In re Microstrategy, Inc. Securities Litigation

Decision Date15 September 2000
Docket NumberNo. Civ.A. 00-473-A.,Civ.A. 00-473-A.
Citation115 F.Supp.2d 620
PartiesIn re MICROSTRATEGY, INC. SECURITIES LITIGATION.
CourtU.S. District Court — Eastern District of Virginia

Craig C. Reilly, Alexandria, VA, for plaintiffs.

Brendan V. Sullivan, Jr., Williams & Connolly, Washington, D.C., for defendant Microstrategy.

Leo S. Fisher, Bean, Kinney & Korman, P.C., Arlington, VA, for defendant Price-waterhouseCoopers.

MEMORANDUM OPINION

ELLIS, District Judge.

The central question presented in these threshold dismissal motions in this securities fraud class action is the unresolved question of the meaning to be given to the state-of-mind pleading requirements of the Private Securities Litigation Reform Act of 1995 ("PSLRA" or the "Act"). Specifically at issue are the meaning of the PSLRA's requirement that a complaint in a securities fraud action must allege sufficient facts giving rise to a "strong inference" of scienter and whether the Consolidated Amended Class Action Complaint ("Complaint") in this case meets that standard. Also at issue are questions as to (i) the materiality of the Complaint's allegations; (ii) whether a plaintiff must allege facts showing "culpable participation" on a defendant's part to state a claim for secondary "control group" liability under Section 20(a) of the Exchange Act; and (iii) the meaning of the contemporaneity requirement of Section 20A of the Exchange Act for insider trading liability.

I. FACTUAL BACKGROUND

This securities class action1 is brought by, and on behalf of, investors in securities of MicroStrategy between June 11, 1998 and March 20, 2000 (the "Class Period"), asserting claims against Defendant MicroStrategy, Inc. ("MicroStrategy" or the "Company"); Defendants Michael Saylor, Sanju Bansal, Mark S. Lynch, Stephen S. Trundle, Ralph Terkowitz, and Frank A. Ingari (collectively "the Individual Defendants" and, along with MicroStrategy, the "MicroStrategy Defendants"); and Defendant PricewaterhouseCoopers ("PwC") under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 (the "Exchange Act"), as amended by the PSLRA, and under Rule 10b-5 promulgated thereunder. 15 U.S.C. §§ 78j(b), 78t(a), 78t-1; 17 C.F.R. § 240.10b-5.

Plaintiffs allege that on June 11, 1998, when MicroStrategy announced its Initial Public Offering ("IPO") of 4,000,000 shares of common stock, Defendants knowingly and purposefully, or recklessly, implemented and executed throughout the Class Period a "massive fraud on the investing public" in the form of a scheme artificially to distort the price of MicroStrategy securities. Allegedly at the heart of this fraudulent undertaking was the repeated inflation of revenues and earnings for the Company, which was accomplished through the improper recognition of revenues from software licensing and servicing contracts in violation of Generally Accepted Accounting Principles ("GAAP") and declared MicroStrategy accounting policies.2 (Complaint ¶ 2.)3 As a result, the MicroStrategy Defendants — with the consent and cooperation of PwC, the Company's auditor — presented investors with a false and misleading picture of MicroStrategy's financial condition and apparent growth. The allegations in the Amended Complaint ("Complaint") and public documents relied on by, and integral to, the Complaint further disclose the following about the MicroStrategy Defendants and PwC, respectively.4

MicroStrategy was founded in 1989 and is a developer and marketer of "e-business" software and related services that facilitate the transaction of business through electronic and wireless media. MicroStrategy software allows companies to retrieve raw data and to turn that data into useful information. The Company also provides, inter alia, installation, maintenance, and consultation services to its clients. (¶ 25.a.) Since its inception, MicroStrategy's business has evolved from a focus on stand-alone software license and maintenance components to the provision of "multiple software products and services for use by the customers and very large numbers of customers' end users, ... often involv[ing] significant implementation and other consulting work which extend[] over periods of time." This evolution of the Company's business has allowed MicroStrategy to receive revenues from multiple sources, including product license fees, product support fees, and royalties from various sources. (¶ 25.b.)

The Individual Defendants are, and during the Class Period were, senior executives and/or directors of MicroStrategy: Defendant Saylor, a co-founder of MicroStrategy, was the President and Chief Executive Officer of the Company; Defendant Bansal was the Executive Vice President and Chief Operating Officer; Defendant Lynch was the Vice President, Finance, Chief Financial Officer, and Principal Financial and Accounting Officer of MicroStrategy; Defendant Trundle was the Senior Vice President of MicroStrategy, Technology; and Defendants Terkowitz and Ingari were Directors of MicroStrategy and members of MicroStrategy's Audit Committee. (¶ 20.) These Defendants allegedly prepared, reviewed, executed, and/or disseminated, and thereby controlled the content of, the Company's filings with the Securities and Exchange Commission ("SEC"), press releases, and other public representations. (¶¶ 21(a)-(f).) By virtue of their positions, the Individual Defendants also allegedly had access to material, adverse nonpublic information regarding MicroStrategy's sales transactions, revenue recognition, and financial condition. (Complaint ¶ 111.)

The Complaint alleges that, throughout the Class Period, Defendants materially misrepresented MicroStrategy's revenues and earnings in violation of GAAP. Plaintiffs point to the Company's press releases and SEC filings concerning revenues and earnings for fiscal years 1997, 1998, and 1999 and for seven of eight interim quarters in 1998 and 1999, and to statements by Defendant Saylor that routinely highlighted "increased revenues" over consecutive periods, as providing MicroStrategy investors with the false impression that the Company's earnings and revenues were consistently increasing throughout the Class Period when, in fact, they were not. Plaintiffs also point out that, during the Class Period, MicroStrategy purportedly recognized and reported its earnings and revenues in conformance with the strictures of GAAP and the Company's declared revenue recognition policies, which stated, for example, that "[p]roduct license revenues are generally recognized upon the execution of a contract and shipment of a related software product, provided that no significant vendor obligations remain outstanding and the resulting receivable is deemed collectible by management." (¶ 27.) But, according to the Complaint, MicroStrategy's statements did not accurately portray the Company's financial status, and — contrary to the representations and filings made by the Defendants — the statements did not conform with either GAAP or MicroStrategy's own revenue recognition policies:

MicroStrategy reported increasing revenues and earnings which were achieved primarily by improperly recognizing revenues on purported contracts prior to agreements being finalized and/or when the agreements were subject to significant contingencies or yet-to-be-fulfilled obligations by the Company. Such practices violated [GAAP].

(¶ 6.)

During this period, MicroStrategy's stock—the initial offering price for which was $12 per share in June 1998—rose significantly in price, reaching a Class Period high of $313 in March 2000. (¶¶ 9, 26.) Moreover, each of the Individual Defendants during this period made private sales of stock, with aggregate proceeds of more than $90 million, and MicroStrategy and certain of the Individual Defendants, through various public offerings of MicroStrategy stock, received, in the aggregate, proceeds in excess of $80 million. (¶¶ 26, 40.) Furthermore, the Company announced on February 24, 2000, its intention to sell 6.5 million shares of stock, including 1.6 million shares owned by Defendant Saylor, in an effort to raise nearly $1 billion. (¶ 53.)

On March 6, 2000, Forbes magazine published an article questioning the timing of MicroStrategy's recognition of revenues on three contracts. The article pointed out that these contracts were not announced until after certain quarters had closed, but that the contracts were treated as if completed during those quarters. (¶ 55.) Then, on Monday, March 20, 2000, MicroStrategy announced that it would have to restate two years of its previously reported financial reports. By the end of that day, the price of MicroStrategy stock had fallen to $86.75, having closed at $226.75 on Friday, March 17, 2000. (¶ 14, 58.)

On April 13, 2000, the Company filed its SEC Form 10-K for the year ending on December 31, 1999. In this filing, MicroStrategy formally restated its previously reported revenues and earnings for the years ending on December 31, 1998, and December 31, 1999. On April 13, MicroStrategy also announced its intention to restate and adjust downward its reported revenues for the year ending on December 31, 1997. Then, on May 30, 2000, the Company filed its Amended Form 10-Q/As for the second and third quarters of 1999. These filings contained restated financials for years 1997 through 1999. These restatements revealed the extent of the discrepancy between MicroStrategy's previously reported financial figures and the actual ones.5 Specifically, the Complaint alleges that:

• MicroStrategy reported revenues of $23.8 million for the second quarter of 1998. These revenues constituted a 100% increase over the same quarter in the previous year. The Company also reported net income of $942,000, or $0.03 per share — a 672% increase over the same quarter in the previous year. The subsequent restatement revealed that the reported net income of $942,000 should have been reported as a net loss of $1.1 million, and that the...

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