United States District Court, N.D. California, San Jose Division
November 2, 2005.
In re Verisign Corporation Securities Litigation.
The opinion of the court was delivered by: JAMES WARE, District Judge
CORRECTED ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS'
MOTION FOR JUDGMENT ON THE PLEADINGS; DENYING WITHOUT PREJUDICE
DEFENDANTS' MOTION TO STRIKE AND MOTION TO SHORTEN THE CLASS
Plaintiffs initiated this securities class action lawsuit on
behalf of themselves and of a proposed class of persons and
entities that acquired VeriSign Corporation's ("VeriSign") common
stock, against VeriSign and four of its executives (collectively,
the "Defendants"), for violations of sections 11 and 15 of the
Securities Act of 1933 ("Securities Act"), 10(b) and 20(a) of the
Securities Exchange Act of 1934 ("Exchange Act"), and Securities
and Exchange Commission Rule 10b-5. Presently before this Court
are Defendants' Motion for Judgment on the Pleadings, Motion to
Strike, and Motion to Shorten the Class Period. The basis for
these motions rests in the recent Supreme Court decision in Dura
Pharms., Inc. v. Broudo, 125 S.Ct. 1627
(2005). The motions were
noticed for hearing on September 26, 2005. The Court finds it
appropriate to take the motions under submission for decision
without a hearing, pursuant to Civil Local Rule 7.1(b). For the
reasons set forth below, this Court GRANTS in Part and DENIES in
Part Defendants' motion for judgment on the pleadings, and denies
without prejudice the motions to strike and to shorten the class
Plaintiffs, on behalf of themselves and a proposed class of
persons and entities that purchased or acquired Verisign
Corporation's stock, filed an action against Verisign Corporation
and four of its officers and directors, for violations of the
Securities Act, the Securities Exchange Act, and Rule 10b-5.
VeriSign is a leader in providing Internet "trust services"
services that verify and authenticate information transmitted
over the Internet. Such services enable consumers to safely
transmit personal financial information (such as credit card
numbers) over the Internet to complete commercial transactions.
On March 7, 2000, VeriSign announced that it would issue $21
billion in new stock to acquire Network Solutions, Inc. ("Network
Solutions") and turn it into a wholly-owned subsidiary. Network
Solutions operated the official registry of Internet domain
names, such that anyone who wanted to register a website under
the .com, .net, or .org domains had to register through Network
Solutions. Network Solutions charged each website listed on its
registry at least $6 per year. Although some industry analysts
supported this acquisition, others questioned whether VeriSign
was paying too much. This skepticism allegedly placed pressure on
VeriSign "to show that it was growing at a rate greater than
could have been realized by either VeriSign or Network Solutions
as a stand-alone company." Consolidated Second Amended Complaint
Not long after VeriSign acquired Network Solutions, the
Internet boom "went bust." VeriSign's business was hit and the
demand for Internet "trust services" and for new Internet domain
names declined. VeriSign's stock price fell from $196 per share
(on the day it acquired Network Solutions) to $75 per share (on
January 24, 2001, the day before the Class Period).
Thereafter, Defendants allegedly employed "an assortment of
schemes, artifices, and devices to mislead investors about both
the amount and source of revenues earned by [VeriSign]."
Consolidated Second Amended Complaint at 2:19-20. In particular,
Plaintiffs allege that Defendants artificially inflated
VeriSign's earnings and stock price via improper reporting
and accounting practices. For example, Plaintiffs allege that Defendants inflated VeriSign's earnings by
improperly reporting revenue generated from "round trip"
transactions. "Round trip" transactions are transactions wherein
VeriSign would invest cash in small, private, start-up businesses
("affiliates") that otherwise could not afford VeriSign's
services. In exchange for VeriSign's investment, the affiliates
would purchase VeriSign's products/services. VeriSign, in turn,
would report these purchases as revenue. Plaintiffs also allege
that Defendants artificially inflated VeriSign's earnings by
improperly accounting for VeriSign's investments in affiliates.
Consolidated Second Amended Complaint at 2,3. VeriSign used an
accounting method known as the "cost method" to account for its
investments in its affiliates. The "cost method" permitted
VeriSign to report at least $12 million in revenues on its
financial statements during the Class Period. Id. However,
Plaintiffs allege that the "equity method" not the "cost
method" was the proper method of accounting for VeriSign's
investments in affiliates. Id. According to Plaintiffs, the
"equity method" is proper when an investor exerts "significant
influence" over its investments. Because Plaintiffs claim that
VeriSign exerted "significant influence" over its affiliates,
Plaintiffs claim that the "equity method" was proper. Id. The
"equity method" would not have permitted VeriSign to report any
of the revenues received from its affiliates. Plaintiffs allege
even further that Defendants artificially inflated VeriSign's
earnings by improperly encouraging VeriSign's sales force to
engage in a process known as "scrubbing." Consolidated Second
Amended Complaint at 4. "Scrubbing" is a method of
double-counting: salespersons in one division would report their
own sales and the sales of other salespersons in other
departments, as if they were their own. Id.
Plaintiffs claim that these practices and others led VeriSign
to issue materially false and misleading statements about
VeriSign's financial status. Defendants allegedly knew that its
business was flagging, yet it continued to artificially inflate
VeriSign's revenues. Plaintiffs contend that they relied upon
these misrepresentations to their detriment.
Currently before this Court is Defendants' Motion for Judgment
on the Pleadings, Motion to Strike, and Motion to Shorten the
Class Period. Defendants contend that Plaintiffs have not met
their burden of adequately pleading loss causation, as set forth
by the Supreme Court in the recent Dura Pharm Inc., decision.
Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1627 (U.S. 2005). III. STANDARDS
In ruling on a motion for judgment on the pleadings pursuant to
Federal Rule of Civil Procedure 12(c), the Court applies the same
standard as ruling on a motion to dismiss pursuant to Rule
12(b)(6). See 5C CHARLES A. WRIGHT & ARTHUR R. MILLER, FEDERAL
PRACTICE AND PROCEDURE § 1368 (2005). Under Rule 12(c), after the
pleadings are closed, but within such time as not to delay the
trial, any party may move for judgment on the pleadings.
Fed.R.Civ.Pro. 12(c). In ruling on a motion to dismiss, the court must
accept as true all allegations of material fact and must construe
said allegations in the light most favorable to the non-moving
party. Western Reserve Oil & Gas Co. v. New, 765 F.2d 1428,
1430 (9th Cir. 1985). Any existing ambiguities must be resolved
in favor of the pleading. Walling v. Beverly Enters.,
476 F.2d 393, 396 (9th Cir. 1973).
A complaint may be dismissed as a matter of law for two
reasons: (1) lack of a cognizable legal theory or (2)
insufficient facts stated under a cognizable theory. Moran,
supra at 893; 2A J. Moore, Moore's Federal Practice ¶ 12.08
at 2271 (2d ed. 1982); Robertson v. Dean Witter Reynolds, Inc.,
749 F.2d 530, 533-34 (9th Cir. 1984). In order to grant a motion
to dismiss, it must appear to a certainty that a plaintiff would
not be entitled to relief under any set of facts which could be
proved. Rothman v. Vedder Park Management, 912 F.2d 315, 316
A. Loss Causation Under Dura
Section 10b of the Securities Exchange Act of 1934 forbids (1)
the "use or employment" of any "deceptive device," (2) "in
connection with the purchase or sale of any security," and (3)
"in contravention of" Securities and Exchange Commission "rules
and regulations." 15 U.S.C. § 78j(b). Rule 10b-5 forbids the
making of any "untrue statement of material fact," or the
omission of any material fact "necessary in order to make the
statements made . . . not misleading." 17 C.F.R. § 240. 10b-5(b).
Congress imposed additional statutory requirements on such a
private action, when it passed into law, the Private Securities
Litigation Reform Act (" PSLRA"). 15 U.S.C. § 78u-4(b) (1)-(2).
Under the PSLRA, a plaintiff must (1) specify "each statement
alleged to have been misleading and the reason why the statement
is misleading," and (2) allege "facts giving rise to a strong inference that the
Defendant acted with the required state of mind." Id. A
plaintiff alleging fraud is also required to show loss causation,
i.e., the plaintiff must prove that defendants' securities fraud
caused economic loss. Id.
The Supreme Court, in a recent decision, clarified this loss
causation pleading and proof requirement for securities fraud
cases. Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1627 (U.S. 2005).
Loss causation, as defined by the Supreme Court, is the "causal
connection between the material misrepresentation and the loss."
Id. at 1631. The Court, in Dura, held that a plaintiff could
not satisfy loss causation merely by alleging (and later
establishing) that the price of the securities on the date of the
purchase was inflated because of misrepresentation. Id. at 1627.
In Dura, plaintiffs were a class of individuals who purchased
stock in Dura Pharmaceuticals on the public market during the
class period. Plaintiffs alleged that the company made false
statements concerning its profits and its prospects for future
approval by the FDA of its products before and during the
purchase period. Id. at 1630. However, on the last day of the
purchase period, Dura Pharmaceuticals announced that its earnings
would be lower than previously expected, principally due to slow
drug sales. Id. The following day, the company's shares lost
almost half their value, falling from $39 per share to $21 per
share. Id. Subsequently, when Dura Pharmaceuticals announced
that the FDA would not approve its products, the company's shares
temporarily fell but almost fully recovered within one week.
Id. With respect to economic loss, the complaint alleged that
"[i]n reliance on the integrity of the market, [the plaintiffs] . . .
paid artificially inflated prices for Dura securities" and
the "plaintiffs suffered `damage[s]' thereby." Id. In reversing
the Ninth Circuit's jurisprudence on loss causation, the Dura
Court stated that "an inflated purchase price will not itself
constitute or proximately cause the relevant economic loss"
because the injury does not necessarily occur at the time of the
purchase. Id. at 1631-32. For instance, where plaintiffs sold
their stock immediately after purchasing it at an inflated price,
before the truth was disclosed to the market, the plaintiffs may
have suffered no economic loss at all. Id. at 1631. In
concluding that plaintiffs did not adequately plead loss
causation, the Supreme Court held that, in light of the numerous
factors affecting share price an inflated purchase price might
suggest that the misrepresentation "touches upon" a later economic loss, but could not be held to have "caused" the
economic loss. Id. at 1632. Although the Supreme Court also
noted that its holding did not affect the applicability of
Fed.R.Civ.P. 8(a)(2) to loss causation (i.e., its holding did not
create a heightened pleading standard for loss causation), the
mere allegation that plaintiffs' class purchased their shares at
an artificially inflated price did not serve to place the
defendant with "fair notice of what the Plaintiff's claim is and
the grounds upon which it rests." Id. at 1634 (quoting Conley
v. Gibson, 355 U.S. 41, 47 (1957)). Even under this test,
plaintiffs' complaint failed to "provide the defendant with some
indication of the loss and the causal connection that the
plaintiff has in mind." Id. at 1634. Specifically, the Court
found that the complaint (1) failed to state that Dura's share
price fell significantly after the truth became known, (2) failed
to specify the relevant economic loss, and (3) failed to describe
the causal connection between the loss and the misrepresentation.
Id. at 1634.
Applying the Dura framework, the Ninth Circuit recognized
that pleading loss causation is a difficult task. In re Daou
Systems, Inc., 411 F.3d 1006, 1014 (9th Cir. 2005). The Daou
Court, however, specified that a plaintiff is not required to
show that a misrepresentation was the sole reason for the
investment's decline in value in order to establish loss
causation. Id. at 1025. As long as the misrepresentation is a
substantial cause of the investment's decline in value, recovery
will not be barred. Id. In Daou, plaintiffs, a class of
former investors, purchased Daou common stock between February
13, 1997 and October 28, 1998. Plaintiffs alleged that defendants
systematically and frequently violated the Generally Accepted
Accounting Principles ("GAAP") by prematurely recognizing revenue
in order to artificially inflate the price of Daou stock; and
that in relying on these prices, plaintiffs suffered substantial
personal losses. Plaintiffs also alleged that if they had known
of Daou's true financial results and conditions, they would not
have purchased the shares, at least not at the inflated prices.
Id. The Daou court held that the complaint adequately pled
loss causation by showing that the price of Daou's stock fell
precipitously after the defendants began to reveal figures
showing the company's true financial condition. Id. at 1025-26.
The court found that the allegations, if assumed true, were
sufficient to provide the defendant "with some indication that
the drop in Daou's stock price was causally related to Daou's
financial misstatements reflecting its practice of prematurely
recognizing revenue before it was earned." Id. at 1026. The
court relied on the plaintiffs' allegation that "beginning in August
1998, the company disclosed that its operating expenses and
margins were deteriorating and, on October 28, 1998, defendants
revealed that Daou had dramatically missed its projected 3Q98
earnings and would have to report a loss of $0.17 a share." Id.
The complaint also alleged that defendants revealed that "the
Company's rapidly escalating work in progress account represented
over $10 million in un-billed receivables the direct result of
prematurely recognizing revenue." Id. (emphasis in the
original). The Ninth Circuit found these allegations sufficiently
specific to establish loss causation under Dura.
Interpreting Dura, some courts have required some "corrective
disclosure" before inflated purchase price can constitute
evidence of loss causation. In In re Initial Public Offering
Sec. Litig., No. MDL 1554(SAS), 2005 WL 1162445 (S.D.N.Y. May 6,
2005) (hereinafter "IPO"), the court stated that, in the Second
Circuit, "to establish loss causation, a plaintiff must allege . . .
that the subject of the fraudulent statement or omission
was the cause of the actual loss suffered, i.e., the misstatement
or omission concealed something from the market that, when
disclosed, negatively affected the value of the security." Id.
at *3 (internal quotations omitted) (emphasis in original). The
plaintiffs in that case alleged that the defendants intentionally
discounted earnings estimates and issued cautionary statements to
excite the market and inflate prices when those estimates were
beaten. Id. The IPO court held that the plaintiffs failed to
allege loss causation because the defendants' fraudulent scheme
was never disclosed to the market. Id.
Relying on th IPO decision, Defendants in the present action
contend that Dura requires Plaintiffs to allege some
"corrective disclosure" before they can satisfy the requirements
for pleading loss causation. They interpret Dura as requiring
evidence of "corrective disclosure' to satisfy loss causation.
Defendants' reply at 6.
Notably, the Dura decision itself does not define the
pleading standard for loss causation. The Dura decision only
speaks in terms of the "truth" and "relevant truth." The Dura
court noted that its holding did not affect the applicability of
Fed.R.Civ.P. 8(a)(2) to loss causation, which requires only a
"short and plain statement of the claim showing that the pleader
is entitled to relief." Dura, 125 S.Ct. at 1634. The complaint
must give the defendant "fair notice of what the plaintiff's
claim is and the grounds upon which it rests." Id. In satisfying this pleading standard, the complaint
needs to "provide the defendant with some indication of the loss
and the causal connection that the plaintiff has in mind." Id.
at 1634 (emphasis added). Similarly in Daou, the court found
that the complaint sufficiently alleged loss causation because
the complaint provided the defendant "with some indication that
the drop in Daou's stock price was causally related to Daou's
financial misstatements." Daou, 411 F.3d at 1026 (emphasis
B. Plaintiffs Adequately Plead Loss Causation For One Of The
Five Categories of Fraud
Plaintiffs allege that Defendants issued numerous
misrepresentations and omissions, causing VeriSign's stock prices
to be artificially inflated during the class period. Consolidated
Second Amended Complaint at 2. The misstatements and omissions
alleged in Plaintiffs' second amended complaint primarily fall
into five categories: (1) improper revenue recognition of
reciprocal and related party transactions, (2) failure to timely
write down alleged impaired assets, (3) improper accounting, (4)
false segment reporting, and (5) upwards revision of sales data.
Id. at 2. Specifically, Plaintiffs contend that VeriSign
recognized at least $27 million from transactions in which
VeriSign bartered its products and services for those of other
companies, and recognized at least $10.5 million in reciprocal
transactions in which it licensed its software to other companies
at or about the same time it was purchasing goods and services
from these companies. Consolidated Second Amended Complaint at 3.
Second, Plaintiffs allege that VeriSign violated GAAP provisions
by failing to timely record a $74 million write down to reflect
an impairment in its investments in startup companies. Id. In
the third category, Plaintiffs allege that VeriSign used improper
accounting principles to report at least $12 million in revenues.
Id. In the fourth category, Plaintiffs allege that VeriSign
segmented its revenue and earnings by reference to the type of
customer from whom the revenues were derived, rather than the
type of service which was the basis for the revenue, and that
revenues from one VeriSign division were "scrubbed" or
transferred to another. Id. at 4. Finally, Plaintiffs allege
that VeriSign took sales data that was reported from regional
sales divisions and fraudulently inflated them. Id. at 4. All
of the above alleged misstatements were purportedly made by
Defendants through various press releases and revenue reports
issued during the period from January 2001 to March 2002.
Consolidated Second Amended Complaint at 19, 23, 25, 28.
Plaintiffs contend that by reporting incorrect revenue results, VeriSign's press reports falsely portrayed the
corporation as being financially secure.
As discussed above, Plaintiffs must show loss causation before
they can prevail on their claim for securities fraud. To
establish loss causation, Plaintiffs rely on three disclosures,
including: (1) a February 6, 2002 Bloomberg report, (2) a March
19, 2002 report issued by VeriSign, and (3) an April 25, 2002
press release disclosing earnings for 1Q02.
The Bloomberg report simply stated that "VeriSign shares fell
9.5 percent on the concern that revenue at the manager of the
database of dot-com web addresses may be inflated by sales to
affiliated companies." (Plaintiffs' CSAC at 38.) Plaintiffs
allege that this Bloomberg report caused "market speculation"
about inflated sales and resulted in a price drop. On March 19,
2002, VeriSign filed its report on Form 10K for its FY01.
Consolidated Second Amended Complaint at 38. In this report, the
company, for the first time, revealed that approximately 10% of
its revenue was attributable to reciprocal arrangements, or
"barter transactions," and sales to the company affiliates that
VeriSign had just invested in. Id. After the issuance of this
report, VeriSign stock dropped 10%, to close at $26.42. Id.
This disclosure is particularly pertinent to the first category
of fraud, namely that Defendants' engagement in improper revenue
recognition of reciprocal and related party transaction.
Plaintiffs allege that Defendants inflated earnings by improperly
reporting more than $64 million of revenue as a result of
numerous "round trip" transactions with its affiliates and other
small private companies in which VeriSign had invested in order
to provide them with a source of funds to purchase products from
VeriSign. Consolidated Second Amended Complaint at 3.
Additionally, VeriSign allegedly improperly reported at least $27
million in cash revenues based on non-monetary barter
transactions, in which VeriSign provided domain names, digital
certificates or other products to third parties in exchange for
their products or services. Id. With regard to these specific
allegations constituting the first category of fraud, the Court
finds that Plaintiffs have sufficiently pled loss causation.
On April 25, 2000, VeriSign reported its 1Q02 results.
(Plaintiffs' CSAC at 40.) VeriSign's ProForma net income dropped
$4.1 million, from $71.8 in December 2001 to $67.7 in March,
2002. Id. Stating that "our first quarter results were not up
to our expectations as we encountered significant spending delays in our IT and telecom customer bases," Mr. Stratton
Sclavos, Chairman and CEO of VeriSign announced plans to
restructure the company's operations to fully rationalize,
integrate and align the resources of the company. Id. at 41.
The Chairman anticipated charges of $70-$80 million as a result
of such restructuring. Id. On this news, VeriSign stock dropped
from $18.24 to $9.89 per share.
Plaintiffs contend that the April 25, 2000, disclosure caused a
third economic loss for them. However, the April 25 disclosure is
not linked to any misstatements alleged in the complaint.
Plaintiffs' complaint essentially admits as much. Specifically,
Plaintiffs allege: "Even this disclosure, however, did not
acknowledge that VeriSign had been maintaining its revenue and
earnings numbers by manipulating its financial results."
(Plaintiffs' CSAC at 2.) In contrast to Daou, where the
complaint alleged deteriorating operating and expense margins,
dramatically misplaced revenue results, and a revelation that the
company's rapidly escalating work in progress account represented
over $10 million in un-billed receivables, Plaintiffs' complaint
in this case does not plead any specific disclosure made by
VeriSign on April 25, 2000, as being the substantial cause for
the decline in stock price. As such, Plaintiffs' complaint fails
to provide Defendants with notice of what the causal connection
might be between their loss and the vast majority of alleged
misrepresentations making up the second through fifth categories
of fraud. Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1634 (U.S.
In summary, Plaintiffs adequately plead loss causation as to
the first category of fraud, namely, allegations regarding
misstatements and omissions of improper revenue recognition of
reciprocal and related party transactions. However, the three
disclosures cited by the Plaintiffs in their complaint do not
satisfy the causal link requirement as to the other four
categories of fraud alleged by Plaintiffs. This Court therefore,
denies Defendants' motion for judgment on the pleadings with
respect to category one of the alleged fraud and grants the
motion with respect to the remaining four categories of fraud.
C. Plaintiffs' Request for Leave to Amend Complaint is
Plaintiffs request leave to amend the complaint if the Court
grants Defendants' Motion for Judgment on the Pleadings.
Plaintiffs' Motion at 3. Defendants' briefs do not address
Rule 15(a), Fed.R.Civ.P., provides that a party may amend
his pleadings once as a matter of course at any time before a responsive pleading is served.
Otherwise a party may amend only by leave of court or by written
consent of the adverse party. Id. Rule 15(a) further provides
that leave shall be freely given when justice so requires.
Federal policy strongly favors determination of cases on their
merits and amendments to pleadings should be allowed with
"extreme liberality." United States v. Webb, 655 F.2d 977, 979
(9th Cir. 1981).
In light of the liberal policy in favor of allowing amendments,
this Court GRANTS Plaintiffs' request to amend their complaint.
Plaintiffs shall file and serve an amended complaint on or before
November 18, 2005.
D. Defendants' Motions to Strike and to Shorten Class Period
Are Denied Without Prejudice
Defendants contend that Plaintiffs do not allege loss causation
with respect to any alleged economic loss after March 19, 2000,
and therefore move to strike all alleged misstatements or
omissions for which Plaintiffs fail to plead loss causation, and
to shorten the class period to end on March 19, 2000. Defendants
contend that because Plaintiffs fail to adequately plead loss
causation, their allegations qualify as "immaterial, redundant,
impertinent, or scandalous."
Generally, a motion to strike must be made before responding to
the challenged pleading. Fed.R.Civ.P. 12(f). However, Rule
12(f) allows a court to exercise its discretion, at any time, to
strike parts of the pleading that the court deems "an
insufficient defense or redundant, immaterial, impertinent, or
scandalous matter." Id.
In section "C" immediately above, this Court granted
Plaintiffs' request for leave to amend their complaint to
adequately plead loss causation. Therefore, this Court does not
deem it necessary at this time, to Rule on the merits of
Defendants' motion to strike and to shorten the Class Period.
Defendants' Motions to Shorten the Class Period and to Strike the
complaint are DENIED without prejudice.
For the reasons stated above, Defendants' Motion for Judgment
on the Pleadings is GRANTED in part and DENIED in part with leave
to amend. Plaintiffs shall file and serve an amended complaint on
or before November 18, 2005. Defendants' Motions to Strike and to
Shorten the Class Period are DENIED without prejudice.
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