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(Article from Securities Law Alert, July 2016) 

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On July 22, 2016, the Eastern District of New York dismissed a securities fraud action against VOXX International in which a “single confidential witness” provided “nearly all of the information [d]efendants allegedly failed to disclose in their public statements.” Ford v. Voxx Int’l, 2016 WL 3982466 (E.D.N.Y. 2016) (Seybert, J.). The court held “the statements and opinions attributed to” the confidential witness were “too vague to form the basis of a fraud claim.”

The court also rejected plaintiffs’ attempt to plead securities fraud based on VOXX’s “ambitious” fiscal guidance. Finally, the court found inactionable alleged misstatements of opinion concerning the value of the company’s goodwill and trademark assets.

Background 

In March 2011, VOXX acquired Klipsch Holding, a company that produces home audio speaker systems and headphones. Klipsch had an increase in net sales of 1.7% in 2012, and 2.6% in 2013. For 2014, VOXX projected a 9% increase in Klipsch’s net sales, but instead net sales declined that year by 3.7%. When VOXX announced its financial results for the fourth quarter of 2014, VOXX’s share price fell by 25%. VOXX also took a $57.6 million impairment charge in the fourth quarter of 2014 consisting largely of write-downs to Klipsch’s goodwill value and the impairment of certain trademarks.

Plaintiffs subsequently brought the instant securities fraud action alleging that VOXX and two of its executives had made misrepresentations with respect to (1) Klipsch’s financial prospects and performance, and (2) the value of VOXX’s goodwill and asset value. Defendants moved to dismiss for failure to plead actionable misstatements or omissions.

Court Finds Plaintiffs’ Confidential Witness Allegations Too Vague to Meet the Particularized Pleading Requirements for a Securities Fraud Claim 

Plaintiffs relied on statements by a single confidential witness to support their claims that defendants misrepresented Klipsch’s financial prospects and performance.

The court explained that “to the extent a complaint relies upon confidential witnesses to show that company insiders made fraudulent public statements, the information must be alleged with sufficient particularity to demonstrate that the insiders’ statements were actually false.” The VOXX court noted that other “courts have dismissed securities fraud claims that [were] solely based upon vague allegations supplied by confidential sources.” For example, in City of Roseville Employees’ Retirement System v. Energysolutions, 814 F. Supp. 2d 395 (S.D.N.Y. 2011), the court declined to rely on confidential witness statements in considering allegations that a company had overstated the value of certain trust fund assets in its registration statement. The court “found the information supplied by the confidential witness to be overly vague because the witness did not provide any information about the period over which the [trust fund] balance declined, the amount of the decline, or the accuracy of the statements in the registration statement.” Id. (discussing Energysolutions, 814 F. Supp. 2d 395).

In the case before it, the VOXX court similarly found plaintiffs’ confidential witness allegations “too vague to form the basis of a [securities] fraud claim.” First, the confidential witness represented “that Klipsch’s sales [had been] ‘flat or declining for years.’” The court found these statements “overly vague because there [was] no indication of the time period to which the statements refer[red], the magnitude of the alleged decline in sales, or the extent to which the decline impacted the [c]ompany’s reported sales figures.”

 Second, the confidential witness opined that (1) Klipsch’s “products were too expensive relative to the competition” and (2) the company’s “advertising campaigns ‘did not generate the recognition or increase in sales that Klipsch had hoped.’” The court explained that “[a]s a general matter, the mere opinions of confidential witnesses . . . are not actionable in securities fraud cases.” Moreover, the court found the confidential witness’s “opinions about the price point of [Klipsch’s] products and the effectiveness of its advertising campaigns [were] untethered to any particular facts about how [the company’s] pricing and advertising actually affected sales,” and therefore “lack[ed] the particularity necessary to allege [falsity].”

Finally, the confidential witness stated that Klipsch “started to lose market share with headphones/earbuds [in 2012].” The court observed that given the witness’s role at the company, the confidential witness was “plausibly in a position to know the [c]ompany’s standing in the market for headphones relative to competitors.” Nevertheless, the court deemed the confidential witness’s “market share claims . . . too vague to support a cause of action under Rule 9(b).” The court found it significant that the confidential witness “provide[d] no information about whether [the company’s] position in the market changed during the [c]lass [p]eriod or to what extent its reported sales figures during the [c]lass period were impacted by its market position.”

Court Finds Allegations of Ambitious Earnings Estimates, Standing Alone, Insufficient to Support a Securities Fraud Claim 

Plaintiffs “place[d] great weight upon [d]efendants’ 2014 financial guidance as a basis for their securities fraud allegations.”

The court explained that statements projecting “future performance may be actionable under Section 10(b) or Rule 10b-5 if . . . the speaker does not genuinely or reasonably believe them.” The court acknowledged that defendants’ “estimated 9% growth rate [for Klipsch] was lofty” considering “Klipsch’s 1.7% growth rate in 2012 and 2.6% growth rate in 2013.” However, the court observed that “Klipsch’s past performance was publicly known at the time [d]efendants issued their 2014 financial guidance.”

The court explained that plaintiffs cannot allege fraud simply by asserting defendants’ “financial estimates were unreasonable in light of publicly available information.” Instead, plaintiffs “must set forth specific facts showing why [d]efendants’ fiscal guidance was false or misleading, and not merely ambitious.” Here, the court held plaintiffs “failed to meet this burden.”

Court Holds Plaintiffs Failed to Allege a Misstatement of Opinion Concerning the Value of VOXX’s Intangible Assets 

Plaintiffs claimed that VOXX’s statements of opinion concerning the value of its goodwill and trademark assets were “materially false or misleading because the reported values were inflated.” According to plaintiffs, VOXX should have tested these assets for impairment no later than the third quarter of fiscal 2013 rather than waiting until the fourth quarter of fiscal 2014 to report an impairment charge.

The VOXX court explained that in order “[t]o state a fraud claim based upon a misstatement of opinion” under the Supreme Court’s decision in Omnicare v. Laborers’ Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015),[1] plaintiffs must allege “material facts that call the basis for the [c]ompany’s opinion into question and ‘whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.’” Id. (quoting Omnicare, 135 S. Ct. 1318). The VOXX court noted that prior to Omnicare, the Second Circuit in Fait v. Regions Fin. Corp., 655 F.3d 105 (2d Cir. 2011)[2] held that a complaint asserting “a misstatement of a company’s goodwill assets . . . must ‘plausibly allege that defendants did not believe the statements regarding goodwill at the time they made them.’” Id. (quoting Fait, 655 F.3d 105).

The VOXX court also found “instructive” the Second Circuit’s decision in City of Omaha, Nebraska Civilian Ems.’ Ret. Sys. v. CBS Corp., 679 F. 3d 64 (2d Cir. 2012).[3] In that case, plaintiffs contended that “various publicly-known ‘red flags,’ should have caused the defendants to perform an impairment test” of the company’s goodwill assets several months earlier than the company reported an impairment charge. Following the Second Circuit’s precedent in Fait, the CBS court “held that the plaintiffs failed to state a claim because they did not plead any facts which ‘plausibly demonstrate[d] that defendants knew, nor even had reason to know . . . it was more likely than not that the goodwill of any specific reporting unit was overvalued.’” Id. (quoting CBS, 679 F.3d 64).

In the case before it, the VOXX court similarly found plaintiffs’ complaint did “not contain facts suggesting that [d]efendants knew at any point during the [c]lass [p]eriod that VOXX’s goodwill or trademark assets were inflated and should have been tested for impairment.” Although VOXX “lowered its sales guidance in the third quarter of 2013,” the court held that “lower than expected sales [do] not implicate the kind of adverse market conditions that should have triggered an impairment test.” As to the fact that “the reported value of VOXX’s intangible assets exceeded its market capitalization,” the court held this “insufficient to show [d]efendants made an actionable misstatement of opinion absent factual allegations regarding ‘the inquiry the [defendants] did or did not conduct or the knowledge [they] did or did not have.’” Id. (quoting Omnicare, 135 S. Ct. 1318). The VOXX court concluded plaintiffs’ allegations fell “short of what is needed to plead an actionable misstatement of opinion” under Omnicare and Fait.