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DAVIS v. SPSS

May 10, 2005.

FRED DAVIS, individually and on behalf of all others similarly situated, Plaintiff,
v.
SPSS, INC., JACK NOONAN, EDWARD HAMBURG, and KPMG LLP, Defendants.



The opinion of the court was delivered by: JAMES MORAN, Senior District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff Fred Davis, individually and on behalf of all others who purchased SPSS, Inc. (SPSS) common stock between May 2, 2001 and March 30, 2004, brought this action for securities fraud against defendants SPSS; two of its executives, Jack Noonan and Edward Hamburg; and its auditor, KPMG. Plaintiff alleges violation of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and the Securities and Exchange Commission (SEC) Rule 10b-5, 17 CFR § 240.10b-5. SPSS, Noonan and Hamburg (SPSS defendants) now move to dismiss the complaint in its entirety, as does KPMG. For the following reasons, both SPSS defendants' and KPMG's motions are granted.

BACKGROUND

  SPSS is a publicly traded, Chicago-based, technology company, which specializes in predictive analytics software and services. Since January 1992, Jack Noonan has served as SPSS' president and chief executive officer, as well as a member of its board of directors. Edward Hamburg was SPSS' executive vice-president of corporate operations, chief financial officer and secretary from July 1992 until August 11, 2004. Plaintiff Fred Davis purchased 115 shares of SPSS common stock at a price of $17.73 per share on April 25, 2002. On May 14, 2004, plaintiff filed a complaint, followed by an amended complaint, arguing that he and others who purchased SPSS stock between May 2, 2001 and March 30, 2004, paid an inflated price for the shares, due to misleading statements knowingly made by defendants.

  From May 2001 through February 2004, SPSS issued press releases and filed 8-K, 10-Q and 10-K forms with the SEC that stated its financial results for various time periods. These press releases and SEC filings included the following:
(1) First Quarter 2001 Earnings Release, issued May 2, 2001
(2) First Quarter 2001 10-Q, filed May 15, 2001
(3) Second Quarter 2001 Earnings Release, issued July 31, 2001
(4) Second Quarter 2001 10-Q, filed August 14, 2001
(5) Press Release, issued October 10, 2001
(6) Third Quarter 2001 Earnings Release, issued October 30, 2001
(7) Third Quarter 2001 10-Q, filed Nov. 14, 2001
(8) Press Release, issued February 12, 2002
(9) Fourth Quarter 2001 and Fiscal Year 2001 Earnings Release, issued February 20, 2002
(10) 2001 Annual Report (Form 10-K), filed April 1, 2002
(11) First Quarter 2002 Earnings Release, issued May 2, 2002
(12) First Quarter 2002 10-Q, issued May 15, 2002
(13) Second Quarter 2002 Earnings Release, issued July 30, 2002
(14) Second Quarter 2002 10-Q, filed August 14, 2002
(15) Third Quarter 2002 Earnings Release, issued October 30, 2002
(16) Third Quarter 2002 10-Q, filed November 14, 2002
(17) Fourth Quarter 2002 and Fiscal Year 2002 Earnings Release, issued February 12, 2003
(18) 2002 Annual Report (Form 10-K), filed April 2, 2003
(19) First Quarter 2003 Earnings Release, issued April 30, 2003
(20) Form 8-K (Transcript of Conference Call with Analyst), filed on April 30, 2003
(21) First Quarter 2003 10-Q, filed on May 15, 2003
(22) Second Quarter 2003 Earnings Release, issued July 3, 2003
(23) Second Quarter 2003 10-Q, filed August 13, 2003
(24) Press Release, issued October 15, 2003
(25) Third Quarter 2003 Earnings Release, issued on October 28, 2003
(26) Third Quarter 2003 10-Q, filed November 10, 2003
  (27) Fourth Quarter 2003 and Fiscal Year 2003 Earnings Release, issued February 17, 2004 In the press release dated October 15, 2003, SPSS announced a revision to an agreement it had with America Online (AOL). Two years earlier, on October 22, 2001, SPSS entered into a multi-year alliance with AOL from which SPSS gained certain operating assets and the exclusive right to distribute survey data drawn from AOL's millions of users. In return, SPSS agreed to pay AOL $12 million in SPSS common stock and $30 million in cash installments. In 2003, SPSS and AOL agreed to reduce the remaining term of their alliance from two years to one year. As SPSS announced in its October 15, 2003, press release, this revision would result in "adjustments to both the assets and liabilities portions of the SPSS balance sheet." A report filed with the SEC that same day, on Form 8-K, listed the adjustments as a $9.8 million reduction in merger consideration ($3.2 million in current liabilities and $6.6 million in non-current liabilities); a $6 million reduction in additional paid-in capital; a $5.5 million reduction in intangible assets; and a $10.3 million reduction in good will. SPSS noted that this would not effect the company's income statement for the third quarter of 2003, nor did it foresee an effect on the fourth quarter.

  On March 15, 2004, SPSS requested a 15-day extension to file its Form 10-K for fiscal year 2003, because it needed to complete the restatement of prior financial results effected by the October 2003 amendments to the AOL agreement. However, on March 30, 2004, the company issued another press release stating that it was further delaying the filing of its 2003 Annual Report on Form 10-K. In addition to adjusting prior financial results to reflect the amended AOL agreement, SPSS announced that it had discovered an error in its deferred revenue accounts related to the implementation, at the end of 2000, of new accounting interpretations of revenue recognition. SPSS stated that the error caused it to overstate revenues by between three and six million dollars. The press release further stated that as a result of this error SPSS was reviewing and having auditors verify its deferred revenue accounts for the restated financial statements for 2001 and 2002, as well as the unreleased financial statements for 2003. The following day the price of SPSS stock fell 12.17% from $20.95 to $18.40 per share.

  SPSS filed its Form 10-K with the SEC for 2003 on July 29, 2004. The report included restated financial results for 2001, 2002, and the first three quarters of 2003. SPSS explained that the restatements were necessary due to amendments in the AOL agreement, errors in deferred revenue accounts from the fourth quarter of 2000 through the third quarter of 2003, income tax expenses, and a change in the recognition of licensing fee revenues from transactions completed by SPSS distribution partners. As a result, for 2001, SPSS' net loss increased from the previously reported $21.232 million to $26.396 million and for 2002 the net loss increased from $7.899 million to $16.760 million. For the first, second and third quarters of 2003, the net incomes went from $1.361 million to a loss of $58,000, from $2.245 million to $513,000, and from $3.351 million to $2.692 million, respectively.

  In his complaint, plaintiff alleges the cause of SPSS' restatements was not inadvertent error, but rather "a manipulative and deceptive scheme to artificially inflate the market price of the Company's common stock." He argues that this is supported by allegations of confidential witnesses, defendants' financial motives, and their violation of generally accepted accounting principles (GAAP). Plaintiff's complaint discusses the allegations of five different confidential witnesses (CW-1 through CW-5). CW-1 was a sales director for SPSS' federal government division in Arlington and Chicago from fall 2000 until the end of 2001. In September 2001, she allegedly notified Hamburg and Senior Vice-President Mark Pataglia, in writing, that Arleen Garcia, the head of the SPSS sales department, directed employees to record revenues from orders before they had shipped, for the purpose of enhancing SPSS' financials. CW-2, a former federal account manager who worked under Garcia in Arlington from February 1999 through May 2004, confirms this practice. Allegedly, Garcia booked sales without purchase orders at the end of every quarter, and then later would record corresponding returns for the false sales. In response to CW-1's notification, Hamburg informed her that she needed to work with Garcia or leave SPSS. Plaintiff, while not alleging the amount involved, contends that the restated financials for the years 2001, 2002 and 2003 still do not fully address this overstated revenue.

  Plaintiff alleges that CW-3, a former vice-president of strategic planning, who worked in SPSS' Chicago and Arlington offices, confirms the regular practice of SPSS employees recording deferred revenue so they could become eligible for sales bonuses. Furthermore, CW-3 claims to have first-hand knowledge that Noonan and Hamburg were aware of this practice and condoned it. CW-4, a former sales manager and product manager for one of SPSS' divisions, adds the allegation that salespeople would have clients post-date and pre-date agreements so they could achieve their monthly sales goals.

  Plaintiff also alleges that the accounting firm KPMG, which served as SPSS' outside auditor during the relevant time period, played a role in the fraud. He maintains KPMG assisted SPSS in the preparation of its annual and quarterly statements by reviewing the quarterly statements and Form 10-Q reports and auditing the company's annual financial statements and Form 10-K reports. Plaintiff asserts that KPMG diverged from the generally accepted auditing standards (GAAS) when auditing SPSS and ignored a number of "red flags." Instead of conducting a legitimate audit, the auditor allegedly rubber-stamped the company's financial statements and provided false and misleading statements regarding SPSS' financial results in its audit opinions.

  DISCUSSION

  Both the SPSS defendants and KPMG filed motions to dismiss. SPSS defendants contend that count I of plaintiff's amended complaint, for violation of § 10(b) of the Securities Exchange Act, and SEC Rule 10b-5, fails to plead fraud with the particularity required by Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4, and fails to state a claim under Federal Rule of Civil Procedure 12(b)(6). Likewise, KPMG argues that this claim does not satisfy the pleading requirements. Noonan and Hamburg, the named defendants in count II, argue that this claim for violation of § 20(a) of the Securities Exchange Act must be dismissed if count I fails, because it is a derivative claim.

  A Rule 12(b)(6) motion to dismiss tests the sufficiency of the complaint, not the merits of the case. Triad Assocs., Inc. v. Chicago Hous. Auth., 892 F.2d 583, 586 (7th Cir. 1989). In deciding a motion to dismiss pursuant to Rule 12(b)(6), the court must assume the truth of all well-pleaded allegations, making all inferences in the plaintiff's favor. Sidney S. Arst Co. v. Pipefitters Welfare Educ. Fund, 25 F.3d 417, 420 (7th Cir. 1994). The court should dismiss a claim only if it appears "beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

  Rule 9(b) applies heightened pleading standards to claims of fraud, including violations of SEC Rule 10b-5. DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990). To satisfy the rule, a complaint must plead fraud claims with particularity, providing the circumstances of the claim — "the who, what, when, where, and how: the first paragraph of any newspaper story." Id. In addition, private securities fraud claims brought under the Securities Exchange Act have an additional pleading hurdle to surmount, the requirements of the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4(b). The PSLRA requires the complaint to "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). The pleading requirement for state of mind is also more stringent under the PSLRA than under Rule 9(b). While the heightened pleading standard of Rule 9(b) still allows a party to aver generally a defendant's condition of mind, under the PSLRA the complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind" with respect to each misleading statement or omission alleged. Id. § 78u-4(b)(2). We will address SPSS defendants' motion first and then KPMG's. The crux of SPSS defendants' arguments rest on the contention that plaintiff has failed to satisfy the stringent requirements of fraud pleading under Rule 9(b) and the PSLRA, but first they argue that plaintiff has no standing to bring count I as to certain statements.

  SPSS Defendants' Motion to Dismiss

  Standing

  To state a claim for violation of § 10(b) and Rule 10b-5, promulgated thereunder, a plaintiff must allege that "1) the defendant made a false statement or omission 2) of material fact 3) with scienter 4) in connection with the purchase or sale of securities 5) upon which the plaintiff justifiably relied 6) and that the false statement proximately caused the plaintiff's damages." Caremark, Inc. V. Coram Healthcare Corp., 113 F.3d 645, 648 (7th Cir. 1997); see Dura Pharmaceuticals, Inc. v. Broudo, 125 S.Ct. 1627, 1631 (2005).*fn1 Plaintiff employs the fraud-on-the-market theory to support his claim. This theory posits that plaintiff's reliance (and that of other investors) on defendants' statements may be presumed in a Rule 10b-5 action because an investor buys stock in reliance on the integrity of the market price, which reflects publicly available information. Basic Inc. v. Levinson, 485 U.S. 224, 247 (1988); Roots Partnership v. Lands' End, Inc., 965 F.2d 1411, 1416 n. 4 (7th Cir. 1992).

  SPSS defendants argue that plaintiff does not have standing to bring a Rule 10b-5 claim based on statements they allegedly made after plaintiff purchased SPSS stock, because he could not have relied on post-purchase statements when buying the shares that caused his loss, or, for purposes of the fraud-on-the-market theory, his share price could not have reflected post-purchase statements. Plaintiff maintains that as long as he has standing based on some claim, he can state claims for which he does not have standing on behalf of putative class members.

  The Seventh Circuit has held that a plaintiff does not have standing to bring a Rule 10b-5 claim based on allegedly false statements made by defendants after plaintiff purchased the defendant company's stock. Roots Partnership, 965 F.2d at 1420. In Roots Partnership, the plaintiff brought a securities fraud class action after purchasing stock in Lands' End. The court affirmed dismissal of the plaintiff's Rule 10b-5 claim based on statements made by Lands' End after the plaintiff purchased its stock. As the court explained, "[s]uch post-purchase statements cannot form the basis of Rule 10b-5 liability, because the statements could not have affected the price at which plaintiff actually purchased." Id. at 1420. Many courts in this circuit have dismissed securities fraud claims in accord with this principle. See, e.g., DH2, Inc. v. Athanassiades, 359 F.Supp.2d 708, 719 (N.D.Ill. 2005); Greater PA Carpenters Pension Fund v. Whitehall Jewellers, Inc., 2005 WL 61480 at *7 (N.D.Ill. 2005) (dismissing plaintiff's class action claim for § 10(b) liability based on allegedly false statements and omissions made after plaintiff's last purchase because "[t]he Court is bound by the Seventh Circuit's decision in Roots"); Ong ex rel. Ong IRA, 2004 WL 2534615 at *23 (N.D.Ill. 2004); Heartland Financial USA, Inc. v. Financial Institutions Capital Appreciation Partners I, L.P., 2002 WL 31819008 at *7 (N.D.Ill. 2002); Anderson v. Abbott Laboratories, 140 F.Supp.2d 894, 908 (N.D.Ill. 2001). Furthermore, the Seventh Circuit found that plaintiff, lacking standing to bring its ...


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