Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-casd-3_13-cv-00580/USCOURTS-casd-3_13-cv-00580-1/pdf.json

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

---

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNIA

IN RE MAXWELL

TECHNOLOGIES, INC.,

SECURITIES LITIGATION.

CASE NO. 13-CV-00580-BEN (RBB)

ORDER GRANTING MOTION TO

DISMISS

[Docket No. 50]

Before this Court is a Motion to Dismiss filed by Defendants Maxwell

Technologies, Inc. (Maxwell), David J. Schramm, and Kevin S. Royal. (Docket No.

50). For the reasons stated below, the Motion is GRANTED.

BACKGROUND

Maxwell Technologies is a Delaware corporation based in San Diego, CA. 

Maxwell develops, manufactures, and markets energy storage and power delivery

products, with a primary focus on ultracapacitors. Schramm served as CEO and

President of Maxwell fromJuly 2007 to December 31, 2013, and reached an agreement

to serve as an advisor for two additional years. Royal has been the Senior Vice

President, CFO, Treasurer, and Secretary of Maxwell since April 2001.

On March 7, 2013, Maxwell announced that it was restating its financial

statements for 2011 and the first three quarters of 2012. Maxwell’s sales organization

made secret arrangements with certain distributors for special payment terms. The

distributors would not have to pay Maxwell until the distributor was paid by the

customers. Under Maxwell’s revenue recognition policy, revenue is only to be

- 1 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 1 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

recognized where certain conditions are met, including that the collectability of the

revenue is “reasonably assured.” (Compl. ¶¶ 29, 134-35). However, Maxwell

recognized the revenue from these sales too early, causing the financial statements to

overstate revenue. The inaccurate revenue numbers had been included in a number of

SEC filings signed by Schramm and Royal. These filings assert that GAAP principles

are used and that the financial statements “present fairly the financial position, results

of operations, and cash flows” of Maxwell. (Id. ¶ 118). Schramm and Royal also

spoke on a number of conference calls about Maxwell and its financial performance. 

On April 26, 2012, Maxwell announced disappointing financial results for the

first quarter of 2012. (Id. ¶¶ 10, 85). A one-day drop of $6.20 per share, from $15.80

per share to $9.60 per share, followed. (¶¶ 10, 86, 162). On March 7, 2013, Maxwell

announced that there had been errorsin past restatements, that it wasrequired to restate

results for 2011 and the first three quarters of 2012. (Id. ¶ 11). It also stated that it had

to delay its annual report, that there were problems with internal controls and its credit

agreement, and announced terminations and resignations ofsome Maxwell executives. 

(Id.) The next day, shares fell $1.01. (Id.) On March 19, 2013, Maxwell announced

that McGladrey LLP had resigned asthe independent accounting firm because it could

not rely on management’s representations and continuing internal control deficiencies. 

(Id. ¶¶ 4, 13, 90). The stock price fell the next day. (Id. ¶ 91 ). Plaintiff contends that,

1

overall, the stock price dropped more than 70% from the class period high of $21.20

per share. (Id.) On April 30, 2013, Maxwell disclosed that the DOJ and SEC had

begun investigations.

Maxwell published the restated financialstatements on August 1, 2013. In total,

Maxwellstatesthat $10.1 million in revenue had been recognized prematurely in 2011,

and $9.2 million had been recognized prematurely in 2012. (Id. ¶ 154). Maxwell

asserts that there were no phony transactions and that, with insignificant exceptions,

The Court notes that the Complaint isinconsistent with respect to the exactsize 1

of the drop in the stock price on March 20, 2013. (Compl. ¶¶ 13, 91).

- 2 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 2 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Maxwell has been paid for all of the problematic sales transactions subject to the

restatement. (Mot. at 5; Def. Ex. A at 11 ). 2

Maxwell’s audit committee conducted an investigation using outside counsel and

forensic accountants. Certain Maxwell employees were terminated, and Senior VicePresident of Sales and Marketing Van Andrews resigned. While the investigation was

ongoing, Maxwell’s accountants, McGladrey LLP, resigned. McGladrey stated that

they had decided not to accept representations from the current management and that

Maxwell lacked sufficient internal controls over revenue recognition. Maxwell hired

new accountants, who accepted representations from current management, including

both individual defendants. Investigations have been commenced by the Securities and

Exchange Commission (SEC) and the Department of Justice (DOJ).

In the wake of the restatements, several lawsuits were filed against Maxwell and

the individual defendants on behalf of persons or entities that purchased Maxwell

stock. On October 24, 2013, this Court consolidated four actions, and appointed The

Employees’ Pension Plan of the City of Clearwater as Lead Plaintiff (“Plaintiff”).

(Docket No. 44). Plaintiff filed a Consolidated Complaint (Compl.) on January 17,

2014. (Docket No. 49). The Complaint, filed on behalf of persons or entities who

purchased Maxwell stock between April 29, 2011 and March 19, 2013 (the “Class

Period”), asserts two causes of action: (1) violation of Section 10(b) of the Securities

and Exchange Act of 1934 (Exchange Act), and (2) violation of Section 20(a) of the

Exchange Act. Plaintiff claims that Defendants made false statements about Maxwell’s

financial condition and internal controls, and that Schramm and Royal knew of or

participated in the secret side arrangements with distributors. 

Defendants ask this Court to take judicial notice of documentsreferenced in the

2

complaint and filed with the United States Securities and Exchange Commission. 

(Docket No. 50-2). Plaintiff did not state any objection to this Court taking judicial

notice of these documents. Documentsincorporated by reference in the Complaint and

whose authenticity no party questions, are properly considered in a Rule 12(b)(6)

motion. E.g., DeMarco v. DepoTech Corp., 149 F. Supp. 2d 1212, 1218 (S.D. Cal.

2001) (taking judicial notice of SEC filings referred to in the complaint). Accordingly

the Request for Judicial Notice is GRANTED.

- 3 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 3 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

On February 20, 2014, Defendants filed a Motion to Dismiss the Complaint on

the grounds that Plaintiff failed to sufficiently allege scienter and that loss causation

fails as to the April 26, 2012 announcement. (Docket No. 50).

LEGAL STANDARDS

Section 10(b) of the Exchange Act makes it unlawful to:

use or employ, in connection with the purchase or sale of any security

registered on a national securities exchange or any security not so

registered . . . any manipulative or deceptive device or contrivance in

contravention ofsuch rules and regulations asthe [SEC] may prescribe as

necessary or appropriate in the public interest or for the protection of

investors. 

15 U.S.C. § 78j(b). Pursuant to that section, the SEC promulgated Rule 10b-5, which

makes it unlawful, in relevant part, to “make any untrue statement of a material fact or

to omit to state a material fact necessary in order to make the statements made, in light

of the circumstance under which they were made, not misleading.” 17 C.F.R.

§ 240.10b-5(b). Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), states that a

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 assuch controlled person

to any person to whom such a 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.

Section 20(a) claims may be dismissed summarily if the plaintiff fails to adequately

plead a primary violation of section 10(b). Zucco Partners, LLC v. Digimarc Corp.,

552 F.3d 981, 990 (9th Cir. 2009) (citations omitted).

To state a securities fraud claim, a plaintiff must plead (1) a material

misrepresentation or omission by the defendant; (2) scienter; (3) a connection between

the misrepresentation or omission and the purchase and sale of a security; (4) reliance

upon the misrepresentation or omission; (5) economic loss; and (6) loss causation. 

Mattrix Init. Inc. v. Siracusano, 131 S.Ct. 1309, 1317 (2011); Reese v. Malone, No. 12-

35260, 2014 WL 555911, at *5 (9th Cir. Feb. 13, 2014) (citations omitted). Scienter

is “a mental state embracing intent to deceive, manipulate, or defraud.” Ernst & Ernst

- 4 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 4 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). 

In ruling on a motion to dismiss in a securities fraud class action, the court

assumes all factual allegations to be true. Tellabs, Inc. v. Makor Issues & Rights, Ltd.,

551 U.S. 308, 322 (2007). A court considers the complaint in its entirety, as well as

other sources courts ordinary examine when ruling on Rule 12(b)(6) motions to

dismiss, such as documents incorporated into the complaint by reference and matters

of which a court may take judicial notice. Id.

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

10b-5 must satisfy the dual pleading requirements of Federal Rule of Civil Procedure

9(b) and the Private Securities Litigation Reform Act of 1995 (PSLRA). Rule 9(b)

requires a party to “state with particularity” the circumstances constituting fraud or

mistake, but allows conditions of a person’s mind to be alleged generally. However,

the PSLRA applies special requirements to private actions for securities fraud. Where

a plaintiff may only recover money damages on proof that a defendant acted with a

particular state of mind, the complaint must, as to each alleged act or omission, “state

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

the required state of mind.” 15 U.S.C. § 78u-4(b)(2)(A). 

The Ninth Circuit has held that in a securities fraud action, plaintiffs must show

that defendants engaged in “knowing” or “intentional conduct.” South Ferry LP, No.

2 v. Killinger, 542 F.3d 776, 782 (9th Cir. 2008) (citing In re Silicon Graphics, Inc.

Sec. Litig., 183 F.3d 970, 975 (9th Cir. 1999)). Reckless conduct can meet the standard

to the extent it “reflects some degree of intentional or conscious misconduct,” or what

has been termed “deliberate recklessness.” Id. (citing Silicon Graphics, 183 F.3d at

977). In pleading deliberate recklessness, the plaintiff must plead 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 a

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.” Zucco, 552 F.3d at 991 (quoting

- 5 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 5 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Silicon Graphics, 183 F.3d at 976). Facts showing “mere recklessness,” or motive and

opportunity to commit fraud, provide some reasonable inference of intent, but are not

independently sufficient. Reese v. Malone, 2014 WL 555911, at *7 (citing Silicon

Graphics, 183 F.3d at 974).

The strong inference is required to be “cogent and compelling, thus strong in

light of other explanations.” Tellabs, 551 U.S. at 324. The inquiry is “inherently

comparative” and requiresthat a court consider plausible, nonculpable explanationsfor

the defendant’s conduct, as well asinferences favoring the plaintiff. Id. Although the

inference that a defendant acted with scienter need not be irrefutable or the “most

plausible” of competing inferences, it must be more that merely “reasonable” or

“permissible.” Id. A complaint will survive “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.” Id. The relevant inquiry is “whether all of the

facts alleged, taken collectively, give rise to a strong inference ofscienter, not whether

any individual allegation, scrutinized in isolation, meets that standard.” Id. at 323

(emphasis in original). In reviewing the sufficiency of scienter allegations after

Tellabs, the Ninth Circuit has conducted a dual inquiry in which it first determines if

any allegation, standing alone is sufficient to create a strong inference of scienter. 

Zucco, 552 F.3d at 992. If not, it examines the complaint holistically to determine if

the insufficient allegations combine to create a strong inference of intentional conduct

or deliberate recklessness. Id.

DISCUSSION

Defendants argue that Plaintiff has failed to sufficiently allege scienter. They

argue that the Complaint does not allege facts giving rise to the “strong inference” that

Schramm or Royal were involved in or knew of the secret side arrangements which

caused the restatement. (Mot. at 2).

Plaintiff points to a number of different allegations which it contends are

sufficient to raise a strong inference of scienter, when viewed holistically. Plaintiff

- 6 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 6 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

pointsto the statements offive confidential witnessesincluded in the complaint. It also

points to a variety of other facts, such as the “noisy” resignation of Maxwell’s auditor,

the individual defendants’ performance-based compensation, government

investigations, the individual defendant’s role in the corporate structure, and alleged

involvement in relevant transactions. Defendants dispute that such allegations give rise

to a strong inference, and point to other facts which they contend undermine a strong

inference of scienter.

This Court individually examined the various allegations raised to determine if

they are sufficient to create a strong inference of scienter. As none are individually

sufficient, the Court examined them holistically to determine if they create a strong

inference of scienter when viewed in combination. As this Court determines that a

strong inference ofscienter is not created, it will not proceed to unnecessarily consider

loss causation.

A. Corporate Scienter

Plaintiff argues that corporate scienter issatisfied because defendants Schramm

and Royal, aswell as non-defendant Andrews, were senior-level executives responsible

for Maxwell’s core operations and acted with the requisite scienter. (Opp’n at 10). 

Plaintiff argues that Maxwell’s corporate scienter is “beyond reasonable dispute”

because it admitted that Andrews left the company “as a result” of the investigation

into wrongdoing. (Opp’n at 4). Plaintiff contends that the scienter of Andrews,

Schramm, and Royal can be imputed to Maxwell, and that Maxwell is liable for the

securities fraud of its “controlling employees.” (Id.) 

Defendants do not appear to dispute that the scienter of named individual

defendants Schramm or Royal can be imputed to Maxwell, but argues that nondefendant Andrews’ scienter cannot be so imputed. Defendants argue that the effort

to attribute the knowledge of an employee to the company is an attempt to use a

“collective scienter” theory which is not the law in this Circuit. (Reply at 1). 

Defendants cite to Glazer Capital Mgmt., LP v. Magistri, 549 F.3d 736, 744-45 (9th

- 7 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 7 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Cir. 2008), in which the Ninth Circuit noted a circuit split on the issue, and stated that

its precedent did not foreclose the possibility that collective scienter might be

appropriate in some circumstances. However, the NinthCircuit in Glazerrequired that

a plaintiff who rested his claim on three statements in a legal document plead scienter

as to the individuals who actually made the false statements in the merger agreement. 

Id. at 745. The Ninth Circuit did not lay out a test for determining when individual

scienter might not be required, but stated that it reached its conclusion based on the

“nature and unique context of the alleged misstatements in this case.” Id.

This Court has examined the arguments raised by Plaintiff, and has determined

that Plaintiff has not demonstrated that collective scienter is applicable here. As in

Glazer, this Court looks at the nature and context of the misstatements. Plaintiff’s

claims are based upon statements by the individual defendants and in official filings

signed by the individual defendants. It is thus necessary to require scienter as to the

individuals who were responsible for the statements. This is not a situation in which

the fact that Andrews or another employee may have had the requisite knowledge

indicated that the individual defendants who made or authorized statements knew they

were false when they were made. The fact that Andrews, a non-defendant, allegedly

had knowledge of misconduct does not indicate that any statements were made with the

necessary mental state.

The Court has examined the cases cited by Plaintiff. Although the case law

supports holding a corporation responsible for the actions of its executives, Plaintiff

does not cite cases that support corporate scienter based only upon the scienter of a

non-defendant who did not make or certify the statements at issue. Thus, although this

Court agrees with Plaintiff that corporate scienter is alleged if it is sufficiently alleged

that Schramm or Royal had the necessary mental state, corporate scienter is not

sufficiently alleged under these circumstances where one executive had the knowledge

and other, perhaps-innocent executives made the statements. 

///

- 8 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 8 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

B. Plaintiff’s Arguments for Individual Scienter

Plaintiff’s briefing points to numerous allegations which it contends support a

strong inference that Schramm and Royal had the necessary mental state.

i. Confidential Witnesses

The principal argument set forth by Plaintiff isthat a strong inference ofscienter

arises from the statements made by five confidential witnesses who are described and

quoted in the Complaint. Plaintiff contendsthat these statementssupport the claimthat

Schramm and Royal engaged in, or knew about, the side deals and improperly realized

revenue. Defendants raise numerous challenges to the statements.

A complaint relying upon statementsfrom confidential witnesses must passtwo

hurdles to satisfy the PSLRA pleading requirements. Zucco, 552 F.3d at 995. First,

the confidential witnesses must be “described with sufficient particularity to establish

their reliability and personal knowledge.” Id. (citing In re Daou Systems, Inc., 411

F.3d 1006, 1015-16 (9th Cir. 2005)). Second, the statements themselves must be

“indicative of scienter.” Id. (citing Daou, 411 F.3d at 1022). 

a. Confidential Witness #1

Confidential Witness #1 (CW1) was Maxwell’s Vice President of Business

Development from January 2006 to March 2013. (Compl. ¶ 52 n. 16). CW1 initially

reported to Schramm, and after 2010 reported to Andrews and Schramm. (Id.) CW1

wasfired for purported involvement in the accounting scheme. (Id.) CW1 reportsthat

“things definitely changed” after Andrews arrived and that she was taken “out of the

3

loop” on many of the issues in the restatement. (Id. ¶ 52).

CW1 reports that she was involved in a shipment of product that was not going

to be accepted by the end user. (Id. ¶ 61). She reports that Andrews directed her to

speak with Alfatec, the company’s German distributor, and have the shipment delivered

to Alfatec. (Id.) CW1 stated that Alfatec knew Maxwell wanted Alfatec to take and

This Court follows Plaintiff’s convention of referring to all confidential 3

witnesses with female pronouns to protect confidentiality.

- 9 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 9 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

store the product, but that Alfatec would not pay for the product at the time. (Id.) CW1

stated that this arrangement might not be a problem if it had been properly accounted

for by Maxwell. (Id. ¶ 62). The Complaint says that CW1 reported questioning

Andrews about changing the terms of the shipment, and Andrews told her that it was

“OK’d by David,” presumably referring to Schramm. (Id.) CW1 also states that

Andrews was warned by Schramm that he would be fired and allowed to resign, but

does not state how she knew Andrews was warned. (Id. ¶ 81).

Defendants raise a number of arguments regarding CW1. First, they point out

that CW1 and CW4 are both former, disgruntled employees. Plaintiff argues that this

goes to the witnesses credibility, and it is not appropriate for this Court to determine

credibility issues at this stage. This Court agrees with Plaintiff. The Court will

examine the witnesses for indicia of reliability and personal knowledge, but it will not

ignore detailed and otherwise reliable allegations simply because the witness might

have a motive to lie. See In re Gilead Scis. Sec. Litig., No. C 03-4999, 2009 WL

3320492, at *2 (N.D. Cal. Oct. 13, 2009).

Second, Defendants argue that the confidential witnesses offer sweeping

generalizations, not specific facts. Plaintiff’s description of the confidential witness

accounts raises serious problems. In reviewing the Complaint’s characterization of

their statements, it is often unclear what the witness actually said, what the Plaintiff has

inferred, and what is commentary by the Plaintiff. To the extent that certain ideas were

expressed by the witness, their basis is often unclear. In particular, this Court cannot

determine from the Complaint whether any of the confidential witnesses had any

reason to believe the individual defendants knew there were improprieties.

In the case of CW1, for instance, the Complaint reports that CW1 stated that the

arrangements might not have been problematic if reported, then states that “However,

the Individual Defendants made sure this was not the case in order to boost Maxwell’s

sales figures.” (Compl. ¶ 62) The Complaint does not indicate whether CW1 said this

or it is Plaintiff’s commentary. If CW1 did say this, it does not explain the basis for the

- 10 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 10 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

statement. For instance, the Complaint does not report any statements made by the

individual defendants that suggest that they knew the sales were not properly reported

to accounting, much less why they did so. The Complaint also states that CW1

confirmed that the secret change was ordered by Andrews and Schramm, and the

Opposition indicates that CW1 stated that Schramm ordered secret alteration of terms

and Andrews carried them out. (Id.; Opp’n at 16). However, the Complaint does not

indicate what, if anything, CW1 said to indicate that she concluded that Andrews or

Schramm knew it was secret, on what basis she reached that conclusion, or whether

either man actually ordered her to do it without telling anyone. This Court therefore

cannot tell whether this statement is CW1’s characterization of events or merely

Plaintiff’s interpretation of the fact that CW1 was told to change the payment terms. 

There is also no basis from which this Court could conclude that CW1 had personal

knowledge of the fact that Andrews was warned in advance of the terminations.

It appears that CW1 wasin a position to know about the existence of unreported

side arrangements, and might have plausibly learned whether the individual defendants

were aware of the sales arrangements and how they were reported to accounting. 

However, in order for the statement of CW1 to support scienter, Plaintiff must give this

Court a sufficiently clear indication of what CW1 actually said and the basis for that

statement. With respect to much of the description of CW1’s statement, this Court

cannot determine which allegations and comments were made by CW1. To the extent

it is clear Plaintiff is relating the statement of CW1, Plaintiff has frequently failed to

establish reliability and personal knowledge. Those statements for which reliability

and personal knowledge have been established are not sufficiently indicative of

scienter. Although Plaintiff’s characterization suggests that CW1 may possess

evidence ofscienter, Plaintiff has not communicated that evidence in a way that allows

this Court to infer scienter.

///

///

- 11 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 11 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

b. Confidential Witness #2

Confidential Witness #2 (CW2) was Maxwell’s Sales Operations Manager from

February 2008 to May 2011. (Compl. ¶ 53 n. 17). CW2 was responsible for sales

reporting and client contracts, including the preparation ofsales reports and attendance

at weekly sales meetings. (Id.) These reports included information about outstanding

sales, received orders, unfulfilled sales, and invoiced orders. (Id.) The Complaint

alleges that CW2 characterized the environment at Maxwell as becoming more

secretive and restrictive after Andrews arrived. (Id. ¶ 53). CW2 is reported as stating

that she did not trust Andrews and that he was a typical sales person who “pushed to

get stuff done” at the end of quarters. (Id.) CW2 stated that she was “not surprised”

by the need for the restatement. (Id.) CW2 reports that Andrews excluded her from

weekly sales meetings after he arrived, but that she still sent reports to Andrews. (Id.

¶ 63). CW2 is quoted as saying she was “sure at the time” that there were orders being

reported as booked when that was not actually the case. (Id.) CW2 also stated that

Andrews addressed issues or discrepancies with the terms of the transaction. (Id.)

The account of CW2 does not support a strong inference of scienter. There is

no indication in the statement that Schramm or Royal were aware of the side deals, or

the fact that the deals were not reported. Indeed, it is not clear that CW2 actually knew

anything about the scheme while at Maxwell, much less who was involved. 

Defendants also correctly point out that CW2 was not working at Maxwell for much

of the Class Period. These statements provide little support to infer scienter.

c. Confidential Witness #3

Confidential Witness #3 (CW3) was Maxwell’s Senior Sales Operations

Administrator from September 2011 through June 2012. (Compl. ¶ 64 n. 19). CW3

was responsible for entering and processing orders, as well as for overseeing the

implementation of a customer relationship system. (Id.) CW3 participated in weekly

Accounts Receivable meetings. (Id.) CW3 reported to Andrews and Tara Whiteside,

the Business Planning & Sales Operations Manager. (Id.) The Complaint reports that

- 12 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 12 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

CW3 talks about the fact that it was “always a scramble” to process Alfatec orders and

put the products “on a boat” to count the orders during the reporting period. (Id. ¶ 64) 

The Complaint states that “CW 3 understood that this was being done so that these

orders could be booked as revenue in the quarter about to end even though the

Individual Defendants knew this wasn’t the case . . .” (Id.) CW3 stated that Schramm,

Royal, and Andrews received flash reports that set forth expected sales, which were

“always inflated” because of the sales quota. (Id. ¶ 65). CW 3 is quoted as saying the

“integrity of the orders came into question.” (Id.)

The Complaint recounts CW3’s description of events involving Maxwell

distributor Pana-Pacific. (Id. ¶ 66). CW3 reported thatshe entered terms for the orders

based on purchase orders and invoices, but that the terms were not the same as the

terms Andrews verbally extended to Pana-Pacific. (Id.) CW3 stated that PanaPacific’s accounts receivable became past-due and that she raised this issue in the

Accounts Receivable meetings, which included Andrews and “on occasion Defendant

Royal.” (Id. ¶ 67). CW3 says that Whiteside told her that Andrews had a verbal

agreement with Pana-Pacific to extend the payment terms. (Id.) CW3 stated that

extending such terms required Royal’s approval, and the Complaint states that “the

CFO should have been involved.” (Id.)

CW3 also discussed Maxwell’s policy on credit holds. (Id. ¶ 68). She stated that

additional orders could only be shipped if one of the individual defendants, usually

Royal, released the hold. (Id.) The hold was released on Pana-Pacific despite unpaid

receivables. (Id.) CW3 states that Whiteside told her that she should not try to collect

from Pana-Pacific because Andrews was “handling it,” and that she should not talk to

Andrews about Pana-Pacific. (Id. ¶ 69). CW3 states she expressed concerns to

Whiteside. (Id.) CW3 did state that she felt it was “very weird” to be directed to

remain silent about the situation. (Id. ¶ 70).

CW3’ s account cannot support a strong inference of scienter. Although the

Complaint’s discussion ofCW3 statesthat the individual defendants knew thatrevenue

- 13 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 13 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

was being improperly booked, it is unclear whether CW3 ever says this, or if CW3 has

any basis to say this. Although the Complaint indicates that CW3 was told to remain

silent, this allegation is too ambiguous to help infer scienter. This Court cannot tell if

the Complaint was referencing Whiteside’s instructions or one of the individual

defendants told her not to talk about the side deals. None of the allegations provide

specific facts from which this Court could infer that the individual defendants knew

that side deals were not being communicated to the accounting department. At most,

it indicates that one or both individual defendants were aware of collection problems

and authorized credit hold decisions that allowed additional productsto be shipped and

improperly booked. It is not, however, clear from the Complaint that Maxwell policy

was followed and that either individual defendant actually authorized special terms or

lifting credit holds. Plaintiff argues that CW3’s testimony “fatally undermines any

claim that Royal and Maxwell were unaware of Pana-Pacific’s undisclosed extended

payment terms.” (Opp’n at 15). The Court agrees that it is somewhat undermined. 

However, even if Schramm and Royal knew about the side deals, this does not indicate

that they knew that revenue was improperly booked. Plaintiff also points out that

CW3’s account of end-of-period activity was corroborated and that other CWs had

suspicions about the revenue being booked. (Id. at 16). However, Plaintiff has not

explained how an active sales department and the suspicions of third parties indicates

that the individual defendants knew about the improper accounting. 

d. Confidential Witness #4

Confidential Witness #4 (CW4) was Maxwell’s Senior Director of Global Sales

and Marketing from August 2012 to March 2013. (Compl. ¶ 71 n.20). CW4 also

worked at Maxwell from February 2008 to July 2010 as Director of Sales and

Marketing for the Americas. (Id.) From 2012, CW4 wasresponsible for sales strategy

and managing customer relationships, and reported to Schramm and Andrews. (Id.) 

CW4 was fired for purportedly having a role in the events leading to the restatement. 

(Id.) CW4 made statements pertaining to both Maxwell business practices, and

- 14 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 14 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

conversations overheard during carpool rides.

First, the Complaint alleges that CW4 states that the illicit business practices

were used with clients worldwide. (Id. ¶ 71). CW4 provides details on the kinds of

arrangements that were made. (Id. ¶ 72). CW4 stated that Royal approved extended

payment terms, and that only Schramm and Royal could lift a credit hold. (Id.)

Although these statements allow an inference that the actions of one or both

defendants was necessary to carry out the misconduct, it alone does not establish

scienter on the part of Schrammor Royal. The fact that the individual defendants made

or should have made decisions on payment terms or credit holds does not indicate that

they knew that the effects of those decisions were not properly reported to accounting.

Second, CW4 makes claims based on the fact that she “often” joined Schramm

and Andrews in their carpools. The Complaint states that she heard “off the record

conversations” which Plaintiff alleges “included these problematic business practices.” 

(Id. ¶ 82). The Complaint states that CW4 recalled Schramm telling Andrews to “take

certain actions necessary to ‘make the numbers,’ and that Schrammboasted that he had

‘a clean bill of health’ regarding his participation in these practices.” (Id.) CW4 states

that she has a lot of information and can put “a nail in the coffin” of Schramm and

Royal. (Id.) CW4 claimed that Schramm and Royal were “spearheading” the

fraudulent transactions and were responsible for the matters that were restated. (Id.

¶ 83). She allegedly claims that they “knew everything” and were “guiding it.” (Id.) 

She states that she was “told what to do” by the individual defendants and that the

individual defendants knew what was going on. (Id.)

The Court has very carefully examined these allegations. These statements

certainly indicate that CW4 may have heard or seen something from which this Court

could infer scienter. However, as with the other confidential witnesses, it is not always

clear what CW4 actually said. Additionally, this Court cannot actually determine what

CW4 claims to have heard. Many of the statements about the role of Schramm and

Royal are conclusory and without foundation. It is not clear from the pleadings, or

- 15 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 15 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

from the briefing, whether the carpool conversations acknowledged that revenue was

improperly recognized, or if the discussion of problematic business practices meant

only that Schramm indicated knowledge of the special sales terms. Although CW4

believes CW4 has damaging evidence, Plaintiff has not shared any specific facts from

which this Court can conclude that CW4 possesses facts giving rise to scienter.

e. Confidential Witness #5

Confidential Witness #5 (CW5) was Maxwell’s Director of Sales and Marketing

from June 2010 to October 2012. (Compl. ¶ 73 n. 21). She was responsible for sales

to both customers and distributors. (Id.) In her final months, CW5 participated in

weekly Days Sales Outstanding meetings with Royal and other executives where they

discussed accountsreceivables. (Id.) She reported to and interacted with Schrammand

Royal. (Id.)

According to theComplaint, CW5 discussed the Alfatec arrangements, including

the fact that Alfatec was brought in to serve as a buffer and hold inventory. (Id. ¶ 73). 

CW5 stated that although later deals and purchase orders usually matched the original

contract, purchase orders for the transactions in the restatement would not have

included the additional terms and concessions. (Id. ¶ 74) She stated that the need to

restate revenue was “not a surprise” given the clients’ failure to send payment. (Id.) 

CW5 also reportsthat an analyst had asked Schrammwhy the accountsreceivables had

grown three-fold, but the sales only grew by a factor of 1.2. (Id. ¶ 75). The Complaint

characterizes CW5’s statement as saying that this analyst was not satisfied with

Schramm’s answer, that the “analyst published that Schramm’s explanations did not

make sense” and that the analyst made efforts to get to bottom of the issue. (Id.) CW5

states that the individual defendants began a weekly meeting in May 2012 regarding

past-due accounts, which CW5 attributed to the analyst’s inquiry. (Id. ¶ 76). Royal

directed this meeting, which would discuss accounts where special payment terms had

been extended. (Id.) From this, the Complaint concludes that the individual

defendants “were pushing to present financial results that were in line with the

- 16 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 16 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Company’s representations to Wall Street.” (Id.).

CW5 also states that while some people at the company blamed lower

executives, other people at Maxwell knew that this was not the case. (Id. ¶ 79). CW5

said the Defendants needed to produce numbersin order to appear to be a growth stock

company. (Id.). CW5 also stated that Andrews, Royal, and Schramm were close

friends and that Schrammand Andrewslived in the same community, went to the same

country club, and carpooled every day. (Id. ¶ 81).

It is unclear from Plaintiff’s characterization of CW5’ s statement whether CW5

actually possesses any knowledge from which this Court could conclude there is a

strong inference ofscienter. The Complaint does indicate that Royal would have been

aware of an issue with past-due accounts. However, none of the statements indicate

that CW5 heard either individual defendant say anything or knew that the individual

defendants heard something that indicates that they knew there was a revenue

recognition problem. It is entirely possible from the description that CW5 might have

such facts, but Plaintiff must present them clearly; this Court cannot speculate on what

CW5 might have meant. The Complaint also fails to indicate if CW5 actually knows

what, if anything, the analyst told Schramm. The Complaint’s characterization of her

statement assaying the analyst “published” that Schramm’s explanations did not make

sense suggests that CW5 was not present and is relying on hearsay from the unnamed

analyst. Although hearsay can be considered, it can indicate that a witnesses’ report

is “not sufficiently reliable, plausible, or coherent to warrant further consideration

under Daou.” Zucco, 552 F.3d at 997 n.4. Here, the fact that CW5 may not have been

present undermines this Court’s ability to draw significance from her report that an

unnamed individual presented unknown facts to Schramm and got a response that did

not satisfy him or her. CW5’ s allegations that the individual defendants and Andrews

were friends and shared a social circle do not mean that the individual defendants knew

of wrongdoing. It is, however, consistent with the theory that Andrews was working

with Royal and Schramm on the scheme and that all three knew about the improperly

- 17 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 17 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

recognized revenue.

f. Conclusion

The confidential witness accounts do not indicate that the individual defendants

were aware of the recognition problem. The parties are not disputing whether there

were accounting improprieties, or the fact that side arrangements were extended. The

confidential witness testimony offered by Plaintiff supports an inference that the

individual defendants knew that there were some problems with collections, and were

aware of special payment terms and credit hold decisions. However, Plaintiff has not

indicated that there was anything inherently wrong with extending payment terms or

making a special sales arrangement. Such arrangements are a problem when they are

not properly taken into account at the accounting stage. The question is thus whether

Schramm and Royal knew that the special sales terms were not being properly taken

into account in the financial statements. If the confidential witnesses possess any

information on this subject, it was not laid out with sufficient clarity for this Court to

infer scienter.

To the extent Plaintiff is arguing that the level of the individual defendant’s

involvement in payment terms and meetingsindicatesthat they must have known there

was a problem with the revenue numbers, Plaintiff needs to explain why thisisso. The

Court cannot speculate.

Review of Plaintiff’s pleading and the characterizations of the CW statements

in Plaintiff’s Opposition indicates that Plaintiff may be able to make a stronger case if

the Complaint is amended to more clearly and completely explain what the CWs know

and have said. To the extent the CWs actually heard or saw something that indicated

that the individual defendants knew the terms were secret or thatsales were improperly

booked, Plaintiff should clearly lay these facts out. Plaintiff should avoid

characterizing the testimony in a manner that makes it difficult for this Court to

differentiate between witness statements and Plaintiff’s own conclusions. 

///

- 18 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 18 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

ii. Andrews

Plaintiff alleges that Andrews wasthe “third in command” who reported directly

to Schramm and Royal. (Compl. ¶ 51). Plaintiff claims that the culture of Maxwell

changed dramatically, “becoming more secretive and isolationist.” (Id.) It also points

to the fact that Maxwell’s financialresultsincreased nearly immediately after Andrews

was hired. (Id. ¶ 54). The confidential witness accounts indicate that Andrews had

strong personalrelationships with the individual defendants, and was actively involved

in extending specialsales terms and handling past-due accounts. Such allegations may

support claims of misconduct by Andrews, but they do not establish that Royal or

Schramm were involved. The personal relationship between Andrews and the

individual defendants is consistent with their cooperation in a revenue scheme, but the

existence of a warm relationship does not indicate that Schramm and Royal knew what

Andrews was doing or that they knew that special sales terms were not properly

considered in Maxwell’s accounting.

iii. Auditor’s Resignation

Plaintiff argues that the “noisy” resignation of Maxwell’s auditor supports a

strong inference of scienter. Plaintiff points to the fact that McGladrey LLP resigned

in part because it could not rely on representations from current management and

certain third parties. (Opp’n at 18). Plaintiff argues that this is consistent with

allegationsthat Defendants colluded with third partiesto improperly recognize revenue

through undisclosed arrangements. (Id.) Plaintiff emphasizes that Maxwell disclosed

the reasons for the resignation, even though such a disclosure is not generally required. 

Defendants dispute this. (Reply at 8 (citing 17 C.F.R. § 229.304(a)(1)(v))). 

Defendants also argue that if McGladrey LLP believed that the CEO and CFO had

engaged in fraud, it would have been required to report this fact to the SEC. (Id. at 8-

9). Defendants point out that a new auditor relied on management’s representations. 

Plaintiff argues that this only points to an “economic opportunity” for the new auditor,

and is not an implicit blessing of management’s integrity. (Opp’n at 18).

- 19 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 19 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Based on the information alleged, this Court cannot find that the resignation

alone gives rise to a strong inference of scienter. One auditor was willing to trust the

representations, and one was not. This Court has no information that allows it to draw

stronger inferences from one more than the other. An independent auditor’s

resignation because it feels it cannot rely on management’s representations may, under

certain circumstances, support an inference that the company was misrepresenting or

concealing its financial health. In re Am. Apparel, Inc. Shareholder Litig., 855 F.

Supp. 2d 1043, 1083 (C.D. Cal. 2012). However, such a recognition by itself does not

demonstrate that management acted intentionally or recklessly, rather than acting

incompetently, in ignorance, or based on a mistake. See id. at 1084. This Court does

not know why McGladrey concluded that it could not rely on the statements of

management. There is no indication that McGladrey believed either individual

defendant was engaged in the misconduct, and no evidence was presented to suggest

that McGladrey had any information about what Schramm or Royal knew about the

misconduct. Without additional explanation about the reasons for resigning and the

basis for their mistrust, the resignation alone does not indicate that the individual

defendants had scienter. However, the fact that McGladrey felt it could not trust the

representations of management does indicate that the auditors had doubts about the

individual defendants’ willingness to be truthful or forthcoming with respect to the

misconduct. The Court considers the resignation in the holistic analysis.

iv. False Certifications, GAAP Violations, and the Need to Restate

Plaintiff points to the false SOX certifications and “numerous admitted GAAP

violations” as contributing to a strong inference of scienter. (Opp’n at 19). It

emphasizesthe importance of the inflated earnings, and claims that if they actually had

designed and evaluated internal controls over financial reporting as they stated in the

certifications, the “substantially inflated financial results and GAAP violations could

not have escaped notice.” (Id. at 19-20).

Plaintiff also contends that the admissions made during the restatement provide

- 20 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 20 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

strong support for inferring scienter. Plaintiff points to the fact that Maxwell restated

nearly two years of financial results and admitted that there was deliberate accounting

misconduct. Plaintiff cites to Backe v. Novatel Wireless, Inc., 607 F. Supp. 2d 1145,

1161-63 (S.D. Cal. 2009), on reconsideration, 642 F. Supp. 2d 1169, 1186 (S.D. Cal.

2009), in which a district court found scienter based in part upon early product

shipment, GAAP violations, and the simplicity of the accounting principles involved.

Defendants contend that the circumstances of the restatement do not give rise to

a strong inference of scienter. (Mot. at 11). They emphasize that merely restating

financial statements or failing to follow GAAP is insufficient, without more, to

establish scienter. (Id. (citing DSAM Global Value Fund v. Altris Software, Inc., 288

F.3d 385, 390 (9th Cir. 2002))). Defendants argue that a financial restatement can

suggest that internal controls were ineffective, but that this is not enough to

demonstrate that a CEO or CFO acted with scienter.

The Court agrees with Defendants that these facts alone do not give rise to a

strong inference of scienter. GAAP violations and false certifications can take place

where there is no scienter. However, Plaintiff appears to argue in the briefing that,

given the nature of the violation, Defendants could not have missed the violations if

they evaluated the internal controls as they claimed. Although the large amount at

issue suggests Plaintiff’s argument may be plausible, this Court does not have the

information to evaluate this argument and conclude there is a strong inference of

scienter. Plaintiff has not presented the necessary information about accounting

principles and internal controls to allow this Court to evaluate whether the individual

defendants should have been or must have been aware of the violations.

v. Core Operations

The Ninth Circuit has stated that as a general matter, corporate management’s

general awareness of the day-to-day workings of the business does not establish

scienter, at least absent additional allegation of specific information conveyed to

management and related to the fraud or other allegations supporting scienter. S. Ferry

- 21 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 21 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

LP, No. 2, 542 F.3d at 785 (citation omitted). However, allegations regarding

management’s role in a corporate structure may be considered as part of the holistic

analysis required in Tellabs, and such allegations can independent satisfy the PSLRA

where they are “particular and suggest that defendants had actual accessto the disputed

information.” Id. at 785-86. Management’s role and the importance of the corporate

information may create a strong inference of scienter when made in conjunction with

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

within the company.” Id. at 785; Zucco, 552 F.3d at 1000. In “rare circumstances,”

particularized allegations are not needed where the nature of the relevant fact is ofsuch

prominence that it would be “absurd” to suggest that management did not have

knowledge of it. S. Ferry LP, No. 2, 542 F.3d at 786.

Plaintiff assertsthat the inference ofscienter isstrengthened because the revenue

recognition scheme involved Maxwell’s “core business.” (Opp’n at 20). Plaintiffs also

allege that Maxwell operated under an “executive-centric, top-down organizational

structure” in which major changes to contract and payment arrangements had to be

approved by senior executives, and material changes to payment terms for sales had to

be approved by Royal and/or Schramm. (Compl. ¶ 31). 

Defendants reject the suggestion that scienter is supported by the individual

defendant’s high-level positions and “top-down” corporate structure, and cite to cases

in which high rank is insufficient to infer scienter. The Court agrees that rank alone

does not suffice to infer scienter. There is also insufficient information before this

Court for the Court to conclude that it is “absurd” to suggest that the individual

defendants did not have knowledge of the improper accounting. The inflation of

revenue arose out of a combination ofside deals, many of which were allegedly carried

out by Andrews, and the failure to communicate those deals to the people who should

have adjusted the revenue reported. Plaintiff has not demonstrated to this Court that

lack of awareness of this fact rises to the level of absurdity. 

The Court also concludes that Plaintiff has not made the necessary “detailed and

- 22 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 22 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

specific allegations” about management’s exposure to information to give rise to a

strong inference of scienter. Although Plaintiff has alleged that the individual

defendants attended sales-related meetings and had accessto sales reports, this does not

support the inference that the individual defendants must have known about the

accounting misconduct. Indeed, it is not clear to this Court exactly what information

Schramm and Royal would have had about what revenue was actually counted and

whether the meetings and reports should have alerted them to the fact that this

information was not accurate.

However, the Court does take into consideration in its holistic analysis that the

scheme involved core operations of Maxwell’s business and that the individual

defendants were allegedly involved or apprised on a regular basis of relevant facts,

such as sales and revenue collection. It considers that the organizational structure

allegedly required the individual defendants to be involved in certain sales and credit

decisions. It also takes into consideration the magnitude of the overstatement, which

comprised millions of dollars, and the long duration of the scheme. These facts make

it more likely that the individual defendants were or could have been aware of the

wrongdoing.

vi. Approval and Holds

Plaintiff’s Complaint alleges that the individual defendants were involved in or

informed of various aspects of sales. It alleges that violations were “well-known” to

individual defendants because they inflated revenue by secretly modifying the payment

terms, but failing to inform accounting so that it was recognized as revenue. (Compl

¶ 58). Plaintiff alleges that they were able to engage in fraud and cover their tracks by

lifting the credit holds on the distributors who did not pay them. (Id. ¶ 60)

These allegations are insufficient to independently establish a strong inference

of scienter. Even if the individual defendants knew about the extension of special

terms to certain customers, and authorized lifting credit holds, this does not indicate

that they knew there was an accounting problem. Other than conclusory statements,

- 23 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 23 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Plaintiff does not plead any particular facts that indicatesthat the individual defendants

knew that the special terms and side deals were unreported. Plaintiff may be

suggesting that individual defendants knew about the side deals, should have known

thatrevenue should therefore not be recognized, and would have seen the inconsistency

in financialstatements. However, Plaintiff has not pleaded facts fromwhich this Court

could make those logical leaps. Close monitoring of accounts and sales does not

necessarily indicate that the individual defendants would have known that the final

reported accounting numbers were manipulated. Plaintiff has not pled sufficient

information about the practices of the company to permit this Court to determine

whether the individual defendants could have learned information about particular sales

and believed the financial statements to be accurate.

However, the Court does consider the fact that the individual defendants had

accessto some sales information, knew about at least some payment problems, and that

company policy called for them to approve lifting credit holds. 

vii. Investigations

Defendant argues that as a restatement alone does not give rise to a strong

inference of scienter, neither can the “routine consequences” of a restatement. (Mot

at 11). Defendants claims that such routine consequences include the signing of

certifications, resignations and terminations of officers and employees engaged in

intentional misconduct, the company concluding that internal controls are weak, or a

government investigation. (Id.)

With respect to the post-restatement investigation, Defendants contend that

government investigations are routine after a financial restatement. (Id. at 12-13). 

Plaintiff argues that this fact nonetheless contributes to a strong inference of scienter,

especially in the wake of the recognition of other internal control problems. (Opp’n

at 21). Without other information regarding the investigation, this Court cannot find

that the investigation gives rise to a strong inference of scienter. Even if the

investigation reflects the fact that there was misconduct and that there issuspicion that

- 24 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 24 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

laws were broken, this does not indicate that Schramm or Royal are suspected of

misconduct, much less allow this Court to infer scienter. It is established that there

were problems in the financialstatements. Plaintiff has not demonstrated how the postdisclosure investigation supports the conclusion that these particular individuals had

the required mental state.

Plaintiff also alleges that Maxwell recognized internal control problems before

the Class Period. The DOJ and SEC investigated Maxwell and filed actions against

Maxwell for violations of the Foreign Corrupt Practices Act (FCPA) that involved the

payment of $2.5 million in illicit kickbacks to foreign officials to secure and retain

contracts. (Compl. ¶ 33). Plaintiff points to SEC charges that Maxwell did not

disclose the material revenues and profits from the bribery scheme, that former

Maxwell officers knew about and tacitly approved payments, that payments were not

accurately recorded, and that Maxwell failed to implement or maintain a system of

effective internal accounting controls. (Id. ¶ 34). Maxwell entered into a deferred

prosecution agreement which admitted responsibility (Id. ¶ 35). Plaintiff’s Complaint

also cites two recent law enforcement investigations. (Id. ¶¶ 36, 37). In the briefing,

Plaintiff cites to case law that points out that, after the occurrence of a crisis that could

repeat itself, there is incentive to review results and assess the possibility of future

problems. (Opp’n at 21 (citing Reese, 2014 WL 555911, at *8)). 

Defendants contend that pre-Class Period settlement of “unrelated” FCPA

violations in China is irrelevant. (Mot. at 13). They point out that Maxwell disclosed

the FCPA violations to the government and claim that Maxwell cooperated with the

investigations. They also point out that there were no allegations of wrongdoing

against Schramm or Royal.

This Court finds that the prior investigation does not give rise to a strong

inference of scienter, and does little to increase the plausibility of Plaintiff’s

allegations. Schramm and Royal do not appear to be directly implicated in the FCPA

misconduct. Although the earlier violations do generally suggest problems in at least

- 25 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 25 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

some aspects of Maxwell’s internal controls, there is no evidence before this Court to

suggest that these past failings in China dealings made it more likely to have internal

control problems with revenue recognition, or that it should have put the individual

defendants on alert with regard to internal controls for revenue recognition.

C. Defendants’ Arguments in Opposition to Scienter

In seeking to dismiss this action, Defendants point to allegations and publiclyavailable evidence that they contend undermines a finding of a strong inference of

scienter.

i. Stock Holdings and Lack of Sales

Defendants argue that allegations of scienter are undermined by the fact that the

individual defendants owned a large number of Maxwell shares, and did not sell them. 

They point out that when the stock price fell as a result of the disclosure, both

individual defendants sustained losses. Schramm’s stock was worth $6,273,992 at the

Class Period high, and fell to $1,749,023 after the March 19, 2013 disclosure. 

Schramm also purchased additional Maxwell stock on the open market between June

3, 2011 and August 15, 2012. Royal’s stock was worth $1,601,300 at the high point,

and fell to $446,400 after the March 19 disclosure. Defendants argue that it is

“inconceivable” that they would hold their shares if they knew there was a problem. 

(Mot. at 8). They further point out that these losses are larger than the 2011 bonuses

of $400,000 for Schramm and $135,800 for Royal. (Id. at 7-8). 

Defendants point to case law in which courts found that a strong inference of

scienter is contradicted where individual defendants do not sell their stock or retain a

large percentage of stock. (Id. at 8; e.g. In re Wet Seal, Inc. Sec. Litig., 518 F. Supp.

2d 1148, 1177-78 (C.D. Cal. 2007) (finding that a lack of tangible personal benefit,

including lack of insider sales, weighs against scienter)). This Court has examined the

cited cases. To the extent they support Defendants’ contention, they rely on the

common-sense notion that a party will generally not engage in illicit behavior that will

cause financial losses to himself or herself.

- 26 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 26 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Plaintiff argues that lack of stock sales does not preclude finding a strong

inference ofscienter. (Opp’n at 22-23). The Ninth Circuit has held that a lack ofstock

sales by a defendant is not dispositive as to scienter. No. 84 Employer-Teamster Joint

Council Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 944 (9th Cir.

2003) (finding scienter despite lack of stock sales). Plaintiff also argues that there are

many reasons why the lack of sales does not necessarily negate scienter. Plaintiff

offers a number of plausible reasons why the defendants might not sell stock despite

being aware of the misconduct, including a belief that fraud would continue unabated

and recognition that sales could be highly incriminating if the fraud were uncovered. 

(Opp’n at 23).

The fact that there were no stock sales during this period can be interpreted to

support an inference that Schramm and Royal were unaware of this misconduct. 

However, it is also consistent with the inference that the individual defendants

mistakenly believed that the fraud would remain hidden and they ultimately would be

able to reap the benefits of the inflated stock value. The individual defendants may

well have believed that they could engage in fraud and retain their stock without

suffering financial losses.

ii. Individual Defendants’ Bonuses

Plaintiff points to Maxwell’s situation before the Class Period. It alleges that it

faced increased competition and lost market share. (Compl. ¶ 38). Maxwell reported

“significant net losses” between 2007 and 2009. (Id. ¶ 39). Plaintiff contends that this

incentivized individual defendants to turn Maxwell’s performance around by padding

financial results because their compensation was affected by these results. (Id. ¶ 39). 

Plaintiff also questions the compensation program, pointing out that despite losses and

financial shortcomings, the individual defendants were able to meet the “ever-changing

criteria.” (Id. ¶ 40).

Defendants contend that the bonuses are insufficient to support scienter. They

suggest that the program is an unremarkable plan designed to reward performance for

- 27 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 27 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

certain goals. They also point to the fact that the 2011 bonus was lower than the 2010

bonus, and that there was no 2012 bonus. (Mot. at 10).

The existence of performance-based compensation provides motive for the

individual defendants to order orignore misconduct that would increase revenues. The

Court considers this in its holistic review. However, the fact that the individual

defendants would benefit personally from apparent improvement in Maxwell’s

financial performance does not create a strong inference that the individual defendants

had knowledge or were deliberately reckless regarding the misconduct. Plaintiff’s

allegations that compensation criteria was manipulated to ensure bonus payment, at

most, calls into question the integrity of the compensation committee, but does not

make it more likely that the individual defendants knew about accounting misconduct. 

Indeed, if the existence of performance-based compensation and motive to increase

short-term profits were enough to establish scienter, scienter could be found for almost

any executive. See Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1038 (9th Cir. 2002)

(citation omitted) (“If scienter could be pleaded merely by alleging that officers and

directors possess motive and opportunity to enhance a company’s business prospects,

‘virtually every company in the United States that experiences a downturn in stock

price could be forced to defend securities fraud actions.’” ).

iii. Sales Agreement

Plaintiff argues that Maxwell benefitted from the misconduct by entering into

an agreement relating to the sale of stock, which ultimately produced $10.3 million in

net proceeds. (Compl. ¶ 48). These sales took place at allegedly inflated pricesseveral

weeks before Maxwell reported disappointing financial results on April 26, 2012. (Id.

¶ 49). The Ninth Circuit has held that stock sales must be “significant enough and

uncharacteristic enough to cast doubt on the defendant company’s motives” in order

to create a strong inference of scienter. Zucco, 552 F.3d at 1006. Although it netted

significant proceeds, Plaintiff has not presented evidence to show thatsuch an offering

was uncharacteristic or out of the ordinary. This sale does not create a strong inference

- 28 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 28 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

of scienter.

iv. The Audit Committee’s Investigation and Results

Defendants point to the fact that neither Schramm nor Royal was found by the

audit committee’s investigation to be aware of the improper arrangements, and that the

sales arrangements were never communicated to the finance department. (Mot. at 12).

Defendants argue that terminations and resignations of other employees after the

investigation, including Andrews, do not prove anything about SchrammorRoyal, and

show that proper remedial actions were taken. (Id.).

Plaintiff argues that the strong inference ofscienter far outweighs any competing

inference provided by self-serving, self-exonerating findings of the audit committee. 

(Opp’n at 22). Plaintiff points out that it has not had a chance to examine the audit

committee’s investigation and cites to caselaw that recognizes potential problems with 

relying upon an audit committee’s investigation of its own company. (Id.; In re LDK

Solar Sec. Litig., 584 F. Supp. 2d 1230, 1246 (N.D. Cal. 2008) (“[O]fficers and

directors are not exonerated when their own audit committee finds nothing wrong in

the company’s accounting practices. To rule otherwise would create a huge

fox-guards-the-chicken-house loophole in our private securities law enforcement.”)). 

Defendants reply that the case law cited by Plaintiff indicatesthat the audit committees

finding is not dispositive, not that it is irrelevant, and points out that Plaintiff has not

alleged facts questioning the sufficiency of the investigation. (Reply at 7 n.4).

The Court takes into account the audit committee’s finding, but does not find it

decisive. That the audit committee conducted an investigation and did not find that the

individual defendants had knowledge supports the individual defendants’ claim that

they lacked scienter. However, this Court will not dismiss the action based on the

findings of a committee which have not been presented or examined. The Court does

agree that the firings and resignations of non-defendants after the investigation do not

necessarily indicate that the individual defendants knew what those employees were

doing or participated in the misconduct.

- 29 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 29 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

D. Holistic Consideration

As discussed above, none of the individual allegations is sufficient to raise a

strong inference ofscienter. However, the Supreme Court’s decision in Tellabs permits

“a series of less precise allegations to be read together to meet the PSLRA

requirement.” S. Ferry, 542 F.3d at 784. The Ninth Circuit has cautioned that “[e]ven

if a set of allegations may create an inference of scienter greater than the sum of its

parts, it must still be at least as compelling as an alternative innocent explanation.”

Zucco, 552 F.3d at 1006.

Here, the primary innocent explanation isthat Schramm and Royal did not know

about the improper financial misstatements and the failing in the internal controls, and

were not deliberately reckless. After full review of the pleadings and the briefing on

scienter, the Court has carefully weighed Plaintiff’s allegations, the competing

inferences, and innocent explanations. The Court concludes that, considered

holistically, the Complaint as currently pled does not raise a strong inference of

scienter.

Many of Plaintiff’s allegations are consistent with the individual defendants’

knowledge and participation in improper accounting. However, these facts are also

consistent with a scenario in which other employees carried out improper accounting

without the knowledge, direction, or deliberate recklessness of the individual

defendants. 

Viewed in the aggregate, Plaintiff alleges that the individual defendants did have

some significant pieces of information related to the fraud. The individual defendants

had regular access to some sales information, and the accounts of confidential

witnesses indicate that Schramm and Royal were or should have been aware of some

revenue collection problems. One confidential witness reports learning that some

information about possible inconsistencies was given to Schramm. The confidential

witness accounts of the structure of the company indicates that one or both of the

individual defendants were supposed to be involved in some decisions involving

- 30 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 30 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

special sales terms or lifting credit holds. The individual defendants also clearly had

information about the revenue numbers, and signed the certifications for the financial

statements containing the reported revenue numbers. The restatement indicatesthat the

revenue numbers were substantially overstated for a period of nearly two years. The

individual defendants had a financial motive to improve the appearance of the

Maxwell’s financial performance, if they believed the fraud would not be discovered.

However, this is not sufficient to allow this Court to infer scienter. There are no

specific facts alleging that an individual defendant acknowledged that revenue was

misreported or ordered anyone to misreport anything. There are no specific allegations

about the information accessed by the individual defendants or the nature of the

accounting process which, taken in combination, suggest that the individual defendants

must have known that there was an accounting deception or were deliberately reckless. 

This Court also considers the fact that both individual defendants suffered financial

losses and that none of the internal or external investigators have yet placed blame on

the individual defendants. Although the allegations suggest that it is possible that the

individual defendants had the requisite scienter, without additional allegations,

Plaintiff’s theory is not as cogent and compelling as the innocent explanation. 

CONCLUSION

As Plaintiff has failed to sufficiently allege scienter, the Motion to Dismiss is

GRANTED. This Court need not address the loss causation arguments briefly raised

by the parties. However, as Plaintiff’s arguments suggest that it may be able to clarify

its Complaint and add additional well-pleaded allegations regarding scienter, thisCourt 

///

///

///

///

///

///

- 31 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 31 of 32
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

grants leave to amend. If Plaintiff wishes to file an amended consolidated complaint,

it must do so no later than 30 days after the date this Order is filed.

IT IS SO ORDERED.

DATED: May 5, 2014

Hon. Roger T. Benitez

United States District Judge

- 32 - 13cv580

Case 3:13-cv-00580-BEN-RBB Document 55 Filed 05/05/14 Page 32 of 32