Barrie v. Intervoice-Brite, Inc.

Citations: 397 F.3d 249; 60 Fed. R. Serv. 3d 811; 2005 U.S. App. LEXIS 500; 2005 WL 57928Docket: No. 03-11064

Court: Court of Appeals for the Fifth Circuit; January 11, 2005; Federal Appellate Court

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Plaintiffs appealed the district court's dismissal of their securities fraud class action against Intervoice-Brite, Inc., claiming violations of the Securities Exchange Act and SEC Rule 10b-5. The appeal follows the district court's ruling under Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA). Intervoice, a company formed from a 1999 merger, initially reported strong performance but later disclosed a loss, prompting the lawsuit from shareholders who purchased stock between October 1999 and June 2000. The plaintiffs alleged the defendants made false statements regarding the merger and earnings projections, using improper accounting techniques, and engaged in insider trading, thereby showing scienter. Following the filing of a consolidated class action complaint and various motions to dismiss, the district court ultimately dismissed the complaint with prejudice. The appellate court reviews the dismissal de novo, accepting the plaintiffs' allegations as true and construing them favorably, while not accepting conclusory claims or unwarranted inferences.

Plaintiffs allege that Intervoice and its controlling directors violated Section 10(b) of the Securities Exchange Act of 1934 by making false statements about the company’s revenues and earnings. The district court dismissed the Complaint, finding it did not meet the heightened pleading standards of the Private Securities Litigation Reform Act (PSLRA) and Federal Rule of Civil Procedure 9(b). The PSLRA mandates specific allegations of fraudulent statements, including who made them, why they are false, and the requisite state of mind. To establish a securities-fraud claim, plaintiffs must demonstrate a misstatement or omission of material fact made with scienter, reliance by the plaintiffs, and a direct causal link to their injuries.

The plaintiffs contend that the district court wrongly applied these pleading standards to their fraud claims related to revenue recognition. Specifically, they assert that Intervoice improperly recognized revenue from software sales in violation of Generally Accepted Accounting Principles (GAAP) and the American Institute of Certified Public Accountants (AICPA) Statement of Position 97-2 (SOP 97-2). SOP 97-2 outlines conditions for recognizing software revenue, which include having a contractual arrangement, completed delivery, a fixed fee, and probable collectability. The plaintiffs claim that Intervoice recognized revenue prematurely, prior to customer delivery and acceptance, during the fourth quarter of 2000. They argue that statements made to investors about compliance with revenue recognition rules were misleading, citing an admission by Intervoice of improperly recognizing $18.3 million in its July 14, 2000, Form 10-Q. The Complaint outlines the necessary elements of the alleged fraud, including the existence of the revenue recognition rule, Intervoice's acceptance and violation of that rule, and public disclosures inconsistent with that rule.

Plaintiffs assert that their allegations sufficiently meet the pleading standards, countering the defendants' claims of proper accounting practices and truthful earnings statements. Following the merger on December 3, 1999, the SEC issued Staff Accounting Bulletin No. 101 (SAB 101) to clarify revenue recognition under GAAP. SAB 101 emphasized the importance of customer acceptance in recognizing revenue, stating that revenue should not be recognized until acceptance occurs or provisions lapse. It allowed companies to adjust revenue reporting either through a one-time cumulative effect adjustment or by restating prior financial statements if GAAP compliance was lacking.

Intervoice adopted the first procedure, announcing in its 1Q01 Form 10-Q that it would recognize revenue upon consumer acceptance starting March 1, 2000, for most sales. The SEC did not object to this change, which Intervoice claims demonstrates its compliance with GAAP. However, the plaintiffs argue that Intervoice improperly recognized unearned revenue, supported by expert testimony from Dr. Lesser, who contends that the reversal of revenue in early 2001 was necessary due to prior non-compliance with SOP 97-2. 

The court found the factual nature of the defendants' arguments insufficient for dismissal, as the plaintiffs’ claims are grounded in specific allegations rather than mere legal conclusions. The complexity of the accounting issues indicates that the case will hinge on whether the defendants acted in good faith or recklessly, which cannot be resolved at this stage. The district court's dismissal of claims related to false revenue recognition was based on the assertion that the statements were true when made and only became false upon restatement, a reasoning the appellate court rejected, emphasizing the need to accept the plaintiffs’ detailed allegations as true.

The plaintiffs assert that Intervoice engaged in fraudulent revenue recognition, a claim that was overlooked in the initial ruling. The Complaint outlines specific allegations of false financial reporting and identifies a key witness, Confidential Witness (CW) 13, who claims that CFO Graham had knowledge of the fraudulent recognition of revenue based on an analysis presented to him in January 2000 regarding project revenues. This analysis purportedly influenced the decision to recognize revenue fraudulently rather than adhering to Generally Accepted Accounting Principles (GAAP). Notably, on May 26, 2000, CEO Hammond, CFO Graham, and director Brandenburg signed the 10K report, which included the disputed revenue recognition.

While the district court dismissed all revenue recognition claims, it correctly dismissed those related to the Iusacell transaction. In this instance, Intervoice announced an $8.7 million order from a Mexican cellular provider, suggesting that revenue would be recognized in the fourth quarter of 2000. However, plaintiffs argue that this recognition was premature under SOP 97-2, as the revenue should only be recognized when earned, not upon shipment. Witnesses CW 14, CW 3, and CW 17 indicated that Intervoice did not earn this revenue in the specified quarter, countering Intervoice's defense that its accounting practices were appropriate.

Intervoice contended that the complaints about unnamed witnesses lacked direct knowledge regarding shipment schedules and revenue recognition. However, the court noted that reliance on confidential sources is permissible if supported by sufficient documentary evidence, which the Complaint provided. It indicated that CW 3 reviewed Project Activity Reports (PARs) demonstrating that Intervoice recognized the entire $8.7 million from the transaction before shipment. Thus, the allegations in the Complaint are deemed sufficient to support claims of false or misleading statements regarding revenue recognition.

CW 17, a Sales Manager, stated that the necessary components to fulfill an order were not requested by the end of the fourth quarter, a claim supported by CW 14, the Project Manager for Network Sales in North America and Latin America. Intervoice contended that allegations regarding the Iusacell transaction did not adequately plead scienter, materiality, or reliance, as the complaint failed to identify a specific corporate official responsible for recognizing revenue from the order. The plaintiffs countered that the court should consider the complaint as a whole to determine if it sufficiently demonstrated that Intervoice and its officers made misleading statements to investors, citing the court's prior decision in Goldstein. However, Goldstein pertains specifically to scienter, not false statements. The court acknowledged Intervoice’s argument, concluding that claims related to the Iusacell transaction must fail due to the lack of identification of a responsible corporate officer. Nonetheless, the dismissal of all claims regarding improper revenue recognition was deemed erroneous, as the Iusacell transaction was merely one instance of alleged accounting fraud, and the complaint sufficiently alleged improper revenue recognition.

Regarding fraudulent earnings projections, the complaint lists 23 allegedly fraudulent earnings projections, with only 12 attributed to Intervoice or individual defendants, while the rest come from third-party analysts. The plaintiffs argued that the district court incorrectly dismissed claims concerning false statements about a merger by analyzing allegations in isolation rather than viewing the complaint in its entirety. This argument was rejected, as each fraud allegation must independently satisfy the particularity requirements of the PSLRA. The complaint identified four statements made by Chairman Hammond and Senior Vice President Smith, but the district court found these statements were not false when made. For instance, Hammond claimed the company was ahead of plan in implementing synergy savings goals, which was challenged based on allegations of declining sales and a shrinking sales force. However, the court deemed these allegations insufficient to demonstrate the falsity of the statement at the time it was made, noting that a reduction in sales personnel might not contradict the assertion of maintaining sales momentum. Additionally, another statement by Hammond regarding sales opportunities was also alleged to be false due to declining sales.

Intervoice contends that declining sales allegations pertain to Network Systems, not Business Systems, leading the district court to correctly dismiss this claim. The court also dismissed Hammond's third statement from the complaint, finding it was not false when made. Hammond's assertion regarding the merger's success and the achievement of financial and operational goals was deemed insufficiently false due to the plaintiffs' reliance on weak sales and layoffs, which did not adequately demonstrate falsehood. However, the plaintiffs argue that Hammond’s reference to financial goals was fraudulent, based on allegations of improper accounting practices, indicating this claim should not have been dismissed. 

Intervoice argued the complaint lacked sufficient scienter for this statement, but plaintiffs noted Hammond had a motive linked to personal financial gain from revenue targets. The complaint alleges that Smith responded to investor concerns by explaining insiders' stock sales as permissible, while confidential witnesses claimed that the merger negatively impacted sales due to staff attrition. Nonetheless, the court found many statements were merely conclusory and lacked specific attribution to identifiable speakers, dismissing claims related to press releases that did not name authors. The court reaffirmed that corporate officers cannot be held accountable for unattributed statements based solely on their positions without specific factual connections. The classification of statements as being made by “management” or collectively by “Hammond and Graham” was deemed insufficient under the PSLRA, leading to proper dismissal of these allegations.

The PSLRA mandates that plaintiffs must clearly distinguish each defendant's role in the alleged fraud. Claims were dismissed because eleven of the twenty-three false statements originated from third-party analysts. For liability to be established against a defendant concerning these statements, the court requires specific facts demonstrating the defendant's control over the analysts' reports. The plaintiffs' claims that analysts acted as "conduits" for defendants’ statements were insufficient, as the complaint failed to specify who provided information to the analysts, how it was received, and the nature of the defendant’s involvement.

Additionally, the PSLRA's specificity requirement applies even if a corporation is a defendant, meaning false statements must be detailed to identify who made them. The plaintiffs contended that defendants who remained silent while false statements were made could be liable for omissions. However, the defendants argued that the complaint did not clarify whether Hammond made a statement that Graham failed to correct, which is essential under the court's prior rulings against group pleading.

Nonetheless, the court maintained that if it is clearly alleged that one defendant made a false statement and another failed to correct it—even without identifying who did which—the fraud claims are adequately pleaded. This interpretation aligns with the PSLRA’s language and the rationale for its heightened pleading standards.

In securities fraud cases, a heightened pleading standard is essential for providing defendants with adequate notice of claims, safeguarding their reputations, mitigating strike suits, and preventing baseless claims. The Southland Court found that both Hammond, who allegedly made false statements, and Graham, who failed to correct them, had fair notice of the claims against them, leading to the conclusion that the district court incorrectly dismissed claims against them. Similarly, Smith was found liable for his failure to correct alleged misrepresentations made during a conference call.

The plaintiffs also raised allegations of suspicious stock sales as a separate ground for liability; however, this argument was waived due to not being presented at the district court level. Even if considered, the argument lacked merit due to the absence of claims regarding improper disclosure of insider sales.

The issue of scienter, or the intent to deceive, was reviewed after the district court did not address it. Under the PSLRA, plaintiffs must plead specific facts indicating a strong inference of scienter. The plaintiffs contended that the Complaint sufficiently established scienter concerning revenue recognition and earnings projections. The Complaint articulates that Graham, as CFO, was or should have been aware of improper accounting methods. However, mere violations of GAAP do not suffice to prove scienter; knowledge of materially false information or severe recklessness is required. The Complaint surpasses mere GAAP violation allegations by identifying a witness who was directed by Graham to investigate potentially fraudulent accounting and states that defendants continued incorrect accounting practices after receiving the report. Thus, the Complaint adequately pleads scienter regarding the actions and omissions of Hammond, Graham, and Smith.

Allegations against the defendants are substantiated by confidential witness reports indicating their knowledge and severe recklessness in making statements. These claims, along with the defendants’ bonuses and stock sales profits, cumulatively support the assertion of scienter for the surviving statements. The court reverses parts of the district court's judgment, reinstating claims regarding Intervoice's fraudulent accounting, Hammond's false statements about financial goals, and allegations that Hammond or Graham made false statements without corrections by the other. Additionally, Smith is implicated for failing to correct statements made by Hammond or Graham. The Complaint sufficiently alleges scienter, precluding further litigation on that issue, and the case is remanded for further proceedings. The defendants include several high-ranking officials of Intervoice, namely Hammond, Graham, Brandenburg, Givens, Berger, Brown, and Smith. Relevant legal provisions cited include Section 10(b) of the Exchange Act, SEC Rule 10b-5, and the Private Securities Litigation Reform Act (PSLRA), which outlines requirements for securities fraud actions, including specifics on misleading statements and necessary mental state. The PSLRA imposes strict pleading requirements that, if not met, can lead to dismissal of the complaint.