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Manger v. Leapfrog Enterprises Inc.

United States District Court, N.D. California

May 9, 2017

PETE J. MANGER, Plaintiff,
LEAPFROG ENTERPRISES, INC., et al., Defendants.


          William H. Orrick United States District Judge.

         In this shareholder derivative lawsuit, plaintiff Pete Manger alleges that defendant Leapfrog Enterprises, Inc. (LeapFrog) and seven of its former Board of Directors members violated the Securities and Exchange Act of 1934 by issuing a false and misleading Recommendation Statement that recommended that shareholders of LeapFrog tender their shares pursuant to a Tender Offer from VTech. On a prior motion to dismiss, I found that Manger failed to state a claim under Section 14(e) of the Exchange Act because he failed to allege with the required specificity which statements in the Recommendation Statement were false or misleading and why, failed to allege facts showing scienter, and failed to allege facts showing loss causation. I dismissed that claim, along with the pendent Section 20(a) claim, with leave to amend.[1]

         Manger filed his Second Amended Complaint (“SAC”), attempting to fix the problems I identified. He did not. For the reasons discussed below, I GRANT defendants' motion and dismiss Manger's SAC without leave to amend.


         In February 2016, LeapFrog, VTech, and VTech's wholly owned subsidiary Bonita Merger Sub, LLC entered into an agreement and plan of merger (Merger Agreement). Pursuant to the terms of the Merger Agreement, VTech made a Tender Offer on March 3, 2016 (expiring April 1, 2016), whereby each LeapFrog share would be cashed out for $1.00. Second Amended Complaint (SAC) ¶ 8.

         On March 3, 2016, LeapFrog filed a Schedule 14D-9 Solicitation/Recommendation Statement with the Securities and Exchange Commission and disseminated it to its shareholders. The Recommendation Statement recommended that shareholders agree to the $1.00 a share Tender Offer. In his SAC, Manger identifies the following false or misleading statements from the Recommendation Statement:

• The deterioration in the Company's business, the major declines in revenues in the past three fiscal years, the timing for its prospects for future growth, including substantial continuing declines anticipated in the children's Tablet business that provided significant revenue and contributed to operating profits and cash flow in prior periods, and the general risks associated with Company's ability to execute on a business plan that would create stockholder value in excess of the consideration offered in the Merger;
The significant possibility that the Company would not have sufficient liquidity available from its cash balances and available credit facility to continue its operations during the first and second quarter of the 2017 fiscal year, leading to the Company's expression of significant and credible doubt that it will be able to continue operations as a going concern;
• The performance of LeapTV, a major new product launch, which required significant costs to develop, and which has fallen significantly short of sales goals. This resulted in a significant reduction to available liquidity and in high costs to assist retailers to reduce their excess inventories and to clear out LeapTV inventories across the Company's supply chain;
• The need to develop new products to remain competitive and relevant to maintaining existing and obtaining prospective customers, the substantial required investment and long lead times associated with new products, and the risk that the Company could make substantial investments in products for markets that do not develop as, or develop more slowly than, the Company may have originally anticipated.

         SAC ¶ 10 (citing Recommendation Statement, p. 22) (emphasis in SAC).

         According to Manger, these “critical” statements went to the core of the business being able to operate as an ongoing concern and were false and/or misleading because they conveyed a more dire financial situation than actually existed. SAC ¶ 11. Defendants relied on these assertions of financial straits and the liquidity problem to push the Tender Offer and justify their position that there was no time to consider offers other than VTech's. Id. ¶ 12. Manger asserts that the March 2016 representations of a liquidity problem were false because, as of a November 9, 2015 earnings call, LeapFrog had no debt obligations and had access to a $75 million revolving credit facility to fund working capital through the fourth quarter, when cash flow was expected to turn positive again. Id. ¶ 13. In that same call, defendant John Barbour (the former CEO) noted LeapFrog's gain in market share in the children's tablet segment, due primarily to the new “EPIC” tablet that had not yet been fully rolled out. Id. ¶ 14. Two confidential witnesses (CW1, a former LeapFrog senior allocations analyst who was employed through September 2016, and CW2 a former manager of sales analytics through May 2016) confirmed that the early roll out of the EPIC tablet was a success and that at company-wide meetings in March 2016 - prior to the close of the Tender Offer - unnamed senior executives reported that LeapFrog was in a “good position” with $40 million in cash, and that with the credit facility the company could have continued as a standalone company for at least another year. Id. ¶¶ 15-16; see also id. ¶¶ 57-58. LeapFrog also acknowledged the success of the EPIC tablet during the negotiations of the merger and Tender Offer, even commencing a trademark infringement action in July 2016 in order to protect the valuable intellectual property rights LeapFrog had in EPIC. Id. ¶ 17.

         After conducting its own investigation, the United Kingdom's Competition and Markets Authority (“CMA”) concluded that there “would have been alternative purchasers for LeapFrog had the VTech Transaction not proceeded” and LeapFrog had sufficient liquidity for operations through June/July 2016. Id. ¶ 18; see also id. ¶¶ 65-67. Finally, Manger notes that in 2015 defendant Barbour announced a number of “cost cutting” efforts and a “major strategic review” in order to guide the company's future, which in part led to the launch of EPIC. Id. ¶¶ 5, 48.

         By ignoring these “positives, ” Manger argues, the Recommendation Statement statements were false or misleading because defendants failed to include: (i) the information about cash and the credit facility; (ii) the remarkable success of the EPIC tablet; (iii) the possibility of other potential buyers; and (iv) any actual internal financial measures. Instead, the Statement repeatedly emphasized the failure of the LeapTV product as the source of its declining revenues and liquidity problems. Id. ¶¶ 19, 21.

         According to Manger, in their rush to push through the VTech Tender Offer the defendants also failed to have their financial advisor Morgan Stanley & Co LLC (who rendered the fairness opinion) run “critical” but unnamed financial valuations “typically” performed in these circumstances. Id. Instead, Morgan Stanley performed a liquidation analysis that it was not qualified to do on which the Board relied on in recommending the Tender Offer. Id. ¶ 20. Defendants also discouraged other bidders by providing VTech with “unreasonable deal-protection” devices, including preventing Board members from soliciting other bids, requiring information about other bids to be provided to VTech, giving VTech five days to make a competing offer, and imposing a $2.9 million termination fee. Id. ¶ 26.

         Manger alleges that despite the potential for future growth - presumably from EPIC and the other unspecified measures resulting from the strategic review - and the alleged ability to fund operations for another year, defendants agreed to the inadequate merger considerations and rejected and/or shut down the bidding process with other companies. Id. ¶ 24. Defendants did so, according to Manger, in order to reap the benefits from “accelerated vesting” of stock options and payments under the employee stock purchase plan and thereby benefitted by giving themselves “liquidity” that they otherwise would not have had. Id. ¶¶ 24-25.

         In early April 2016, 56% of outstanding shares were tendered, just enough to effectuate the merger. All LeapFrog shareholders were cashed out of their shares at $1.00 per share. SAC ¶ 8.


         Under Federal Rule of Civil Procedure 12(b)(6), a district court must dismiss a complaint if it fails to state a claim upon which relief can be granted. To survive a Rule 12(b)(6) motion to dismiss, the plaintiff must allege “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). A claim is facially plausible when the plaintiff pleads facts that “allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (citation omitted). There must be “more than a sheer possibility that a defendant has acted unlawfully.” Id. While courts do not require “heightened fact pleading of specifics, ” a plaintiff must allege facts sufficient to “raise a right to relief above the speculative level.” Twombly, 550 U.S. at 555, 570.

         In deciding whether a plaintiff has stated a claim upon which relief can be granted, the Court accepts plaintiff's allegations as true and draws all reasonable inferences in favor of the plaintiff. Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987). However, the court is not required to accept as true “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). Moreover, in this case, with omissions-based claims asserted under Section 14(e) of the Exchange Act, the heightened pleading requirement of Rule 9(b) applies. See, e.g., Deutsch v. Flannery, 823 F.2d 1361, 1362 (9th Cir. 1987) (applying Rule 9(b) to 14(e) claim that tender offer solicitation “failed to disclose” material information).

         If the court dismisses the complaint, it “should grant leave to amend even if no request to amend the pleading was made, unless it determines that the pleading could not possibly be cured by the allegation of other facts.” Lopez v. Smith, 203 F.3d 1122, 1127 (9th Cir. 2000). In making this determination, the court should consider factors such as “the presence or absence of undue delay, bad faith, dilatory motive, repeated failure to cure deficiencies by previous amendments, undue prejudice to ...

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