Ninth Circuit Reverses District Court’s Dismissal of Complaint Against VeriFone

On December 21, 2012, the Ninth Circuit reversed a district court order dismissing a complaint filed by lead plaintiff National Elevator Industry Pension Fund on behalf of investors who purchased VeriFone Holdings, Inc. stock between August 31, 2006 and April 1, 2008. The lead plaintiff alleged that VeriFone, its CEO Douglas Bergeron and its former CFO Barry Zwarenstein knowingly or recklessly made materially false and misleading statements about VeriFone’s financial results in 2007 following the acquisition of Lipman Electronic Engineering Ltd. in 2006.

Following an appeal led by Robbins Geller partner Sanford (Sandy) Svetcov, with assistance from partner Susan Alexander and O’Donoghue & O’Donoghue LLP partner Lou Malone, the Ninth Circuit concluded that the “logical inference” was that “VeriFone’s priority was meeting projections even at the expense of accuracy.” Additionally, the Ninth Circuit said that it “defies common sense that for three straight quarters following a merger, when preliminary reports came in substantially below expectations and the acquired company had lower margins, the correct ‘adjustments’ to flash reports also happened to be the precise amounts Zwarenstein and Bergeron had identified as necessary to hit earnings targets.” The Ninth Circuit also found that defendants’ attack on “individual allegations in isolation … cannot overcome the overwhelming inference drawn from a holistic review” that defendants were “deliberately reckless to the truth or falsity of the financial reports.”

Defendants had touted the merger with Lipman, told investors that VeriFone’s gross margins would increase after the merger, and then reported increased gross margins in each of the first three quarters of 2007. However, investors did not know that the reported results were a sham and the result of fraudulent accounting practices. On December 3, 2007, VeriFone reported that it would have to restate its financial results for the first three quarters of 2007, which caused VeriFone’s stock price to decline by more than 45%, from $48.03 to $26.03.

Moreover, as alleged by lead plaintiff, investors did not know that defendants received “flash reports” in each quarter showing that gross margins were substantially lower than what defendants told investors to expect. Defendants characterized these results as an “unmitigated disaster” and the “end of the party big time,” and directed VeriFone’s accounting staff to “figure it out” and to “fix the problem.” They also provided the accounting staff with the specific dollar amounts of adjustments that were needed for VeriFone to report results in line with guidance. When the accounting staff made those suggested adjustments, it caused an unprecedented increase in VeriFone’s inventory, when Bergeron had earlier stated that reducing inventory was as “important as any goal we’ve set in the past.” Nevertheless, defendants blindly accepted the fraudulent accounting entries without requiring any support or verification. The district court had previously concluded that those allegations failed to raise a strong inference of scienter and dismissed the case with prejudice.

In reversing the district court, the Ninth Circuit focused on the collective impact of defendants’ knowledge of the flash reports, their responses to them, and their failure to question or demand supporting documentation for the fraudulent accounting adjustments. The Ninth Circuit found it significant that defendants’ communications “did not reflect concern with operational issues that might have been driving margins down: their priority was the financial statements and publicly reported results.” Nor did their communications reflect “a search for errors” or “concern … with the accuracy of or basis for the manual accounting adjustments,” even though the adjustments increased inventory by millions of dollars. The Ninth Circuit stated that such “complacency can be described only as willful at this stage of the pleadings.” Further, while defendants touted the SEC’s decision to decline to charge VeriFone or its executives with fraud, the Ninth Circuit ruled that it was impermissible to draw any inferences from SEC inaction.

The Ninth Circuit found that the “allegations, viewed holistically, give rise to a strong inference that Bergeron, Zwarenstein and VeriFone were deliberately reckless to the truth or falsity of their statements regarding VeriFone’s financial results, particularly gross margin percentages.” The appeals court noted that that inference was more compelling than a nonfraudulent inference “in light of Bergeron and Zwarenstein’s public statements celebrating the merger as an unprecedented success.” In addition, the Ninth Circuit noted that Bergeron and Zwarenstein appeared “not to have asked … whether the adjustments were based in fact or even why changes of that magnitude were necessary in the first place,” and that their “overriding concern was avoiding the ‘unmitigated disaster’ of missing earnings targets, which led them to ignore unprecedented increases in inventory at the same time Bergeron was ‘obsessed’ with reducing it and claimed publicly that VeriFone had achieved supply chain efficiencies.”

In re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694 (9th Cir. 2012).