Booth v. Verity, Inc.

• Decision Date: 19 December 2000
• Docket Number: No. CIV. A. NO. 3:00-CV-83-H.,CIV. A. NO. 3:00-CV-83-H.
• Citation: 124 F.Supp.2d 452
• Parties: Lady Evelyn BOOTH, et al Plaintiffs v. VERITY, INC, et al. Defendants
• Court: U.S. District Court — Western District of Kentucky

124 F.Supp.2d 452

Lady Evelyn BOOTH, et al Plaintiffs v. VERITY, INC, et al. Defendants

No. CIV. A. NO. 3:00-CV-83-H.

United States District Court, W.D. Kentucky. at Louisville.

December 19, 2000.

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Robert A. Florio, Louisville, KY, for Plaintiffs.

Phillip W. Collier, Stites & Harbison, Louisville, KY, for Defendants.

MEMORANDUM OPINION

HEYBURN, District Judge.

This case is brought under the Kentucky Blue Sky laws. Plaintiffs are two individual citizens of Kentucky who at one time owned stock or stock options in Verity, Inc. ("Verity"), one of the Defendants. The other defendants are the eleven individual directors¹ of Verity ("Defendant Directors"). Plaintiffs assert that Defendants' optimistic statements to market analysts, combined with their failure to warn investors that revenues would fall short of analysts' projections, fraudulently induced Plaintiffs to purchase Verity securities at inflated prices.

All Defendants have now moved to dismiss the complaint. The Defendant Directors say that this Court is without personal jurisdiction, while Defendant Verity argues that Plaintiffs have not pled their case with sufficient particularity. The Court will discuss each issue in turn.

I.

Plaintiffs Lady Evelyn Booth ("Booth") and David Austin Wise ("Wise") purchased shares and options in Verity between December 1, 1999 and December 14, 1999. At one time Booth held 4,930 shares purchased at prices ranging between $50.00 and $587/16 per share and Wise held three option contracts on Verity stock purchased at $10¾ per share. On December 14, 1999 Verity's stock fell 46% after the Company announced quarterly earnings would belower than expected. By December 15, 1999 Verity's share price declined as low as $23.88. Because of this dramatic decline Booth, facing a margin call, was forced to close out her Verity positions and Wise could not exercise his options. Plaintiffs allege that the high price at which they bought their shares and the low price which forced Booth to sell her shares and prevented Wise from exercising his options was caused by the fraudulent statements and material omissions of Verity and the Defendant Directors.

Verity is a publicly traded corporation listed with NASDAQ (National Association of Securities Dealers Automatic Quotation System). Its principle business is the development, marketing, and support of "knowledge retrieval software." A large portion of Verity's revenue comes from a small number of contracts such that the company's quarterly revenue and Estimated Price per Share ("EPS") estimates are highly sensitive to news about the company's ability, or lack thereof, to close certain large contracts.

The Individual Defendants are senior executives and/or directors of Verity. Plaintiffs allege that the Individual Defendants possessed the power and authority to control the contents of Verity's presentation to securities analysts and the general market. Further, these defendants had access to material non-public information concerning Verity's business prospects which was willfully concealed from Plaintiffs and the general public.

The complaint alleges that Verity engaged in a series of statements and omissions that, taken together, constitute fraud. Beginning on September 15, 1999, Verity announced extraordinary earnings results of $19.8 million for its first fiscal quarter of 1999 ("1FQ"), a 50% increase over the same period from the previous year. Plaintiffs attributed these earnings to the success of several large contracts with major corporations. Plaintiffs contend that this news and the enthusiastic, sincere manner in which the Company presented it, caused the stock price to rise from the $15 to $20 per share range at which it had traded during the first nine months of 1999 to around $40.00 per share by November, 1999.

In early October, 1999 the financial press reported that Verity was negotiating three large contracts. Plaintiffs assert that "Verity senior management" made "several false and misleading statements" and omitted material facts related to these contracts and the Company's business prospects. In general terms, the complaint alleges that the Company disseminated information to analysts which "over stated assessments of Verity's future business prospects, stated that Verity had, in fact, closed contracts it had not closed, and that Verity would report a 2FQ earnings figure in line with analyst expectations." Notwithstanding these statements, the Company was "well aware" that analyst EPS expectations were more than 50% higher than they actually could be by the close of 2FQ on November 30, 1999, and that these false EPS estimates were widely reported and relied on by the market.

The complaint specifically quotes an S.G. Cowen Securities report by analyst Drew Brosseau, dated November 12, 1999 and "based on conversations with Verity management," as an example of the sort of news reported at that time:

[W]ith about 3 weeks left, Q2 (November) is shaping up well. Business closings through the first two months were on track and the pipeline of business in running well ahead of what's needed to make our estimates of $21.MM (+ 41%) in revenues and [$.11] (vs.[$.06]) in EPS.

This sort of report led to a "general consensus among financial analysts that Verity would hit QF2 earnings." Verity's 2FQ ended on November 30, 1999 with no warning regarding the company's earnings shortfall for that quarter. On three previous occasions the Company preannounced shortfalls in quarterly earnings expectations.

In fact, Defendants encouraged bullish market expectations when Defendants Sbona and Bettencourt spoke to "market participants" stating, inter alia, that: "(1) Verity continued to dominate its category; (2) Verity had been strong during QF2; (3) Verity was on track to have over $90 million in revenues in F00." Later, on December 7, 1999 Verity management advised Jason Maynard of the Seidler Companies of earnings forecasts for F00 and F01 of $.49 and $.64, respectively which indicated a 35% EPS growth rate. Specifically, this report forecast EPS 2FQ at $.12 which turned out to be off by nearly $.08. Since Verity's 2FQ for F00 had already closed on November 30, 1999, this report concealed revenue and EPS shortfalls Verity had already suffered for 2FQ, 2000.

Verity disclosed its actual 2FQ earnings on December 14, 1999 in a press release:

"Verity Inc. (Nasdaq: VRTY), a leading provider of enterprise and Internet knowledge retrieval solutions, today reported financial results for its second fiscal quarter ended November 30, 1999.

* * * * * *

...[T]his quarter's revenue performance was lower than Verity expected due to a delay in closing three large transactions, rather than a lessening in demand for Verity's products or services. Two of the three transactions that did not close have now been closed. Verity is still aggressively working, and expects to close, the third transaction."

In a conference call following this press release Defendant Sbona stated:

"Clearly, as we had stated and the facts remain, it was the best interest for shareholder value rather than come out and have a preannouncement saying that we in fact...anticipate missing our projected revenue. We thought that within a matter of just a few days we could get one firm absolute audited numbers that we could talk in terms of, not just the revenue, preliminary revenue projections, but also the financial performance, as well as having the status of where those deals were. That would give people a far better view of what the value of Verity was, rather than the thing whip-sawed back and forth based on speculation."

Based upon these facts, Plaintiffs allege two causes of action against Defendant Directors and one against Verity. The first cause of action, asserted only against Defendant Directors, alleges breach of fiduciary duty by disseminating false information and failing to mention certain facts, all of which fraudulently misled Plaintiffs. The second cause of action alleges that all Defendants violated two provisions of Kentucky's Blue Sky law, KRS § 292.320 and § 292.480.

II.

Before considering Defendants' substantive arguments, this Court must determine whether it has jurisdiction as to the individual Defendant Directors. See Burnham v. Superior Court, 495 U.S. 604, 608-09, 110 S.Ct. 2105, 109 L.Ed.2d 631 (1990). Because jurisdiction in this case is based on diversity of citizenship, this Court must apply Kentucky law. Stalbosky v. Belew, 205 F.3d 890 (6th Cir.2000); Erie R.R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938).

In these circumstances, this Court has three options: decide the motion solely by the parties' affidavits; permit discovery in aid of deciding the motion; or conduct an evidentiary hearing to resolve any apparent factual questions. See Theunissen v. Matthews, 935 F.2d 1454, 1458 (6th Cir.1991). The choice is left to this Court's discretion. Id. Plaintiffs bear the burden of establishing jurisdiction and, confronted by a properly supported motion to dismiss, they may not rely on pleadings alone but must, "by affidavit or otherwise, set forth specific facts showing that the court has jurisdiction." Id., (citing Weller v. Cromwell Oil Co., 504 F.2d 927, 930 (6th Cir.1974)). "Where a court relies solely on the parties' affidavits to reach its decision, the plaintiff must make only a prima facie showing that personal jurisdiction exists in order to defeat dismissal." Id. A court must view the plaintiff's allegations in the light most favorable to the plaintiff and cannot consider defendant's statements contradicting these allegations. See Id. at 1462; CompuServe v. Patterson 89 F.3d 1257, 1262 (6th Cir.1996). Where there is no reasonable basis to expect that further discovery would reveal contacts sufficient to support personal jurisdiction it is not an abuse of discretion to deny discovery. Chrysler Corp. v. Fedders...