Panther Partners Inc. v. Ikanos Commc'ns, Inc.

• Decision Date: 25 May 2012
• Docket Number: Docket No. 11–63–cv.
• Citation: 681 F.3d 114
• Parties: PANTHER PARTNERS INC., on Behalf of Itself and All Others Similarly Situated, Plaintiff–Appellant, v. IKANOS COMMUNICATIONS, INC., Rajesh Vashist, Daniel K. Atler, Danial Faizullabhoy, Michael L. Goguen, Michael Gulett, Paul G. Hansen, Gopal Venkatesh, Citigroup Global Markets Inc., Defendants–Appellees, Lehman Brothers Inc., Defendant.
• Court: U.S. Court of Appeals — Second Circuit

681 F.3d 114

PANTHER PARTNERS INC., on Behalf of Itself and All Others Similarly Situated, Plaintiff–Appellant,

v. IKANOS COMMUNICATIONS, INC., Rajesh Vashist, Daniel K. Atler, Danial Faizullabhoy, Michael L. Goguen, Michael Gulett, Paul G. Hansen, Gopal Venkatesh, Citigroup Global Markets Inc., Defendants–Appellees,Lehman Brothers Inc., Defendant.^*

Docket No. 11–63–cv.

United States Court of Appeals, Second Circuit.

Argued: April 17, 2012.

Decided: May 25, 2012.

Susan K. Alexander, Robbins Geller Rudman & Dowd LLP, San Francisco, CA (Sanford Svetcov, Robins Geller Rudman & Dowd LLP, San Francisco, CA, Samuel H. Rudman, David A. Rosenfeld, Robins Geller Rudman & Dowd LLP, Melville, NY, on the briefs), for Plaintiff–Appellant.

James N. Kramer (Michael D. Torpey, on the brief), Orrick, Herrington & Sutcliffe LLP, San Francisco, CA, for Defendants–Appellees Ikanos Communications, Inc., Rajesh Vashist, Daniel K. Atler, Danial Faizullabhoy, Michael L. Goguen, Michael Gulett, Paul G. Hansen and Gopal Venkatesh.

Daniel J. Toal (Daniel J. Kramer, Farrah R. Berse, Aaron H. Crowell, on the brief), Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, for Defendant–Appellee Citigroup Global Markets Inc.

Before: JACOBS, Chief Judge, B.D. PARKER and HALL, Circuit Judges.

BARRINGTON D. PARKER, Circuit Judge:

Plaintiff Panther Partners Inc. (“Panther”) appeals an order of the United States District Court for the Southern District of New York (Crotty, J.), denying leave to amend its complaint alleging violations of §§ 11, 12(a)(2), and 15 of the Securities Act of 1933. See15 U.S.C. §§ 77k, 77 l(a)(2), 77 o. The proposed complaint alleged that defendant Ikanos Communications Inc. (“Ikanos” or the “Company”) was required to disclose, and failed adequately to disclose, in connection with a March 2006 secondary offering of its securities (the “Secondary Offering”), known defects in the Company's semiconductor chips. We hold that the proposed complaint stated a claim because it plausibly alleged that the defects constituted a known trend or uncertainty that the Company reasonably expected would have a material unfavorable impact on revenues. See Item 303 of SEC Regulation S–K, 17 C.F.R. § 229.303(a)(3)(ii). Accordingly, we vacate the judgment of the district court and remand with instructions to permit the filing of the amended complaint.

BACKGROUND¹

In this putative securities class action, Panther alleges that Ikanos and various of its officers, directors, and underwriters violated §§ 11, 12(a)(2), and 15 of the Securities Act by failing to disclose known defects in the Company's VDSL (very-high-bit-rate digital subscriber line) Version Four chips. Ikanos is a publicly-traded company that develops and markets programmable semiconductors. The semiconductors enable fiber-fast broadband services over telephone companies' existing copper lines. Ikanos's customers are primarily large original equipment manufacturers (“OEMs”) in the communications industry that incorporate Ikanos's products into their products, which are then sold to telecommunications carriers. All of Ikanos's revenues derive from the sale of semiconductor chip sets.

In 2005, Ikanos sold its VDSL Version Four chips to Sumitomo Electric and NEC, its two largest customers and the source of 72% of its 2005 revenues. Sumitomo Electric and NEC then incorporated the chips into products that were in turn sold to NTT and installed in NTT's network.

Ikanos learned in January 2006 that there were quality issues with the chips. In particular, the chips had developed a problem called “Kirkendahl voiding,” ² traceable to a third-party assembling company in China to which Ikanos had switched the majority of its assembly work during the third and fourth quarters of fiscal year 2005. In the weeks leading up to the Secondary Offering, the defect issues became more pronounced as Ikanos received an increasing number of complaints from Sumitomo Electric and NEC. The thrust of the complaints was that the chips that had been installed in the NTT network were defective and were causing the network to fail, and that end-users who had subscribed to NTT's television, Internet and telephone services were losing signals and access to their subscribed services. According to Ikanos's former Director of Quality and Reliability, the defects“were a substantial problem for [Ikanos] to resolve in order to appease Sumitomo Electric and NEC and to retain them as customers,” in part because Ikanos knew it would be unable to determine which of the chip sets it sold to these customers actually contained defective chips. J.A. at 52. Panther alleges that Ikanos's Board of Directors met and discussed the defect issue at the time it arose, and Company representatives regularly traveled to Japan to meet with Sumitomo and NEC representatives to evaluate the problem and to discuss possible solutions.

Panther goes on to allege that Ikanos did not disclose the magnitude of the defect issue in either the Registration Statement or the Prospectus for the Secondary Offering. Instead, the Registration Statement simply cautioned in generalized terms that

[h]ighly complex products such as those that [Ikanos] offer[s] frequently contain defects and bugs, particularly when they are first introduced or as new versions are released. In the past we have experienced, and may in the future experience, defects and bugs in our products. If any of our products contains defects or bugs, or have reliability, quality or compatibility problems, our reputation may be damaged and our OEM customers may be reluctant to buy our products, which could harm our ability to retain existing customers and attract new customers. In addition, these defects or bugs could interrupt or delay sales or shipment of our products to our customers.

Id. at 54–55, 168.

Some 5.75 million shares of Ikanos stock were sold in the Secondary Offering at $20.75 per share, raising more than $120 million. The individual defendants sold stock valued at $7.3 million.

Ikanos ultimately determined that the chips had an “extremely high” failure rate of 25–30%. Id. at 53. In June 2006, three months after the Secondary Offering, the Company reached an agreement with Sumitomo Electric and NEC to replace at Ikanos's expense all of the units sold—not just the units containing observably defective chips. This recall resulted in the return of hundreds of thousands of chip sets whose cost had to be written off.

In July 2006, the Company reported a net loss of $2.2 million for the second quarter, causing the price of its shares to drop over 25% from $13.85 to $10.24. Three months later, in October 2006, it reduced its expected third-quarter revenues from $40–$43 million to $36–37 million, citing “product delays and manufacturing constraints” involving its fourth-and fifth-generation chip sets. Id. at 56. The share price dropped almost 30%, from $10.94 to $7.76, on the news, and analysts lowered their fourth-quarter revenue projections from $45 million to $25 million. Three weeks later, Chief Executive Officer and Board Chairman Rajesh Vashist resigned. Two days later, Ikanos announced third-quarter revenues of $36.7 million and revised revenue estimates for the fourth quarter down further to $21–24 million. Shortly thereafter, plaintiff filed its initial complaint, alleging, among other things, that in contravention of Item 303 of SEC Regulation S–K, defendants failed to disclose the “known ... uncertaint[y]” that the VDSL Version Four chips were defective and were causing system failures where they were deployed. See17 C.F.R. § 229.303(a)(3)(ii).

The operative complaint on this appeal, from which the facts above are drawn, is the third to have been considered by the district court in this case. The First Amended Complaint (“1AC”) alleged merely that Ikanos learned in January 2006 that its VDSL Version Four chips were failing and causing NTT's customers to lose access to their subscribed services; that, some time later, Ikanos was forced to ship replacement products to Sumitomo Electric and NEC at Ikanos's expense; and that, at some point, Ikanos determined that the chips had a failure rate of 25–30%. The district court dismissed the 1AC for failure to state a claim, concluding that “[n]o plausibly pleaded fact suggests that Ikanos knew or should have known of the scope or magnitude of the defect problem at the time of the Secondary Offering.” Panther Partners, Inc. v. Ikanos Commc'ns, Inc., 538 F.Supp.2d 662, 673 (S.D.N.Y.2008) (“Panther Partners I ”).

Panther moved for reconsideration, providing the court with a proposed amended complaint (the “First Proposed Second Amended Complaint” or “1PSAC”). The 1PSAC added allegations that the defect issue was becoming “more pronounced” in the weeks leading up to the Secondary Offering, when Ikanos was receiving “an increasing number of calls” from Sumitomo Electric and NEC; that the defect problems were “a substantial problem” for the Company to resolve; and that the Board of Directors was discussing the issue at the time it arose. 1PSAC at 7, 8. The district court denied the motion for reconsideration and for leave to replead, reasoning that plaintiff's filing of the 1PSAC would be futile because its new “vague” allegations were—like the 1AC's allegations—

“silent about the rate at which chips were being returned ... or the volume of the defect [in the weeks leading up to the Secondary Offering].... Nor do the allegations specify that Ikanos knew exactly what the particular defect was at that time. It is no secret that chips are subject to some percentage of failure (and here there is no pleading as to what a ‘normal’ defect rate is), so the allegation that ‘there were defects' is meaningless without more.... The [p]laintiff must tell the Court what was going on when—and how much the defect experienced actually differed from the norm.”

Panther Partners, Inc. v. Ikanos Commc'ns, Inc., No. 06 Civ. 12967, 2008 WL...