Berson v. Applied Signal Technology, Inc.

• Decision Date: 05 June 2008
• Docket Number: No. 06-15454.,06-15454.
• Citation: 527 F.3d 982
• Parties: Brent BERSON, individually and on behalf of all others similarly situated, Plaintiff, and Frank Whiting, Plaintiff-Appellant, v. APPLIED SIGNAL TECHNOLOGY, INC.; Gary Yancey; James Doyle, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

527 F.3d 982

Brent BERSON, individually and on behalf of all others similarly situated, Plaintiff, and Frank Whiting, Plaintiff-Appellant, v. APPLIED SIGNAL TECHNOLOGY, INC.; Gary Yancey; James Doyle, Defendants-Appellees.

No. 06-15454.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 6, 2007.

Filed June 5, 2008.

Mark Kindall, Andrew M. Schatz and Jeffrey S. Nobel, Schatz & Nobel, P.C., Hartford, CT; Alan R. Plutzik, Kathryn Scholfield, Bramson, Plutzik, Mahler & Birkhaeuser, LLP, Walnut Creek, CA, for the plaintiff-appellant.

David Priebe, DLA Piper Rudnick Gray Cary U.S. LLP, East Palo Alto, CA; Shirli Fabbri Weiss, DLA Piper Rudnick Gray Cary U.S. LLP, San Diego, CA; and Kathryn E. Karcher, DLA Piper Rudnick

Gray Cary U.S. LLP, Seattle, WA, for the defendants-appellees.

Appeal from the United States District Court for the Northern District of California; Saundra B. Armstrong, District Judge, Presiding. D.C. No. CV-05-01027-SBA.

Before: ALEX KOZINSKI, Chief Judge, ROBERT E. COWEN,^* and HAWKINS, Circuit Judges.

KOZINSKI, Chief Judge:

We consider whether plaintiffs adequately pled a claim of securities fraud — something that is much harder now than in days gone by.

Facts

Plaintiffs bought stock in Applied Signal Technology, Inc., during the six months before the company revealed that its revenue had fallen 25% from the preceding quarter. Immediately following this disclosure, the stock price dropped 16%. Plaintiffs sued the company and two of its officers under Securities Exchange Act § 10(b), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5.

Applied Signal's customers are almost all agencies of the federal government. Two civilian agencies together account for 80% of the company's revenue; military agencies account for most of the rest. According to plaintiffs, these government customers can, at any time and for any reason, order the company to stop working on existing contracts for up to 90 days. Compl. ¶ 26; see 48 C.F.R. § 52.242-15(a) (model contract provision); id. § 42.1305(b)(1) (agencies "may" use this provision). The company only gets paid for work it actually performs, so when the government issues a "stop-work order," Applied Signal immediately ceases to earn money. And, because stopped work often is eventually cancelled altogether, a stop-work order signals a heightened risk that the company never will earn the money. See Compl. ¶ 26; 48 C.F.R. § 52.242-15(a) (after issuing a stop-work order, agencies may unilaterally modify or cancel the contract). According to plaintiffs, the precipitous drop in Applied Signal's revenue was caused by four stop-work orders the company received, which halted tens of millions of dollars of work it had contracted to do. Investors were surprised by the drop in revenue, plaintiffs claim, because Applied Signal continued to count the stopped work as part of its "backlog"—a term the company defines as the dollar value of the work it has contracted to do but hasn't yet performed. Plaintiffs claim that the company's backlog reports misled them into believing that Applied Signal was likely to perform work that, in reality, had been halted and was likely to be lost forever.

The district court dismissed the complaint on several grounds and plaintiffs, naturally, appeal.

Analysis

We first consider whether plaintiffs have pled with sufficient particularity the existence, content and effect of the stop-work orders. We then discuss whether defendants' alleged practice of counting stopped work as backlog was misleading, before weighing plaintiffs' allegations of scienter and loss causation. Finally, we ponder whether the backlog reports are immune from liability as "forward-looking" statements.

1. Fed.R.Civ.P. 9(b) and the requirement of particularity

Defendants claim that plaintiffs haven't alleged sufficient facts to show that the company ever received three of the four stop-work orders, or that these orders halted any work that was later reported as backlog, and that plaintiffs therefore haven't pled with "particularity" the "reasons" why the backlog figures were misleading. 15 U.S.C. § 78u-4(b)(1); Fed. R.Civ.P. 9(b).

But the complaint identifies four confidential witnesses who worked for Applied Signal and who allegedly will testify to the existence and effect of the stop-work orders. Defendants quibble that these witnesses weren't in a position to see the stop-work orders first-hand because they were "engineers or technical editors" rather than managers. But any number of company employees would be in a position to infer the issuance of stop-work orders, which would have had the very obvious effect of putting numerous employees out of work. It's entirely plausible that "engineers or technical editors" would know, or could reasonably deduce, that the company had suffered such setbacks. See In re Daou Sys., Inc., 411 F.3d 1006, 1015-16 (9th Cir.2005) (complaint described confidential witnesses "with sufficient particularity to support the probability" that they knew about the fraud).

The complaint also alleges with particularity that defendants counted stopped work as backlog. Defendants admitted as much in two conference calls with analysts (transcripts of which were included in the company's SEC filings). See pp. 986-97 infra. And the complaint alleges that the stop-work orders were still in effect when defendants touted the company's backlog; defendants' arguments to the contrary simply misread the complaint.¹ Defendants suggest that the stop-work orders may have expired (and work may have resumed) before they announced the backlog, and they speculate that two of the orders may have actually been "renewals" of an earlier order. But plaintiffs' confidential witnesses suggest otherwise, so these disputes must at least await discovery.

2. Ruminations on "misleading"

Defendants argue that, even if they did count stopped work as backlog, this couldn't have misled reasonable investors, who would have understood that this was just what defendants were doing. See Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th Cir.2002) (a statement is misleading if it would give a reasonable investor the "impression of a state of affairs that differs in a material way from the one that actually exists"). Reasonable investors, defendants claim, would grasp that stopped work was included in backlog upon reading the following paragraph in the company's SEC filings:

Our backlog . . . consists of anticipated revenues from the uncompleted portions of existing contracts . . . . Anticipated revenues included in backlog may be realized over a multi-year period. We include a contract in backlog when the contract is signed by us and by our customer. We believe the backlog figures are firm, subject only to the cancellation and modification provisions contained in our contracts.... Because of possible future changes in delivery schedules and cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. We may experience significant contract cancellations that were previously booked and included in backlog.

(Emphasis added.) According to defendants, reasonable investors would interpret the underlined phrase to mean that backlog includes stopped work: Because a stop-work order doesn't actually cancel the contract, the contract continues to "exist[ ]"; and because stopped work is perforce "uncompleted," it still counts as backlog, even though Applied Signal may never get to complete it.

While this is a conceivable interpretation of this paragraph, it is hardly the only—or even the most plausible—one. It is just as likely that investors would interpret the underlined phrase as limited to work still in progress or work yet to be started on ongoing contracts. And, though the paragraph refers to customers' rights to "cancel[]" or "modif[y]" existing contracts, it says nothing about the right to simply stop work and thus immediately interrupt the company's revenue stream. The passage, moreover, speaks entirely of as-yet-unrealized risks and contingencies. Nothing alerts the reader that some of these risks may already have come to fruition, and that what the company refers to as backlog includes work that is substantially delayed and at serious risk of being cancelled altogether.

In ruling otherwise, the district court thought it significant that in a conference call with analysts,² one defendant hinted that stopped work counted as backlog. (As discussed above, see p. 985 supra, this conversation supports plaintiffs' allegation that Applied Signal did count stopped work as backlog.) The brief exchange went as follows:

Q. [O]ne more question for you . . . please. Does the $143 million [of backlog] include—is that net of any potential debooking?

A. That includes the $12 million that has not been debooked.

Q. So it's not net of any potential debooking? Includes?

A. That's right.

With the benefit of hindsight and some help from the briefs,³ we can see how this exchange might be interpreted to communicate that defendants counted stopped work as backlog. The $12 million figure matches the amount of work halted by the first stop-work order (which the company had disclosed some three months earlier) and the company representative (who was one of the two individual defendants) admits that backlog still "[i]ncludes" this stopped work. But it's far from clear that a reasonable investor could have decoded this meaning at the time. Neither speaker made clear what $12 million was being referred to, nor said anything about stop-work orders, nor explained what the words "debook" and "potential debooking" mean. Absent undisputed evidence that these were terms of art that investors would have understood to refer to stop-work orders, we cannot find, as a matter of law, that defendants...