a cash flow analysis/detailed assessment of impairment.” Id. at 206 (mem. at 3). RE-MEC’s management determined that goodwill was not impaired and the CPA firm made an informed decision not to object. Id. at 209 (mem. at 6) (“Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements for them to be in conformity with generally accepted accounting procedures.”); accord id. Ex. 11 (same, first quarter ended May 2, 2003).
Defendants correctly note that Ragland did not sell any stock during the class period. Deck Ragland ¶ 13. This fact dispels an inference of scienter.
Worlds of Wonder,
Finally, the company released other negative information and cautioned investors of the risks of predictions. For example, the Form 10-Q for the second quarter of FY04 again warned investors that “[significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit.” Brownlie Deck Ex. H. The company disclosed negative information during the class period. REMEC took a $17,695,000 write off in the fourth quarter of FY02 in relation to the goodwill recorded from the acquisition of Pacific Microwave Corporation. Williams Deck Ex. 2 at 42 (FY02 Form 10-K at F — 8);
e.g.,
Brownlie Deck Ex. L (Feb. 10, 2004 press release entitled “REMEC Announces Preliminary 4th Quarter Results Below Expectations”); Ex. M (Mar. 24, 2004 press release announces $34.7 million net losses
3. Plaintiffs’ Other Contentions are Unsupported Conclusions
Plaintiffs press other arguments to support their case against Ragland; however, each fails due to lack of evidence.
Plaintiffs assert that “Ragland, as CEO, was responsible for overseeing the integrity of the financials and certifying to the SEC and the public that they were accurate and complete.” Pis.’ Opp. Br. at 14. This merely states the obvious that Ragland performed the duties of a CEO. A corporate officer’s job title does not prove that he was personally involved with the alleged fraud.
Metzler Inv. GMBH v. Corinthian Colleges, Inc.,
Plaintiffs further contend that Ragland falsely told investors that RE-MEC had an adequate system of internal controls to ensure accurate financial reports.
29
See e.g.,
FAC ¶¶ 36-37, 47, 73(f), 74(m). They contend that this misstatement is probative of Ragland’s state of mind. Order Grant. Mot. to Dismiss at 10, n. 2 [Doc. No. 34];
In re Atlas Air Worldwide Holdings, Inc. Sec. Litig.,
324
The challenged statement is contained in a quarterly financial report that REMEC filed with the SEC during Ragland’s tenure as CEO. Williams Decl. Ex. 28 (Form 10-Q, filed Dec. 2003). 30 The report is accompanied by a Certification, in which Ragland states that he has reviewed the form, and that, based on his knowledge, it does not contain false statements or misleading omissions. Id. at 25 ¶¶ 1-3 (R768868). Ragland states that he is “responsible for establishing and maintaining disclosure controls and resources” that ensure he is informed of material information. Id. ¶ 4. Ragland states that he evaluated the effectiveness of those controls and presented his conclusion in the body of the SEC filing. Turning back to that section of the Form 10-K, Ragland concluded that the internal controls were “effective, in that they provide reasonable assurance that information required to be disclosed” is timely reported. Id. at 22 (R768865). The Certification concludes with a statement that Ragland disclosed to the independent auditor and the Board’s Audit Committee “[a]ll significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect [REMEC’s] ability to record, process, summarize and report financial data” and any fraud. Id. at 25 ¶ 5.
Plaintiffs contend that Ragland knew that the internal control procedures were flawed because a few months earlier Ernst & Young told REMEC that it had observed “certain weaknesses involving internal control” when it had conducted its annual audit. Williams Ex. 63 (Mar. 14, 2003 memo). Ernst & Young was primarily concerned that REMEC did not have enough trained accounting staff to prepare timely reports, but it described six “areas where sufficient expertise, oversight or process controls were not employed, resulting in adjustments made subsequent to the initial close.” Id. Ernst & Young recommended that REMEC hire and supervise more personnel in the accounting and finance departments; establish a closing calendar; improve communications with foreign locations; and use a computer system to identify obsolete inventory and reserves rather than rely on subjective analysis. Id. The memo reports that the auditors consulted with management and that the company had hired new staff, increased review and oversight, re-evaluated its internal control processes, and instituted an internal audit function. Id.
The Court finds that Ragland’s Certification that REMEC’s internal controls were “effective” is
not
evidence that Rag-land had an intent to deceive.
Cf. Zucco Partners, LLC v. Digimarc Corp.,
First, the Ernst
&
Young memorandum, dated March 2003, contains the management’s response to the concerns the independent auditor uncovered in the annual audit which shows the weakness had been discussed at some earlier date. The memo
Second, there is no evidence that RE-MEC did not respond effectively to the auditors’ concerns. Rather, the memo itself confirms that a past problem had been addressed. The memo that Ernst & Young submitted a year later, after completing the FY04 audit, confirms that conclusion. None of the concerns raised in the March 2003 memo were mentioned in the March 2004 memo. Williams Decl. Ex. 64 (listing concerns with derivatives, foreign currency translation, payroll issues, other review processes, and computer security); accord Katsell Supp. Decl. Ex. A at 7 (Ernst & Young Audit Report dated April 17, 2003) (“We noted no material deficiencies” in internal controls, but recommended two improvements to increase efficiency of cash disbursements and bank reconciliations).
Similarly, evidence that a member of the Board of Directors perceived weaknesses in internal controls while Ragland was in charge bears on mismanagement. Williams Decl. Ex. 66 at 7 (evaluating internal control environment as “still ineffective”), 12, 18, 24, 28.
31
It does not support an inference of securities fraud in the context of this litigation.
In re GlenFed, Inc. Sec. Litig.,
Plaintiffs do not provide any evidence to support their claim that Ragland “participated in numerous Audit Committee meetings.” Pis.’ Opp. Br. at 15. Plaintiffs did not produce evidence such as the minutes of the Audit Committee meetings that show Ragland participated in any discussion concerning goodwill testing. Instead, Plaintiffs cite to the Audit Committee’s Charter. Williams Decl. Ex. 46. That document outlines the responsibilities of the three directors on the Audit Committee. Id. It is not probative of Ragland’s role in the alleged accounting fraud.
Plaintiffs argue that REMEC’s purchase of Himark is indicative of Ragland’s scienter. Plaintiffs note that Ragland was dating the owner of Himark, Shu-Yi Lin, at the time REMEC acquired the company for $12.1 million. Pis.’ Opp. Br. at 12 (describing “deception,” “secret affair,” “impropriety”). The couple later married. Williams Decl. Ex. 38 (Bernard Lirola
The Court agrees with Defendants that Plaintiffs have not presented evidence of any misconduct as to that transaction. Attorney argument is not admissible evidence, and the available evidence negates the inference that Plaintiffs attempt to draw. Lirola testified that he had “no reason to believe” that Ragland’s personal relationship influenced REMEC’s decision to buy Himark. Id. (Dep. at 107). In addition, the fact that a member of the Board of Directors contacted an attorney for advice is not evidence that the transaction was deceptive, particularly when the conclusion of that independent investigation confirmed there was nothing to disclose. Williams Decl. Ex. 37 at 6 (Gibbs Dep. at 227-29); id. Ex. 34 at 129 (minutes show two attorneys advised Board of findings); but see id. Ex. 41 at 2-4 (Director Harold Hughes believed the relationship created a conflict of interest problem, but noted the independent investigation found “nothing untowards”).
Ernst & Young concurred. Ernst & Young conducted an independent review of the Himark acquisition and concluded that the purchase price had not been inflated, but was consistent with comparable transactions. Williams Decl. Ex. 45 at 2. Ernst & Young concluded that the conditions of the sale had not affected REMEC’s financial statements and REMEC was not required to make any disclosures. Id.
Though the FAC casts aspersions at the motivation for acquiring Himark and its value, Plaintiffs have not produced evidence to support the allegation. See e.g., FAC ¶¶ 189,192,196.
The Court must construe all reasonable inferences in Plaintiffs favor. By the same token, Defendants should not endure an expensive trial when no reasonable jury could conclude that Plaintiffs have proven their case. The Court concludes that Plaintiffs have not offered “concrete evidence from which a jury might return a verdict in his favor” — it is not sufficient to merely assert “the jury might, and legally could, disbelieve the defendant’s denial of [deceitful intent].”
Anderson,
Even assuming Plaintiffs’ experts are right that REMEC’s goodwill was impaired, their opinions about the
falsity
of the statement do not defeat Ragland’s
scienter
summary judgment. A deliberate violation of accounting procedures, by itself, is not sufficient to create an inference that the CEO, who was not involved in selecting the data, acted with an intent to defraud investors.
Wet Seal,
In conclusion, Plaintiffs have not presented sufficient evidence to survive Rag-land’s motion for summary judgment as to scienter.
Celotex,
B. Individual Defendant Winston E. Hickman
Hickman, the other executive named in this class action, moves for summary judgment on the ground there is no evidence that he acted with scienter. Hickman submitted a sworn declaration in support of his motion.
Hickman joined REMEC as CFO on November 14, 2003, when REMEC was in the midst of preparing FY04 reports as well as budgets and forecasts for FY05. Hickman Decl. ¶ 4 & 7. He has an MBA in finance, but relied on accountants for “technical accounting expertise.” Id. ¶ 5. Hickman states he had a good faith belief that the challenged statements were true; he did not make any statement with the intent to deceive; and he relied on the staff accountants as well as outside auditors to prepare accurate financial reports. Id. ¶¶ 4-21.
Hickman’s job responsibilities as CFO bring him closer to REMEC’s financial reports; however, the Court finds that Plaintiffs have not produced sufficient evidence of scienter to survive his summary judgment motion. Plaintiffs’ assertion that Hickman was “directly involved and knew the goodwill test assumptions were false and misleading” is not supported by the evidence. Plaintiffs rely on exaggerated characterizations to argue Hickman intended to deceive the investing public. 33 The record contains no such evidence. The Court agrees with Defendants that Hickman did not have an opportunity to manipulate the goodwill impairment tests. That task was performed by other employees, Hickman did not direct the manner in which the test was performed or its outcome, and the outside auditor approved the analysis.
1. Hickman’s Involvement in FY04 Impairment Testing
Plaintiffs first argue that internal emails that contain different scenarios demonstrate that Hickman intentionally manipulated the numbers to perform a “bogus” goodwill impairment test in FY04. Pis.’ Opp. Br. at 4-5 (“Defendants used false, arbitrary inputs in the calculations to
On February 1, 2004, David Hinkle, Vice President and Corporate Controller, sent Hickman an email with the subject line “FAS 142 — Commercial all scenarios 1-19 vs.xls.” Williams Decl. Ex. 16. 34 Hinkle attached three different versions of the valuation of the Commercial segment “as of’ December 31, 2003. Id. at 2, 18, & 34. At the time these documents were prepared, REMEC had the actual numbers through October 31, 2003 and a fairly reliable estimate of results for Q4 of FY04. REMEC’s actual FY gross profit margins had been 25% in 2001, 6% in 2002, 10% in 2003, and approximately 18 to 23% in 2004. Id. at 2. The three versions differ in their assumptions and forecasts of the figures for the future years. 35 One scenario would have resulted in a goodwill impairment of $8.4 million, whereas the two other versions calculated no impairment by an excess of at least $44.3 million and at most $263.4 million.
Ultimately, as noted above, in its final April 15, 2004 public filing, REMEC assumed “sales growth rates ranging from 5%-40%; gross profit margins ranging from 24%-28% (excluding depreciation); an income tax rate ranging from 0%-23% and a discount rate of 20%” for the Commercial segment. Williams Decl. Ex. 5 at 25 (draft FY04 Form 10-K). REMEC used numbers in its Form 10-K that were different from those in the three scenarios that Hinkle sent Hickman in February. Compare Ex. 5 (highest GPM of 28% & top income tax rate of 23%) with Ex. 16 (GPM could reach 31% & income tax rate could reach 25%).
The Court finds that the emails (including those listed
supra
n. 32) are devoid of evidence that Hickman directed that cer
Any permissible inference that could be drawn from the existence of three different scenarios is negated by undisputed evidence. Hickman acted in a supervisory role by reviewing the final result, but was not involved in selecting the data or dictating a specific outcome. Hickman testified that Controller David Hinkle prepared the annual goodwill impairment test for FY04 36 Hickman Deck ¶ 8; Williams Deck Ex. 32 at 7 (Dep. at 148). Hickman described his own involvement in the process as “reviewing” the completed analysis. Williams Deck Ex. 32 at 6-7 (Dep. at 147-48). Hickman testified that he recalls seeing one scenario and that Hinkle performed the analysis with the assistance of others in the accounting department. Katsell MSJ Deck Ex. J at 270 (Hickman Dep. at 170) (“I don’t recall different scenarios. I recall one analysis.”); Hickman Deck ¶ 8. He testified that the company used an existing model that had been prepared by an outside accounting firm. Hickman Deck ¶ 8. As noted, Hickman testified that he believed the optimistic estimates and forecasts were reasonable. Id. ¶ 10. He relied on the outside audit by Ernst & Young to evaluate the methodology, estimates, and assumptions. Id. ¶ 12.
The employees in REMEC’s accounting department confirmed the accuracy of Hickman’s description of his role. Hinkle testified that he “oversaw the analysis.” Katsell MSJ Deck Ex. S at 251 (Hinkle Dep. at 251); Katsell Reply Deck Ex. 3 (attached to this Feb. 19, 2004 Ernst & Young mem. is analysis Hinkle performed on Feb. 5, 2004, in which he states his reasons for predicting future growth “despite the on-going financial difficulties”) (EY-000695 to 000698); see also Williams Deck Ex. 19 (on Feb. 14, 2004, Hinkle sent an email to Kristen Janis at Ernst & Young and attached a scenario of goodwill impairment that assumed a gross margin of 21.8%). Tiernan Hussey testified that the accounting staff input the data into the model. Katsell Reply Deck Ex. 8 at 190 (Hussey Dep. at 118) (“We populated the model with our most recent business projection.”).
Furthermore, the independent CPA discerned no impropriety in multiple versions because they were working on determining sensitivity to some of the variables. Katsell Scienter Deck Ex. G (Krutop Dep. at 301-02).
Plaintiffs next assert, without supporting facts, that the lower level employees “were no doubt doing his bidding when they constructed numerous goodwill impairment testing scenarios for the FY04 test until a result of ‘no impairment’ was achieved.” Pis.’ Opp. Br. at 15-16.
The actual testimony unambiguously defeats speculation that Hickman deliberately manipulated the data or outcome. As mentioned, Hinkle, not Hickman, was primarily responsible for goodwill impairment testing. Williams Deck Ex. 52 (Hickman Dep. at 147-48) (Hickman reviewed the
In a similar vein, Plaintiffs argue that REMEC “intentionally omitted Power-wave” as a competitor for comparison for the FY03 test, but Hickman conveniently used that company when REMEC took the writeoff the following year. Pis.’ Opp. Br. at 13. Plaintiffs cite their expert’s speculation about Defendants’ state of mind. Id. n. 46 (citing Minstein Report). As discussed above, the relevant portion of Minstein’s report is not evidence, it is an improper legal conclusion. There is no evidence that Hickman had any input into the selection of guideline companies.
Plaintiffs rely on the actual results to show that reality did not confirm the optimistic assumptions. The Court discounts the observation because it depends on hindsight.
GlenFed,
2. Independent Auditor Concurred in Test Result
Ernst & Young reviewed and evaluated the annual impairment tests that Hinkle’s accounting team assembled and presented while Hickman was CFO, including the FY04 impairment test conducted during the class period. Ernst & Young examined the methodology REMEC used to value goodwill for FY04. Katsell Reply Decl. Ex. 3 (FY04 audit work papers). The audit team approved the conclusion that REMEC’s goodwill was not impaired in FY04. Williams Decl. Ex. 33 at 8 (FY04 Summ. Rev. Mem.) (“The Company performed an impairment analysis on their intangible assets of year end. We have reviewed the related analysis and concur with their analysis.”) (emphasis added); Katsell Reply Decl. Ex. 3 at 49 (Partner Niki Krutop concurs in Senior Manager Kristen Jams’ opinion that “goodwill does not appear to be impaired”). The independent auditor’s approval of REMEC’s goodwill impairment testing corroborates Defendants’ view that the company accurately reported its financial situation.
Plaintiffs discount the value of Ernst & Young’s audits on two grounds. 37 First, Plaintiffs argue that Ernst & Young relied on information provided by senior management — the same individuals who allegedly carried out the fraudulent scheme to conceal the true financial picture. As just discussed, the record does not support this criticism because Hinkle, and others in the accounting department, performed the analysis.
Further, Ernst & Young’s audit work papers describe the specific actions taken to review the impairment test. Katsell Reply Decl. Ex. 3 (FY04). Among other steps, the outside auditor “reviewed sup
The other reason Plaintiffs discredit Ernst & Young’s audit is that the firm resigned shortly after REMEC disclosed the goodwill writeoff. Plaintiffs suggest that Ernst & Young “questioned Defendants’ conduct” and resigned because the auditor recognized “the potential for fraud.” Pis.’ Opp. Br. at 6.
The record does not support this speculation. There is no evidence to connect Ernst
&
Young’s resignation as REMEC’s outside auditor to any corporate misconduct. The evidence clearly shows that Ernst & Young did
not
resign on the ground that REMEC’s financial statements contained “an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles.” 17 C.F.R. § 229.304,
cited in
Williams Deck Ex. 67 at 2 (Form 8-K). REMEC did not issue a restatement.
Cf. Atlas Air,
As discussed above in connection with Ragland’s motion, Plaintiffs’ reliance on the Internal Control and Fraud Considerations form is misplaced. The evidence shows that Ernst & Young conducted its audit with those potential fraud considerations in mind and found no misstatements in REMEC’s financial reports. Williams Deck Ex. 33 at 8 (FY04 Summ. Rev. Mem.). Each member of the audit team signed the conclusion which stated: “It is my opinion that the scope of the audit was adequate and that the financial position of REMEC, Inc. at January 31, 2004, and the results of its operations and its cash flows for the year then ended, are in conformity with generally accepted accounting principles applied on a consistent basis.”
Id.
at 12-13. Ernst & Young’s resignation in these circumstances cannot be used to infer Defendants made financial statements with an intent to defraud.
Zueco,
Moreover, Ernst & Young’s concerns about Ragland’s management style did not extend to Hickman. Williams Deck Ex. 26 at 6 (“this risk no longer exists”). Instead, Ernst & Young was “impressed” with Hickman’s “technical and leadership capabilities” and concluded “our view is that the replacement of [former CFO David Morash] with Winston [Hickman] has improved the financial, management and control environment.” Williams Deck Ex. 45
Plaintiffs submit evidence that Hickman attended an Audit Committee meeting when Ernst & Young discussed the audit results for FY04. Williams Decl. Ex. 65 (Apr. 7, 2004). One item on the agenda was a discussion of the review process for establishing and monitoring inventory and receivable reserves, with an eye toward future compliance with the heightened standards in the Sarbanes-Oxley Act. Hickman also participated in a private, executive session to discuss “finance organization and staff enhancement plan.” Id. at 3. This evidence is not probative of Hickman’s scienter.
As with Defendant Ragland, Plaintiffs allege that Hickman made inaccurate statements that REMEC had adequate internal controls. In April 2004, Hickman certified that REMEC’s Form 10-K for FY04 was accurate. Williams Decl. Ex. 5 at 68 (draft FY04 Form 10-K Certification) (R232853). Hickman stated he had evaluated the company’s disclosure controls and procedures, and concluded they were “effective.” Id. at 27 (draft FY04 Form 10-K at 24, Item 9a) (R232812). Plaintiffs argue that Hickman falsely told investors that the internal controls were adequate, when in fact, Ernst & Young, the independent auditor, informed Hickman of problems discovered in the annual audit. Id. Ex. 64 (Mar. 19, 2004 memo). 38
Arguably, one could draw a rational inference from the nature of the problems listed in the March 2004 memo that Hickman’s public evaluation of the internal controls was suspect; however, any such inference is expressly refuted by a May 2004 memo. There, Ernst
&
Young reconsidered its evaluation of entity level controls in light of Ragland’s departure as CEO in February 2004, as well as the termination of David Morash as CFO in September 2003.
39
Williams Decl. Ex. 45. The May
Plaintiffs next argue that REMEC concealed internal control violations during the class period until it disclosed them on September 30, 2004. Pis.’ Opp. Br. at 25 (citing Ex. 67). Once again, Plaintiffs’ characterization of the record is flawed. Plaintiffs cite the Form 8-K in which RE-MEC disclosed that Ernst & Young had resigned as the independent auditor. That document refers to the preliminary internal control issues discussed in Ernst & Young’s March 19, 2004 memo. Williams Decl. Ex. 67 at 2. As the Court discussed above, although Ernst & Young flagged initial concerns in March 2004, upon further evaluation, in May 2004, the auditor concluded that REMEC’s internal controls issues had been cured and did not constitute a “reportable event.” 40 Id. Exs. 64 (Mar. 19, 2004 memo) & 45 (May 2004 memo). The information does not create an inference of scienter.
3. Hickman Presented Undisputed Evidence of Good Faith
In addition to the auditor’s approval of the goodwill impairment analysis, Defendants produced other undisputed evidence of Hickman’s lack of scienter. “Insofar as Hickman may have had a sliver of opportunity to commit the alleged fraud,” there is no evidence that he had any motive to do so. Defs.’ MSJ Br. at 2.
His overall conduct is inconsistent with a fraudulent intent.
Apple Computer,
Over the last several years we have acquired a number of companies. Many of these businesses were small and have required considerable infrastructure upgrade. In addition, we have approximately $65.5 million of goodwill resulting from these acquisitions, which may become impaired should we experience a major change in our business outlook due to the loss of a major customer, our products becoming technically obsolete or if we continue to experience significant losses.
Brownlie Ex. F at 157 (FY03 Form 10-K at 11).
A variance in the discount rate or gross margin assumptions could have a significant impact on the amount of identified goodwill impairment. For example, a l%-2% change in either of these factors in our Commercial segment analysis would have resulted in an indication of possible impairment that would have led us to further quantify the impairmentand record a charge to write-down these assets.
Id. at 158.
Further, Hickman discussed his concerns about potential impairment with the outside auditor. Hickman Decl. ¶ 14 (“E & Y advised that we closely watch for indicators that an interim impairment analysis should be performed.”)
Sq
16 (“I consulted with E & Y about whether RE-MEC should conduct an interim test” for the first quarter);
accord
Katsell Scienter Decl. Ex. G (Krutop Dep. at 301-07) (Ernst & Young discussed indicators and suggested disclosure). He followed the independent advice about whether REMEC should conduct an interim test (as opposed to waiting to conduct the annual test at the next FYE). Williams Decl. Ex. 49 (March 17, 2004 emails between Ernst
&
Young and Hickman on the need to conduct an interim test and listing the FAS 142 factors with examples; Hickman forwarded the information to the appropriate employees (Hinkle and Hussey)). On August 24, 2004, Ernst & Young advised Hickman that REMEC should conduct an interim goodwill impairment test based on the Board of Directors’ plan to sell the company. Brownlie Decl. Ex. P. REMEC conducted that interim test and reported the goodwill impairment on September 8, 2004. William Decl. Ex. 23. Hickman’s open communication with the independent auditor dispels any notion that he manipulated the goodwill impairment tests while he was CFO.
Cirrus Logic,
Plaintiffs contend Hickman ignored actual operating losses, disregarded low profits, and tried to conceal the actual numbers. Pls.’ Opp. Br. 14-16, nn. 49
&
64. Yet, Hickman lacked a motive to delay disclosing adverse.information about RE-MEC’s financial situation.
See Acterna,
Defendants make a valid observation that the two individual defendants worked at REMEC at different times. Ragland was CEO at the time REMEC hired Hickman from a competitor on November 14, 2003. Ragland and Hickman worked together for barely three months — until Ragland left on February 10, 2004. The Court agrees with Defendants that the brief overlap of their tenures considerably weakens any inference that the two officers carried out a continuous scheme to conceal REMEC’s true financial condition. Defs. MSJ Br. at 2.
Hickman’s lack of motive to commit securities fraud is also exhibited by the absence of any allegation of insider trading.
Worlds of Wonder,
Finally, even assuming Plaintiffs could establish that Hickman violated GAAP regarding goodwill impairment, there is no evidence to establish he must have been aware of the violation or that he acted with an intent to deceive investors.
U.S. Aggregates,
A reasonable fact finder could not conclude on this record that Hickman acted with an intent to deceive or with recklessness. Accordingly, the Court GRANTS Defendant Winston E. Hickman’s motion and DISMISSES him from the first cause of action.
C. Corporate Defendant REMEC
The briefs focus on the Individual Defendants, but REMEC also asserts that there is no evidence the corporation acted with scienter.
“A corporate defendant’s scienter is necessarily derived from its employees.”
Marsh & Mclennan,
The Court concludes that this case falls within the general rule and finds no extraordinary circumstances to justify holding REMEC liable when the executives have been granted summary judgment on scienter.
The parties have completed discovery and the Court has analyzed all of the evidence presented in relation to individual Defendants Ragland and Hickman. There is one exception. The February 10, 2004 press release announcing Ragland’s “retirement” was not attributed to either executive. Fraser Decl. Ex. 31 at 2.
42
The Court found this statement misleading as a matter of law. It concerned a tangential issue to the core issue in this case about the proper valuation of goodwill; consequently, that statement is not sufficient to
Accordingly, the Court GRANTS the scienter motion as to the corporation and DISMISSES Defendant REMEC from the case.
V. Control Person Liability
Plaintiffs’ second cause of action against Individual Defendants Ragland and Hickman is based upon § 20(a), which makes certain “controlling” individuals liable for violations of § 10(b). FAC ¶¶ 393-96. Because Plaintiffs’ cause of action alleging a primary violation of § 10(b) fails on the merits, it necessarily follows that the control person cause of action fails as well.
See VeriFone,
The Court notes at this juncture that because Plaintiffs allege only two causes of action, both of which fail as to the individual Defendants, the first of which fails as to all Defendants, this case shall be dismissed in its entirety with prejudice and judgment entered in Defendants’ favor. The Court nevertheless shall rule on all pending motions in this case to be as thorough as possible and for the sake of completeness.
VI. Reliance
Defendants move for summary adjudication on the element of reliance. 43 The Court DENIES the motion because material factual disputes remain as to whether the class representative, Lowell Sitton, relied on the integrity of the market; therefore, the Defendants have not, as a matter of law, rebutted the fraud-on-the-market presumption.
Initially, the Court designated John Hu and Sitton as class representatives, but Hu is no longer serving in that capacity. Order Granting Mot. to Dismiss PI. Hu [Doc. No. 342], Consequently, the part of Defendants’ summary judgment motion that challenges Hu’s reliance on the integrity of the market is moot.
A. Sitton’s Transactions in REMEC Stock
By February 2004, Sitton, who had been investing on his own for approximately ten years, had been watching REMEC as a possible investment in his retirement account for a few months. Trippitelli Decl. Ex. B at 249-55 (Sitton Dep. at 33-38).
On February 10, 2004, REMEC announced its financial results for the fourth quarter “will be lower than its break-even net income goal and advised that operating results will be under pressure through at least the first quarter of the Company’s new fiscal year” and that Ragland, who had founded the company, retired as Chief Executive Officer. FAC ¶ 48. On February 11th, the stock dropped to $7.80 per share.
On February 12, 2004, Sitton purchased 5,700 shares of REMEC stock at $6.45 per share because “[t]he price dropped pretty significantly” and he hoped “to sell it on the rebound.” Trippitelli Deck Ex. B at 256 (Sitton Dep. at 39). Sitton thought “it looks like maybe it’s a bargain today.” Id. He believed at that moment that the market had undervalued REMEC. Id.
In September, Sitton read that REMEC had been sued. Id. at 246 (Dep. at 29); id. at 299-302 (Dep. at 83-85) (by Oct. 6, 2004, Sitton had read a complaint against RE-MEC).
Sitton sold all of his shares on December 8, 2004 at a loss. Id. at 283 & 287 (Dep. at 66 & 70) (sold at $6.25 per share).
That same day, however, “the price had dropped a little bit” and Sitton purchased 5,880 shares in an attempt “to recoup some of the losses that I had suffered.” Id. at 286 (Dep. at 69). He held those shares only a brief time, selling them on December 10, 2004. Id. at 284 (Dep. at 67-68); id. at 287 (Dep. at 70) (“I got scared”; “I didn’t know what the stock was going to do.... [I]t didn’t rebound up anywhere where I could recoup any of my losses. So I decided it’s best to cut my losses and get out.”); see also id. at 286 (Dep. at 69) (Sitton placed a third order, but cancelled it before it was executed).
B. Legal Standard
Reliance is an element 'of a securities fraud action.
Dura Pharms.,
When a material public misrepresentation has distorted the price of stock on the well-developed, open market, the fraud on the market theory creates a presumption of reliance because proof of actual reliance would be impractical.
Id.
at 243-44,
When the presumption of reliance arises, the burden of proof then shifts to the defendant. A defendant can rebut the presumption in different ways, including disproving the materiality of the alleged omissions or misrepresentations; establishing that the shares were not traded in an “efficient” market; or with evidence that “severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price.”
Basic,
“[0]ne way to rebut the fraud-on-the-market theory is to show that the plaintiff would have bought his stock at the same price had he known the information that was not disclosed or misrepresented.”
Hanon,
Courts have observed that defendants may find it difficult to rebut the fraud on the market presumption, “as we doubt that a defendant would be able to prove in many instances to a jury’s satisfaction that a plaintiff was indifferent to a material fraud.”
Blackie, 524
F.2d at 906 n. 22
&
908 (common sense dictates “that a stock purchaser does not ordinarily seek to purchase a loss in the form of artificially inflated stock”);
accord Basic,
C. Analysis
Plaintiffs in this case rely on the fraud on the market theory. FAC ¶¶ 379-80. Defendants argue they have presented sufficient evidence to rebut the presumption as a matter of law. Defendants argue that Sitton admitted in his deposition that he did not invest in REMEC in reliance on the integrity of the market price, but instead, purchased his shares for the specific reason that he thought the market
undervalued
REMEC. “This market timing strategy is premised on the belief that the market
had failed to reflect the true value
of REMEC’s stock. It is the polar opposite of purchasing stock in reliance on the integrity of the market price.” Defs.’ Mot. at 2 (emphasis added). Defendants argue that Sitton is like a “short seller,” who decides for himself that the market price was not an accurate valuation, or a “position trader,” who “focuses on technical price movements rather than price.”
See Zlotnick v. TIE Commc’ns & L.W.,
The Court does not accept Defendants’ premise that because Sitton purchased stocks that were out of favor, he did not rely on the
integrity
of the market. Defendants rely on the Third Circuit’s decision in
Zlotnick
as support for their logic. In that case, the Third Circuit applied the test for reliance to a “short seller,” that is, an investor who thinks the market price is too high and expects the share price to go down after his purchase.
Zlotnick,
and other cases that follow its logic, are questionable authority because they pre-date the Supreme Court’s decision in
Basic
to embrace the fraud-on-the-market presumption.
E.g., In re Western Union Sec. Litig.,
The Court concludes that a decision to invest may be based on the integrity of the market price, regardless of whether the particular investor thinks the current price is too high (like the short seller) or too low (like the typical investor as well as the bargain hunter). The weight of authority recognizes that an investment strategy, such as averaging down or Sitton’s hunt for bargains, does not rebut the fraud on the market presumption as a matter of law.
See e.g., Seidman v. Am. Mobile Sys. Inc.,
The Malone decision potently and clearly explains the problem with Defendants’ argument about Sitton’s investment strategy-
Whenever an investor purchases a particular stock with the expectation of realizing a profit in excess of the market’s average return on investment for securities with a comparable risk, the investor is per force wagering that his individual assessment for the future earning potential of that company is superior to the assessment of the marketplace as a whole, presumably because he believes he has superior information or judgment. Thus, virtually every investment decision is entered on the belief that a particular investment is undervalued by the market relative to comparable investments. This does not mean that all investors motivated by the desire to make an above average return on their investment are not relying on the integrity of the marketplace. An investor may hold the conviction that the marketplace has inaccurately predicted the earning potential of a company, and yet still enter a transaction relying, in part, on the assumption that the market has not been artificially inflated or depressed by material, false information disseminated by corporate insiders. In other words, simply because an investor believes that the market price is an inaccurate assessment of the value of a stock, does not necessarily mean that the investor is not relying on the integrity of the market.
Malone v. Microdyne Corp.,
In any event, the Court DENIES Defendants’ motion because Sitton’s deposition testimony raises questions of fact regarding his reliance. Sitton testified that he “was basically trying to buy securities and — and make some money on them.” Trippitelli Decl. Ex. B at 250 (Sitton Dep. at 33);
id.
at 253 (Dep. at 36) (“Like I think anyone else that is in the stock market ... [I] try to catch a rebound on the stock and try to show a profit on the stock.”). Sitton also testified he was affected by the fraud that allegedly occurred before he bought shares in February 2004 because “the stock was already artificially inflated” by REMEC’s failure to properly account for goodwill.
Id.
at 360-62 (Dep. at 143-45);
id.
at 365 (Dep. at 148) (“It sounds to me like they had artificially inflated the price before [the February 10, 2004 press release]”);
id.
at 241 (Dep. at 24) (“a lot of other investors out there were misled on the financial situation of the company, as I was misled.”). In addition, Sitton testified that he “read some press releases, I’m sure” before investing in REMEC, though he “could not be specific.”
Id.
at 261 (Dep. at 44);
id.
at 310 (Dep. at 93) (Sitton was aware he could obtain REMEC press releases on the website he used to research companies). On this record, Defendants are not entitled to summary judgment as to reliance.
Hanon,
As to the fact that Sitton bought shares after REMEC’s September 8, 2004 press release, Defendants have not cited any Ninth Circuit authority, and other courts are divided on the significance of such evidence. In
Rosen v. Textron, Inc.,
Even if Defendants establish that Sitton cannot recover because he continued to purchase stock after reading a complaint alleging securities fraud,
the class
may still use the presumption to establish reliance. 7
Newberg on Class Actions,
§ 22:61, p. 284-85 (4th ed. 2002) (a rebuttal of reliance by a particular class member must necessarily be on an individual basis because there can be no class presumption of non-reliance) (citing
Arthur Young & Co. v. United States Dist. Ct.,
VII. Loss Causation Element
Defendants also move for summary judgment on the element of loss causation. Plaintiffs must prove loss causation to establish their § 10(b)/Rule 10b-5 claim. Defendants argue that Plaintiffs cannot establish loss causation as to any of the misrepresentations or omissions alleged in the FAC, excluding those relating to goodwill or internal controls. 45
A. Loss Causation
In order to succeed on a private right of action brought pursuant to § 10(b) of the Securities and Exchange Act, a plaintiff must prove,
inter alia,
“loss causation.”
See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc.,
In the context of a summary judgment motion, failure to establish that the disclosure of the relevant wrongdoing played a significant role in a loss merits entry of summary judgment for failure to show loss causation.
In re Mercury Interactive Corp. Sec. Litig.,
Plaintiffs rely on the testimony and report of an expert witness, Dr. Blaine F. Nye, who identifies December 8-9, 2003, February 10-11, 2004, and September 8-9, 2004, as dates upon which corrective. disclosures were made by REMEC. 48 Relying on the efficient capital market theory, Dr. Nye asserts that the market for RE-MEC stock was efficient during the class period. Based thereon, Dr. Nye concludes that each of these corrective disclosures resulted in a decline in the stock price that cannot be attributed to general market trends, industry trends, or other external factors, but rather were caused by the company’s fraud and misrepresentations regarding REMEC’s true financial condition.
As a threshold matter, pursuant'to Federal Rule of Evidence 702, Defendants object to and move to strike Dr. Nye’s declaration in support of Plaintiffs’ opposition to the summary judgment motion.
B. Daubert Motion
1. Legal Standard
As previously stated, Federal Rule of Evidence 702 provides that expert testimony is admissible if “scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue.” Fed.R.Evid. 702. Expert testimony under Rule 702 must be both relevant and reliable.
Daubert,
2. Analysis
Defendants argue that Dr. Nye bases his conclusions on a “true financial condition” theory, which Defendants assert has been rejected by the Ninth Circuit as a legitimate framework for the analysis of loss causation.
See
Defs.’ Mot. to Strike at 10 (citing
Metzler,
Defendants further assert that Dr. Nye’s failure to determine whether specific
In order to provide some background on Dr. Nye’s work and his role as a plaintiffs expert in securities cases, the Court begins its analysis by reviewing the methods that he used and those which were rejected by the court in Williams. Similar to this case, the plaintiffs in Williams relied upon Nye’s expert opinion regarding loss causation, and the defendant moved to strike his testimony and report from the record based on his alleged failure to satisfy the requirements set forth in Daubert.
a) Williams
In
Williams,
Dr. Nye was retained on behalf of plaintiffs to provide his expert opinion on loss causation, among other issues. Nye’s expert report offered three scenarios as an analytical base for his estimation of compensable losses during the relevant class period. The court, after a detailed summary of Nye’s findings,' applied the principles of loss causation as articulated in
Dura
to his three scenarios and ultimately rejected all three.
Williams,
The Williams court rejected Dr. Nye’s conclusions based in large part on his “deficient” methodology, specifically his failure to consider any non-fraud company specific information or to identify any specific corrective disclosures for the class period, and as a necessary result, his failure to parse out the effect of the two categories of data on the price of the defendant’s stock. Id. at 1264 (the non-fraud company specific event being the filing of a lawsuit against the defendant company on the same day that certain fraud-related news was revealed to the public). The court found that under Dura, when a plaintiff proceeds on a “leakage” theory of corrective disclosure, as was the case there, the plaintiff must establish that the decline in stock price directly reflects the fraud-related inflation, ie., there must be a distinct causal connection between the two. The court faulted Dr. Nye for proceeding under the assumption of leakage of relevant truth, making his opinion unreliable and more or less irrelevant to the purpose of establishing whether leakage occurred in the first instance. Id.
In addition, the court rejected Dr. Nye’s conclusions due to his failure to demonstrate an adequate factual basis for his assertion of loss causation, and his use of a “constant percentage inflation” approach. The court explained that “where, as in the case at bar, the value of a common share is driven down to the penny stock range by forces unrelated to revelation of the fraud (as must be assumed for purposes of Dr. Nye’s Scenario 2), the application of the constant percentage inflation approach would give the equity investor the “partial downside insurance policy” which
Dura
counsels that securities law should not provide.”
Id.
at 1270. Finally, the court rejected Dr. Nye’s conclusions because Nye did not perform any statistical analysis,
ie.,
an “event study,” to support his conclusions.
Id.
at 1272-73. The court excluded Dr. Nye’s expert opinion on loss causation because of his unscientific methodology and his failure to distinguish between loss attributable to alleged fraud and loss attributable to non-fraud related news and events. The plaintiffs appealed, and the Tenth Circuit Court of Appeals affirmed the district court’s holding.
See
b) REMEC
For reasons similarly articulated in Williams, Defendants argue here that Dr. Nye’s expert opinion must be rejected due to his reliance upon discredited methodology and his failure to consider non-fraud company specific information, as well as information not specific to REMEC, when drawing his conclusions. Defendants challenge his identification of corrective disclosures, as noted above, and assert that Nye fails to show a sufficient causal connection between the one correctly identified corrective disclosure and the decline in RE-ME C’s stock price.
As an initial point, Nye has altered his methods of analysis since the decision in Williams. In this case, Dr. Nye identifies three corrective disclosures, performs an event study supported by the results of a multivariate regression, and rather than relying solely on a “constant percentage” approach to calculate losses, he also uses a “constant dollar” approach.
A review of Dr. Nye’s declaration in support of Plaintiffs’ opposition reveals the following. First, Nye identifies five specific disclosures during the class period occurring on September 8-9, 2003, December 8-9, 2003, February 10-11, 2004, March 24-25, 2004, and September 8-9, 2004.
See
Nye Decl. ¶ 19. Of these, Dr. Nye opines that REME C’s announcements regarding its financial status on December 8, 2003, March 24, 2004, and September 8, 2004, corrected former misrepresentations and omissions by the company regarding its true financial status. As noted above, Nye bases his conclusions on the results of an event study, utilizing regression analysis to determine statistically significant changes in REMEC’s stock price and their relation to the disclosures.
Id.
¶ 22. An event study is a “statistical method of measuring the effect of a particular event such as a press release ... on the price of a company’s stock.”
In re Enron Corp. Sec. Derivative & ERISA Litig.,
Dr. Nye relies on the efficient capital market theory to presume that REMEC shares were being “traded on a well-developed, efficient, and information-hungry market” during the class period.
Basic,
is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business .... Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.... The causal connection between the defendants’ fraud and the plaintiffs’ purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations.
See id.
1. September 8-9, 2003:
Dr. Nye begins his analysis by looking at events occurring on September 8, 2003, the first day of the class period, and September 9, 2003. On September 8, 2003, after market close, REMEC announced its financial results for the second quarter of 2004, which included an increase in sales, improved gross profits, narrowing losses, forecasts of increased net sales, profit margin increases, the benefits of low cost inventory, as well as increased operating expenses and a decrease in cash and short term investments. Nye also notes that
2. December 8-9, 2003:
Dr. Nye next turns to events occurring on December 8 and 9, 2003. On December 8, 2003, after market close, REMEC announced its financial results for the third quarter of 2004, including an increase in net sales, the beneficial sale of low cost inventory, as well as a decrease in gross profit margin, an increase in operating expenses, an operating loss, and a decrease in cash and short term investments. On December 9, 2003, REMEC’s stock price decreased by 21.8% to close at $8.65, a drop which analysts attributed to the December 8, 2003 earnings report.
Nye classifies the December 8, 2003 press release as a partially corrective disclosure due to the announcement of declining gross profit margins. Nye opines that this new, negative, company-specific information “explains the company-specific stock price decline on December 9, 2003.”
Id.
¶ 31. However, Dr. Nye’s assertion contradicts Plaintiffs’ actual allegations regarding the December 8, 2003 announcement. The FAC alleges that REMEC based its announcement on artificially inflated gross profit margins, REMEC’s manipulation of its results to state falsely that profits were growing, that REMEC knew that the overseas facilities were unprofitable, and that the strategy of reducing material costs to improve profitability was unsuccessful. FAC ¶ 44. Plaintiffs allege that this disclosure contained false and misleading information about the company’s financial condition, and the FAC characterizes the statements regarding profitability as additional misrepresentations, not as statements that corrected previous misrepresentations by the company. FAC ¶ 46. As such, Dr. Nye wrongly identified the December 8, 2003 announcement as a corrective disclosure. Plaintiffs’ losses which allegedly were caused by this announcement may not be factored into Dr. Nye’s loss causation analysis because the losses occurred
before
REMEC made any corrective disclosures and prior to the disclosure of REMEC’s true financial condition.
Metzler,
3. February 10-11, 2004:
On February 10, 2004, after market close, REMEC confirmed that its financial results for the fourth quarter of 2004 would be lower than its previous “breakeven net income goal,” advised the public that its operating results would be “under pressure,” and announced the unexpected retirement of then-CEO, founder, and Chairman of the Board Ronald Ragland. The press release detailed that REMEC was experiencing higher costs than originally planned with respect to the transition of production to China, and that the company also was experiencing higher than
Plaintiffs allege in the FAC that the decline in stock price on February 11, 2004, was due to the February 10, 2004 announcement. FAC ¶ 49. Dr. Nye classifies the February 10, 2004 press release as a partially corrective disclosure due to the announcement of financial results below expectations, specifically the news regarding the higher than expected start up costs and related inventory actions, as well as Ragland’s sudden retirement. Nye opines that this new, negative company-specific information was a partial revelation of the truth regarding REMEC’s true operating costs, failure to improve gross profit margins, and inability to achieve near-term profitability. See FAC ¶48. The inventory related information partially corrected the company’s statements from the December 8, 2003 announcement that Plaintiffs allege overstated inventory to make REMEC’s financial condition falsely appear stronger. Id. ¶ 44.
4. March 24-25, 2004:
On March 24, 2004, after market close, REMEC announced its financial results for the fourth quarter and fiscal year as a whole. The company reported a net loss for the fourth quarter and the fiscal year, due in part to a larger than expected operating loss from its commercial wireless division, and in part to restructuring charges, transition costs, and inventory write-downs, all of which had been anticipated by the February press release. The company also announced that gross profits were down from the previous fiscal year and operating expenses had increased. On March 25, 2004, REMEC’s stock price increased by 13.4% to close at $7.51. According to Dr. Nye’s research, analysts responded mostly positively to the press release because the financial results were better than anticipated, causing the stock price to increase. Dr. Nye therefore includes the increase in his analysis as an increase in price inflation. Nye Decl. ¶ 41.
5. September 8-9, 2004:
On September 8, 2004, after market close, REMEC announced its earning for the second quarter of 2005. The company reported an increase in sales from the previous year but below the “First Call consensus.” Also announced was a net loss of $1.23 per share attributable in part to a goodwill write-down of $62.4 million associated with the company’s commercial wireless division. The press release also informed the public that gross profits were a much lower percentage of sales in comparison to the previous fiscal year, a decrease in zero-value inventory sales, as well as several other pieces of financial, company-specific information. REMEC also announced that it would be delayed in filing its Form 10-Q with the SEC due to unresolved deficiencies with its internal controls and the need for a review of its tax filings by retained tax specialists. On September 9, 2004, REMEC’s stock price decreased by 18.9% to close at $4.30 per share. Dr. Nye classifies the September 8, 2004 press release as a wholly corrective disclosure, revealing REMEC’s true financial condition to investors, and causing the decline in REMEC’s stock price. Id. ¶ 46.
c) Statistical Analysis
Dr. Nye uses an event study to analyze the impact of the above-referenced corrective disclosures, the “events,” on RE-MEC’s stock. In order to do so, Nye compares actual return on the company’s shares with “predicted return,”
i.e.,
the stock price that one would anticipate in the absence of fraud. Dr. Nye finds that on
Appendix B to Dr. Nye’s declaration details the results of his statistical analysis. He uses regression analysis to measure the relationship between the REMEC stock returns and changes in market-wide factors and changes in industry-wide factors. 51 Dr. Nye starts by creating a market index and an industry index (independent variables) to reflect these factors, and analyzes a control period of September 8, 2002 through September 7, 2003, to calculate the daily predicted return (dependent variable) on REMEC stock in relation to the two indices. Dr. Nye chose this time period, hypothesizing that it would serve as a normal representation of the movements in REMEC’s stock prices absent any fraud. The resulting regression equation may be presented as:
Ypr = P0 + pi(Xmi) +p2(Xini)
wherein YPR is predicted return, Xmi is the market index and Xini is the industry index. p0 represents the Y intercept, the height of the regression line as it crosses the Y axis; in other words, the value of the dependent variable when all other variables equal zero, pi and p2 represent the coefficients, which indicate the magnitude of the effect that the market index and industry index, respectively, have on predicted return during the control period.
As expected, the regression results indicate that both indices have an impact on the predicted return, indicating that during the control period, market forces and industry forces affected the daily return on REMEC’s stock prices. The coefficients for both variables are statistically significant, as shown by the resulting t-statistics, their associated 2-tailed p-values, and using a 95% confidence limit for the coefficients. 52 The coefficient of the market index variable is 1.61541, therefore for every unit increase in the market index, the model predicts a 1.61541 unit increase in predicted return, holding all other variables constant. The coefficient of the industry index is .44985. The model across all data points demonstrates that approximately 24% of the variance in REMEC’s return during the control period can be predicted by the two indices. 53
Using the results of this model, Dr. Nye calculates the residual return of REMEC’s stock for each date during the class period. Dr. Nye weights the value of the two
d) Daubert Scrutiny
Upon due consideration, the Court finds that Dr. Nye’s statistical analysis and results do not meet Rule 702’s standards for admissibility as articulated in Daubert. His methodology is fatally flawed such that his results cannot be relied upon by a trier of fact.
Dr. Nye predetermines the results of his analysis. Nye purports to test the hypothesis that REMEC’s corrective disclosures exerted a material negative influence on the per-share price of REMEC stock during the class period. Nye builds a multivariate regression model which predicts the predicted return on REMEC stock as a function of a weighted market index and a weighted industry index, and then defines residual return as a function of actual return and predicted return. Nye’s model assumes that the difference between actual return and predicted return is necessarily a result of company-specific information.
Dr. Nye makes no attempt to account for other possible causes, i.e., industry-specific news (for example, if an increase in global sales of defense products due to an increase in U.S. presence in Iraq was announced during the class period), market-specific news (for example, if a 5% decline in stock prices occurred across the market due to an announcement of an expected drop in consumer sales in December), or other measurable macroeconomic variables (for example, the inflation rate and GDP).
See e.g., In re Wireless Tel. Servs. Antitrust Litig.,
The failure to include a variable in a regression analysis affects the probative value of the analysis and not necessarily its admissibility.
Bazemore v. Friday,
In addition, Dr. Nye’s conclusion that residual return is the result of company-specific news has very little explanatory power because Nye’s model does not account for categories of news. This is a key flaw in Nye’s methodology, pointed out by the
Williams
court, that he has not corrected. Dr. Nye fails to separate the loss caused by the disclosure of corrective information (new, negative, company-specif
For instance, as the Court notes above, Nye states that the December 8, 2003 announcements included multiple pieces of information, including: (1) an increase in net sales (positive); (2) the beneficial sale of low cost inventory (positive); (3) a decrease in gross profit margin (negative); (4) an increase in operating expenses (negative); (5) an operating loss (negative); and, (6) a decrease in cash and short term investments (negative). Dr. Nye classifies the December 8, 2003 announcement of financial results as a partially corrective disclosure due to the information provided to the public regarding the company’s earning results, including its declining gross profit margins. Nye opines that this particular piece of new, negative, company-specific information “explains the company-specific stock price decline on December 9, 2003.” Nye goes on to state that “I have not identified any other new, negative, company specific news that would have materially contributed to the company specific stock price decline on December 9, 2003.” See Nye Deck ¶ 31.
The problem with this last statement is that Dr. Nye clearly identifies other new, negative, company-specific information in the press release, as noted above. Nye also identifies positive information, which he does not attempt to account for in his analysis. Nye himself notes that the analysts’ responses to the company’s announcement were mixed, and that most analysts reacted positively to the company’s earnings results. Id. ¶ 30. The failure to consider this additional information demonstrates that his methodology is flawed to the point of being unreliable, and that his results reveal very little about REMEC’s residual returns in relation to the public announcements made by the company diming the class period.
Finally, the Court notes that Dr. Nye’s regression model suffers from several deficiencies in addition to the omission of key independent variables. For example, Dr. Nye uses time-series data,
54
but does not account for any possible lag in the affect of his independent variables upon his dependent variable, even though he theorizes that one exists. A one-year control period to determine the affect of market-wide and industry-wide forces on value of REMEC’s stock is arguably too short, particularly when additional data is readily accessible. He does not appear to test his model for multieollinearity or for autocorrelation.
55
As to multieollinearity, it would not be unreasonable to suspect that the market index and the industry index move together, which would skew the coefficients. As to autocorrelation, a review of the individual data observations reveals that residual
Dr. Nye’s expert opinion under Rule 702 must be both relevant and reliable.
Daubert,
Accordingly, the Court GRANTS Defendants’ objections to Dr. Nye’s declaration, as well as the motion to strike him as an expert in this case. Without Nye’s report and testimony, Plaintiffs are left with only their allegations and cannot withstand Defendants’ motion for summary judgment as to loss causation. Because loss causation is an element Plaintiffs must prove to succeed on either of their two causes of action, 56 dismissal of both claims is appropriate.
VIII. Plaintiffs’Motion in limine
Pursuant to the Court’s Scheduling Order, in October 2008, Defendants designated their expert witnesses. In addition to the two retained experts who provided expert reports, Defendants list approximately seventy percipient witnesses who may also give expert testimony. These include the key accountants at Ernst & Young, the individual Defendants Ragland and Hickman, and other former REMEC employees. Accounting is the main subject matter (such as REMEC’s procedures regarding goodwill and its internal controls), but a few will testify about the telecommunications industry and its market.
Plaintiffs object because Defendants did not provide expert reports as required by Federal Rule of Civil Procedure 26. They argue that the witnesses are not qualified and their testimony would duplicate that given by the retained experts. Fed. R.Evid. 403, 702, 703, & 705. The Court DENIES the motion for the reasons set forth in Defendants’ opposition brief.
IX. Costs
As prevailing parties, Defendants are presumed to be entitled to recover court costs. Fed.R.Civ.P. 54(d)(1);
Association of Mexican-Am. Educators v. Calif,
Conclusion
Upon due consideration of the parties’ memoranda and exhibits, a comprehensive review of the record, and for the reasons set forth above,
IT IS HEREBY ORDERED THAT:
(1) The Court DENIES Defendants’ motion to strike the declaration of Plaintiffs’ expert witnesses Regan [Doc. No. 263]; and GRANTS IN PART AND DENIES IN PART Defendants’ motion to strike portions of Minstein’s expert report;
(2) The Court GRANTS IN PART AND DENIES IN PART Plaintiffs’ and Defendants’ motions for summary judgment as to falsity [Doc. Nos. 336 & 308];
(3) The Court GRANTS Defendants’ motion for summary judgment on scienter, but DENIES that part of the motion concerning internal controls [Doc. No. 173];
(4) The Court GRANTS Defendants’ objections to and motion to strike Blaine F. Nye as an expert witness;
(5) The Court GRANTS Defendants’ motion for summary judgment as to loss causation, but DENIES it as to reliance [Doc. No. 194]; and,
(6) The Court DENIES Plaintiffs’ motion in limine [Doc. No. 310].
Based on the foregoing, the Court DISMISSES this civil action WITH PREJUDICE. The Clerk of Court shall enter judgment in favor of Defendants and close the case.
IT IS SO ORDERED.
. Plaintiffs quote language stating that RE-MEC “said it will return to profit in the
Plaintiffs mischaracterize a headline in another Bloomberg article as being an affirmative statement of fact. Williams Decl. Ex. 29 (Sept. 8, 2003). The reporter wrote that statement, thus, it cannot be attributed to the Defendants.
Cirrus Logic,
Notes
. All pending motions are resolved herein, including the summary judgment motions concerning false and misleading statements, reliance, internal controls, and loss causation, as well as the evidentiary motions.
. The Fourth Amended Complaint ("FAC”) is the operative pleading.
. REMEC reorganized its divisions over the years. REMEC had been divided into four segments. Williams Decl. Ex. 28 at 10;
id.
. Plaintiffs abandoned two allegations regarding the improper practice of selling and booking revenue for known, non-functional products and "pulling-in” orders from the future to meet current quotas. Pis.' Opp. to Falsity MSI at 24, n. 57. Plaintiffs previously alleged these accounting practices in FAC ¶ 11(c) & (d). See also FAC ¶ 8.
. Defendants submitted a later version of the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets ("FAS 142”), which reflects amendments made after the initial standard was adopted. Brownlie Decl. Ex. C (2008). For example, ¶ 24 was deleted from the original version in 2006. Id. at 25. The parties dispute whether V 24 or Appendix B sets forth the controlling standard. Pis.' Opp. Br. at 5; Regan Decl. ¶ 2 (Appendix B contains background information and is not authoritative); Defs.’ Reply Br. at 2. For purposes of ruling on the summary judgment motions, the Court uses the standard in effect at the time REMEC conducted its tests. The Court rejects Plaintiffs' argument that "shockingly” Defendants "admitted” violating FAS 142 because "the Company ignored ¶ 24.” Pis.’ Opp. Br. on Falsity at 4-5.
Plaintiffs' original exhibit of FAS 142 was illegible, and was replaced in a "Notice of Errata.” For simplicity, the Court cites Plaintiffs’ exhibit as if it had been filed with Williams’ initial declaration. [Doc. No. 286.]
. REMEC’s fiscal year ends on the last day of January, and its quarters end on the last day of April, July, October, and January. The Court uses the abbreviations employed by the parties, such as "FY04.”
. REMEC acquired several companies before the class period commenced. Plaintiffs use the pre-class purchases to show the extent to which REMEC used goodwill to overstate its financial situation and give the false impression that the acquisition strategy was working. FAC ¶ 85 (at beginning of class period, REMEC’s Commercial segment carried $44.1 million of goodwill, which represented 13% of total assets); id. ¶¶ 100, 139. Plaintiffs highlight the following pre-class acquisitions: (1) October 2001, acquired ADC Mersum Ov (a/ k/a "Solitra”) for $56 million and recorded goodwill of $26 million; (2) November 2001, purchased CWH WEIHUA Shanghai Telecommunications Ltd. (a/k/a "China”) for $2.7 million and recorded $2 million of goodwill; (3) December 2002, Spectrian acquired but no goodwill was recorded; (4) June 2003, bought Himark Telecom Group for $12.1 million and recorded goodwill of $9.9 million. Katsell Reply Decl. Ex. 3 at 50 (Feb. 5, 2004 Hinkle mem.) (EY000695); see Williams Decl. Ex. 2 (FY02 Form 10-K at 6-7 describes other acquisitions).
REMEC also acquired Nanowave, but it was merged into the Defense segment which is not involved in this litigation.
. Defendants submitted several declarations by attorney Noah Katsell in connection with the various motions. The Court distinguishes between five of them as follows: (1) "Katsell Scienter Decl.” for the exhibits accompanying the reply brief to Defendants’ scienter motion [Doc. No. 253-2]; (2) "Katsell MSJ Decl.” refers to the exhibits attached to Defendants’ motion for summary judgment on falsity [Doc. No. 308-3]; (3) "Katsell Reply Decl.” refers to the exhibits attached to Defendants’ reply brief on that same motion [Doc. No. 339-4]; (4) "Katsell Opp. Decl.” refers to the exhibits accompanying Defendants' opposition to the Plaintiffs’ motion on false and misleading statements [Doc. No. 259-2]; and (5) "Katsell Supp. Decl.” refers to the supplemental briefs that the Court allowed the parties to file regarding the February 2002 transitional test [Doc. No. 317-2].
The parties provided duplicates of several exhibits because of the factual overlap of the issues. To simplify the quantity of exhibits, the Court has in some instances cited an exhibit attached to a declaration filed with the scienter motion when the same document is also attached to another declaration filed in support of another motion.
. Plaintiffs submitted a document that appears to the Court to be a draft of REMEC's FY04 Form 10-K because it contains data from the FY03 Form 10-K, has bracketed text in bold face that indicates a work in progress, and is not signed. Williams Decl. Ex. 5 (R232786 to 232854, e.g., R232799) (referring to 34% revenue figure from "fiscal year ended January 31, 2003,” "[disease]” & 232853); accord Fraser Decl. Ex. 23. The Court discovered the problem when it compared the warning language that Defendants quoted from the paragraph entitled "We may encounter difficulties in effectively integrating acquired businesses.” Compare Brownlie Ex. F at 157 (FY03 Form-1 OK) with Williams Decl. Ex. 5 at 14 (FY03) and Williams Ex. 56 at 20 (same paragraph as FY03). Defendants did not provide a complete copy of the Form 10-K. Id.; Katsell MSJ Decl. Ex. Q. The Court therefore cites Plaintiffs’ Exhibit 5 as "draft FY04 Form 10-K.”
. Minstein submitted his expert report in the form of a declaration, which the Court cites as "Minstein Report," [Doc. No. 284-2], to distinguish it from the separate declaration he submitted to oppose the Defendants' motion, which the Court cites as "Minstein Decl." [Doc. No. 330.]
The Court acknowledges that Defendants justifiably criticized Minstein’s original report. His explanation of his methodology and assumptions were concise, but bordered on being conclusory. The declaration he prepared to respond to the Defendants’ specific complaints, however, provides the necessary illumination for the Court to conclude that his opinion is admissible. For instance, Defendants criticized Minstein’s failure to make a clear statement that a reasonable accountant would not have made the same decisions and his failure to review the depositions before preparing his report. Minstein responded to and resolved those two matters in his Declaration. Minstein Decl. ¶ 18 ("In my opinion, any competent valuation analyst conducting unbiased analysis of the data available to me would conclude that there was an indication of impairment of the goodwill at the end of FY2003”); id. ¶ 45 ("I prepared the Minstein report for submission on December 29, 2008. At that time a substantial amount of deposition testimony was unavailable to me, and a number of depositions had not yet been taken.... After I prepared my report I reviewed all relevant deposition testimony. I found nothing in any deposition testimony that alters any opinions expressed in my report.’’).
. This is not a situation in which a party would be sanctioned for misconduct in failing to preserve or produce evidence, for example, by drawing an adverse inference that relevant evidence was wrongfully suppressed. Fed. R.Civ.P. 37(b);
Von Brimer v. Whirlpool Corp.,
. Ernst & Young prepared the Audit Report for the Audit Committee. The CPA specifically reviewed the implementation of the new accounting standard FAS 142. Ernst & Young summarized its procedure as follows: "We reviewed the Company’s initial and annual impairment tests performed by the Company during fiscal 2003 in accordance with FAS 142. A discounted cash flow analysis (Step I) was performed for both the Commercial and Defense business segments as of February 1, 2002 and December 27, 2002.” Katsell Supp. Decl. Ex. A at 12.
. The FAC contains similar allegations about the assumptions (gross profit margins ranging from 24% to 29% excluding depreciation) RE-MEC used to conduct its goodwill impairment analysis for FY04. The FAC highlights the same "consistent” statement in the Form 10-K for FY04. FAC ¶ 52. Plaintiffs have not moved for summary adjudication on the falsity of that statement.
. Ernst & Young produced this document. Defendants state that the exhibit contains the audit work papers for the FY03 (ended January 31, 2003). Katsell Opp. Decl. ¶ 12;
ac
. The parties did not point the Court to the exact date REMEC completed its FY03 impairment test. The only certainty is that it was finalized before REMEC released the results to the public on April 30, 2003 in its Form 10-K. Williams Decl. Ex. 56 at 1.
. For example, as to the FY03 test, Defendants note that REMEC acquired Paradigm in the middle of the class period, which added $17.56 million worth of goodwill to its balance sheet. Defendants further stress that REMEC expressly warned investors that the 30% to 38% gross margins were uncertain predictions. Williams Ex. 56 at 33. Defendants also rely on the testimony of their accounting expert. Holder Report at 18 (concluding REMEC's goodwill impairment analyses were reasonable).
. Plaintiffs appear to suggest that Defendant Hickman, the CFO, may be responsible for the December statements, e.g., Pis.' Br. at 7; however, the record shows that Defendant Ragland made the contested statements.
Hickman was not employed by REMEC at the time Ragland made his other optimistic forecast in September 2003.
. The expert also points to REMEC’s actual performance. Id. The Court disregards this evidence which depends wholly on hindsight.
. The Court overrules Defendants' objection to the admissibility of the transcript of the conference call because the document could be easily authenticated. Fraser Deck Ex. 1;
Hal Roach,
. Plaintiffs also point to an email sent to Ragland on December 17, 2003. Pls.' Mo. at 10 (citing Fraser Decl. Ex. 14). Because Rag-land received the preliminary income statement for November 2003 after he made the statement that Plaintiffs contend was false, this document is not probative of Ragland’s knowledge on December 8, 2003.
. Plaintiffs cite to Morash’s deposition as further support; but saying "I don't remember” is not evidence. Pls. Br. at 8-9 (citing Fraser Decl. Ex. 11)
. Defendants filed this motion in September 2008, when the parties were still engaged in discovery. The Court continued the motion until the parties completed discovery. [Doc. No. 187.]
. Patrick Gray’s deposition testimony that he "could not remember” if Ragland was involved in goodwill impairment testing, "but based on the E & Y work paper, it says he was” is not based on his personal knowledge and is not admissible as evidence. When counsel instructed Gray not to assume, Gray confirmed that he did "not recall whether Ron was involved in this or not.” Katsell Reply Decl. Ex. 5 at 111 (Gray Dep. at 34). Gray did not recall discussing the assumptions with Ragland. Id. at 113 (Gray Dep. at 55).
. In January 2004, REMEC began the process of conducting its annual goodwill impairment testing for FY04. Ragland was CEO at that time, but Hinkle does not recall having any discussions with “anyone'' regarding the analysis, nor any instructions to achieve a conclusion that goodwill was not impaired. Katsell Scienter Deck Ex. C at 17. In February, the process continued and Hinkle discussed goodwill impairment with Ernst &
. Minstein states that REMEC’s actual FY02 performance was 7.1%. Minstein Report at 6. Defendants cite a document prepared in 2003 reporting the Commercial segment's actual gross margin results were 6%. Katsell Reply Decl. Ex. 2 at 19.
. The form is not dated. It indicates that it was prepared in connection with the audit to be performed for REMEC’s FY04, which ended on January 31, 2004. The audit team completed its initial risk assessment in November 2003. Williams Decl. Ex. 33 at 2. The document refers to events "subsequent to our initial planning and risk assessments,” including Ragland's departure in February 2004.
. Plaintiffs attached a Summary Review Memorandum for 2003, but it concerned only the Finland subsidiary. Williams Decl. Ex. 53.
. The Court rejects Defendants’ argument that Plaintiffs are attempting to plead a separate cause of action concerning internal controls under the Sarbanes-Oxley Act. Defs.' MSJ Scienter Br. at 21-25. That statute requires the principal corporate officer to evaluate the effectiveness of internal controls. 15 U.S.C. § 7241 (§ 302(a)). The allegations that Defendants made false statements about the effectiveness of REMEC’s internal controls are offered as evidence that Defendants acted with scienter regarding Plaintiffs’ § 10(b) claim. Accordingly, the Court denies that part of Defendants' motion that purports to seek summary judgment on the internal control "claims.” [Doc. No. 173.]
The Court also rejects Defendants’ contention that the FAC did not give sufficient notice of certain allegedly false statements.
See e.g.,
Defs.' MSJ Falsity Br. at 6 n. 3 & 17; Defs.’ Opp. False and Misleading Br. at 6-7;
see
FAC V¶ 36-38, 47, 51, 59, 73(f), 74(m). Plaintiffs have not changed the legal theory. Plaintiffs simply submit evidence obtained in discovery to support their securities fraud claims.
See Kaplan,
Nor have Plaintiffs "avoided” the heightened pleading standards of the PSLRA by presenting evidence that was produced during discovery. Once a plaintiff states a securities fraud cause of action under the heightened pleading standard, the case is like any other law suit. The parties conduct discovery, and in the course of reviewing internal documents and taking depositions of employees, plaintiffs may uncover additional facts of direct misconduct or circumstantial evidence that corroborates their theory. When those facts are presented with a summary judgment motion, the question is whether the facts are admissible and relevant. Here, Plaintiffs included facts in their opposition brief that were fully explored in discovery and that relate to the same course of conduct alleged in their pleading.
. The FAC alleges that other SEC filings contain similar language, e.g., FAC ¶ 36; however, the parties submitted only a few of the reports as exhibits to this motion. Williams Decl. Ex. 56 at 39 & 74 (R887577 & R887612) (pre-class Form 10-K for FY03); but see Williams Decl. Ex. 2 at 55 (FY02 Form 10-K contains simple signature line that Rag-land "duly caused” the report to be filed but does not contain a Certification page). The Court considers the evidence submitted. Fed. R.Civ.P. 56.
. Plaintiffs state that Chairman of the Board Andre R. Horn completed this 28-page questionnaire. Pls.’ Opp. Br. at 25 n. 114. Plaintiffs have not provided any support for that assertion; however, it appears that ’’Andre” is written on the first page. Id. Ex. 66 at 1. The questionnaire appears to be have been printed in July 2003 and given the footer "aec7/8/2003” and was thus completed before Hickman joined REMEC. Id.
The Court could not locate the separate questionnaire that Plaintiffs attribute to Director Howard E. Hughes, Jr., nor the page with a quotation that the control environment did not rate a "passing grade.” Pis.' Opp. Br. at 25 n. 114 (citing REM 0008439). The Court notes that Hughes joined REMEC’s Board in September 2003 and served on the Audit Committee. See Williams Decl. Ex. 5 at 28 & 30.
. The
GlenFed
decision pre-dates the PSLRA, which enacted "formidable” pleading standards.
Metzler,
. For example, Plaintiffs’ state in their brief that "Hickman also insured that he was constantly apprised of REMEC’s financial status by hiring a direct reporter whose sole purpose at REMEC was to constantly run financial projections.” Pis.’ Opp. Br. at 14. Plaintiffs cite deposition testimony that purportedly supports that claim. It does not. Tiernan Hussey testified that his primary responsibilities were to "conduct the forecasting process”; analyze "cost studies, returns, financial return studies”; and provide "financial input into the business decision-making process for the company.” Williams Decl. Ex. 43 at 3 (Dep. 14-18). Hussey's description of his job duties does not by any means indicate that Hickman acted with intent to defraud investors.
. Exhibit 16 is the only email sent to Defendant Hickman and thus the only document that reflects his personal knowledge. Plaintiffs cite to email exchanges between the accounting staff before and after the February 1, 2004 message to Hickman. Pls.' Opp. Br. at 5, n. 13. The emails between Hinkle and others do not show any conduct by Hickman, the named Defendant. See e.g., Williams Decl. Ex. 11 (Dec. 20, 2003 email from Trevor Renfield to Hinkle); Ex. 12 (Jan. 17, 2004 email from Renfield to his other email address); Ex. 13 (Jan. 19, 2004 email from Renfield to Hinkle); Ex. 14 (Jan. 20, 2004 email from Renfield to Hinkle); Ex. 15 (update of Jan. 20, 2004 email); Ex. 17 (Feb. 7, 2004 email from Jerry Nelson to Hinkle); Ex. 18 (Feb. 9, 2004 email from Nelson to Hinkle); Ex. 19 (Feb. 14, 2004 email from Hinkle to Kristen Janis at Ernst & Young, the outside auditor); Ex. 20 (Feb. 14, 2004 email from Hinkle to Patrick Gray, a member of the Board of Directors); Ex. 21 (Feb. 18, 2004 email from Hinkle to David Wilkinson, RE-MEC’s tax director); & Ex. 22 (Wilkinson's revisions later that day to Hinkle).
. The first version forecasted gross profit margins of 31% in 2005, 32% in 2006, and 35% in 2007 (and thereafter to 2014). Id. at 2-3 & 8 (excluding depreciation). After deducting the Net Book Value from the Current Book Value, the first version reports a Present Value over $263.4 million. Id. at 5-6.
The second version forecasted profit margins of 24% in 2005, 22 to 24% in 2006, and 26% in 2007 (with steady increases of 1% in most of the years to come). Id. at 18-20 & 24 (excluding depreciation expense). By subtracting the Net Book Value from the Current Book Value, the second version reports a Present Value under $8.4 million. Id. at 21-22. This calculation reflected impaired goodwill because it assumed lower gross margins.
The third and final variation forecasted gross profits of 24% in 2005 (the same figure used in the second version), 26 to 27% in 2006, and 28% in 2007 (with 1% increases every year or two in the future). Id. at 34-36 & 40 (excluding depreciation). After deducting the Net Book Value from the Current Book Value, the third version shows a Present Value over $44.3 million. Id. at 37-38.
. The FY03 impairment testing was conducted, completed, and reported several months before Hickman began working at REMEC, thus, that pre-class statement in the FY03 Form 10-K is not relevant to his state of mind. Williams Deck Ex. 56 (filed Apr. 30, 2003).
. Plaintiffs’ citation to the affirmative defense of "auditor reliance” is irrelevant. Pls.’ Opp. Br. at 23-24; Defs.' Reply Br. at 8 n. 17. Defendants use the evidence of Ernst & Young’s role as evidence that Hickman did not act with an intent to defraud investors.
. The format of the March 19, 2004 Ernst & Young memo is the same as the 2003 memo described above in connection with Defendant Ragland, with two differences. First, the auditor identified a longer list of concerns. Ernst & Young recommended that REMEC improve its accounting of "forward contracts to hedge against foreign currency changes"; implement review processes of accounts payable to avoid duplicate payments, to record foreign currency translations, to approve credit limits, and to approve speculative sales orders; and adopt procedures to verify various payroll issues. Id. at 2-3. Specific recommendations were made concerning transactions with the Finland, Philippines, and China locations, including establishing controls to review foreign currency transactions and accounts and clearing certain inter-company accounts; to study whether it needed a procedure regarding “transfer pricing risks”; and to train staff on procedures for recognizing revenue, issuing checks, balancing bank statements, expenses, and other issues specific to the foreign locations. Id. at 3-5. The memo finds many areas where RE-MEC could improve the security of its computer system. Id. at 5-9. Finally, Ernst & Young advised REMEC that it would need to prepare for the probing review and verification process required by the new Sarbanes-Oxley Act. Id. at 9-10.
Second, the memo does not include a response from REMEC management.
. Ernst & Young stated that the newly hired CEO's "attitude, experience and fresh perspective have been a positive influence on the Company[’s] overall control environment during the year-end financial statement close process.”
Id.
at 2. Robert Shaner "quickly analyzed the business and has taken many steps to restructure the Company's processes and controls.”
Id.
"[H]e wants the finance and accounting department to do the right thing.”
Id.
Later in the memo, Ernst & Young describes recent changes in corporate governance, including adding two new members to the Audit Committee, reinstating the internal auditor to a full time position, and updating its Code of Conduct.
Id.
at 3-4. Ernst & Young commented: "We have considered these changes to be a significant improvement of the 'tone at the top’ and have noted that these individuals have been a positive change in the control environment during
. Federal regulations require the disclosure of a "reportable event” when a company announces a change in its independent auditor. 17 C.F.R. § 229.304(a)(l)(v) (Item 304).
. By contrast, at the pleading stage, some courts recognize “collective scienter,” and in certain circumstances, a plaintiff may be able to "plead the requisite scienter against a corporate defendant without successfully pleading scienter against a specifically named individual defendant.”
Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, Inc.,
. Hickman is listed as the contact person on the press release. It is not clear who drafted the Question and Answer script, which was apparently prepared for the interim CEO, Robert Shaner. See Fraser Decl. Ex. 32 ("I have agreed to act as interim CEO.”). Hickman was not involved in the decision to terminate Ragland because he was not an independent member of the Board of Directors. See Fraser Decl. Ex. 6 (listing independent members).
. In certifying the class, the Court found that "the proposed class representatives and the class members benefit from a presumption that they indirectly relied on Defendants’ alleged misstatements by relying on the integrity of the stock price established by the market." Order Granting Pis.’ Mot. for Class Certification at 4 [Doc. No. 103]. At that stage of the proceedings, Defendants argued that Sitton’s and Hu’s claims were atypical because they bought REMEC stock after it dropped in price based on a belief it was undervalued. The Court held that regardless of a "personal perception that the stock was at a bargain price, they are still alleging — as the class is — that (1) they relied on the integrity of the market at the time of their purchase; (2) the stock was artificially inflated in the market by Defendants' misrepresentations and omissions; and (3) they suffered losses as a result.”
Id.
at 5 (citing
Blackie v. Barrack,
When determining class certification, the district court does not resolve the merits, even though the factual and legal issues are related.
Coopers & Lybrand v. Livesay,
. The Court notes that Defendants have not argued that Sitton's December purchase followed his knowledge that REMEC had been sued for securities fraud. This arguably shows that with regard to his December purchase he knew or had reason to believe that REMEC had committed fraud.
E.g., Jones v. Intelli-Check, Inc.,
In addition, Defendants could argue that Sitton’s conduct demonstrates that the statement announcing the write-off was not material information, which is a separate element of Plaintiffs’ securities fraud claim.
E.g., Greenspan,
. Defendants state that they do not concede that Plaintiffs can establish loss causation as to goodwill or internal controls, but exclude those allegations based on the assertion that the undisputed facts as to the remaining allegations demonstrate that loss causation cannot be demonstrated. See Defs.’ Mem. P & A at 1, n. 3.
. Five Categories of Allegations include: REMEC Was Unable to Calculate Proper Inventory Reserves; REMEC Manipulated Revenue; REMEC Failed to Disclose Operational Difficulties; REMEC Over-Valued Inventory; REMEC Further Manipulated Revenue by Selling "Zero Value Inventory.”
. The Court notes as an initial matter that Plaintiffs challenge Defendants' categorization of the allegations in the FAC and assert that loss causation must be analyzed by looking at Plaintiffs' claims as a whole. The Court agrees, and therefore shall disregard the categorical approach adopted by Defendants.
. Keeping in mind that REMEC’s fiscal year began on February 1st and ended on January 31st each year.
. The Court notes that for this reason alone, it might be reasonable to suggest that Dr. Nye's analysis could be rejected as fatally flawed and classify Dr. Nye’s results as unreliable and subject to exclusion under Rule 702.
. Nye notes that he was instructed by counsel that no damages should be awarded for shares sold prior to the disclosure of the fraud, i.e., no damages to shareholders who sold prior to the first partially corrective disclosure on December 8, 2003.
. Multiple regression analysis is a commonly accepted statistical tool used to examine "the effect of independent variables on a dependent variable.”
Bickerstaff v. Vassar Coll.,
. The confidence intervals are related to the p-values such that the coefficient will not be statistically significant if the confidence interval includes 0. Confidence intervals assist in placing the coefficients into perspective by seeing how much each coefficient’s value could vary.
. Indicated by an adjusted R-Square equal to .2360. Note that this is an overall measure of the strength of association, and does not reflect the extent to which any particular independent variable is associated with the dependent variable.
. A time series is a sequence of observations which are ordered in time (or space).
. Autocorrelation is the correlation (relationship) between members of a time series of observations, such as weekly share prices or interest rates, and the same values at a fixed time interval later. More technically, auto-correlation occurs when residual error terms from observations of the same variable at different times are correlated (related).
. In order to prove a claim for violation of Section § 20(a), a plaintiff must prove: "(1) a primary violation of federal securities laws and (2) that the defendants exercised actual power or control over the primary violator.”
No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp.,