Bao v. Solarcity Corp.

          ORDER GRANTING MOTION TO DISMISS THIRD AMENDED COMPLAINT WITH PREJUDICE [Re: ECF 81]

          BETH LABSON FREEMAN United States District Judge.

         Over the past two years, Plaintiffs have offered four iterations of their complaint for this securities class action case. See Compl., ECF 1; First Amended Compl. (“FAC”), ECF 56; Second Amended Compl. (“SAC”), ECF 66; Third Amended Compl. (“TAC”), ECF 78. The Court has previously dismissed the complaint on two occasions, both times through a reasoned order specifically outlining the deficiencies in Plaintiffs’ allegations and with leave to amend. See Order Granting Motion to Dismiss Amended Compl. With Leave to Amend (“First Dismissal Order”), ECF 65; Order Granting Motion to Dismiss SAC With Leave to Amend (“Second Dismissal Order”), ECF 77. Defendants argue that, notwithstanding this guidance, Plaintiffs have again failed to cure the deficiencies and that the TAC should be dismissed with prejudice. Mot., ECF 81. This time, the Court agrees. For the reasons stated below, Defendants’ Motion to Dismiss the TAC is granted with prejudice.

         I. BACKGROUND

         The Court has previously granted Defendants’ motion to dismiss on two occasions. In the First Dismissal Order, the Court granted leave to amend all claims. In the Second Dismissal Order, the Court dismissed former defendant Elon Musk with prejudice but otherwise allowed amendment. The following is a summary of the amended allegations of the TAC.

         Defendant SolarCity Corporation (“SolarCity”) is a Delaware corporation that offers solar energy systems for sale or lease. TAC ¶¶ 20, 28-30. Defendant Lyndon R. Rive is SolarCity’s Chief Executive Officer (“CEO”). Id. ¶ 21. Defendant Robert D. Kelly was the company’s Chief Financial Officer (“CFO”) during the relevant period. Id. ¶ 22. The Court refers to Mr. Rive and Mr. Kelly collectively as “Individual Defendants.” Although he is not a named defendant, Plaintiffs make certain allegations against Peter Rive, SolarCity’s co-founder and Chief Technology Officer and Lyndon Rive’s brother. Id. ¶ 21.

         Lead Plaintiff James Webb and Plaintiff Tai Jan Bao (“Plaintiffs”) seek to represent a putative class of investors who purchased SolarCity securities between December 12, 2012 and March 18, 2014 (“Class Period”). Id. ¶¶ 1, 19. Plaintiffs allege that, during this time, Defendants manipulated an accounting formula to “portray the illusion of profitability” by shifting overhead costs from sales, where they would be recognized immediately, to leases, where they amortized over a twenty-year period. Id. ¶¶ 58, 71. Specifically, Plaintiffs allege that Defendants inflated a ratio used to allocate overhead costs to leases (“burden ratio”) by including the prior period’s overhead costs in the numerator, but excluding the prior period’s direct costs from the denominator. Id. ¶¶ 71-72. This formula change did not affect the company’s allocation of direct costs between sales and leases, but did cause an inflated portion of overhead costs to go to leases.

         Plaintiffs allege that this error in the burden ratio violated Generally Accepted Accounting Principles (“GAAP”) and enabled Defendants to overstate sales gross margins for seven consecutive quarters. Id. ¶¶ 31-33, 61-63. Plaintiffs allege that the timing of the misreporting, which began in Q1 2012, enabled SolarCity to raise $ 94 million in its December 2012 initial public offering (“IPO”). Id. ¶ 74. In addition to the IPO, the change in the burden ratio-which permitted the company to report seven consecutive quarters of highly improved sales gross margins-enabled SolarCity to secure an additional $396 million from stock and note offerings in 2013 and to acquire two companies by paying with SolarCity’s common stock. Id. ¶¶ 74, 79, 81-86. Plaintiffs allege that this fundraising was necessary for SolarCity, and that the acquisitions enabled SolarCity to acquire complementary technologies and assets, thereby giving Defendants a clear motive for the fraud. Id. ¶ 83.

         Plaintiffs allege that Defendants were also motivated to create the accounting error and misstate their financials to help Elon Musk, who allegedly provided the initial concept for SolarCity, is Mr. Rive’s cousin, and remains SolarCity’s largest shareholder. Id. ¶¶ 91-92. Plaintiffs allege that Mr. Musk secured $275 million in loans from Goldman Sachs in part with SolarCity capital stock and that Defendants were motivated to keep SolarCity’s common stock at artificially inflated prices to avoid a forced sale of Mr. Musk’s stock. Id. ¶¶ 91, 95.

         Plaintiffs additionally allege that Defendants knew that SolarCity’s internal controls were weak, having had to issue restatements of 2008, 2009, and 2010 consolidated financial statements and having experienced delays in the close process for the 2010 and 2011 statements because of deficiencies in the design and operation of SolarCity’s internal controls. Id. ¶ 35.

         Plaintiffs also offer statements by eleven confidential witnesses (“CWs”) to suggest that the Individual Defendants knew of or deliberately ignored this accounting error at the time that it was made. CWs 1 and 2 have been in the complaint since the FAC. Both of these witnesses left SolarCity before the Class Period. They stated that SolarCity’s accounting and financials were “a mess” and that the corporate controller likely informed Individual Defendants of “what they were doing” with overhead accounting. Id. ¶¶ 37-38.

         In the SAC, Plaintiffs introduced eight new CWs. Five of the new witnesses-CWs 3, 6, 8, 9, and 10-similarly did not work at SolarCity during the Class Period, which commenced in December 2012, the same month SolarCity went public.^[1] These witnesses explained that, during their tenure with SolarCity, the cost accounting team was “lean, ” id. ¶ 39 (CW 3); Mr. Kelly sat with the accounting department, id. ¶ 50 (CW 8), and was involved in accounting policy decisions, id. ¶¶ 39 (CW 3), 48 (CW 6); and Mr. Rive was also involved in accounting discussions at “a high level, ” id. ¶ 48 (CW 6), and the decisions of other departments on a more detailed basis, id. ¶¶ 51 (CW 9), 52 (CW 10). CWs also recalled that the Rive brothers told employees at all-hands meetings, held at unidentified times between November 2007 and September 2012, “We’re not profitable on a GAAP basis” but that, on a non-GAAP basis, long-term revenue could cover short-term costs, id. ¶ 50 (CW 8), and stated that the company had to show profit before it could go public, id. ¶ 51 (CW 9).

         Of the witnesses who worked at SolarCity during the Class Period, CW 4, an Accounts Payable Specialist from January 2011 to August 2014, stated that the overhead costs team consisted of seven employees who stayed in corporate headquarters even after other accounting department employees transferred to Las Vegas in 2012. Id.¶ 40. CW 5 was a Project Development Manager at SolarCity from July 2011 to May 2014, both before and during the Class Period. CW 5 made “cash sales, ” which Plaintiffs define as “generally sales of large solar systems, ” to public entities. Id. ¶ 41. S/he reported to the Vice President of Commercial Sales and participated on conference calls with Mr. Rive. CW 5 stated that Mr. Rive knew about cash sale projects that came in with negative margins. Id. ¶ 41, 45.

         In the TAC, Plaintiffs offer additional statements from CW 5. Id. ¶¶ 42-44, 46. CW 5 specified that sales “were not making profit margins, or if they were, they were much lower than expected” during the Class Period. Id. ¶ 42. CW 5 explained that, by talking with other sales people, s/he learned that the company’s cash sale projects in general, and not only his/her own sales, were showing negative or far below expected “cash margins.” Id. ¶ 42. CW 5 also stated that “everybody at the high level knew about” the poor performance of the cash sales and that, starting in mid-2012, unspecified individuals “kept discouraging us from doing cash deals.” Id. ¶ 44. As in the SAC, CW 5 explained that s/he regularly participated in conference calls with Mr. Rive and sometimes Mr. Kelly “to discuss cash sale projects that came in with negative margins.” Id. ¶ 45. CW 5 also recalled that reports about cash sales projects were submitted to Individual Defendants. CW 5 did not know if Individual Defendants “looked at [the reports] line by line” but stated that “[t]hey were verbally aware of the situation.” Id. ¶ 46.

         In the TAC, Plaintiffs also introduce CW 11, the Office Manager for SolarCity’s corporate headquarters in San Mateo from June 2010 to September 2013. Id. ¶ 53. CW 11 stated that s/he knew from conversations with colleagues and comments by Mr. Rive and Mr. Kelly in meetings that SolarCity was not earning profit during his/her employment. Id. ¶ 53.

         On March 3, 2014, Defendants announced that senior management had discovered an error in the overhead accounting formula that had originated in Q1 2012. Id. ¶ 67. Shortly before the disclosure, Peter Rive stepped down as Chief Operations Officer. Id. ¶ 81. On March 18, 2014, Defendants issued restated financials, which revealed that, contrary to SolarCity’s prior reports of consistent sales profit, sales had had a negative gross margin for six of the affected quarters (Q2 and Q4 2012 and every quarter of 2013) and made only a slight profit in two of them (Q1 and Q3 2012). Id. ¶ 203. In August 2014, Mr. Kelly resigned as CFO. Id. ¶ 82.

         Plaintiffs allege that the disclosure shows that Individual Defendants were responsible for and monitored the company’s gross margins, and were well-versed in cost accounting. Id. ¶ 69. Plaintiffs also allege that the burden ratio was properly calculated for the years that did not directly affect the IPO, as shown by the fact that Defendants did not need to restate financial for 2010 and 2011. Id. ¶ 74.

         Based on the above allegations, the TAC, like the FAC and SAC, asserts that (1) all Defendants violated § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 of the Securities and Exchange Commission (“SEC”) and (2) each Individual Defendant is liable as a controlling person under § 20(a) of the Exchange Act.

         II.LEGAL STANDARDS

         A. Rule 12(b)(6)

         To survive a Rule 12(b)(6) motion to dismiss, “a complaint 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 Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007)). When considering a motion to dismiss, the Court “accept[s] factual allegations in the complaint as true and construe[s] the pleadings in the light most favorable to the nonmoving party.” Manzarek v. St. Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1031 (9th Cir. 2008). The Court “need not, however, accept as true allegations that contradict matters properly subject to judicial notice or by exhibit.” Sprewell v. Golden State Warriors, 266 F.3d 979, 988 (9th Cir. 2001).

         B. Rule 9(b) and the PSLRA

         In addition, 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 PSLRA. See 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, 704 F.3d at 701. Similarly, the PSLRA requires that the complaint “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, 704 F.3d at 701 (internal quotation marks and citation omitted) (alteration in original). The scienter allegations must give rise not only to a plausible inference of scienter, but to an inference of scienter that is “cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007).

         C. Confidential Witnesses

         To satisfy the PSLRA, “a complaint relying on statements from confidential witnesses must pass two hurdles.” Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009) (citing In re Daou Sys., Inc., 411 F.3d 1006, 1015-16 (9th Cir. 2005)). First, the confidential witnesses “must be described with sufficient particularity to establish their reliability and personal knowledge [of the events ...