IN RE: NVIDIA CORPORATION SECURITIES LITIGATION, ROBERTO COHEN; NEW JERSEY CARPENTERS PENSION AND ANNUITY FUNDS, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants,
NVIDIA CORP.; JEN-HSUN HUNAG; MARVIN D. BURKETT, Defendants-Appellees
Argued and Submitted, San Francisco, California:
January 14, 2014.
Appeal from the United States District Court for the Northern District of California. D.C. No. 3:08-cv-04260-RS. Richard Seeborg, District Judge, Presiding.
The panel affirmed the district court's dismissal of a securities fraud action against NVIDIA Corp., a publicly traded semiconductor company, and other defendants under § § 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities Exchange Commission Rule 10b-5.
The amended complaint alleged that NVIDIA should have informed investors of product defects earlier and that absent such a disclosure, the company's intervening statements regarding its financial condition were misleading to investors.
The panel held that the plaintiffs failed adequately to allege scienter by stating with particularity facts giving rise to a strong inference that the defendants acted with the required state of mind, as required by the Private Securities Litigation Reform Act, because they intentionally misled investors, or were at least deliberately reckless. Agreeing with the Third Circuit, the panel held that the district court did not err by failing to consider plaintiffs' allegations of scienter in the context of Item 303 of Regulation S-K, C.F.R. § 229.303, because Item 303's disclosure duty is not actionable under § 10(b) and Rule 10b-5. The panel held that none of the plaintiffs' allegations of scienter created a strong inference of scienter individually and that, together, they did not give rise to a strong inference of scienter holistically. The panel concluded that neither the corporate scienter doctrine nor the core operations doctrine supported a strong inference of scienter.
David Brower (argued), Brower Piven, New York, New York, for Plaintiffs-Appellants.
James Kramer (argued) and Michael Torpey, Orrick, Herrington & Sutcliffe, LLP, San Francisco, California, for Defendants-Appellees.
Before: Richard C. Tallman and Sandra S. Ikuta, Circuit Judges, and Beverly Reid O'Connell, District Judge.[*] Opinion by Judge O'Connell.
O'CONNELL, District Judge:
This case involves allegations of securities fraud. Defendant NVIDIA Corporation is a publicly traded semiconductor company. In the spring of 2008, it disclosed to investors information about defects in two of its products. A little over one month later, it further disclosed that it would be taking a $150-$200 million charge to cover costs arising from those product defects. As a result, NVIDIA's share price dropped 31% and its market capitalization contracted by $3 billion. According to Plaintiffs, who had purchased NVIDIA's stock in the preceding eight months, the company knew it would be liable for the defective products long before its 2008 disclosures. They claim that NVIDIA should have informed investors about the defects as early as November 2007. They further contend that, absent a disclosure about the product defects, NVIDIA's intervening statements regarding its financial condition were misleading to investors, and consequently in violation of Section 10(b) of the Securities Exchange Act of 1934 and corresponding Securities Exchange Commission (" SEC" ) Rule 10b-5.
The district court below dismissed Plaintiffs' amended complaint without further leave to amend, holding that it failed to adequately allege scienter, a necessary element for a claim under either Section 10(b) or Rule 10b-5. We have jurisdiction under 28 U.S.C. § 1291.
On appeal, Plaintiffs essentially raise three distinct arguments, all directed to the element of scienter. First, they argue that the disclosure duty under Item 303 of Regulation S-K, 17 C.F.R. § 229.303, is actionable under Section 10(b) and Rule 10b-5. A proper analysis, they contend, should ascertain whether Defendants acted with scienter in violating Item 303's disclosure duty. Second, Plaintiffs assert that the district court failed to consider their allegations holistically. They contend that, when considered holistically, their allegations give rise to a strong inference of scienter. Third, Plaintiffs argue that the district court erred in finding that neither the corporate scienter doctrine nor the core operations doctrine supports a strong inference of scienter.
For the reasons discussed below, we affirm.
NVIDIA Corporation is a publicly traded semiconductor company founded in 1993 by Jen-Hsun Huang, its current CEO. Its core business involves the design and sale of two similar semiconductor chips. One is a graphics processing unit (" GPU" ); the other is a media and communications processor (" MCP" ). In essence, GPUs are designed to process the vast amount of data necessary to render images to a computer's visual display. MCPs are similar to GPUs in that they function as a GPU in addition to various other devices, such as a system memory interface, Ethernet communications controller, and audio signal processor. Original equipment manufacturers (" OEMs" ), such as Hewlett-Packard (" HP" ) and Dell Computer (" Dell" ), purchase these chips and incorporate them into the motherboards of computers they assemble and sell to consumers.
In addition to their similar functions, GPUs and MCPs also share a similar configuration, which comprises two main parts: (1) a " die," or the silicon chip itself; and (2) a " substrate," or wafer, which is a green circuit board that ultimately connects the die to the motherboard's electrical
components. To manufacture the GPUs and MCPs, the die is mounted onto the substrate. Importantly, the die electronically connects to the substrate through " bumps" of solder that relay electrical signals between the die and the rest of the computer. The bumps are attached to the substrate using a solder paste. Between the die and substrate is an " underfill," which is a glue-like material that acts as an additional bonding agent to fortify the connection between the die and substrate. Together, the solder and underfill are referred to as the " Material Set."
Given the highly complex and technical nature of NVIDIA's GPU and MCP products, there is an inherent risk that some will fail. As a result, NVIDIA routinely includes in its SEC forms a statement explaining that " [its] products may contain defects or flaws," and warning investors that " [it] may be required to reimburse customers for costs to repair or replace the affected products." To cover costs relating to inevitable defects, NVIDIA automatically records a reduction to revenue as a cash reserve. As product return and replacement costs accrue, NVIDIA withdraws cash from that reserve.
According to the complaint, in September 2006, NVIDIA began experiencing problems with certain of its GPU and MCP products, particularly with those products' Material Set. Plaintiffs allege that some of NVIDIA's chips experienced cracks in the solder bumps when subjected to excessive pressure during product testing. At that time, NVIDIA had been using a " eutectic" solder (which has a relatively low lead content) together with eutectic solder paste. In an attempt to remedy the cracking problem, NVIDIA switched some of the solders used in the chips from a eutectic solder to a high-lead solder, which is more malleable and therefore less susceptible to cracking from the pressure in product testing. It continued to use the eutectic solder paste, however. According to Plaintiffs, varying thermal properties of the new, high-lead solder and the eutectic solder paste contributed to new problems with NVIDIA's chips. Specifically, because the two materials undergo thermal expansion at varying rates, the high-lead solder is susceptible to fatigue and cracking over time.
At some point, these new problems began manifesting in laptop computers incorporating NVIDIA's GPU and MCP products that were made using high-lead solder. After HP (and later Dell) began investigating these problems, it observed new cracking of the solder bumps connecting the die to the substrate (the " Material Set Problem" ). At first, NVIDIA attributed the problem to " 'customer-induced damage or [OEM] design issues.'" HP hypothesized that heat cycling was the root cause of the problem. Specifically, HP believed that the solder bumps would weaken over time due to repeated thermal expansion caused by heat cycling.
To reduce the stress on the chips' solder bumps, and thus ameliorate the cracking problem, HP and Dell, with the help of
NVIDIA, issued software updates (" BIOS"  updates) to their laptop computers. These BIOS updates altered a computer's fan algorithm, causing the internal cooling fans to run continuously, thereby eliminating heat cycling. Evidently, HP believed that by maintaining a fairly constant temperature, the solder bumps would not undergo thermal expansion as often and thus not be as susceptible to fatigue and failure.
Ultimately, after significant testing, HP concluded that the root cause of GPU and MCP failures in its computers was not caused by cracking due to heat cycling, but by cracking due to operation of the chips within a narrow temperature range. Apparently, the stress on the solder bumps caused by varying thermal properties of the high-lead solder and eutectic solder paste was especially acute in this temperature range. HP shared with NVIDIA its data demonstrating this problematic thermal profile, and, at some point, NVIDIA reproduced the data in its own laboratories.
In May and June 2008, NVIDIA issued to its OEM customers Product Change Notifications (" PCNs" ), indicating that it would be transitioning back to eutectic solder.
Between November 8, 2007, and May 22, 2008, NVIDIA filed several forms with the SEC, as required by law. According to Plaintiffs, those forms contained materially false and misleading statements, principally because they omitted information regarding the Material Set Problem.
For example, in the November 8, 2007 Form 8-K, Plaintiffs point to NVIDIA's claim that " [its] core businesses are continuing to grow as the GPU becomes increasingly central to today's computing experience." In NVIDIA's February 13, 2008 Form 8-K, it highlights the assertion that " Fiscal 2008 was another outstanding and record year for us. Strong demand for GPUs in all market segments drove our growth." Plaintiffs argue that these statements and others made in NVIDIA's March 21, 2008, Form 10-K and May 8, 2008, Form 8-K are materially false and misleading because NVIDIA failed to disclose reported defects in its products as well.
On May 22, 2008, NVIDIA disclosed in its quarterly report that it had received claims for reimbursement from one of its OEMs for incremental costs due to an " 'alleged die/packaging material set defect.'" The report also indicated that the product was included in a significant number of the customer's computer products and had been shipped to other customers in significant quantities. NVIDIA explained that it was " evaluating the potential scope" of the problem " and cause of the alleged defect and the merits of the customer's claim." It further indicated that it was " unable to estimate the amount of costs that may be incurred" at that time.
Just over one month later, on July 2, 2008, NVIDIA filed an SEC Form 8-K indicating it would be taking " a $150 to $200 million charge to cover warranty, repair, return, replacement, and other costs 'arising from a weak die/packaging material set in certain versions of [its] previous MCP and GPU products used in notebook systems.'"  After NVIDIA's July 2, 2008
disclosure, the market reacted accordingly, causing a 31% decline in NVIDIA's share price and a decrease of over $3 billion in its market capitalization.
Plaintiffs invested in NVIDIA's stock between November 8, 2007 and July 2, 2008 (the " class period" ). They allege that, beginning November 8, 2007, NVIDIA knew of the defect in the GPU and MCP Material Set, this knowledge was material to investors, and failure to disclose it made other statements in NVIDIA's SEC filings misleading.
Believing that Defendants violated federal securities laws, Plaintiffs filed three separate lawsuits, which the district court consolidated into a single action. In the consolidated complaint, Plaintiffs allege three distinct but related counts. In the first and second counts, they allege that NVIDIA and Huang, respectively, are liable for violations of both Section 10(b) of the Securities Exchange Act of 1934 and corresponding SEC Rule 10b-5. In the third count, they aver that Huang is further liable for violations of Section 20(a) of the Securities Exchange Act of 1934.
Upon Defendants' motion, the district court dismissed Plaintiffs' first consolidated class action complaint with leave to amend. Plaintiffs then filed a second consolidated class action complaint. Upon a second motion by Defendants, the district court dismissed that complaint without leave to amend. In its order of dismissal, the district court specifically held that Plaintiffs failed to sufficiently plead scienter, an element required for each count.
We review dismissals under Federal Rule of Civil Procedure 12(b)(6) de novo. In re Daou Sys., Inc., 411 F.3d 1006, 1013 (9th Cir. 2005). In doing so, we accept as true all factual allegations and determine whether they are sufficient to state a claim for relief; we do not, however, accept as true allegations that are conclusory. Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009). Moreover, " [f]actual allegations must be enough to raise a right to relief above the speculative level." Bell A. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 ...