Opinion
03 Civ. 6594 (RMB).
April 25, 2006
DECISION AND ORDER
I. Background
This is a consolidated securities class action against Check Point Software Technologies Ltd. ("Check Point" or the "Company"), Gil Shwed, Check Point's Chairman and Chief Executive Officer ("Shwed"), Jerry Ungerman, Check Point's President ("Ungerman"), and Eyal Desheh, Check Point's Chief Financial Officer ("Desheh") ("Individual Defendants") (collectively, with Check Point, "Defendants"), alleging that Defendants violated the federal securities laws, particularly Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) ("Section 10(b)" or "§ 10(b)"), Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a) ("Section 20(a)"). Plaintiffs claim that Defendants misled investors by, inter alia, conveying a false upbeat picture of the health and market value of the Company, while knowing about an increasingly competitive market environment, serious flaws in Check Point's "flagship" product, and alleged anti-competitive conduct by the Company.
By order dated March 7, 2005 ("March 7, 2005 Order"), the Court dismissed Plaintiffs' Amended Complaint pursuant to Federal Rule of Civil Procedure ("Fed.R.Civ.P.") 12(b)(6) because, among other things, the Amended Complaint failed "to identify any specific report or statement that supports Plaintiffs' assertion that Defendants knew of facts or had access to information contradicting their public statements" and because the Amended Complaint failed "to adequately allege when Defendants became aware or should have become aware that their public statements were misleading." (March 7, 2005 Order at 9-10.)
On or about April 22, 2005, Plaintiffs filed a Second Amended Complaint ("SAC"), which included some 93 new paragraphs relating, inter alia, to alleged problems with Check Point's flagship product, Next Generation Firewall/VPN software ("NG"), and Defendants' alleged anti-competitive conduct.
On or about September 2, 2005, Defendants filed a motion to dismiss the SAC pursuant to Fed.R.Civ.P. 12(b)(6). (See Memorandum of Law in Support of Motion to Dismiss, dated September 2, 2005.) Defendants argue that (i) "the SAC does not plead facts that provide a strong basis for finding that any one of the Individual Defendants knew, or were reckless in not knowing, that the Company's revenue projections for 1Q02 were too high" (Def. Mem. at 2); (ii) that the SAC does not allege when Defendants learned of the allegedly anti-competitive conduct (Def. Mem. at 21); (iii) that "[t]he SAC does not properly plead loss causation" i.e., "a causal connection between . . . allegations of wrongdoing and their losses" (Def. Mem. at 2); and (iv) that Plaintiffs' Section 20(a) control person liability claims must be dismissed because the SAC "does not properly allege a primary violation of Section 10(b)" and because the SAC "fails to allege that any of the Individual Defendants acted as a culpable participant in the alleged fraud." (Def. Mem. at 23.)
Familiarity with the March 7, 2005 Order and the SAC is presumed.
On or about October 7, 2005, Plaintiffs filed an opposition, (see Memorandum of Law in Opposition to Defendants' Motion to Dismiss, dated October 7, 2005), contending that (i) "[t]he SAC pleads with overwhelming particularity that Defendants, while extolling the virtues of Check Point's flagship product, [NG], knew that NG was defective and causing a loss of customers" (Pl. Mem. at 1); (ii) a witness "confirmed that [Check Point's] illegal [anti-competitive] conduct took place throughout the Class Period" (Pl. Mem. at 21); (iii) that the SAC alleges "that the undisclosed facts regarding, inter alia, the problems with NG and increased competition caused Check Point's revenue shortfall at the end of the class period" (Pl. Mem. at 22); and (iv) that "Plaintiffs have adequately pled the Individual Defendants' liability under § 20(a)." (Pl. Mem. at 25.)
Defendants filed a reply on or about November 3, 2005. (See Reply Memorandum of Law in Further Support of the Motion to Dismiss, dated November 3, 2005.)
For the reasons set forth below, Defendants' motion to dismiss is denied.
II. Legal Standard
In resolving a motion to dismiss, the Court "must accept the factual allegations of the complaint as true and must draw all reasonable inferences in favor of the plaintiff." Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir. 1996). "The issue is not whether a plaintiff is likely to prevail ultimately, `but whether the claimant is entitled to offer evidence to support the claims.'"Gant v. Wallingford Bd. of Educ., 69 F.3d 669, 673 (2d Cir. 1995) (citation omitted). In considering a motion to dismiss under Fed.R.Civ.P. 12(b)(6), a district court limits consideration "to the factual allegations in plaintiffs' [complaint], . . . to documents attached to the complaint as an exhibit, or incorporated in it by reference, to matters of which judicial notice may be taken, or to documents either in plaintiffs' possession or of which plaintiffs had knowledge and relied on in bringing suit." Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993); see also Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991).
To state a claim under § 10(b) and Rule 10b-5, a plaintiff "must plead that the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff's reliance on the defendant's action caused injury to the plaintiff." Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000); see Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1627, 1631 (2005) (basic elements of Section 10(b) claim are "(1) a material misrepresentation (or omission);" "(2) scienter;" "(3) a connection with the purchase or sale of a security;" "(4) reliance;" "(5) economic loss;" and "(6) `loss causation'") (emphasis omitted). Where plaintiffs allege fraud, "the circumstances constituting fraud . . . shall be stated with particularity." Fed.R.Civ.P. 9(b);see Stern v. Gen. Elec. Co., 924 F.2d 472, 476 (2d Cir. 1991). Defendants must be afforded "a reasonable opportunity to answer the complaint and adequate information to frame a response." Ryan v. Hunton Williams, No. 99 Civ. 5938, 2000 WL 1375265, at *6 (E.D.N.Y. Sept. 20, 2000). The Private Securities Litigation Reform Act of 1995 ("PSLRA") 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." Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000);see 15 U.S.C. § 78u-4(b)(1).
III. Analysis
(i) Knowledge of Material Misstatements Regarding Check Point's Revenue Projections
Defendants argue, among other things, that "the SAC does not allege facts showing that Defendants (a) received any reports indicating that revenues would be eroded due to problems with NG or increased competition, (b) knew of customers who cancelled purchases of NG in 1Q02, or (c) knew that Check Point was losing sales to competitors in 1Q02." (Def. Mem. at 2.) Plaintiffs respond that "Defendants had actual knowledge of and received information concerning NG's defects at the same time they publicly praised its functionality and capability" (Pl. Mem. at 11-12) and that "NG's failings were so apparent throughout the class period that fifteen witnesses, from different regions across the United States, independently and universally confirmed that NG was defective upon its premature release" (Pl. Mem. at 13.)
A plaintiff can establish a "strong inference" of scienter by either of two methods. The plaintiff may allege: (1) facts constituting "strong circumstantial evidence of conscious misbehavior or recklessness," or (2) facts showing that defendants had "both motive and opportunity to commit fraud."Rothman, 220 F.3d at 90; Shields v. Citytrust Bancorp, 25 F.3d 1124, 1128 (2d Cir. 1994). "To qualify as reckless conduct, defendants' conduct must have been highly unreasonable and 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." In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 76 (2d Cir. 2001);In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000) ("To survive dismissal under the `conscious misbehavior' theory, [a plaintiff] must show that the alleged reckless conduct by [defendant] . . . was either known to the defendant or so obvious that the defendant must have been aware of it.") "Although this is a highly fact-based inquiry, the Second Circuit has held that where the complaint alleges that defendants had knowledge of facts or access to information contradicting their public statements, recklessness has been adequately pled." In re Mercator Software, Inc. Sec. Litig., 161 F.Supp.2d 143, 149 (D. Conn. 2001) (citing Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000). "Where plaintiffs contend defendants had access to contrary facts, they must specifically identify the reports or statements containing this information." Novak, 216 F.3d at 309; see San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812 (2d Cir. 1996).
The (new) allegations contained in the SAC cure the scienter deficiencies relating to revenue projections identified in the March 7, 2005 Order to the effect that the Individual Defendants knew of material differences between their public statements and Check Point's financial performance. Among other things, Plaintiffs allege that Defendants had access to specific information of sales results, sales projections, and updates with various departments that sales were declining due to increased competition and that problems with NG, Check Point's most important product, were well understood. (See, e.g., Compl. ¶¶ 145-148 ("[A]s a result of the fierce competition from Cisco and NetScreen, Ungerman implemented a schedule of regular teleconferences entitled `Major Deal Review' (`MDR') to increase visibility of the Company's sales pipeline . . . W-18 confirmed that the MDR calls informed defendants that Check Point was rapidly losing market share to Cisco and NetScreen during the Class Period . . . [and] offered that while the exact amount of lost deals was maintained only by headquarters, it was `obvious' from [documents reviewed during these calls] that Check Point was losing market share to NetScreen and Cisco."); Compl. ¶ 175 ("According to W-16, management, including the Individual Defendants, `absolutely' knew of the afore-alleged problems with NG and resulting decline in sales . . . [I]n very early 2002, Shwed fired the entire 15-20 member RD team located at headquarters that was responsible for developing the NG and FPI software . . . Shwed terminated the group because of the problems associated with NG, and its failure to fix them."); Compl. ¶ 177 ("A vice president of sales between 1995 and mid-2001 confirmed that at least once a month he would participate in a teleconference with,inter alia, Shwed and Ungerman, to discuss sales results and generate projections. He confirmed that specific real time numbers were known by everyone on the calls through point-of-sale reports generated through Check Point's SAP system.").) The SAC includes details of where and when this information was reviewed by Defendants. (See, e.g., Compl. ¶¶ 170-173 ("W-16 stated that Check Point held two sales managers meetings during the Class Period — first in Colorado Springs, Colorado and then in Canada . . . At the meetings, sales managers and upper management discussed the state of the business, what was needed from a product upgrade perspective, and complaints from the field.").); see In re Mercator Software, Inc. Sec. Litig., 161 F.Supp.2d 143, 150 (D.Conn. 2001) ("The Court finds that, when the allegations of the amended complaint, which we accept as true for purposes of this motion, are read in their totality, plaintiffs have alleged sufficient facts from which a reasonable jury could find reckless conduct on the part of the defendants. This is sufficient to meet the pleading standards for scienter in the Second Circuit."); In re Complete Management Inc. Sec. Litig., 153 F.Supp.2d 314, 333 (S.D.N.Y. 2001) ("Plaintiffs allegations, when read in toto and most favorably to plaintiff, establish the requisite prima facie case.").
The SAC describes technical problems with NG as "pervasive" and states that, among other things, NG caused at least one customer's "primary and back up firewalls and entire network to crash." (Compl. ¶ 108.)
Knowledge of NG's alleged failings relates to Check Point's core business operations. See In re Atlas Air Worldwide Holdings, Inc. Sec. Litig., 324 F.Supp.2d 474, 489 (S.D.N.Y. 2004) ("When a plaintiff has adequately alleged that the defendant made false or misleading statements, the fact that those statements concerned the core operations of the company supports the inference that the defendant knew or should have known the statements were false when made. Indeed, if facts that contradict a high-level officer's public statements were available when the statements were made, it is reasonable to conclude that the speaker had intimate knowledge of those facts or should have known of them.").
Defendants described NG as central to Check Point's business operations. (See, e.g., Compl. ¶ 211 ("The most important technology we've ever delivered, Check Point Next Generation, enables end to end security by making it more open, manageable and easy to deploy, helping our customers to significantly decrease their communication costs."); Compl. ¶ 213 ("Perhaps the biggest highlight of the quarter, and quite frankly one of the most important milestones in Check Point's history, was the completion and shipment of Check Point Next Generation.").)
(ii) Knowledge and Timing of Anti-Competitive Conduct
Defendants also argue that the SAC does not sufficiently allege scienter with respect to anti-competitive conduct because it "does not provide any additional details that relate to when Defendants learned of the allegedly illegal conduct . . . or whether the alleged conduct occurred during the class period." (Def. Mem. at 21.) Plaintiffs argue that Defendants' anti-competitive conduct "took place throughout the Class Period." (Pl. Mem. at 21 n. 17.)
The SAC adequately alleges scienter with respect to Plaintiffs' anti-competitive conduct claims. Plaintiffs allege that "Company officials told resellers `to drop all competing products' or Check Point would not allow them to distribute their products" (Compl. ¶ 157); that "this policy was in place throughout the Class Period and did not stop until late-2003 or early-2004" (Compl. ¶ 158); and that "two resellers who gave in to Check Point's demands during the Class Period were GE Access and Wescon." (Compl. ¶ 158); see Novak, 216 F.3d at 311 ("the [strong inference of recklessness] may arise where the complaint sufficiently alleges that the defendants . . . engaged in deliberately illegal behavior.").
(iii) Loss Causation
Defendants argue that "Plaintiffs have not properly alleged that problems with NG or increased competition caused Check Point to miss its revenue projections for 1Q02, which led the Company's stock price to decline." (Def. Mem. at 22.) Plaintiffs respond that the SAC "alleged that the undisclosed facts regarding,inter alia, the problems with NG and increased competition caused Check Point's revenue shortfall at the end of the Class Period, which in turn caused the stock price to drop, thereby damaging investors." (Pl. Mem. at 22.)
"Loss causation `is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff.'" Lentell v. Merrill Lynch Co., 396 F.3d 161, 174 (2d Cir. 2005) (quoting Emergent Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d 189, 197 (2d Cir. 2003)). Under the PSLRA, Plaintiffs must "adequately allege a causal connection between defendants' non-disclosures and the subsequent decline in the value of [the security]." Emergent Capital, 343 F.3d at 197; see also 115 U.S.C. § 78u-4(b)(4) ("In any private action arising under this chapter, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages."). "[T]o establish loss causation, `a plaintiff must allege . . . that the subject of the fraudulent statement or omission was the cause of the actual loss suffered' . . . i.e., that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security." Lentell, 396 F.3d at 173 (emphasis in original) (citations omitted). "[L]oss causation has to do with the relationship between the plaintiff's investment loss and the information misstated or concealed by the defendant. . . . If that relationship is sufficiently direct, loss causation is established." Lentell, 396 F.3d at 174 (internal quotations and citations omitted).
Plaintiffs adequately alleges loss causation. Lentell, 396 F.3d at 174. Among other things, Plaintiffs allege that competitive pressure and problems with NG caused Check Point's revenue shortfall which caused Check Point's share price to decline when the Company announced its 1Q02 revenue. (See, e.g., Compl. ¶ 8 ("Check Point's first quarter drop in sales resulted from `competitive pressures' and the failings associated with NG."); Compl. ¶ 48 ("[U]nbeknownst to the public, NG was not ready for distribution as it was riddled with problems, leading to further customer flight and loss of revenues."); Compl. ¶ 321 ("These material misstatements and omissions had the cause and effect of creating in the market an unrealistically positive assessment of Check Point and its financial condition, business, prospects and operations, thus causing the Company's securities to be overvalued and artificially inflated at all relevant times.").)
The Court has previously determined that the timing and the amount of information that Check Point disclosed is a question of fact. See March 5, 2005 Order at 15 ("[W]hether or not Check Point should have disclosed additional facts about Stonesoft would not properly be decided at this stage of the litigation.").
(iv) Control Person Liability
Defendants argue that "the Complaint does not properly allege a primary violation of Section 10(b)" and that "[a]s a result, there is no predicate for control person liability." (Def. Mem. at 23-24.) Defendants also argue that "Plaintiffs have failed to allege that any of the Individual Defendants acted as a culpable participant in the alleged fraud." (Def. Mem. at 24.) Plaintiffs contend that the SAC alleges violation of Section 10(b) and that "[a]s CEO, CFO and President, responsible for global `sales marketing, business development and technical services,' it is without doubt that Shwed, Desheh and Ungerman had control over the Company." (Pl. Mem. at 24-25.)
Section 20(a) of the Exchange Act imposes joint and several liability on any person who "controls any person liable under any provision of this title or any rule or regulation thereunder."Ruskin v. TIG Holdings, Inc., No. 98 Civ. 1068, 2000 WL 1154278, at *7 (S.D.N.Y. Aug. 14, 2000); see 15 U.S.C. § 78t(a). To state a claim for controlling person liability under Section 20(a), a plaintiff must show: (i) a primary violation of Section 10(b) by the controlled person; (ii) control of the primary violator by the defendant; and (iii) "that the controlling person was in some meaningful sense a culpable participant." S.E.C. v. First Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996). The SAC adequately alleges Section 20(a) claims against the Individual Defendants. As explained above, Plaintiffs have alleged a primary violation of Section 10(b). See, e.g., In re Sterling Foster Co. Sec. Litig., 222 F. Supp. 2d 216, 277, 282-23 (E.D.N.Y. 2002) (denying motion to dismiss Section 20(a) claim where Section 10(b) claim survives). Plaintiffs have also adequately alleged that the Individual Defendants controlled Check Point.See In re Van Der Moolen Holding N.V. Sec. Litig., 405 F.Supp.2d 388, 412-413 (S.D.N.Y. 2005); (Compl. ¶ 330 ("Each of the Individual Defendants' . . . controlling person liability arises from the following facts: (a) each of the Defendants was a high-level executive at the Company during the Class Period; (b) each of the Defendants, by virtue of his responsibilities and activities as a senior executive officer, was privy to and participated in the creation, development and reporting of the Company's internal budgets, plans, projections, and/or reports.").) And, the SAC sufficiently alleges that the Individual Defendants acted as culpable participants. See Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 101 (2d Cir. 2001) ("The complaint alleges that [Defendant] was an officer of the Bank and that he had primary responsibility for the dealings of that Bank . . . While somewhat broad, this allegation is sufficient to plead controlling-person liability."); (see, e.g., Compl. ¶ 31 ("Notwithstanding its size and success, former employees of the company stated that Check Point was run like a close corporation during the class period, with the Individual Defendants responsible for making and being aware of the Company's core business decisions."); Compl. ¶ 36 (Defendant Ungerman confirmed his and Shwed's heavy involvement in the day-to-day business operations when he stated . . . that he and Shwed review Check Point's sales transactions `every week with our top sales VP's around the world.'").
The definition of "culpable participant" is somewhat "unclear." See, e.g., In re Initial Public Offering Sec. Litig., 241 F.Supp.2d 281, 395 (S.D.N.Y. 2003) ("Thus, although the meaning of "culpable participation" is unclear, there is strong reason to believe that it is not the same as scienter.");In re Alstom SA, 406 F.Supp.2d 433, 490 (S.D.N.Y. 2005) ("Culpable participation clearly requires `something more than negligence.' Disagreement exists within the Second Circuit, however, as to precisely what conduct, beyond negligence, the test entails.").
IV. Conclusion and Order
For the reasons stated herein, Defendants' Motion to Dismiss [39] is denied.
The parties are directed to appear at a settlement/status conference with the Court on May 15, 2006 at 11:15 a.m., in Courtroom 706 of the Thurgood Marshall Courthouse, 40 Centre Street, New York, New York, 10007. The Court directs the parties to engage in good faith settlement negotiations prior to the conference with the Court.