The opinion of the court was delivered by: Hon. Anthony J. BattagliaU.S. District Judge
ORDER GRANTING IN PART AND
DENYING IN PART MOTIONS TO EXCLUDE EXPERT TESTIMONY OF D. PAUL
REGAN AND ANTHONY LENDEZ [Doc. Nos. 298 and 397]
Defendants filed a motion to exclude expert testimony of Plaintiffs' expert D. Paul Regan, [Doc. No. 298], on February 15, 2011, which was heard on July 8, 2011 and taken under submission. The Plaintiffs filed a motion to exclude the expert testimony of Defendants' rebuttal expert Anthony Lendez, [Doc. No. 397], on July 15, 2011. The hearing on Plaintiffs' motion was held on November 18, 2011. Based upon the moving papers and arguments and for the reasons set forth herein, the Court hereby GRANTS IN PART and DENIES IN PART the Defendants motion, [Doc. No. 298] and GRANTS IN PART AND DENIES IN PART the Plaintiffs' motion, [Doc. No. 397], as set forth
On February 20, 2008, Novatel disclosed that it had missed its revenue guidance for 4Q07 by $2 million and the projected revenue guidance for 1Q08 was far lower than analysts expected. Ex. 2 at NOV-E-2788091-92. Two months later, Novatel announced a $19 million revenue shortfall (nearly $30 million below analysts' expectations) and attributed it, in part, to weaker than expected demand at Verizon Wireless ("Verizon"), its largest customer at the time.
After that announcement, and after a Company whistleblower subsequently disclosed questionable accounting practices, Novatel undertook an accounting investigation into whether several specific transactions violated Generally Accepted Accounting Principles (hereinafter "GAAP"). In the course of that investigation, the Company retained the law firm of Paul Hastings to act as its investigative counsel, and the law firm in turn, retained PricewaterhouseCoopers (hereinafter "PwC"), an accounting firm, to assist in the investigation. For purposes of its own audit opinion, Novatel retained KPMG to shadow the investigation. Ex. 3 at 107:10-110:22. On August 19, 2008, Novatel announced that the investigation uncovered $3.4 million in GAAP violations, where revenue was recognized improperly in 1Q08 instead of 2Q08. Ex. 4 at NOV-E-1216854.
Plaintiffs subsequently conducted discovery on Novatel's accounting practices between 2006 and 2008. Plaintiffs' accounting expert D. Paul Regan opined, based on his review of that discovery, that Novatel had actually been manipulating its financial results for all financial quarters between 2Q06 and 3Q08. Ex. 5 at Ex. C(1). Plaintiffs served Defendants with Mr. Regan's report on December 13, 2010. Id. Defendants proffered the rebuttal report of Lendez, an accountant and CPA, on January 12, 2011. See Ex. 6.
Mr. Lendez analyzed the report of D. Paul Regan and submitted a rebuttal report that, among other things, criticized Mr. Regan for (i) not conducting a proper GAAP analysis of the approximately 125 transactions he now challenges, (ii) failing to address the bases for the company's contemporaneous accounting, which was approved by its auditors, (iii) relying exclusively on a sales worksheet as the cornerstone of his accounting analysis concerning so-called "pull in" transactions without consideration of several columns, (iv) offering an "undue pressure" opinion that was not the product of any established test, and (v) misunderstanding and misapplying disclosure rules. Defendants filed a motion to exclude these opinions.
Plaintiffs also filed a motion seeking to exclude four categories of opinion offered in the Lendez Report: (1) opinions that it was reasonable for Novatel's management to rely on KPMG; (2) opinions that management did not exert undue pressure to manage revenue and earnings; (3) opinions concerning the effectiveness of Novatel's internal controls; and (4) opinions concerning the application of GAAP. Plaintiffs' base their motion to exclude Mr. Lendez's opinions on the following grounds: (1) failure to comply with Rule 26; (2) reliance on the opinions of KPMG, PwC, and Paul Hastings render Lendez's opinion unreliable; (3) Undue Pressure opinion must be excluded under Rule 702; and (4) opinions on the Application of GAAP are unreliable, irrelevant, and offer improper legal conclusions.
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 v. Merrell Dow Pharms., Inc., 509 U.S. 579, 589 (1993). When considering evidence proffered under Rule 702, the trial court must act as a "gatekeeper" by making a preliminary determination that the expert's proposed testimony is reliable. Elsayed Mukhtar v. Cal. State Univ., Hayward, 299 F.3d 1053, 1063 (9th Cir. 2002), amended by 319 F.3d 1073 (9th Cir.2003).
As a guide for assessing the scientific validity of expert testimony, the Supreme Court provided a non-exhaustive list of factors that courts may consider: (1) whether the theory or technique is generally accepted within a relevant scientific community, (2) whether the theory or technique has been subjected to peer review and publication, (3) the known or potential rate of error, and (4) whether the theory or technique can be tested. Daubert, 509 U.S. at 593--94; see also Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137 (1999). The Ninth Circuit also has indicated that independent research, rather than research conducted for the purposes of litigation, carries with it the indicia of reliability. See Daubert v. Merrell Dow Pharmaceuticals, Inc., 43 F.3d 1311, 1317 (9th Cir.1995) ( "Daubert II"). In particular, using independent, pre-existing research "provides objective proof that the research comports with the dictates of good science" and is less likely "to have been biased by the promise of remuneration." Id. If the testimony is not based on "pre-litigation" research or if the expert's research has not been subjected to peer review, then the expert must explain precisely how he went about reaching his conclusions and point to some objective source-a learned treatise, the policy statement of a professional association, a published article in a reputable scientific journal or the like, to show that he has followed the scientific method, as it is practiced by (at least) a recognized minority of scientists in his field. Id. at 1318--19 (citing United States v. Rincon, 28 F.3d 921, 924 (9th Cir.1994)); see also Lust v. Merrell Dow Pharmaceuticals, Inc., 89 F.3d 594, 597 (9th Cir.1996). The proponent of the evidence must prove its admissibility by a preponderance of proof. See Daubert, 509 U.S. at 593 n. 10.
The Defendants have filed a motion, [Doc. No. 298], seeking to exclude the testimony of Plaintiffs' accounting expert, D. Paul Regan, as inadmissible under Rule 702 of the Federal Rules of Evidence and Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), and its progeny.
Mr. Regan stated in his report of December 13, 2010, and further clarified during his deposition, the following opinions in this case: (1) Novatel Wireless, Inc. ("Novatel") improperly "pulled in" revenue to the current quarter by shipping product before the customer's request date; (2) Management exerted "undue pressure" to manage its publically reported revenue and earnings at Novatel; and (3) Novatel failed to abide by SOP 94-6 and Securities and Exchange Commission ("SEC") guidance requiring the disclosure of certain "channel stuffing" practices and Sprint's decision to stop using the U720 modem.
A. Mr. Regan's "Pull In" Opinion
Mr. Regan opines that across the ten quarters ending September 30, 2008, Novatel improperly shipped $19.5 million worth of product "early." In particular, for the 125 "pull in" transactions identified, (Report (Ex. A), Exhibit D to Report), Mr. Regan contends customers requested delivery in a subsequent quarter, but Novatel delivered the product, and recognized the revenue, in the current quarter. Mr. Regan contends Novatel should have delayed recognizing the revenue on these transactions until the subsequent quarter.
Plaintiffs contend that these Novatel practices violated revenue recognition and disclosure rules established under GAAP and relevant SEC rules and argue that GAAP requires that "persuasive evidence of an arrangement" exist in order to record revenue. Mr. Regan states that he has found no such evidence. Mr. Regan opines that the "facts and circumstances of Novatel's 'pull in' transactions prohibited revenue recognition under GAAP" based on contracts, emails, testimony, and various transactional documents.
Defendants argue that Mr. Regan's analysis invades the province of the Court, is built on incorrect assumptions and is demonstrably unreliable, requiring its exclusion. Defendants motion seeks exclusion of Mr. Regan's pull-in opinion on two grounds: (1) Defendants argue that his position "rests on nothing more than a thinly-veiled legal conclusion that Novatel had no right to deliver product even a day earlier than requested by its customers;" and (2) Defendants contend that Mr. Regan "improperly relie[d] exclusively on a spreadsheet maintained by the Novatel sales department."
1. Whether Mr. Regan's Pull In opinions Rest on Improper Legal Conclusions
Defendants argue thatMr. Regan's 'pull in' opinion is unreliable and inadmissible because it offers inappropriate and flawed legal analysis. Specifically, the Defendants contend Mr. Regan's 'pull in' opinion is a thinly veiled legal conclusion that Novatel had no right to deliver product even a day earlier than requested per the contract and did not consider all the appropriate evidence. The court finds that to the extent that Mr. Regan's 'pull in' opinion addresses whether Defendants complied with SEC and GAAP requirements is both reliable and admissible. However, to the extent that Mr. Regan opines on the question of whether the contracts at issue allowed Defendants to ship products to customers in the manner they did, the Court finds such opinions to be improper legal conclusions and therefore GRANTS the Plaintiffs' motion to exclude these improper legal conclusions.
2. Whether Mr. Regan's Opinion Relied on Improper or Insufficient Data or Misinterpreted a Sales Worksheet Specifically, Defendants argue that Mr. Regan relies on a Novatel worksheet that isn't ordinarily used for such purposes and Mr. Regan omitted two of the columns entirely, the "promise date" and the "scheduled ship date" columns. Defendants contend that Mr. Regan "cherry picked" the information he wanted to use and disregarded the rest. The Court finds that Defendants contention that Mr. Regan's Opinion is based on insufficient data and a misinterpretation of a sales worksheet is not supported by the record. Despite Defendants arguments to the contrary, the Court finds that Mr. Regan's opinion is based upon numerous sources including contracts, emails, testimony, and various transactional documents, not just the spreadsheet as suggested by the Defendants. Based upon the foregoing, Defendants motion to ...