Horowitz V Green Mountain Coffee - July Legal Brief

Case 2:10-cv-00227-wks Document 43
Filed 07/12/11 Page 1 of 60
UNITED STATES DISTRICT COURT DISTRICT OF VERMONT DAN M. HOROWITZ, Individually and on Behalf of All Others Similarly Situated, ) ) ) Plaintiff, ) ) vs. ) ) GREEN MOUNTAIN COFFEE ROASTERS, ) INC., et al., ) ) Defendants. ) ) No. 2:10-cv-00227-WKS (Consolidated) CLASS ACTION
LEAD PLAINTIFFS OMNIBUS OPPOSITION TO DEFENDANTS GREEN MOUNTAIN COFFEE ROASTERS, INC.S, LAWRENCE J. BLANFORDS, FRANCES G. RATHKES, AND ROBERT P. STILLERS MOTIONS TO DISMISS THE CONSOLIDATED CLASS ACTION COMPLAINT
TABLE OF CONTENTS Page I. II. III. PRELIMINARY STATEMENT .........................................................................................1 STATEMENT OF FACTS ..................................................................................................6 ARGUMENT.....................................................................................................................11 A. The Complaint Adequately Alleges a Violation of 10(b)....................................11 1. 2. Applicable Standards on a Motion to Dismiss a 10(b) Claim .................11 The Complaint Adequately Alleges Material False Statements Regarding Improper Revenue Recognition on Shipments to MBlock ......................................................................................................13 Board Chairman Stiller Can Be Held Liable for Class Period Misstatements ............................................................................................17 The Complaint Adequately Alleges Scienter.............................................19 a. The Complaint Has Pled with Particularity Motive and Opportunity ....................................................................................21 (1) (2) The Disclosure of the SEC Inquiry on the Day of the Lavazza Closing Was Highly Suspicious ....................21 The Scienter of the Senior Executives Who Engaged in Highly-Suspicious Stock Sales May Be Imputed to GMCR .............................................................23
3. 4.
b.
The Complaint Adequately Alleges Conscious Misbehavior or Recklessness ..............................................................................29 (1) (2) Improperly-Recognized MBlock Revenues Implicate GMCRs Core Operations .................................30 The Complaint Alleges Scienter with Respect to the Misrepresentations in and Omissions from the Third Quarter 2010 Form 10-Q ...................................................34
c. d.
Confidential Witnesses Support Defendants Actual Knowledge or Recklessness...........................................................37 A Strong Inference of Scienter Is at Least as Compelling as Any Other.......................................................................................44
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Page B. IV. The Complaint Adequately Alleges Control Person Liability Under Section 20(a) ..........................................................................................................45
CONCLUSION..................................................................................................................47
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TABLE OF AUTHORITIES Page CASES Acito v. IMCERA Group, Inc., 47 F.3d 47 (2d Cir. 1995) ........................................................................................................28 Aldridge v. A.T. Cross Corp., 284 F.3d 72 (1st Cir. 2002)......................................................................................................16 Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009).............................................................................................................11 Basic, Inc. v. Levinson, 485 U.S. 224 (1988).................................................................................................................14 Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007).................................................................................................................11 Boguslavsky v. Kaplan, 159 F.3d 715 (2d Cir. 1998).....................................................................................................45 Campo v. Sears Holding Corp., 371 Fed. Appx. 212 (2d Cir. 2010)...................................................................................33, 39 Cent. Laborers Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546 (5th Cir. 2007) ...................................................................................................24 City of Brockton Retirement Systems v. Shaw Group Inc., 540 F. Supp. 2d 464 (S.D.N.Y. 2008)......................................................................................31 Cornwell v. Credit Suisse Group, 689 F. Supp. 2d 629 (S.D.N.Y. 2010)................................................................................38, 42 Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42 (2d Cir. 1991).......................................................................................................47 Cosmas v. Hassett, 886 F.2d 8 (2d Cir. 1989) ........................................................................................................30 Croker v. Carrier Access Corp., No. Civ. 05CV01011, 2006 WL 2035366 (D. Colo. July 18, 2006).....................................................................................................42, 43 Dresner v. Utility.com, Inc., 371 F. Supp. 2d 476 (S.D.N.Y. 2005)......................................................................................19
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Page ECA v. J.P. Morgan Chase Co., 553 F.3d 187 (2d Cir. 2009).........................................................................................12, 21, 36 Edison Fund v. Cogent Inv. Strategies Fund, Ltd., 551 F. Supp. 2d 210 (S.D.N.Y. 2008)......................................................................................45 Frank v. Dana Corp., 547 F.3d 564 (6th Cir. 2008) ...................................................................................................37 Frank v. Dana Corp., No. 09-4233, 2011 WL 2020717 (6th Cir. May 25, 2011) .....................................................................................................36, 37 Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171 (S.D.N.Y. 2010)................................................................................24, 26 Ganino v. Citizens Utilities Co., 228 F.3d 154 (2d Cir. 2000).....................................................................................................14 Glickman v. Alexander & Alexander Services, Inc., No. 93-7594, 1996 WL 88570 (S.D.N.Y. Feb. 29, 1996) .........................................................................................................31 Hall v. Childrens Place Retail Stores, Inc., 580 F. Supp. 2d 212 (S.D.N.Y. 2008)................................................................................39, 41 Hart v. Internet Wire, Inc., 163 F. Supp. 2d 316 (S.D.N.Y. 2001)......................................................................................31 Heller v. Goldin Restructuring Fund, L.P., 590 F. Supp. 2d 603 (S.D.N.Y. 2008)................................................................................12, 20 Higginbotham v. Baxter Intl., Inc., 495 F.3d 753 (7th Cir. 2007) .............................................................................................38, 39 Holmes v. Baker, 166 F. Supp. 2d 1362 (S.D. Fla. 2001) ....................................................................................29 In re Alstom SA Sec. Litig., 454 F. Supp. 2d 187 (S.D.N.Y. 2006)......................................................................................33 In re Am. Bank Note Holographics Sec. Litig., 93 F. Supp. 2d 424 (S.D.N.Y. 2000)........................................................................................31 In re Am. Intl Group, Inc., 741 F. Supp. 2d 511 (S.D.N.Y. 2010)......................................................................................21 - iv -
Page In re Ambac Fin. Group, Inc. Sec. Litig., 693 F. Supp. 2d 241 (S.D.N.Y. 2010)......................................................................................39 In re ArthroCare Corp. Sec. Litig., 726 F. Supp. 2d 696 (W.D. Tex. 2010)....................................................................................24 In re ATI Techs. Inc., Sec. Litig., 216 F. Supp. 2d 418 (E.D. Pa. 2002) .......................................................................................21 In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F. Supp. 2d 474 (S.D.N.Y. 2004)..........................................................................15, 30, 38 In re Bausch & Lomb, Inc. Securities Litigation, 592 F. Supp. 2d 323 (W.D.N.Y. 2008) ....................................................................................26 In re BISYS Sec. Litig., 397 F. Supp. 2d 430 (S.D.N.Y. 2005)................................................................................15, 17 In re Cabletron Sys., Inc., 311 F.3d 11 (1st Cir. 2002).............................................................................................. passim In re Cardinal Health Inc. Sec. Litig., 426 F. Supp. 2d 688 (S.D. Ohio 2006) ....................................................................................24 In re CINAR Corp. Sec. Litig., 186 F. Supp. 2d 279 (E.D.N.Y. 2002) .....................................................................................31 In re CitiGroup Inc. Bond Litig., 723 F. Supp. 2d 568 (S.D.N.Y. 2010)......................................................................................15 In re Dynex Capital, Inc. Sec. Litig., No. 05 Civ. 1897(HB), slip op., 2009 WL 3380621 (S.D.N.Y. Oct. 19, 2009) .........................................................................................................38 In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266 (S.D.N.Y. 2006)......................................................................................30 In re Fed. Natl. Mortg. Assn. Sec., Deriv., and ERISA Litig., 503 F. Supp. 2d 25 (D.D.C. 2007) ...........................................................................................24 In re Focus Enhancements, Inc. Sec. Litig., 309 F. Supp. 2d 134 (D. Mass. 2001) ......................................................................................43 In re Immucor Inc. Sec. Litig., No. 05-CV-2276, 2006 WL 3000133 (N.D. Ga. Oct. 4, 2006)............................................................................................................26 -v-
Page In re Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d 741 (S.D.N.Y. 2001)......................................................................................18 In re IPO Sec. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003)......................................................................................18 In re IPO Sec. Litig., 544 F. Supp. 2d 277 (S.D.N.Y. 2008)......................................................................................20 In re KeySpan Corp. Securities Litigation, 383 F. Supp. 2d 358 (E.D.N.Y. 2003) .....................................................................................27 In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006)................................................................................13, 20 In re MBIA, Inc. Securities Litigation, 700 F. Supp. 2d 566 (S.D.N.Y. 2010)......................................................................................33 In re MCI Worldcom, Inc. Sec. Litig., 93 F. Supp. 2d 276 (E.D.N.Y. 2000) .........................................................................................4 In re MRU Holdings, Securities Litigation, No. 09-3807, 2011 WL 650792 (S.D.N.Y. Feb. 17, 2011) .........................................................................................................38 In re MSC Indus. Direct Co., Inc., 283 F. Supp. 2d 838 (E.D.N.Y. 2003) .....................................................................................42 In re Musicmaker.com Sec. Litig., No. 00-2018, 2001 WL 34062431 (C.D. Cal. June 4, 2001) ..........................................................................................................46 In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613 (S.D.N.Y. 2003)................................................................................12, 29 In re NovaGold Resources Inc. Sec. Litig., 629 F. Supp. 2d 272 (S.D.N.Y. 2009)......................................................................................38 In re Oxford Health Plans, Inc. Sec. Litig., 51 F. Supp. 2d 290 (S.D.N.Y. 1999)........................................................................................36 In re Oxford Health Plans Sec. Litig., 187 F.R.D. 133 (S.D.N.Y. 1999) .............................................................................................28 In re Par Pharm., Inc. Sec. Litig., 733 F. Supp. 668 (S.D.N.Y. 1990)...........................................................................................13 - vi -
Page In re Peoplesoft, Inc., No. C 99-472, 2000 WL 1737936 (N.D. Cal. May 25, 2000) ........................................................................................................37 In re Proquest Sec. Litig., 527 F. Supp. 2d 728 (E.D. Mich. 2007)...................................................................................15 In re PXRE Group, Ltd. Sec. Litig., 600 F. Supp. 2d 510 (S.D.N.Y. 2009)......................................................................................12 In re Scholastic Corp. Sec. Litig., 252 F.3d 63 (2d Cir. 2001).................................................................................................20, 41 In re Scottish Re Group Sec. Litig., 524 F. Supp. 2d 370 (S.D.N.Y. 2007)................................................................................33, 45 In re Security Capital Assurance Ltd. Securities Litigation., 729 F. Supp. 2d 569 (S.D.N.Y. 2010)......................................................................................31 In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247 (S.D.N.Y. 2008)......................................................................................20 In re Time Warner Inc. Sec. Litig., 9 F.3d 259 (2d Cir. 1993) ........................................................................................................21 In re Tommy Hilfiger Sec. Litig., No. 04-civ-7678, 2007 WL 5581705 (S.D.N.Y. July 20, 2007) .........................................................................................................11 In re Tower Automotive Sec. Litig., 483 F. Supp. 2d 327 (S.D.N.Y. 2007)......................................................................................45 In re Unisys Corp. Sec. Litig., No. Civ. A. 00-1849, 2000 WL 1367951 (E.D. Pa. Sept. 21, 2000) .........................................................................................................21 In re Van Der Moolen Holding N.V. Sec. Litig., 405 F. Supp. 2d 388 (S.D.N.Y. 2005)......................................................................................33 In re Veeco Instruments Sec. Litig., 235 F.R.D. 220 (S.D.N.Y. 2006) .................................................................................21, 30, 36 In re Winstar Commcns., No. 01 CV 3014, 2006 WL 473885 (S.D.N.Y. Feb. 27, 2006) .........................................................................................................30 - vii -
Page In re WorldCom, Inc. Sec. Litig., 352 F. Supp. 2d 472 (S.D.N.Y. 2005)......................................................................................20 Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001).....................................................................................................29 King County, WA v. IKB Deutsche Industriebank AG, 751 F. Supp. 2d 652 (S.D.N.Y. 2010)......................................................................................17 Lefkoe v. Jos. A. Bank Clothiers, No. WMN-06-1892, 2008 WL 7275126 (D. Md. May 13, 2008) ............................................................................................................24 Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161 (2d Cir. 2005).....................................................................................................12 Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702 (7th Cir. 2008) .............................................................................................20, 39 Malin v. XL Capital Ltd., 499 F. Supp. 2d 117 (D. Conn. 2007)................................................................................24, 42 Matrix Cap. Mgt. Fund, LP v. BearingPoint, Inc., 576 F.3d 172 (4th Cir. 2009) ...................................................................................................37 McMahan & Co. v. Wherehouse Ent., Inc., 900 F.2d 576 (2d Cir. 1990).....................................................................................................14 Middlesex Retirement Sys. v. Quest Software Inc., 527 F. Supp. 2d 1164 (C.D. Cal. 2007) ...................................................................................15 Mills v. Polar Molecular Corp., 12 F.3d 1170 (2d Cir. 1993)...............................................................................................12, 16 Miss. Pub. Emps. Ret. Sys. v. Boston Scientific Corp., 523 F.3d 75 (1st Cir. 2008)......................................................................................................24 Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000)............................................................................................. passim Pension Comm. of the Univ. of Montreal Pension Plan v. Banc of Am. Sec., LLC, 440 F. Supp. 2d 163 (S.D.N.Y. 2006)......................................................................................18 Rombach v. Chang, 355 F.3d 164 (2d Cir. 2004)...............................................................................................12, 16 - viii -
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Page Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000).......................................................................................................28 Schnall v. Annuity and Life Re (Holdings) Ltd., No. 3:02 CV 2133, 2004 WL 231439 (D. Conn. Feb. 4, 2004) ...........................................................................................................18 SEC v. Espuelas, 579 F. Supp. 2d 461 (S.D.N.Y. 2008)......................................................................................31 SEC v. Kelly, 663 F. Supp. 2d 276 (S.D.N.Y. 2009)......................................................................................15 Senn v. Hickey, No. 03-CV-4372, 2005 WL 3465657 (D.N.J. Dec. 19, 2005) .............................................................................................................28 Sgalambo v. McKenzie, 739 F. Supp. 2d 453 (S.D.N.Y. 2010)......................................................................................20 Shaw v. Digital Equip. Corp., 82 F.3d 1194 (1st Cir. 1996)....................................................................................................23 Skydell v. Ares-Serono S.A., 892 F. Supp. 498 (S.D.N.Y. 1995)...........................................................................................12 Sloman v. Presstek, Inc., No. 06 CV 377, 2007 WL 2740047 (D.N.H. Sept. 18, 2007) ...........................................................................................................20 Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87 (2d Cir. 2001).......................................................................................................20 Teachers Ret. Sys. of La. v. A.C.L.N., Ltd., No. 01-11814, 2003 WL 21058090 (S.D.N.Y. May 12, 2003).........................................................................................................11 Teamsters Allied Benefit Funds v. McGraw, No. 09 Civ. 140, 2010 WL 882883 (S.D.N.Y. Mar. 11, 2010) ........................................................................................................32 Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., No. 05 Civ. 1898, 2005 WL 2148919 (S.D.N.Y. Sept. 6, 2005)....................................................................................................21, 32
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Page Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, Inc., 531 F.3d 190 (2d Cir. 2008).....................................................................................................20 Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308 and 322-24 (2007)...................................................................................... passim Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991).........................................................................................................13, 14 STATUTES, RULES AND REGULATIONS 15 U.S.C. 78j(b).............................................................................................................................. passim 78u-4(b)(2).............................................................................................................................12 78u-4(e)(2) ...............................................................................................................................4 Federal Rules of Civil Procedure Rule 8(a)...................................................................................................................................12 Rule 9(b) ..............................................................................................................................4, 12 Rule 15(a).................................................................................................................................47 17 C.F.R. 230.405...................................................................................................................................46 240.10b-5 ...............................................................................................................................13 249.308...................................................................................................................................23
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I.
PRELIMINARY STATEMENT For at least the past ten months, Defendant Green Mountain Coffee Roasters, Inc. (GMCR
or the Company) has been under the cloud of an investigation by the Securities and Exchange Commission (SEC) concerning aggressive revenue recognition practices suggested by some to be a form of earnings management arising from GMCRs relationship with its primary fulfillment company, M. Block & Sons (MBlock). Although the SEC investigation has not yet concluded or its findings been made public, witnesses have provided Plaintiffs with alarming details of the Companys accounting improprieties and reckless conduct and how, before the Class Period, these facts were known to GMCR executives. For example, one witness explained that GMCR used sales to MBlock to manipulate the Companys financial reporting. Indeed, shortly before the end of the Companys financial quarter ended December 26, 2009, GMCR sent a 150-truckload shipment of product to MBlock for which no documentation exists to evidence that the shipment was actually made in response to any customer orders. Since GMCR recorded revenue for these types of deliveries upon shipment, GMCR was able to report millions of dollars in revenue for this transaction. This witness indicated that senior officers, including VP of Operations, Jonathan Wettstein (Wettstein) (who made regular reports to Defendant Lawrence J. Blanford (Blanford)), as well as SCBU President R. Scott McCreary (McCreary) and VP of Finance, Tina Bissonette (Bissonette) were well aware of the suspicious shipment. 65, 70-71, 74.1 Investors were kept in the dark about the Companys actions and were shocked when, at the end of the Class Period, GMCR not only disclosed the SECs inquiry into GMCRs relationship with MBlock, but also that it would be making a negative financial adjustment to its previously-reported
1
References to __ are to paragraphs of the Consolidated Class Action Complaint, dated February 18, 2011, Dkt. No. 26. -1-
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financial results a $7.6 million cumulative reduction of past earnings. The discovery of this error spurred GMCR to conduct an internal inquiry, ultimately resulting in the Companys announcement that it had identified and uncovered a multitude of accounting problems. While the Company deemed the half dozen adjustments it chose to explain (from among all of those that were made) to be immaterial, despite the fact that these adjustments spanned many years and concerned a number of different line items2 the widespread nature of these problems ultimately led GMCR to announce the existence of material weaknesses in its internal controls over financial reporting. 95. These weaknesses, as confirmed by witness accounts, are what allowed GMCR to manipulate shipments to, and inventory stored by, MBlock. Witnesses also described a reckless lack of accounting coordination between GMCRs business units. See, e.g., 65-76, 82. Although Defendants3 seek to undermine the Complaint by arguing that the restatement issued in December 2010 ultimately had nothing to do with shipments to MBlock,4 the first of the restated items (inventory and cost of sales) and the SECs investigation of GMCRs relationship with MBlock were announced the same day. 90. Investors were, understandably, concerned that
On his blog White Collar Fraud, a former CFO convicted of fraud, Sam Antar, explained, on January 4, 2011, why one of the errors, the K-Cup margin error, was, in fact, a material error under SEC Staff Accounting Bulletin No. 99. See Declaration of David A. Rosenfeld in Support of Lead Plaintiffs Omnibus Opposition to Defendants Green Mountain Coffee Roasters, Inc.s, Lawrence J. Blanfords, Frances G. Rathkes, and Robert P. Stillers Motions to Dismiss the Consolidated Class Action Complaint (Rosenfeld Decl.), dated July 12, 2011 and submitted herewith, Exhibit A Sam E. Antar, Green Mountain Coffee Roasters: Calling a Bean a Bean, White Collar Fraud (Jan. 4, 2011), http://whitecollarfraud.blogspot.com/2011/01/green-mountain-coffeeroasters-calling.html.)
3
Blanford, Robert P. Stiller (Stiller) and Frances G. Rathke (Rathke) (collectively, the Individual Defendants) and GMCR are, together, referred to as Defendants.
4
See, e.g., Dkt. No. 35-1, Defendant Green Mountain Coffee Roasters, Inc.s Memorandum of Law in Support of Its Motion to Dismiss the Consolidated Class Action Complaint, filed April 25, 2011 (GMCR Br.) at 15-16. -2-
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additional restatements might be necessary as a result of the SECs inquiry.5 Rather than err on the side of transparency while under SEC scrutiny, Defendants continued to issue financial reports with figures that do not add up from one reporting period to the next.6 A number of analysts have questioned the legitimacy of GMCRs financial reporting, noting the continuation of the SEC probe.7 Defendants point to the Companys past record of social responsibility8 and recent success in
GMCRs 2010 Form 10-K, filed December 9, 2010 (the 2010 10-K), at 16-17 (attached to the Rosenfeld Decl. as Exhibit B), concedes this point (the resolution of the SEC inquiry could require the filing of additional restatements of our prior financial statements, and/or our restated financial statements). See Rosenfeld Decl., Exhibit C Sam E. Antar, Green Mountain Coffee Roasters: Murky Financial Disclosures, White Collar Fraud (Feb. 13, 2011), http://whitecollarfraud.blogspot. com/2011/02/green-mountain-coffee-roasters-murky.html (article wherein Antar notes potential stealth restatements during the Class Period revising, in a later SEC filing, the reporting of total assets and income before taxes for the 39-week period ended June 27, 2009, and the Keurig segments profits). See, e.g., 3; see also Rosenfeld Decl., Exhibit D Jason Merriman, Green Mountain Coffee: Only Thing Brewing Is Trouble, Seeking Alpha (Feb. 13, 2011), http://seekingalpha. com/article/252486-green-mountain-coffee-only-thing-brewing-is-trouble (article calling GMCRs accounting practices downright ludicrous). The article notes: the SEC investigation on GMCR is in fact still ongoing, contrary to rumors that it had ended. When CNBC questioned a $22 million reserve reversal that appeared to allow GMCR to meet analyst estimates, GMCR explained it as a change in reporting method in a private email sent to a handful of people rather than to all investors. After being accused of selectively disseminating material information, GMCR posted the explanation on its website but the figures did not add up. See May 5, 2011 CNBC video report, available at http://ori.cnbc.com/ id/15840232?video=3000020386&play=1; and Rosenfeld Decl., Exhibit E Roddy Boyd, GMCR: From Small Beans Big Trouble One Day Brews, The Financial Investigator (June 6, 2011) http://www.thefinancialinvestigator.com/?p=382 (article revealing that Investor Relations director Suzanne DeLong refuted the CNBC story in an email to some hedge funds and brokerage analysts, providing non-public information); and Rosenfeld Decl., Exhibit F Sam E. Antar, To the Securities and Exchange Commission; Green Mountain Coffee Roasters selectively spills the beans and its numbers still dont add up, White Collar Fraud (June 6, 2011), http://whitecollarfraud.blogspot.com/2011/06/to-securities-and-exchange-commission.html (finding an $847,000 discrepancy using DeLongs figures).
8 7 6
In addition to the environmental effects of disposal of single-use plastic and foil K-Cups, those opting specifically for socially responsible investments (SRI) are beginning to weigh more heavily the negatives of GMCRs questionable accounting practices against the positives of its -3-
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securing lucrative partnerships to insulate themselves from Lead Plaintiffs9 claims of securities fraud. GMCR Br. at 6 & n.4. However, such obfuscation does not detract from the fact that many investors lost significant amounts of money in the days after the SEC investigation and the initial items to be restated were announced. Alarmed investors sold their stock en masse, with over 30 million shares exchanging hands and GMCRs share price falling more than 16%.10 Lead Plaintiffs have more than adequately alleged that Defendants made materially false and misleading statements during the Class Period,11 with scienter, that caused significant financial losses to the Class. The requirements of the PSLRA and Fed. R. Civ. P. 9(b) are met where the [c]omplaint alleges the specific statement, the reasons why [plaintiffs] believe the statement is misleading, and the facts on which that belief is formed. In re MCI Worldcom, Inc. Sec. Litig., 93 F. Supp. 2d 276, 280 (E.D.N.Y. 2000); see also Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000) (The primary purpose of Rule 9(b) is to afford defendant fair notice of the plaintiffs claim and the factual ground upon which it is based.) (internal citation omitted). However, plaintiffs are not required to plead with particularity every single fact upon which their beliefs concerning the false or misleading statements are based. Id. at 313.
societal contributions. See Rosenfeld Decl., Exhibit G Green Mountain Coffee: The Dr. Jekyll & Mr. Hyde of SRI, Socially Responsible Investing (Feb. 15, 2011) http://socialresponsibleinvest. blogspot.com/2011/02/green-mountain-coffee-dr.html (article noting that in late 2010, the firm Audit Integrity gave GMCR a score of 6 (very aggressive), indicat[ing] it had higher accounting and governance risk than 94% of companies). Lead Plaintiffs herein are Jerry Warchol, Robert M. and Jennifer M. Nichols, Loren Marc Schmerler, and Mike Shanley. See Dkt. No. 20 (Order appointing Lead Plaintiffs). While Class members may be subject to a damages limitation, under the Private Securities Litigation Reform Acts (PSLRA) 90-day bounce-back provision, a general rise in the stock price thereafter does not deprive Class members who sold immediately or shortly after the Companys announcement of their right to recover their damages. See 15 U.S.C. 78u-4(e)(2). The Class Period includes those who purchased GMCR common stock between July 28, 2010 and September 28, 2010, inclusive. 1. -411 10
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The Complaint puts Defendants on more than fair notice of Lead Plaintiffs claims in this litigation and the factual grounds upon which the allegations are based. Lead Plaintiffs allege in detail Defendants misrepresentations regarding: (i) improper revenue recognition on shipments of product to GMCRs primary fulfillment vendor, MBlock; (ii) improper accounting for intercompany transactions, which caused inventory and earnings to be overstated; (iii) improper understatement of customer incentive and marketing expenses; (iv) the dissemination of financial statements that were in violation of Generally Accepted Accounting Principles (GAAP); and (v) Defendants false statements regarding GMCRs internal controls over financial reporting. See 4. Evidence of scienter abounds. One witness (CW1) indicated that GMCR knew of an SEC investigation no later than early May 2010 (when the witness was contacted by GMCR employees to ask if he/she was the whistleblower). 68. Without disclosing this fact, GMCRs unit Presidents exercised options years before they were to expire to sell more than $7.9 million worth of stock in the six-week period before the SEC inquiry was revealed. While GMCR claims it was first informed of the SEC inquiry and an accompanying document request on September 20, 2010, it withheld this information from investors for more than a week. In the interim, Keurig President Michelle Stacy (Stacy) sold 5,000 shares on September 21, 2010 her third set of transactions in five weeks.12
See 102. Stacy belatedly filed an Amended Form 4, claiming she established a Rule 10b5-1 trading plan on August 13, 2010. 104. While Defendants argue that the plan is exculpatory (see GMCR Br. at 19-20 and n.9), on March 14, 2011, Antar devoted two articles to the uncanny luck Stacy has had with respect to her trading. See Rosenfeld Decl., Exhibit H Sam E. Antar, Green Mountain Coffee Roasters: The Foul Aroma of Michelle Stacys Stock Sales, White Collar Fraud (Mar. 14, 2011), http://whitecollarfraud.blogspot.com/2011/03/green-mountain-coffee-roastersfoul.html; and Rosenfeld Decl., Exhibit I Sam E. Antar, Is Michelle Stacy a shrewd insider, a psychic or just plain lucky?, White Collar Fraud (Mar. 14, 2011), http://whitecollarfraud. blogspot.com/2011/03/is-michelle-stacy-shrewd-insider.html. -5-
12
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Witnesses also indicated that senior management was aware of problems with revenue recognition, inventory control, and accounting, particularly as related to MBlock, and simply ignored these problems. See, e.g., 65-66, 70-71, 75-76, 82. Thus, despite protestations that the timing of the exercise of stock options by unit Presidents Stacy and McCreary was innocent and coincidental, it appears to have been quite calculated. While these GMCR executives took full advantage of their inside knowledge by exercising options and unloading their stock prior to an official announcement of bad news, the investing public did not fare as well: Defendants egregious mistakes and their reckless behavior resulted in an inquiry by the SEC, substantial and material accounting misstatements requiring the restatement of five years of financial reporting, a loss of investor confidence, and a precipitous price decline. 48. In sum, using Class Period and post-Class Period admissions, SEC filings, confidential witnesses, press releases, and conference calls to detail their claims, Lead Plaintiffs have more than adequately satisfied their pleading burden on these motions. Accordingly, it is respectfully submitted that Defendants motions13 should be denied in their entirety. II. STATEMENT OF FACTS Defendant GMCR is engaged in the specialty coffee and coffee maker business, selling a variety of coffees, cocoa, and teas under more than a dozen brand names. 2. The Companys business is largely concentrated in the manufacturing and marketing of gourmet single-cup coffee and tea brewing systems under the Keurig brand name. Id. The Keurig brewing system, acquired by GMCR in 2006, consists primarily of single-cup brewing packages known as K-Cups and special brewers in which K-Cups are inserted. During fiscal 2010, these two items respectively accounted for approximately 62% and 24% of the Companys total revenue. Id. The Companys
13
See Dkt. Nos. 33-35, Motions to Dismiss filed by Defendants Blanford and Rathke, jointly (B&R Br.), Stiller (Stiller Br.), and GMCR, respectively. -6-
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business is conducted in two main segments: (i) the Specialty Coffee Business Unit (SCBU), which sources, produces and sells coffee, tea and cocoa in traditional packages and in single-serving K-Cups; and (ii) the Keurig unit, which sells brewers and accessories as well as coffee, tea and cocoa in K-Cups that are produced by SCBU and other licensed roasters. 33-34. After a number of years of steadily-increasing organic growth, Defendants saw the pace of sales increases declining just as the 2012 expiration of the patented Keurig technology appeared on the horizon. 37, 55 (chart). Thus, over the past few years, GMCR shifted its business strategy, and acquired several roasting companies which had previously licensed its K-Cup technology. The Companys recent acquisitions and rapid revenue growth put GMCR on the map as a high-growth company, and sparked the interest of the investing community. During the Class Period, GMCR assured investors in its SEC filings that the Companys financial statements were being presented in conformance with GAAP and that the Company maintained a sound system of internal controls over its financial reporting. 38.14 However, starting in 2006, the year it purchased the Keurig technology, and continuing throughout its acquisition spree, GMCR recklessly failed to integrate its corporate accounting e.g., Keurig and SCBU not only maintained separate accounting departments, but used entirely different software systems (82(a)-(d)) or to hire employees with the accounting expertise necessary to produce the accurate
GMCR amended its 2009 Form 10-Ks Managements Report on Internal Control Over Financial Reporting. Although the 2009 Form 10-K, filed November 25, 2009 (the 2009 10-K; Rosenfeld Decl., Exhibit J), at 37, had, as did the 2006-2008 Form 10-Ks, expressly stated that GMCRs CEO and CFO participated in the assessment of the effectiveness of GMCRs internal control over financial reporting, the Form 10-K/A deleted references to their participation in the process. Compare Form 10-K/A, filed March 11, 2010 (Rosenfeld Decl., Exhibit K), with 2006 Form 10-K, filed December 14, 2006 (Rosenfeld Decl., Exhibit L), at 37 (under CEOs and CFOs supervision and with their participation); 2007 Form 10-K, filed December 13, 2007 (the 2007 10-K; Rosenfeld Decl., Exhibit M), at 39 (same); 2008 Form 10-K, filed December 11, 2008 (the 2008 10-K; Rosenfeld Decl., Exhibit N), at 36 (same). In light of what has transpired since, the intentional deletion is rather telling. -7-
14
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reporting required of a public company that was growing quickly through acquisitions. Instead of consolidating the financial statements and operations of its acquisitions, GMCR failed to adjust its inter-company inventory valuations and miscalculated income on royalties from third-party K-Cup sales. (Prior to GMCRs acquisition of several licensee roasters, GMCR managed earnings by recording royalty revenues on sales from the licensees to Keurig, which resold K-Cups with its brewers. 51-53 & n.3.)15 Aside from consolidation and inter-company elimination errors, GMCR had very basic internal control problems as well, failing to adequately account for marketing and incentive programs, because the sales force did not properly communicate incentives provided to customers to the Companys accounting department. 49, 92-95. Separate and apart from Defendants reckless reporting of GMCRs financial information arising from, inter alia, GMCRs integration of acquired companies, Defendants also managed the Companys revenues, on an as-needed basis, by using GMCRs primary fulfillment vendor, MBlock, as a captive warehouse to park its products. Former employees of both GMCR and MBlock described the one-sided nature of the relationship: the close relationship between the two companies resulted in MBlock whose business with GMCR grew from 20% to 75% of its overall business with the execution of a new contract in mid-2009 (67) agreeing to accept shipments from GMCR for which there were no retail orders.
GMCR contends that Plaintiffs have not sufficiently alleged scienter with respect to the restatement of $1 million of such royalty payments. See GMCR Br. at 28-29. However, no adjustments to royalty revenues were announced at the end of the Class Period on September 28, 2010; moreover, the 2010 10-Ks restated financial statements for the entire year show an increase to royalty payments in 2010 providing no indication that royalties from licensees were overstated in the third quarter of 2010. See Rosenfeld Decl., Exhibit B 2010 10-K at ii. Thus, one could reasonably infer that the reason that Defendants made a large investment in MBlock upon the signing of a new contract in mid-2009, allowing MBlock to open two new facilities at a time when GMCR was growing to become 75% of its business (65(a)-(d), 67), is that upcoming acquisitions of third-party licensees would mean an end to the ability to use royalty payments for earnings management and a new method was needed. 51-53. -8-
15
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64-66. Indeed, CW1 indicated that VP of Operations Wettstein and Director of Operations Don Holly did not set production levels based upon customer ordering history or inventory levels, but, instead, production was simply increased to give the illusion of continued growth to shareholders. As a result, according to CW1 and CW2, inventory piled up at MBlocks facilities; so much so that large quantities of product were stored beyond their expiration dates and had to be destroyed. 65(b). This practice enabled GMCRs management to knowingly boost reported sales because GMCR recognized revenues upon shipments to MBlock, telling employees to book revenues upon shipment even though the requisite paperwork to validate the sales as proper could not be located. See 70-71, 76. In other words, GMCR was able to ship its products to MBlock whether these products were ordered or not as a way to increase reported revenues and give the impression to investors that there was strong customer demand for its products. This practice was able to occur because, prior to the SEC inquiry, GMCRs revenue recognition policy allowed for revenue to be recognized upon shipment to MBlock.16 Because the SEC raised significant questions about the parties relationship, GMCR recently revised its revenue recognition policy to now provide that revenue is not booked until MBlock ships the product out to its customers. 73. Before Defendants disclosed any of the Companys accounting malfeasance to the investing public, unit Presidents Stacy and McCreary each sold a significant amount of GMCR stock between August 13, 2010, and September 21, 2010. See GMCR Br. at 22; 6-7. Prior to these sales, there had not been significant insider trading activity since June 2009. 6-7. These sales occurred during CW1 indicated that GMCRs outside auditor forced senior management to change GMCRs stated revenue recognition policy once before, after discrepancies had been discovered. 74. Indeed, the 2007 10-K stated that revenue was only recognized upon product delivery; however, the 2008 10-K adds that, in addition, revenue is recognized in some cases upon product shipment. Compare Rosenfeld Decl., Exhibit M 2007 10-K at 34, with Rosenfeld Decl., Exhibit N 2008 10K at 30; see also Rosenfeld Decl., Exhibit J 2009 10-K at 32 (same). -916
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a time of Company expansion GMCR having announced a $250 million stock sale to Italian coffee and coffee-maker giant Luigi Lavazza S.p.A. (Lavazza) on August 10, 2010 (6-8) and the acquisition of GMCRs Canadian rival VanHoutte (LJVH Holdings, Inc.), for $915 million (Canadian), and debt refinancing associated therewith, on September 14, 2010. 8. On September 28, 2010, shortly after the flurry of insider trading and deal making, the Company announced that the SECs Division of Enforcement was conducting an accounting inquiry into the Companys financial statements, particularly as they related to revenue recognition practices concerning GMCRs relationship with MBlock. GMCR also admitted to a $7.6 million cumulative overstatement of pre-tax income due to errors in several line items of GMCRs financial statements from 2007 forward. 5, 60. Immediately thereafter, GMCRs share price declined more than 16%, on almost ten times the average trading volume. 5. Ultimately, on November 19, 2010, the Company informed investors that its previously-issued financial statements for 2007 through the third quarter of 2010 could no longer be relied upon, and would need to be restated. 9, 39, 42.17 A sweeping, multi-year restatement was finally disclosed in GMCRs 2010 10-K, filed December 9, 2010, at which time GMCR also announced that the SECs inquiry could result in additional restatements. Not surprisingly, due to the broad scope of items covered by the restatement, and contrary to prior assurances of effective internal control over financial reporting, GMCR also notified investors of two material weaknesses in its internal control over financial reporting. 94-95. The weaknesses identified were failures in the consolidation process, causing GMCR not [to] have effective controls to ensure the completeness and accuracy of the accounting for inter-company transactions and, because of a lack of communication between accounting and
17
Although the November 19, 2010, press release only indicated a restatement of financial statements from 2007-2010 would be necessary, the 2010 10-K added the Companys fiscal 2006 financial statements to the list of GMCRs previously-issued, misstated financials. 48, n. 2. - 10 -
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sales functions and inexperienced accounting staff, GMCR did not have effective controls to ensure the completeness, accuracy and proper classification of certain marketing and customer incentive programs and related accrued liabilities. The 2010 10-K listed a half dozen remedial measures to be implemented to rectify the situation. 95. III. ARGUMENT A. The Complaint Adequately Alleges a Violation of 10(b) 1. Applicable Standards on a Motion to Dismiss a 10(b) Claim
Motions to dismiss are generally viewed with disfavor. See Teachers Ret. Sys. of La. v. A.C.L.N., Ltd., No. 01-11814, 2003 WL 21058090, at *10 (S.D.N.Y. May 12, 2003). When considering a motion to dismiss, the complaint is liberally construed, accepting all factual allegations in the complaint as true, and drawing all reasonable inferences in the plaintiffs favor. In re Tommy Hilfiger Sec. Litig., No. 04-civ-7678, 2007 WL 5581705, at *2 (S.D.N.Y. July 20, 2007) (citations omitted). A complaint need only allege enough factual matter (taken as true) to suggest that a violation occurred, and a well-pleaded complaint may proceed even if it strikes a savvy judge that actual proof of those facts is improbable . . . Bell Atl. Corp. v. Twombly, 550 U.S. 544, 556 (2007) (citation omitted). The pleading need only contain [f]actual allegations . . . [sufficient] to raise a right to relief above the speculative level. Id. When there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement to relief. Ashcroft v. Iqbal, 129 S. Ct. 1937, 1940-41 (2009). Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act) provides that it is unlawful for a person to employ any manipulative or deceptive device in contravention of the rules and regulations of the SEC in connection with the purchase or sale of any security. 15 U.S.C. 78j(b). To state a claim under 10(b) and SEC Rule 10b-5, one must allege: (1) a misrepresentation
- 11 -
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or omission of a material fact in connection with the purchase or sale of a security; (2) made by the defendant with scienter;18 (3) reliance on the representation; and (4) damage resulting from the representation. See Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172 (2d Cir. 2005); Heller v. Goldin Restructuring Fund, L.P., 590 F. Supp. 2d 603, 613 (S.D.N.Y. 2008) (citations omitted). In 1995, Congress amended the Exchange Act by enacting the PSLRA. A new, heightened pleading standard now applies to one of the elements of a 10(b) claim listed above, the mental state requirement of scienter. 15 U.S.C. 78u-4(b)(2) requires that, when considered together, all of the facts alleged must give rise to a cogent and compelling inference that defendants acted recklessly. See Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308, 314, 319 n. 3 and 322-24 (2007); ECA v. J.P. Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009). All other elements of a 10(b) claim are still governed by traditional pleading standards under Fed. R. Civ. P. 8(a) or 9(b). See In re PXRE Group, Ltd. Sec. Litig., 600 F. Supp. 2d 510, 528-29 (S.D.N.Y. 2009).19 Rule 9(b), which applies to all averments of fraud, requires that a complaint (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent. Rombach v. Chang, 355 F.3d 164, 170 (2d Cir. 2004) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)). Under neither Rule 9(b) nor the PSLRA is a plaintiff required to plead evidence. See Skydell v. Ares-Serono S.A., 892 F. Supp. 498, 501 (S.D.N.Y. 1995).
Scienter, which includes both intentional and reckless behavior, is defined as conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care . . . to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000) (citation omitted). Nor did the PSLRA alter the time-honored tenets, cited in the text, that motions to dismiss are disfavored (see In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613, 621 (S.D.N.Y. 2003)), and that the Court must accept all factual allegations in the complaint as true, drawing all reasonable inferences in the plaintiffs favor. See Tellabs, 551 U.S. at 322. - 12 19
18
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Although Defendants filed three separate motions, spanning more than 75 pages, their arguments are limited: they challenge the Complaint on the basis of the scienter allegations, the falsity of the statements related to improper revenue recognition on shipments to MBlock, and whether Defendant Stiller can be found liable if he did not make any explicit statements. Importantly, Defendants do not dispute, nor can they, that Plaintiffs have adequately alleged the material falsity of both the Class Period financial figures later restated and the Individual Defendants certifications of the accuracy of GMCRs SEC filings, as well as the elements of reliance, loss causation and damages. See, generally, Dkt. Nos. 33-35. 2. The Complaint Adequately Alleges Material False Statements Regarding Improper Revenue Recognition on Shipments to MBlock
Rule 10b-5(b) prohibits mak[ing] any untrue statement of material fact or . . . omit[ting] to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. 17 C.F.R. 240.10b-5. [O]nce corporate officers undertake to make statements, they are obligated to speak truthfully and to make such additional disclosures as are necessary to avoid rendering the statements made misleading. In re Par Pharm., Inc. Sec. Litig., 733 F. Supp. 668, 675 (S.D.N.Y. 1990); see also Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1098 n.7 (1991) (when a company chooses to speak, there can be no question that the statement [it] do[es] make carrie[s] with it no option to deceive); In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452, 469 (S.D.N.Y. 2006) (corporations have a duty to disclose all facts necessary to ensure the completeness and accuracy of their public statements). A statement is misleading if a reasonable investor would have received a false impression from the statement. See Par Pharm., 733 F. Supp. at 677. Moreover: [S]tatements, although literally accurate, can become, through their context and manner of presentation, devices which mislead investors. For that reason, the disclosure required by the securities laws is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead . . . - 13 -
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McMahan & Co. v. Wherehouse Ent., Inc., 900 F.2d 576, 579 (2d Cir. 1990) (citation omitted). The purpose of the disclosure requirements is to inform, not to challenge the readers critical wits. Va. Bankshares, 501 U.S. at 1097. A misrepresentation or omission is material when a reasonable investor would attach importance to it in making an investment decision. See Va. Bankshares, 501 U.S. at 1090 (citation omitted); Basic, Inc. v. Levinson, 485 U.S. 224, 231 (1988) (there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available). The materiality requirement poses a very low burden: [A] complaint may not properly be dismissed . . . on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance. Ganino v. Citizens Utilities Co., 228 F.3d 154, 162 (2d Cir. 2000). Thus, the trier of fact usually decides the issue of materiality. Here, Defendants made three categories of materially false and/or misleading statements during the Class Period: (1) an earnings release and related disclosures, including a Form 10-Q filing, containing misstated financial information that was eventually restated; (2) the CEOs and CFOs false certifications of the Form 10-Qs accuracy and GMCRs internal and disclosure controls; and (3) revenue figures that were inflated by improper sales to MBlock.20 As they must
GMCR makes the curious argument that the Complaint does not allege any false statements concerning revenue recognition in conjunction with sales to MBlock. See GMCR Br. at 14-16. In addition to alleging that the third quarter 2010 39-week revenue figure is inflated because of such sales (80), the Complaint explains the inflation was due, in part, to a highly-suspect 150-truckload sale to MBlock in the first quarter 2010 (70-71), because sales for which there are no purchase orders violate GAAP because, inter alia, there is no evidence that the price to the buyer is fixed or determinable. 72. For this reason, the lack of purchase orders, material requisition forms and product shipment authorizations violated internal GMCR policies used to validate sales as legitimate. 71. - 14 -
20
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when a restatement is made, Defendants concede the sufficiency of the pleading of material misstatements in the first two categories.21 Defendants contend that they do not know which statements the Complaint alleges to be materially false and misleading with respect to the relationship between GMCR and MBlock. See GMCR Br. at 13-15. They understand that the gravamen of the allegations is that the Companys financial reporting for the third quarter of 2010 was false, but then jump to the conclusion that the false statements contained therein were limited to the restated items, none of which were (ultimately) connected to the SEC inquiry into GMCRs relationship with MBlock. See id. at 13-15. This conclusion is unwarranted. Specifically, Plaintiffs allege that the 39-week figures reported at the end of the third quarter 2010 for the first three quarters of fiscal 2010, in GMCRs earnings release, conference call and Form 10-Q later filed with the SEC, were materially false and misleading because they included
21
[T]he mere fact that financial results were restated is sufficient basis for pleading that those statements were false when made. In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F. Supp. 2d 474, 486 (S.D.N.Y. 2004). The scope of the false statements include the financial statements and press releases issued during the Class Period . . . to the extent they reported, discussed, or analyzed figures that subsequently were restated[,] as well as any financial statistics derived from restated figures, In re BISYS Sec. Litig., 397 F. Supp. 2d 430, 437 (S.D.N.Y. 2005), and also representations that a companys financial statements had been compiled in accordance with GAAP when they were not. See In re CitiGroup Inc. Bond Litig., 723 F. Supp. 2d 568, 594 (S.D.N.Y. 2010). Similarly, false certifications under the Sarbanes-Oxley Act (SOX), concerning effectiveness of internal controls over financial reporting and disclosure of potential fraud, are themselves actionable misstatements. See In re Proquest Sec. Litig., 527 F. Supp. 2d 728, 745-46 (E.D. Mich. 2007). Indeed, [f]or these certifications to have any substance, signatories to the certifications must be held accountable for the statements. Middlesex Retirement Sys. v. Quest Software Inc., 527 F. Supp. 2d 1164, 1189 (C.D. Cal. 2007). In cases where, as here, there is a restatement, the element of materiality is alleged because, under GAAP, previously issued financial statements should be restated only to correct material accounting errors that existed at the time the statements were originally issued. Atlas Air, 324 F. Supp. 2d at 486; SEC v. Kelly, 663 F. Supp. 2d 276, 285 (S.D.N.Y. 2009) (same). - 15 -
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revenues from the first quarter that were the result of a substantial and undocumented delivery to MBlock. 72, 77-78, 80. According to CW1, a former distribution planning manager, 150 truckloads of product were shipped to MBlock even though CW1 and GMCRs global transportation manager could not find the requisite paperwork for the large shipment, i.e., purchase orders, material requisition orders, and product shipment authorizations, and the shipment was not listed on GMCRs production forecast schedule. Employees who worked for CW1 saw the trucks leave GMCR and saw the MBlock warehouses packed to the rafters with K-Cup inventory thereafter. CW1 indicated that members of GMCRs senior management were aware of this highly-unorthodox, undocumented shipment, including VP of Operations, Wettstein (who regularly provided updates to GMCR CEO, Defendant Blanford), SCBU President McCreary and VP of Finance, Bissonette. Finally, CW1 approximated the amount of the improperly recognized revenue on the shipment as between $7.5 million and $15 million. 70-72. These allegations, which describe why GMCRs 39-week revenue figures were inflated by $7.5-$15 million, readily satisfy the Second Circuits standard for pleading fraud with specificity, as affirmed in Rombach, because they (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent. 355 F.3d at 170 (quoting Mills, 12 F.3d at 1175). While this alleged improperly-recognized revenue was not part of the revenues removed in the restatement announced on December 9, 2010, that does not reduce their falsity. Indeed, a restatement requires the consent of management and it is thus within their discretion to determine if a restatement should be made for this transaction, which resulted from the Companys inadequate internal controls. See Aldridge v. A.T. Cross Corp., 284 F.3d 72, 83 (1st Cir. 2002). In any event, GMCR has already warned investors that additional restatements might be necessary, depending upon the conclusions reached in the SEC investigation. - 16 -
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3.
Board Chairman Stiller Can Be Held Liable for Class Period Misstatements
Defendant Stiller, the Companys founder, and its President and CEO from GMCRs inception until 2007, argues that he cannot be held responsible for any of GMCRs misstatements during the Class Period because he did not personally speak or execute any Class Period documents filed by GMCR with the SEC. See Stiller Br. at 2, 12-13.22 Stiller further contends that he is not liable for GMCRs public statements under the group pleading doctrine because he is not actively involved in the day-to-day operations of the Company. Id. at 13-15. However, as explained below, that bald assertion is not supported by the facts. For pleading purposes, under the group pleading doctrine, plaintiffs may rely on a presumption that statements in prospectuses, registration statements, annual reports, press releases, or other group-published information, are the collective work of those individuals with direct involvement in the everyday business of the company. BISYS, 397 F. Supp. 2d at 438.23 Rather than being solely limited to current officers, the doctrine may apply to outside directors, who . . . can fall within the group pleading presumption when, by virtue of their status or a special relationship with the corporation [they] have access to information more akin to a corporate insider.
Founder Stiller was GMCRs President and CEO for nearly 26 years, from July 1981 until May 2007. See Stiller Br. at 14. The period of the restatement started in fiscal 2006, the year that GMCR acquired Keurig. Thus, not only did the financial misstatements incorporated into GMCRs later financial filings begin on Stillers watch (95), but even after stepping down as CEO, Stiller continued to execute GMCRs yearly Form 10-K filings in 2008, 2009 and 2010 both prior to and subsequent to the Class Period. See Rosenfeld Decl., Exhibit B 2010 10-K at 57; Rosenfeld Decl., Exhibit J 2009 10-K at 43; Rosenfeld Decl., Exhibit N 2008 10-K at 41. During the Class Period, the statements made in these earlier Forms 10-K remained alive and uncorrected. Stiller suggests that it is unclear whether, in the Second Circuit, group pleading survived the 2007 Tellabs decision. See Stiller Br. at 13 n.4. However, other courts in this Circuit have affirmed its viability. See King County, WA v. IKB Deutsche Industriebank AG, 751 F. Supp. 2d 652, 659-60 and nn.48 and 49 (S.D.N.Y. 2010) (citing cases). - 17 23
22
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Pension Comm. of the Univ. of Montreal Pension Plan v. Banc of Am. Sec., LLC, 440 F. Supp. 2d 163, 180 (S.D.N.Y. 2006). Such a special relationship can be found where a board chairman executes SEC filings, is a significant consultant on company affairs, serves on board committees (see Schnall v. Annuity and Life Re (Holdings) Ltd., No. 3:02 CV 2133, 2004 WL 231439 (D. Conn. Feb. 4, 2004) (so holding)), or where the chairman founded and still owns a significant percentage of the company. See In re Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d 741, 767-68 (S.D.N.Y. 2001), abrogated on other grounds, In re IPO Sec. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003) (so holding where founder and chairman still a 3% owner). All of these factors are present here. Stiller is not only GMCRs founder, but he owns more than 12% of GMCRs outstanding shares. See Form DEF 14A, filed January 24, 2011 (the January 24, 2011 DEF 14A; Rosenfeld Decl., Exhibit O), at 39. While Stiller claims that he was only acting as the Chairman of the Board after May 2007 (Stiller Br. at 14), his role is a far more unique and active one than he implies: [T]he Chairman is charged with presiding over all meetings of the Board and our shareholders, and providing advice and counsel to our Chief Executive Officer and other Company officers regarding our business and operations . . . Moreover, as the Companys founder and former Chief Executive Officer, our Chairman is uniquely qualified to provide insight, advice, guidance and counsel to our Chief Executive Officer about the Companys operations and strategy. Rosenfeld Decl., Exhibit O January 24, 2011 DEF 14A at 7.24 Moreover, in addition to his director fees of $92,000, in 2009, Stiller received a one-time stock option grant of 30,643 shares at an exercise price of $26.11 per share in recognition of his important role in the successful transition to a
24
Indeed, Stiller is not only the Chairman of the Board; he also serves as the Chairman of the Boards Corporate Social Responsibility Committee. See Rosenfeld Decl., Exhibit O January 24, 2011 DEF 14A at 8. As such, he remains a very public face for GMCRs social responsibility initiatives. - 18 -
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new chief executive officer. Form DEF 14A, filed January 25, 2010 (the January 25, 2010 DEF 14A; Rosenfeld Decl., Exhibit P), at 21. Notably, the more traditional duties of a Chairman of the Board, e.g., chairing and calling Board meetings, serving as a liaison between the Board and the CEO, consulting with the CEO (and Chairman Stiller) on matters to be presented at Board and committee meetings, have been delegated to Lead Director William Davis, who appears to have held that role since 2009. See Form DEF 14A, filed January 26, 2009 (the January 26, 2009 DEF 14A; Rosenfeld Decl., Exhibit Q), at 24; Rosenfeld Decl., Exhibit P January 25, 2010 DEF 14A at 7. Consequently, Chairman Stillers significant and unique duties and actions place him squarely within the realm of an insider, for the purposes of group pleading liability. Thus, Defendant Stiller may be held liable for GMCRs public statements during the Class Period.25 4. The Complaint Adequately Alleges Scienter
Plaintiffs plead a strong inference of scienter by alleging facts that, when accepted as true and taken collectively, would [have] a reasonable person deem the inference of scienter at least as strong as any opposing inference[.] Tellabs, 551 U.S. at 310, 322. The inference is strong if it is cogent and compelling and at least as likely as any plausible opposing inference. Id. at 324, 328 (emphasis in original). Where the inference of scienter is equal to a plausible opposing inference, a
Stiller repeatedly cites Dresner v. Utility.com, Inc., 371 F. Supp. 2d 476 (S.D.N.Y. 2005), to argue that a founder and former board chairman is not an insider because he is no longer involved in the day-to-day activities of the corporation. See Stiller Br. at 12-15. Dresner, however, distinguished between officers, denominated insider defendants, and all other individual defendants, referred to as non-insider defendants. 371 F. Supp. 2d at 482-83. The court noted that non-insiders, almost by definition, are excluded from the day-to-day management of a corporation. Id. at 494. Here, however, because of Stillers recent employment history as well as his ongoing special role with the Company GMCR deemed Stiller an inside director rather than an independent, outside director. See, e.g., Rosenfeld Decl., Exhibit P January 25, 2010 DEF 14A at 6 (At the Boards meeting in September 2009, the Board determined that all of our Directors, except Messrs. Blanford and Stiller, are independent . . .). - 19 -
25
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tie goes to the plaintiff. See id. at 324; see also Heller, 590 F. Supp. 2d at 620; Sloman v. Presstek, Inc., No. 06 CV 377, 2007 WL 2740047, at *7 (D.N.H. Sept. 18, 2007). Also [t]he inference that the defendant acted with scienter need not be irrefutable, i.e., of the smoking-gun genre, or even the most plausible of competing inferences. Tellabs, 551 U.S. at 324 (citation omitted). GMCRs scienter may be established separate and apart from the Individual Defendants: [I]t is possible to draw a strong inference of corporate scienter without being able to name the individual who concocted and disseminated the fraud. Suppose General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero. There would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false. Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, Inc., 531 F.3d 190, 195-96 (2d Cir. 2008) (Dynex) (quoting Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702, 710 (7th Cir. 2008)). Thus, a complaint may adequately allege corporate scienter without alleging scienter as to any particular defendant. Sgalambo v. McKenzie, 739 F. Supp. 2d 453, 486 n.205 (S.D.N.Y. 2010) (citing Dynex, 531 F.3d at 195). A corporations scienter necessarily derives from the state of mind of its employees (In re Marsh & McClennan, 501 F. Supp. 2d at 481 (citing Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 101 (2d Cir. 2001)) . . . Proof of a corporations collective knowledge and intent is sufficient. In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247, 281 (S.D.N.Y. 2008) (quoting In re WorldCom, Inc. Sec. Litig., 352 F. Supp. 2d 472, 497 (S.D.N.Y. 2005)). In this Circuit, the scienter requirement can be satisfied by alleging facts constituting strong circumstantial evidence that: (1) Defendants had motive and opportunity to commit fraud; or (2) facts that demonstrate Defendants conscious misbehavior or recklessness. See In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 74 (2d Cir. 2001) (citing Novak, 216 F.3d at 311); In re IPO Sec. Litig., 544 F. Supp. 2d 277, 286 (S.D.N.Y. 2008). Regarding the second prong, allegations that may give rise to a strong inference of scienter include that the defendants knew facts or had access to - 20 -
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information suggesting that their public statements were not accurate or that they failed to check information they had a duty to monitor. ECA, 553 F.3d at 199 (citing Novak, 216 F.3d at 311). To satisfy either prong, great specificity is not required provided the plaintiff alleges enough facts. See Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., No. 05 Civ. 1898, 2005 WL 2148919, at *7 (S.D.N.Y. Sept. 6, 2005) (Bombardier); In re Veeco Instruments Sec. Litig., 235 F.R.D. 220, 231 (S.D.N.Y. 2006); In re Am. Intl Group, Inc., 741 F. Supp. 2d 511, 532 (S.D.N.Y. 2010) (multiple facts may complement each other to create an inference of sufficient strength to satisfy the PSLRA); cf. Tellabs, 551 U.S. at 322-23 (allegations contributing to strong inference are considered together, not individually). Here, Plaintiffs allege fact, with sufficient detail, that, when taken together, make it at least as likely as not that Defendants acted with scienter. a. The Complaint Has Pled with Particularity Motive and Opportunity (1) The Disclosure of the SEC Inquiry on the Day of the Lavazza Closing Was Highly Suspicious
Defendants scoff at the notion that GMCRs financing activities may give rise to an inference of scienter, contending that it is a motive of all companies to keep share prices high to enhance stock placements. See GMCR Br. at 4, 17-18; B&R Br. at 8-10; Stiller Br. at 6-8. However, the Second Circuit long ago recognized that in certain instances, the artificial inflation of stock price in the acquisition context may be sufficient for securities fraud scienter. In re Unisys Corp. Sec. Litig., No. Civ. A. 00-1849, 2000 WL 1367951, at *6 (E.D. Pa. Sept. 21, 2000) (citing In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 270 (2d Cir. 1993)). Specifically, in a transaction where the investment amount is fixed but the number of shares to be issued is tied entirely to the price of common stock, scienter may be inferred when a defendant conceals material facts because their disclosure would have caused a price drop and the defendant would have had to issue more shares to close the deal. See In re ATI Techs. Inc., Sec. Litig., 216 F. Supp. 2d 418, 439-40 (E.D. Pa. 2002) (and cases cited - 21 -
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therein). Here, Lavazza agreed to purchase $250 million of newly-issued shares, with the share price to be equal to the volume-weighted average price of the Common Stock as quoted on the Nasdaq for the 60 Business Days ending on the Business Day immediately preceding the Closing, less seven and a half percent (7.5%). (Emphasis added.)26 Consequently, while GMCR argues that disclosure of the SEC inquiry and the initial items to be restated on the same day as the Lavazza closing serve to negate scienter, quite the contrary is true. While one witness claims that Defendants knew about the SEC inquiry as early as the spring of 2010 (68), GMCR admittedly knew about the SEC inquiry no later than September 20, 2010. 90. A strong inference of scienter is thus raised by GMCR withholding bad news news which brought its share price down 16% once revealed until the day of the Lavazza closing, once the price per share had just been fixed pursuant to the terms of the contract.27
26
See Rosenfeld Decl., Exhibit R Common Stock Purchase Agreement, Form 8-K, filed August 11, 2010, at Ex. 10.1, Sec. 2.
Nor does the VanHoutte (LLVH Holdings) deals event chronology negate scienter, as GMCR contends. See GMCR Br. at 4, 17-18. The purchase and the terms of debt financing for the deal were announced on September 14, 2010, one week before the SEC requested documents concerning the MBlock relationship, and two weeks before the revelation of problems at GMCR. 87, 88, 90. Disclosure of the SEC inquiry and the initial items to be restated was made pursuant to Regulation FD, in conjunction with the deal and the associated financing transaction meaning that GMCR, having disclosed this material information to the participating lenders, was required to publicly disclose it as well. Thereafter, the scope of the restatement grew, stemming from internal control problems, and the SEC inquiry was not quickly resolved. 92-95. The deal closed only after the audited restatement was filed, with the terms of the financing significantly altered. Compare Rosenfeld Decl., Exhibit S Form 8-K, filed September 14, 2010, at Ex. 99.1 ($1.35B of new debt financing comprised of: (i) $750M 5-year senior secured revolving credit facility; (ii) $250M 5-year senior secured term loan A; and (iii) a $350M 6-year senior secured term loan B), with Rosenfeld Decl., Exhibit T Form 8-K, filed December 17, 2010, at Ex. 99.1 ($1.45B of financing, consisting of: (a) $250M term loan A; (b) $550M term loan B; (c) $450M U.S. revolving credit facility; and (d) $200M alternative currency revolving credit facility). - 22 -
27
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(2)
The Scienter of the Senior Executives Who Engaged in Highly-Suspicious Stock Sales May Be Imputed to GMCR
The Complaint alleges suspiciously-timed stock sales by Stacy and McCreary, the Presidents of GMCRs Keurig and SCBU business units, respectively. 102-104. Even though neither had sold stock in more than a year, McCreary sold shares valued at $6.6 million just six weeks before GMCR announced the first restated items and the SEC inquiry; Stacy reaped almost $1 million in proceeds on shares sold on the very same day she adopted a Rule 10b5-1 plan a plan she had initially forgotten she had adopted when she made the required SEC filings on later sales and another $185,000 on shares sold the day after GMCR claimed to have first been contacted about the SECs inquiry, a week before GMCR made the information public.28 Yet GMCR contends that there is nothing unusual or suspicious about McCrearys and Stacys sales. See GMCR Br. at 19-23, arguing the point at length. As explained below, GMCRs claim strains credulity. Before undertaking a contextual analysis of the trading, GMCR stresses at the outset that neither unit President is named as a defendant; later, they make the parallel argument that the Individual Defendants did not sell any shares. See GMCR Br. at 19 and 23. Neither argument is dispositive. With respect to the first point, because, as explained above, corporate scienter is not limited to the scienter of the named defendants, courts may consider insider sales by other members of senior management. See, e.g., Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1225 (1st Cir. 1996) (insider trading in suspicious amounts or at suspicious times may permit an inference that the
The SEC inquiry is clearly material, in light of the fact that MBlock is GMCRs chief fulfillment vendor, one so critical that GMCRs SEC filings contain risk warnings concerning adverse business effects a disruption of this relationship would cause. See, e.g., Rosenfeld Decl., Exhibit B 2010 10-K at 14. Material information to be filed on Form 8-K must be filed within four business days yet GMCR did not do so on Friday, September 24, 2010, but waited instead until September 28, 2010. See 17 C.F.R. 249.308; see also Rosenfeld Decl., Exhibit U blank, fillable Form 8-K, available at http://www.sec.gov/about/forms/form8-k.pdf. - 23 -
28
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trader and by further inference, the company possessed material nonpublic information at the time) (citation omitted). Regarding the latter point, the Supreme Court made clear in Tellabs, the absence of a motive allegation is not fatal. 551 U.S. at 325. Next, in defense of Stacys sales, GMCR argues that periodic stock sales pursuant to a trading plan adopted under Rule 10b5-1 cannot be deemed unusual or suspicious. See GMCR Br. at 20. This argument is flawed in three respects. First, the existence of a Rule 10b5-1 trading plan is an affirmative defense, not properly raised on a motion to dismiss. See Miss. Pub. Emps. Ret. Sys. v. Boston Scientific Corp., 523 F.3d 75, 92 (1st Cir. 2008) (Boston Scientific) (on a pleading motion, there is no evidence of when the trading plans went into effect, that such trading plans removed entirely from defendants discretion the question of when sales would occur, or that they were unable to amend these trading plans); In re ArthroCare Corp. Sec. Litig., 726 F. Supp. 2d 696, 72223 (W.D. Tex. 2010) (quoting Boston Scientific, 523 F.3d at 92); Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 200-01 (S.D.N.Y. 2010) ([T]he existence of a Rule 10b5-1 Trading Plan is an affirmative defense that must be pled and proved.) (quoting Malin v. XL Capital Ltd., 499 F. Supp. 2d 117, 156 (D. Conn. 2007)). While it is true that the Complaint references Stacys plan, its terms are not before the Court; thus, it is cannot be used to negate an inference of scienter. Second, an attempt to use a Rule 10b5-1 plan as a non-suspicious explanation for trading is undercut when the plan is entered into during the class period. See Freudenberg, 712 F. Supp. 2d at 201 (citing Cent. Laborers Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546, 554 (5th Cir. 2007)); In re Fed. Natl. Mortg. Assn. Sec., Deriv., and ERISA Litig., 503 F. Supp. 2d 25, 48 (D.D.C. 2007) (citing cases). An inference of innocence can only be afforded if the plan was adopted prior to the time the insider came into possession of material, non-public information. See Lefkoe v. Jos. A. Bank Clothiers, No. WMN-06-1892, 2008 WL 7275126, at *5 and n.7 (D. Md. May 13, 2008); In re Cardinal Health Inc. Sec. Litig., 426 F. Supp. 2d 688, 734 and n.58 (S.D. Ohio - 24 -
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2006) (finding four sales on two dates by insider, totaling $743,984, to be evidence of scienter and rejecting argument that timing of adoption is not beside the point: The timing of the plan is crucial because, without a 10b5-1 plan in existence, Jensens trading activity could very well point to Jensens effort to dump his Cardinal stock.). Here, the Class Period began on July 28, 2010, when GMCR announced its results for the 13 and 39 weeks ended June 26, 2010. 77. According to CW1, however, by no later than early May, Defendants were aware of the SEC investigation (because CW1 had received telephone calls from employees still at GMCR asking if CW1 had been the whistleblower to the SEC). 68. Whereas Keurig relies on a single order fulfillment entity, [MBlock], to process the majority of sales orders for its AH single-cup business with retailers in the United States, Rosenfeld Decl., Exhibit B 2010 10-K at 43, it defies logic that Stacy, the President of Keurig, was not aware of the SEC inquiry by May 2010. Therefore, Plaintiffs have alleged sufficient facts to establish that Stacy was in possession of material, non-public information both at the start of the Class Period and at the time she purportedly adopted her Rule 10b5-1 trading plan on August 13, 2010. 104. Third, a question of fact exists about the date on which Stacys plan was actually adopted. On August 17, 2010, Stacy filed a Form 4 (as required by the SEC for all stock transactions by officers, directors and large shareholders) for a $928,500 stock sale made on August 13, 2010. See Rosenfeld Decl., Exhibit W. No reference is made to adoption of a Rule 10b5-1 trading plan29 although it supposedly occurred just four days earlier. See id. On September 15, 2010, Stacy filed a Form 4 for a $177,000 sale made on September 13, 2010. See Rosenfeld Decl., Exhibit X. Again, no mention is made of a Rule 10b5-1 trading plan. See id. On September 21, 2010 a day after GMCR claims to have been first contacted by the SEC and asked to produce documents concerning A Form 4 includes an area where one can make a notation to indicate if the sale is being made pursuant to a rule 10b5-1 trading plan. - 25 29
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the MBlock relationship Stacy made two sales, totaling $185,000. See Rosenfeld Decl., Exhibit Y. Once again, there is no mention in the Form 4 of any Rule 10b5-1 trading plan. See id. In the wake of the accounting revelations that followed, Sam Antar raised questions about the propriety of the trades: On October 21, 2010, I raised questions about the timing of Michelle Stacys stock sales. On October 28, 2010, Stacy belatedly filed amended Form 4 reports and claimed she established a Rule 10b5-1 trading plan on August 13, 2010 . . . She amended certain SEC Form 4 filings for her stock sales on September 13 and September 21 to reflect her 10b5-1 trading plan. However, her sale of 30,000 shares on August 13 was not pursuant to a 10b5-1 trading plan. According to Stacys amended SEC filings, her 10b5-1 trading plan only covered future stock transactions. (Emphasis added.)30 Even Stacys highly-suspect, after-the-fact amendments did not claim that her largest sale ($928,000) is covered by her Rule 10b5-1 plan. Therefore, it is cannot be used to negate scienter.31 Citing to two cases, GMCR next argues that neither Stacys nor McCrearys sales were unusual or suspicious because they were not made in close proximity to the September 28, 2010, revelation. See GMCR Br. at 20-21 and n.10. Both are readily distinguishable. In In re Bausch & Lomb, Inc. Securities Litigation, 592 F. Supp. 2d 323, 344 and n.24 (W.D.N.Y. 2008), many sales were made over an extended period of time, pursuant to Rule 10b5-1 trading plans, with almost all
30
See Rosenfeld Decl., Exhibit I (http://whitecollarfraud.blogspot.com/2011/03/is-michellestacy-shrewd-insider.html). It should be noted that Lead Plaintiffs erroneously alleged that amended Form 4/As were filed for the sales made on all three dates. 104. However, Antar is correct that Stacy only amended the Form 4s for the sales in September 2010 curiously made just eight days apart and not for the August 13, 2010, sale. Nor could she a pre-planned sale could not occur on the day the plan is first adopted.
Even if Stacy did adopt her Rule 10b5-1 trading plan in August 2010, the act of adoption itself may give rise to an inference of scienter because a clever insider might maximize their gain from knowledge of an impending price drop over an extended amount of time, and seek to disguise their conduct with a 10b5-1 plan. Freudenberg , 712 F. Supp. 2d at 200 (quoting In re Immucor Inc. Sec. Litig., No. 05-CV-2276, 2006 WL 3000133, at *18 n.8 (N.D. Ga. Oct. 4, 2006)). - 26 -
31
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sales made more than two months before the negative disclosure. In particular, the court noted: Well over half of the sales were made more than eight months prior to the first alleged corrective disclosure; 81% were made more than five months before; and virtually all (97%) of the sales were made more than two months before the first disclosure of accounting problems. Here, in contrast, there was no insider selling at all in the year before the Class Period and all of the sales in question, valued at a whopping $7.9 million (for profits of $7.6 million), occurred within 46 days of the negative announcement. 90, 102-03. Supportive of Plaintiffs position herein, rather than Defendants, the court in In re KeySpan Corp. Securities Litigation, 383 F. Supp. 2d 358, 384 (E.D.N.Y. 2003), found that sales made in May 2001 were plausibly suspicious because of their proximity to a negative announcement on July 17, 2001. The court also acknowledged that other courts had found similar gaps of two months to be suspicious. Ultimately, however, because there were no other suspicious facts suggesting the sales were made at particularly propitious moments, the court found the sales were not probative of scienter. Id. at 386. Here, there are sufficient reasons to infer that August 13 through September 21, 2010 was a desirable time for McCreary and Stacy to sell their stock. First, even GMCR concedes the embarrassing timing of Stacys sale the day after the SEC purportedly requested documents in aid of an investigation weakly contending that the sales were small and made pursuant to the Rule 10b5-1 plan allegedly adopted a month before. See GMCR Br. at 21. Second, according to CW1, the SEC was already in the process of investigating the Company at that time. 68. McCreary, whom CW1 implicated in engaging in a multi-million dollar bogus sale to MBlock (70-71), had reason to sell shares before the SEC took action. Third, because the disclosures made on September 28, 2010 were made pursuant to Regulation FD, this material information had already been provided to the lenders in conjunction with the financing transaction, which was announced on September 14, 2010. 87. Thus, Stacy certainly knew about the - 27 -
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$7.6 million overstatement of Keurigs pre-tax income when she sold her stock on September 13, 2010. 90, 102. See In re Oxford Health Plans Sec. Litig., 187 F.R.D. 133, 139 (S.D.N.Y. 1999) (holding that [t]rades made a short time before a negative public announcement are suspiciously timed). GMCR does not contest that McCreary bought and sold in a single day more than twice the number of shares he held before or after, and that Stacy held a mere 1,894 shares both before and after her 40,000 share selling spree. Rather, they ask the Court to view this cynical activity in a more favorable light for two reasons. First, they ask the Court to consider all unexercised options as part of McCrearys and Stacys unsold holdings, although there is a split of authority as to whether this is proper. See GMCR Br. at 21-22.32 Even if this is proper, sale of 20% of Stacys and McCrearys overall holdings can still raise an inference of GMCRs scienter. See Senn v. Hickey, No. 03-CV-4372, 2005 WL 3465657, at *6 (D.N.J. Dec. 19, 2005) (insiders sale of 11.8% of holdings for $4 million sufficient to constitute scienter for insider and corporation). Second, without citation to authority, GMCR baldly asserts that because Stacy and McCreary flipped shares rather than selling what they already held, their sales activity is not suspicious or unusual. However, the Forms 4 filed in conjunction with the sales reveal that Stacys options did not expire until 2018 or 2019 and McCrearys did not expire until 2014.33 Thus, there was no time pressure to exercise them
32
While Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995) may have implied that the relevant comparison is percentage of holdings sold rather than stock sold, Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir. 2000), holds the opposite: after noting that one insider sold 9.9% of shares, representing 7.8% of his total holdings, the court ultimately ruled that a sale of 9.9% of his stock is not sufficient to be unusual (citing Acito, 47 F.3d at 54). See Rosenfeld Decl., Exhibit V Form 4, filed August 19, 2010 (McCreary); see also Rosenfeld Decl., Exhibits W-Y Forms 4, filed August 17, September 15, and September 23, 2010 (Stacy). - 28 -
33
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and the fact that those options were exercised or sold during the Class Period supports Plaintiffs claims. Finally, GMCR argues that scienter is negated by the fact that, during the Class Period, no other officers sold stock and that several directors acquired shares; additionally, Defendant Blanford acquired shares just prior to the Class Period. See GMCR Br. at 23; B&R Br. at 6-7. However, even in a case where three defendants purchased shares during the class period, at least one court expressed concern that permitting defendants to evade liability on that basis would lead to purchases made solely to aid the commission of securities fraud. See, e.g., Holmes v. Baker, 166 F. Supp. 2d 1362, 1378 (S.D. Fla. 2001). Thus, the purchases made by a few outside directors and one officer cannot negate the inference of scienter raised by McCrearys and Stacys highly-suspicious sales. b. The Complaint Adequately Alleges Conscious Misbehavior or Recklessness
Recklessness is conduct which represents an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Nortel Networks, 238 F. Supp. 2d at 631. Where a complaint alleges that defendants knew facts or had access to non-public information contradicting their public statements, an inference arises that defendants knew or, more importantly, should have known that they were misrepresenting material facts related to the corporation. Novak, 216 F.3d at 308. A number of factors point to a strong inference of Defendants recklessness.34
Although some courts continue to cite Kalnit v. Eichler, 264 F.3d 131, 142 (2d Cir. 2001), for the proposition that allegations of circumstantial misconduct have to be stronger where there is no motive alleged, the viability of that formulation is called into question by Tellabss rejection of a motive requirement and its holistic approach to consideration of all facts alleged. In any event, since the Complaint has adequately alleged motive, the Court should not hold the allegations of recklessness up to a higher standard as suggested by Defendants. See GMCR Br. at 24. - 29 -
34
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(1)
Improperly-Recognized MBlock Revenues Implicate GMCRs Core Operations
More than 20 years ago, the Second Circuit held that it is reasonable for plaintiffs to allege that senior executives have knowledge of facts concerning a critical portion of their companys business. In Cosmas v. Hassett, 886 F.2d 8 (2d Cir. 1989), the plaintiffs alleged that Inflight, a company that sold projection materials used in aircraft, made bullish projections when its executives knew of strict import restrictions imposed by China on its equipment. Plaintiffs alleged that Inflight was ultimately required to take a large inventory write-down because $5 million of its $6 million backlog had been for sales to Chinese customers which could not be consummated. Previously, Inflights CEO had boasted to Forbes magazine about sales to China being an important source of new revenues. See id. at 10-11. Although plaintiffs had not alleged specific facts demonstrating the defendant senior executives knowledge of the import restrictions, the court concluded that because sales to China were such a large portion of current sales 5/6s of Inflights backlog it could infer defendants knew about the import restrictions. See id. at 13. Because of the critical importance of accurate reporting of financial and operating results to investors evaluations of public companies, even in the absence of specific information contradicting defendants public statements, knowledge of the falsity of a companys financial statements can be imputed to key officers who should have known of facts relating to the core operations of their company that would have led them to the realization that the companys financial statements were false when issued. Atlas Air, 324 F. Supp. 2d at 489-490; In re Winstar Commcns., No. 01 CV 3014, 2006 WL 473885, at *7 (S.D.N.Y. Feb. 27, 2006); Veeco, 235 F.R.D. at 232-233 (so holding); see also In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266, 293 (S.D.N.Y. 2006) (imputing knowledge of contrary facts where statements concern matters of sufficient significance to the company).
- 30 -
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Here, the Complaint alleges that Defendants Blanford, Rathke, and Stiller, as CEO, CFO and Chairman of GMCR, respectively, were intimately involved in important issues affecting the Companys business and operations and had access to undisclosed information. 17-25, 99. Their positions also allowed them to directly control the Companys revenue recognition and other accounting practices. See In re Am. Bank Note Holographics Sec. Litig., 93 F. Supp. 2d 424, 448 (S.D.N.Y. 2000) (finding scienter allegation sufficient as to CFO where, because of his position, he was uniquely situated to control the revenue recognition procedures of the company). While Defendants argue that such allegations are insufficient (see GMCR Br. at 23-26; B&R Br. at 12; Stiller Br. at 9-10),35 the Complaint adds more specific allegations as well.
Plaintiffs do not simply allege that the Individual Defendants positions with the Company support an inference of scienter; rather, Plaintiffs allege that the roles of these Defendants, coupled with the restatement, pending SEC investigation, and accounts of confidential witnesses tying Defendants to the misstatements, are what support a strong inference of scienter. See In re CINAR Corp. Sec. Litig., 186 F. Supp. 2d 279, 316 (E.D.N.Y. 2002). Not surprisingly, the facts in Defendants cited cases are not comparable those alleged here a multi-year restatement arising from a failure (a) to properly account for every-day transactions between Keurig and SCBU and (b) of basic communication to the accounting department of customer incentives provided by the sales force. 95. For example, in City of Brockton Retirement Systems v. Shaw Group Inc., 540 F. Supp. 2d 464, 473 (S.D.N.Y. 2008), one restated item was an arithmetic error in one quarters financial statements and another error involved misinterpretation of complex accounting principles, FASB Interpretation 46(R), concerning the rules applied to consolidation of variable interest investments. Similarly, in SEC v. Espuelas, 579 F. Supp. 2d 461, 478-81 (S.D.N.Y. 2008), following depositions, the SEC failed to allege scienter against officers for misapplication of complicated revenue recognition rules for barter transactions. Hart v. Internet Wire, Inc., 163 F. Supp. 2d 316, 318-19 (S.D.N.Y. 2001) involved a hoax by a former employee of defendant financial press wire service to disseminate a false press release about a company to lower its price so that he could avoid a margin call. The court dismissed securities fraud claims against Internet Wire and Bloomberg for issuing the release, based solely upon the allegation that they merely ought to have known a press release provided to them was false. Id. at 321. In In re Security Capital Assurance Ltd. Securities Litigation., 729 F. Supp. 2d 569, 596 (S.D.N.Y. 2010), an insurer of collateralized debt obligations had no access to information concerning the underlying assets, which were quite weak. Scienter was not found because defendants relied upon ratings agencies AAA rating as an assurance that the obligations being insured were top-tranche and thus backed by solid assets. Glickman v. Alexander & Alexander Services, Inc., No. 93-7594, 1996 WL 88570, at *1, *14 (S.D.N.Y. Feb. 29, 1996), involved improper accounting at an independent subsidiary of a large insurance broker with operations in 80 countries. Because the subsidiary had its own management team, the court refused - 31 -
35
Filed 07/12/11 Page 43 of 60
As discussed above, at 9 and n.15, CW1 indicated that GMCRs outside auditors had earlier required a change in the published revenue recognition policy, which occurred from 2007 to 2008, to disclose that some revenues were booked on shipment. The policy changed yet again, in the 2010 10-K, with revenue now only being recognized after MBlock shipped its inventory out to buyers. The Individual Defendants signed the Forms 10-K for 2007, 2008, 2009 and 2010,36 and CEO Branford and CFO Rathke signed both the Class Period Form 10-Q and the SOX certifications filed with it. 80, 83. In light of the important changes to the revenue policy and MBlocks preeminent position as Keurigs sole fulfillment entity, before executing the various documents filed with the SEC, the Individual Defendants had a duty to familiarize themselves with the accuracy of GMCRs reporting with respect to revenues on sales to MBlock. See Bombardier, 2005 WL 2148919, at *13 (In order to sign the 8-Ks, Peters had a duty to familiarize himself with the facts relevant to the core operations of BCI, and he should have been aware that the high delinquency rates stemmed from improper underwriting.). Defendants next argue that Plaintiffs fail to allege Defendants access to specific reports or statements that demonstrate the inaccuracy of GMCRs public filings. See GMCR Br. at 26; B&R Br. at 12-13; Stiller Br. at 10-12. This is not the case. First, citing to CW1, Plaintiffs allege that VP Wettstein and VP Don Holly ignored GMCR documents including customer ordering history and
to find the parents management reckless for failure to monitor information they theoretically had unfettered access to. Lastly, Teamsters Allied Benefit Funds v. McGraw, No. 09 Civ. 140, 2010 WL 882883 (S.D.N.Y. Mar. 11, 2010) (McGraw) involved a shareholder derivative action. See Stiller Br. at 9-10. The case is distinguishable because shareholder derivative suits enforce a corporate cause of action, whereas here the claims are brought on behalf of investors. Id. at *4 (emphasis in original). In a similar vein, the court in McGraw employed the legal standard applied to claims brought in shareholder derivative suits, which is a substantially different standard i.e., containing additional elements of proof from the standard to be applied in actions where investors assert direct claims.
36
See Rosenfeld Decl., Exhibit B 2010 10-K at 57; Rosenfeld Decl., Exhibit J 2009 10-K at 43; Rosenfeld Decl., Exhibit N 2008 10-K at 41; Rosenfeld Decl,, Exhibit M 2007 10-K at 44. - 32 -
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inventory levels when they set production levels to give the illusion of growth (65(b)), which led to a sharp year-over-year increase in inventory in 2010. 54. Second, VP of Operations Wettstein, SCBU President McCreary and VP of Finance Bissonette were well aware that a 150-truckload shipment was made to MBlock despite the absence of all of the usual documentation for customer orders that accompanied shipments of product to MBlock, i.e., purchase orders, material requisition orders and product shipment authorizations. 70-71. With the knowledge of three senior executives, this suspicious sale to MBlock was booked as $7.5-15 million of revenue in the first quarter of 2010. 65(c) and 76.37 Scienter is sufficiently pled where the plaintiffs allege that a defendant was directly confronted with information that made its public disclosures inaccurate and unreasonable. See In re Alstom SA Sec. Litig., 454 F. Supp. 2d 187, 206 (S.D.N.Y. 2006); see also In re Van Der Moolen
Citing In re MBIA, Inc. Securities Litigation, 700 F. Supp. 2d 566, 590 (S.D.N.Y. 2010), Campo v. Sears Holding Corp., 371 Fed. Appx. 212, 216 (2d Cir. 2010), and other inapposite cases, the Individual Defendants contend that the existence of reports that CW1 acknowledged were seen by GMCRs VP of Operations and were presumably accessed by Blanford, who received regular updates from that executive, does not satisfy the scienter requirement because the Complaint did not allege the Individual Defendants actual knowledge of the content of the reports. See B&R Br. at 15-16. However, the Second Circuit, in Novak, only held that [w]here plaintiffs contend defendants had access to contrary facts, they must specifically identify the reports or statements containing this information. 216 F.3d at 309. Novak does not require an allegation that the defendant actually received the reports or statements or knew their contents. Indeed, any such requirement of actual knowledge would render the word access in Novak meaningless, since Novak permits a plaintiff to allege scienter by alleging that defendants knew facts or had access to information suggesting that their public statements were not accurate. Id. at 311 (emphasis added). Whether or not the Individual Defendants read order history or inventory reports, they plainly had direct access to them or their contents, through periodic updates by the VP of Operations. Similarly, through (at least) his updates from the VP of Operations, it is reasonable to infer that Blanford was aware of the $7.5-$15 million MBlock shipment in the first quarter of 2010, the completely undocumented nature of which raised concern among GMCR employees, including CW1 and the global transportation manager, such that it was brought to the attention of three senior executives. See In re Scottish Re Group Sec. Litig., 524 F. Supp. 2d 370, 394 (S.D.N.Y. 2007) (It is simply not a plausible opposing inference that the Companys officers sophisticated executives actively engaged in the planning of these transactions were ignorant of the transactions consequences on the Companys deferred tax assets.). - 33 -
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Holding N.V. Sec. Litig., 405 F. Supp. 2d 388, 406 (S.D.N.Y. 2005). Thus, in light of the first quarter 2010 multi-million dollar sale to MBlock being improperly recorded as revenue with the knowledge of senior management, GMCR inaccurately reported its 39-week results with scienter in its July 28, 2010 press release and August 5, 2010 SEC filing on Form 10-Q.38 (2) The Complaint Alleges Scienter with Respect to the Misrepresentations in and Omissions from the Third Quarter 2010 Form 10-Q
With respect to the inter-company transactions that were not properly accounted for especially after GMCR acquired various roasters who, rather circularly, had paid GMCR royalties for K-Cups they produced and sold to Keurig the Complaint alleges that it was common knowledge that Keurig did not use the same software as the rest of the Company (Great Plains instead of Peoplesoft) and that it operated separately as well. 82(a)-(d). One witness, CW10, who worked in the accounting department of a roaster company acquired by GMCR, commented that problems with inter-company transfers could arise because of the fact that the two units used different systems. 82(d). Whereas Keurig was acquired in 2006, the potential danger arising from GMCR relying upon non-uniform accounting software presented itself at that time and should have been the subject of internal control checks from that point forward, particularly when GMCR acquired roasting companies whose software was also incompatible with Keurigs. Instead, Defendants were reckless and relied upon unsophisticated, manual processes for inter-company accounting entries. See 95 (GMCRs remediation plan includes a thorough review of the
38
GMCRs assertion that the Complaint does not allege its employees made a knowingly unreasonable accounting judgment is thus completely baseless. See GMCR Br. at 27-28. Three senior executives at GMCR one who reported to Blanford, one who was VP of Finance, and one who sold $6.6 million worth of stock after GMCR was contacted by the SEC in the spring of 2010 were all well aware that GMCRs usual procedures to document each step of such a large transaction had not been followed. Failure to follow standards accounting policy, e.g., by shipping 150 truckloads to MBlock without purchase orders, is evidence of scienter. See Novak, 216 F.3d at 311. - 34 -
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processes and procedures used in the Companys inter-company accounting, including an evaluation of possible methods to simplify and automate certain aspects of the inter-company accounting). In the third quarter 2010 Form 10-Q, signed by Defendants Blanford and Rathke, GMCR represented that: As of June 26, 2010, the Companys management with the participation of its Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Rule 13a-15 and 15d-15 under the Securities Exchange Act of 1934 (the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures (as defined in Rule 13a-15 of the Exchange Act) are effective. There have been no changes in the Companys internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. 80 (emphasis added). The following month, GMCR revealed the existence of accounting errors which resulted in a $7.6 million overstatement of earnings ($0.03 cents per share), accumulated over several years relating to margin percentage . . . effectively overstating consolidated inventory and understating cost of sales. 90. Investors were warned in the Form 8-K, filed September 28, 2010 (attached to the Rosenfeld Decl. as Exhibit Z), that GMCR does not intend to provide further updates regarding the correction of this error or the Companys results for fiscal year 2010 until its fiscal 2010 fourth quarter earnings release and conference call. Additional details regarding the correction of this error will be provided in the Companys Annual Report on Form 10-K for the fiscal year ended September 25, 2010. In the 2010 10-K filed with the SEC on December 9, 2010, GMCR admitted: The company did not have effective controls to ensure the completeness and accuracy of the accounting for intercompany transactions in its financial statement consolidation process. The method used to identify all intercompany transactions between the business segments for purposes of performing required eliminations, and to process and to document the eliminations, was not accurately designed and adequately performed during each reporting period.
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81 (emphasis added). In fact, GMCR specifically admitted: Management believes that these material weaknesses arose due to the Companys rapid growth, both organically and through acquisitions, outpacing the development of the Companys accounting infrastructure. 95. A failure to maintain sufficient internal controls to avoid fraud is sufficiently indicative of scienter. See Veeco, 235 F.R.D. at 232 (citing In re Oxford Health Plans, Inc. Sec. Litig., 51 F. Supp. 2d 290, 294 (S.D.N.Y. 1999)). In Veeco, as here, following an acquisition, insufficient accounting staffing resulted in a loosening of accounting control, [which] constitutes strong circumstantial evidence of recklessness (if not conscious misbehavior) . . . 235 F.R.D. at 232. Additionally, whereas recklessness is alleged through facts demonstrating that defendants failed to review or check information that they had a duty to monitor (see Novak, 216 F.3d at 308), so dramatic a change in the Companys public position concerning the accuracy of its accounting and its internal controls, occurring in such a short time span, strongly compels the inference that Defendants Blanford and Rathke failed to adequately monitor GMCRs financial processes and controls to ensure their sufficiency and the accuracy of GMCRs financial reporting prior to filing GMCRs third quarter 2010 Form 10-Q with the SEC certifying that they had.39 See Frank v. Dana Corp., No. 09-4233, 2011 WL 2020717, at *4 (6th Cir. May 25, 2011) (defendants inflated net
Defendant officers argue that [j]ust because Mr. Blanford and Ms. Rathke now know that the Company made accounting errors, does not mean that they knew this prior to the Companys disclosure of the errors. B&R Br. at 14 n.5. This argument is misguided. Plaintiffs allege that Defendants Blanford and Rathke had a duty to monitor, and accordingly either knew of the inadequacies of GMCRs accounting system and made deliberate misrepresentations, or were ignorant and therefore consciously reckless for failing to accurately assess the adequacy of the Companys accounting systems. In either event, scienter is established. See ECA, 553 F.3d at 199. That these Defendants uncovered the flaws in the accounting systems shortly after the third quarter 2010 Form-Q was filed only underscores the inference that they acted in a highly unreasonable fashion, constituting an extreme departure from the standards of ordinary care, by failing to monitor GMCRs accounting controls prior to representing in signed SEC filings and statements to the public that they had conducted evaluations of the Companys internal controls. 80-81, 83, 90. - 36 -
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income through their announcement of second quarter 2005 before slashing earnings projections two months later).40 Finally, the Complaint alleges that GMCR had been notified of the SEC inquiry no later than five months prior to the issuance of the September 28, 2010 Form 8-K by early May 2010, during the third quarter of 2010. 68-69. Blanford and Rathkes omission of the SEC inquiry from the Form 10-Q materially misled investors, as evidenced by the rapid decline in GMCRs share price once the SEC inquiry was made public on September 28, 2010. 90-91. At the time, CEO Blanford and CFO Rathke were either aware of the SEC inquiry or, far less likely but equally culpable were consciously reckless in making a statement attesting to the accuracy of GMCRs financial reporting without knowing of an SEC investigation of such reporting. See, generally, Matrix Cap. Mgt. Fund, LP v. BearingPoint, Inc., 576 F.3d 172, 199 (4th Cir. 2009) (existence of SEC investigation can support an inference of scienter).41 c. Confidential Witnesses Support Defendants Actual Knowledge or Recklessness
Scienter may be proven and pled by reference to circumstantial evidence, for it is rare that perpetrators of a fraud would confess outright. In re Peoplesoft, Inc., No. C 99-472, 2000 WL 1737936, at *3 (N.D. Cal. May 25, 2000). Confidential sources, familiar with the defendant
The Sixth Circuit referred to an earlier opinion in the case for a more thorough discussion of the facts. See Frank, 2011 WL 2020717, at *1. In the earlier decision, the court noted that the last positive statement was made on July 20, 2005, and less than two months later, on September 15, 2005, the first partial disclosure was made. Frank v. Dana Corp., 547 F.3d 564, 568-69 (6th Cir. 2008). Because the SEC inquiry put Blanford and Rathke on notice of potential problems with GMCRs accounting, this was a red flag for them to be especially careful before they represented in August 2010 that disclosure process and controls were effective to produce accurate reporting. In light of the fact that GMCR was days away from announcing a $250 million investment by Lavazza and a month away from obtaining $1.35 billion to refinance debt and finance the VanHoutte purchase, it is reasonable to infer that GMCR had a financial motive to conceal the ongoing SEC investigation. - 37 41
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corporation, its management and their actions during the class period, can provide such evidence. As with all allegations of scienter, the statements of confidential witnesses (CWs) should be viewed as a whole to determine whether they support a strong inference of recklessness. Atlas Air, 324 F. Supp. 2d at 492-93, 495; see also In re Cabletron Sys., Inc., 311 F.3d 11, 30 (1st Cir. 2002) (the number of different sources helps the complaint meet the standard). In this Circuit, material from such sources will be permitted to contribute to an inference of scienter under certain circumstances: Where plaintiffs rely on confidential personal sources but also on other facts, they need not name their sources as long as the latter facts provide an adequate basis for believing that the defendants statements were false. Moreover, even if personal sources must be identified, there is no requirement that they be named, provided they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged. Novak, 216 F.3d at 314. Here, such other facts are alleged: the witnesses information with respect to premature revenue recognition on shipments to MBlock is corroborated by the fact that the SEC is currently investigating that very issue; the restatement and admission of material weaknesses corroborates the other accounting allegations. Thus, Plaintiffs are not required to name their various witnesses.42 Additionally, where a plaintiff provides information from witnesses with hands-on
GMCR criticizes Plaintiffs use of confidential witnesses, citing a recent case in this circuit, In re MRU Holdings, Securities Litigation, No. 09-3807, 2011 WL 650792 (S.D.N.Y. Feb. 17, 2011), which, in turn, cited a skeptical opinion from the Seventh Circuit, Higginbotham v. Baxter Intl., Inc., 495 F.3d 753 (7th Cir. 2007), suggesting that confidential witnesses may have an axe to grind, be lying or may not even exist. However, this extreme statement has not been followed by the Seventh Circuit, let alone by the Second Circuit and district courts within it. As one court noted: Courts in the Southern District routinely apply the rule in Novak, and have continued to do so following the Supreme Courts recent decisions establishing stricter pleading requirements. See, e.g., Cornwell v. Credit Suisse Group, 689 F. Supp. 2d 629, 63637 (S.D.N.Y. 2010); In re Dynex Capital, Inc. Sec. Litig., No. 05 Civ. 1897(HB), slip op. at 7, 13, 2009 WL 3380621 (S.D.N.Y. Oct. 19, 2009); In re NovaGold Resources Inc. Sec. Litig., 629 F. Supp. 2d 272, 298 & n. 14 (S.D.N.Y. 2009). Even the - 38 -
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experience in various parts of a company, such allegations will satisfy the Court that the plaintiffs claim is not unwarranted. Hall v. Childrens Place Retail Stores, Inc., 580 F. Supp. 2d 212, 232-33 (S.D.N.Y. 2008). Finally, when the witnesses supply details consistent with one another, they reinforce each other and suggest reliability of the information reported. Cabletron, 311 F.3d at 33. As set forth below, the Complaint describes the witnesses with sufficient detail to support the probability that the sources possess the information alleged. Therefore, the facts provided by numerous CWs can and should be considered, together, to support a finding that Defendants acted with knowledge or recklessness. See, e.g., 65-66, 70-71, 75-76, 82. Regarding the MBlock allegations, several CWs, including those who worked for both GMCR (CW1, CW2) and MBlock (CW3) describe a one-sided relationship where GMCR made significant investments in MBlocks warehousing capacity starting in mid-2009 a time when, in fact, MBlock did add two new facilities. Starting in July 2009, when the parties signed a new contract, the percentage of MBlocks business attributable to GMCR more than tripled. 65(a), 66, 67. CW2, a former regional sales manager, indicated that it was common knowledge at GMCR that MBlock was a captive company and would do what was asked of it by GMCR. (Even CW2s current employer, a competitor, is aware of this close relationship.) 66. CW1 provided an example of this, explaining that GMCR, not MBlock, controlled the warehousing process; because MBlock did not have tight inventory controls, GMCR shuffled product in and out of MBlock at will.
Seventh Circuits decision in Higginbotham [], upon which defendants principally rely, was severely limited when that court decided the Tellabs case on remand from the Supreme Court. Makor v. Tellabs, 513 F.3d 702, 712 (7th Cir. 2008) (holding that, while it would be better to have named sources, the absence of proper names does not invalidate the drawing of a strong inference from [the confidential witnesses] assertions)[.] In re Ambac Fin. Group, Inc. Sec. Litig., 693 F. Supp. 2d 241, 283 and n.2 (S.D.N.Y. 2010) (rejecting argument that Campo places Novak rule into question). - 39 -
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65(c) and (d). Both CW1 and CW2 recall that GMCR overstocked MBlock with so much inventory, that sometimes product remained in storage so long past its expiration date because it had not been shipped to MBlock specifically to fill a valid customer order that it had to be destroyed. 65(b). CW1 and CW6, a former VP of Operations, both questioned MBlocks ownership of the products GMCR shipped to MBlock because payment was not required: CW1 believed the sales were improperly booked as revenues on shipment; CW6 stated that the accounting department in Vermont told CW6 to book MBlock shipments as a sale. 65(c), 76. A detailed example of an improper shipment was provided by CW1, who recalled the important accounting details for an allegation of revenue recognition fraud the quarter in which it occurred (the first quarter of 2010), the amount of the shipment (150-truckloads) and the approximate amount of revenue booked ($7.5-$15 million). CW1 also recalled a number of handson details one would expect a distribution planning manager to know: senior operations executives set artificially-high production levels by ignoring inventory and prior order history (65(b)); there was no documentation for the 150-truckload shipment, to wit, neither CW1 nor the global transportation manager nor other employees could find the purchase order, materials requisition or product shipment authorizations. Employees who worked with CW1 reported that MBlocks warehouses were packed to the rafters with product following this large shipment they saw depart from GMCR. 70-71. Because CW1 and other employees could not find any proper documentation, CW1 made sure management was aware of the problem, and confirmed that VP of Operations Wettstein (who regularly reported to CEO Blanford), SCBU President McCreary and VP of Finance Bissonette knew about the shipment at issue. Id. and 68-69 (when the SEC began its investigation in the spring of 2010, GMCR employees called CW1 to inquire whether CW1 was the whistleblower to the SEC). These are the precise types of details deemed adequate in Cabletron, a case which also - 40 -
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involved false sales and inventory parking, i.e., unusual activities involving shuttling large quantities of product back and forth to warehouses, observation of truckloads in the yards and high returns (here, inventory destruction). Regarding the reckless failure to maintain sufficient controls over financial reporting to ensure accurate accounting for inter-company transactions, witnesses from different areas of the Company and even an outsider an accounting manager for an acquired roaster company (CW10), a director of operations (CW7), a territory manager (CW9), and a consultant (CW8) were aware that Keurig and SCBU had separate accounting departments and used different software (Great Plains and Peoplesoft), and that Keurig operated separately from the rest of the Company. 82(a)-(d). CW10 confirmed that problems with inter-company transfers could arise from this physical and technological separation. Id. The corroboration provided by witnesses from different areas in the Company satisfies the Hall and Cabletron standards. While the CW accounts are reliable and should be credited to contribute to an inference of scienter, not unexpectedly, GMCR nit-picks the witness accounts for ways to find fault with their consistent observations. See GMCR Br. at 32-37. None of their attacks have merit. First, they assert that the CW descriptions are not particular enough, citing a case where the witness was described only as a high-level corporate employee. GMCR Br. at 32-33. Plaintiffs here, however, provided a job title and the dates of employment of the various CWs. Second, GMCR complains about a few of the witnesses not being employed by GMCR during the two-month class period. See GMCR Br. at 33 and n.16. This fact does not disqualify their accounts; in fact, it defies both Second Circuit law and common sense. In Scholastic, the Second Circuit found that pre-class period information was relevant to establish defendants knowledge of the true facts even before the start of the class period. See 252 F.3d at 72. (Any information that sheds light on whether class period statements were false or materially misleading is - 41 -
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relevant); Cornwell v. Credit Suisse Group, 689 F. Supp. 2d 629, 638 (S.D.N.Y. 2010) (court draws inference that serious problems known to exist pre-Class Period remained pertinent to public statements made during the Class Period). If defendants knew the truth before the Class Period, they knew it during the Class Period, as well. This is particularly true here: (a) GMCRs admission in December 2010 that remediation for one of the material weaknesses would require inter-company accounting to be simplified and automated, strongly suggests that the problems noted by CW8 in the summer of 2009 and by CW10 existed before, during and after the short Class Period; and (b) the significant MBlock transaction that CW1 recalled occurred in the first quarter of 2010 and inflated GMCRs revenues throughout 2010, both before and during the Class Period. In any event, there is no requirement that a CW be employed during the Class Period. See Croker v. Carrier Access Corp., No. Civ. 05CV01011, 2006 WL 2035366, at *5, *10-*12 (D. Colo. July 18, 2006) (assessment of senior accountant employed prior to class period, that one defendant was responsible for accounting misstatements, but not another, was credited by court). Third, there is no requirement that a witness describing a suspicious sales transaction work in the accounting department. See GMCR Br. at 34. In the two cases cited by GMCR, the accounting violations concerned the manipulation of reserves to manage earnings (In re MSC Indus. Direct Co., Inc., 283 F. Supp. 2d 838, 842-43 (E.D.N.Y. 2003)) and the process of estimating loss reserves based upon insurance claim rates (Malin, 499 F. Supp. 2d at 141-42). Accounting misstatements rooted in creative number crunching are difficult to have knowledge of if one works on the loading dock. However, the same does not hold true in revenue recognition cases, where the persons involved in shipments and returns of product are witnesses who can speak to the unusual nature of activities when products are being moved off-site to make the numbers and then returned days thereafter. See Cabletron, 311 F.3d at 24-25 (noting, inter alia, that receiving - 42 -
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department was busiest in early days of quarter, logging returns); see also In re Focus Enhancements, Inc. Sec. Litig., 309 F. Supp. 2d 134, 145 (D. Mass. 2001) (director of operations recalled defendants loaded Focus products onto rented UPS and Yellow tractor trailers in order to comply technically with the requirement that an order must be . . . out of the warehouse[ ] before it can be booked as income . . . [O]n the last day of every month . . . all operations employees were expected to stay all night or all weekend . . . The products were unloaded from the trucks and processed as returns shortly after the . . . reporting period closed.). As in Cabletron and Focus, allegations from CW1 a distribution planning manager who faulted senior operations executives for producing and shipping out more product than was warranted by customer history and inventory reports, and recalled members of his/her department (all the way up to the global transportation manager) being unable to find any paperwork for a 150-truckload shipment that was described by other employees as filling MBlock to the rafters with products are sufficient to support a finding of reckless revenue recognition fraud, especially where three Company executives are alleged to have been aware of the improper shipment. In a last-ditch effort, GMCR questions the veracity of the CW allegations, particular CW1 and CW6, analyzing them with a microscope and determining that they do not appear plausible or supportable because every possible question about the timing of revenue recognition and payment was not answered by their accounts. See GMCR Br. at 35-36. However, Defendants may not: . . . require that a plaintiffs complaint mimic a newspaper article, specifying the what, where, when, why, and how of each discrete communication and transaction of which the fraud was constituted . . . [D]istrict courts [must] draw reasonable inferences from indirect allegations when direct allegations of scienter are unavailable. Requiring plaintiffs to set forth in their complaints each and every piece of evidence demonstrating the fraudulent event would be tantamount to trying the case at the pleadings stage, which is verboten. Croker, 2006 WL 2038011, at *12.
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d.
A Strong Inference of Scienter Is at Least as Compelling as Any Other
Defendants, in their Dr. Jekyll hat, ask the Court to weigh the inferences and to find that GMCR simply grew too fast and had innocent troubles integrating the various systems and operations of its acquisitions. Moreover, it asks the Court to credit its internal investigation and its conclusion that no one at GMCR engaged in any misconduct. See GMCR Br. at 37-38. However, that is for this Court, not GMCRs management or Board of Directors, to decide. In so doing, the Court must also weigh the many inferences described above that do not have an innocent explanation: (a) the serious MBlock allegations leveled not only by CW1 and CW6, but which are also the subject of an investigation by the SEC; (b) a material weakness in controls over financial reporting that existed because the sales and marketing function was not even communicating customer incentives to the accounting department a fundamental failure of basic corporate communication; (c) the delay in disclosing the SEC investigation; (d) the almost $8 million in suspicious stock sales by the Presidents of GMCRs units in the month before the SEC investigation was made public and the belated effort, after the SEC investigation was disclosed, for Keurig President Stacy to claim the sales were made pursuant to a Rule 10b5-1 trading plan; (e) the changing revenue recognition policies concerning shipments to MBlock; (f) the amendment of an SEC filing to delete that the CEO and CFO supervised and participated in an assessment of GMCRs internal controls; (g) only disclosing the first items to be restated because that material, non-public information had already been provided to lenders in a debt refinancing transaction in conjunction with the VanHoutte purchase and not closing that deal until after the full restatement was filed; and (h) continuing, in 2011, to file financial reports that are inconsistent and opaque, while doling out non-public information only to selected hedge funds and analysts. The inference of scienter arising from these Mr. Hyde facts, is not only cogent and compelling, but as plausible as
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the innocent explanation posited by Defendants. Under Tellabss holistic analysis, Plaintiffs have alleged enough facts to raise a strong inference of scienter. B. The Complaint Adequately Alleges Control Person Liability Under Section 20(a)
Defendants Blanford, Rathke and Stiller contend that Complaints control person claim, brought under Section 20 of the Exchange Act, should be dismissed because Plaintiffs have purportedly failed to allege: (i) an underlying violation of the securities laws; and (ii) their culpable participation in the violation. See B&R Br. at 18-20; Stiller Br. at 16-17. Defendants are wrong. First, as discussed in Section III, above, Plaintiffs have established a primary violation by Defendants. Second, there is a split in authority in this Circuit over what a plaintiff must plead to satisfy the Second Circuits requirement that the controlling person was in some meaningful sense a culpable participant in the primary violation. Edison Fund v. Cogent Inv. Strategies Fund, Ltd., 551 F. Supp. 2d 210, 230 (S.D.N.Y. 2008) (internal quotation marks omitted; quoting Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998)). In Edison, the court characterized [t]he weight of well-reasoned authority as follows: to withstand a motion to dismiss a section 20(a) controlling person liability claim, a plaintiff must allege some level of culpable participation at least approximating recklessness in the section 10(b) context. Id. at 231 (internal quotation marks and citation omitted). Plaintiffs have satisfied this requirement. The Complaint alleges that Blanford, Rathke and Stiller held positions of authority and control at GMCR the former being senior officers (18-19), the latter being the founder and Chairman of the Board of Directors (17) and they all acted with, at a minimum, recklessness, as the scienter discussion above makes clear. Moreover, the Complaint alleges that the Individual Defendants had direct involvement in the day-to-day management of the Company and were responsible for its statements to the public which is all that it must do. See, e.g., Scottish Re, 524 F. Supp. 2d at 401; In re Tower Automotive Sec. Litig., 483 F. Supp. 2d 327, - 45 -
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351 (S.D.N.Y. 2007) (Plaintiffs assertion that Defendants exerted control by virtue of their senior positions within the company combined with the scienter allegations scattered throughout the Complaint satisfied the pleading standard.). Finally, Stiller is GMCRs largest shareholder, holding more than 12% of the Companys outstanding common shares. See Rosenfeld Decl., Exhibit O January 24, 2011 DEF 14A at 39. Control is defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. 17 C.F.R. 230.405 (emphasis added). For the purposes of Section 20(a), a majority or otherwise controlling shareholder is prima facie a controlling person of the corporation in which it owns a majority or controlling stake. In re Musicmaker.com Sec. Litig., No. 00-2018, 2001 WL 34062431, at *16-*17 (C.D. Cal. June 4, 2001) (37% indirect owner is control person under 20(a)). According to GMCRs most recent proxy statement, Stillers interest is a controlling owner. See, e.g., Rosenfeld Decl., Exhibit O January 24, 2011 DEF 14A at 36 (change of control as defined in CFO Rathkes employment agreement, excludes a merger or consolidation after which Stiller or his affiliates, directly or indirectly, continues to beneficially own at least 10% or more of the combined voting power of the Companys then outstanding securities). Accordingly, the Complaint adequately pleads a claim against the Individual Defendants under Section 20(a).
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IV.
CONCLUSION For all of the reasons stated above, Plaintiffs respectfully request that the Court deny the
motions to dismiss in their entirety. However, in the event the Court determines the Complaint is deficient in any respect, Plaintiffs respectfully request an opportunity to amend in accordance with Fed. R. Civ. P. 15(a) (leave shall be freely given when justice so requires). See Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991) (It is the usual practice upon granting a motion to dismiss to allow leave to replead.). DATED: July 12, 2011 ROBBINS GELLER RUDMAN & DOWD LLP SAMUEL H. RUDMAN DAVID A. ROSENFELD EDWARD Y. KROUB /s/ David A. Rosenfeld DAVID A. ROSENFELD 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax) GLANCY BINKOW & GOLDBERG LLP LIONEL Z. GLANCY ROBERT V. PRONGAY COBY M. TURNER 1801 Avenue of the Stars, Suite 311 Los Angeles, CA 90067 Telephone: 310/201-9150 310/201-9160 (fax) GLANCY BINKOW & GOLDBERG LLP ROBIN BRONZAFT HOWALD 1430 Broadway, Suite 1603 New York, NY 10018 Telephone: 212/382-2221 212/382-3944 (fax) Co-Lead Counsel for Plaintiffs
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WOODWARD & KELLEY, PLLC PHILIP C. WOODWARD 1233 Shelburne Road, Suite D-3 South Burlington, VT 05403 Telephone: 802/652-9955 802/652-9922 (fax) LAW OFFICE OF BRIAN HEHIR BRIAN HEHIR 239 South Union Street Burlington, VT 05401 Telephone: 802/862-2006 802/862-2301 (fax) Co-Liaison Counsel for Plaintiffs
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CERTIFICATE OF SERVICE I hereby certify that on July 12, 2011, a copy of the foregoing was submitted for filing with the Clerk of the Court and served by mail on all counsel of record. DATED: July 12, 2011 ROBBINS GELLER RUDMAN & DOWD LLP DAVID A. ROSENFELD
/s/ David A. Rosenfeld DAVID A. ROSENFELD 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax)
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