Guttman v. Huang

Decision Date05 May 2003
Docket NumberC.A. No. 19571-NC.
Citation823 A.2d 492
PartiesJosh GUTTMAN, Plaintiff, v. Jen-Hsun HUANG, Tench Coxe, James C. Gaither, Harvey C. Jones, William J. Miller, A. Brooke Seawell, Mark A. Stevens, Chris A. Malachowsky, Christine B. Hoberg, and Jeffrey Fisher, Defendants, and NVIDIA Corporation, a Delaware Corporation, Nominal Defendant.
CourtCourt of Chancery of Delaware

Joseph A. Rosenthal, Herbert W. Mondros, Rosenthal Monhait Gross & Goddess, P.A., Wilmington, Delaware; Peter Bull, Bull & Lifshitz, LLP, New York, New York, for Plaintiff.

Gregory V. Varallo, Kelly A. Green, Richards, Layton & Finger, P.A., Wilmington, Delaware; Michael D. Torpey, James N. Kramer, Penelope A. Graboys, Jonathan Gaskin, Christopher A. Garcia, Clifford Chance U.S. LLP, San Francisco, California; David M. Shannon, Stephen Pettigrew, Nvidia Corporation, Santa Carla, California, for Defendants.

OPINION

STRINE, Vice Chancellor.

In this case, the plaintiffs bring a derivative action on behalf of NVIDIA Corporation, a technology firm. They allege that the defendants — all NVIDIA directors and/or officers — either sold stock at a time when they knew material, non-public information about the company and/or are culpable for failing to prevent accounting irregularities that caused the company to restate its financial statements for the period during which the stock sales took place. The plaintiffs seek relief for NVIDIA for harm relating to this supposed malfeasance and nonfeasance.

The defendants have moved for dismissal for failure to make a demand under Court of Chancery Rule 23.1. In support of that contention, they point to the conclusory allegations of the amended complaint1 as being insufficient to cast a doubt on the impartiality of NVIDIA's majority independent board.

In this opinion, I conclude that the defendants' motion must be granted. Having failed to heed the numerous admonitions by our judiciary for derivative plaintiffs to obtain books and records before filing a complaint, the plaintiffs have unsurprisingly submitted an amended complaint that lacks particularized facts compromising the impartiality of the NVIDIA board that would have acted on a demand. When the case most cries out for the pleading of real facts — e.g., about the board's knowledge of the accounting problems at the company or the company's audit committee process — the complaint is at its most cursory, substituting conclusory allegations for concrete assertions of fact.

I. Facts

The following recitation of facts is drawn entirely from the amended complaint filed by the plaintiffs. That complaint is quite lengthy and contains substantial excerpts from NVIDIA financial statements and press releases. The bulk of the complaint, however, is misleading because in many materially consequential ways the complaint is wholly conclusory, if not entirely silent.

A. The Company

NVIDIA makes and markets three-dimensional ("3D") graphics processors and related software. Its customers are other technology companies that incorporate NVIDIA products and software into their own computer products — e.g., "mother-boards" — which are, in turn, sold to other downstream industry members — e.g., personal computer manufacturers.

NVIDIA went public in January 1999 and its stock is listed on the NASDAQ. As of the time it went public, the company had not achieved profitability. In 2000, NVIDIA raised $400 million in additional capital by way of a secondary offering of debt and common stock.

B. The Essence of the Plaintiffs' Claims

The plaintiffs allege that the defendants engaged in a variety of misconduct related to NVIDIA's failure to accurately account for and disclose its financial results for the period from February 15, 2000 to July 30, 2002 — what I shall call the "Contested Period." During the Contested Period, NVIDIA allegedly released bullish disclosures regarding its results and future prospects.

These optimistic statements were, the plaintiffs contend, materially misleading because they were premised on improper accounting. According to them, NVIDIA "used `cookie jar' reserves (bad debt, sales returns, and account[s] payable) to even out earnings in bad times, used `back-in' accounting to ensure that forecasted margins were achieved and managed profit margins by manipulating shipments at the end of quarters."2 The plaintiffs contend that this conduct was intended to inflate NVIDIA's stock price.

Also during the Contested Period, the defendants as a class sold $194.6 million in company stock at diverse times. Four of the defendants were responsible for over $157 million of this sum:

Defendant Jen-Hsun Huang sold almost 1.2 million shares, reaping proceeds of over $50 million. Huang is a co-founder of NVIDIA, and has been the company's President, Chief Executive Officer and a director at all relevant times.
Defendant Christine B. Hoberg was NVIDIA's Chief Financial Officer from December 1998 until April 29, 2002. She sold $22.3 million worth of stock during the Contested Period.
Defendant Jeffrey Fisher has been, at all relevant times, NVIDIA's Vice President of Worldwide Sales. During the Contested Period, Fisher sold $36.3 million worth of NVIDIA stock.
Defendant Chris A. Malachowsky, at all relevant times, has been NVIDIA's Vice President of Hardware Engineering. Malachowsky co-founded the company with Huang. During the Contested Period, he sold $48.6 million in company shares.

Although the bulk of the disputed sales resulted from these sales by NVIDIA managers — only one of whom, defendant Huang, was on the NVIDIA board — the plaintiffs have also pointed to large sales during the Contested Period by the following defendants, all of whom are members of the NVIDIA board:

Defendant Tench Coxe sold 160,000 shares of NVIDIA stock on November 27, 2001, yielding proceeds of over $8.6 million. Coxe is a managing director of Sutter Hill Ventures, a venture capital firm.
Defendant James C. Gaither sold 19,804 NVIDIA shares on November 14, 2001, reaping proceeds of over $472,000. Like Coxe, Gaither is a managing director of Sutter Hill. Gaither is also senior counsel and former partner of Cooley Godward LLP, a law firm that was brought in to help NVIDIA's audit committee address SEC concerns regarding its financial statements during the Contested Period.
Defendant Harvey C. Jones sold 90,000 shares of NVIDIA stock on December 5, 2001 for over $5.5 million. Jones is Chairman of a privately held microprocessing design and licensing firm that he co-founded.
Defendant William J. Miller sold a total of 150,000 shares in March and December of 2001, yielding proceeds of over $9.7 million. When the SEC began investigating NVIDIA's financial statements for the Contested Period, Miller allegedly became head of the internal audit committee NVIDIA formed to address those issues.
Defendant A. Brooke Seawell engaged in sales of 105,000 shares of NVIDIA stock during three months of the Contested Period — September, November, and December of 2001 — yielding over $5.6 million. Aside from a brief tenure as NVIDIA's interim CFO during FY 1999, Seawell has primarily made his living outside NVIDIA. Since February 2000, Seawell has been a general partner of Technology Cross-over Ventures.
Defendant Mark A. Stevens sold 112,500 NVIDIA shares during March 2001 in return for nearly $7.2 million. Stevens is a managing member of Sequoia Capital, a venture capital firm.

According to the plaintiffs, at some point in 2001, the SEC commenced an investigation into NVIDIA's accounting practices during the Contested Period. In February 2002, the company announced that it was conducting an internal review of its financial statements for the Contested Period in response to the SEC inquiry. After this disclosure, NVIDIA's stock price dropped significantly.

On April 29, 2002, the internal review resulted in a restatement of the company's financial results for the first three quarters of fiscal year ("FY") 2002, and for FY 2001 and 2000. NVIDIA's CFO, defendant Hoberg, resigned that same day.

Unhelpfully, the complaint fails to detail specifically the net result of these restatements. Of course, the very fact that the financials were restated suggests that the original filings for those periods were materially deficient. Still, as we shall see later, the plaintiffs' omission was no doubt tactical, leaving the court without a way to assess the magnitude of the corrections.

Allegedly, during the same time frame the company was reacting to the SEC's inquiry, NVIDIA continued to provide bullish reports regarding its prospects for calendar year 2002 (i.e., NVIDIA's FY 2003), despite adverse news reports and the filing of a lawsuit against the company by a former accounting manager, claiming, among other things, that NVIDIA's accounting practices were improper in the following respects:

A. [NVIDIA used its] returns reserve policy as a way of creating a "slush" fund to use to manage gross margin in times when actual revenues were too low or actual expenses were too high to meet targeted gross operating margin requirements. There was no consistent articulated returns reserve policy.
B. All accounting was done in a back-in fashion. Proper accounting procedures would have the compilation of revenue and expenses done first and have these actual figures be used in the computation of gross margin. NVIDIA used a targeted gross margin number and then worked backward to achieve that by creating revenue and expense calculations necessary to achieve the forecasted margin which were not reflective of the actual transactions or results that occurred. Examples would include stopping shipments before the end of a quarter to prevent revenue from being too high and using a nearly-fictional returns reserve to manage expenses as needed. The end result was that quarterly results of NVIDIA reported to the public and the Securities and Exchange Commission
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