Naglich v. Applied Optoelectronics

• Decision Date: 29 January 2020
• Docket Number: Civil Action No. H-18-3544
• Parties: Mark NAGLICH, Lead Plaintiff, Plaintiffs, v. APPLIED OPTOELECTRONICS, Thompson Lin, and Stefan J. Murray, Defendants.
• Court: U.S. District Court — Southern District of Texas

436 F.Supp.3d 954

Mark NAGLICH, Lead Plaintiff, Plaintiffs,

v.APPLIED OPTOELECTRONICS, Thompson Lin, and Stefan J. Murray, Defendants.

Civil Action No. H-18-3544

United States District Court, S.D. Texas, Houston Division.

Signed January 29, 2020

Johnston de Forest Whitman, Jr., Joshua A. Materese, Samuel C. Feldman, Kessler Topaz Meltzer & Check, LLP, Radnor, PA, Thomas Robert Ajamie, Ajamie LLP, Houston, TX, for Plaintiffs.

Amy Tankersley Perry, Emily Schomburger Johnson, Richard Kent Piacenti, Michael C. Holmes, Vinson and Elkins LLP, Dallas, TX, Allison Lee Fuller, Vinson & Elkins, Houston, TX, for Defendants.

MEMORANDUM OPINION AND ORDER

SIM LAKE, SENIOR UNITED STATES DISTRICT JUDGE

This action is brought against Applied Optoelectronics, Inc., ("AOI"), AOI's Chief Executive Officer ("CEO") and President, Thompson Lin ("Lin"), and AOI's Chief Financial Officer ("CFO"), Stefan J. Murry ("Murry"), for alleged violations of§§ 10(b) and 20(a) of the Securities Exchange Act of 1934 (1934 Act), 15 U.S.C. § 78j (b) and 78t(a), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, during a proposed class period beginning on August 7, 2018, and ending on September 27, 2018.¹ Pending before the court is Defendants' Motion to Dismiss Plaintiffs' Amended Class Action Complaint ("Defendant's Motion to Dismiss") (Docket Entry No. 40), Plaintiffs' Memorandum of Law in Opposition to Defendants' Motion to Dismiss Plaintiffs' Amended Class Action complaint which includes a request for leave to amend ("Plaintiffs' Memorandum in Opposition") (Docket Entry No. 49), and Reply in Support of Defendants' Motion to Dismiss Plaintiffs' Amended Class Action Complaint ("Defendants' Reply") (Docket Entry No. 50). For the reasons stated below, the Defendants' Motion to Dismiss will be granted.

I. Procedural History and Alleged Facts

Plaintiffs initiated this action on October 1, 2018, by filing a Class Action Complaint (Docket Entry No. 1) asserting claims for violations of § 10(b) and § 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. On January 4, 2019, the court signed an Order Granting the Motion of Putative Class Member Mark Naglich for Consolidation, Appointment as Lead Plaintiff, and Approval of His Selection of Counsel and Denying the Competing Motions (Docket Entry No. 29). Pursuant to the January 4, 2019, Order Mark Naglich was appointed lead plaintiff for this consolidated class action, and Kessler Topaz Meltzer & Check, LLP was appointed as Lead Counsel for the class. On March 5, 2019, Lead Plaintiff and additional plaintiff Rick Fasnacht filed the ACAC (Docket Entry No. 34).

Plaintiffs allege that AOI designs and manufactures a range of communications products, used primarily by large, internet-based data center operators such as Facebook, Amazon, and Microsoft.² AOI is incorporated under the laws of Delaware, its principal office is located in Sugar Land, Texas, and its securities trade on the NASDAQ exchange.³ Plaintiffs allege that throughout the class period defendant Lin served as AOI's President and CEO, and defendant Murry served as AOI's CFO and Chief Strategy Officer.⁴

The ACAC alleges that

in February 2018, Defendants formally announced ... [a] purportedly lucrative new Supply Agreement. To this end, they boasted to investors "a minimum commitment for the first year that represents, at a minimum $125 million [in revenue] for one product family." To put that number in perspective, AOI's data center business generated approximately $306 million in revenue during the entirety of 2017, across all customers and products. Defendants introduced the Supply Agreement as a single deal that, by itself, would guarantee minimum revenue equal to more than 40% of the Company's entire data center revenue for the preceding year.⁵

The ACAC alleges that

[i]n connection with announcing the Supply Agreement, Defendants also proclaimed that in the second half of 2018, AOI planned to "more than double" volumes in 100G based in large part (if not entirely) on "committed orders" under the Supply Agreement. Similarly, Defendants represented that AOI would book the lion's share of the minimum $125 million in 2018 revenues from sales to Facebook during the second half of the year.⁶

The ACAC alleges that

[a]gainst this backdrop, on August 7, 2018, Defendants issued to the market what Defendant Murray characterized as "conservative" guidance for AOI's third quarter 2018 performance, anchored by sales the Company claimed were already booked under the Supply Agreement. Among other things, Defendants told investors that AOI expected "[r]evenue in the range of $82 million to $92 million," and that the 3Q18 Guidance "encompass[ed] the range of possibilities that we see out there."⁷

The ACAC alleges that

[b]ehind the scenes, however, Defendants quickly learned that AOI could not and would not achieve its 3Q18 Guidance. Specifically, Defendants identified a debilitating issue with 25G laser chips that AOI used in its prized 100G CWDM transcievers – the lynchpin of the Supply Agreement. The product defect was so significant that Defendants elected to halt all shipments of transceivers to Facebook while the Company scrambled to comprehend the problem, manufacture replacement chips and transceivers, and repair its relationship with Facebook.⁸

The ACAC alleged

[g]iven the centrality of the Supply Agreement to AOI's 3Q18 performance, as soon as Defendants halted shipments to Facebook, it was obvious that AOI could not meet the quarterly revenue guidance (and, in turn, earnings figures) that Defendants provided on August 7, 2018. Indeed, AOI recognizes revenue as soon as it ships its products. Thus, when Defendants halted shipments to Facebook, a hole in AOI's revenue arose immediately ... Because AOI lacked any non-defective product on hand with which to satisfy Facebook's demand, the Company could not bridge the gap or prevent it from widening. The revenue shortfall continued to grow unabated for the remainder of the quarter.

Meanwhile, Defendants kept the market in the dark. Having chosen to publish to the market positive concrete guidance for AOI's 3Q18 performance, which Defendants openly represented was "conservative" and based in large part on revenue locked in under the Supply Agreement, Defendants had a duty to update investors by informing them that the 3Q18 Guidance was no longer reliable when those subsequent events put AOI off course.

Defendants, however, disregarded their duty. Instead of updating their August 7, 2018 statements when AOI elected to stop shipments to Facebook – thereby halting all revenue under the Supply Agreement – Defendants concealed the truth. Providing the required update to investors would have confirmed the market's deepest fear: AOI was not equipped to satisfy Facebook's demand or to compete and maintain its critical market share in the transceiver space; and it would not meet the 3Q18 Guidance or 100G volume promise Defendants shared with investors on August 7, 2018.⁹

The ACAC alleges that

[t]he true state of affairs with AOI's quality control issue and deteriorating revenue under the Supply Agreement only began to come to light on September 27, 2018, and only after certain securities analysts shocked the market by issuing reports disclosing, among other things, that AOI was "having product quality issues in 100G CWDM4 transceivers" and that "the quality concerns could result in market share loss."

These analysts' reports forced Defendants to publicly address the conceded internal issues these market commentators had finally exposed. In this regard, Defendants revealed to the market the next morning (September 28, 2018) that since issuing the 3Q18 Guidance, they had: (i) identified a product quality issue; (ii) curtailed all shipments and sales of 100G products to Facebook for an undisclosed time; and (iii) launched and completed an "investigation." ... Defendants were forced to dramatically revise down the Company's 3Q18 Guidance by approximately $30 million, or more than 33%.

The market would later learn that the undisclosed chip problem had caused a shortfall of atleast $35 million in third quarter revenue from the expected "minimum $125 million" in revenue for 2018 from the Supply Agreement.¹⁰

The ACAC alleges that the claims for violation of the federal securities laws asserted arise from

Defendants' deliberate decision to conceal from investors that a serious product defects had both: (i) caused AOI to suspend all product shipments and receipt of related revenue under the Company's most important and highly touted supply contract with Facebook, Inc...; and (ii) rendered Defendants' putatively "conservative" third quarter 2018 financial guidance (the "3Q18 Guidance") — issued a short time earlier on August 7, 2018 — unattainable and misleading.¹¹

II. Defendants' Motion to Dismiss

Defendants argue that plaintiffs' ACAC should be dismissed pursuant to Federal Rule of Civil Procedure 12(b) (6) for failure to state a claim for which relief may be granted because the ACAC "fails to plead an actionable misstatement or omission, scienter, or loss causation."¹² Defendants also argue that plaintiffs' secondary liability claim for violation of Section 20(a) fails, and that plaintiffs should not be permitted an opportunity to amend.¹³

A. Standards of Review

1. Federal Rule of Civil Procedure 12 (b) (6)

A Rule 12 (b) (6) motion tests the formal sufficiency of the pleadings and is "appropriate when a defendant attacks the complaint because it fails to state a legally cognizable claim." Ramming v. United States, 281 F.3d 158, 161 (5th Cir. 2001), cert. denied sub nom. Cloud v. United States, 536 U.S. 960, 122 S. Ct. 2665, 153 L.Ed.2d 839 (2002). The court must accept the factual allegations of the complaint as true, view them in a light most favorable to the plaintiff, and draw all reasonable inferences in the plaintiff's favor. Id. To defeat a motion to dismiss pursuant to Rule 12(b) (6), a...