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Bao v. Solarcity Corp.

United States District Court, N.D. California, San Jose Division

April 27, 2015

TAI JAN BAO, et al., Plaintiffs,
SOLARCITY CORPORATION, et al., Defendants.



Before the Court is the Motion to Dismiss Amended Complaint by defendants SolarCity Corporation, Lyndon R. Rive, Robert D. Kelly, and Elon Musk (collectively, "Defendants"). Def.'s Mot., ECF 58. The Court heard oral argument on April 16, 2015. For the reasons set forth herein and on the record, Defendants' Motion to Dismiss is GRANTED with leave to amend.


Lead plaintiff James Webb ("Plaintiff") represents a putative class of investors who purchased securities from defendant SolarCity Corporation during a class period beginning December 12, 2012 and ending March 18, 2014. SolarCity is a Delaware corporation that sells renewable solar energy to customers in fourteen states. Amended Compl. ("FAC") ¶¶ 19-25. Defendant Rive co-founded the company with his brother and is SolarCity's Chief Executive Officer. Defendant Kelly was the company's Chief Financial Officer during the relevant time period. Defendant Musk is the Chairman of the Board of Directors and provided the "initial concept" for SolarCity. Musk and Rive are cousins. Id. ¶¶ 20-22.

SolarCity derives revenue from two types of business operations: sales of its solar energy systems and renewable twenty-year leases of its solar energy products. Id. ¶¶ 27-29. Under Generally Accepted Accounting Principles ("GAAP"), revenue from sales is recognized in full upon installation of the solar energy system, whereas revenue from leases is amortized across the term of the lease so that only a fraction of the total value of the lease is recognized in any given year. Id. ¶¶ 30-31. Gross profit and net income are calculated under GAAP after the cost of goods sold is subtracted from sales revenue. Id. ¶ 32. Plaintiff alleges that during the class period, Defendants deliberately misallocated overhead expenses for the sales operation to the leasing unit in order to improve the sales unit's gross margin and make it appear profitable. Id. ¶ 43.

On March 3, 2014, SolarCity announced that due to an error in its formula for allocating overhead expenses between operating lease assets and the cost of solar energy systems sales, it had "discovered tens of millions in overhead expenses that it had incorrectly classified." Id. ¶¶ 9, 173. On March 18, 2014, the company disclosed restated numbers for its financial statements for the year ended December 31, 2012, as well as for each quarter in 2012 and 2013. Id. ¶¶ 11, 176. The restated numbers revealed that instead of the reported profitability that the sales operation had enjoyed since December 2012, the unit was actually losing money.

Most notably, in 2012-the year in which SolarCity went public-Defendants reported full year sales revenues higher than their corresponding costs, resulting in a gross profit margin of 21% for the company's solar energy systems sales operation. Id. ¶ 46. By contrast, in the two years prior to going public, SolarCity reported negative gross margins for its sales unit of (19%) in 2010 and (14%) in 2011. Id. After the restatement, it became clear that the 2012 sales unit gross margin was also negative: it was (5%) instead of the reported 21%. Id. The overstatement of gross profit and gross margin for the sales unit continued for seven consecutive quarters from Q1 2012 to Q3 2013. In each quarter, the reported sales gross margin was consistently positive (though the amount fluctuated) while, following the restatement, the restated gross margin was generally negative, with only two quarters (Q1 and Q3 2012) showing modest profitability. Id. ¶ 47. Plaintiff alleges that this misallocation of indirect costs for solar systems sales also materially affected SolarCity's other reporting metrics including net income and earnings per share (EPS). Id. ¶ 48. As such, Plaintiff points to a slew of allegedly misleading statements made in SolarCity's financial statements and press releases during the Class Period, each embodying or reflecting the misallocation of overhead expenses for the sales operation. See id. ¶¶ 78-172.

SolarCity had previously had to restate its financial statements for 2008, 2009, and 2010 due to discovered weaknesses in internal control over financial reporting. Id. ¶ 34. Confidential witnesses claim that SolarCity's accounting and financial systems "continued to be flawed in 2012" in the months leading up to the IPO. Id. ¶¶ 36-37. Plaintiff alleges that Defendants disregarded these known flaws and intentionally manipulated SolarCity's financial statements to create a "façade of profitability for its critical solar energy systems sales." Id. ¶ 46. Plaintiff claims that Defendants were motivated by SolarCity's looming initial public offering ("IPO") in December 2012, as well as subsequent secondary offerings and strategic acquisitions, to make the company appear profitable. Id. ¶¶ 57-64. Moreover, defendant Musk had pledged six million shares of his SolarCity stock-about one third of outstanding shares-to partially secure a $275 million loan from Goldman Sachs, which Plaintiff alleges contributed to Musk's motive to keep SolarCity's share prices artificially inflated so as to avoid a forced sale of his stock from margin calls. Id. ¶¶ 65-69. Finally, Plaintiff points to SolarCity's replacement of its Chief Operating Officer in February 2014 and Kelly's resignation from his position in July 2014 as evidence that Defendants were culpably aware of SolarCity's financial manipulation throughout 2012 and 2013.

Based on the foregoing allegations, Plaintiff asserts claims for (1) securities fraud under § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 of the Securities and Exchange Commission ("SEC") and (2) controlling person liability under § 20(a) of the Exchange Act.


A. Rule 12(b)(6)

"A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted tests the legal sufficiency of a claim.'" Conservation Force v. Salazar, 646 F.3d 1240, 1241-42 (9th Cir. 2011) (quoting Navarro v. Block, 250 F.3d 729, 732 (9th Cir. 2001)). When determining whether a claim has been stated, the Court accepts as true all well-pled factual allegations and construes them in the light most favorable to the plaintiff. Reese v. BP Exploration (Alaska) Inc., 643 F.3d 681, 690 (9th Cir. 2011). However, the Court need not "accept as true allegations that contradict matters properly subject to judicial notice" or "allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences." In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008) (internal quotation marks and citations omitted). While a complaint need not contain detailed factual allegations, it "must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). A claim is facially plausible when it "allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id.

B. Rule 9(b) and the PSLRA

In addition to the pleading standards discussed above, a plaintiff asserting a private securities fraud action must meet the heightened pleading requirements imposed by Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA"). In re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694, 701 (9th Cir. 2012). Rule 9(b) requires a plaintiff to "state with particularity the circumstances constituting fraud...." Fed.R.Civ.P. 9(b); see also In re VeriFone Holdings, 704 F.3d at 701. Similarly, the PSLRA requires that "the complaint shall specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading...." 15 U.S.C. § 78u-4(b)(1)(B). The PSLRA further requires that the complaint "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. § 78u-4(b)(2)(A). "To satisfy the requisite state of mind element, a complaint must allege that the defendant[ ] made false or misleading statements either intentionally or with deliberate recklessness." In re VeriFone Holdings, 704 F.3d at 701 (internal quotation marks and citation omitted) ...

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