Hoffman v. Comshare Inc.

• Decision Date: 28 January 1999
• Docket Number: No. 97-2098,PLAINTIFFS-APPELLANTS,DEFENDANTS-APPELLEES,97-2098
• Citation: 183 F.3d 542
• Parties: (6th Cir. 1999) IN RE: COMSHARE, INCORPORATED SECURITIES LITIGATION. HARRY M. HOFFMAN, ET AL.,, v. COMSHARE, INC., ET AL., Argued:
• Court: U.S. Court of Appeals — Sixth Circuit

Page 542

183 F.3d 542 (6th Cir. 1999)

IN RE: COMSHARE, INCORPORATED SECURITIES LITIGATION.

HARRY M. HOFFMAN, ET AL., PLAINTIFFS-APPELLANTS, v. COMSHARE, INC., ET AL., DEFENDANTS-APPELLEES.

No. 97-2098

U.S. Court of Appeals, Sixth Circuit

Argued: January 28, 1999

Decided: July 08, 1999

Rehearing and Suggestion for Rehearing En Banc Denied Aug. 23, 1999.

Appeal from the United States District Court for the Eastern District of Michigan at Detroit. No. 96-73711--Lawrence P. Zatkoff, Chief District Judge. [Copyrighted Material Omitted] Alan R. Miller, George LaPlata, Birmingham, MI, Sherrie R. Savett (argued and briefed), Arthur Stock, Berger & Montague, Philadelphia, PA, Stuart H. Savett, Savett, Frutkin, Podell & Ryan, Philadelphia, PA, Patrick E. Cafferty, Miller, Faucher, Chertow, Cafferty & Wexler, Ann Arbor, MI, for Plaintiffs-Appellants.

Kathleen McCree Lewis(briefed), Donald S. Young (argued and briefed), Dykema Gossett, Detroit, MI, Daniel J. Stephenson (briefed), Andrew J. McGuinness (briefed), Dykema Gossett, Ann Arbor, MI, for Defendants-Appellees.

Jacob H. Stillman (briefed), Luis DeLaTorre, U.S. Securities and Exchange Commission, Washington, D.C., Mark R. Pennington, Adam C. Pritchard (briefed), Securities and Exchange Commission, Washington, D.C., Harvey J. Goldschmid (argued), Securities and Exchange Commission, Office of General Counsel, Washington, D.C., Jonathan C. Dickey (briefed), Gibson, Dunn & Crutcher, Palo Alto, CA, Louis A. Craco (briefed), Willkie, Farr & Gallagher, New York, NY, for Amici Curiae.

Before: Kennedy, Daughtrey, and Clay, Circuit Judges.

OPINION

Clay, Circuit Judge.

Plaintiffs, shareholders of Comshare, Inc. ("Comshare"), appeal an order entered by the district court dismissing pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure their class action complaint against Comshare and several of its officers and directors alleging securities fraud in violation of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78j(b) & 78t(a) (1998). Specifically, the parties ask us to decide an issue of first impression for this Court--whether, under the heightened pleading standards set forth in the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b)(2) (1998), a plaintiff alleging securities fraud in violation of the Securities and Exchange Act may survive a motion to dismiss by alleging facts giving rise to a strong inference of recklessness or of motive and opportunity. For the reasons set forth below, we AFFIRM, on different grounds, the judgment of the district court.

I.

Defendants include Comshare, a Michigan corporation headquartered in Ann Arbor, Michigan that develops, licenses, and services computer software to enable business professionals to use data in decisionmaking. Comshare's fiscal year ends on June 30 of each calendar year. Comshare stock is publicly traded on the NASDAQ. On June 30, 1996, Comshare had approximately 9.7 million shares outstanding. The majority of Comshare's revenues derive from sales outside of the United States, and revenue from the software licensing has comprised approximately 50% of Comshare's reported revenues. Various subsidiaries conduct Comshare's foreign operations.¹ Defendants also include the following officers and directors of Comshare: (1) T. Wallace Wrathall, President and Chief Executive Officer ("CEO"); (2) Kathryn A. Jehle, Chief Financial Officer ("CFO"); (3) Richard L. Crandall, Chairman of the Board of Directors; (4) Stephen R. Fluin, Vice President for European Operations; (5) Dion T. O'Leary, Vice President for Agents and Distributors; and (6) Donald J. Walker, Senior Vice President. Walker left Comshare in May 1996, and Fluin left Comshare in October 1996.

Since the district court stayed class certification pending its resolution of Defendants' motion to dismiss, the case presently before this Court is not a class action but is instead a consolidation of several cases that the district court designated as In re Comshare Incorporated Securities Litigation. The nine Plaintiffs in this action include Harry and Deborah Hoffman, Donald Knuth, Nancy Totten, Mark Cook, Oleg Kohkhlov, Paul Knapp, Christopher Yost, and Gabriel Briceno. All but two of the Plaintiffs first bought shares of Comshare common stock on or after July 30, 1996.² The remaining two, Totten and Kohkhlov, purchased their shares of Comshare common stock both before and after July 30, 1996.³ According to Comshare, Plaintiffs collectively own 17,621 shares, or 0.18%, of Comshare's stock.

A.

Comshare's revenue generally consists of software license fees, software maintenance service fees, and other consulting and service fees. With regard to license fees in particular, Comshare's policy is that it will not recognize revenue in such business until a customer contract is fully executed and the software has been shipped--in other words, the sale must be final before Comshare will recognize its revenue from the transaction. According to Plaintiffs, recognition of the revenue from sales before payment of the purchase prices is reasonably assured violates not only Comshare's own revenue recognition policy, but also violates Generally Accepted Accounting Principles ("GAAP").⁴

On July 30, 1996, the news service Reuters reported that Comshare had delayed publication of its quarterly report for the quarter ended June 30, 1996 because Comshare had not yet completed its audit of its United Kingdom ("UK") subsidiary. On August 6, 1996, after the market closed, Comshare issued a press release stating it was delaying release of the results for the fourth quarter and year ending June 30, 1996 pending completion of its year-end audit, which Comshare had expanded to include a detailed review of orders in the UK and other foreign countries. Specifically, Comshare disclosed that it initiated a detailed review "after discovery of letters setting forth conditions to certain orders in the United Kingdom, which the Company had not been made aware of at the time the revenue was recognized," and disclosed that Comshare was aware of approximately $4 million in such orders. (J.A. at 172.) After this announcement, the price of Comshare stock fell from 18 1/2 on August 6, 1996 to a trading low of 10 3/4 on August 7, 1996, and eventually closed at 11 7/8.

On September 5, 1996, after completing its year-end audit, Comshare announced its results for fiscal year 1996. Comshare reported $26.6 million in revenues for the quarter, down from $28.8 million in the fourth quarter of 1995. Comshare also announced that its total revenue had increased 9.8% in fiscal year 1996 as compared with fiscal year 1995, even after accounting for the revenue recognition problem. In its Form 10-K for 1996, Comshare stated:

"In connection with the Company's fiscal 1996 year end audit, the Company discovered side letters setting forth conditions to certain foreign orders in violation of the Company's revenue recognition policies. No violations were found in U.S. orders. The growth in software license revenue in fiscal 1996 for all the Company's products was negatively impacted by these violations, although it is difficult to estimate what license growth would have been in fiscal 1996 without the violation of Company policies.... Corrective actions have been taken, including management changes, personnel terminations and other disciplinary actions and the establishment of new orders procedures."

(J.A. at 264.) Comshare further stated that "[s]everal of the contracts that were not recognized in the fourth quarter are already revenue in the first quarter of FY 1997." (J.A. at 177.)

B.

The Hoffmans filed the first complaint in this case on August 9, 1996. Yost filed a second complaint on August 14, 1996. Totten filed a third complaint on August 21, 1996. Knapp and Knuth filed a fourth complaint on September 5, 1996. Each of these complaints alleged a "class period" of April 17, 1996 through August 6, 1996. On October 16, 1996, the parties filed a Joint Motion to Consolidate Actions. The district court consolidated all pending cases before the Honorable Lawrence P. Zatkoff, and permitted Plaintiffs to file a Consolidated Amended Complaint ("Complaint"). Plaintiffs filed their Complaint on December 13, 1996. In the Complaint, Plaintiffs extended the class period to August 2, 1995 through August 21, 1996, and added Defendant Walker, who was not named in the original complaints.

The Complaint charges that all Defendants engaged in a scheme to defraud Plaintiffs by knowingly or recklessly disregarding the acknowledged errors in revenue recognition, and that, through its public misrepresentations about its revenue, Defendants fraudulently induced Plaintiffs to purchase Comshare stock at artificially inflated prices in violation of § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) (1998), and Rule 10b-5, promulgated thereunder by the SEC, 17 C.F.R. § 240.10b-5 (1998). The Complaint further alleges that the individual Defendants are liable as "controlling persons" of Comshare, under Section 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78t(a) (1998). Finally, the Complaint alleges that Defendants Wrathall, Crandall and Jehle made negligent misrepresentations regarding Comshare's financial situation. Generally, Plaintiffs claim that Defendants' actions in improperly recognizing revenue for conditional sales and in thereby misstating its revenue amount to securities fraud. Plaintiffs contend that the side letter agreements and the premature revenue recognition were more than mere negligence, and were instead part of a scheme to defraud the public and to inflate stock prices so that individual Defendants could sell their own shares at high prices. Plaintiffs also claim that individual Defendants profited from this scheme because their compensation plans were tied to the price of Comshare's stock.

On January 31, 1997, Defendants filed, in lieu of an...