Private Securities Litigation Reform Act's - Essay Example

Private Securities Litigation Reform Act's In this case, Plaintiffs were former Daou Systems, Inc. (“Daou”) investors who purchased Daou common stock between February 13, 1997 and October 28, 1998 (In re Daou Systems, Inc., 2005). They allege that defendants Daou, Chief Executive Officer and Chairman of the Board Georges Daou (“G. Daou”), President and Director Daniel Daou (“D. Daou”), Chief Financial Officer and Senior Vice President Fred McGee, Chief Operating Officer and Executive Vice President Robert McNeill, and Director John Moragne systematically and fraudulently violated the Generally Accepted Accounting Principles (“GAAP”) in order to artificially inflate the price of Daou's stock (2005). Plaintiffs also allege that they incurred substantial personal losses due to their respective purchases of Daou stock at fraudulently inflated prices (2005). The district court, held that the plaintiffs had failed to state sufficiently particularize claims under the 1933 Securities Act and the 1934 Exchange Act (2005). Hence, Plaintiffs now appeal the district court's dismissal of their Third Amended Complaint (“TAC”) with prejudice (2005). Plaintiffs contend that Daou fraudulently inflated the price of its stock by reporting revenues before they were earned, in violation of GAAP (2005). They claim that the said company employed an accounting method known as the percentage-of-completion (“POC”) method, which is used primarily to account for progress on long-term projects (2005). Under this method, revenue from these projects could only be recognized based on the percentage of labor costs incurred to date compared to the total estimated labor costs for the project (2005). Plaintiffs allege, however, that defendants would prematurely recognize revenue in contravention of the POC method (2005). Hence, because of such artificial inflation of the price of Daou stock, Plaintiffs allege that Daou was able to acquire eleven companies, and Daou executives and their respective family members were able to sell nearly 2.5 million shares for a total of $54.67 million in improper proceeds (2005). Plaintiffs also allege that to their detriment they purchased their Daou shares during the class period at artificially inflated prices and that, had they been aware of Daou's true financial results and condition, they would not have purchased their shares, or at least not at the prices paid (2005). Defendants claimed that their method of accounting did not violate GAAP or their own stated policy, that “Revenues recognized in excess of amounts billed and project costs are classified as contract work in progress” (2005). The district court sided with the Defendants. It held that plaintiffs failed to expose any financial tomfoolery on the part of Daou in its execution of the POC accounting method. It held that plaintiffs failed to locate and identify any allegations quantifying and contrasting the revenue. The Court of Appeals in this case found at least some specific allegations of how the adjustments affected the company's financial statements and whether they were material in light of the company's overall financial position (2005). It held that the complaint alleges various observations of accounting misfeasance and at least some of such allegations reveal that the amount of revenue Daou formally recognized was completely unrelated to the amount of labor incurred to date (2005). The Court held that indeed, it is a violation of GAAP to recognize revenue before it is earned (2005). It found basis to Plaintiffs allegation that “defendants recognized millions of dollars in revenue before it was earned and without regard to actual labor costs incurred or total estimated labor costs” (2005). Plaintiffs also provided figures allegedly indicating the discrepancy between the revenues Daou recognized and the amount that it was entitled to bill its customers during certain quarters within the class period (2005). An investor would easily read defendants' disclosure of revenues “recognized” as meaning that the excess revenues recognized were at the very least earned which is in itself misleading (2005). The Court further held that, systematically recognizing a set amount of revenues before such percentage of labor had been performed and accounting for such premature recognition simply by dumping those amounts in the work-in-progress account could violate other GAAP principles such as “financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions,” (citing FASB Statement of Concepts No. 1, ¶ 34), and “financial reporting should be reliable in that it represents what it purports to represent,” (citing FASB Statement of Concepts No. 2, ¶¶ 58-59). The Court held that the contract amounts Daou had recognized as revenue, was in fact not entitled to bill “because little or no labor had yet taken place” (2005). All of these then provided the Court with enough information for to discern whether the alleged GAAP violations were minor or technical in nature, or whether they constituted widespread and significant inflation of revenue” (2005). Certainly, prematurely recognizing millions of dollars in revenue is not minor or technical in nature (2005). These allegations, the Court held, were sufficiently state reasons why the reporting statements were misleading and, as an allegation made on information and belief, the facts on which that belief was formed (2005). Similarly, the Court also held that plaintiffs' claims regarding employee training and turnover contain sufficient particularity to support a securities fraud claim, as opposed to the district court’s decision that plaintiffs did not sufficiently particularize to state a cause of action under the PSLRA's heightened pleading standards (2005). The Court found that Plaintiffs adequately pled fraud as to defendants' alleged misuse of the GAAP protocols and alleged misstatements regarding employee training and turnover to survive a motion to dismiss for failure to state a claim under 10(b) (2005). Plaintiffs provide several accounts of confidential witnesses claiming that “Daou University” did not in fact exist and that Daou actually had “no in-house training program whatsoever, and according to CW21, the Company was hiring, among others, untrained mechanics and cable pullers as computer technicians, not college graduates” (2005). The Court held that the foregoing allegations, if assumed true, are sufficient to provide Daou with some indication that the drop in Daou's stock price was causally related to Daou's financial misstatements reflecting its practice of prematurely recognizing revenue before it was earned (2005). Hence, the Court of Appeals held that: (1) investors' allegations regarding violation of GAAP were sufficiently particularized to state a cause of action under Private Securities Litigation Reform Act's (PSLRA) heightened pleading standards; (2) company's alleged misleading statements of employee turnover and lack of training were sufficiently particularized to state a cause of action; (3) with the exception of one executive who was not involved in company's day-to-day operations, investors' allegations were sufficient to create a strong inference that executives acted with requisite degree of scienter; and (4) investors satisfied requirements of pleading both transaction causation and loss causation (2005). In the Matter of Albert Glenn Yesner, CPA Administrative Proceeding File No. 3-9586 22 May 2001 This case involves an administrative case against Albert Glenn Yesner for violation of the following: Section 8A of the Securities Act of 1933 (Securities Act), Section 21C of the Securities Exchange Act of 1934 (Exchange Act), and Rule 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice. 17 C.F.R. § 201.102(e)(1)(ii) and (iii) (In the Matter of Albert Glenn Yesner, 2001). This stems from an improperly recognized revenue on shipments made outside the appropriate accounting period in order to manipulate its quarterly revenue and earnings to meet analysts' quarterly earnings projections done by the Sensormatic Electronics Corporation, in violation of GAAP (2001). Because of this practice, the quarterly earnings of the said company were allegedly included in periodic reports and registration statements filed with the Commission, and were misstated from the first quarter of fiscal year 1994 through the third quarter of fiscal year 1995 (2001). Furthermore, it was alleged that the company issued a press release on July 10, 1995, allegedly containing inflated preliminary estimates for fourth quarter and year-end earnings for fiscal year 1995 by allegedly inflating its preliminary estimates of net income by over 40% for the fourth quarter of 1995 and 18% for the fiscal year (2001). Finally, it was alleged that Yesner, as controller and director of business controls (DBC), knew of and participated in improper accounting practices and therefore willfully violated various Exchange Act Rules and caused Sensormatic's violations of the Securities Act (2001). The Judge held that, Sensormatic violated Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act, by improperly recognizing revenue in order to manipulate its quarterly revenue and earnings to reach its budgeted earnings goals and thereby meet analysts' quarterly earnings projections (2001). The Judge explained that for liability under the antifraud provisions, omissions or misstatements must be material (2001). The test for materiality is whether there is a substantial likelihood that a reasonable investor would consider the information important to the investment decision, and would view it as having significantly altered the total mix of available information (2001). Sensormatic's Deerfield office was responsible for approximately 50% of the revenue for the company (2001). The company included out-of-period shipments in its quarterly revenue calculations, which were incorporated into its annual reports (2001). Both quarterly and annual reports were filed with the Commission (2001). This practice falsely represented to analysts and investors that the company was experiencing a continuous growth rate for over thirty quarters, which was touted in analysts' reports, articles, and press releases (2001). This practice, the Judge explained, fulfilled investor expectations, based on analysts' forecasts, and promoted shareholder confidence in the company (2001). Sensormatic's ability to publicize its continuous growth rate and the impact this had on the company's reputation is also relevant to the issue of materiality (2001). The Judge held that the accounting method employed at Sensormatic that permitted premature revenue recognition was not in accordance with the company's stated revenue recognition policy (2001). Sensormatic’s practice of not disclosing to investors the change in accounting method allowed the premature recognition of revenue (2001). This omission is material because the effect, when viewed in conjunction with misstatements uncovered by E&Y's expanded audit, was to alter the total mix of information, and furthered the scheme (2001). Hence, such misstatements and omissions as set out above were material (2001). Sensormatic was also found to have engaged in the intentional improper recognition of revenue by bringing down the computer system and backdating documents (2001). By intentionally recording revenue in periods it was not realized or earned, Sensormatic intentionally violated GAAP (2001). The record illustrates that senior management was fully aware that the revenue recognition practices deviated from GAAP, but believed them to be immaterial deviations, and the senior management even made no effort to quantify the GAAP deviations before recording them (2001). The Judge also concluded that Sensormatic also violated Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act (2001). Sensormatic's scheme included long-standing, intentional, material violations of GAAP in order to meet analysts' expectations and give the appearance of constant growth (2001). This practice operated as a fraud in the offer or sale, or upon any purchaser of Sensormatic securities because it misrepresented the company's financial performance (2001). Lastly, by incorporating the materially misleading periodic reports into its registration statements, Sensormatic used false statements and omissions to obtain money and property (2001). The Judge ruled that Sensormatic violated Section 10(b) of the Exchange Act and Rule 10b-5 in that there was fraud through the dissemination of false information, such as press releases, quarterly and annual reports, and other documents (2001). Sensormatic's common stock was listed on the New York Stock Exchange, and it filed and distributed quarterly and annual reports, through jurisdictional means, that contained material misrepresentations and omissions (2001). Furthermore, the company was held to have acted with scienter by employing different accounting practices than those disclosed to the investing public and engaging in long-standing, material violations of GAAP that evolved into a very elaborate scheme to meet analysts' expectations and give the appearance of constant growth (2001). However, the Judge found that Yesner did not act with scienter or that his conduct was so extremely unreasonable to be reckless when he failed to report to the audit committee that there was a possibility documents were withheld from E&Y (2001). However, Yesner had knowledge of the out-of-period shipments and improperly recognized revenue, and some awareness that documents were misdated to facilitate the recording of revenue (2001). His failure to report this practice to the audit committee was unreasonable, and hence, the Judge concluded that he was negligent in remaining silent about the revenue recognition practices (2001). His silence permitted the practices to continue. Therefore, the Judge concluded that Yesner's inaction was a cause of Sensormatic's primary violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act. Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, were also violated by Sensormatic according to the Judge, as its books and records were not maintained in reasonable detail, or in accordance with a level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs (2001). The misdating of documents used to book revenue was a deliberate act that resulted in inaccurate books and records, namely the general ledger (2001). Revenue was booked based on misdated "ship-to" notices (2001). The Judge explained that it was impossible to discern from the "ship-to" notices, the base documents used to book revenue, the sales that legitimately occurred within the quarter from out-of-period shipments (2001). All of this revenue was recorded in the company's general ledger and incorporated in the financial statements and not in conformity with GAAP based on the books and records (2001). This practice went on for several years with scant, if any, attempt to track the quantity of the out-of-period shipments (2001). In the end, the judge found Yesner's violations of the securities laws through his negligence to report said violations, warrant a cease and desist order (2001). Yesner was a cause of Sensormatic's violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act, Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 (2001). Yesner’s expressed a desire to continue working as a CPA, clearly present opportunities for future violations (2001). However, the administrative proceeding, insofar as it alleges that Albert Glenn Yesner violated, aided and abetted, or caused violations of Section 17(a)(1) of the Securities Act of 1933, Sections 10(b) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 10b-5, 13b2-1, and 13b2-2 thereunder, was dismissed (2001). The administrative proceeding, insofar as it alleges that Albert Glenn Yesner violated Rule 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice was also dismissed (2001). Takara Trust v. Molex Inc. 429 F.Supp.2d 960 N.D.Ill.,2006. April 28, 2006 Securities fraud class action was brought against high-level officers and directors of a global manufacturer of electronic connectors (Takara Trust v. Molex, Inc., 2006). Defendants moved to dismiss (2006). The Plaintiffs herein includes all persons who purchased Molex securities from July 27, 2004 through February 14, 2005 (2006). Molex is a global manufacturer of electronic connectors (2006). During the Class Period, Molex had fifty-five manufacturing operations in nineteen countries (2006). Molex's management is long-tenured, and Molex's stock price historically has been stable (2006). In mid-July 2004, Molex's Corporate Finance Group discovered that Molex had overstated inventory and income because inter-company profit included in “in-transit” inventory had not been eliminated in consolidated financial statements (2006). On July 21, 2004, Bullock brought this matter to the attention of King, Slark, and John or Frederick Krehbiel, disclosing that the PII Error resulted in an overstatement of Molex's income and inventory in the amount of $8 million (2006). The meeting attendees discussed whether they should report the error to Deloitte and the Audit Committee as part of the year-end audit (2006). At the meeting, these defendants also contemplated whether to reverse a $2.7 million reserve for self-insurance to boost Molex's earnings (2006). The defendants did not disclose any of these issues to their independent auditor, Deloitte, or to the outside directors of Molex's Audit Committee (2006). In July 2004, Business Wire issued a news release from Molex entitled “Molex Reports Revenue for 2004 Fiscal Fourth Quarter; Revenue up 33 Percent; Earnings Per Share Up 88 Percent” (2006). Further, on September 9, 2004, Neil Lefort, Molex's Vice President for Investor Relations, made a presentation to SmithBarney Citigroup technology conference, where he reiterated that in Molex's fiscal fourth quarter of 2004, Molex's “earnings per share were up in the 70% to 80% range” (2006). On September 2004, Molex filed its fiscal year 2004 report with the SEC on Form 10-K, which was signed by all of the Individual Defendants, which reaffirmed the financial results for the fourth fiscal quarter of 2004 and fiscal year 2004 (2006). In the said form, King and Bullock certified that “the report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements ... not misleading” and that they disclosed in the report any material change, deficiencies or weaknesses in the design or operating of internal control over financial reporting (2006). On that day, Molex also delivered a representation letter to Deloitte (2006). The letter concerned financial results published in the Form 10-K, but did not mention the excess profit from inter-company inventory or the Company's proposed treatment of the $2.7 million insurance reserve (2006). Plaintiffs allege that Defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated by carrying out a plan, scheme and course of conduct which was intended to and, throughout the Class Period, deceived the investing public, including lead plaintiffs and other Class members; artificially inflated and maintained the market price of Molex's securities; and caused lead plaintiffs and other Class members to purchase Molex's securities at artificially inflated prices and, as a result, suffer economic losses when the truth about Defendants' alleged fraud was revealed (2006). Plaintiffs alleged that Defendants made untrue statements of material fact and/or omitted to state material facts necessary to make the statements not misleading and engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of the Company's securities in an effort to maintain artificially high market prices for Molex's securities in violation of section 10(b) of the Exchange Act and Rule 10b-5 (2006). Plaintiffs allege that Defendants deceived them by making misleading statements or omissions regarding: (1) the inventory accounting error; (2) raw material price increases; (3) Molex's financial accounting practices; and (4) inventory backlog (2006). The Court held that Plaintiffs have adequately alleged that Defendants made false or misleading statements or omissions regarding the PII Error (2006). The Court explained that the Defendants made false or misleading statements or omissions in conjunction with the manipulation of their financial statements through improper accounting and recording of accruals, contingent gains and adjustments in order to make Molex's earnings appear larger than they actually were (2006). These allegedly false or misleading statements or omissions include that Individual Defendants: (1) failed to disclose the reversal of a $2.7 million self-insurance reserve to boost Molex's earnings and offset the charge for the PII Error; (2) failed to disclose the reduction of Molex's inventory allowance by $1.5 million to offset the charge taken for the PII Error; (3) failed to correct for a $3 to $4 million overstatement of Molex's accounts receivable reserve until months after they were aware of the overstatement ; and (4) improperly recorded contingent gain by prematurely recording $1.9 million of potential earnout payments related to the sale of an investment and failed to disclose this fact until February 15, 2005 (2006). The Court also held that Plaintiffs have adequately alleged that Molex's statements predicting stability in raw materials and boasting of their ability to absorb the higher cost of raw materials three months earlier were misleading when made (2006). Furthermore, it stated that Molex’s financial statements filed with the SEC were not prepared in compliance with GAAP, and hence were presumed to be misleading and inaccurate (2006). Given these specific allegations of GAAP violations and manipulation of accruals, allowances, contingent gains and adjustments, Plaintiffs have adequately alleged that Defendants' various accounting methods during the Class Period were false or misleading (2006). The Court also held that Plaintiffs adequately alleged that Defendants made false or misleading statements or omissions regarding Molex's order backlog, violating GAAP and SEC rules by failing to disclose that Molex's reported order backlog was due to a change in the method of calculating its backlog in fiscal year 2004 (2006). In all these, the Court found that Plaintiffs' allegations are sufficiently detailed and specific to survive the current motion to dismiss (2006). Hence, the District Court held that: (1) investors adequately alleged that defendants made false or misleading statements or omissions; (2) investors adequately alleged that defendants' false or misleading statements were material; and (3) investors established a strong inference of scienter (2006). Defendants' motion to dismiss was then denied (2006). In re Ibis Technology Securities Litigation 422 F.Supp.2d 294 D.Mass.,2006. April 12, 2006 Investors filed securities fraud class action alleging that company's principal intentionally misrepresented company's true condition in order to artificially inflate price of its stock and ensure success of its public offering (2006). Company and its principal moved to dismiss complaint (2006). The complaint alleged, that the 1000 implanters and the 200mm wafers were virtually obsolete as of 2002, and, that, in recognition of this fact, Ibis allowed its 1000 implanters to fall into disuse and disrepair by that time (2006). The complaint further alleged that by July 23, 2003, the beginning of the Class Period, the 300mm wafers had become responsible for an ever more dominant percentage of all Ibis wafer sales, reaching 97% during the quarter ended June 30, 2003 (2006). The plaintiffs alleged that the defendants artificially inflated Ibis' stock price by exaggerating the i2000 implanter's acceptance in the marketplace, by repeatedly stating that they anticipated booking new orders for one to three i2000 implanters by December 31, 2003, by stating that Ibis would continue to record significant revenues from product sales of all sizes of wafers, and by failing to timely record an impairment in the value of an asset group, which consisted of eight 1000 implanters and related assets and had a carrying value of approximately $12 million (2006). Defendants countered that by making specific warnings, in that it stated that, “although our 200mm and smaller wafer size production line is currently underutilized, considering our future plans, current potential business prospects and alternatives, Management believes that we do not have an impairment issue at this time” (2006). The plaintiffs alleged then that, by making these statements the defendants, were falsely reassuring investors that there were substantial business prospects for Ibis' 200mm wafer production line, when the defendants knew that no such prospects existed (2006). The plaintiffs assert that pursuant to GAAP, and in particular FAS 144, the defendants were required but failed to perform an impairment analysis of Ibis' eight 1000 implanters and related assets, and to write-off the carrying value of those assets by approximately $11 million prior to the start of the Class Period (2006). As a result, according to the plaintiffs, the defendants' statements during the Class Period concerning Ibis' financial condition and the status of its 200mm wafer production line were false and misleading (2006). The Court in this case held that the plaintiffs' impairment loss allegations are sufficient to state a claim (2006). The Court explained that these allegations, especially when combined with the allegations concerning motive and the failure to comply with GAAP, are sufficient to support a strong inference that the defendants either knowingly misrepresented the value of the small wafer asset group at the time they made the challenged statements, or recklessly disregarded facts indicating that those assets were impaired and should have been written down in the fiscal quarter ended June 30, 2003 (2006). The Court further explained that the evidence of motivation alleged by the plaintiffs is strong: Ibis was in a desperate cash crunch, had been laying off a significant portion of its workforce and needed an immediate cash infusion to keep the business alive (2006). In addition, the timing of the eventual write-down-at the next possible opportunity after the stock sale-is suspicious (2006). On the basis of these allegations, the Court concluded that the plaintiffs sufficiently have pleaded that, pursuant to GAAP, the defendants should have reduced by $11 million the value reported on Ibis's books for the assets associated with its small wafer production line (2006). The Court concluded that it should have been clear to the defendants that no one would want to purchase these assets for anywhere near the value at which they were stated on the company's books (2006). The “potential buyer” is a less plausible explanation for the delay of the write-down than that the defendants wished to wait until after the stock offering to make the appropriate accounting adjustment (2006). Accordingly, the court recommended that the motion to dismiss be denied as to allegedly misleading statements and omissions regarding the value of Ibis' small wafer production assets (2006). However, as to the company's statements regarding its prospects for booking orders in next year fell within Private Securities Litigation Reform Act's (PSLRA) safe harbor for forward-looking statements, and hence, are excused from liability (2006). References In re Daou Systems, Inc., 411 F.3d 1006. C.A.9 (Cal.), February 02, 2005. In the Matter of Albert Glenn Yesner, CPA . Administrative Proceeding, File No. 3-9586, 22 May 2001. Takara Trust v. Molex Inc., 429 F.Supp.2d 960, N.D.Ill.,2006. April 28, 2006. In re Ibis Technology Securities Litigation, 422 F.Supp.2d 294, D.Mass., 2006. 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