William H. Orrick, United States District Judge.
In this shareholder derivative lawsuit, plaintiff Pete Manger alleges that defendant Leapfrog Enterprises, Inc. (LeapFrog) and seven of its former Board of Directors members violated the Securities and Exchange Act of 1934 by issuing a false and misleading Recommendation Statement that recommended that shareholders of LeapFrog tender their shares pursuant to a Tender Offer from VTech. On a prior motion to dismiss, I found that Manger failed to state a claim under Section 14(e) of the Exchange Act because he failed to allege with the required specificity which statements in the Recommendation Statement were false or misleading and why, failed to allege facts showing scienter, and failed to allege facts showing loss causation. I dismissed that claim, along with the pendent Section 20(a) claim, with leave to amend.
Manger filed his Second Amended Complaint ("SAC"), attempting to fix the problems I identified. He did not. For the reasons discussed below, I GRANT defendants' motion and dismiss Manger's SAC without leave to amend.
In February 2016, LeapFrog, VTech, and VTech's wholly owned subsidiary Bonita Merger Sub, LLC entered into an agreement and plan of merger (Merger Agreement). Pursuant to the terms of the Merger Agreement, VTech made a Tender Offer on March 3, 2016 (expiring April 1, 2016), whereby each LeapFrog share would be cashed out for $1.00. Second Amended Complaint (SAC) ¶ 8.
On March 3, 2016, LeapFrog filed a Schedule 14D-9 Solicitation/Recommendation Statement with the Securities and Exchange Commission and disseminated it to its shareholders. The Recommendation Statement recommended that shareholders agree to the $1.00 a share Tender Offer. In his SAC, Manger identifies the following false or misleading statements from the Recommendation Statement:
SAC ¶ 10 (citing Recommendation Statement, p. 22) (emphasis in SAC).
According to Manger, these "critical" statements went to the core of the business being able to operate as an ongoing concern and were false and/or misleading because they conveyed a more dire financial situation than actually existed. SAC ¶ 11. Defendants relied on these assertions of financial straits and the liquidity problem to push the Tender Offer and justify their position that there was no time to consider offers other than VTech's. Id. ¶ 12. Manger asserts that the March 2016 representations of a liquidity problem were false because, as of a November 9, 2015 earnings call, LeapFrog had no debt obligations and had access to a $75 million revolving credit facility to fund working capital through the fourth quarter, when cash flow was expected to turn positive again. Id. ¶ 13. In that same call, defendant John Barbour (the former CEO) noted LeapFrog's gain in market share in the children's tablet segment, due primarily to the new "EPIC" tablet that had not yet been fully rolled out. Id. ¶ 14. Two confidential witnesses (CW1, a former LeapFrog senior allocations analyst who was employed through September 2016, and CW2 a former manager of sales analytics through May 2016) confirmed that the early roll out of the EPIC tablet was a success and that at company-wide meetings in March 2016 — prior to the close of the Tender Offer — unnamed senior executives reported that LeapFrog was in a "good position" with $40 million in cash, and that with the credit facility the company could have continued as a stand-alone company for at least another year. Id. ¶¶ 15-16; see also id. ¶¶ 57-58. LeapFrog also acknowledged the success of the EPIC tablet during the negotiations of the merger and Tender Offer, even commencing a trademark infringement action in July 2016 in order to protect the valuable intellectual property rights LeapFrog had in EPIC. Id. ¶ 17.
After conducting its own investigation, the United Kingdom's Competition and Markets Authority ("CMA") concluded that there "would have been alternative purchasers for LeapFrog had the VTech
By ignoring these "positives," Manger argues, the Recommendation Statement statements were false or misleading because defendants failed to include: (i) the information about cash and the credit facility; (ii) the remarkable success of the EPIC tablet; (iii) the possibility of other potential buyers; and (iv) any actual internal financial measures. Instead, the Statement repeatedly emphasized the failure of the LeapTV product as the source of its declining revenues and liquidity problems. Id. ¶¶ 19, 21.
According to Manger, in their rush to push through the VTech Tender Offer the defendants also failed to have their financial advisor Morgan Stanley & Co. LLC (who rendered the fairness opinion) run "critical" but unnamed financial valuations "typically" performed in these circumstances. Id. Instead, Morgan Stanley performed a liquidation analysis that it was not qualified to do on which the Board relied on in recommending the Tender Offer. Id. ¶ 20. Defendants also discouraged other bidders by providing VTech with "unreasonable deal-protection" devices, including preventing Board members from soliciting other bids, requiring information about other bids to be provided to VTech, giving VTech five days to make a competing offer, and imposing a $2.9 million termination fee. Id. ¶ 26.
Manger alleges that despite the potential for future growth — presumably from EPIC and the other unspecified measures resulting from the strategic review — and the alleged ability to fund operations for another year, defendants agreed to the inadequate merger considerations and rejected and/or shut down the bidding process with other companies. Id. ¶ 24. Defendants did so, according to Manger, in order to reap the benefits from "accelerated vesting" of stock options and payments under the employee stock purchase plan and thereby benefitted by giving themselves "liquidity" that they otherwise would not have had. Id. ¶¶ 24-25.
In early April 2016, 56% of outstanding shares were tendered, just enough to effectuate the merger. All LeapFrog shareholders were cashed out of their shares at $1.00 per share. SAC ¶ 8.
Under Federal Rule of Civil Procedure 12(b)(6), a district court must dismiss a complaint if it fails to state a claim upon which relief can be granted. To survive a Rule 12(b)(6) motion to dismiss, the plaintiff must allege "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). A claim is facially plausible when the plaintiff pleads facts that "allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (citation omitted). There must be "more than a sheer possibility that a defendant has acted unlawfully." Id. While courts do not require "heightened fact pleading of specifics," a plaintiff must allege facts sufficient to "raise a right to relief above the speculative level." Twombly, 550 U.S. at 555, 570, 127 S.Ct. 1955.
In deciding whether a plaintiff has stated a claim upon which relief can be granted, the Court accepts plaintiff's allegations as true and draws all reasonable inferences in favor of the plaintiff. Usher v.
If the court dismisses the complaint, it "should grant leave to amend even if no request to amend the pleading was made, unless it determines that the pleading could not possibly be cured by the allegation of other facts." Lopez v. Smith, 203 F.3d 1122, 1127 (9th Cir. 2000). In making this determination, the court should consider factors such as "the presence or absence of undue delay, bad faith, dilatory motive, repeated failure to cure deficiencies by previous amendments, undue prejudice to the opposing party and futility of the proposed amendment." Moore v. Kayport Package Express, 885 F.2d 531, 538 (9th Cir. 1989).
Section 14(e) of the Exchange Act prohibits a person from making "any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation." 15 U.S.C. § 78n. In addition to meeting the Rule 9(b) heightened pleadings requirements, under the PSLRA Manger must plead particular facts showing falsity and scienter. See, e.g., Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1167 (9th Cir. 2009) ("the analysis of Rubke's section 14(e) claims is identical to that of her section 10(b) claims with regard to falsity").
As I noted in my prior Order, there were two problems with Manger's prior Amended Complaint:
January 23, 2017 Order at 6.
Manger contends he has cured these defects by alleging additional facts and linking those facts to the allegedly misleading Recommendation statements. In the SAC, Manger repeats his initial claim that the "doom and gloom" characterization of LeapFrog's financial condition as portrayed in the Recommendation Statement was false or misleading because of the success of the EPIC tablet, which was
Manger also attempts to plead falsity by relying on certain allegations that were attacked by defendants on the last round of briefing, but not discussed in Manger's opposition. Defendants argue that Manger cannot now rely on those "waived" claims.
In the SAC, Manger adds some additional facts regarding the EPIC tablet's initial success and its continued success after the Merger was consummated. See SAC ¶¶ 14, 15, 17, 56-58. Manger relies on these facts to argue, again, that the failure to disclose how well EPIC was doing in the Recommendation Statement and instead disclosing only how the poor performance of LeapTV impacted the company "misled stockholders about the company's future prospects." Oppo. at 6-7.
Manger points to the following statements in the Recommendation that he claims were false or misleading:
Oppo. at 6-7 (citing FAC ¶ 118, emphasis in original).
Manger's new facts do not, however, get him to where he needs to be. As I noted in the prior Order, Manger needed to allege facts showing that the omission of the EPIC information from the Recommendation Statement is contrary to the information contained in the Recommendation or makes that information misleading. Manger does not dispute that defendants had disclosed the positive EPIC information, both in the earnings calls relied on by Manger and in other SEC filings. More significantly, there are no facts alleged that the EPIC success meant that the "declines anticipated in the children's Tablet business that provided significant revenue and contributed to operating profits and cash flow" were not a problem or as big of a problem as the Recommendation conveyed. There are similarly no facts alleged that LeapTV did not result in a significant reduction in liquidity or that reduction was offset by EPIC such that the Recommendation Statement was false or misleading.
Seeking to put a gloss on his prior allegations, Manger narrows his focus and
In addition to the narrowed focus as to the consequences of the misleading Recommendation Statement (that in reality LeapFrog had more financial stability and time to pursue offers other than the VTech's), Manger has also shifted his focus on what was false or misleading in the Recommendation Statement to emphasize misstatements or misleading statements regarding the company's liquidity. In particular, he identifies the following:
SAC ¶ 118 (emphasis in SAC, citing Recommendation Statement at 22). Manger contends that these liquidity representations — the significant possibility of running out of cash "as early as" the first fiscal quarter 2017 (i.e., April 2016)
However, as defendants point out, the Recommendation Statement says that there is a "significant possibility" that LeapFrog would not be able to continue its operations during the first and second quarter. April is simply the beginning of the first quarter, ending June 30th with the second quarter starting July 1st — the exact time when Manger himself alleges the liquidity crisis would have hit. SAC ¶¶ 65-67 (relying on the conclusions of the UK CMA Report).
Manger also considers "misleading" the Recommendation Statement's silence whether the Bank of America would have extended the credit facility. Oppo. 11; SAC ¶¶ 61, 66. But the document relied on by Manger to substantiate his allegation that LeapFrog would not have run out of cash or credit until June 2016 notes that there is no evidence that BofA would have extended more credit and that it was likely LeapFrog would have defaulted on its covenants by June 2016. CMA Report §§ 5.10, 5.17. In sum, everyone is in agreement that by June 2016 LeapFrog's liquidity would have run out.
Manger has not identified anything potentially false or misleading in the Recommendation Statement regarding the liquidity statements. Manger's real complaint — in essence — is that the Board was wrong to push the VTech Tender Offer after the L & M offer came in, and the Board should have put the brakes on VTech and at least pursued the L & M offer. Oppo. 11. But this case is not about the Board making wrong or imprudent business decisions. Manger's case is about a false or misleading Recommendation Statement. That the Board made bad decisions either prior to or after the Statement was released does not mean the Recommendation Statement was false or misleading.
In the prior round of briefing on defendants' motion to dismiss Manger's Amended Complaint, defendants attacked but Manger did not address (and therefore arguably waived reliance on) the following allegations of falsity: (i) that the Recommendation Statement did not disclose Morgan Stanley's conflict of interest, namely its $4 million fee was contingent on closing a transaction; and (ii) that LeapFrog had
Even if each of these arguments were not waived by Manger's failure to defend them in the prior round of briefing and argument, they do not in and of themselves establish falsity. Concerning Morgan Stanley's fee, the Recommendation Statement identified that:
Recommendation Statement at 28. The Statement also disclosed that a "substantial portion" of that fee was contingent upon the closing of the transaction. Id. at A-2.
Manger argues that the Statement should have disclosed exactly what portion of the $4 million fee was contingent because otherwise stockholders would not be able to assess Morgan Stanley's incentives and potential bias in recommending acceptance of the Tender Offer. Oppo. 12. That failure, according to Manger, is even more serious here in light of the fact that the company's financial forecasts reviewed by Morgan Stanley were not disclosed and Morgan Stanley, in agreement with the Board, did not perform the main valuation methodologies traditionally performed for the type of transaction at issue. SAC ¶¶ 130-132.
However, the disclosure that a "significant portion" of the $4 million fee was contingent is sufficient to allow shareholders to evaluate the role the fee might have played in Morgan Stanley's valuations and recommendation. See, e.g., Cty. of York Employees Ret. Plan v. Merrill Lynch & Co., No. CIV.A. 4066-VCN, 2008 WL 4824053, at *11 (Del. Ch. Oct. 28, 2008) (the fact that the financial advisor would receive a fee, "a substantial portion of which is contingent upon the merger being consummated," was a sufficient disclosure).
Regarding the intellectual property rights, Manger argues that the following statements were false or misleading, specifically that: (i) a liquidation of assets would not yield a per share value even close to the VTech offer of $1.00. (SAC ¶ 20), and (ii) on June 29, 2015, Morgan Stanley recommended that Leapfrog explore other alternatives in the event that a sale did not successfully occur, including opportunities to "divest or license certain assets." SAC ¶ 144. Those statements were made misleading, according to Manger, because defendants did not in the Recommendation Statement disclose the "very assets" that would have produced the greatest value in a liquidation or asset sale. Oppo. 13. But Manger cites no facts
Manger has not adequately alleged facts supporting falsity, despite having had three chances to do so. Defendants' motion to dismiss is GRANTED and Manger's claims are dismissed WITH PREJUDICE.
Although I do not need to reach this issue, Manger argues that he cured his prior failure to adequately allege facts that are so "critically adverse" or "dramatically false" to the representations made that scienter can be inferred. He relies on what he calls the "corporate scienter doctrine" — which defendants contend is more appropriately called the "core operations doctrine" — that allows a plaintiff to combine allegations of falsity with specific allegations regarding management's role that suggest the defendants at issue had access to the "true" information. The doctrine also covers situations where the reportedly false information is "so obviously false," it would be absurd to suggest that top management were not aware of its falsity. Opp. 15-16 (relying on Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 1000 (9th Cir. 2009), as amended (Feb. 10, 2009)).
In order to invoke this doctrine, Manger relies on the same allegations of falsity discussed above — the Recommendation Statement's failure to disclose information about and mischaracterization of its future prospects given EPIC and the misrepresentation of the liquidity situation. He then points to the following: (i) CFO Arthur was optimistic about the company's financials in the November 2015 earnings call; (ii) CEO Barbour (according to CW1) was fully aware of the success of EPIC and its prospects; and (iii) EPIC was successful, as evidenced in part by increased orders from Walmart following the merger.
The success of EPIC was never in dispute. What has been in dispute and missing from the beginning are facts that the success of EPIC meant that the statements made in the Recommendation Statement were false or misleading. Moreover, that the company was in a certain position and expressed optimism in November 2015, at the cusp of its major sales season, does not provide much if any relevance to the company's status in March 2016 when the Recommendation Statement was published. The CW1 does not say, or provide facts establishing, that the information conveyed in the Recommendation Statement was false or misleading. The CW1 simply confirms what defendants do not dispute (EPIC was a success during the relevant time and even exceeded expectations set in 2015).
Manger focuses on Arthur and Barbour, in part, to argue in his opposition that these two executives were incentivized to have the VTech Tender Offer consummated before either of them could be terminated for their poor performance. Opp. 18-19. However, those allegations are not made the SAC, even if they were somehow relevant to scienter.
Finally, defendants again point to the UK CMA Report — the same report Manger relied upon extensively in his SAC — as negating any inference of scienter because that report concluded that it was likely LeapFrog would have hit a liquidity crisis by June or July 2016 and BofA indicated it would not have extended the credit facility past May 2016,
Manger has not alleged facts supporting a strong inference of scienter.
Having been given an opportunity to adequately plead the elements of his Section 14(e) claim, and having been unable to do so through three amendments, Manger's Second Amended Complaint is DISMISSED WITH PREJUDICE.
