In re Navarre Corp. Securities Litigation

Decision Date31 July 2002
Docket NumberNo. 01-2543.,01-2543.
Citation299 F.3d 735
PartiesIn re: NAVARRE CORPORATION SECURITIES LITIGATION Daniel Chen, on behalf of himself and all others similarly situated, Plaintiff — Appellant, Judy Poucher, on behalf of herself and all others similarly situated, Plaintiff, Advanced Data Concepts; Steve Chahine; Lee Tachman, Plaintiffs-Appellants, v. Navarre Corp.; Eric H. Paulson; Charles E. Cheney; Alfred Teo; Dickinson G. Wiltz; James G. Sippl; Michael L. Snow, Defendants — Appellees.
CourtU.S. Court of Appeals — Eighth Circuit

Richard A. Lockridge, argued, Minneapolis, MN Gregg M. Fishbein and Gregory J. Myers, Minneapolis, MN, James C. Krause and Patrick N. Keegan, San Diego, CA, on the brief), for appellant.

David P. Pearson, argued, Minneapolis, MN (Jeffrey R. Ansel, Minneapolis, MN, on the brief), for appellee.

Before FAGG, BEAM, Circuit Judges, GOLDBERG,1 Judge.

BEAM, Circuit Judge.

The issue before us is whether the amended complaint in this securities fraud class action states a claim under the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b)(1), (2). The district court2 held that it did not, and dismissed the amended complaint with prejudice. The plaintiffs appeal, and we affirm.

I. BACKGROUND

This action is brought under sections 10(b) and 20 of the Securities Exchange Act of 1934 ("Act"), 15 U.S.C. §§ 78j(b) and 78t, and Rule 10b-5 of the Securities Exchange Commission, 17 C.F.R. § 240.10b-5 ("Rule"). The plaintiffs ("investors") allege violations of the Act and Rule on behalf of a class of investors who bought Navarre stock between November 25, 1998, and July 26, 1999 (the "class period"). The defendants are the Navarre Corporation and certain of its officers and directors. For the purpose of a motion to dismiss, we assume that the facts alleged in the amended complaint are true. Florida State Bd. of Admin. v. Green Tree Financial Corp., 270 F.3d 645, 648 (8th Cir.2001).

Navarre is a major distributor of music, software and interactive CD-ROM and DVDs. Through its subsidiary, NetRadio Corporation, Navarre also owns and operates NetRadio Network, a leading audio content provider on the Internet. Eric Paulson has been the Chairman of the Board of Directors and President and Chief Executive Officer of Navarre since 1983. The other named defendants in this action are officers or members of the Board of Directors. On May 1, 1996, Navarre purchased a fifty percent interest in NetRadio, and the following year Navarre purchased the other half of NetRadio. The NetRadio purchase capped a successful five years during which Navarre grew from $20 million in sales in 1991 to $200 million in 1996. However, the NetRadio purchase drained Navarre's working capital, forcing officials to raise $20 million through a private placement in May 1998.

As early as July 1998, Navarre hoped to take advantage of the lucrative Internet market by taking NetRadio public. According to the investors, Navarre stood to benefit from such an IPO because NetRadio was valued by Navarre as a zero asset on its books. In the months leading up to the class period, the defendants increased the number of public announcements about Navarre and ultimately began making announcements about the NetRadio IPO. On July 27, 1998, NetRadio issued a press release stating that it intended to file a registration statement with the SEC for an IPO of NetRadio common stock. However, a depressed market put NetRadio's IPO plans on hold until October and November, the time at which the class period begins.

In the amended complaint, the investors allege several fraudulent schemes. First, the investors allege that Navarre issued false and misleading statements that it was in the final stage of spinning off a majority-owned subsidiary and taking the newly formed company public by the end of the year 1998, which created heightened demand for Navarre stock — the "NetRadio Hype." Second, the investors allege that Navarre participated in a "ship and store" scheme that artificially inflated Navarre's stock price. Both of these schemes, according to the investors' amended complaint, artificially inflated Navarre's stock price and allowed the individual defendants to sell Navarre stock at a large profit.

A. The NetRadio Hype

The amended complaint sets forth many public statements made by Navarre regarding the NetRadio IPO during the class period. The investors pinpoint the following statements and allege that the defendants, in each instance, knew or were reckless in not knowing that the statements were false:

(1) In November 1998, Navarre began making public statements that it would complete the NetRadio IPO by the end of the year 1998, which created heightened demand for Navarre stock. Investors also allege that Paulson said the IPO would happen "soon."

(2) On November 27, 1998, after Paulson allegedly confirmed efforts to sell NetRadio shares in a public offering, the price of Navarre stock more than doubled to $12.1875.

(3) On November 30, 1998, a transcript from CNNfn states "[t]he company has publicly admitted that it is working to bridge NetRadio out as an IPO before the end of the year. Spoke with a company spokesmen [sic] who did confirm that the company is trying to bring the IPO out." The identity of the speaker was not disclosed by CNNfn.

(4) On December 8, 1998, a Navarre spokeswoman confirmed that Navarre would spin off NetRadio, but said Navarre had not yet registered a filing with the SEC.

(5) On December 9, 1998, Paulson told a reporter with CNBC that in order to spin off NetRadio in an IPO, Navarre would have to file documents with the SEC and may need shareholder approval. Additionally, Paulson announced Navarre had retained Everen Securities, Inc. to complete the IPO within 60 days.

(6) In December 1998 or January 1999, rather than correcting the information, Paulson held a conference saying he was "reasonably comfortable" that the NetRadio IPO would occur by early February. Navarre stock traded above $15 per share at that time.

(7) On February 3, 1999, a story from the Minneapolis Star Tribune stated that Navarre was expected to file a registration statement with the SEC early the following week. A spokesman for Navarre declined to comment. Navarre stock surged to at or above $20 per share.

(8) On February 8, 1999, Navarre retreated from the previous announcement but still confirmed plans for an IPO within the next several weeks.

(9) On March 3, 1999, NetRadio filed a registration statement but the investors allege that Navarre stopped discussing the IPO altogether at that time and Navarre's stock began a downward trend beginning in late May 1999.

(10) By June 4, 1999, Navarre stock traded at $9 per share. Navarre's June 29, 1999, 10-K reported that "there can be no assurance that [NetRadio] will successfully complete the offering."

(11) On July 26, 1999, Navarre disclosed that the NetRadio IPO would not occur before September and that Navarre was interviewing new investment bankers to replace Everen Securities, which was in the midst of its own pending acquisition announced April 27, 1999. The investors allege that at that time Everen Securities had completed almost no work on the NetRadio IPO.

(12) NetRadio ultimately completed its IPO on October 14, 1999.

B. The Ship and Store Scheme

In addition to the above-mentioned "NetRadio Hype" scheme, the investors also allege that "[b]y utilizing improper accounting practices, defendants reported revenues on products that had been shipped to warehouses, as opposed to purported customers of [Navarre] — even though defendants anticipated most of the products would be returned and had no expectations that [Navarre] would be paid." This scheme, the investors state, contributed to the artificial inflation of Navarre's stock during the class period and allowed the individual defendants to sell large portions of their company stock, realizing great profits.

The investors allege that in order to compensate for revenue shortfalls between what Navarre had publicly forecast and Navarre's actual sales, defendants implemented a scheme to meet or exceed projected sales. This was accomplished by increasing Navarre's product offerings, or "label list," and inducing customers to sign "ship and store" agreements that allowed Navarre to ship product offerings to a storage facility and invoice the customer as if the customer had received the products. Further, it is alleged that Navarre authorized its sales managers to offer the customer free shipping, allowed them to waive the order down payment and assure customers that they would not have to pay the invoice until the product was actually received. By doing this, defendants were able to report a growing volume of sales transactions and record them as revenue throughout the fiscal year. The investors allege that this scheme violated many Generally Accepted Accounting Principles ("GAAP") and ultimately unraveled when the stored products failed to yield revenue or the merchandise was returned to Navarre's possession. As a result, Navarre reported a $25.57 million loss in 1999, which the investors attribute to anticipated sales returns.

C. Insider Sales

According to the investors, the alleged wrongdoing resulted in an avalanche of insider trading as the individual defendants began to liquidate their stock holdings in the company. Specifically, the individual defendants sold a total of 474,470 shares of their 3,965,257 combined stock ownership, or about twelve percent of their Navarre stock, realizing $11.5 million in proceeds.

The district court dismissed the appellant's amended complaint, holding that (1) investors failed to plead facts supporting the "ship and store" scheme with sufficient particularity because they failed to provide the who, when, where or how of the alleged fraud scheme, (2) investors did not...

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