United States District Court, N.D. California
Order Granting Reconsideration in Part Jan. 10, 2013.
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Shawn A. Williams, Mark Punzalan, San Francisco, CA, Darren Jay Robbins, David Conrad Walton, San Diego, CA, Michael I. Fistel, Jr., Holzer Holzer and Fistel LLC, Atlanta, GA, Robert J. Dyer, III, Denver, CO, for Plaintiffs.
Elizabeth Patz Skola, Jessica Perry Corley, Atlanta, GA, for Defendants.
Gidon M. Caine, Menlo Park, CA.
ORDER GRANTING DEFENDANTS' MOTION TO DISMISS SECOND AMENDED COMPLAINT
EDWARD M. CHEN, District Judge.
Plaintiffs have filed a class action against Oclaro, Inc. and two of its officers, Alain Couder and Jerry Turin, for violations of the federal securities laws. In
essence, Plaintiffs charge Defendants with making false and misleading statements about Oclaro's customer demand and how Oclaro could be expected to fare for the first quarter of 2011 (" 1Q11" ) and for the calendar year. See SAC ¶ 1. Currently pending before the Court is Defendants' motion to dismiss Plaintiffs' second amended complaint (" SAC" ). Having considered the parties' briefs and accompanying submissions, as well as the oral argument of counsel, the Court hereby GRANTS the motion to dismiss.
I. FACTUAL & PROCEDURAL BACKGROUND
In their SAC, Plaintiffs allege as follows.
Oclaro is a company that manufactures and distributes core optical network components and subsystems to global telecom equipment manufacturers. See SAC at 1 n. 1; see also SAC ¶ 20. During the class period, Mr. Couder was Oclaro's CEO and a member of the board of directors. See SAC ¶ 21. During the class period, Mr. Turin was Oclaro's CFO. See SAC ¶ 22. The putative class consists of persons who purchased or otherwise acquired Oclaro common stock between May 6 and October 28, 2010. See SAC ¶ 1.
According to Plaintiffs, from May to August 2010, Defendants made false statements that, e.g., (1) current customer demand for Oclaro's products was strong and that (2) revenues and earnings for 1Q11 would increase. See SAC ¶ 1.
A. False Statements
1. May 2010
On May 6, 2010, Oclaro filed a Form 424(b)(5) Prospectus Supplement with the SEC for a secondary offering of 6.9 million shares of common stock to the public. See SAC ¶¶ 2, 4, 40. In the SEC filing, Oclaro stated that: (1) " We are currently seeing a return of customer demand which had decreased as a result of economic conditions in the preceding 18 to 24 months" ; and (2) " customer demand has recently increased in our markets." SAC ¶ 40.
Plaintiffs allege that the above statements were false because, in fact, Oclaro " had experienced a material decline in customer order trends in [April 2010]." SAC ¶ 45. Plaintiffs claim that, as a result of the April 2010 decline, Oclaro's book-to-bill ratio declined from 1.35 (in March 2010) to just over 1 (in June 2010). See SAC ¶¶ 6-7. A book-to-bill ratio is the ratio of orders taken (booked) to products shipped and bills sent (billed). It is used as a tool in determining whether demand for a product is rising or falling. " ‘ A ratio of above 1 implies that more orders were received than filled, indicating strong demand, while a ratio below 1 implies weaker demand.’ " SAC at 3 n. 4.
2. June 2010
In June 2010, Mr. Turin made statements at a conference (the RBC conference), indicating that (1) Oclaro was experiencing a surge in customer demand and that (2) customer demand was true customer demand— i.e., not just a reflection of customers building up their inventories— which Oclaro knew because (a) it was close to its customers and therefore had visibility into what their needs were  and (b) the book-to-bill ratio did not stay at the level of 1.35 (from March 2010). See SAC ¶¶ 8, 47-48.
According to Plaintiffs, these statements were false because, as noted above, there had actually been a decline in customer demand in April 2010. See SAC ¶ 49. Plaintiffs also claim that the statement about Oclaro's visibility into its customers needs was false because a confidential witness— a former Oclaro vice president of sales— confirmed that " purported close customer relationships could not be converted in any way into confidence in the strength of firmness of customer orders." SAC ¶¶ 13; see also SAC ¶¶ 32, 49, 76. According to the confidential witness, " Oclaro's customers were often reluctant to provide detailed information about their own needs to that suppliers like Oclaro would not dedicate manufacturing capacity to other customer's needs," and " these nuances are known to those who are experienced in the industry" as well as to Mr. Turin and Mr. Couder specifically. SAC ¶ 76(c). Thus, at best, Defendants " only had good visibility or a ‘ good grip’ into customer demand for about two weeks forward" but, " beyond a couple [of] weeks, ... visibility into what customers might do with orders scheduled for even 30 days out was ‘ a reach’ and beyond that was ‘ a crap shoot.’ " SAC ¶ 76(d).
3. July and August 2010
On July 29, 2010, Oclaro issued a press release announcing its 4Q10 and FY10 financial results. See SAC ¶ 52. In the same press release, Oclaro reported " accelerated and increasing financial forecasts," in particular, for 1Q11.  SAC ¶ 52. For example, for 1Q11, revenues were expected to be in the range of $120 to $126 million, and non-GAAP gross margins in the range of 31 to 33%. See SAC ¶ 53.
On July 29, 2010, Oclaro also held a conference call to discuss the 4Q10 and FY10 financial results. During the call, Mr. Turin made statements about Oclaro's current strong customer demand. See SAC ¶ 54. He also made statements about how Oclaro was expected to perform in 1Q11, consistent with the press release described above, and even beyond. See SAC ¶¶ 56-57. Similar to above, Mr. Turin attributed the customer demand to true customer demand and not inventory buildup by customers. See SAC ¶ 58.
Finally, during the July 29, 2010, conference call, Mr. Turin suggested that Oclaro would meet its 1Q11 forecast because, as of that date, " 85% to 90% of orders needed to meet [the] 1Q11 outlook were already secured," with these " order figures represent[ing] end user demand, rather than customers stocking up on inventory." SAC ¶ 11; see also SAC ¶¶ 58-59. Mr. Turin declined to answer analyst questions about whether the absolute level of orders had declined. See SAC ¶ 59. Plaintiffs suggest that this was because Mr. Turin knew that orders had declined, not increased, from the quarter ending March 2010. See SAC ¶ 76(e). Plaintiffs indicate that Mr. Turin was aware of the decline because he got weekly bookings reports and " thus [was] aware of order flows on a weekly basis." SAC ¶ 45.
Shortly thereafter, on August 11, 2010, Mr. Turin made comments during a conference (the Morgan Keegan conference), during which he reiterated that (1) Oclaro
had 90% coverage for 1Q11 and (2) customer demand was strong for all Oclaro products. See SAC ¶ 73. When Mr. Turin was questioned about his claim of 90% coverage, he indicated that he was confident about the number because Oclaro had only a few large customers and had close relationships with those customers. See SAC ¶¶ 74-75. This visibility " virtually removed the risk of inventory build up and order cancellations." SAC ¶ 74. Mr. Turin also indicated that Oclaro's customers had " ‘ push[ed] most of the inventory risk back on us .... There's not a lot of room in their food chains to build up inventory.’ " SAC ¶ 75.
Plaintiffs maintain that the above statements were false because, as noted above, a confidential witness— a former Oclaro vice president of sales— has reported that Oclaro does not in fact have visibility into customer needs. See generally SAC ¶ 76.
B. Disclosures of Truth
As alleged in the SAC, the truth was partially disclosed on July 29, 2010, and subsequently on October 28, 2010.
Plaintiffs allege that there was a partial disclosure on July 29, 2010, because, during the conference call on that day, Mr. Turin admitted that there was " ‘ a little bit of a slowdown in early April  as people digested the huge order flow in March.’ " SAC ¶ 59. Plaintiffs allege that, although there was a decrease in Oclaro's stock price as a result of this disclosure in July, see, e.g., SAC ¶¶ 66-67; SAC at 26 n. 7 (pointing to analyst reports suggesting a link between the decrease in the book-to-bill ratio to the decline in stock price), the stock price remained artificially inflated because of Defendants' " continued misleading statements concerning increasingly strong customer demand, claims of significant visibility into customer needs, and [claims] that the Company already had 85% to 90% of the order coverage ... needed to meet its increased 2Q11 forecasts." SAC ¶ 70.
According to Plaintiffs, the final disclosure took place on October 28, 2010, when Oclaro issued a press release in which it reported, inter alia, its 1Q11 financial results (ending October 2, 2010). See SAC ¶ 82. Previously, Oclaro had predicted— for 1Q11— revenues in the range of $120 to $126 million and non-GAAP gross margins in the range of 31 to 33%. See SAC ¶ 53. As it turned out, Oclaro's revenues were on the low end of the range for 1Q11 ($121 million) and it missed its gross margins (29%). See SAC ¶ 82. Apparently, these results were due to a decrease in customer demand, with customer cancellations beginning in at least the second week of September 2010. See SAC ¶¶ 82(d), 84, 87-88. During a conference call on October 28, 2010, Mr. Couder admitted to customer cancellations in September 2010 (inventory corrections) and to limited visibility into customer needs. See SAC ¶ 84.
Based on, inter alia, the above allegations, Plaintiffs have asserted two federal securities claims against Oclaro and its executives Mr. Couder and Mr. Turin:
(1) Violation of § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.
(2) Violation of § 20(a) of the Act.
In the pending motion to dismiss, Defendants seek dismissal of both claims.
Under Federal Rule of Civil Procedure 12(b)(6), a party may move to dismiss based on the failure to state a claim upon which relief may be granted. See Fed.R.Civ.P. 12(b)(6). A motion to dismiss based on Rule 12(b)(6) challenges the legal sufficiency of the claims alleged. See
Parks Sch. of Bus. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995). In considering such a motion, a court must take all allegations of material fact as true and construe them in the light most favorable to the nonmoving party, although " conclusory allegations of law and unwarranted inferences are insufficient to avoid a Rule 12(b)(6) dismissal." Cousins v. Lockyer, 568 F.3d 1063, 1067 (9th Cir.2009). While " a complaint need not contain detailed factual allegations ... it must plead ‘ enough facts to state a claim to relief that is plausible on its face.’ " Id. " A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009); see also Bell Atl. Corp. v. Twombly, 550 U.S. 544, 556, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). " The plausibility standard is not akin to a ‘ probability requirement,’ but it asks for more than sheer possibility that a defendant acted unlawfully." Iqbal, 129 S.Ct. at 1949.
In ruling on a motion to dismiss, a court may consider not only the complaint itself but also documents incorporated into the complaint by reference and matters of which a court may take judicial notice. See Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 991 (9th Cir.2009). In the instant case, Defendants have filed a request for judicial notice. Plaintiffs have made a partial objection to the request. Where it is necessary for the Court to make a ruling, it has so indicated in this order. In essence, the Court may take judicial notice of everything except for the presentations/handouts given at conferences. (This would not include the July 2010 conference call headed up by Oclaro itself.)
A. Elements of § 10(b)/10b-5 Claim
As noted above, Plaintiffs have asserted two claims against Defendants: (1) a § 10(b)/10b-5 claim and (2) a § 20(a) claim. Section 10(b) and Rule 10b-5 essentially impose liability for securities fraud. There are five elements that must be proven to establish a violation of Rule 10b-5. More specifically, a plaintiff must show " ‘ (1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss.’ " Id. at 990. As for § 20(a), it essentially provides for derivative liability; that is, it " makes certain ‘ controlling’ individuals also liable for violations of section 10(b) and its underlying regulations." Id.
Because Plaintiffs have brought securities fraud claims, Rule 12(b)(6) is not the only governing legal standard; so too are Rule 9(b) and the Private Securities Litigation Reform Act (" PSLRA" ). Rule 9(b) provides that, " [i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed.R.Civ.P. 9(b). As for the PSLRA, it requires that a plaintiff alleging securities fraud
" plead with particularity both falsity and scienter." Thus, to properly allege falsity, a securities fraud complaint must now " specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, ... state with particularity all facts on which that belief is formed." To adequately plead scienter, the complaint must now " state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."
Zucco, 552 F.3d at 990-91 (emphasis added).
In the instant case, Defendants challenge Plaintiffs' securities fraud claims on the ground that Plaintiffs have failed to adequately plead both falsity and scienter. Defendants also argue that Plaintiffs have inadequately pled loss causation.
1. May and June 2010 Statements
Plaintiffs assert that Defendants made false and misleading statements in May and June 2010 by referring to strong current customer demand when, in fact, just in April 2010, Oclaro had experienced a slowdown in such demand. Previously, the Court held that there were insufficient allegations that the slowdown was material:
As the complaint currently stands, there is essentially no indication that the slowdown was significant or material. For example, the slowdown was only for " a little bit." FAC ¶ 58. Furthermore, it appears that there was a slowdown only from " the huge order flow [that Oclaro had] in March." FAC ¶ 58. There is nothing to indicate that the slowdown meant that Oclaro's order levels had, e.g., dropped below normal or was instead a drop relative to an unusually strong March. This is particularly true since it appears that the performance for the entire quarter met expectation.
Docket No. 58 (Order at 3).
In their papers, Defendants argue that Plaintiffs have still failed to establish that the April 2010 slowdown was material. Defendants emphasize that the huge customer demand in March was the anomaly and suggest that the April slowdown was just part of a trend back to more normal or rational numbers by June. See Mot. at 5. Moreover, there is no dispute that Oclaro had a strong quarter, exceeding its guidance. See Mot. at 6.
Defendants' argument is not without force. While this is a close question, the Court concludes that given the inferences that must be drawn in Plaintiffs' favor and the applicable standard of materiality, a dismissal under Rule 12(b)(6) is not warranted. " For purposes of securities fraud, ‘ materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.’ A statement is material if ‘ a reasonable investor would have considered it useful or significant.’ " United States v. Jenkins, 633 F.3d 788, 802 (9th Cir.2011). Even if March was the anomaly, that does not necessarily mean that a reasonable investor would deem a subsequent decline— even if to more regular levels— unimportant. As a point of comparison, in Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir.2009), aff'd
__ U.S. __, 131 S.Ct. 1309, 179 L.Ed.2d 398 (2011), the Ninth Circuit disagreed with the district court's conclusion that the plaintiffs had failed to adequately allege materiality because the number of complaints of which the defendants were aware was not statistically significant. The court emphasized: " In relying on the statistical significance standard to determine materiality, the district court made a decision that should have been left to the trier of fact." Id. at 1179. " Questions of materiality ... involv[e] assessments peculiarly within the province of the trier of fact. Thus, the ultimate issue of materiality [is] appropriately resolved as a matter of law only where the omissions are so obviously important to an investor, that reasonable minds cannot differ on the question of materiality." Id. at 1178 (emphasis added; internal quotation marks omitted); see also Matrixx, 131 S.Ct. at 1318-19 (rejecting " a bright-line rule that reports of adverse event associated with a pharmaceutical company's products cannot be material absent a sufficient number of
such reports to establish a statistically significant risk that the product is in fact causing the events" ).
That a reasonable investor might deem the decline in the instant case important is supported by allegations in Plaintiffs' complaint— in particular, allegations that (1) the April 2010 downturn was responsible for the decline in the book-to-bill ratio from 1.35 in March 2010 to just over 1 in June 2010, see SAC ¶ 63, and that (2) the July 2010 disclosure of the decline in the book-to-bill ratio led to an immediate decline in the stock price. See SAC ¶ 65; No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 935 (9th Cir.2003) (noting that even if slightly delayed decline in stock price after a disclosure supports a finding of materiality). The fact that several securities analysts posited the stock price drop was due, at least in part, to the decline in the book-to-bill ratio also supports a finding of materiality. See SAC ¶ 66 (noting that the Bloomberg report stated: " Some investors may be disappointed in the deceleration in [Oclaro] book-to-bill" ); SAC ¶ 67 (noting that the Auriga report stated: " [T]his deceleration may disappoint certain class of investors" ; although adding that " the steady growth prospects should be seen as a positive by longer-term shareholders" ); SAC at 26 n. 7 (noting that Stifel report noted: " The undue weakness in the stock and sector was likely due to investors interpreting a sharp fall in the book-to-bill ... as a sign that the optical cycle was ending and the industry would return to a trend of declining profitability as supply exceeds demand after several quarters of the industry being supply constrained" ).
In their papers, Defendants argue that there were other reasons for the decline in the stock price, see, e.g., Reply at 4, 14-15, but this is really a loss causation argument rather than one of materiality. As noted above, Defendants also suggest that the April 2010 slowdown was not material because Oclaro actually exceeded its guidance for the quarter that covered the May and June 2010 statements. See Mot. at 6. While this is certainly a significant fact that favors Defendants, it does not establish as a matter of law that the April 2010 decline was not material. As Plaintiffs point out, in Litwin v. Blackstone Group, L.P., 634 F.3d 706 (2d Cir.2011), the Second Circuit found the lower court's materiality analysis problematic precisely because it
place[d] too much emphasis on ... the fact that a loss in one portfolio company might be offset by a gain in another portfolio company. [The defendant] is not permitted, in assessing materiality, to aggregate negative and positive effects on its performance fees in order to avoid disclosure of a particular material negative event. Cf. SAB No. 99, Fed.Reg. at 45,153 (noting in the context of aggregating and netting multiple misstatements that " [r]egistrants and their auditors first should consider whether each misstatement is material, irrespective of its effect when combined with other misstatements" ). Were we to hold otherwise, we would effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on the revenues of a public private equity firm like [the defendant] was immaterial.
Id. at 719. Furthermore, in Fecht v. Price Co., 70 F.3d 1078 (9th Cir.1995), the Ninth Circuit implicitly rejected the lower court's reasoning that, as a matter of law, " the defendants' failure to disclose the losses sustained by the warehouses opened in the expansion program was not a material omission because it is the profitability of the Company as a whole, not any one particular aspect of the Company's operations,
that is significant." Id. at 1080 (emphasis omitted).
For the reasons stated above, the Court holds that Plaintiffs have alleged enough facts which, while not very compelling, suffice to support a finding of materiality for purposes of Rule 12(b)(6) where all reasonable inferences are drawn in Plaintiffs' favor. To the extent Plaintiffs claim that there were statements in June 2010 about good customer visibility which were false, that is, in essence, addressed in the next section below.
2. July and August Statements
For the July and August statements, Plaintiffs seem to arguing falsity with respect to statements that Oclaro already had 85-90% order coverage for 1Q11; statements that orders represented true end-user demand and not an inventory buildup; and statements that Defendants had " a great deal of visibility" into what their customer needs are. SAC ¶ 76(a). Plaintiffs also argue that forecasts about 1Q11 and beyond were false and misleading in that they were premised on purported visibility into customer demand and purported order coverage of 85-90%. These statements are all related. In other words, Plaintiffs seem to be taking the position that: (1) statements about 85-90% coverage were false and misleading because Defendants did not adequately disclose the risk that these orders could be cancelled and in fact suggested that the orders were firm by touting good customer visibility; and (2) statements about true end-user demand were false and misleading because Defendants did not actually know this to be the case because they lacked good customer visibility although they claimed to the contrary. Thus, this claim of falsity turns on Defendants' claims of good customer visibility. According to Plaintiffs, Defendants lacked good customer visibility; in support of this allegation, Plaintiffs rely on a confidential witness known as FE1.
As pled in the complaint, " FE1 is a former Oclaro Senior Vice President of Sales who worked at the Company between 2007 and 2011. FE1 was responsible for sales of all Oclaro's products ...." SAC ¶ 76(b). According to FE1, " Oclaro's customers were often reluctant to provide detailed information about their own needs so that suppliers like Oclaro would not dedicate manufacturing capacity to other customer's needs." SAC ¶ 76(c). Furthermore, according to FE1, even though Mr. Turin " regularly met with top executives at Oclaro's key customer accounts," and even though there were " good relationships with customers," Defendants " only had good visibility or a ‘ good grip’ into customer demand for about two weeks forward" ; " the Company was not likely to receive cancellations of orders scheduled to be delivered less than a couple weeks out." SAC ¶ 76(d). " [B]eyond a couple [of] weeks, ... visibility into what customers might do with orders scheduled for even 30 days out was ‘ a reach’ and beyond that was ‘ a crap shoot.’ " SAC ¶ 76(d).
Defendants challenge Plaintiffs' reliance on FE1 in three way. First, they argue that FE1's statements lack foundation. Second, they argue that the statements are lacking in factual particularity. Finally, they argue that FE1's explanation of Oclaro's visibility into customer demand is consistent with Defendants' contemporaneous statements about customer visibility.
As to the first argument, Defendants fail in any substantive way to establish why FE's statements are lacking in foundation. In fact, Ninth Circuit case law indicates that a court's concern with respect to a confidential witness is whether he or she is " described with sufficient particularity to establish [his or her] reliability and personal knowledge" — i.e., " ‘ with
sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.’ " Zucco, 552 F.3d at 995 (discussing confidential witnesses whose statements were introduced to establish scienter, as opposed to falsity). Given that FE1 was a former senior vice president responsible for all sales of Oclaro, it is a fair inference that he or she has knowledge about what visibility Oclaro had into customers' needs.
As for the second argument, Defendants seem to contend that FE1's statements are lacking in particularity because he or she fails to allege any specific information regarding customer orders and/or cancellations. See Mot. at 8; Reply at 6. This argument is not particularly persuasive because it is not clear why FE1 would have to point to specific customers orders and/or cancellations simply to establish the falsity of a claim that Defendants had good customer visibility.
Finally, with respect to the third argument, it is hard to say, as a matter of law, that Defendants' public statements about customer visibility are entirely consistent with FE1's statements. As alleged in the complaint, Mr. Turin stated the following at the Morgan Keegan conference in August 2010:
" [W]e're very close to our customers. The customer base we support are the major telecomm equipment companies and that's a close relationship. If I had 500 customers of the same size and you couldn't drill down to the different areas within the business, you would have less visibility. But we have a great deal of visibility with these guys. We've not seen order cancellations. When we come to a quarter and there are orders that are unfulfilled, those tend to roll into the next quarter."
FAC ¶ 75 (emphasis added). There were no real qualifications about customer visibility— e.g., that visibility was only ...