Court Opinion

ID: 5122436
Source: CourtListenerOpinion
Date Created: 2021-11-01 19:20:28.669116+00
Date Added: 2024-06-11T08:22:28.341333
License: Public Domain

IN THE COURT OF APPEALS FOR THE STATE OF WASHINGTON

IN RE FUNKO, INC. SECURITIES                           No. 81811-2-I
LITIGATION.
                                                       DIVISION ONE

                                                       UNPUBLISHED OPINION

          ANDRUS, A.C.J. — Investors purchasing Funko, Inc. securities during a 2017

initial public offering (IPO) sued Funko, its officers and directors, the IPO

underwriters, and allegedly controlling venture capital firms for violations of

Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. 1 They now appeal the

dismissal of their claims under CR 12(b)(6), arguing they adequately allege

material omissions and misstatements in Funko’s registration statement and

prospectus. We affirm in part, reverse in substantial part and remand for further

proceedings.

                                 FACTUAL BACKGROUND

          Founded in 1998 in Everett, Washington, Funko designs, creates, and

distributes collectible products depicting characters and icons from movies,

television shows, video games, sports teams, and other pop culture celebrities.

On October 6, 2017, Funko filed a registration statement with the Securities

1   15 U.S.C. § 77a et seq.
No. 81811-2-I/2

Exchange Commission (SEC) in anticipation of the IPO. On November 3, 2017,

the company filed a prospectus, which incorporated and formed part of the

registration statement (collectively referred to here as “the registration statement”).

Funko used the registration statement to sell approximately 10.4 million shares of

Class A common stock in the IPO.

       The registration statement described Funko, its products and customers, its

business model and strategies for mitigating market risk, historical financial data

for Funko and its predecessor, Funko Acquisition Holdings, LLC (FAH), between

January 2015 and June 2017, and its estimated revenue for the three months

ending September 30, 2017.

       The SEC declared Funko’s registration filing effective on November 1, 2017.

Funko common stock began trading at a price of $12 per share on November 2.

That same day, Bloomberg Gadfly, an online business blog, posted an article

written by financial journalist Stephen Gandel, which criticized Funko’s registration

statement for misstating its earnings. Gandel wrote:

               In Funko’s IPO prospectus, in a chart with a big arrow pointing
       up, the company says that an important measure of its income, which
       it uses to determine the success of its operational strategies, rose by
       an average of 86 percent in its past two full years. The actual bottom
       line, though, was up an average of just 16 percent in 2015 and 2016
       and has turned negative lately. Funko lost just more than $10 million
       in the first half of this year. How the toymaker gets a loss of $10
       million to reflect back as an 86 percent earnings increase is the latest
       example of fun-house accounting on Wall Street.

                                         -2-
No. 81811-2-I/3

At the close of trading that day, the price of Funko stock dropped to $7.07,

described by the Seattle Times as “the worst first-day return for an IPO in 17

years.” 2

        Several IPO investors (Investors) filed this lawsuit on November 16, 2017.

Multiple additional lawsuits followed, all of which were consolidated in the trial

court. The Investors claimed they purchased Funko stock sold in or traceable to

the offering, and that Funko, certain Funko officers and directors, 3 the IPO

underwriters, 4 and allegedly controlling venture capital firms5 violated Sections 11,

12(a)(2), and 15 of the Securities Act of 1933 by making materially false or

misleading statements in the registration statement.

        The Investors initially alleged that the registration statement made false and

misleading statements regarding the company’s financial growth in the years

before the IPO, based on the Gandel article, and failed to disclose that this growth

was due in large part to Funko’s reliance on the intellectual property of third-party

content providers.

        Funko, the Underwriters, and the Venture Capital Firms moved to dismiss

the Investors’ claims under CR 12(b)(6). Funko argued it made no materially false

2 Seattle Times Staff, Funko stock plunges in ‘worst first-day return for an IPO in 17 years’, THE
SEATTLE TIMES, https://www.seattletimes.com/business/funko-stock-plunges-in-ipo-shocker/.
3 The named officers and directors were Brian Mariotti, Russell Nickel, Ken Brotman, Gino Dellomo,

Adam Kriger, Richard McNally, Charles Denson, and Diane Irvine. Funko and its officers and
directors will be referred to collectively as “Funko.”
4 The named underwriters were Goldman Sachs & Co.; LLC, J.P. Morgan Securities LLC; Merrill

Lynch, Pierce, Fenner & Smith Incorporated; Piper Jaffray & Co.; Jeffries LLC; Stifel Nicolaus &
Co.; BMO Capital Markets Corp.; and SunTrust Robinson Humphrey, Inc. These named
defendants will be referred to hereafter as “the Underwriters.”
5 The named venture capital firms were Fundamental Capital Partners, LLC, Fundamental Capital

Partners, LLC, and ACON Investments, LLC. These named defendants will be referred to hereafter
as “the Venture Capital Firms.”

                                              -3-
No. 81811-2-I/4

or misleading statements in the registration statement and that some of the

statements on which the Investors relied were inactionable opinions or puffery.

The Venture Capital Firms also argued that they could not be held liable under

Section 15 of the Securities Act because they did not in fact exercise any power

or control over Funko.

       In an order dated August 2, 2019, the court dismissed the Investors’ Section

11 and 12(a) claims without prejudice.       The court found that the registration

statement did not contain any materially false or misleading financial disclosures.

The court further found that the Gandel article did not question the accuracy of

Funko’s disclosures and was therefore not a “corrective disclosure” revealing any

falsity in the registration statement. To the extent that the Investors challenged

allegedly false and misleading opinions, rather than statements of fact, the court

concluded that the Investors had not established that the opinions were misleading

under the standard set forth in Omnicare, Inc. v. Laborers Dist. Council Constr.

Indus. Pension Fund, 575 U.S. 175, 135 S. Ct. 1318, 191 L. Ed. 2d 253 (2015).

The court also dismissed without prejudice the Investors’ Section 15 claim against

the Venture Capital Firms, concluding that they could not be secondarily liable if

Funko was not liable for any primary violations of the Securities Act.

       Although the trial court concluded the Investors failed to state claims under

the Securities Act, it allowed them to amend their complaint. The Investors filed

an amended complaint on October 3, 2019, adding specific allegations that

Funko’s financial disclosures were misleading because Funko failed to disclose it

had abandoned a $1.4 million e-commerce platform, had engaged in “channel

                                       -4-
No. 81811-2-I/5

stuffing” to artificially inflate its revenue in the months preceding the IPO, failed to

disclose that it lacked the ability to track and record the value of obsolete inventory,

and made false statements about the value of its intellectual property.

       Funko, the Underwriters, and the Venture Capital Firms again moved to

dismiss the amended claims, making the same arguments as in their initial CR

12(b)(6) motions.    The trial court again dismissed the lawsuit, this time with

prejudice. The Investors appeal.

                                      ANALYSIS

       The Securities Act of 1933 protects investors by ensuring that companies

issuing securities make a “full and fair disclosure of information” relevant to a public

offering. Pinter v. Dahl, 486 U.S. 622, 646, 108 S. Ct. 2063, 100 L. Ed. 2d 658

(1988). “The linchpin of the Act is its registration requirement.” Omnicare, 575

U.S. at 178. In general, an issuer may offer securities to the public only after filing

a registration statement. See 15 U.S.C. §§ 77d, 77e. A registration statement

must contain specific information about both the company and the security for sale.

See 15 U.S.C. §§ 77g, 77aa. “Section 11 of the Act promotes compliance with

these disclosure provisions by giving purchasers a right of action against an issuer

or designated individuals . . . for material misstatements or omissions in

registration statements.” Omnicare, 575 U.S. at 179.

       Section 11 of the Securities Act provides:

       In case any part of the registration statement . . . contained an untrue
       statement of a material fact or omitted to state a material fact
       required to be stated therein or necessary to make the statements
       therein not misleading, any person acquiring such security . . . may,
       either at law or in equity, in any court of competent jurisdiction, sue.

                                         -5-
No. 81811-2-I/6

15 U.S.C. § 77k(a). To prevail on a claim under Section 11, a plaintiff must prove

(1) that the registration statement contained an omission or misrepresentation, and

(2) that the omission or misrepresentation was material, meaning that it would have

mislead a reasonable investor about the nature of their investment. Rubke v.

Capitol Bancorp Ltd., 551 F.3d 1156, 1161 (9th Cir. 2009). No scienter is required

for liability under Section 11; a defendant can be liable for innocent or negligent

material misstatements or omissions. In re Daou Sys., Inc., 411 F.3d 1006, 1027

(9th Cir. 2005).

       Section 12(a)(2) of the Securities Act imposes civil liability on

       [a]ny person who . . . offers or sells a security . . . by the use of any
       means or instruments of transportation or communication in
       interstate commerce or of the mails, by means of a prospectus or
       oral communication, which includes an untrue statement of a
       material fact or omits to state a material fact necessary in order to
       make the statements, in the light of the circumstances under which
       they were made, not misleading . . . .

15 U.S.C. § 77l(a)(2).      To prevail under Section 12(a)(2), a plaintiff must

demonstrate (1) an offer or sale of a security, (2) by the use of a means or

instrumentality of interstate commerce, (3) by means of a prospectus or oral

communication, (4) that includes an untrue statement of material fact or omits to

state a material fact that is necessary to make the statements not misleading by

any person. Miller v. Thane Int’l, 615 F.3d 1095, 1099 (9th Cir. 2010).

       For a misstatement to be actionable under Section 11 or 12, it must be both

false and material. In re Restoration Robotics, Inc. Sec. Litig., 417 F. Supp. 3d

1242, 1254 (N.D. Cal. 2019) (citing Basic Inc. v. Levinson, 485 U.S. 224, 238, 108

S. Ct. 978, 99 L. Ed. 2d 194 (1988)). For a statement to be misleading, it must

                                         -6-
No. 81811-2-I/7

affirmatively create an impression of a state of affairs that differs in a material way

from the one that actually exists. Id. (quoting Brody v. Transitional Hosp. Corp.,

280 F.3d 997, 1006 (9th Cir. 2002)). Materiality is fact-specific and turns on

context. Id. at 1257. Statements in a prospectus must be read in the context of

the whole document and be judged based on the facts as they existed when the

applicable registration statement became effective. Id. The issue is not whether

the statements, taken separately, are literally true; the issue is whether the

statements, taken in context, would have misled a reasonable investor about the

nature of the investment. Id. at 1258.

       Although the Investors’ claims arise under federal law, we apply state rules

of civil procedure to test the sufficiency of the Investors’ allegations at the CR

12(b)(6) stage. Dismissal is warranted under CR 12(b)(6) only if it appears beyond

doubt that the plaintiff can prove no set of facts consistent with the complaint that

would entitle him or her to relief. Leishman v. Ogden Murphy Wallace, PLLC, 196

Wn.2d 898, 903-04, 479 P.3d 688 (2021). All facts alleged in the complaint are

taken as true and “a court may consider hypothetical facts not part of the formal

record in deciding whether to dismiss a complaint pursuant to CR 12(b)(6).”

Haberman v. Wash. Pub. Power Supply Sys., 109 Wn.2d 107, 120, 744 P.2d 1032

(1987) (citations omitted). Under CR 12(b)(6), a plaintiff must merely demonstrate

that it is possible that facts could be established to support allegations in a

complaint. McCurry v. Chevy Chase Bank, FSB, 169 Wn.2d 96, 101, 233 P.3d

861 (2010). We review CR 12(b)(6) dismissals de novo. FutureSelect Portfolio

                                         -7-
No. 81811-2-I/8

Mgmt., Inc. v. Tremont Group Holdings, Inc., 180 Wn.2d 954, 962, 331 P.3d 29

(2014).

        Although the Investors alleged multiple false or misleading statements in

the amended complaint, they focus on only five categories of statements on

appeal. We address each category of statements in turn.

Statements of Net Revenue

        The Investors first claim that Funko’s registration statement included

materially false and misleading statements of net revenue for the first three

quarters of 2017. They allege that the reported revenue was misleading because

Funko failed to disclose that it “was capitalizing an abandoned e-commerce project

and over one million dollars in expenditures that should have been entirely written

off the bottom line.” They contend that Funko had a duty to disclose the fact that

the asset was valueless.           Under Generally Accepted Accounting Principles

(GAAP), when a long-lived asset ceases to be used, the carrying amount of the

asset should equal its salvage value, if any. Accounting Standards Codification

(ASC) 360-10-35-47. 6 The Investors allege that had Funko written off these

expenses, as required by GAAP, the company’s reported net income for the first

six months of 2017 would have reflected a net loss and would have reduced

estimated net income for the third quarter of 2017 by almost 20 percent.

        Funko argues that its estimated net revenue for the third quarter of 2017

could not have been false or misleading because its actual sales, reported to the

6The ASC is the source of authority on the GAAP published by the Financial Accounting Standards
Board. In re Perrigo Company PLC Securities Litigation, 435 F. Supp. 3d 571, 582 (S.D.N.Y. 2020).

                                              -8-
No. 81811-2-I/9

SEC in December 2017, exceeded the prospectus estimates. 7 But to state a claim

under Section 11 of the Securities Act, a plaintiff need only plead that “any part of

the registration statement, when such part became effective, contained an untrue

statement of a material fact or omitted to state a material fact required to be stated

therein or necessary to make the statements therein not misleading.” 15 U.S.C. §

77k(a) (emphasis added). The Investors here did just that. The Investors alleged

that Funko omitted information from the 2017 financial statements and the missing

information rendered the financial information contained in its registration

statement misleading at the time the registration statement became effective. That

Funko later proved to outperform those estimates does not exclude the possibility

that its failure to write off the value of the e-commerce platform was a material

omission.      Nor is there any indication in the record that Funko’s exceptional

financial performance was due to its accurate treatment of the e-commerce

platform in its financial disclosures.

        Funko next contends that subjective “accounting judgments,” such as

whether Funko’s financial statements complied with ASC standards, are

nonactionble statements of opinion. Id. at 20-21. For this proposition, Funko cites

to In re Hertz Global Holdings, Inc., 2017 WL 1536223 (D. N.J. 2017). In that case,

the plaintiff investors alleged that Hertz’s financial statements were false or

7 Funko submitted SEC filings to support its argument that it made no materially false or misleading
statements about its estimated third quarter 2017 sales revenue. “Generally, in ruling on a CR
12(b)(6) motion to dismiss, the trial court may consider only the allegations contained in the
complaint and may not go beyond the face of the pleadings. Rodriguez v. Loudeye Corp., 144 Wn.
App. 709, 725, 189 P.3d 168 (2008). But “the trial court may take judicial notice of public documents
if their authenticity cannot be reasonably disputed in ruling on a motion to dismiss.” Id. at 725-26.
In Rodriguez, this court held that SEC filings are properly subject to judicial notice at the CR 12(b)(6)
stage. 144 Wn. App. at 728. The Investors do not challenge the trial court’s review of and reliance
on these SEC filings.

                                                 -9-
No. 81811-2-I/10

misleading because they “were presented in violation of GAAP.” Id. at *7. The

federal court in that case concluded that because GAAP standards are often

subjective, and involve “a range of possible treatments instead of a single objective

set of calculations,” a company’s representation that its financial statements were

GAAP-compliant was not a matter of objective fact. Id. at *11. The U.S. Supreme

Court has recognized that GAAP does not present a “canonical set of rules,” but

rather tolerates a range of reasonable treatments left to the discretion of those

preparing financial reports. See Thor Power Tool Co. v. Comm’r, 439 U.S. 522,

544, 99 S. Ct. 773, 58 L. Ed. 2d 785 (1979) (accountants have long recognized

that “generally accepted accounting principles” will not ensure identical accounting

treatment of identical transactions).

       But there is a difference between alleging that a company engaged in

improper accounting practices and alleging that a company simply applied a GAAP

rule incorrectly. Fresno County Employees’ Ret. Ass’n v. comScore, Inc., 268 F.

Supp. 3d 526, 546 (S.D. N.Y. 2017) (distinguishing Hertz).           And even if a

company’s statements about GAAP compliance are subjective opinions, they may

still be actionable under the Securities Act. Id.

       Although Sections 11 and 12 refer to misrepresentations and omissions of

material fact, matters of opinion are not beyond the purview of these provisions.

See Omnicare, 575 U.S. at 188-89. The Supreme Court in Omnicare established

three different standards for pleading falsity of opinion statements. First, every

statement of opinion explicitly affirms one fact: that the speaker actually holds the

stated belief. Id. 184. Second, some statements of opinion contain embedded

                                        - 10 -
No. 81811-2-I/11

statements of fact. Id. at 185. Third, a reasonable investor may, depending on the

circumstances, understand an opinion statement to convey facts about how the

speaker has formed the opinion—or, otherwise put, about the speaker’s basis for

holding that view. Id. at 188. Such a statement could give rise to liability under an

omission theory if the facts conveyed in that fashion are untrue. Golub v. Gigamon,

Inc., 994 F.3d 1102, 1106 (9th Cir. 2021).

        In this case, the Investors allege Funko knew it had invested over $1 million

to develop a new e-commerce platform and knew by early 2017 that it did not work.

They further allege that by July 2017, Funko realized it was not usable at all,

abandoned the project, and returned to using an old e-commerce platform. Yet,

the Investors allege Funko did not include these expenses in calculating its net

income for any part of 2017. Given that the net income for all of 2017 was only

$7.3 million, the Investors contend that an expenditure of $1.4 million for a failed

e-commerce platform would have been material to any reasonable investor. 8 In

other words, it is possible—based on the Investors’ allegations—that Funko did

not have a factual basis for the actual net revenues reported in the registration

statement. We conclude that these allegations are sufficient to survive a CR

12(b)(6) motion to dismiss under the third prong of Omnicare. 9

8  Funko’s financial statement revealed a net loss in the first six months of 2017 of $5.4 million. The
Investors appear to allege that Funko should have reported an additional $1.4 million in losses in
that six month period or in the three month period ending September 30, 2017.
9 Funko argues that the Investors abandoned this claim on appeal because, although they included
it in their assignments of error, they did not adequately address the issue in their brief. We disagree.
In referring to the e-commerce platform, the Investors argue that “Funko did not write it off and
failed to disclose the underlying fact that the platform was not functioning.” The Investors further
argue that “Funko’s failure to disclose the write-off of this important asset along with other material
inaccuracies in Funko’s Registration Statement was information that would mislead investors.” The
Investors adequately raised the issue in their brief.

                                                - 11 -
No. 81811-2-I/12

       Funko disputes whether the ASC standard invoked by the Investors actually

required it to write off the e-platform asset before it issued the registration

statement. It suggests that Funko had not abandoned the asset as of July 2017.

Id. But whether Funko knew before July 2017 that the asset had no value to the

company and whether it should have written that asset off as a loss are questions

of fact not properly addressed at the pleading stage. See In re Burlington Coat

Factory Sec. Litig., 114 F.3d 1410, 1421 (3rd Cir. 1997) (whether company’s

earnings overstatement can be fully explained by the company’s use of a different

accounting method should not be resolved on a motion to dismiss). We reverse

the dismissal of the Investors’ Section 11 and 12 claims arising out of the allegedly

failed e-commerce platform.

Channel Stuffing

       Funko’s registration statement contained several statements attributing

Funko’s “strong growth” in the years before the IPO to “strong licensing

relationships with many established content providers,” “a nimble and low-fixed

cost production model,” and a “dynamic business model.” The Investors allege

that these statements, as well as Funko’s 2017 revenue figures, were false and

misleading because the company’s growth and revenue in the year prior to the IPO

was driven, not by its production or business model, but by its practice of “channel

stuffing.”

       “Channel stuffing is the oversupply of distributors in one quarter to artificially

inflate sales, which will then drop in the next quarter as the distributors no longer

make orders while they deplete their excess supply.” Steckman v. Hart Brewing,

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No. 81811-2-I/13

Inc., 143 F.3d 1293, 1298 (9th Cir. 1998). The Supreme Court recognized that

channel stuffing may be “the illegitimate kind (e.g., writing orders for products

customers have not requested) or the legitimate kind (e.g., offering customers

discounts as an incentive to buy).” Tellabs, Inc. v. Makor Issues & Rights., Ltd.,

551 U.S. 308, 325, 127 S. Ct. 2499, 168 L. Ed. 2d 179 (2007). Courts have also

recognized that there may be legitimate reasons to shift sales earlier in the cycle.

For example, in Waterford Twp. Police v. Mattel, Inc., 321 F. Supp. 3d 1133, 1148

(C.D. Cal. 2018) and In re ICN Pharma, Inc. Sec. Litig., 299 F. Supp. 2d 1055,

1061-62 (C.D. Cal. 2004), federal courts recognized that when the demand for a

company’s products is seasonal, that company may choose to drive up sales

during the high season to make up for lower sales later on. “Channel stuffing” is

therefore not inherently improper and not always guaranteed to lower sales in the

future. Yaron v. Intersect ENT, Inc., 2020 WL 6750568 at *6 (N.D. Cal. 2020).

       But even legitimate channel stuffing may be part of a scheme to hide poor

business fundamentals.      Id.   Because channel stuffing “borrows” from future

demand, the underlying weakness will necessarily reveal itself in time.            Id.

Channel stuffing will support a Securities Act claim when a plaintiff alleges that the

defendants knew the business was weak, falsely represented to investors that

business was strong, and used channel stuffing to bolster their misrepresentations

in the short-term.    Id.   Alternatively, channel stuffing that involves shipping

unneeded or unordered products may also be actionable. Id. at *7.

       A company’s failure to disclose its reliance on channel stuffing may also

form the basis of a claim under Section 12 if such nondisclosure violated former

                                        - 13 -
No. 81811-2-I/14

17 C.F.R. § 229.303(a)(3)(ii), 10 known as Item 303 of Regulation S-K of the

Securities Act. Steckman, 143 F.3d at 1296. Item 303 requires a company to

        [d]escribe any known trends or uncertainties that have had or that
        are reasonably likely to have a material favorable or unfavorable
        impact on net sales or revenues or income from continuing
        operations. If the registrant knows of events that are reasonably
        likely to cause a material change in the relationship between costs
        and revenues (such as known or reasonably likely future increases
        in costs of labor or materials or price increases or inventory
        adjustments), the change in the relationship must be disclosed.

        To the extent the Investors allege that Funko made statements attributing

its success to its “dynamic business model,” rather than channel stuffing, we agree

these allegations are insufficient, by themselves, to establish a Section 11 or 12

claim. An actionable statement must be “capable of objective verification.” Retail

Wholesale & Dep’t Store Union Local 338 Ret. Fund v. Hewlett-Packard Co., 845

F.3d 1268, 1275 (9th Cir. 2017). Statements that lack a standard against which a

reasonable investor could expect them to be pegged are puffery. City of Roseville

Emps.’ Ret. Sys. v. Sterling Fin. Corp., 47 F. Supp. 3d 1205, 1219-20 (E.D. Wash.

2014). As a result, business puffery or opinion (vague, optimistic statements) are

not actionable because they do not induce the reliance of a reasonable investor. 11

Or. Pub. Emp. Ret. Fund v. Apollo Grp. Inc., 774 F.3d 598, 606 (9th Cir. 2014).

        The Investors point to statements in the registration statement that “[w]e

have developed a nimble and low-fixed cost production model,” and “we can

dynamically manage our business to balance current content releases and pop

culture trends . . . .” Whether Funko is a “nimble” company or its management

10Now codified as 17 C.F.R. § 229.303(b)(2)(ii).
11“Puffing” concerns expressions of opinion, as opposed to knowingly false statements of fact. Or.
Pub Emps. Ret. Fund, 774 F.3d at 606.

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No. 81811-2-I/15

“dynamic” are statements not subject to objective verification. We agree with the

trial court that such statements, by themselves, are puffery and not actionable. We

therefore affirm the dismissal of any claim based on these statements alone.

      But to the extent the Investors allege Funko failed to disclose its reliance on

channel stuffing in violation of Item 303, the allegations are sufficient to pass CR

12(b)(6). To state a claim of a violation of Item 303, a plaintiff must allege facts

showing that (1) management knew of a trend, demand, commitment, event or

uncertainty (2) the trend, demand, commitment, event, or uncertainty was

reasonably likely to have a material effect on the company’s financial condition or

results of its operations and (3) management did not disclose these facts in the

offering statement. Steckman, 143 F.3d at 1296-97.

      In paragraph 47 of the amended complaint, the Investors allege:

             The statements [in the registration statement] were materially
      false and misleading when made because . . . they failed to disclose:
             ....

              (b) that the Company had overloaded its sales channels with
      excess inventory, including with its flagship Pop! collectibles line, as
      demand for the Company’s products had slowed during the same
      quarter in which defendants had carried out the IPO, increasing the
      likelihood that Funko products would be sold at a discount or on
      clearance during the critical 2017 holiday shopping season.

They allege that Funko relied on channel stuffing to boost its sales revenue and

did not disclose that this business model created a significant risk that retailers

would return excess products to Funko or would have to sell excess products at

deeply discounted prices. They further alleged that the company was aware it was

experiencing adverse sales and earnings trends far below the reported 86%

compound annual growth rate reported in the registration statement, from which a

                                       - 15 -
No. 81811-2-I/16

trier of fact could infer knowledge. And they allege that in November 2017, just

weeks after the IPO, market analysts reported that retailers had a significant

amount of Funko’s products on their shelves and were selling more items at

clearance prices.

        The overloading of inventory, per the Investors, damaged Funko’s

business. When securities analysts reported about slow sales at major retailers

and the risk that demand would be satiated and the market saturated, Funko’s

stock price dropped from $9.85 per share to $8.67 per share. Subsequent reports

identified this market saturation as a “warning sign,” and downgraded the

company. In late December 2017, the Investors allege, Funko’s common stock

closed at $6 per share, a 50 percent decline from the IPO stock price just two

months earlier.

        Funko contends that the Investors’ Item 303 claim fails because the

Investors failed to plead that Funko knew of the omitted trend or risk and that it

reasonably expected the trend would have a material impact on revenue or

income. We can easily dispose of these arguments because the allegations in the

complaint are sufficient, particularly under the state CR 12(b)(6) standard, to allege

this requisite knowledge. 12          The Investors allege that Funko had accounts

receivable growing faster than the rate of its sales growth, that internal documents

12Funko cites multiple federal cases indicating that a Section 11 channel stuffing claim must be
supported by specific factual allegations to survive a motion to dismiss for failure to state a claim.
But these cases were dismissed under FRCP 12(b)(6) and involve claims brought under Section
10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), which requires a plaintiff to plead
scienter and are thus inapposite here. See Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d
702, 712 (7th Cir. 2008); In re Cabletron Sys., Inc., 311 F.3d 11, (1st Cir. 2002); In re ICN Pharm.,
Inc. Sec. Litig., 299 F. Supp.2d 1055 (C.D. Cal. 2004); Sekuk Glob. Enters. v. KVH Indus., Inc., No.
04-cv-306, 2005 WL 1924202 (D.R.I. Aug. 11, 2005).

                                               - 16 -
No. 81811-2-I/17

recognized that customers were taking longer to pay for the products Funko was

delivering to them, and Funko was extending payment terms to these customers.

They contend Funko knew that the average number of days it was taking to collect

payment was increasing and the company recognized its inventory turnover had

decreased by double digits. The Investors further allege that Funko engaged in

channel stuffing for “at least the twelve months leading up to the IPO” and that this

practice rendered Funko’s stated growth strategies “impotent” and that its

statements concerning the company’s growth and revenue during that period were

misleading because they were based on those undisclosed practices. They allege

that all of these key metrics constitute evidence that management knew it was

channel stuffing and that this practice would likely have a material impact on its

sales revenue.     These allegations adequately satisfy CR 12(b)(6)’s pleading

standard.

       Funko also argues the Investors’ Item 303 claim fails because it is premised

on financial information that it fully disclosed in the registration statement. Funko

cites Dropbox Sec. Litig., No. 19-cv-06348, 2020 WL 6161502, at *8 (N.D. Cal.

Oct. 21, 2020), to support its argument that a Section 11 claim is appropriately

dismissed where “[a]nyone with basic mathematical skills” could discern the

allegations from the disclosed information. First, we do not read the Investors’

claim to be based exclusively on disclosed information. The Investors’ complaint

makes reference to “internally reported accounts receivable amounts,” and

“internal reports” indicating saturated sales channels. They thus allege that there

                                       - 17 -
No. 81811-2-I/18

are records in Funko’s possession that prove it stuffed sales channels with its

products in the run up to the IPO.

        Second, whether a reasonable investor could discern the possible presence

of channel stuffing from Funko’s financial statements is a question of fact that we

will not decide on the pleadings under CR 12(b)(6). 13 See In re Control Data Corp.

Sec. Litig., 933 F.2d 616, 621 (8th Cir. 1991) (“whether a misrepresentation would

have the effect of defrauding the market and inflating the stock price is a jury

question.”) (citing TSC Indus. Inc. v. Northway, Inc., 426 U.S. 438, 450, 96 S. Ct.

2126, 48 L. Ed. 2d 757 (1976).

        We reverse the CR 12(b)(6) dismissal of the Investors’ Item 303 claim

based on the allegation that Funko failed to disclose its channel stuffing practices.

We affirm the dismissal of the claim to the extent it is based on unverifiable

descriptions of the company as “nimble” or its management “dynamic.”

Inventory Control Practices

        The Investors next contend the trial court erred in dismissing their claim that

Funko failed to disclose that it lacked the ability to track obsolete inventory and

included “dead stock” (outdated stock it could not sell) in its reported inventory

figures in violation of GAAP standards. 14 The Funko consolidated balance sheet

13  Funko also argues that the channel stuffing claim cannot survive because the company’s
performance after the IPO exceeded its estimates, making it impossible for any jury to conclude
that it engaged in channel stuffing. But the Investors’ channel stuffing claim does not fail as a
matter of law at this stage simply because the company’s revenues have grown in the years
following the IPO. Although the company’s post-IPO performance may undercut the Investors’
claim of channel stuffing on summary judgment or at trial, it does not preclude the possibility that
Funko inflated its sales numbers before the IPO, or that Funko continued to artificially inflate its
revenue by engaging in channel stuffing following the IPO, as the Investors allege.
14 The Investors rely on former ASC 330-10-35-1, which states:

                                              - 18 -
No. 81811-2-I/19

valued its inventory at the end of 2016 at $43.6 million and at the end of 2017 at

$79 million. The Investors allege that Funko had warehouses full of excess and

outdated inventory that it was moving between warehouses and once moved,

these items would vanish from the company tracking system. They allege Funko

did not write down the value of this dead stock, resulting in an overstatement of

the value of its inventory.

        We conclude that the allegation that Funko overstated the value of its

inventory in its financial statements is sufficient to state a Section 11 and 12(a)

claim under CR 12(b)(6). 15

        Funko argues that the valuation of its inventory is an accounting judgment

and thus a nonactionable statement of opinion under Omnicare. The consolidated

balance sheets did explain how the company valued its inventory:

        Inventory consists primarily of figures, plush, accessories and other
        finished goods, and is accounted for using the first-in, first-out
        (“FIFO”) method. The Company maintains reserves for excess and
        obsolete inventories to reflect the inventory balance at the lower of
        cost or net realizable value. This valuation requires us to make
        judgments, based on currently available information, about the likely
        method of disposition, such as through sales to customers, or
        liquidation, and expected recoverable value of each disposition
        category. The Company estimates obsolescence based on
        assumptions regarding future demand. Inventory costs include
        direct product costs and freight costs.

        A departure from the cost basis of pricing the inventory is required when the utility
        of the goods is no longer as great as their cost. Where there is evidence that the
        utility of goods, in their disposal in the ordinary course of business, will be less than
        cost, whether due to physical deterioration, obsolescence, changes in price levels,
        or other causes, the difference shall be recognized as a loss of the current period.
        This is generally accomplished by stating such goods at a lower level commonly
        designated as market.
15 The Investors also alleged that Funko’s statements regarding its inventory management

practices were rendered misleading by the fact that the company did not have an effective inventory
management system. Because the Investors failed to identify an affirmative misstatement or
omission, this allegation was appropriately dismissed.

                                              - 19 -
No. 81811-2-I/20

       But the Investors allege that Funko lacked a functional inventory tracking

system and that “internal reports at the Company as of the IPO indicated that

Funko’s inventory included significant amounts of obsolete merchandise.” If true,

Funko was aware of undisclosed facts undermining the reported valuation it placed

on its inventory and this awareness is sufficient to establish falsity of an opinion

statement at the pleading stage under Omnicare.

Value of Intellectual Property

       The Investors next claim the Funko registration statement “materially

overstated the value of its intangible assets, including its intellectual property.”

According to these documents, as of December 31, 2016, Funko reported $243

million in net intangible assets, including $107 million in intellectual property. The

Investors allege these figures were misleading because Funko failed to disclose

the fact that its intellectual property valuation included the value of the items

already deemed unsaleable by the company. We conclude the Investors have

satisfied the CR 12(b)(6) pleading standard as to this claim.

       Funko first contends we should not reach the issue because the trial court

found that Funko adequately disclosed that it licenses all of its intellectual property

from third parties and the Investors failed to assign error to this finding. But our

review is de novo so any trial court “findings” on CR 12(b)(6) are immaterial to our

analysis. See Deegan v. Windermere Real Estate/Center-Isle, Inc., 197 Wn. App.

875, 884, 391 P.3d 582 (2017) (because de novo review is based on the complaint

and hypothetical facts, findings of fact by the trial court are superfluous).

                                        - 20 -
No. 81811-2-I/21

       Moreover, Funko mischaracterizes the Investors’ argument. The Investors

do not now contend that Funko failed to disclose its reliance on third-party

licensors, but that the reported value of its intellectual property licenses was

undermined by the amount of dead stock in its warehouses. If these allegations

are true, the reported value of Funko’s intellectual property was overstated and

materially misleading.

       Funko also argues that the valuation of its intellectual property is

nonactionable statement of opinion. But as with the statements about the value of

its inventory, the Investors have satisfied the Omnicare standard by alleging facts

demonstrating that the company knew its purported opinion was not factually

supportable because that valuation was based in part on the amount of unsaleable

stock in its inventory.

Adequacy of Risk Disclosures

       Lastly, the Investors contend the trial court erred in concluding, as a matter

of law, that Funko’s disclosure of “Risk Factors” was neither false nor misleading.

The Investors allege that a number of risks Funko identified as events that “could

occur,” had already come to fruition. They allege:

       The Registration Statement contained pages and pages of
       numerous generalized possible “Risk Factors” that might occur and
       “[in] case” they did actually occur, then Funko’s financial condition
       and results of operation “could be materially and adversely affected.”
       Those statements were false or misleading and omitted material
       information. For example, the Registration Statement listed a host
       of factors and stated “[i]f demand or future sales do not reach
       forecasted levels, we could have excess inventory that we may need
       to hold for a long period of time, write down, sell at prices lower than
       expected or discard.” . . . . What the Registration Statement
       described as future possibilities had already occurred.

                                        - 21 -
No. 81811-2-I/22

They allege that this disclosure violated Item 503 of SEC’s Regulation S-K, former

17 C.F.R. § 229.503, 16 by not describing one of the most significant factors making

Funko’s stock risky.

        Funko’s registration statement included the mandatory “Risk Factors”

discussion. The Investors point to the section entitled “Our success depends, in

part, on our ability to successfully manage our inventories.” In this section, Funko

stated:

        We must maintain sufficient inventory to operate our business
        successfully, but we must also avoid accumulating excess inventory,
        which increases working capital needs and lowers gross margin. We
        obtain substantially all of our inventory from third-party
        manufacturers located outside the United States and must typically
        order products well in advance of the time these products will be
        offered for sale to our customers. As a result, it may be difficult to
        respond to changes in consumer preferences and market conditions,
        which for pop culture products can change rapidly. If we do not
        accurately anticipate the popularity of certain products, then we may
        not have sufficient inventory to meet demand. Alternatively, if
        demand or future sales do not reach forecasted levels, we could
        have excess inventory that we may need to hold for a long period of
        time, write down, sell at prices lower than expected or discard. If we
        are not successful in managing our inventory, our business, financial
        condition and results of operations could be adversely affected.

The Investors allege that this statement is materially misleading because “the

Company’s inventory problems had already arrived, born of channel stuffing and

Funko’s poor internal controls over inventories,” leading to the improper

postponement of write-downs on obsolete inventory.

        The Investors also point to the section entitled “Failure to successfully

operate our information systems and implement new technology effectively could

16Now codified as 17 CFR § 229.105. This regulation requires securities registrants to “provide
under the caption ‘Risk Factors’ a discussion of the most significant factors that make the offering
speculative or risky.”

                                               - 22 -
No. 81811-2-I/23

disrupt our business or reduce our sales or profitability.” In this section, Funko

stated:

       We rely extensively on various information technology systems and
       software applications to manage many aspects of our business,
       including . . . management of our supply chain [and] sale and delivery
       of our products. . . .

       In addition, we have recently implemented, and expect to continue
       to invest in and implement, modifications and upgrades to our
       information technology systems and procedures to support our
       growth and the development of our e-commerce business. These
       modifications and upgrades could require substantial investment,
       and may not improve our profitability at a level that outweighs their
       costs, or at all.

The Investors allege this statement was misleading or omitted material facts

because “Funko’s business had already been harmed by the failure of a new

ecommerce platform and a recent past implementation failure.”

       As the Investors argue persuasively, risk disclosures that describe factors

that could occur in the future are misleading if they fail to disclose that the risk has

already transpired.     “Cautionary words about future risk cannot insulate from

liability the failure to disclose that the risk has transpired.” Rombach v. Chang,

355 F.3d 164, 173 (2d Cir. 2004). And perhaps even more persuasive is Ferreira

v. Funko, Inc., 2021 WL 880400 (C.D. Cal. 2021), in which a federal court

examined Funko’s statement in a 2019 SEC filing that, like its registration

statement, identified as a risk factor that its “success depends, in part, on [its] ability

to successfully manage [its] inventories.” Id. at *16. The plaintiffs in Ferreira, as

the Investors here, alleged that this statement was misleading because Funko

knew that the risk of excess inventory had already materialized. Id. at *17. The

                                          - 23 -
No. 81811-2-I/24

court concluded that the plaintiffs had adequately pleaded facts to support the

allegation that the risk disclosure was misleading:

         While the Court agrees with the Funko Defendants that the risk
         disclosure only discussed possible future risks and did not
         affirmatively state Funko had no excess or obsolete inventory, the
         disclosure is misleading and not meaningful because it sets forth
         various hypothetical risks associated with maintaining excess
         inventory without disclosing that this risk had materialized, as alleged
         by Plaintiffs. This is exactly the circumstance under which the Ninth
         Circuit has found this type of statement to be misleading.

Id. at *18. See also Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167, 1181

(9th Cir. 2009) (company made material misrepresentations where it disclosed the

risks of possible product liability lawsuits without disclosing that a product liability

lawsuit had already been filed).

         Funko argues that dismissal of this claim was appropriate under the

“bespeaks caution” doctrine. Dismissal on the pleadings under this doctrine is

appropriate only where “the documents containing defendants' challenged

statements include enough cautionary language or risk disclosure that reasonable

minds could not disagree that the challenged statements were not misleading.”

Fecht v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995) (citations and quotations

omitted), cert. denied, 517 U.S. 1136 (1996). To meet this standard, the language

bespeaking caution must relate directly to the language which plaintiffs claim to be

misleading. In re Atossa Genetics Inc. Sec. Litig., 868 F.3d 784, 798 (9th Cir.

2017).

         Funko did caution potential investors that “if demand or future sales do not

reach forecasted levels, we could have excess inventory that we may need to hold

for a long period of time, write down, sell at prices lower than expected or discard.”

                                          - 24 -
No. 81811-2-I/25

But Funko’s risk disclosures did not directly address the issue of which the

Investors now complain: that its collection of unsaleable stock had already

negatively impacted the value of its inventory, the value of which was thus

overstated in the consolidated balance sheets. In light of these factual allegations,

reasonable minds could disagree on the sufficiency of this cautionary language

and thus the bespeaks caution doctrine does not warrant dismissal at the CR

12(b)(6) stage.

        We therefore conclude that, under CR 12(b)(6), the Investors adequately

allege material omissions in the registration statement’s risk disclosures. The trial

court erred in concluding otherwise. 17

Section 15 Claims

        Section 15 provides investors with a private cause of action against anyone

who “controls” a party found liable under Section 11 or 12:

        Every person who, by or through stock ownership, agency, or
        otherwise, or who, pursuant to or in connection with an agreement or
        understanding with one or more other persons by or through stock

17  Funko argues that the trial court’s finding that the Gandel article was not a “corrective disclosure”
provides an independent basis for dismissing the Investors’ claims regarding its financial
disclosures. We reject this argument. To recover for securities fraud under Section 10(b) of the
Securities Act of 1934, 15 U.S.C. § 78j(b), a plaintiff must establish “loss causation,” i.e., a causal
connection between a material misrepresentation and the plaintiff’s loss. In re Iso Ray, Inc. Sec.
Litig., 189 F. Supp. 3d 1057, 1079 (E. D. Wash. 2016). One method of proving loss causation is
by showing that a corrective disclosure, or a disclosure that reveals the fraud, caused the stock to
decline. Id. But under Section 11, damages are measured by the difference between the amount
paid for a security and its price either at the time it was sold or the date the Section 11 claim was
filed. 15 U.S.C. §77k(e). Loss causation is thus not an element of a Section 11 claim, but can be
used as an affirmative defense if the defendant can prove that the depreciation in value of its
security resulted from factors other than the alleged material misstatements or omissions in the
registration statement. In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1421-22 (9th Cir. 1994).
Because the Investors here allege claims under Section 11 of the Securities Act of 1933, and not
Section 10(b) of the Securities Act of 1934, they do not have to show that the stock price drop
occurred as a result of a corrective disclosure. The trial court’s finding that the Gandel article did
not disclose any fraud and merely disclosed an analysis of Funko’s financial condition based on
disclosures in the registration statement does not require a dismissal of the Investors’ claims, as
Funko has not established this affirmative defense as a matter of law.

                                                 - 25 -
No. 81811-2-I/26

      ownership, agency, or otherwise, controls any person liable
      under sections 77k or 77l of this title, shall also be liable jointly and
      severally with and to the same extent as such controlled person to
      any person to whom such controlled person is liable, unless the
      controlling person had no knowledge of or reasonable ground to
      believe in the existence of the facts by reason of which the liability of
      the controlled person is alleged to exist.

15 U.S.C. § 77o(a).

      In order to state a prima facie case under Section 15, a plaintiff must allege:

“(1) a primary violation of federal securities law and (2) that the defendant

exercised actual power or control over the primary violator.”        No. 84 Emp’r–

Teamster Joint Council Pension Tr. Fund v. Am. W. Holding Corp., 320 F.3d 920,

945 (9th Cir. 2003) (quoting Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th

Cir. 2000)) (quotation marks omitted). Because the Investors adequately allege

primary violations of Sections 11 and 12(a) of the Securities Act, the Investors

adequately pleaded the first prong of their Section 15 claim.

      As to the control prong, the Investors allege that each of the individual

defendants were control persons of Funko by virtue of their positions as directors

or senior officers of Funko’s predecessor, FAH LLC. The Investors also allege that

the Venture Capital Firms were control persons of Funko and FAH by virtue of their

ownership    of    Funko   securities,   board    membership,    relationships    with

management, and contractual rights regarding Funko’s governance.

      Fundamental Capital LLC and Fundamental Capital Partners, LLC moved

to dismiss the Investors’ Section 15 claim on the ground that, as a minority

shareholder, they could not be a “control person” as a matter of law under the

Securities Act. The trial court granted their motion without specifying whether the

                                         - 26 -
No. 81811-2-I/27

dismissal was based on the primary violation prong or the control prong of the

Section 15 test. Fundamental Capital argues that the Investors have abandoned

their “control person” argument by failing to raise it on appeal. We decline to

conclude that the Investors abandoned a legal argument when there is no clear

indication in the record that the trial court ruled against them on this ground.

       Fundamental Capital contended below that the Investors failed to allege

facts to support the contention that they had the power to direct Funko’s

management policies or day-to-day activities or had the ability to control the

content of the registration statement. We disagree. The Investors allege that

Fundamental Capital owned 34.9% of the Funko Class A common stock and

27.7% of the Funko Class B common stock as of the IPO. They also allege that

Fundamental Capital was a part of a group that, with a representative from ACON

and the chief executive officer, remained on Funko’s board after the IPO. The

Investors further allege that Fundamental Capital was a member of FAH and

through that membership had the ability to control the board, the power to cause

the registration of the stock sold in the IPO, and through their representative on

the board, signed the registration statement, affirming the statements the Investors

now claim to be false or misleading.

       The SEC defines control as, “the possession, direct or indirect, of the power

to direct or cause the direction of the management and policies of a person,

whether through the ownership of voting securities, by contract, or otherwise.” 17

C.F.R. § 230.405. The determination of who is a control person is “an intensely

factual question.” Arthur Children’s Tr. v. Keim, 994 F.2d 1390, 1396 (9th Cir.

                                        - 27 -
No. 81811-2-I/28

1993). We cannot say, at this stage of the pleadings, that it appears beyond doubt

that the Investors can prove no set of facts which would entitle them to relief

against Fundamental Capital under Section 15. For this reason, we reverse the

dismissal of the Investors’ Section 15 claim against both Venture Capital Firms.

       Affirmed in part, reversed in part, and remanded for further proceedings

consistent with this opinion.

WE CONCUR:

                                      - 28 -