Dismissal Denied in Options Backdating Securities Case

With the recent dismissals of the options backdating securities class actions filed against Hansen Natural (refer here) and Amkor Technology (refer here), it was beginning to seem that momentum might be building against these suits. But in an October 31, 2007 opinion (here), the court denied in significant part the motion to dismiss the options backdating securities class action lawsuit pending against Openwave Systems and certain of its present and former directors and officers. The portion of the ruling of Judge Denise Cote of the federal court in Manhattan denying the dismissal motion may provide other plaintiffs some grounds to hope that their complaints may also survive motions to dismiss.

The amended complaint against Openwave contained allegations both under the Securities Act of 1933 and the Securites Exchange Act 0f 1934. The court granted the defendants’ motion to dismiss the ’33 Act claim, on the ground that claim, raising allegations related to Openwave’s 2005 secondary offering and only added to the lawsuit in the plaintiff’s amended complaint, was barred by the ’33 Act’s one-year statute of limitations. The dismissal included also the plaitniff’s ’33 Act claims against the company’s offering underwriters and the company ‘s auditors.

Judge Cote also granted certain individual defendants’ motions to dismiss the ’34 Act claims against them as well, on the grounds that the specific individuals had left the company before the beginning of the class period; did not arrive at the company until the alleged backdating took place; or were not alleged to have participated in the supposed misrepresentations.

Judge Cote denied the company’s and the remaining individual defendants’ motions to dismiss the '34 Act claims. The defendants had moved to dismiss the allegations for failure to plead scienter and loss causation. In concluding that the plaintiffs had adequately pled scienter as to certain individual defendants, the court found that the individuals had "benefited in a concrete and personal way" by receiving backdated options from which they "garnered immediate returns," which the court said were "immediate and risk free." The court rejected as "irrelevant" defendants’ arguments that the options grant dates were nowhere near the monthly lows, noting that this "simply indicates that backdating did not achieve as much benefit to the grantee as it could have," not that backdating did not occur.

The court also found, referring to plaintiff's backdating allegations, that "such evidence" is "no less probative of scienter after the Supreme Court’s decision in Tellabs." Judge Cote found that the defendants had "not pointed to any competing inferences" that "could explain their receipt of options bearing dates other than the ones on which they received them." Judge Cote also rejected defendants’ arguments based on the fact that the defendants had received options prior to the class period, since the financials issued during the class period reflected faulty accounting based on the allegedly improper grants.

The court also specifically denied motions to dismiss as to the compensation committee member defendants, finding that their failure to monitor the exercise dates of the options grants "give rise to an inference of scienter."

The court also found that plaintiff had adequately pleaded loss causation, rejecting defendants’ arguments that other causes explained the company’s stock price fluctuations, the factual determination of which the court found "is not an issue to be resolved on the basis of the pleadings alone," but is rather "a matter for proof at trial."

As shown on my running list of options backdating case dispositions (here), there has been at least one prior dismissal motion denial in an options backdating securities class action lawsuit (in the UnitedHealth Group class action case, refer here), but the Openwave Systems court’s denial, perhaps by contrast to the UnitedHealth opinion, is based on a detailed review of the allegations and applicable law. The Openwave dismissal denial also stands in contrast to the recent options backdating dismissal grants, such as in the recent Hansen Natural decision granting a motion to dismiss (refer here), where the court seemed very skeptical of plaintiffs’ allegations and very unwilling to find any support for the plaintiffs’ contention that the options had actually been backdated.

The short shrift given the defendants’ arguments represents a potentially significant development for plaintiffs in other options backdating securities cases. The quick work the court made of defendants’ arguments on scienter and loss causation could, if followed by other courts, have a significant impact on the ourcome of pending motions to dismiss.

The question is whether other courts will follow. Not all judges will be as willing as Judge Cote to conclude that the recipient of options "garnered returns" that were "immediate and risk free." Other judges may focus on the fact there can be no gains on any options until they are exercised, and that until exercised, the share price can decline below the exercise price. Other judges might find the fact that the grants were not even at monthly lows to be inconsistent with the theory of fraud, just as when courts (and as did Judge Cote in another part of her opinion) will find an insider’s sale of a small portion of their share holdings to be inconsistent with the theory of fraud. Other courts might well conclude, in line with their duties under Tellabs, that options grants at other than the maximizing date to be similarly inconsistent with the theory of fraud, and sufficient to create a competing theory at least as compelling as theory that the defendants acted with the requisite intent.

In any event, I have added the Openwave Systems opinion to my running tally of options backdating lawsuit settlement, dismissals and denials, which can be found here. Press coverage discussing the October 31 opinion can be found here.

Openwave Systems (as nominal defendant) and certain of its current and former directors and officers were also the targets of options backdating-related shareholders’ derivative lawsuits. On May 17, 2007, the California federal court presiding over the consolidated shareholders’ derivative litigation granted (here) the defendants’ motion to dismiss with leave to amend. The plaintiffs filed an amended complaint June 29, 2007, and the defendants’ motion to dismiss the amended complaint remains pending.