Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_04-cv-02297/USCOURTS-cand-3_04-cv-02297-0/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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UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

In re OMNIVISION TECHNOLOGIES, INC.

and related cases.

 

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No. C-04-2297 SC

ORDER RE: DEFENDANTS'

MOTION TO DISMISS THE

SECOND CONSOLIDATED

AMENDED COMPLAINT 

I. INTRODUCTION

Lead Plaintiffs ("Plaintiffs") have brought this class action

against Defendant OmniVision Technologies, Inc. ("OmniVision") and

Individual Defendants Shaw Hong, Raymond Wu, H. Gene McCown, and

John Rossi ("Individual Defendants"). Defendants seek dismissal

of the Second Consolidated Amended Complaint ("SCAC") in its

entirety pursuant to Federal Rules of Civil Procedure 9(b) and

12(b)(6) and the Private Securities Litigation Reform Act, 15

U.S.C. § 78u-4 ("PSLRA"). For the reasons described herein, the

Court hereby DENIES the Motion in its entirety.

II. BACKGROUND

OmniVision is a Delaware corporation headquartered in

Sunnyvale, California. Motion at 3. OmniVision develops and

sells semiconductor image sensor devices used in mobile phones,

digital still cameras, and video game consoles. Id. Individual

Defendants are directors and officers at OmniVision. Id.

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On June 9, 2004, OmniVision announced that it was carrying

out a review of previously released financial results. Id. The

review dealt with improper revenue recognition methods. Although

the review was expected to lead to an upward revision of the

financial results for certain quarters, damage to confidence in

OmniVision's accounting practices led to a sharp sell-off in its

stock. Opposition at 2. OmniVision eventually restated its

financial results for the quarters ended July 31, 2003; October

31, 2003; and January 31, 2004. Motion at 4.

The class period runs from June 11, 2003 to June 9, 2004. 

SCAC at 1. Plaintiffs allege that over this period preceding the

June 9, 2004 announcement, Defendants deliberately delayed

recognition of certain revenues and income so as to smooth out

OmniVision's earnings and mask the impact of competition on its

growth rate. Id. Plaintiffs also allege that the Individual

Defendants sold significant amounts of stock at prices that were

artificially inflated because of the earnings manipulation. Id.

at 2.

The Second Consolidated Amended Complaint puts forth two

causes of action. The first is brought against all Defendants

pursuant to Section 10(b) of the Securities Exchange Act of 1934. 

The second is brought against the Individual Defendants pursuant

to Section 20(a) of the Act.

III. LEGAL STANDARD

Under Rule 12(b)(6) of the Federal Rules of Civil Procedure,

a party may move for dismissal "for failure to state a claim upon

which relief can be granted." When presented with a motion to

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dismiss, "[a]ll allegations of material fact are taken as true and

construed in the light most favorable to the nonmoving party." 

Jacobellis v. State Farm Fire & Cas. Co., 120 F.3d 171, 172 (9th

Cir. 1997). "[A] complaint should not be dismissed for failure to

state a claim unless it appears beyond doubt that the plaintiff

can prove no set of facts in support of his claim which would

entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46

(1957); see also Gompper v. VISX, Inc., 298 F.3d 893, 896 (9th

Cir. 2002).

Defendants also rely on Rule 9 of the Federal Rules of Civil

Procedure to support their Motion. Rule 9 states, "In all

averments of fraud or mistake, the circumstances constituting

fraud or mistake shall be stated with particularity."

Plaintiffs' claims are brought pursuant to Sections 10(b) and

20(a) of the Exchange Act. The PSLRA controls the pleading

standards for these claims. In re Silicon Graphics, 183 F.3d 970,

973 (9th Cir. 1999). Under the PSLRA, a plaintiff "must plead, in

great detail, facts that constitute strong circumstantial evidence

of deliberately reckless or conscious misconduct." Id. at 974. 

More specifically, a plaintiff "is required to state with

particularity all facts giving rise to a 'strong inference' of the

required state of mind." Id. at 983.

The Court notes that "an inevitable tension arises between

the customary latitude granted the plaintiff on a motion to

dismiss under Fed. R. Civ. P. 12(b)(6), and the heightened

pleading standard set forth under the PSLRA." Gompper, 298 F.3d

at 896. The Ninth Circuit, resolving this tension with a tilt

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toward the heightened pleading standard of the PSLRA, has stated

that "to consider only inferences favorable to [plaintiffs']

position would be to eviscerate the PSLRA's strong inference

requirement." Id. at 896. Rather than considering only

inferences in favor of plaintiffs, "the court must consider all

reasonable inferences to be drawn from the allegations, including

inferences unfavorable to the plaintiffs." (emphasis in original) 

Id. at 897. In other words, "[t]he heightened pleading

requirements of the Private Securities Litigation Reform Act are

an unusual deviation from the usually lenient requirements of

federal rules pleading." Ronconi v. Larkin, 253 F.3d 423, 437

(9th Cir. 2001). As stated in Ronconi, "[f]or a securities fraud

case based on false statements to survive a motion [to dismiss],

the pleading has to state particularized facts that, taken as a

whole, raise a strong inference that defendants intentionally or

with deliberate recklessness made false or misleading statements

to investors." Id.

IV. DISCUSSION

"To avoid dismissal under the PSLRA, the Complaint must

specify each statement alleged to have been misleading [and] the

reason or reasons why the statement is misleading ..." Nursing

Home Pension Fund v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir.

2004) (internal citations and quotations omitted). "In addition,

the PSLRA requires that the Complaint state with particularity

facts giving rise to a strong inference that the defendant acted

with the required state of mind, or scienter." Id. (internal

citations and quotations omitted). A complaint must be dismissed

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if either of these two prongs are not met. Id. Defendants assert

that Plaintiffs have failed to meet both prongs. Furthermore,

Defendants assert that the individual defendants are not liable

for any statements that they did not make. Finally, Defendants

assert that Plaintiffs failed to allege that their economic losses

were caused by OmniVision's restatements. The Court will consider

each of these arguments in turn.

A. Whether the Complaint describes misleading statements

It is undisputed that OmniVision engaged in revenue

recognition practices which resulted in a restatement of revenues

and earnings for the financial reporting periods covered by the

class period. Motion at 3-5. OmniVision eventually restated

earnings results for the quarters ended July 31, 2003; October 31,

2003; and January 31, 2004. Motion at 4. Given that the

financial results for these periods were restated, the originally

announced results were clearly misleading. "Properly pled,

overstating of revenues may state a claim for securities fraud

..." Hockey v. Medhekar, 30 F. Supp. 2d 1209, 1216 (N.D. Cal.

1998). Here, the allegations concern understating of revenue, but

Defendants' argument that there is a distinction between

overstatements and understatements of revenue is simply not

credible. The one third drop in OmniVision's stock price on June

9, 2004 overwhelmingly demonstrates that the investing community

finds improper revenue recognition incidents to be serious matters

regardless of the direction of the improper recognition. 

Therefore, this Court holds that Plaintiffs have sufficiently

plead facts showing that Defendants issued misleading statements. 

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Of course, this alone cannot defeat dismissal. "[T]he mere

publication of inaccurate accounting figures, or a failure to

follow GAAP, without more, does not establish scienter." Provenz

v. Miller, 102 F.3d 1478, 1490 (9th Cir. 1996) (internal citations

and quotations omitted). As discussed in the following section,

the Court finds that the allegations of scienter are sufficient to

defeat dismissal.

B. Whether the Complaint alleges scienter

As a preliminary matter, the Court notes the connection

between a § 10(b) claim and a § 20(a) claim. "Scienter is an

essential element of a § 10(b) or Rule 10b-5 claim. And to

prevail on their claims for violations of § 20(a) ..., plaintiffs

must first allege a violation of § 10(b) or Rule 10b-5. Absent

pleading scienter with particularity, there can be no liability"

on either the § 10(b) claim or the § 20(a) claim. Lipton v.

Pathogenesis Corp., 284 F.3d 1027, 1035 (9th Cir. 2002) (internal

citations and quotations omitted). In other words, dismissal of

the § 10(b) claim necessitates dismissal of the § 20(a) claim as

well. Similarly, allegations sufficient to support a § 10(b)

claim provide strong support for a corresponding § 20(a) claim. 

Therefore, the Court will focus its analysis on the § 10(b) claim.

Turning to the legal definition of the element of scienter

applicable here, the PSLRA's "required state of mind," in 15

U.S.C. § 78u-4(b)(2), "refers to the scienter requirement

applicable to [a section 10b claim]." In re Silicon Graphics, 183

F.3d at 975. The PSLRA states, "In any private action arising

under this title in which the plaintiff may recover money damages

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only on proof that the defendant acted with a particular state of

mind, the complaint shall ... 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). The Ninth

Circuit has held that "the PSLRA language that the particular

facts must give rise to a strong inference of the required state

of mind [means] that the evidence must create a strong inference

of, at a minimum, 'deliberate recklessness.'" In re Silicon

Graphics, 183 F.3d at 977 (internal quotations omitted). A

plaintiff bringing a claim controlled by the PSLRA, as Plaintiffs

do here, "can no longer aver intent in general terms of mere

'motive and opportunity' or 'recklessness,' but rather, must state

specific facts indicating no less than a degree of recklessness

that strongly suggests actual intent." Id. at 979.

"Scienter can be established by direct or circumstantial

evidence." Provenz, 102 F.3d at 1490. The preferable way for a

plaintiff to show scienter is by putting forth contemporanous

reports or data which contradict the allegedly misleading

statements. Nursing Home Pension Fund, 380 F.3d at 1230. 

Plaintiffs here have put forth a variety of arguments to support

their allegations of scienter. For example, Plaintiffs allege

that "the restatement and GAAP violations create an inference of

scienter." Opposition at 10. However, as stated above, "the mere

publication of inaccurate accounting figures, or a failure to

follow GAAP, without more, does not establish scienter." Provenz,

102 F.3d at 1490. Alternatively, Plaintiffs suggest that

OmniVision's muddled explanations of its improper accounting at

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the time of the restatement and its unstable upper management

ranks during the class period support an inference of scienter. 

Opposition at 14-16. However, the Court finds these arguments to

be insufficient under the heightened pleading requirements of the

PSLRA.

An alternative method of showing an inference of scienter

involves insider trading data. "[I]nsider trading in suspicious

amounts or at suspicious times is probative of scienter." 

Provenz, 102 F.3d at 1491 (internal citations and quotations

omitted). Generally speaking, under Ninth Circuit law, "[s]tock

trades are only suspicious when dramatically out of line with

prior trading practices at times calculated to maximize the

personal benefit from undisclosed inside information." Nursing

Home Pension Fund, 380 F.3d at 1232 (internal citations and

quotation omitted). "To evaluate suspiciousness of stock sales,

[a court considers] three factors: (1) the amount and percentage

of shares sold; (2) timing of the sales; and (3) consistency with

prior trading history." Id.

Plaintiffs have detailed a series of stock sales by the

Individual Defendants. For example Defendant Hong sold 18% of his

shares during the class period, but only 7% of his shares in the

year earlier period. SCAC at 43. Defendant Wu sold 64% of his

shares in the class period, but only 29% of his shares in the year

earlier period. Id. Defendants McCown and Rossi sold 100% of

their shares during the class period. Id. at 44. These

percentages, the timing, and the inconsistency with prior trading

history all support a finding of an inference of scienter for

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purposes of this Motion. In particular, two of the Individual

Defendants more than doubled the relative proportion of their

shares they sold during the class period. The other two simply

sold all of their shares. The Court finds that these sales meet

the "dramatically out of line" standard described in Nursing Home

Pension Fund.

The Court recognizes that "credible and wholly innocent

explanations for stock sales, ranging from long-standing programs

of periodic divestment, to the need to free cash to meet matured

tax liabilities [if unrebutted] are sufficient to defeat any

inference of bad faith." Provenz, 102 F.3d at 1491 (internal

citations and quotations omitted). Tellingly, Defendants have

offered no such explanations. Reply at 12-13. Rather, Defendants

rely on their misconstrued theory that because this case involves

earnings understatements, instead of overstatements, insider sales

are not indicative of scienter. For example, Defendants state,

"If, in fact, defendants were causing financial results (and hence

OmniVision's stock price) to be artificially deflated in the

current period, so that it would be higher in future periods,

there would be no reason to sell stock in the current period." 

Reply at 12. This statement is a dramatic misconception of how

stock markets function as demonstrated by the movement of

OmniVision's stock on June 9, 2004. Clearly, the investing

community does not view improper revenue recognition resulting in

understated earnings in the same light as Defendants because the

share price of OmniVision fell by approximately one third on June

9, 2004 when the company first announced its accounting problems.

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In light of the above, the Court finds that Plaintiffs have

demonstrated an inference of scienter sufficient to meet the

heightened pleading requirements of the PSLRA and defeat this

Motion to Dismiss.

C. Individual defendants' liability for others' statements

The parties disagree over the applicability and extent of the

"group pleading doctrine." Under the group pleading doctrine,

there is "a presumption that the allegedly false and misleading

'group published information' complained of is the collective

action of officers and directors." Berry v. Valence Tech.,

Inc. 175 F.3d 699, 706 (9th Cir. 1999). The Court has found no

case law to suggest that this doctrine does not apply here. It is

true that the Ninth Circuit has limited the doctrine in cases of

directors' liability to situations where a director participated

in day-to-day corporate control or had some other special

relationship with the corporation. Id. However, this limitation

is moot here since all four Individual Defendants were executives

with day-to-day responsibilities at OmniVision. Therefore, the

Court holds that at this time the group pleading doctrine does

apply. However, with respect to Defendants McCown and Rossi, who

were CFOs of OmniVision for different sub-periods of the class

period, the Court cautions Plaintiffs that the potential liability

of an Individual Defendant for statements attributable to the

corporation or other individuals is limited by when that defendant

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1 As to the attempt to limit Defendant Wu's liability, the

argument put forward by Defendants is at best unclear. Defendants

state, "Contrary to the [Complaint], with the exception of the 2003

10-K and the secondary offering documents, Mr. Wu did not sign any

of the SEC filings challenged by plaintiffs." Motion at 23. These

are two rather large exceptions. While the Court recognizes that

the 2003 10-K concerned past results which did not fall within the

class period, clearly the secondary offering documents were

concerned with revenue recognition methods during the class period. 

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served in a position encompassed by the group pleading doctrine.1

D. Whether complaint alleges economic losses

On April 20, 2005, Defendants' original Motion to Dismiss was

vacated by this Court subsequent to the Supreme Court's holding in

Dura Pharmaceuticals, Inc. v. Broudo, 125 S. Ct. 1627, 161 L. Ed.

2d 577, 2005 U.S. LEXIS 3478 (April 19, 2005), that plaintiffs in

a securities fraud action must show that they "suffered actual

economic loss." An "'artificially inflated purchase price' is not

itself a relevant economic loss." Id. *19. Rather, where the

facts suggest that false or misleading statements led to an

artificially inflated purchase price, the complaint cannot fail to

allege that the "share price fell significantly after the truth

became known." Id.

Plaintiffs' Amended Complaint of November 23, 2004 merely

alleged that "members of the Class acquired OmniVision securities

during the Class Period at artificially high prices and were

damaged thereby." Consolidated Complaint at 42. This was

insufficient under Broudo. The Second Consolidated Amended

Complaint now before the Court alleges, "Plaintiffs purchased

OmniVision securities at artificially inflated prices and suffered

damages when revelation of the true facts caused a decline in the

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value of their investments." SCAC at 49. The Court finds this to

be a sufficient allegation of economic loss as required under the 

Broudo standard described above.

V. CONCLUSION

The PSLRA and Rule 9(b) of the Federal Rules of Civil

Procedure require a heightened standard of pleading and

particularity with regard to securities class actions. Here,

these pleading requirements are met by the Second Consolidated

Amended Complaint. It is uncontested that Defendant OmniVision

engaged in accounting procedures which led to earnings

restatements for several periods. It is also uncontested that the

executives in charge at the time engaged in a pattern of share

sales that was distinguishable from earlier sales. While these

facts alone do not prove by themselves any liability on the part

of the entity or Individual Defendants, the Court holds them to be

sufficient to defeat the instant Motion. Therefore, the Court

DENIES Defendant's Motion to Dismiss in its entirety. It is

further ordered that the parties are to appear on September 16,

2005 at 10 a.m. in Courtroom Number 1 for a status conference. 

The parties are to file one joint status conference statement 7

days prior to the conference.

IT IS SO ORDERED.

Dated: July 29 , 2005

 /s/ Samuel Conti 

UNITED STATES DISTRICT JUDGE

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