Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_09-cv-00151/USCOURTS-cand-3_09-cv-00151-6/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:78m(a) Securities Exchange Act

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United States District Court

For the Northern District of California

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1 Hereinafter, the Court shall refer to the Greater Pennsylvania Carpenters’

Pension Fund as “Plaintiff.”

NOT FOR PUBLICATION

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

IN RE: TALEO CORPORATION

SECURITIES LITIGATION

 /

No. C 09-00151 JSW

ORDER GRANTING MOTION TO

DISMISS AMENDED CLASS

ACTION COMPLAINT WITH

LEAVE TO AMEND

INTRODUCTION

Now before the Court for consideration is the Motion to Dismiss filed by Defendants

Taleo Corporation (“Taleo”), Michael Gregoire (“Gregoire”), Katy Murray (“Murray”), and

Divesh Sisodraker (“Sisodraker”) (collectively “Defendants”). Having considered the parties’

papers, relevant legal authority, and the record in this case, the Court HEREBY GRANTS

Defendants’ motion and GRANTS Plaintiff leave to amend.

BACKGROUND

A. Procedural History.

On January 13, 2009, Scott Stemper and Molly Martin filed the original complaint in

this action. (Docket No. 1.) On January 22, 2009, Greater Pennsylvania Carpenters’ Pension

Fund filed a motion to be appointed Lead Plaintiff.1

 (Docket No. 8.) The motion was not

opposed and, on February 9, 2009, the Court granted the motion. (Docket No. 14.) On June 15,

2009, Plaintiff filed the Amended Class Action Complaint (“FAC”).

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2 The following facts are drawn from the FAC and documents of which the

Court may take judicial notice. See Section C, infra.

3 Hereinafter, the Court shall abbreviate fiscal years and quarters as, “Q3

2005.”

2

B. Factual Background.2

1. The Parties.

a. Lead Plaintiff Greater Pennsylvania Carpenters’ Pension Fund.

Plaintiff is a pension fund that provides retirement benefits for its approximately 15,000

members. (FAC ¶ 15.) Plaintiff alleges that between July 19, 2007 and September 11, 2008, it

purchased shares of Taleo stock at artificially inflated prices and suffered damages as a result. 

(Id. ¶ 15, Ex. A.) Plaintiff seeks to represent a class of Taleo shareholders who purchased or

otherwise acquired Taleo Class A common stock between September 29, 2005 and November

12, 2008 (the “Class Period”). (Id. ¶¶ 1, 21.) 

b. Defendant Taleo. 

Taleo was founded in 1998 and provides two suites of talent management software

solutions, Taleo Enterprise Edition and Taleo Business Edition, which it delivers to its

customers “on-demand as a hosted service that is accessed through the internet.” (Id. ¶¶ 16, 27-

28.) Taleo went public on September 29, 2005, and Taleo Class A common stock has traded

actively on the NASDAQ since that time. (Id. ¶¶ 2, 16, 27.)

c. The Individual Defendants.

Gregoire has served as Taleo’s President and Chief Executive Officer (“CEO”) since

March 2005, as a Taleo director since April 2005, and as Taleo’s Chairman of the Board of

Directors since May 2008. (Id. ¶ 17.) During the Class Period, Gregoire signed Taleo’s Form

10-K Annual Reports, and accompanying certifications made pursuant to the Sarbanes-Oxley

Act of 2002 (“SOX”). Gregoire also signed Taleo’s Form 10-Q Quarterly Reports for the third

quarter of fiscal year 2005 through the second quarter of fiscal year 2008, the accompanying

SOX certifications, and Management’s Report on Internal Control Over Financial Reporting

contained in the Form 10-Ks filed in 2006 and 2007.3

 (See generally FAC ¶¶ 66-69, 75-76, 81-

89, 106-119.) During the Class Period, Gregoire also made statements during conference calls

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and press releases regarding his “confidence” that Taleo’s financial statements were accurate,

his knowledge of the software Taleo used for revenue recognition purposes, his knowledge of

efforts Taleo made to improve its internal controls over financial reporting, and his knowledge

of Taleo’s financial performance. (See, e.g., id. ¶¶ 70, 73, 77, 80, 98, 99, 122-123, 168.) 

Plaintiff alleges that while he was in possession of non-public material information, Gregoire

sold 250,000 shares of Taleo stock, which generated proceeds of $6,625,000 and which

represented 42% of the approximately 595,000 shares he possessed or acquired during the Class

Period. (Id. ¶¶ 227, 229.) 

Murray has served as Taleo’s Executive Vice President and Chief Financial Officer

(“CFO”) since September 2006, is responsible for Taleo’s financial operations, and reports

directly to Gregoire. (Id. ¶ 18.) According to Plaintiff, Murray “joined Taleo ... as part of the

plan to restructure the accounting department, which was supposed to add technically

competent accounting personnel to Taleo’s staff.” (Id. ¶¶ 217, 223.) Murray is a Certified

Public Accountant and previously served as CFO for other technology companies providing

software and technology services. (Id.) Murray signed Form 10-K Annual Reports for 2006

and 2007, Form 10-Qs for Q3 2006 through Q2 2008, the accompanying SOX certifications,

and Management’s Report on Internal Control Over Financial Reporting contained in the Form 

10-Ks for 2006 and 2007. (See generally FAC ¶¶ 81-89, 155, 160, 162.) During the Class

Period, Murray also made statements during conference calls about Taleo’s efforts to improve

its revenue recognition procedures and Taleo’s financial performance. (See, e.g., id. ¶¶ 94, 153-

154, 166, 168, 224-225.) 

Plaintiff alleges that between September 2006 and November 11, 2008, while in

possession of non-public information, Murray sold 60,236 shares of Taleo stock, which resulted

in gross proceeds of $1,164,019, that she sold 40% of the approximately 151,000 shares she had

available for sale during the Class Period, and that all of her sales “occurred within

approximately one year of Taleo[’s] announcement of its possible restatement due to revenue

recognition issues.” (Id. ¶ 228.) Plaintiff alleges that Murray sold 9,687 shares, resulting in

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4 In paragraphs 96-211, Plaintiff sets forth its allegations of false and

misleading statements regarding Taleo’s financial performance that are attributed either to

Taleo generally or to one or more of the individual defendants. This section of the FAC

focuses on Plaintiff’s allegations that Taleo’s financial statements during the Class Period

4

gross proceeds of $209,502, within three months of a press release in which Taleo revealed

possible revenue recognition issues. (Id.) 

Sisodraker served as Taleo’s Executive Vice President, CFO, and Secretary from

September 2005 through September 2006. (Id. ¶ 19.) Sisodraker is a Chartered Accountant,

which is the Canadian equivalent of a CPA in the United States. (Id.) Sisodraker signed

Taleo’s Form 10-K Annual Report for 2005 and Form 10-Qs for Q3 2005 through Q2 2006, and

the accompanying SOX certifications for those reports. (See generally FAC ¶¶ 66-69, 75-76,

106-119.) During the Class Period, Sisodraker made statements during conference calls and in

press releases regarding Taleo’s efforts to eliminate material weaknesses in financial reporting,

his knowledge of Taleo’s revenue recognition systems, and Taleo’s financial performance. 

(See, e.g., id. ¶¶ 71-72, 74, 78, 98, 124, 222.)

2. The Alleged Scheme to Defraud.

Plaintiff contends that after Taleo went public in 2005, Defendants “quickly realized that

the ability to deliver revenue growth and, therefore, earnings was key to driving Taleo’s stock

price,” i.e. revenue was a “key financial metric” used to evaluate Taleo’s financial performance. 

(Id. ¶¶ 2, 31-32.) “Taleo management devised a scheme to make it appear that Taleo was

consistently delivering revenue at levels that exceeded analysts [sic] expectations when, in fact,

the opposite was true.” (Id. ¶¶ 2, 33.) If Taleo exceeded revenue estimates, Taleo also would

exceed analysts’ estimates on earnings-per-share (“EPS”). (Id. ¶ 33.) When Taleo did not meet

analysts’ expectations on EPS, even if it exceeded expectations on reported revenue, its stock

price dropped. (Id. ¶¶ 3, 34.) Plaintiff alleges that Defendants took notice of that correlation

and “[a]fter the first quarter of 2006, Taleo never again in the Class Period reported quarterly

revenue or earnings that fell short of consensus estimates.” (Id., ¶¶ 3, 34-35.) Plaintiff’s theory

is that Defendants recognized revenue before it was earned, in order to drive up Taleo’s stock

price. (FAC ¶¶ 1, 42-43.)4

 

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28 were materially false and misleading because Defendants failed to disclose that Taleo’s

“record revenues” were achieved through improper revenue recognition. (See, e.g., FAC ¶¶

105, 125, 145, 159.)

5

Taleo has two primary sources of revenue: application revenue and consulting revenue. 

Application revenue is derived from fixed fee contracts where fees generally are paid over the

term of the contract. (Id. ¶ 29.) Consulting revenue is derived from fees charged to Taleo

customers that are for services separate from, but related to, the customer’s ability to access

Taleo’s software applications. (Id. ¶ 30.) In general, Taleo’s customers purchase applications

and consulting services in a single “bundled” revenue arrangement. “In other words, at the time

a customer purchases the right to use Taleo’s software applications for a fixed time period or

term, the contract will generally include the right to access Taleo’s software applications for

that term [and] various services offered by Taleo such as set-up and training. These services are

provided at or close to the inception of the contract.” (Id.) 

A fundamental principle of Generally Accepted Accounting Principles (“GAAP”) is that

revenue should not be recognized before it is earned. (FAC ¶ 41.) Under GAAP, accounting

and revenue recognition for Taleo’s bundled contracts were governed by Emerging Issues Task

Force Abstract Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF

00-21”). (Id. ¶ 43-48; see also Declaration of Cheryl W. Foung In Support of Motion to

Dismiss (“Foung Decl.”), Ex. 19 (“EITF 00-21”).) 

EITF 00-21 provides, in pertinent part, that

In an arrangement with multiple deliverables, the delivered item(s) should be

considered a separate unit of accounting if all of the following criteria are met:

a. The delivered item(s) has value to the customer on a standalone basis. That

item(s) has value on a standalone basis if it is sold separately by any vendor

or the customer could resell the delivered item(s) on a standalone basis. In the

context of a customer’s ability to resell the delivered item(s), the Task Force

observed that this criterion does not require the existence of an observable

market for that deliverable(s).

b. There is objective and reliable evidence of the fair value of the undelivered

item(s).

c. If the arrangement includes a general right of return relative to the

delivered item, delivery or performance of the undelivered item(s) is

considered probable and substantially in control of the vendor.

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(EITF 00-21, ¶ 9; see also FAC ¶ 46.) If these criteria are not met, the multiple items are to be

combined and treated as a single unit of accounting. (FAC ¶ 47; EITF 00-21 ¶ 10.) 

According to Plaintiff, in order to apply EITF 00-21 properly, Taleo was required to

“answer two, straightforward, yes or no questions:” (1) did application and consulting services

have stand alone value to the customer; and (2) did Taleo have objective and reliable evidence

of the fair value of its application and consulting services? (Id. ¶ 45.) If the answer to either of

those questions was no, Taleo was required to recognize consulting and application revenue

together, ratably, over the life of the contract. (Id.) However, Taleo historically treated

consulting revenue and application revenue as separate units of accounting, i.e. “when

application services and consulting services were sold together, [Taleo] recognized consulting

services revenue as the services were delivered,” rather than ratably over the life of the contract. 

(FAC ¶¶ 4, 48; Foung Decl., Ex. 8 (April 30, 2009 Form 10-K at 4).)

In November 10, 2008, Taleo issued a press release and disclosed that its auditors had

requested a re-evaluation of its historical application of EITF 00-21. (FAC ¶ 4; Foung Decl.

Ex. 14 (Nov. 10, 2008 Press Release); April 30, 2009 Form 10-K at 3.) In that press release,

Gregoire stated that the request was a “timing issue, and does not impact the total amount of

revenue Taleo has under contract.” (Nov. 10, 2008 Press Release at 1.) Murray stated that the

questions raised were “(1) whether our policy that delivery of our software solutions has

occurred when access to the software is provided to the customer is correct, and (2) whether our

policy that our consulting services have standalone value is correct.” 

Murray stated that historically Taleo “has taken the position that delivery of its software

solutions occurs on the initial access date to the software solution, which is the point in time

that a customer is provided access to the on-demand application suite.” She also stated that

when application and consulting services were sold together, “Taleo has taken the position that

its time and materials consulting services have standalone value and fair value and, thus, it is

appropriate to recognize revenue for these services as the services are performed.” (Id.) 

Murray also reiterated that these issues impacted timing and not the amount of revenue. (Id. at

1-2.) 

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On November 11, 2008, Taleo’s share price closed down $3.22 from the prior day,

which represented a 29% decline in its stock price. (Id. ¶ 5.)

As a result of the re-evaluation, Taleo changed its accounting practices. On April 30,

2009, Taleo issued restated financial statements for fiscal years 2003 through 2007, as well as

the financial statements for Q1 2008 and Q2 2008, in order to correct the timing of revenue

recognition for consulting services (the “Restatement”). (FAC ¶¶ 5-8, 51; April 30, 2009 Form

10-K at 3, 18.) In the Restatement, Defendants stated that going forward, when Taleo provided

application and consulting services in a bundled arrangement, “our consulting services revenue

will be recognized ratably over the term of the application services agreement, typically three

years.” (April 30, 2009 Form 10-K at 4.) Defendants also stated that Taleo’s

consulting services have standalone value because those services are sold

separately by other vendors and we have objective and reliable evidence of

fair value for consulting services based on the consistency when sold

separately. Our application services have standalone value because we often

sell such services separately; however, in multiple element arrangements that

include both application and consulting services, we typically do not have

objective and reliable evidence of fair value for our application services. As

such, we treat multiple element arrangements that include both application

and consulting services as a single unit of accounting and recognize the

combined revenue over the subscription term.

(April 30, 2009 Form 10-K at 40 (emphasis added).) Taleo deferred approximately $18 million

in consulting revenue to future periods. (See FAC ¶¶ 1, 53; April 30, 2009 Form 10-K at 4.) 

Plaintiff alleges that Defendants “disseminated materially false and misleading

statements concerning Taleo’s revenue and earnings thereby artificially inflating Taleo’s stock

price. (See FAC ¶¶ 1, 31-58, 96-211.) Plaintiff also alleges that Defendants either falsely

asserted that its internal controls over financial reporting were effective or failed to disclose

material weaknesses in internal controls regarding revenue recognition practices when

application and consulting services were sold together. (See, e.g., id. ¶¶ 59-89.) Based on these

allegations, Plaintiff alleges Defendants violated Section 10(b) of the Securities Exchange Act,

SEC Rule 10b-5, and Section 20(a) of the Securities Exchange Act.

ANALYSIS

A. Motion to Dismiss for Failure to State a Claim.

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A motion to dismiss is proper under Federal Rule of Civil Procedure 12(b)(6) where the

pleadings fail to state a claim upon which relief can be granted. The complaint is construed in

the light most favorable to the non-moving party and all material allegations in the complaint

are taken to be true. Sanders v. Kennedy, 794 F.2d 478, 481 (9th Cir. 1986). Rule 8(a) requires

only “a short and plain statement of the claim showing that the pleader is entitled to relief.” 

Accordingly, motions to dismiss for failure to state a claim pursuant to Rule 12(b)(6) are

typically disfavored; complaints are construed liberally to set forth some basis for relief, as long

as they provide basic notice to the defendants of the charges against them. In re McKesson

HBOC, Inc. Sec. Litig., 126 F. Supp. 1248, 1257 (N.D. Cal. 2000). Where a plaintiff alleges

fraud, however, Rule 9(b) requires the plaintiff to state with particularity the circumstances

constituting fraud. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547-49 (9th Cir. 1994). 

Even under the liberal pleading standard of Rule 8(a), “a plaintiff’s obligation to provide

the ‘grounds’ of his ‘entitle[ment] to relief’ requires more than labels and conclusions, and a

formulaic recitation of the elements of a cause of action will not do.” Bell Atlantic Corporation

v. Twombly, 550 U.S. 544, 555 (2007) (citing Papasan v. Allain, 478 U.S. 265, 286 (1986)). 

Pursuant to Twombly, a plaintiff must not merely allege conduct that is conceivable but must

instead allege “enough facts to state a claim to relief that is plausible on its face.” Id. at 570. 

“A claim has facial plausibility when the plaintiff pleads factual content that allows the court to

draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft

v. Iqbal, __ U.S. __, 129 S. Ct. 1937, 1949 (2009) (citing Twombly, 550 U.S. at 556). “The

plausibility standard is not akin to a probability requirement, but it asks for more than a sheer

possibility that a defendant has acted unlawfully. ... When a complaint pleads facts that are

merely consistent with a defendant’s liability, it stops short of the line between possibility and

plausibility of entitlement to relief.” Id. (quoting Twombly, 550 U.S. at 556-57) (internal

quotation marks omitted). The Court may consider the facts alleged in the complaint,

documents attached to the complaint, documents relied upon but not attached to the complaint

when the authenticity of those documents is not questioned, and other matters of which the

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Court may take judicial notice. Zucco Partners LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th

Cir. 2009). 

 In the securities context, the pleading requirements are even more stringent. 

B. Private Securities Litigation Reform Act (“PSLRA”).

To plead a claim under section 10(b) and Rule 10b-5, a plaintiff must allege (1) a

misrepresentation or omission, (2) of material fact, (3) made with scienter, (4) on which the

plaintiff justifiably relied, (5) that proximately caused the alleged loss. Siracusano v. Matrixx

Initiatives, Inc., 585 F.3d 1167, 1177 (9th Cir. Oct. 28, 2009); Zucco Partners, 552 F.3d at 990. 

“At the pleading stage, a complaint stating claims under section 10(b) and Rule 10b-5 must

satisfy the dual pleading requirements of ... Rule 9(b) and the PSLRA.” Zucco Partners, 552

F.3d at 990. Thus, the PSLRA requires that “a complaint plead with particularity both falsity

and scienter.” Id. (internal quotations omitted). Where a plaintiff asserts a Section 20(a) claim

based on an underlying violation of section 10(b), the pleading requirements for both violations

are the same. See In re Ramp Networks, Inc. Sec. Lit., 201 F. Supp. 2d 1051, 1063 (N.D. Cal.

2002).

In order to adequately plead scienter, the PSLRA requires that the plaintiff “‘state with

particularity facts giving rise to a strong inference that the defendant acted with the required

state of mind.’” Zucco Partners, 552 F.3d at 991 (quoting 15 U.S.C. § 78u-4(b)(2)). “To

adequately demonstrate that the ‘defendant acted with the required state of mind,’ a complaint

must ‘allege that the defendants made false or misleading statements either intentionally or with

deliberate recklessness.’” Id. (quoting In re Daou Sys., Inc., 411 F.3d 1006, 1014-15 (9th Cir.

2005)). “[D]eliberate recklessness” requires a plaintiff to plead facts demonstrating “a highly

unreasonable omission, involving not merely simple, or even inexcusable negligence, but an

extreme departure from the standards of ordinary care, and which presents of danger of

misleading buyers or sellers that is either known to the defendant or is so obvious that the actor

must have been aware of it.” Id. (internal quotations and citations omitted).

The Ninth Circuit recently clarified that a court should “conduct a dual inquiry,” when it

evaluates scienter. Id. at 991-92. First, a court should determine “whether any of the plaintiff’s

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allegations, standing alone are sufficient to create a strong inference of scienter.” Id. at 992. 

Second, “if no individual allegations are sufficient,” a court should “conduct a ‘holistic’ review

of the same allegations to determine whether the individual allegations combine to create a

strong inference of intentional conduct or deliberate recklessness.” Id.; accord Siracusano, 585

F.3d at 1180.

“‘[I]n determining whether the pleaded facts give rise to a strong inference of scienter,

the court must take into account plausible opposing inferences.’” Zucco Partners, 552 F.3d at

992 (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 310 (2007)). A

plaintiff sufficiently alleges scienter “only if a reasonable person would deem the inference of

scienter cogent and at least as compelling as any opposing inference one could draw from the

facts alleged.” Tellabs, 551 U.S. at 324. The inquiry “is inherently comparative.” Id. “A court

must compare the malicious and innocent inferences cognizable from the facts pled in the

complaint, and only allow the complaint to survive a motion to dismiss if the malicious

inference is at least as compelling as any opposing innocent inference.” Zucco Partners, 552

F.3d 991 (citing Tellabs, 551 U.S. at 324). If the allegations are insufficient to state a claim, a

court should grant leave to amend, “unless it is clear that the complaint could not be saved by

any amendment.” Id. at 989 (quoting Livid Holdings, Ltd. v. Solomon Smith Barney, Inc., 416

F.3d 940, 946 (9th Cir. 2005)).

C. Request for Judicial Notice.

Federal Rule of Evidence 201 authorizes a court to take judicial notice of facts “capable

of accurate and ready determination by resort to sources whose accuracy can not reasonably be

questioned.” Defendants ask the Court to take judicial notice of excerpts from documents Taleo

filed with the Securities and Exchange Commission (“SEC”), transcripts of Taleo Conference

calls, Taleo press releases, and EITF 00-21. Many of these documents are explicitly referred to

in the FAC. The incorporation by reference doctrine permits a court to consider documents

alleged in a complaint and whose authenticity no party questions, but that are not physically

attached to a complaint. Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994). Those documents

that are not explicitly referenced in the FAC have been filed publicly with the SEC. Plaintiff

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does not challenge the authenticity of the documents. Accordingly, Defendants’ request to take

judicial notice of Exhibits 1-9 and Exhibits13-19 to the Foung Declaration is GRANTED.

Defendants also ask the Court to take judicial notice of documents that are not

referenced in the FAC, but which Plaintiff necessarily relies upon, specifically SEC Forms 3

and 4, and a chart referencing Taleo’s stock price during the Class Period. Plaintiff has not

challenged the authenticity of these documents. Accordingly, the Defendants’ request to take

judicial notice of Exhibits 10-12 and Exhibit 23 to the Foung Declaration is GRANTED. 

Defendants also ask the Court to take judicial notice of a copy of EITF Abstract for

Issue 08-1, Revenue Arrangements with Multiple Deliverables; Accounting Principles Board

Opinion No. 20, Accounting Changes; excerpts from the U.S. GAO, Financial Restatements:

Update of Public Company Trends, Market Impacts, and Regulatory Enforcement Activities,

dated March 5, 2007; and an Order issued in In re Veritas Software Corp. v. Securities

Litigation, No. C-03-0283 MMC, slip. op. (N.D. Cal. Dec. 10, 2003). The Court did not find it

necessary to refer to these documents to resolve the motion. Accordingly, Defendant’s request

to take judicial notice of Exhibits 20-22 and Exhibit 24 to the Foung Declaration is DENIED

AS MOOT. 

D. Plaintiff Has Not Alleged Facts Sufficient to Show a Strong Inference of Scienter. 

Defendants’ motion is based only on the argument that Plaintiff has not alleged facts

that raise a strong inference of scienter. Plaintiff argues that they have alleged scienter based on

the following allegations: (1) the accounting fraud centered on Taleo’s core operations; (2) the

GAAP violations were significant; (3) the magnitude of the Restatement; (4) Taleo’s history of

material weaknesses in its internal controls; and (5) Gregoire and Murray engaged in suspicious

stock sales.

1. The Core Operations Theory and The Nature of the GAAP Violations.

“Violations of GAAP standards can ... provide evidence of scienter,” as long as they are

pled with particularity. In re Daou Systems, 411 F.3d at 1016, 1022; see also In re McKesson,

126 F. Supp. 2d at 1273. However, “‘the mere publication of inaccurate accounting figures, or

a failure to follow GAAP, without more, does not establish scienter.’” DSAM Global Value

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5 This Court adopts the terminology used by Judge Coughenour in South Ferry

II and refers to these three circumstances as “the ‘actual knowledge’ analysis, the

‘abusurdity’ analysis, and the ‘holistic’ analysis.” South Ferry II, 2009 WL 3153067 at *5.

12

Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002) (quoting In re Software

Toolworks, Inc., 50 F.3d 615, 627 (9th Cir. 1994)). 

Defendants acknowledge that the Restatement was necessary, in part, because they had

not interpreted EITF 00-21 correctly to determine “the proper accounting treatment when

application and consulting services are sold together.” (April 30, 2009 Form 10-K at 19.) 

Plaintiff cannot rely on that fact alone to establish scienter and must allege facts to show that

“the defendants knew specific facts at the time that rendered their accounting determinations

fraudulent.” In re Cadence Design Systems, Inc. Sec. Litig., 654 F. Supp. 2d 1037, 1046 (N.D.

Cal. 2009) (internal quotations and citation omitted) (“In re Cadence”); see also In re Connetics

Corp. Sec. Litig., 542 F. Supp. 2d 996, 1011 (N.D. Cal. 2008) (same).

Plaintiff relies in part on the “core operations” theory to support its allegations of

scienter. Under this theory, “allegations regarding management’s role in a company may be

relevant and help to satisfy the PSLRA scienter requirement in three circumstances.” South

Ferry LP, #2 v. Killinger, 542 F.3d 776, 785 (9th Cir. 2008) (hereinafter “South Ferry I”). 

Those three circumstances are: (1) where defendants have actual knowledge of the disputed

information; (2) where it would be absurd to conclude that defendants did not have knowledge

of the disputed information; (3) and where “core operations” allegations taken together with

other allegations raise a cogent and compelling inference of scienter. Id.; see also South Ferry

LP, #2 v. Killinger, __ F. Supp. 2d __, 2009 WL 3153067 at *5-*6 (W.D. Wash. Oct. 1, 2009)

(hereinafter “South Ferry II”).5

A plaintiff may satisfy the “actual knowledge” analysis when the complaint includes

“detailed and specific allegations about management’s exposure to factual information within

the company.” South Ferry I, 542 F.3d at 785; see also In re Daou Systems, 411 F.3d at 1022

(“specific admissions from top executives that they are involved in every detail of the company

and that they monitored portions of the company’s database, are factors in favor of inferring

scienter in light of improper accounting reports”) (citing Nursing Home Pension Fund, Local

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144 v. Oracle Corp., 380 F.3d 1226, 1234 (9th Cir. 2004)). In contrast, “[g]eneral allegations

of defendants’ ‘hands-on’ management style, their interaction with other officers and

employees, their attendance at monthly meetings, and their receipt of unspecified weekly or

monthly reports,” are not sufficient to establish scienter. In re Daou Systems, 411 F.3d at 1022

(citing In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1087 (9th Cir. 2002)). 

The Court must determine whether Plaintiff has alleged facts to show that Defendants

had knowledge of the “disputed information,” i.e., that Defendants knew they should have

recognized accounting and consulting services as a single unit of accounting, rather than

separate units, when those services were bundled. By way of example, Plaintiff alleges that

during a conference call held on February 17, 2007, Murray stated that she “focus[ed] on the

finance and accounting function of Taleo’s business.” (FAC ¶ 218.) Gregoire made statements

to the effect that Taleo “progressed in every [financial] metric we tracked,” and that “we have

our fingers closely on the pulse of the operations of this company.” (See FAC ¶¶ 216, 220.) 

Sisodraker stated that he knew what accounting software Taleo used, and he discussed efforts

Taleo made to improve internal financial operations. (FAC ¶¶ 72, 74.) 

In In re Cadence, plaintiffs alleged that Cadence improperly accounted for two major

transactions based on the manner in which it classified two licenses, which impacted whether

Cadence could recognize revenue on those licenses up-front or ratably. It was undisputed that

Cadence did classify the two licenses incorrectly, and the plaintiffs claimed that the individual

defendants did so deliberately. In re Cadence, 654 F.3d at 1040-43. The plaintiffs relied, in

part, on statements that the individual defendants “‘spent time’ with customers and the

individual defendants’ general roles in the approval process for Cadence transactions. Id. at

1047-49. The court, however, concluded that those facts did not support a strong inference of

scienter, because none of the statements demonstrated that the defendants “were likely to know

first hand the facts that were key to” properly classifying the licenses. Id. at 1046-48. 

In contrast, in South Ferry II, the court concluded that plaintiffs had alleged sufficient

facts to satisfy the “actual knowledge” analysis. In that case, the plaintiffs’ claims were

premised upon allegations that the defendants made misrepresentations regarding the

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6 The Court concludes that the facts alleged do not demonstrate that this case is

similar to Berson v. Applied Signal Technology, Inc., 527 F.3d 982 (9th Cir. 2008) such that

it could be placed into “the exceedingly rare category of cases in which the core operations

inference, without more, is sufficient” to establish scienter under the PLSRA. South Ferry

II, 542 F.3d at 785 n.3; see also id. at 786 (noting that absurdity analysis will apply in “rare

circumstances”).

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company’s risk management capabilities and were supported by statements from the individual

defendants that demonstrated they had direct access to the information on which the statements

were based. South Ferry II, 2009 WL 3153067 at *9-*12. 

Here, the statements cited above demonstrate that Murray and Sisodraker had a general

knowledge of Taleo’s accounting procedures. Gregoire’s statements are even more generalized,

but do suggest that he had information regarding Taleo’s financial performance. However, as in

In re Cadence, and in contrast to South Ferry II, none of these statements suggest that

Defendants “were likely to know first hand the facts that were key” to properly applying EITF

00-21 when consulting services and application services were sold as a bundle. Cf. City of

Brockton Retirement System v. Shaw Group, Inc., 540 F. Supp. 2d 464, 473-74 (S.D.N.Y. 2008)

(emphasis added) (finding that plaintiffs failed to allege scienter where they did not allege facts

demonstrating that defendants “were furnished with information that would have allowed them

to discern that the financial data was wrong”) (emphasis added). As discussed in more detail

below, the Court also finds that this case involves application of a GAAP principle that appears

to require some exercise of judgment, which further distinguishes South Ferry II. Thus, the

Court concludes that the “actual knowledge” analysis of the “core operations” theory does not

assist Plaintiff in establishing scienter. The Court shall, however, consider the core operations

allegations in its “holistic” evaluation of the FAC.6

With respect to the “significance” of the GAAP violations, it is undisputed that the

Restatement covered fiscal years 2003 through 2007, as well as the first two quarters of 2008. 

Plaintiff acknowledges, however, that Defendants historically, and consistently, interpreted

EITF 00-21 to treat consulting services and application services as separate units of accounting,

when sold as a bundle, until its outside auditors requested that Taleo re-evaluate this practice in

2008. (See FAC ¶¶ 4, 231; Nov. 10, 2008 Press Release at 1.) 

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Plaintiff relies heavily on Stocke v. Shuffle Master, Inc., 615 F. Supp. 2d 1180 (D. Nev.

2009). However, in that case, the defendants improperly accounted for revenue approximately

one year after they had acknowledged and disclosed a similar error. Stocke, 615 F. Supp. 2d at

1188-89. The court concluded the “similar circumstances” surrounding the two transactions, as

well as the magnitude of the impact on the defendants’ revenue, contributed to the overall

inference of scienter. Id. at 1190. In contrast, in this case Defendants had practiced the

disputed method of revenue recognition since at least 2005 and publicly disclosed their methods

in SEC filings, yet during that time there was no indication that Defendants’ application of

EITF 00-21 was erroneous. That fact distinguishes this case from the Stocke case. Indeed, the

fact that Defendants applied EITF 00-21 in such a consistent and transparent manner raises a

plausible inference that Defendants’ error was innocent. See, e.g., In re WatchGuard Sec.

Litig., 2006 WL 2038656 at *5-*6 (W.D. Wash. Apr. 21, 2006) (finding that allegations did not

support a strong inference of scienter where, inter alia, defendants had “consistently disclosed”

accounting error on which restatement was based and where “blatant error had been committed

in each quarter in open and notorious fashion for years”). 

Plaintiff also contends that application of EITF 00-21 is simple and straightforward, but

it fails to support that allegation with any facts. For example, although Plaintiff alleges that

Murray was a CPA and that Sisodraker was a Chartered Accountant, Plaintiff does not allege

facts to suggest that, by virtue of their professional status or their prior experience, Murray and

Sisodraker would have known, or should have known, that Taleo was not applying EITF 00-21

properly. Compare In re IMAX Sec. Litig., 587 F. Supp. 2d 471, 483 (S.D.N.Y. 2008) (finding

that plaintiffs had sufficiently alleged scienter where plaintiffs set forth facts demonstrating,

inter alia, defendants’ “understanding of the relevant accounting rules, ... the ramifications of

selecting certain interpretations of the rules over others,” and an “increasingly aggressive

accounting of [product] revenue”). Thus, there are no facts from which the Court could

conclude or infer that “the accounting was so simple and basic that [D]efendants could not have

made an innocent mistake.” In re International Rectifier Corp. Sec. Litig., 2008 WL 4555794

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at *14 (C.D. Cal. May 23, 2008) (citing In re Hypercom Corp. Sec. Litig., 2006 WL 726791 at

*5 (D. Ariz. Mar. 9, 2006)). 

Indeed, contrary to Plaintiff’s contentions, it does not appear that application of EITF

00-21 is a simple task. See, e.g., IMAX., 587 F. Supp. 2d at 483. In the IMAX case, plaintiffs

also alleged that the defendants failed to properly apply EITF 00-21. Although the court

concluded that plaintiffs had alleged sufficient facts to establish scienter, it noted that “the

violations alleged here are far more technical than those in other cases where the defendants

faced civil liability for the premature recognition of revenue in contravention of GAAP.” Id.

The apparent complexity of the accounting principle at issue distinguishes this case from cases

where defendants misapplied simple accounting principles over long periods of time. See, e.g.,

Backe v. Novatel Wireless, Inc., 642 F. Supp. 2d 1169, 1185-86 (S.D. Cal. 2009) (defendants

alleged to have shipped products prematurely and, in doing so, violated “basic” accounting

principles); Batwin v. Occam Networks, Inc., 2008 WL 2676364 at *12 (C.D. Cal. July 1, 2008)

(defendants allegedly improperly recognized revenue because resellers did not have ability to

pay defendants independent of payment by end-users and terms and conditions did not

appropriately transfer title or risk of loss at time of shipment); In re Microstrategy, Inc. Sec.

Litig., 115 F. Supp. 2d 620, 637-38 (E.D. Va. 2000) (defendants alleged to have recognized

revenue on contracts that had not yet been executed; court noted that “violations of simple rules

are obvious, and an inference of scienter becomes more probable as the violations become more

obvious”).

The Court finds that Plaintiff’s allegations regarding Defendants’ purported knowledge

of Taleo’s “core operations” and the purported significance of the GAAP violations do not

demonstrate a strong inference of scienter. The Court shall, however, consider each of these

allegations in its holistic evaluation of the FAC.

2. The Magnitude of the Restatement.

Plaintiff also relies on the alleged magnitude of the Restatement to support its

allegations of scienter. It is undisputed that Taleo was required to reduce consulting revenues

by $18 million, or 21%, but Plaintiff acknowledges that Taleo’s total revenue was overstated by

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approximately $18,200,000 or only 4%. (FAC ¶ 54.) Plaintiff also alleges that the Restatement

impacted Taleo’s reported net income and losses. (Id. ¶¶ 131, 144, 196, 206.) However,

according to Taleo’s financial statements, it derived its revenues primarily from application

services and consulting services were a secondary form of revenue. (See, e.g., Foung Decl., Ex.

4 (March 16, 2007 Form 10-K at 37).) Plaintiff alleges that the motive behind Defendants’

improper revenue recognition was to create the impression that Taleo “was consistently

delivering revenue at levels that exceeded analysts [sic] expectations when, in fact, the opposite

was true.” (FAC ¶¶ 2, 33.) However, in at least some of the quarters subject to the

Restatement, Taleo still exceeded consensus estimates. (Id. ¶ 34.) 

The Court concludes that the allegations regarding the magnitude of Restatement are not

so significant that they would support a strong inference of scienter. See, e.g., In re UTStarcom,

Inc. Sec. Litig., 617 F. Supp. 2d 964, 975 (N.D. Cal. 2009) (finding that “$400 million in

allegedly restated revenues supports an inference of scienter”); In re Microstrategy, 115 F.

Supp. 2d at 637 (finding allegations premised on magnitude of restatement contributed to strong

inference of scienter, where restatement was of such magnitude that it amounted to “night and

day difference with regard to” representations of profitability”). The Court shall, however,

consider these allegations in its holistic evaluation of the FAC.

3. The Prior Weaknesses in Internal Controls.

Plaintiff also supports its allegations of scienter with allegations that Defendants

disclosed material weaknesses in Taleo’s internal controls and, thereafter, claimed that they had

corrected for these deficiencies, claims that apparently were belied by the Restatement. (See,

e.g., FAC ¶¶ 65-68, 75, 81, 84.) That is, Plaintiff contends that Defendants’ awareness of prior

deficiencies suggests that they must have known that they were not recognizing revenue in

accordance with the proper interpretation of EITF 00-21, or at least recklessly disregarded that

fact. Because, however, the Court concludes that the other allegations in the FAC do not

support an inference that Defendants knowingly misapplied EITF 00-21, or were deliberately

reckless, the Court concludes that the allegations regarding prior deficiencies, which are

unrelated to the manner in which Taleo accounted for its bundled products, do not give rise to a

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strong inference of scienter. The Court, however, shall consider these allegations in its holistic

evaluation of the FAC.

4. The Insider Stock Sales.

Plaintiff also attempts to plead scienter by relying on insider stock sales. “Although

‘unusual’ or ‘suspicious’ stock sales by corporate insiders may constitute circumstantial

evidence of scienter, ... insider trading is suspicious only when it is dramatically out of line with

prior trading practices at times calculated to maximize the personal benefit from undisclosed

inside information.” Silicon Graphics, 183 F.3d at 986 (internal quotations and citations

omitted). Thus, courts consider the following factors in determining whether stock sales by

inside officers or directors provide sufficient evidence of scienter: “(1) the amount and

percentage of shares sold by insiders; (2) the timing of the sales; and (3) whether the sales were

consistent with the insider’s prior trading history.” Id.; see also Ronconi v. Larkin, 253 F.3d

423, 435 (9th Cir. 2001).

Plaintiff does not allege that Sisodraker sold any stock during the Class Period. Plaintiff

alleges that Gregoire and Murray sold 42% and 62% of their respective holdings. Defendants

do not dispute the total amount of stock sold, but they contend that Plaintiff understates

Gregoire’s holdings and overstates Murray’s holdings, and that the actual percentages are

approximately 38% and 61%. Although these percentages are large, “large numbers do not

necessarily create a strong inference of fraud.” In re Vantive Corp. Sec. Litig., 283 F.3d 1079,

1093 (9th Cir. 2002). The Court finds that is the case here.

First, as noted Plaintiff’s Class Period runs from September 2005 through November

2008. See, e.g., International Rectifier, 2008 WL 4555794 at *19. Second, the Court does not

find the timing to be suspicious. Although almost 50% of Gregoire’s stock sales were made

three months before the announcement regarding the Restatement, the bulk of Murray’s sales

occurred in November 2007. (See FAC ¶¶ 227-228.) In addition, Defendants sold their stock

pursuant to Rule 10b-5 trading plans. As the Ninth Circuit has noted, that fact may rebut an

inference of scienter. Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049, 1067

n.11 (9th Cir. 2008) (citing In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427-28 (9th Cir.

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28 7 Because the Court concludes that Plaintiff has not alleged facts sufficient to

state a claim under Section 10b-5, Plaintiff’s Section 20(a) claim also must be dismissed.

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1994)). Plaintiff also does not allege that either Gregoire or Murray amended their 10b-5 plans,

and the fact that they may have entered into the plans during the Class Period is not inherently

suspicious, given its length. Compare International Rectifier, 2008 WL 4555794 at *19

(finding allegations of scienter insufficient where class period spanned four years and where

there were no allegations that defendant had “actively amended, modified or manipulated his

10b-5 trading plans), with Backe, 642 F. Supp. 2d at 1185-86 (finding allegations sufficient to

allege scienter where plaintiff alleged that defendant had amended 10b-5 plan in order to sell

more stock). Accordingly, the Court finds that the allegations regarding the insider stock sales

do not give rise to a strong inference of scienter. The Court shall, however, consider these

allegations in its holistic analysis of the FAC.

5. Holistic Analysis.

The Court has considered the facts set forth above holistically and concludes that they

do not support a cogent and compelling inference of scienter. It is evident from the Court’s

analysis that Plaintiff does not rely on statements from confidential witnesses, does not rely on

internal Taleo documents, does not contend that Defendants violated Taleo’s internal

accounting policies, and does not allege facts that suggest the Defendants attempted to deceive

Taleo’s auditors. The lack of such facts negate an inference that Defendants acted intentionally

or with deliberate recklessness. See, e.g., Metzler, 540 F.3d at 1069 (relying on the fact that

auditors did not counsel against revenue recognition practice and fact that there were not facts

that defendant admitted practice was improper); cf. Atlas v. Accredited Home Lenders Holding

Co., 556 F. Supp. 2d 1142, 1156 (S.D. Cal. 2008) (relying on fact that defendants deviated from

its internal underwriting standards to support strong inference of scienter). 

The scienter inquiry is “inherently comparative.” Tellabs, 551 U.S. at 324. In this case,

without more, the Court cannot conclude that the “malicious inference” Plaintiff urges “is at

least as compelling as any opposing innocent inference.” Zucco Partners, 552 F.3d 991 (citing

Tellabs, 551 U.S. at 324). Accordingly, Defendants’ motion to dismiss is GRANTED.7

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D. Leave to Amend.

There have only been two iterations of the complaint in this matter, and the Court cannot

conclude that, at this point, it would be futile to grant Plaintiff leave to amend. Accordingly,

Plaintiff shall be granted leave to amend the FAC to address the deficiencies identified in this

Order.

CONCLUSION

For the foregoing reasons, Defendants motion to dismiss is GRANTED, and Plaintiff is

GRANTED leave to amend. Plaintiff shall file its second amended complaint by no later than

March 12, 2010, and this matter shall be set down for a case management conference on Friday,

May 14, 2010 at 1:30 p.m.

IT IS SO ORDERED.

Dated: February 17, 2010 

JEFFREY S. WHITE

UNITED STATES DISTRICT JUDGE

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