In re Number Nine Visual Technology Corp.

• Decision Date: 01 June 1999
• Docket Number: No. CIV. A. 96-11207-WGY.,CIV. A. 96-11207-WGY.
• Citation: 51 F.Supp.2d 1
• Parties: In re NUMBER NINE VISUAL TECHNOLOGY CORP. SECURITIES LITIGATION.
• Court: U.S. District Court — District of Massachusetts

Page 1

51 F.Supp.2d 1

In re NUMBER NINE VISUAL TECHNOLOGY CORP. SECURITIES LITIGATION.

No. CIV. A. 96-11207-WGY.

United States District Court, D. Massachusetts.

June 1, 1999.

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Thomas R. Murtagh, John Sylvia, Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, P.C., Boston, for John J. Foley, Consolidated Plaintiffs.

Thomas R. Murtagh, John Sylvia, Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, P.C., James W. Prendegrast, Jeffrey B. Rudman, Hale & Dorr, Brian E. Pastuszenski, Christine A.S. Chung, Testa, Hurwitz & Thibeault, Boston, for Andrew Najda, Stanley W. Bialek, Number Nine Visual Technology Corporation, Cowen & Co., Unterberg Harris, Robertson, Stephens & Co., Defendants.

MEMORANDUM AND ORDER

YOUNG, Chief Judge.

Remember when we were One Ls? How the civil procedure professors extolled the virtues of notice pleading? See, e.g., Jack H. Friedenthal, Mary Kay Kane & Arthur R. Miller, Civil Procedure § 5.7, at 253 (2d ed.1993). This case writes a sad (and overlong) epitaph to that era. Who could have expected that, in little over half a century, society would become so chary of dealing with cases on the merits that the law, like some ancient amphibian, would begin to slip back into the primeval ooze of common law forms of pleading?

I. Introduction

This securities class action is brought on behalf of all persons who purchased shares of common stock of the defendant Number Nine Visual Technology Corp. ("Number Nine") in or traceable to Number Nine's initial public offering (the "Offering") of May 26, 1995, and all persons who purchased or otherwise acquired shares of Number Nine common stock between May 26, 1995 and January 31, 1996 (collectively, the "Class").¹ The defendants (collectively, the "Defendants") in this action are (1) Number Nine, (2) a group of individuals who were principals in Number Nine (the "Insiders"), (3) a group of individuals who served as outside directors on the board of directors of Number Nine (the "Outsiders"), and (4) Robertson, Stephens & Co., Cowen & Co., and Unterberg Harris (collectively, the "Underwriters"). Two principal claims are brought in the Consolidated Class Action Complaint (the "Complaint"). First, the Class has alleged that the Defendants violated Section 11 of the Securities Act of 1933 ("the Securities Act") through misrepresentations and omissions contained in the Prospectus for the Offering (the "Prospectus").² Second, the Class charges that Number Nine and the Insiders, through certain misrepresentations and omissions, violated Section 10(b) of the Securities Exchange Act of 1934 ("the Exchange Act"), and Rule 10b-5 promulgated thereunder by the Securities Exchange Commission.³

Each defendant has moved to dismiss all claims brought against it. Although the Securities Act claims and the Exchange Act claims primarily rely on the same factual allegations, they are subject to different pleading standards. Moreover, even within the Securities Act claims, different allegations are subject to different standards under controlling First Circuit precedent. Thus, this Memorandum engages in detailed and seemingly repetitive analysis, and also renders seemingly conflicting rulings. Specifically, the Court GRANTS the motions to dismiss the claims under Sections 11 and 15 of the Securities Act insofar as those claims rely on factual allegations other than Number Nine's inability to obtain memory supplies at the time of the Offering. The Court further GRANTS the motions to dismiss the claims under Section 10(b) and 20(a) of the Exchange Act insofar as those claims rely on factual allegations other than Number Nine's alleged overvaluation of inventory.

II. Factual Background

Taking all allegations in the Complaint as true and granting all reasonable inferences in favor of the Class, see Lirette v. Shiva Corp., 27 F.Supp.2d 268, 274 (D.Mass.1998) ("Shiva"), the following tale of corporate malfeasance emerges:

A. The Offering

Number Nine is a Massachusetts corporation engaged in the design and manufacture of graphics accelerator cards for personal computers. See Compl. ¶¶ 14, 16. During the relevant time periods, Number Nine's principal products included: (a) a 128-bit family of products known as the "Imagine 128"; (b) two 64-bit products including the newer 64-bit 9FX card and the older 64-bit GXE card; and (c) an obsolete 32-bit GXE family of products.⁴ See id. at ¶ 16(c). In the Prospectus, Number Nine reported inventory of $17,333,000 as of the close of the first quarter of 1995 (the last full quarter prior to the Offering). See id. at ¶ 37. Included in that inventory were millions of dollars of inventory of "(a) 64-bit VL Bus graphics accelerators that were rapidly approaching obsolescence and (b) excess printed circuit boards that Number Nine could not realistically hope to sell at a cost even approaching the cost of producing those products." Id. Despite the dubious value of this inventory, Number Nine admitted in the Prospectus that it only carried an "immaterial" provision for excess and obsolete inventory on April 1, 1995. See id. This representation violated several generally accepted accounting principles ("GAAP"), including the principle that inventory must be carried at the lower of cost or market. See id. at ¶ 38(e). Moreover, by failing to include a write-down of Number Nine's inventory of 64-bit VL bus products and printed circuit boards, the financial statements included in the Prospectus materially overstated Number Nine's inventory, net income, earnings per share, and stockholder equity.⁵ See id. at ¶ 39.

The Prospectus also represented that Number Nine's product line represented a broad and diversified range of products that "facilitate[] the penetration of the retail channel by spanning a range of prices, beginning at $150 and extending to $2,000." Id. at ¶ 43. This representation was false and misleading because, at the time it was made, Number Nine's inventories were overstocked with 64-bit VL bus products which were "rapidly becoming obsolete," and Number Nine's competitors "were offering significantly less expensive alternatives to [Number Nine's] high-priced Imagine 128 products that offered features such as 3-D graphics and superior motion video which were not available in Number Nine's products." Id. at ¶ 44(a). Moreover, the second generation Imagine II line of products, which Number Nine specifically touted in the Prospectus as an example of its broad product line, was experiencing numerous difficulties in technical development which precluded Number Nine from meeting its announced 1995 shipment date. See id. at ¶ 44(b).

Number Nine also misrepresented the expected profitability of its main product offerings. Specifically, Number Nine stated in its Prospectus that margins could increase through (a) potential cost reductions from efficiency gains and volume purchasing, (b) potential changes in product mix toward a greater concentration of higher-margin products like the Imagine 128 line, and (c) potential changes in its distribution methods. See id. at ¶ 45. These representations were false and misleading for a number of reasons. First, recalling the inflated value at which 64-bit VL bus cards were carried on the books, Number Nine's margins were certain to decline in light of the impending and inevitable inventory markdown. Second, Number Nine's proposed Imagine 128 card for the Apple PowerMac, a product which Number Nine relied upon for at least part of its expectation of increased margins, was experiencing significant production delays that would cause Number Nine to lose millions of dollars in high-margin sales due to its failure to fill outstanding orders. Finally, Number Nine knew that it was unable to procure needed DRAM and VRAM memory chips from its normal suppliers, and instead had to turn to the much more expensive "spot market" for the parts. Relying on such alternative sources for memory chips significantly increased the cost of goods sold and therefore was hurting Number Nine's margin by the time of the Offering. See id. at ¶ 46.

This failure to disclose the problem of obtaining memory chips also appeared in the "Risk Factors" section of the Prospectus. Number Nine did disclose that memory shortages "have from time to time required the Company to obtain memory from distributors or on the `spot market' at higher than anticipated prices," and that "[a]ny shortage of [memory chips] in the future could materially adversely affect" results. Id. at ¶ 47. Number Nine did not disclose, however, that it was experiencing just such a shortage of supply at the time the Prospectus was signed and the Offering was made. Nor did it disclose that it was resorting to alternative sources of memory chips that were significantly more costly than its normal suppliers, and that this increased cost could only be passed on to consumers to a limited extent, given the competitive nature of the graphics accelerator market. Finally, Number Nine failed to disclose that the memory crunch also caused it to fail to fill some orders and, consequently, some customers, including Number Nine's largest customer, sought alternate suppliers for graphics accelerators. For all of these reasons, many of the key financial measures included in the Prospectus were misleading at the time they were made. See id. at 48 B. Post-Offering Misrepresentations

The Complaint also alleges a variety of misrepresentations and omissions that form the basis, along with the above facts, for the claims under the Exchange Act.

Following the Offering, Number Nine issued additional financial reports — a July 27, 1995 press release, a second quarter 1995 Form 10-Q filing, and a third quarter 1995 Form 10-Q filing — that contained misrepresentations and omissions similar to those contained in the Prospectus. See id. at ¶¶ 49-57. Certain allegedly actionable statements by individuals were also made. For instance, in the July 27,...