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In Re Novatel Wireless Securities Litigation

November 23, 2011

IN RE NOVATEL WIRELESS SECURITIES LITIGATION


The opinion of the court was delivered by: Hon. Anthony J. Battaglia U.S. District Judge

ORDER GRANTING MOTION FOR JUDGMENT ON THE PLEADINGS AND GRANTING IN PART AND DENYING IN PART MOTION FOR SUMMARY JUDGMENT [Doc. Nos. 289 and 290]

Currently before the Court are two motions: (1) Defendant Peter Leparulo's Motion for Judgment on the Pleadings, Doc. No. 289; and (2) a Motion for Summary Judgment, Doc. No. 290, by Defendants Robert Hadley, Peter Leparulo, Novatel Wireless, Inc., Catherine Ratcliffe, Slim Souissi, and George Weinert. The Plaintiffs filed oppositions, Doc. Nos. 327 and 328 respectively, to these motions and Defendants filed replies, Doc. Nos.325 and 338 respectively.*fn1 Based upon the parties arguments and moving papers, and for the reasons set forth herein, Defendant Leparulo's Motion for Judgment on the Pleadings, Doc. No. 289, is hereby GRANTED and Defendants' Motion for Summary Judgment, Doc. No. 290, is hereby GRANTED IN PART AND DENIED IN PART as set forth below.

Background

I. Factual Background

A. Parties

Lead Plaintiffs, Pension Fund Group is comprised of: (1) Plumbers & Pipefitters' Local #562 Pension Fund; and (2) Western Pennsylvania Electrical Employees Pension Fund. Plaintiffs brought this securities class action against Defendants Novatel, Peter V. Leparulo, George B. Weinert, Robert M. Hadley, Slim S. Souissi, and Catherine F. Ratcliffe claiming that they purchased securities during the Class Period*fn2 and were allegedly damaged as a result of these purchases. (Compl. ¶42-48.)

Plaintiffs alleges that during the Class Period, Novatel employed 300 people company-wide, with only 44 employees, including all five individually named Defendants, in "operations." (Id. at ¶34.) Plaintiffs allege that the individual Defendants essentially controlled Novatel, including its accounting practices, earning announcements, and SEC filings. (Id. at ¶34.)

1. Defendant Novatel

Novatel is headquartered in San Diego, California and trades stock under the symbol NVTL on the Nasdaq. Novatel is a provider of wireless broadband access solutions for the worldwide mobile communications market and produces about 25 different products for the wireless communications industry. (Consolidated Complaint ("CC") Doc. No. 23, filed Jan. 9, 2009), ¶ 43.) In 2007, Novatel sold the "Ovation" product line, including the first-generation U720 and the next-generation U727 wireless modems. (Ex. 4, at 39-40.)

2. Defendant Peter V. Leparulo

Leparulo was, at relevant times, Chairman and Chief Executive Officer ("CEO") of Novatel. (Compl. ¶44.) During the Class Period, Leparulo prepared and signed Novatel's Form 10-K, attesting that he had reviewed the contents of the filings to confirm that they did not contain untrue statements of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances, not misleading. (Id.) Leparulo issued statements in press releases and led the Company's conference calls with analysts and investors, representing himself as the primary person, along with Weinert, with knowledge about Novatel's business, outlook, financial reports, and business practices. (Id.) Plaintiffs allege that while in possession of non-public material information, Leparulo sold 473,357 shares of his Novatel stock for insider trading proceeds of $11,530,258 during the Class Period. (Id.)

3. Defendant George Brad Weinert

Weinert was, at relevant times, President of Novatel. (CC, Doc. No. 23, at ¶45.) During the Class Period, Weinert prepared and signed the Company's Form 10-K and 10Q, and Sarbanes-Oxley Act of 2002 ("SOX") certifications filed with the SEC, attesting that he had reviewed the contents of the filings to confirm that they did not contain untrue statements of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances, not misleading. (Id.) Weinert also issued statements in press releases and led the Company's conference calls with analysts and investors, representing himself as the primary person, along with Leparulo, with knowledge about Novatel's business, outlook, financial reports, and business practices. (Id.) Plaintiffs allege that while in possession of non-public material information, Weinert sold 121,985 shares of his Novatel stock for insider trading proceeds of $3,305,560 during the Class Period. (Id.)

4. Defendant Robert M. Hadley

Hadley was, at all relevant times, Senior Vice President of Worldwide Sales and Marketing of Novatel. (CC, Doc. No. 23, at ¶46.) Plaintiffs allege that while in possession of non-public material information, Hadley sold 247,198 shares of his Novatel stock for insider trading proceeds of $4,681,696 during the Class Period. (Id.)

5. Defendant Slim S. Souissi

Souissi was, at all relevant times, Senior Vice President and Chief Technology Officer of Novatel. (CC, Doc. No. 23, at ¶47.) Plaintiffs allege that while in possession of non-public material information, Souissi sold 272,560 shares of his Novatel stock for insider trading proceeds of $5,488,870 during the Class Period. (Id.)

6. Defendant Catherine F. Ratcliffe

Ratcliffe was, at all relevant times, Senior Vice President of Business Affairs and General Counsel of Novatel. (CC, Doc. No. 23, at ¶48.) Plaintiffs allege that while in possession of nonpublic material information, Ratcliffe sold 143,366 shares of her Novatel stock for insider trading proceeds of $3,646,804 during the Class Period. (Id.)

B. Plaintiffs Allegations

Plaintiffs allege that between February 27, 2007 and November 10, 2008 (the "Class Period"), Defendants engaged in a fraudulent scheme to inflate Novatel's stock value so that Defendants could sell their stock in the company for a profit. (Id. at ¶¶1, 12.) Plaintiffs contend that Novatel's success was largely dependent on its ability to supply wireless modems to its two largest customers, Sprint and Verizon, which in 2006 accounted for 38.2% and 19.7% of Novatel's revenue respectively. (Id. at ¶14.) According to Plaintiffs, "defendants knew that the market was particularly sensitive to information about these customers" and "[s]trong financial results would surely spur an increase in Novatel's stock price whereas any negative information regarding these customers would reduce it." (Id. at ¶14.)

Plaintiffs allege that throughout the Class Period, Defendants Weinert and Leparulo misrepresented the financial condition of the Company because they told investors that the Company was seeing strong demand for its products, and did not disclose to investors that Novatel did not have an adequate "product mix" to meet the needs of its customers. (CC, Doc. No. 23, at ¶¶ 57(a)(iii)), 62(a)(ii), 66(a)(ii), 73(a)(ii)).) Plaintiffs also allege that Novatel covered up the slowdown in its business by shipping product "early," which purportedly violated accounting rules governing revenue recognition.

., ¶¶ 6.) Plaintiffs claim that four specific stock price declines-on July 20, 2007; February 21, 2008; April 15, 2008; and August 20, 2008-purportedly resulted from the market learning of these allegedly concealed facts. (Id., ¶¶ 125-28.) Plaintiffs further allege that Defendants sold Novatel stock because they learned that Sprint would stop placing additional orders for Novatel's U720 modem. (Id., ¶ 4.)

1. Financial Condition of Novatel

a. Sprint Cancellation

On January 8, 2007, Tamara Juenger of Sprint forwarded an email to three low-level Novatel employees stating that Sprint planned to replace the U720 modem. (Ex. 14, at 267.) Ms. Juenger informed the Novatel employees that the last purchase order for U720s would probably be for the week of April 1, 2007. (Id.) Within Novatel, word that a customer would no longer be ordering a certain product was not unusual. (Ex. 16 [Weinert Dep., 79:16:80:6].) In Novatel's industry it was and is quite common, and is most often a prelude to pricing negotiations, particularly when competitive product is available and next generation product is expected in the near term. (Id.; Exs. 6 [Souissi Expert Dep., 51:25-10]; 17 [Leparulo Dep., 220:17-222:14].) In this case, Novatel was the first to market, and when Sierra Wireless (Novatel's competitor) readied its competing wireless USB modem for sale, Sprint leveraged the opportunity to negotiate. Mot. at 4. Novatel's Acting CEO, Mr. Weinert, was upset by Sprint's decision, but immediately set out to convince Sprint to continue placing orders for the U720 to ensure a smooth transition to the successor U727, which was anticipated to be faster and smaller than Sierra's Wireless' product. Id. Just two weeks after Ms. Juenger's email, representatives of Sprint and Novatel met, and Tim Hipsher of Sprint said that contrary to Ms. Juenger's email, the U727 would be removed from only one channel. (Ex. 18, at 298-99.) Mr. Hipsher also said the end of life plan for the U720 might drag out for some time. (Id.) On March 1, 2007, Ms. Juenger emailed four lower-level Novatel employees that the discontinuation of the U720 would be pushed back to the middle or end of May. (Ex. 19, at 301.) All the while, Sprint kept ordering the U720. As late as May 18, 2007, Sprint was sending forecasts to Novatel showing product being anticipated for delivery through the third quarter of 2007. (Ex. 20, at 303.) On May 24, 2007, a Sprint representative finally told Novatel employees in a conference call that Sprint would not order any more U720s; however, delivery of open orders for the U720 would continue through June 2007. (Ex. 21, at 309.) Sprint placed its first orders for the next generation U727 shortly thereafter, in late July 2007. (Ex. 99.)

b. Novatel's Public Statements

In early 2007, Novatel reported strong financial results. It told investors that its USB modem was extremely successful in the market, and that Novatel was seeing strong sales to Verizon and Sprint. (CC, Doc. No. 23, at ¶15). On February 27, 2007, Defendant Weinert, in a press release, stated with respect to the first quarter of 2007, that Novatel would "continue to ramp to meet increasing demand in the marketplace." (Id. at ¶51). Weinert also stated that day, during the Company's earnings conference call, that competitors are using "fairly well tried out, older technologies and really the market isn't ready for that right now." (Id. at ¶52). In a press release on May 1, 2007, Novatel reported first quarter revenue increases of 174% year over year and Weinert stated that "[o]ur first quarter performance was the best in Company history . . . Sales were even higher than forecasted in our revised guidance due to strong end-of-the-quarter momentum for newly introduced ExpressCards and Ovation USB devices." (Id. at ¶¶53-54). On May 1, 2007, during the Company's earnings conference call, Defendant Leparulo stated that "the market for 3G Wireless is taking off and we believe we're perfectly positioned to take advantage of that growth." (Id. ¶55.) Defendant Weinert stated that, "[w]e certainly see strong demand for [our first generation] products, and we're leading the way, we're actually in a leadership position, in both the express card and the USB markets." (CC, Doc. No. 23, at ¶55.) On May 10, 2007, Novatel filed its Quarterly Report on Form 10-Q containing Sarbanes-Oxley Act of 2002 ("SOX") certifications with the SEC, which was signed by Defendant Weinert and which reaffirmed Novatel's financial results previously announced on May 1, 2007. (Id. 56.)

Plaintiffs allege that these statements about the Company's financial results and market share were false and misleading because they did not fairly present the financial condition of the Company throughout the first quarter of 2007. (Id. ¶57.) Plaintiffs allege that Novatel failed to disclose it was prematurely shipping product to meet or exceed its quarterly and yearend forecasts, failed to disclose that Sprint would discontinue all further orders of the Company's popular 720 USB card by the end of July 2007, concealed that the Company's product mix failed to meet the immediate needs of its two largest domestic customers, Sprint and Verizon, which was causing Novatel to lose market share, and signed false SOX certifications attesting to the accuracy of the financial results and effectiveness of Novatel's internal controls, as the Company admitted on November 10, 2008 that there were several control deficiencies in the Company's internal control over financial reporting that in the aggregate constituted a material weakness. (Id. ¶57.) Plaintiffs allege that at the same time, Defendants were selling significant amounts of their Novatel holdings. (Id.) Plaintiffs allege that during the Class Period, Defendants sold 1,258,466 shares of Novatel stock for almost $29 million in proceeds. (Id. ¶15.) Plaintiffs allege that 62% of the Defendants' Class Period sales occurred in June and July 2007, just before the market learned that Sprint would no longer be purchasing Novatel's 720 USB modem, information the company allegedly knew "for some time." (Id. ¶16.) Defendants sold this stock at the same time that Novatel was certified by Vodafone to sell its products in late June 2007, and when Novatel was on the verge of being certified at Telefonica and T-Mobile. (CC, Doc. No. 23, at ¶18.) Novatel's stock price fell from $29 in late July to almost $20 by the beginning of August. (Id. ¶17.) According to an analyst on July 20, 2007, "NVTL shares were off sharply this morning, we believe in response to a rumor that NVTL may lose market share at Sprint . . . We agree with the notion making the rounds indicating that the popular EU 720 USB card from NVTL will in fact be end-of-lifed at Sprint as early as next week."*fn3 (Id. ¶17.)

2. Loss of Market Share

Plaintiffs allege that Novatel not only lost market share with Sprint's cancellation of the 720 USB modem, but throughout 2007 and continued to mislead investors. (CC, Doc. No. 23, at ¶20.) On June 8, 2007, Defendant Weinert in a press release stated, "[w]e are currently seeing strong demand across our major product lines, most notably for our ExpressCards and Ovation USB devices." (Id. ¶58.) Novatel reported 113% revenue growth in 2Q07 and 90% revenue growth in 3Q07, which Defendants emphasized exceeded previous guidance. (Id. ¶¶59, 63.) In a press release dated August 6, 2007, Weinert stated that, "[d]emand is strong across a wide range of products" and that "[a]doption of USB wireless modems has been a primary growth driver with over $85 million in sales in the nine months since its introduction." (Id. ¶59.) On November 5, 2007, on the Company's earnings conference call, Defendant Leparulo stated, "[we] saw strong demand for these products, and beat guidance and expectations once again. Our market continues to grow rapidly as 3G wireless data proliferates into mainstream technology." (CC, Doc. No. 23, at ¶64.) On the same call, Weinert stated that demand for Novatel's Next Generation USB products was so strong that, "our major hurdle is tightness in our supply channel for selected components due to the strong demand." (Id. ¶64.) Weinert stated on August 6, 2007, on the Company's earnings conference call that, "[w]e had an exceptionally strong first half of the year with Sprint." (Id. ¶60.)

Plaintiffs allege that these statements and the Company's 10-Q filings were false and misleading because Novatel was losing market share to competitors. Other wireless carriers were targeting the consumer market by slashing monthly service fees. (Id. ¶23.) Novatel did not have a viable USB product to immediately compete in this retail market and lost market share to its competitors not only at Sprint, but also at Verizon and in Europe at T-Mobile, Telefonica/O2, and Orange. (Id. ¶24.) Plaintiffs also allege that Novatel shifted its focus to the European market in the second half of 2007 because Defendants knew that Novatel was losing market share in the United States. (Id. ¶¶25-27.) Novatel's international sales trended upward throughout 2007, even though international sales adversely affected Novatel's profit margins. (CC, Doc. No. 23, at ¶¶25-27.)

Plaintiffs allege that Novatel's statements concerning the demand for its products were also false and misleading because Defendants failed to disclose that Novatel was prematurely shipping products. . ¶28.) Plaintiffs allege that in early 2007, Novatel began shipping as much product as it could to its customers to meet its quarterly and year-end forecasts. (Id. ¶28.) A former Novatel employee explained, there was always a crunch time at the end of each quarter and that Novatel would frequently ship large amounts of product up to four weeks early so it allegedly could recognize the revenue up front in the current quarter and meet or exceed Wall Street expectations. (Id. ¶28.) Novatel sold product on credit with extended payment terms in 2007 to Sprint and Verizon in order to ship product early and increase its financial results. (Id. ¶30.) This practice caused Verizon and Sprint to be flush with inventory by 4Q07. (Id. ¶31.) Novatel admitted on November 10, 2008, in its delayed Form 10-Qs for the first and second quarters of 2008, that there were several control deficiencies in the Company's internal control over financial reporting that in the aggregate constituted a material weakness. (CC, Doc. No. 23, at ¶¶28, 62.) Plaintiffs allege that Novatel's stated financial results misled analysts about end-market demand and sales execution because of this practice of early shipment to post strong results throughout 2007. (Id. ¶29.)

3. Prematurely Recognized Revenue in Violation of Novatel's Revenue Cut-Off Procedures and Generally Accepted Accounting Principles ("GAAP")

Plaintiffs allege that Defendants' scheme to inflate revenues began to unravel in the first quarter of 2008. (Id. ¶32.) On February 20, 2008, Novatel issued a press release forecasting $110 million in revenues for 1Q08, which was $10 million below analysts' estimates. (Id. ¶¶67-68.) Novatel attributed this guidance to a consolidation issue at its customers who were supposedly focusing on eliminating inventory from Novatel's competitors, stating that, "[w]e believe that the major North American carriers are looking to significantly consolidate vendors down to two suppliers . . . this may have some modest impact as carriers flush through competitors' products as they consolidate vendors and lower inventory." (CC, Doc. No. 23, at ¶68.) Defendants also disclosed on February 20, 2008 that Novatel was seeing the market shift to the consumer segment, and that this "is a positive move that increases our addressable market." (Id. ¶70.) Defendants' forecasts for 1Q08 and their explanations for them took analysts by surprise as none of Novatel's competitors had mentioned the consolidation issue at Sprint and Verizon when raising their outlooks for the quarter. (Id. ¶¶67-70.) Plaintiffs allege that in reality, Novatel's main customers were overextended because of early shipments and had to clear their inventory. (Id. ¶32.) Novatel's stock price dropped from approximately $14 to as low as $10.20, or roughly 27%, after Defendants' disclosures. (Id. ¶33.) On March 3, 2008, Novatel filed its Annual Report on Form 10-K with the SEC largely reaffirming the financial results for 4Q07 and fiscal year 2007 announced on February 20, 2008, which was signed by Defendants Weinert and Leparulo and contained SOX certifications. (Id. ¶72.)

Through 1Q08, Defendants repeated the Company's guidance and told analysts that "we are very pleased with the long-term trends and how we are positioned to fulfill them." (CC, Doc. No. 23, at ¶¶33, 74.) On April 14, 2008, Novatel disclosed preliminary results for 1Q08 that were $19 million below the Company's original forecast of $110 million, and $29 million below the original analyst estimates of $120 million. (Id. ¶76.) Defendant Leparulo partially attributed this shortfall to the fact that Novatel was "between product launch cycles for our USB devices and demand in the current environment has shifted toward lower end products" and that, "in some cases, we did not have the right products for the right customers." (Id. ¶¶76, 77.) On May 1, 2008, Novatel issued a press release which stated that, "revenues for the first quarter of 2008 were $91.3 million." (Id. ¶78.) On May 13, 2008, Novatel filed a Form 12b-25 with the SEC for an extension of time to file its Form 10-Q, disclosing that Novatel could not file its Form 10-Q for the quarter because the Company and its Audit Committee undertook an enhanced review of the accounting for a specific customer contract, stating that the review was substantially completed. (Id. ¶79.) Novatel claimed that the review was not expected to change any previously reported financial statements or earnings. (CC, Doc. No. 23, at ¶79.)

Plaintiffs allege that Novatel's financial results concerning 1Q08 revenues and earnings, as reported in press releases, SEC filings, and conference calls were false and misleading. (Id. ¶80.) Plaintiffs allege that Novatel failed to disclose that the Company was recognizing revenue in violation of its own revenue cut-off procedures and GAAP, thus rendering the Company's publicly reported financial results materially false. (CC, Doc. No. 23, at ¶80.) On August 19, 2008, Novatel announced that it had broadened its accounting review and determined to move at least $3.4 million in revenue out of 1Q08. (Id. ¶81.) Plaintiffs allege that as a result of this disclosure, Novatel's stock price dropped from $8.40 to $6.29 in one day. (Id. ¶83.) On November 10, 2008, Novatel issued its delayed Form 10-Qs for the first and second quarters of 2008, disclosing that the revenues for the first quarter were misstated by $3.4 million due to improper revenue cut-off procedures and accounting irregularities relating to certain customer contracts. (Id. ¶84.) The Form 10-Qs also indicated that there were several control deficiencies in Novatel's internal control over financial reporting that in the aggregate constituted a material weakness during the Class Period. (Id. ¶84.) After the November 10 disclosure, Novatel's stock slid below $5 per share, trading as low as $3.90 per share by November 17, 2008. (Id. ¶85.)

Discussion

Currently before the Court are Defendant Leparulo's motion for judgment on the pleadings and a Motion for Summary Judgment by Defendants Robert Hadley, Peter Leparulo, Novatel Wireless, Inc., ...


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