United States District Court, N.D. California, San Jose Division
ORDER GRANTING MOTION TO DISMISS THIRD AMENDED
COMPLAINT WITH PREJUDICE [Re: ECF 81]
LABSON FREEMAN United States District Judge.
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
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.
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.
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.
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. ¶
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.
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.
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.
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. 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).
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.
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.
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.
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.
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.
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
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).
Rule 9(b) and the PSLRA
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.
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
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 ...