Richard v. Northwest Pipe Company et al, No. 3:2009cv05724 - Document 59 (W.D. Wash. 2011)
Court Description: ORDER denying 41 Motion to Dismiss; denying 43 Motion to Dismiss; denying 44 Motion to Dismiss, signed by Judge Ronald B. Leighton.(DN)
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Richard v. Northwest Pipe Company et al Doc. 59 1 2 3 4 5 6 UNITED STATES DISTRICT COURT WESTERN DISTRICT OF WASHINGTON AT SEATTLE 7 8 9 JERRY RICHARD, 10 Plaintiff, Case No. C9-5724RBL 11 12 v. ORDER DENYING MOTIONS TO DISMISS [Dkt. #41, 43, 44] NORTHWEST PIPE COMPANY, et al., 13 Defendants. 14 15 16 17 18 19 20 21 22 23 THIS MATTER comes before the Court on Motions to Dismiss filed by defendants Northwest Pipe Company, its former Chief Executive Officer Brian Dunham, and its former Senior Vice President of Finance and Chief Financial Officer Stephanie Welty (collectively, “defendants”). [Dkt. #41, 43, 44]. Plaintiffs,1 who are suing on behalf of themselves and all others similarly situated, assert that for years, defendants committed accounting improprieties that caused the company to overstate its earnings, in violation of federal securities laws. Plaintiffs allege that when the truth emerged, the stock price fell, damaging all stockholders. For the reasons set forth below, the Court denies the Motions to Dismiss.2 24 1 25 26 The Court previously consolidated two actions and granted an unopposed motion to appoint as lead plaintiff Plumbers and Pipefitters Local No. 630 Pension-Annuity Trust Fund. 2 27 Because this matter can be resolved based on the parties’ submissions and the balance of the record, plaintiffs’ request for oral argument is denied. 28 ORDER - 1 Dockets.Justia.com I. FACTS 1 2 This is a federal securities class action brought on behalf of all persons who purchased or 3 otherwise acquired the common stock of Northwest Pipe Company (“Northwest” or the 4 “company”) from April 2, 2007 through March 30, 2010 (the “class period”). Northwest is a 5 manufacturer of large-diameter, high-pressure steel pipeline systems for use in water 6 infrastructure applications, primarily related to drinking water systems. [Consolidated 7 Complaint, Dkt. #29, at ¶ 3]. Plaintiffs allege that during the class period, defendants engaged in 8 numerous accounting improprieties which inflated the company’s financial results, violated 9 Generally Accepted Accounting Principles (“GAAP”) and SEC disclosure rules, and made 10 11 contradictory representations. [Id. at ¶ 4]. On November 4, 2010, the company announced the completion of its year-long 12 investigation, which resulted in a financial restatement of three years of financial results. 13 [Consolidated Complaint at ¶ 50]. Plaintiffs allege, “When defendants’ fraud was exposed, the 14 Company was forced to issue a massive financial restatement which wiped out the Company’s 15 entire reported earnings for certain accounting periods, resulting in up to 77% overstatements in 16 gross profit, 152% overstatements of net income, and 154% overstatements of EPS.” [Id.]. The 17 complaint alleges that defendants committed fourteen separate accounting violations, including 18 improperly recognizing steel as revenue when it was purchased, artificially inflating revenue and 19 earnings by concealing liabilities caused by contractual penalty provisions, liquidated damages 20 and back charges, manipulating expenses related to depreciation of assets, and falsifying the 21 assignment of costs. 22 Plaintiffs filed this lawsuit on November 20, 2009 alleging that defendants violated 23 Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Securities 24 Exchange Commission (“SEC”) Rule 10b-5. The consolidated complaint also contends that the 25 individual defendants are “control persons” subject to liability under Section 20(a) of the 26 Exchange Act, 15 U.S.C. § 78t(a). 27 28 ORDER - 2 II. DISCUSSION 1 2 A. Dismissal Standard Defendants have filed a 12(b)(6) motion for failure to state a claim upon which relief can 3 4 be granted. The complaint should be liberally construed in favor of the plaintiff and its factual 5 allegations taken as true. See, e.g., Oscar v. Univ. Students Co-Operative Ass’n, 965 F.2d 783, 6 785 (9th Cir. 1992). The Supreme Court has explained that “when allegations in a complaint, 7 however true, could not raise a claim of entitlement to relief, this basic deficiency should be 8 exposed at the point of minimum expenditure of time and money by the parties and the court.” 9 Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 558 (2007) (internal citation and quotation 10 omitted). A complaint must include enough facts to state a claim for relief that is “plausible on 11 its face” and to “raise a right to relief above the speculative level.” Id. at 555. The complaint 12 need not include detailed factual allegations, but it must provide more than “a formulaic 13 recitation of the elements of a cause of action.” Id. A claim is facially plausible when plaintiff 14 has alleged enough factual content for the court to draw a reasonable inference that the 15 defendant is liable for the misconduct alleged. Ashcroft v. Iqbal, __ U.S. __, 129 S. Ct. 1937, 16 1949 (2009). “Threadbare recitals of the elements of a cause of action, supported by mere 17 conclusory statements, do not suffice.” Id. at 1949. 18 B. 19 Loss Causation “Loss causation is the causal connection between a defendant’s material 20 misrepresentation and a plaintiff’s loss.” In re Oracle Corp. Sec. Litig., 627 F.3d 376, 392 (9th 21 Cir. 2010). Plaintiff bears the burden of proving that defendant’s unlawful act “‘caused the loss 22 for which the plaintiff seeks to recover damages.’” In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 23 1055 (9th Cir. 2008) (quoting 15 U.S.C. § 78u-4(b)(4)). 24 The Supreme Court has explained that liability attaches for the loss the purchaser sustains 25 “after the truth became known” regarding defendant’s material misrepresentation. Dura 26 Pharms., Inc. v. Broudo, 544 U.S. 336, 344 (2005). To survive a motion to dismiss, a plaintiff 27 need only provide “some indication of the loss and the causal connection [plaintiff] has in 28 ORDER - 3 1 mind.” Id. at 346-47 (explaining that the pleading rules for loss causation were “not meant to 2 impose a great burden upon a plaintiff” and that plaintiffs must only plead a “short and plain 3 statement” pursuant to Fed. R. Civ. P. 8). Based on Dura, the Ninth Circuit has explained that 4 the issue of loss causation should not be decided on a Rule 12(b)(6) motion to dismiss if the 5 “complaint alleges facts that, if taken as true, plausibly establish loss causation.” Gilead, 536 6 F.3d at 1057. 7 8 9 [L]oss causation is not adequately pled unless a plaintiff alleges that the market learned of and reacted to the practices the plaintiff contends are fraudulent, as opposed to merely reports of the defendant’s poor financial health generally. The market need not know at the time that the practices in question constitute a ‘fraud,’ nor label them ‘fraudulent,’ but in order to establish loss causation, the market must learn of and react to those particular practices themselves. This reaction, in turn, must be the cause of a plaintiff’s loss. 10 In re Oracle, 627 F.3d at 392 (citing Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 11 1049, 1063 (9th Cir. 2008)). 12 In this case, the price of the company’s stock went up when the company announced in 13 July 2010 that it would likely restate earlier financial results, and went up again in November 14 2010 when the company issued that restatement. Faced with that reality, plaintiffs allege that 15 three other company disclosures triggered the losses. First, on November 12, 2009, the company 16 reported that financial results for 3Q09 were less than analysts were expecting, and that the 17 Company could not timely file its 3Q09 Form 10-Q, due to a pending internal investigation 18 regarding certain “revenue recognition” practices. [Consolidated Complaint at ¶¶ 178-79]. 19 Following that disclosure, the company’s stock price declined 14% and an analyst opined, “As a 20 result of the ongoing investigation and uncertainty regarding previously stated results, we lack 21 conviction on the future earnings power of the business pending additional information from the 22 company.” Id. at ¶ 181. Second, the Complaint alleges that on March 16, 2010, the company 23 announced that it would not file its 2009 Form 10-K on time because the internal investigation 24 had not been completed; the company also disclosed that the SEC had commenced a formal 25 investigation. [Consolidated Complaint at ¶¶ 15, 182]. The stock price declined 16.2%. Id. at 26 ¶ 183. Again, an analyst commented on the “uncertainty” of the situation. The analyst noted, 27 28 ORDER - 4 1 “The lack of clarity on business conditions for the water transmission business coupled with 2 uncertainty regarding the outcome and timing of completion of the internal accounting review 3 makes it difficult for us to advocate committing new money into the shares.” [Id. at ¶ 184]. Third, plaintiffs allege that the market reacted negatively to Dunham’s resignation, 4 5 disclosed on April 2, 2010. Faced with the fact that the stock price dropped before the 6 announcement, plaintiffs contend that the resignation was leaked. That allegation, however, is 7 absent from the Complaint. However, regarding the first two disclosures, courts have held that the disclosure of an 8 9 internal investigation is sufficient to plead loss causation. See, e.g., Rudolph v. UTStarcom, 10 2008 U.S. Dist. LEXIS 63990 at *9-12 (N.D. Cal. Aug. 21, 2008); In re New Century, 588 F. 11 Supp. 2d 1206, 1237 (C.D. Cal. 2008). Moreover, courts have held that the disclosure of SEC 12 investigations is sufficient to allege loss causation. See, e.g., Freudenberg v. E*Trade Fin. 13 Corp., 712 F. Supp. 2d 171, 203 (S.D.N.Y. 2010); In re IMAX Sec. Litig., 587 F. Supp. 2d 471, 14 485-86 (S.D.N.Y. 2008); In re Bradley Pharm., Inc. Sec. Litig., 421 F. Supp. 2d 822, 828 (D.N.J. 15 2006). In contrast, in Metzler, the disclosures simply revealed negative financial information 16 and a seemingly isolated problem at one campus. Neither statement “disclosed – or even 17 suggested – to the market that [defendant] was manipulating student enrollment figures 18 company-wide in order to procure excess federal funding.” Metzler, 540 F.3d at 1063. The truth need not be disclosed through a single, complete disclosure. See, e.g., Dura, 19 20 544 U.S. at 342 (explaining that the loss causation element was met where the price dropped 21 after “the relevant truth began to leak out.”); In re Daou Sys., 411 F.3d 1006, 1026-27 (9th Cir. 22 2005). In this case, the disclosures that required filings would be delayed and that the company 23 and SEC were investigating revenue recognition practices – the subject of the alleged fraud – are 24 sufficiently linked to defendants’ prior statements about the company’s financial results and are 25 sufficient to plausibly allege loss causation. 26 C. 27 28 Scienter To adequately plead scienter, a complaint must “state with particularity facts giving rise ORDER - 5 1 to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u- 2 4(b)(2)(A). “A complaint can plead scienter by raising a strong inference that the defendant 3 possessed actual knowledge or acted with deliberate recklessness.” Zucco Partners, LLC v. 4 Digimarc Corp., 552 F.3d 981, 991 (9th Cir. 2009). A securities fraud complaint will survive a 5 motion to dismiss “only if a reasonable person would deem the inference of scienter cogent and 6 at least as compelling as any opposing inference one could draw from the facts alleged.” 7 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007). Therefore, the Court 8 considers the Complaint in its entirety. Id. at 322. 9 Certainly, plaintiffs have not alleged any direct evidence of scienter such as an 10 incriminating statement from either of the individual defendants. Nor are the alleged statements 11 from the anonymous witnesses compelling because, for the most part, the Complaint fails to 12 allege how the witnesses “would possess the information alleged” and to provide “adequate 13 corroborating details.”3 Daou, 411 F.3d at 1015-16. 14 The Court also considers whether the allegations, when taken together, are sufficient. See 15 Tellabs, 551 U.S. at 322-23. Although the misapplication of GAAP standards is insufficient 16 alone to support a finding of scienter, the misapplication “‘combined with a drastic 17 overstatement of financial results can give rise to a strong inference of scienter . . . [and] the 18 totality and magnitude of the accounting violations [may] constitute strong circumstantial 19 evidence of reckless or conscious misbehavior.’” New Mexico State Inv. Council v. Ernst & 20 Young LLP, 641 F.3d 1089 (9th Cir. 2011) (quoting Carley Capital Group v. Deloitte & Touche, 21 27 F. Supp. 2d 1324, 1339-40 (N.D. Ga. 1998)). In this case, the restatement was significant: 22 the company restated three years of financial statements, including significantly revising net 23 income figures, retained earnings figures, and earnings per share results. [Consolidated 24 Complaint at ¶¶ 50, 62, 65, 89, 126-42, 155]. Plaintiffs have also alleged fourteen accounting 25 26 27 28 3 For example, plaintiffs contend that CW4 states that Dunham had “final authority” for approving settlements of claims, but fails to allege background facts to support that witness’s alleged knowledge. ORDER - 6 1 violations. Although defendants attempt to explain them away, their explanations introduce 2 evidence outside the record and not properly considered on a motion to dismiss. Similarly, to 3 counter plaintiffs’ contention that the accounting principles defendants allegedly violated were 4 simple, defendants have attempted to introduce declarations and information about audits, which 5 is beyond the scope of this motion.4 6 In addition, defendants each made an inconsistent statement about the company’s revenue 7 recognition practices. During an analyst call in July 2008, Dunham stated that the “shipment 8 date is not really the driver” of when POC revenue was recognized; “[i]t’s when it’s built that’s 9 the driver.” [Consolidated Complaint at ¶ 82]. Similarly, Welty stated that “we recognize 10 revenue as the work is completed.” [Id. at ¶¶ 82-83]. Clearly, those statements are inconsistent 11 with the company’s revenue recognition practices and with defendants’ argument that their 12 practices were open and notorious. Although defendants attempt to explain away the issue, their 13 explanation is unsupported by any citation or evidence appropriately considered in this motion. 14 Defendants’ Reply at p. 11 n.9. Moreover, plaintiffs convincingly argues that defendants, who 15 were both CPAs and had extensive accounting experience, should have known of the falsity of 16 their statements. 17 Additional factors suggest scienter. First, plaintiffs have alleged a motive: absent the 18 accounting violations, the company “would have missed Wall Street expectations, which would 19 have devastated the stock price.” [Consolidated Complaint at ¶ 156 (citing examples)]. 20 Similarly, plaintiffs allege that “[p]erformance-based incentive compensation made up a 21 significant portion of defendants’ compensation. . . . Awards were based on achievement of 22 certain financial performance measures for the year, including sales and net incomes 23 measures.” Id. at ¶ 159 (emphasis in original); see also Tellabs, 551 U.S. at 325 (explaining 24 that “personal financial gain may weigh heavily in favor of a scienter inference”). In turn, net 25 26 4 27 In contrast, in Zucco, 552 F.3d at 987, on which defendants rely, it appears that plaintiffs did not contest the complexity of the accounting rules at issue. 28 ORDER - 7 1 income was significantly overstated. During the relevant years, defendants Dunham and Welty 2 received significant sums in incentive compensation, sometimes in excess of their base salary. 3 Id. at ¶ 160; see also No. 84 Emp’r-Teamster Joint Council Pension Trust Fund v. Am. W. 4 Holding Corp., 320 F.3d 920, 944 (9th Cir. 2003). 5 Second, both individual defendants certified pursuant to the Sarbanes-Oxley Act of 2002 6 that after review, the company’s financial results were “fairly present[ed] in all material 7 respects.” Plaintiffs’ Response at p. 36. The certifications, though insufficient alone, are 8 “probative of scienter if the person signing the certification was severely reckless in certifying 9 the accuracy of the financial statements.” Glazer Capital Mgmt., LP v. Magistri, 549 F.3d 736, 10 747 (9th Cir. 2008). Third, the timing and circumstances surrounding the individual defendants’ 11 departure from the company support an inference of scienter. Welty resigned on January 20, 12 2011, shortly after the restatement was issued. Dunham abruptly resigned his position as CEO 13 during the pendency of the company’s internal investigation. [Consolidated Complaint at 14 ¶ 165]. He subsequently resigned as President and as a member of the board of directors less 15 than a month before the company issued the restatement. Id. at ¶ 166. Standing alone, the 16 departures are insufficient. “But because the changes in management occurred while [the 17 company] was preparing its own internal investigation of revenue recognition practices, the 18 departures ‘add one more piece to the scienter puzzle.’” Fouad v. Isilon Sys., 2008 U.S. Dist. 19 LEXIS 105870 at *31-32 (W.D. Wash. Dec. 29, 2008) (quoting In re Adaptive Broadband Sec. 20 Litig., 2002 U.S. Dist. LEXIS 5887 at *14 (N.D. Cal. April 2, 2002)); see also In re Impax 21 Labs., Inc. Sec. Litig., 2007 U.S. Dist. LEXIS 52356 at *26-27 (N.D. Cal. July 18, 2007). 22 Similarly, Dunham’s departure was suspicious because the company had previously touted him 23 as essential. [Consolidated Complaint at ¶ 165]; see also Zucco Partners, 552 F.3d at 1002 24 (explaining that a resignation that was “accompanied by suspicious circumstances” could be 25 sufficient to support an “inference that the defendant corporation forced certain employees to 26 resign because of its knowledge of the employee’s role in the fraudulent representations.”). In 27 sum, taken together, plaintiffs’ allegations meet their burden. 28 ORDER - 8 1 D. Control Person Liability Plaintiffs contend that the individual defendants are liable as “controlling persons” under 2 3 the Securities Exchange Act of 1934 §20(a). To prove a prima facie case under that section, 4 plaintiffs must establish: (1) a primary violation of federal securities law; and (2) the defendant 5 exercised actual power or control over the primary violator. See, e.g., Am. West, 320 F.3d at 6 945. 7 As an initial matter, because Welty began working for the company seven months into the 8 class period, she could not have controlled anything prior to that time. Any control person 9 theory against her based on events that occurred prior to when she joined the company is 10 untenable. 11 The statute provides: 12 Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. 13 14 15 15 U.S.C. § 78t(a). Welty argues that she was not a controlling person because plaintiffs have 16 not alleged how she controlled Dunham, her boss. However, if the company is alleged to be a 17 violator, as it is in this case, alleging control over the company can be sufficient. See, e.g., Am. 18 West, 320 F.3d at 945-46. Furthermore, the Complaint alleges that Welty and Dunham were 19 control persons because of the nature of their positions, the fact that they both participated in the 20 day-to-day affairs of the company, and they had the power to control the company’s financial 21 disclosures, including the ones alleged to be false. [Consolidated Complaint at ¶¶ 28, 206-08]. 22 Accordingly, plaintiffs have sufficiently alleged that Welty and Dunham were “control persons.” 23 24 25 26 27 28 ORDER - 9 III. CONCLUSION 1 2 3 For all of the foregoing reasons, the Court DENIES defendants’ Motions to Dismiss (Dkt. #41, 43, 44). 4 5 6 7 8 9 10 IT IS SO ORDERED. Dated this 26th day of August, 2011. A RONALD B. LEIGHTON UNITED STATES DISTRICT JUDGE 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 ORDER - 10
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