U.S. v. Goyal

• Decision Date: 10 December 2010
• Docket Number: No. 08-10436,08-10436
• Citation: 629 F.3d 912
• Parties: UNITED STATES of America, Plaintiff-Appellee, v. Prabhat GOYAL, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

629 F.3d 912

UNITED STATES of America, Plaintiff-Appellee,

v.Prabhat GOYAL, Defendant-Appellant.

No. 08-10436.

United States Court of Appeals,Ninth Circuit.

Argued and Submitted Jan. 12, 2010.

Filed Dec. 10, 2010.

Amber S. Rosen (argued), Brian Stretch, Elise Becker, Assistant United States Attorneys, San Jose, CA, for plaintiff-appellee United States of America.

Seth P. Waxman (argued), Jonathan E. Nuechterlein, Carey Bollinger, Wilmer Cutler Pickering Hale and Dorr LLP, Washington, D.C., and Mark C. Fleming, Wilmer Cutler Pickering Hale and Dorr LLP, Boston, MA, for defendant-appellant Prabhat Goyal.

Donald M. Falk, Mayer Brown LLP, Palo Alto, CA, for Amicus National Association of Criminal Defense Lawyers.

Appeal from the United States District Court for the Northern District of California, Martin J. Jenkins and Susan Illston, District Judges, Presiding. D.C. No. 3:04-cr-00201-SI.

Before: ALEX KOZINSKI, Chief Judge, J. CLIFFORD WALLACE and RICHARD R. CLIFTON, Circuit Judges.

OPINION

CLIFTON, Circuit Judge:

Prabhat Goyal, former chief financial officer of Network Associates, Inc. ("NAI"), appeals from his convictions on fifteen counts of securities fraud and making materially false statements to auditors. The government alleged that NAI, under Goyal's supervision, violated generally accepted accounting principles ("GAAP") by recognizing revenue from certain software sales earlier than it should have. Goyal was indicted for concealing the allegedly improper accounting from NAI's outside auditors and for filing reports with the Securities and Exchange Commission that, because of NAI's accounting, allegedly misstated revenue in certain reporting periods between 1998 and 2000. Goyal argues that no jury could have found him guilty beyond a reasonable doubt, as the jury below did, based on the evidence the prosecution presented at trial. We agree, and we reverse his convictions on all counts.

I. Background

From approximately 1997 to 2001, Goyal was chief financial officer of NAI. NAI, formerly known as McAfee, was and remains a major vendor of antivirus and network security software.

Before 1998, NAI used a "direct sales" business model, meaning that it primarily sold its software directly to end users. In 1998, the company added a "distribution channel" model, selling products through distribution companies. These distributors in turn sold NAI's software to retail stores that resold the software to end users.

The prosecution's case against Goyal challenged the accounting method that NAI used, under Goyal's supervision as CFO, to recognize revenue from sales to its largest domestic distributor, Ingram Micro. In particular, the government took issue with the accounting method NAI used to recognize large sales that it made to Ingram at the end of financial quarters between 1998 and 2000. Following a practice common in the software industry, which the government did not contend wasillegal, NAI negotiated significant quarter-end deals with Ingram, called "buy-in" transactions, to help meet its quarterly revenue projections. ¹ To close these sales, NAI granted Ingram substantial discounts, rebates, and other favorable sales terms. One enticement that NAI offered Ingram in the last two quarters of 1998 and the first quarter of 1999, was a guarantee that its wholly owned subsidiary, NetTools, would repurchase unsold product from Ingram in specified amounts. NetTools would then sell the repurchased product to customers.²

The government did not contend that any of the sales concessions that NAI gave Ingram in the buy-in deals were improper or that NAI claimed revenue that it never earned. Rather, the government objected to the timing of NAI's recognition of revenue from these deals. The government maintained that NAI violated GAAP by using "sell-in" accounting to recognize revenue from these deals earlier than it should have and thereby overstated its revenue. Under sell-in accounting, a manufacturer like NAI recognizes revenue when it ships products to its distributors (i.e., "sells in" to the distribution channel). The manufacturer must estimate the amount of future rebates, discounts or returns and then reduce its stated revenue by this amount.

By contrast, a company using "sell-through" accounting recognizes revenue when its distributors sell the product to a reseller (i.e., "sells through" the distribution channel). Sell-through accounting recognizes revenue later than sell-in accounting does and nets out rebates, discounts, and returns. Thus the manufacturer does not need to estimate their effect on its revenue.

The jury convicted Goyal of one count of securities fraud and seven counts of making false filings with the SEC (collectively, "the securities counts"), ³ and seven counts of making materially false statements to NAI's auditors at PricewaterhouseCoopers ("PwC") (the "lying-to-auditors counts"). ⁴

After Goyal's conviction, the district court denied his motions for judgment of acquittal and for a new trial. Goyal appealed.

II. Discussion

We review de novo the district court's denial of Goyal's Rule 29 motion for judgment of acquittal. See United States v. Mosley, 465 F.3d 412, 415 (9th Cir.2006). We must decide "whether 'after viewing the evidence in the light most favorable to the prosecution, any rational trier of fact could have found the essential elements of the crime[s] beyond a reasonable doubt.' " United States v. Nevils, 598 F.3d 1158, 1163-64 (9th Cir.2010) (en banc) (quoting Jackson v. Virginia, 443 U.S. 307, 319, 99 S.Ct. 2781, 61 L.Ed.2d 560 (1979)); see also McDaniel v. Brown, 558 U.S. ----, 130 S.Ct. 665, 673, 175 L.Ed.2d 582 (2010). We apply this standard to the securitiescounts and the lying-to-auditors counts in turn.

A. Securities Counts

All of the securities counts—one count of securities fraud and seven counts of making false filings with the SEC—required the government to prove that NAI materially misstated the revenue it earned in certain quarters and years through its choice of accounting method. NAI's reports of allegedly inflated revenue furnished the "untrue statement of material fact" required for each of the false filing counts, as well as the "misleading statement or omission of a material fact made with scienter" needed to sustain a fraud conviction under the general antifraud provision of § 10(b) of the Securities Exchange Act of 1934. United States v. Smith, 155 F.3d 1051, 1063 (9th Cir.1998) (internal quotation marks and numbering of elements omitted).

The government's contention that NAI materially overstated its revenue necessarily entailed two claims: (1) that NAI recognized revenue at a different time than it should have; and (2) that NAI's accounting produced artificially higher revenue figures in certain periods that "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). The government relied on GAAP to make its case, on the first point, that sell-through accounting was required in instances where NAI used the sell-in method. But we need not decide whether NAI actually violated GAAP, because the government clearly failed to carry its burden on the second point, materiality. The prosecution offered no evidence adequate to prove that any GAAP violations materially affected the revenue that NAI reported.

The government relied at trial on the parties' stipulations that applying sell-through accounting to NAI's entire business would have resulted in "a revenue figure that is materially less than the reported figure" for the periods charged in the false filing counts.⁵ These stipulations are fatally overbroad, however, because the government did not contend that GAAP required NAI to use sell-through accounting for all sales. The government only offered evidence that sell-through accounting was required for the Ingram buy-in transactions, and the stipulations did not provide that applying sell-through accounting to those transactions alone would have made a material difference in any given period. Without evidence of how much less revenue NAI would have recognized on the Ingram deals if it had used sell-through accounting, the jury had no basis to conclude that the misstatement of reported revenue resulting from the Ingram transactions was material. Even presuming, as we must, that the jury drew all reasonable inferences in the prosecution's favor, see Nevils, 598 F.3d at 1164, there was no way it could have properly inferred materiality from the evidence it had before it.

Confronted with this problem, the government argued after the verdict that the jury could have inferred materiality fromthe mere fact that the buy-in deals with Ingram were substantial. The dollar amounts in the purchase orders for these transactions, according to the government's calculations, "represented approximately 24% of the total revenue for NAI during 1998, 1999, and 2000" and "between approximately 7% to 40% of NAI's total revenue" on a quarterly basis. But this argument failed to bridge the materiality gap because Goyal's jury had to make the materiality findings that his convictions required, and it never saw these figures. See United States v. Rigas, 490 F.3d 208, 231 n. 29 (2d Cir.2007) (declining, in a sufficiency-of-the-evidence challenge, to "consider in the first instance arguments regarding materiality that were not presented to the jury").

The jury could not have inferred materiality from this evidence even if it had seen it, because it was not the absolute magnitude of the buy-in deals that mattered. The jury needed to assess whether NAI's use of sell-in accounting for the Ingram transactions materially increased NAI's overall revenue when compared to using sell-through accounting. But the jury had no evidentiary basis for making the required comparisons. There was simply no evidence that the effect of using sell-in rather than...