Pirraglia v. Novell, 02-4077.

• Decision Date: 11 August 2003
• Docket Number: No. 02-4077.,02-4077.
• Parties: Domenico PIRRAGLIA, Bella Pasternak, Bernard Pasternak, Mohamad S. Bakizada, Henriette Bakizada, Michael C. Dodge, Gary M. Goodman, Peter Cole, Antonio Tripodi, Leslie I. Handler, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. NOVELL, INC., Joseph A. Marengi, James R. Tolonen, John A. Young, Defendants-Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

339 F.3d 1182

Domenico PIRRAGLIA, Bella Pasternak, Bernard Pasternak, Mohamad S. Bakizada, Henriette Bakizada, Michael C. Dodge, Gary M. Goodman, Peter Cole, Antonio Tripodi, Leslie I. Handler, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. NOVELL, INC., Joseph A. Marengi, James R. Tolonen, John A. Young, Defendants-Appellees.

No. 02-4077.

United States Court of Appeals, Tenth Circuit.

August 11, 2003.

COPYRIGHT MATERIAL OMITTED

Susan K. Alexander (Patrick J. Coughlin and Sanford Svetcov of Milberg, Weiss, Bershad, Hynes & Lerach LLP, San Francisco, CA; Eric A. Isaacson and Henry Rosen of Milberg, Weiss, Bershad, Hynes & Lerach LLP, San Diego, CA; Richard D. Burbidge, Stephen B. Mitchell, Jason D. Boren and Jefferson W. Gross of Burbidge & Mitchell, Salt Lake City, UT, with her on the briefs), Milberg, Weiss, Bershad, Hynes & Lerach LLP, San Francisco, CA, for the Plaintiffs-Appellants.

Terry T. Johnson (Daniel Turbow of Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA; Jeffrey Hunt of Parr Waddoups Brown Gee & Loveless, Salt Lake City, UT, with him on the brief), Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA, for the Defendants-Appellees.

Before LUCERO, BALDOCK, and O'BRIEN, Circuit Judges.

LUCERO, Circuit Judge.

This court is once again called upon to interpret the provisions of the Private Securities Litigation Reform Act of 1995, Pub.L. No. 104-67, 109 Stat. 737 (1995) ("Reform Act") (codified at 15 U.S.C. § 78u-4), as applied to a private securities-fraud complaint. Plaintiffs filed a securities-fraud class-action complaint against Novell, Inc. ("Novell"), asserting that Novell executives made materially false statements that induced investors to purchase Novell stock shortly before the price of shares plummeted. Applying the rigorous pleading requirements of the Reform Act, the district court dismissed plaintiffs' complaint for failure to state a claim. We conclude that plaintiffs have stated a claim with respect to an alleged "in-transit" revenue category and the recognition of revenue from Original Equipment Manufacturers ("OEMs"),¹ but not with respect to alleged "channel stuffing,"² special deals with distributors, and general statements regarding the demand for company products. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm in part and reverse in part.

I

Novell is a manufacturer and distributor of computer software. Faced with increasing competition in the software market, Novell announced in early 1996 that it intended to reduce the amount of inventory in its distribution channels by not shipping any new product into the channels during 2Q96.³ This move was intended to bolster investor confidence by making Novell's revenue reports more reflective of end-user demand. At the end of the quarter, then-Executive Vice President Joseph A. Marengi informed investors that the channels were "clean worldwide now," and other Novell executives, including Chairman Robert Frankenberg and Chief Financial Officer James R. Tolonen, predicted that revenue would grow in subsequent quarters. (Appellants' App. at 38-39, ¶¶ 25-27.)

Several months later, Novell reported its 3Q96 results, which were substantially lower than earlier projections. Novell's stock fell, and Frankenberg was forced to resign as Chairman, President, and Chief Executive Officer ("CEO") of Novell. John A. Young replaced Frankenberg as Chairman and interim CEO, and Marengi replaced him as President.

Novell's new management was under pressure to increase revenues and bolster Novell's stock price. Initial reports suggested that Novell's earnings were improving, and Novell's reported income for 4Q96 exceeded projections. Novell press releases explained the revenue growth in 4Q96 as driven by increased demand for Novell products, and, based on information allegedly provided by Novell, analysts projected continued growth in 1Q97. In February 1997, however, Novell reported that 1Q97 revenues had declined from 4Q96 levels. Novell's stock price fell from $13 to $10 in reaction to the news.

In March 1997, Novell announced that Eric Schmidt had been named Chairman and CEO of Novell. One month later, Novell announced that its 2Q97 earnings would be much lower than earlier forecast, and Novell's stock price fell to $7, where it remained for several months. Once the disappointing 2Q97 results were released, Novell announced major layoffs and proposed to reduce the level of inventory in the channels. A few days later, Marengi was fired. Schmidt later stated that there had been "too much inventory" when he came to Novell and that special terms had been negotiated with some of Novell's distributors and customers. (Id. at 35, ¶ 13.)

In early 1998, several investors who lost money when Novell's stock price fell ("plaintiffs") filed a purported class action in the Northern District of California against Novell, Marengi, Tolonen, and Young ("defendants"), claiming violations of federal securities laws.⁴ The case was transferred to the District of Utah, and plaintiffs filed a First Amended Complaint, which was dismissed. Plaintiffs' motion for leave to amend was granted, and plaintiffs filed a Second Amended Complaint. Plaintiffs allege in the Second Amended Complaint that defendants made materially false statements and issued false financial reports between November 1, 1996 and April 22, 1997 (the "Class Period") in violation of: (1) section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b),⁵ and Rule 10b-5 thereunder 17 C.F.R. § 240.10b-5;⁶ and (2) section 20 of the 1934 Act, 15 U.S.C. § 78t(a).⁷

In the Second Amended Complaint, plaintiffs claim that defendants falsely told analysts and investors in two conference calls and other conversations (1) that demand for Novell's products was generally high; (2) that Novell had achieved strong 4Q96 and 1Q97 results "without engaging in any special promotional pricing, discounting, or other unusual inducements to distributors to accept product"; and (3) that "channel inventory remained lean and reflective of end-user demand for Novell's products." (Appellants' App. at 47-48, ¶ 47; 56, ¶ 64.) According to plaintiffs, Novell had offered special consignment sale terms, product exchanges, and discounts to various large distributors, and "Distribution Inventory Reports" and "Pull Side Reports" sent to defendants showed that these distributors were carrying a six-month inventory backlog. (Id. at 45, ¶ 40; 66-68, ¶¶87-91.) Plaintiffs further assert (4) that defendants had engaged in accounting fraud and Novell's financial reports for 4Q96 and 1Q97 "were materially overstated." (Id. at 63, ¶ 79.)

Concluding that plaintiffs had not satisfied the pleading requirements of the Reform Act, the district court dismissed the Second Amended Complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted.⁸ Plaintiffs appeal the district court's dismissal of the Second Amended Complaint.

II

Since 1995, private securities-fraud complaints have been subject to the stringent pleading requirements of the Reform Act, a statute enacted to curb abuse in private securities lawsuits. City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1258 (10th Cir.2001). Under the Reform Act, a private complaint that alleges a violation of section 10(b) of the 1934 Act and Rule 10b-5 thereunder must first "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, . . . [must] state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). Second, in order to show that the defendant acted with the requisite state of mind for securities-fraud cases, i.e., scienter, the complaint must also, "with respect to each act or omission alleged to violate [the 1934 Act], state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." § 78u-4(b)(2); see also Fleming, 264 F.3d at 1257-59 (discussing the scienter requirement).

As has been noted, "an inevitable tension arises" between the strict pleading requirements of the Reform Act and the "customary latitude granted the plaintiff" under Rule 12(b)(6). Gompper v. VISX, Inc., 298 F.3d 893, 896 (9th Cir.2002). A court's function on a Rule 12(b)(6) motion "is not to weigh potential evidence that the parties might present at trial, but to assess whether the plaintiff's complaint alone is legally sufficient to state a claim for which relief may be granted." Sutton v. Utah State Sch. for the Deaf & Blind, 173 F.3d 1226, 1236 (10th Cir.1999) (quotation omitted). "A 12(b)(6) motion should not be granted `unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" GFF Corp. v. Associated Wholesale Grocers, Inc., 130 F.3d 1381, 1384 (10th Cir.1997) (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). Because this is a question of law, we review a 12(b)(6) dismissal de novo, Grossman v. Novell, Inc., 120 F.3d 1112, 1118 (10th Cir.1997), and, in general, "all well-pleaded factual allegations in the . . . complaint are accepted as true and viewed in the light most favorable to the nonmoving party," Sutton, 173 F.3d at 1236.

In Gompper, the Ninth Circuit determined that, as regards the state of mind requirement of the Reform Act, the 12(b)(6) standard has been modified by that statute. According to the Ninth Circuit, because the Reform Act requires plaintiffs to plead facts with particularity giving rise to a "strong inference" that the defendant acted with scienter, § 78u-4(b)(2), a court considering whether scienter has been established "must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to...