Zucco Partners, LLC v. Digimarc Corp., 04-CV-1390-BR.

• Decision Date: 04 August 2006
• Docket Number: No. 04-CV-1390-BR.,04-CV-1390-BR.
• Parties: ZUCCO PARTNERS, LLC; Rex Boggs; Kennard McAdam; and Glen Thomas, on behalf of themselves and all others similarly situated, Plaintiffs, v. DIGIMARC CORP., Bruce Davis, and E.K. Ranjit, Defendants.
• Court: U.S. District Court — District of Oregon

Page 1201

445 F.Supp.2d 1201

ZUCCO PARTNERS, LLC; Rex Boggs; Kennard McAdam; and Glen Thomas, on behalf of themselves and all others similarly situated, Plaintiffs, v. DIGIMARC CORP., Bruce Davis, and E.K. Ranjit, Defendants.

No. 04-CV-1390-BR.

United States District Court, D. Oregon.

August 4, 2006.

Gary M. Berne, David F. Rees, Mark A. Friel, Stoll Stoll Berne Lokting & Shlachter P.C., Portland, OR, Lori G. Feldman, Milberg Weiss Bernshad & Schulman LLP, New York City, for Plaintiffs.

Barnes H. Ellis, Lois 0. Rosenbaum, Robin B. Skarstad, Stoel Rives LLP, Portland, OR, for Defendants.

OPINION AND ORDER

BROWN, District Judge.

This matter comes before the Court on Defendants' Motion to Dismiss (# 101) Plaintiffs' Second Amended Class Action Complaint. For the following reasons, the Court GRANTS Defendants' Motion.

PROCEDURAL BACKGROUND

On September 28, 2004, Plaintiffs filed a Class Action Complaint in this Court on behalf of all persons who purchased publicly traded securities of Defendant Digimarc Corporation between April 17, 2002, and July 28, 2004 (the class period). Plaintiffs alleged Defendants Digimarc; Bruce Davis, Digimarc's Chief Executive Officer (CEO); and E.K. Ranjit, Digimarc's Chief Financial Officer (CFO), violated §§ 10(b) of the Securities Exchange Act of 1934 and the regulations promulgated thereunder including Rule 10b-5 and, in addition, Davis and Ranjit violated § 20(a) of the Securities and Exchange Act.

On May 16, 2005, Plaintiffs filed a First Amended Class Action Complaint that contained the same allegations and claims as those in their original Complaint, but Plaintiffs shortened the class period to April 22, 2003, through July 28, 2004. On June 15, 2005, Defendants filed a Motion to Dismiss Plaintiffs' First Amended Complaint. The Court heard oral argument regarding Defendants' Motion on October 3, 2005. On November 30, 2005, the Court granted Defendants' Motion to Dismiss the First Amended Complaint on the ground that Plaintiffs had not pled the scienter component of fraud with the particularity required by the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4(b)(1) and (2). The Court granted Plaintiffs leave to file a second amended complaint.

On January 17, 2006, Plaintiffs filed a Second Amended Complaint. On February 14, 2006, Defendants filed a Motion to Dismiss the Second Amended Complaint on the ground that Plaintiffs again failed to plead the scienter component of fraud with the requisite particularity. The Court heard oral argument regarding Defendants' Motion on June 7, 2006, and took the Motion under advisement.

GENERAL BACKGROUND

In their Second Amended Complaint, Plaintiffs allege Defendants knowingly or recklessly "issued or caused to be issued" false and misleading statements during the class period that caused the value of Digimarc stock to be artificially inflated. Plaintiffs contend Defendants throughout the class period (1) improperly capitalized research and development expenses, (2) failed to expense charges to write off or to write down obsolete inventory, and (3) improperly capitalized payroll expenses in violation of Generally Accepted Accounting Principles (GAAP).

Plaintiffs allege virtually every financial statement, press release, or announcement made by Defendants during the class period was false or misleading because these statements and releases contained predictions of growth and did not reveal Digimarc's improper capitalization of expenses and failure to write down inventory. Plaintiffs contend they purchased Digimarc stock at inflated prices because of Defendants' false or misleading statements. Finally, Plaintiffs assert the value of Digimarc's stock dropped after Defendants allegedly disclosed Digimarc's true financial status to the market in press releases on January 20, 2004, and July 28, 2004, which, in turn, caused Plaintiffs' alleged injury.

STANDARDS

Dismissal under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim "is appropriate only if it appears beyond doubt that the plaintiff can prove no set of facts in support of the claim which would entitle him to relief." McGary v. City of Portland, 386 F.3d 1259, 1261 (9th Cir.2004) (citation omitted). A court must limit its review to the contents of the complaint, take all allegations of material fact as true, and view the facts in the light most favorable to the nonmoving party. Cooper v. Pickett, 137 F.3d 616, 622 (9th Cir.1997).

In addition, if a court dismisses a claim pursuant to Rule 12(b)(6), the court must grant leave to amend unless the court determines the allegation of other facts consistent with the operative pleading could not possibly cure the deficiency. Schreiber Distrib. Co. v. Serv-Well Furn. Co., 806 F.2d 1393, 1401 (9th Cir.1986). See also Reddy v. Litton Indus., 912 F.2d 291 (9th Cir.1990).

DISCUSSION

In their Second Amended Complaint, Plaintiffs bring two claims: (1) all Defendants violated § 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder and (2) the individual Defendants violated § 20(a) of the Securities Exchange Act.

Defendants move to dismiss Plaintiffs' Second Amended Complaint on the ground that Plaintiffs have not met the stringent pleading standards required by the PSLRA, 15 U.S.C. § 78u-4 (b)(1) and (2).

I. The Law

Claims brought under Rule 10b-5 and § 10(b) of the Securities Exchange Act must meet the particularity requirements of Federal Rule of Civil Procedure 9(b) and the PSLRA. In re Daou Sys., 411 F.3d 1006, 1014 (9th Cir.2005)(citing Semegen v. Weidner, 780 F.2d 727, 729, 734-35 (9th Cir.1985)).

Rule 9(b) provides: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." In 1995, however, Congress enacted the PSLRA and significantly altered the pleading requirements in private securities-litigation actions to require plaintiffs to "plead with particularity both falsity and scienter." Id. (citations omitted).

To satisfy the requirements of the PSLRA, securities-fraud complaints must

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, the complaint shall state with particularity all facts on which that belief is formed.

15 U.S.C. § 78u-4(b)(1). Securities-fraud complaints also must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4 (b)(2) (emphasis added). "[T] he complaint must allege that the defendants made false or misleading statements either intentionally or with deliberate recklessness." Daou, 411 F.3d at 1015 (citing In re Silicon Graphics, Inc., Sec. Litig., 183 F.3d 970, 974 (9th Cir.1999)). Recklessness is defined as a highly unreasonable omission that involves an extreme departure from the standards of ordinary care rather than simple or even inexcusable negligence and that presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious the actor must have been aware of it. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 389 (9th Cir. 2002).

There is tension between the inferences the Court must make when considering a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) and the PSLRA's heightened pleading standard. As the court explained in In re Metawave Communications Corporation:

On one hand, the Court must accept all allegations of material fact as true and construe them in the light most favorable to the Plaintiff. However, in determining whether there has been a strong inference of scienter, the Court must consider "all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs." America West, 320 F.3d at 938 (quoting Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir.2002))(emphasis in original). These statements appear to be contradictory, but the tension can be resolved by accepting a plaintiffs' allegations as true and viewing them in the light most favorable to the plaintiff, except when determining whether scienter has been adequately pled, in which case the Court can draw inferences both favorable and unfavorable to the plaintiff. In re North Point Communications Group, Inc., Sec. Litig. ("North Point IF), 221 F.Supp.2d 1090, 1094 (N.D.Cal.2002) ... If the Court could not draw inferences unfavorable to the plaintiff in determining scienter, the PSLRA's strong inference requirement would be eviscerated, and Congress's basic purpose in enacting the PSLRA would be thwarted. Gompper, 298 F.3d at 896-97. The Court... can draw inferences both favorable and unfavorable to the plaintiff only when determining whether scienter has been adequately pled.

298 F.Supp.2d 1056, 1066 (W.D.Wa.2003)(emphasis added).

II. Plaintiffs' Rule 10b-5 and § 10(b) Claims

Plaintiffs allege Defendants knowingly or recklessly violated the Securities Exchange Act by issuing or causing to be issued financial statements that were materially false due to improper capitalization of payroll expenses and software-development costs and the failure to write down or write off inventory.

To support their allegations of scienter, Plaintiffs rely on (1) the statements of six confidential witnesses (CWs), (2) Sarbanes-Oxley (SOX) certifications, and (3) sales of Digimarc stock by the individual Defendants during the class period.

A. Confidential-Witness Statements

"Reliance on confidential witnesses is not per se improper under the PSLRA, notwithstanding its requirement that a plaintiff plead `all facts' when making allegations based on information and belief." In re Northpoint Commc'n Group, Inc., Sec. Litig., 221 F.Supp.2d 1090, 1097 (N.D.Cal.2002)(citing In re...