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 Company
background
Litigation
background
- USDC SD California (San Diego)
3:98-cv-01537-L-AJB
- Filed 8.24.98
Summary
- In In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. 2005), the
plaintiffs, a
class of investors, alleged that the defendants, Daou Systems and its
executives,
systematically and fraudulently violated GAAP to artificially inflate the
companys stock
price. The district court dismissed the complaint, holding that plaintiffs
failed to
sufficiently plead particularized claims. Id. at 1013. The Ninth Circuit
reversed.
With regard to the Section 10(b) claim, the Ninth Circuit held that the
investors
descriptions of confidential witnesses met the PSLRAs requirements because the
complaint described the witnesses with a large degree of specificity, including
describing each witnesss job description and responsibilities and, in some cases,
giving the witnesss
exact title and the name of the executive to whom the witness reported. Id. at
1016.
Accordingly, the Ninth Circuit stated that the [p]laintiffs complaint . . .
states a
sufficiently particularized claim for accounting fraud under the heightened
pleading
standards of the PSLRA. Id. at 1030. The Ninth Circuit noted that to comply
with the particularity requirement for pleading confidential sources of
information, this circuit has applied the Second Circuits standard that
personal sources of information relied upon in a complaint should be described
in the complaint with sufficient particularity to support the probability that a
person in the position occupied by the source would possess the information
alleged. Id. at 1015-16 (internal quotations and citations omitted).
- In In re Daou Sys., Inc. Sec. Litig., 411 F.3d
1006, 1012 (9th Cir. 2005), the plaintiffs alleged that the defendants
systematically recognized revenue before it was earned in violation of GAAP. To
plead a securities fraud violation based upon alleged GAAP violations, the Ninth
Circuit noted that plaintiffs must allege (1) such basic details as the
approximate amount by which revenues and earnings were overstated; (2) the
products involved in the contingent transaction; (3) the dates of any of the
transactions; or (4) the identities of any of the customers or [company]
employees involved in the transactions. Id. at 1016-17 (citations omitted).
The Ninth Circuit also noted that the plaintiffs must allege enough information
so a court can discern whether the alleged GAAP violations were minor or
technical in nature, or whether they constituted widespread and significant
inflation of revenue. Id. at 1017 (citation omitted). The Ninth Circuit found
that the plaintiffs complaint alleged at least some specific allegations of
how the adjustments affected the companys financial statements and whether they
were material in light of the companys overall financial position. Id. at
1018. The Ninth Circuit noted that the complaint contained allegations that the
companys CEO and President adjust[ed] upward the percent of completion for
projects. Id. The complaint also contained allegations from a confidential
witness that the company recognized revenue from a contract with Candler Health
Systems before any contract was signed. Id. at 1019. Furthermore, the
plaintiffs alleged that if the company had properly recorded revenue in line
with what it was entitled to bill customers for, its revenue would have been
$5.9 million, 48% less than publicly reported. Id. Based upon these allegations,
the Ninth Circuit reversed the decision of the district court and sustained the
plaintiffs complaint.
- In In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. 2005), the
Ninth Circuit
reversed the district courts dismissal and found the following allegations
sufficient to
plead intentional behavior and/or conscious misconduct by the defendants because
they
(1) personally directed the [companys] recognition of revenue, financial
reporting and
public statements, (2) made the decision[s] on how much revenue to recognize
without
regard to any actual percentage of completion, and (3) presented themselves as
knowledgeable about all aspects of the Companys finances, including earnings
and
revenue recognized under POC accounting. Id. at 1023.
The plaintiffs brought class action securities claims against Daou Systems, Inc.
(Daou) and certain officers and directors for systematically and fraudulently
violating
GAAP in order to inflate Daous stock price. Specifically, the plaintiffs
alleged that the
defendants violated GAAP by reporting revenues gained from labor Daous
employees
performed under long-term service contracts before the company earned such
revenue. Id.
at 1012. The district court held that the plaintiffs failed to plead that the
defendants
accounting methods were misleading because plaintiffs failed to quantify and
contrast the
amount of revenue that Daou would have been entitled to if it accounted for the
revenue
properly. Id. at 1018. The Ninth Circuit disagreed, holding that the plaintiffs provided sufficient
allegations as to how the adjustments affected the companys financial
statements and
whether they were material in light of the companys overall financial
position. Id. The
Ninth Circuit also held that the district court improperly concluded that the
plaintiffs failed
to adequately plead scienter as to the individual defendants. Specifically, the
Ninth Circuit
held that whether a plaintiff adequately pleads scienter is to be determined by
looking at
the totality of the allegations here, where (1) the complaint provided
statements from
confidential witnesses that the individual defendants were aware of and approved
the
accounting methods at issue and that the company was run from the top to
bottom; (2)
the defendants admitted that they were detailed oriented managers; and (3) the
defendants
stock sales were suspicious in terms of amount and timing, the totality of the
allegations
led the court to state that there was a reasonable inference that the defendants
acted with
the requisite level of scienter. Id. at 1022-24.
- The Ninth Circuit appears to have moderated its position in In re Daou Sys.,
Inc.
Sec. Litig., 411 F.3d 1006, 1024 (9th Cir. 2005). The Ninth Circuit noted that:
When considered as a whole, plaintiffs allegations are
sufficient to create a strong inference that all defendants
except Moragne acted with at least deliberate recklessness.
The complaint relays specific information from actual
witnesses, albeit unnamed, that defendants knowingly
violated GAAP procedures and present more than mere
evidence of a motive and opportunity to commit fraud.
Although plaintiffs allegations of Daous top-to-bottom
management hierarchy, defendants suspicious stock sales,
or the corporate acquisitions alone would not likely
demonstrate defendants scienter, these plus the complaints
specific allegations of deliberate accounting misfeasance
create a strong inference of scienter.
Id. (emphasis added).
- The Ninth Circuit appears to have moderated its
position in In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, 1024 (9th Cir.
2005). The Ninth Circuit noted that:
When considered as a whole, plaintiffs allegations are
sufficient to create a strong inference that all defendants
except Moragne acted with at least deliberate recklessness.
The complaint relays specific information from actual
witnesses, albeit unnamed, that defendants knowingly
violated GAAP procedures and present more than mere
evidence of a motive and opportunity to commit fraud.
Although plaintiffs allegations of Daous top-to-bottom
management hierarchy, defendants suspicious stock sales,
or the corporate acquisitions alone would not likely
demonstrate defendants scienter, these plus the complaints
specific allegations of deliberate accounting misfeasance
create a strong inference of scienter.
Id. (emphasis added).
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