In Re Remec Incorporated Securities Litigation. This Document Relates To All Actions.

• Decision Date: 21 April 2010
• Docket Number: Case No. 04-CV-1948-MMA (AJB).
• Citation: 702 F.Supp.2d 1202
• Parties: In re REMEC INCORPORATED SECURITIES LITIGATION. This Document Relates to all Actions.
• Court: U.S. District Court — Southern District of California

702 F.Supp.2d 1202

In re REMEC INCORPORATED SECURITIES LITIGATION.

This Document Relates to all Actions.

Case No. 04-CV-1948-MMA (AJB).

United States District Court,S.D. California.

April 21, 2010.

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Jeff S. Westerman, Andrew Joseph Sokolowski, David E. Azar, Jeff S. Westerman, Michiyo Michelle Furukawa, Neil Fraser, Milberg LLP, Lionel Z. Glancy, Glancy Binkow and Goldberg, Los Angeles, CA, David J. Noonan, Kirby Noonan Lance and Hoge, Blake M. Harper, Bridget Fogarty Gramme, Hulett Harper Stewart LLP, San Diego, CA, Todd Kammerman, Milberg LLP, New York, NY, for Plaintiffs.

Autumn Partners LLC, pro se.

Heather Noelle Stone, Solomon Ward Seidenwurm & Smith, James Aloysius Garrett, Jeffrey Bruce Coopersmith, Karen S. Chen, Noah A. Katsell, Robert W. Brownlie, DLA Piper US LLP, San Diego, CA, for Defendants.

ORDER RULING ON PENDING MOTIONS;

[Doc. Nos. 173, 194, 263, 308, 310, 336]

DISMISSING CASE WITH PREJUDICE

MICHAEL M. ANELLO, District Judge.

Currently pending before the Court are four summary judgment motions and several evidentiary motions in these consolidated securities fraud cases against Defendants REMEC, Inc., Ronald E. Ragland, and Winston E. Hickman. In sum, for the reasons stated below, and because the Court finds that Defendants are entitled to summary judgment on the element of scienter, judgment shall be entered in favor of Defendants and the case shall be dismissed with prejudice. ¹

I. BackgroundA. Basic Facts

Defendant REMEC, Inc. (“REMEC”) designed and manufactured “high frequency subsystems used in the transmission of voice, video and data traffic over wireless communications networks and in space and defense electronics applications.” FAC ² ¶ 2. This action concerns REMEC's Commercial segment (also known as the Wireless Systems division). ³ Defendant Ronald Ragland, an engineer, founded REMEC in 1983 and served as its Chief Executive Officer (“CEO”) and Chairman of the Board of Directors until February 2004. Ragland Decl. ¶¶ 3-4. In November 2003, REMEC purchased Paradigm Wireless Systems, Inc., and hired that company's Chief Financial Officer (“CFO”) Winston Hickman to serve in that same position at REMEC. Hickman Decl. ¶ 4; Ragland Decl. ¶ 11.

Plaintiffs accuse REMEC of materially overstating its financial results by failing to recognize millions of dollars in losses related to goodwill impairment. See e.g., FAC ¶¶ 3-6, 139-225. Although the heart of Plaintiffs' case concerns impaired goodwill, Plaintiffs allege REMEC engaged in other deceptive accounting practices such as inflating revenue by overstating the value of excess, obsolete inventory and by failing to disclose significant internal control deficiencies. See e.g., FAC ¶¶ 8, 11, & 14. ⁴

The FAC contains two causes of action. REMEC, Ragland, and Hickman are named in the first cause of action for securities fraud pursuant to § 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. Plaintiffs' second claim alleges control person liability against Ragland and Hickman under § 20 of the Securities Exchange Act of 1934.

The Court certified a class of plaintiffs who purchased or otherwise acquired REMEC securities between September 8, 2003 and September 8, 2004. Fed.R.Civ.P. 23(a) & (b)(3); Order Granting Pls.' Mo. for Class Certification. [Doc. No. 103.]

B. Defining Goodwill Impairment Testing

Plaintiffs' case primarily involves an accounting method to test the value of goodwill, which is calculated and reported on a company's financial statement. Goodwill is an intangible asset that reflects the “excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed.” Williams Decl. Ex. 1 at 105. ⁵ In other words, goodwill, though it is an intangible asset, must be measured. If the value of the goodwill is “impaired,” the company must deduct or “write off” that value on the balance sheet. When the value is positive, the company records goodwill as an asset. Williams Decl. Ex. 2 at 42 (FY02 Form 10-K at F-8 reports purchases of Solitra and Pacific Microwave Corp. and subsequent $17.7 million write-off associated with Pacific).

Goodwill is customarily acquired when an existing company purchases another company. With each acquisition, goodwill is recorded on the company's financial statement. In this case, Plaintiffs allege that REMEC pursued an aggressive strategy of buying companies and recording inflated goodwill values in a scheme to mask the true financial condition. See e.g., FAC ¶ 87. Under Ragland's command, part of REMEC's business strategy was to expand by buying other specialized technology companies that would complement REMEC's product offerings. Williams Decl. Ex. 2 at 8-9 (FY02 Form 10-K at 6-7 describes strategy to pursue acquisitions); Williams Decl. Ex. 56 at 10 (FY03 Form 10-K). ⁶ Beginning in 1999, REMEC's Commercial unit acquired several companies. REMEC recorded the acquired goodwill as an asset on its financial statements in most of those transactions. ⁷ For example, in November 2003, during the class period, REMEC bought Paradigm Wireless (Hickman's former employer) and recorded $17 million on its financial statement as goodwill, or 81 % of the $21 million purchase price. See Pls.' Opp. Br., Attachment 3; Fraser Decl. Ex. 4 at 1 (Hinkle mem. dated 2/19/04). Plaintiffs calculate that REMEC recorded goodwill totaling $55.9 million from the Commercial Wireless's four main acquisitions (or 64% of the $87 million purchase prices). See Pls.' Scienter Opp. Br., Attachment 3.

As mentioned, companies must test the value of goodwill using generally accepted accounting procedures (“GAAP”). The Financial Accounting Standard (“FAS”) Board changed the rules governing the valuation of intangible assets in 2002. Under the prior rule, companies accounted for goodwill by amortizing the value over a period of years as a long-term asset. Brownlie Decl. Ex. D (FAS 121). The prior rule instructed companies to account for and disclose impaired goodwill “whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recovered.” Id. at 84.

The statement of FAS 142 eliminated the prior method of amortizing goodwill. Williams Decl. Ex. 1. Instead, FAS 142 uses a two-step test to identify potential goodwill impairment and to measure the amount of loss. Id. at 12 (¶ 18). The first step compares the fair value of a reporting unit with its carrying value. Id. at 12-14 (¶¶ 19 & 23-25). If the fair value exceeds the carrying amount, goodwill is not impaired and the second step is not required. Id. at 12 (¶ 19). If the carrying amount exceeds its fair value, the second step is performed to measure the amount of impairment loss. Id. The second step “compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill.” Id. at 13 (¶ 20).

The accounting method to value goodwill involves predictions of future results and other uncertain variables. The language of FAS 142 states that it measures a “reasonable estimate of the value of goodwill.” Williams Decl. Ex. 1 at 12 & 108 (¶ 18 n. 13). “Unlike many other assets that are tested for impairment, goodwill does not have a set of cash flows uniquely associated with it. Instead, the cash flows associated with acquired goodwill usually are intermingled with those associated with internally generated goodwill and other assets because entities generally enter into business combinations to reduce costs and achieve synergies, which entails integrating the acquired entity with the acquiring entity.” Id. at 50 (App.B84); id. at 54 (App. B96 & B97); id. at 61-62 (App.B127) (“a goodwill impairment test by its very nature will include some level of imprecision”). As the definition states, goodwill measures amorphous concepts like the “synergy” created by merging two companies. Goodwill is measured in large part on predictions, such as predictions of future sales and estimates of the cost savings that will be achieved by combining two entities ( e.g., reductions in duplicative labor and facilities).

The prediction of gross profit margin is central to Plaintiffs' suit against REMEC. These types of business judgments should not be invalidated merely because, in hindsight, they proved wrong.

FAS 142 also changed the timing of goodwill testing. It required companies to test the value of goodwill every fiscal year. In addition to the annual test, certain conditions “that would more likely than not reduce the fair value” of an acquisition could trigger a requirement to perform an interim test. Id. at 15 ¶ 28.

REMEC implemented the new FAS 142 rule in early 2002 and first reported its compliance after its FY03 ended on January 31, 2003. See Williams Decl. Ex. 2 at 28; Katsell Supp. Decl. Ex A at 12 & 16. ⁸ The first test conducted under the new rule is called the transitional test. REMEC's transitional test applied “as of” the beginning of REMEC's fiscal year, and the company had six months to complete it. Williams Decl. Ex. 1 at 23 (¶ 55). The annual test must be conducted the “same time every year,” id. at 14 (¶ 26), and REMEC elected to measure goodwill impairment “as of” the last business day of December.

In its Securities and Exchange Commission (“SEC”) filings, REMEC told investors that it tested goodwill and found no impairment. See e.g., Williams Decl. Ex. 56 at 33 (FY03 Form 10-K at 27) (“We did not recognize any goodwill impairment as a result of performing this annual test.”). Plaintiffs dispute the accuracy of those statements. Plaintiffs allege Defendants falsely assured the market it used assumptions that were “consistent with the plans and estimates that we use to manage the underlying business” to calculate its goodwill. FAC ¶¶ 5 & 151. Pla...