| Background | | | | The court applies this rule that investors have a |
| United States district court, northern district of | | | | right to action if the company uses materially |
| California was the start of Verisign's ("the | | | | false or misleading statements that leads to harm |
| Company") class action complaint for a violation of | | | | of those who buy or sell that particular security. |
| securities laws. Plaintiff, James H. Harrison Jr., on | | | | The claim must state a material representation, |
| behalf of himself and all others similarly situated | | | | scienter, a purchase or sale of the security |
| filed vs. Verisign, Inc., Stratton D. Sclavos, Robert | | | | related to that representation, reliance on the |
| J. Korzeniewski, Dana L. Evan and Quintin P. | | | | information, and a loss caused by that reliance. In |
| Gallivan. The "class" period is for people who | | | | this case the "defendants do not challenge that |
| purchased shares of the company between | | | | the misstatements or omissions were made in |
| January 25 and April 25 2002. | | | | connection with the purchase, reliance on those |
| The defendant Verisign is headquartered in | | | | misstatements or omissions or that they suffered |
| Mountain View California and offers users the | | | | an economic loss." Along with the 10b-5 |
| ability to engage in secure digital commerce and | | | | requirements, securities fraud allegations must |
| communications. Verisign's stock is traded on the | | | | adhere to Rule 9(b) of the Federal Rules of Civil |
| NASDQ national market. | | | | Procedure (In re Advanta, 180 F.3d at 531) of "(1) |
| Allegations | | | | a specific false representation of material fact, (2) |
| The allegation is that the defendants tried to | | | | knowledge by person who made it that it was |
| artificially increase the Company's revenue and | | | | false, (3) ignorance of its falsity, (4) intention that |
| create the perception that its deferred revenue | | | | it should be acted on, and (5) that plaintiffs action |
| was being generated organically rather than | | | | upon it to his damage." Therefore, the court must |
| through acquisition. It is claimed that the Company | | | | decide on materiality, misrepresentations or |
| derived a portion of its revenue from | | | | omissions, scienter, and the loss causation. |
| non-monetary barter transactions and | | | | Materiality |
| investments in other companies. The later claim | | | | Both the parties rely on Oran v. Stafford, 226 |
| stated simply, they were financing the payments | | | | F.3d at 282 that for a fact to be material the |
| they were receiving for their goods and services. | | | | disclosure of bad news must cause a decline in |
| The complaint states that the revenues were | | | | stock price. The court ruled that although there |
| dubious at best and claimed that "whenever a | | | | was not an immediate decline in stock price since |
| two-way set of transactions occurs in which a | | | | from the partial disclosures that he negative |
| company acts as the lender and service provider, | | | | information could have been displaced by what |
| an investor lacks assurance as to whether the | | | | the market appeared as good news. Defendants |
| related parties would have made a similar decision | | | | held that Ieradi v. Mylan Lab 230 F.3d 594 ruling of |
| regarding purchases in the absence of financing | | | | the initial disclosure would be sufficient and |
| from the company". They claimed that because | | | | following admissions would be insignificant in the |
| of this it was not possible to get an accurate | | | | total mix of information available. The court |
| measure of the real demand for Verisign's | | | | disagrees because in this case the market hardly |
| products. | | | | reacted to the news of MedQuist possible delisting |
| The complaint also alleges that the defendants | | | | and the stock price actually increased until they |
| misrepresented the company's prospects and | | | | were actually de-listed. The threat of the delisting |
| failed to properly disclose improper acts until they | | | | was unimportant to the market and although the |
| were able to sell at least $26 million of their own | | | | risk was disclosed it was not materialized until it |
| stock, and also to buy companies in | | | | significantly altered the mix of information. Since |
| stock-for-stock transactions. Verisign violated | | | | also the disclosures were a series of partial |
| Generally Accepted Accounting Principles and | | | | information and the actual over billings were |
| Securities Exchange rules by engaging in improper | | | | substantially larger then disclosed estimates there |
| barter transactions. These activities dramatically | | | | is not a "reliable benchmark with which to |
| overstated the company's margins in its financial | | | | conclude that the earlier financial misstatements |
| statements. | | | | were immaterial. (Burlington, 114 F.3d at 1425)" |
| The final complaint states that in addition to the | | | | Misrepresentations or Omissions |
| above activities, the defendants had other | | | | The plaintiffs allegations of several misstatements |
| material information that they concealed from the | | | | omissions through 15 press releases, 4 annual |
| plaintiffs. The defendants concealed an acquisition | | | | reports, 12 quarterly reports, and many |
| because they wanted the public to get the | | | | conference calls led to defendants arguing that |
| impression that the company's revenue growth | | | | there is no Section 10(b) liability as a matter of |
| was organic when in fact it was not. Statements | | | | law "isolated statements of factual revenues |
| were made concerning the company's ability to | | | | allegedly generated by improper activities led to |
| grow its operating margins that were "simply | | | | no duty to disclose and thus do not give rise to |
| impossible". The integration of two acquisitions | | | | Section 10(b) liability (Convergent Tech. Sec. Litig., |
| was a disaster and clients began to decline rather | | | | 948 F.2d 507, 512-12)." Using In re Par Pharm., Inc. |
| than grow as the defendants had stated. Other | | | | Sec. Litig., 733 F. Supp. 668, the courts ruled that |
| information that was withheld by the defendants | | | | the obligation of executives is to speak the true in |
| included; quickly losing market share to the | | | | disclosures and make additional comments when |
| competitors because of outrageous prices, the | | | | there is a chance of making prior statements |
| company's web certificate business would post | | | | misleading. The court found that the plaintiffs' |
| zero growth for the year, the ESP division would | | | | complaint sufficiently illustrates "how the scheme |
| post zero organic growth and the fact that 100% | | | | was devised, who (did) it, and how it was |
| of the growth was from acquisitions, the domain | | | | implemented." Coupled with the Board of Directors |
| name business was losing customers at the rate | | | | admission to not rely on prior financial statements |
| of 11,000 per day, contrary to statements made | | | | during 2002-2003, it is clear that the defendant |
| by the defendants recent acquisitions would cost | | | | made statements during the class period deemed |
| $80 million more than expected, receivables were | | | | false or misleading. |
| dubious and allowance for doubtful accounts had | | | | Scienter |
| increased five times over the prior period and | | | | The court uses GSC Partners CDO Fund v. |
| lastly the company manipulated its Days Sales | | | | Washington, 368 F.3d 228, 237 to determine that |
| Outstanding to paint a rosier picture. | | | | scienter may be established in one of two ways: |
| Issues | | | | "(1) by alleging facts to show that defendants had |
| Plaintiffs argue five key categories of | | | | both motive and opportunity to commit fraud, or |
| misrepresentations: | | | | (2) by alleging facts that constitute strong |
| 1. Defendants inflated accounts receivable, | | | | circumstantial evidence of conscious misbehavior |
| revenue and deferred revenue by improperly | | | | or recklessness." Further clarification is provided |
| accounting for two-year auto-renewals on domain | | | | from In re Supremea, 438 F.3d at 277 that |
| names, and acquired deferred revenue. | | | | insider stock sales are not inferred to be motive |
| 2. Defendants used improper accounting to | | | | unless the sale is done in a means that is unusual |
| recognize revenue on roundtrip and barter | | | | in the scope or time of the action. The factors |
| transactions. | | | | that are considered include the profit, the number |
| 3. Defendants failed to adequately reserve for | | | | of shards, % ownership or number of people |
| uncollectible delinquent receivables thereby | | | | involved on the inside (Wilson v. Bernstock, 195 F. |
| overstating earnings. | | | | Supp. 2d 619, 635). The plaintiffs' complaints allege |
| 4. Defendants misreported domain name | | | | that CTO Ethan Cohen, COO Donohoe, and CEO |
| registrations by concealing the number of free | | | | David Cohen had created the technology to over |
| and promotional registrations and two-year | | | | bill customers, used undocumented invoices to |
| auto-renewal registrations. | | | | eliminate customer's ability to verify the accuracy, |
| 5. Defendants overstated earnings by failing to | | | | and even bragged about their billing scheme to |
| properly account for long-term investments in | | | | other managers about the increased billing they'd |
| non-public companies and by failing to record | | | | mastermind. Based on these facts the court |
| impairment charges on many investments. | | | | found that since they were in controlling positions |
| Specifically, Plaintiffs contend that VeriSign | | | | of the company they had direct knowledge of |
| recognized $27 million in barter transactions, $10.5 | | | | the fraud scheme at the time of the false |
| million in reciprocal transactions, $64 million by | | | | statements therefore the plaintiffs have properly |
| roundtrip transactions and $12 million by improper | | | | pleaded scienter. |
| accounting practices. Plaintiffs further allege that | | | | Loss Causation |
| VeriSign failed to follow GAAP in terms of | | | | According to Lentell, 396 F.3d at 173 "holding loss |
| recording a $74 million impairment charge. | | | | causation will be established if (the) relationship |
| Defendants argue that companies regularly | | | | between plaintiff's investment los and information |
| disclose their true financial condition and their | | | | concealed by defendant is sufficiently direct." In |
| stock price declines when they fail to meet the | | | | addition, Newton, 259 F.2d at 172 states that |
| market expectations. Defendants further argue | | | | plaintiffs must also establish transaction causation; |
| that Plaintiffs fail to allege that April 25, 2002 | | | | "establishes that but for the fraudulent |
| disclosure was responsible for the decline in stock | | | | misrepresentation the investor would not have |
| price or revelation of any fraud by the company. | | | | purchased or sold the security." Defendants do |
| The disclosure that causes the stock price to | | | | not argue the transaction causation but do argue |
| decline must be the subject matter of the | | | | that the delisting disclosure was not related to the |
| misstatements or omissions that are the basis for | | | | billing scheme thus there was no way to prove |
| plaintiffs' securities fraud claims. | | | | causation of that disclosure to the fraudulent loss. |
| The Defendants site Dura Pharmaceuticals, Inc. v. | | | | The court ruled that the press release of the |
| Broudo, 125 S. Ct. 1627, 1634 (2005) as an | | | | delisting was directly related to the fraud because |
| example. The Court held, however, that the | | | | it was leading to the investigation into the |
| complaint failed to claim "that Dura's share price | | | | company's fraudulent billing scheme therefore the |
| fell significantly after the truth became known," | | | | plaintiffs have "properly pleaded loss causation" |
| and thus failed to provide defendants with notice | | | | Additional Facts |
| of the causal connection between any economic | | | | Section 20(a) claims against the individual |
| loss and the alleged misrepresentation. | | | | defendants were found to be convincing that |
| In another example of Tellium Inc, where the | | | | "control persons" were reasonably accountable for |
| company suddenly reveled in January 2002 that it | | | | the losses. Also, the accounting firms were not |
| needed new customers to achieve its $288 million | | | | held responsible because the plaintiffs failed to |
| revenue guidance even after repeated assurances | | | | prove KPMG & Arthur Anderson had seen |
| about its sales commitments, the Defendants | | | | the false documents, whether the documents |
| pointed out the following. The court held that | | | | alone would suffice to knowledge of fraud and |
| these allegations did not plead loss causation | | | | they admitted that the billing scheme was based |
| because "[p]laintiffs have failed to allege that the | | | | on secret coding that had left no clear paper trail. |
| concealed scheme was ever disclosed to the | | | | After all these findings Versign decided to settle |
| market, thereby affecting the price of Tellium's | | | | the case outside of court and the decision was |
| stock." | | | | approved. |
| Based on Plaintiffs inability to allege a causal | | | | Opinions Regarding Courts Decision |
| connection between the alleged fraud and their | | | | We felt that the court came to the proper |
| alleged losses, the Defendants appealed that their | | | | decision in this case as there was clearly an |
| motion should be granted. | | | | egregious bill fraud scheme that was being |
| The courts found that the Plaintiffs have pled loss | | | | covered up with an argument that said the stock |
| causation only with respect to the first category | | | | price change was related to the delisting news. |
| of fraud, namely, improper revenue recognition | | | | The defendants could not prove that the delisting |
| and misstatements of reciprocal and related party | | | | was unrelated to the billing scheme as it clearly |
| transactions. Hence the Plaintiffs continued to | | | | was the source of the problems. The general |
| plead through future amendments trying to | | | | disregard that management held towards |
| establish loss causation. On the contrary, the | | | | disclosing their scheme at company conferences |
| Defendants argued motion to dismiss on the | | | | is outrageous and should not be treated lightly. |
| pretext that the Plaintiffs were unable to establish | | | | The only issue we had with the decision with the |
| loss causation by repeatedly stating that even | | | | settlement is that the executives were not held |
| though the market was unaware of the | | | | personally responsible for their deception. |
| fraudulent scheme, April 25, 2002 disclosure was | | | | Settlement only cost those remaining shareholders |
| responsible for the price decline. | | | | that were not a part of the lawsuit. Criminal |
| Court's Findings | | | | charges against the executives would be justified |
| Rule 10b-5 Claims | | | | and warranted by these actions. |