United States District Court, District of Columbia
LEONARD HOWARD, Individually and on behalf of all others similarly situated, Plaintiff,
LIQUIDITY SERVICES, INC., et al, Defendants.
Beryl A. Howell, Chief Judge
The co-lead plaintiffs, Caisse de dépôt et placement du Québec (“Caisse”) and the Newport News Employees’ Retirement Fund (“NNERF”), bring this proposed shareholder class action lawsuit on behalf of themselves and all others similarly situated, against Liquidity Services, Inc. (“LSI”), the company’s Chief Executive Officer (“CEO”) William Angrick, and Chief Financial Officer (“CFO”) James Rallo, pursuant to sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), for disseminating “materially false and misleading information” and omitting “other material information that artificially inflated Liquidity’s stock price.” Amended Compl. (“Am. Compl.”) ¶ 1, ECF No. 35. Relying heavily on the fact that the “[p]laintiffs do not challenge the accuracy of any of LSI’s reported historical financial or operating results, ” Defs.’ Mem. Supp. Mot. Dismiss (“Defs.’ Mem.”) at 1 (emphasis in original), ECF No. 40, the defendants have moved to dismiss the plaintiffs’ 145-page Amended Complaint. For the reasons set forth below, and in accordance with recent guidance from the D.C. Circuit, In re Harman Intern. Indus., Inc. Sec. Litig., 791 F.3d 90 (D.C. Cir. 2015), this motion is denied in part and granted in part.
LSI, founded in 1999, is an online auction marketplace for “surplus and salvage assets” for which service Liquidity retains a percentage of the sale proceeds. Am. Compl. ¶ 37. LSI is comprised of three business divisions-the retail division, which sells consumer goods, id. ¶ 46; the capital assets division, which sells “large items such as material-handling equipment, rolling stock (such as trucks or military tanks), heavy machinery, and scrap metal, ” id. ¶ 48; and the public sector division, which “enables local and state government entities . . . to sell surplus and salvage assets, ” id. ¶ 51. The capital assets division is further divided by type of seller: commercial sellers and the Department of Defense (“DoD”). Id. ¶ 48. LSI “commonly refers to the ‘commercial’ capital assets business to describe the non-DoD portion of its capital assets business. Id.
The plaintiffs allege that the majority of LSI revenue comes from its “exclusive right to manage and sell substantially all DoD scrap property.” Id. ¶ 2. Consequently, the company’s relationship with DoD is “vital to the overall health of the Company.” Id. ¶ 3. In 2012, DoD renewed, until 2014, two contracts with LSI: a non-rolling surplus goods contract and a scrap goods contract. Id. ¶ 50. As the contract expiration date of 2014 approached, however, “[f]ear was mounting within all levels of the Company” that the contracts with DoD, which were “subject to a competitive bidding process, ” would not “be renewed on the same favorable terms, or even renewed at all.” Id. ¶ 3; id. ¶ 58 (“As the renewal period for Liquidity’s lucrative DoD Surplus Contract loomed, and in the face of growing competition in that marketplace, Defendants grew increasingly concerned that it would not be renewed or extended.”). Therefore, LSI embarked on an expansion of its business in order to “lessen its substantial dependence on the government contracts market, ” id. ¶ 3, by “acquiring competing businesses, ” id. ¶ 4.
Based in part upon information supplied by twenty confidential witnesses, including a vice-president, directors and other senior managers of LSI components, the plaintiffs allege that from February 1, 2012 to May 7, 2014 (the “Class Period”), the defendants constructed a story of sustained growth and expansion of LSI’s business outside of the DoD contracts by making fraudulent and misleading public statements on fifteen separate days over nine consecutive fiscal quarters regarding the growth of its non-DoD business-particularly emphasizing the “two pillars of growth: (1) ‘organic’ growth through sustained margins and improvements in client penetration and services; and (2) ‘inorganic growth through Liquidity’s acquisition strategy.” Id. ¶ 5 (emphasis in the original). The plaintiffs allege that these misrepresentations artificially inflated stock prices throughout the Class Period, id. ¶ 60, and that the defendant CEO exploited this “wave of artificial stock inflation” with “strategically timed stock sales during the Class Period” that “paid him $68.2 million, ” id. ¶ 18 (emphasis in original).
The plaintiffs quote extensively from public statements made in press releases, earnings calls, and filings with the Securities Exchange Commission (“SEC”) for each of the nine fiscal quarters. The pertinent statements are summarized below.
A. Public Releases in 2012
1. First Quarter 2012
Starting on February 1, 2012, upon release of its first quarter 2012 financial results, LSI allegedly began building a narrative that its “[r]ecord GMV [gross merchandising volume] results were driven by growth in the volume of capital assets sales across our commercial and government clients, and benefited from improved merchandising, penetration of existing clients and expanding market share.” Am. Compl. ¶ 100 (emphasis in original) (quoting defendant CEO’s statement accompanying Form 8-K, dated February 1, 2012); Defs.’ Reply Supp. Mot. Dismiss (“Defs.’ Reply”), Ex. 5 (8-K, dated Feb. 1, 2012), ECF No. 48-6. As such, LSI suggested that the company’s growth was partially attributable to its non-DoD business and “organic growth . . . principally from using data and expertise to enhance the value of the assets we sell, penetrating existing client relationships, and adding new sellers to our platform.” Am. Compl. ¶ 105 (quoting defendant CEO’s statement during Feb. 1, 2012 earnings call). In particular, the defendant CEO touted during the February 1, 2012 earnings call with analysts “[w]e are increasing the demand side of [LSI’s] marketplace to drive higher returns on the assets we sell, ” “we continue to add new Fortune 500 clients, including retailers, manufacturers and industrial corporations.” Id. (emphasis in original). During the earnings call, the defendant CFO explicitly attributed LSI’s “strong results for the quarter” to the “record volume in both [LSI’s] commercial capital assets and retail supply chain verticals, ” id. ¶ 106 (emphasis in original), noticeably leaving out reference to the renewed DoD contracts, id. ¶ 50.
Despite public statements of growth in the non-DoD business, the plaintiffs allege that, according to a former LSI Senior Sales Executive, margins began to decline in the retail division “as early as March 2011, ” and “declined again during 2012.” Id. ¶ 69. Indeed, a former LSI Business Analyst and Contact Center Manager observed that “GMV and margins trended downwards” in the retail division “during his three-year tenure, ” from October 2010 through November 2013, “due to ‘new players on the block, ’” and margins were compressed due to “competition forc[ing] Liquidity to renegotiate with big-box stores.” Id. ¶ 67.
Stock prices surged from $34.51 per share at the close of January 31, 2012 to $39.36 at the close of February 2, 2012. Id. ¶ 108. The defendant CEO sold a total of 500, 000 shares on February 6, 2012, and February 10, 2012, for $40.35 and $40.02 per share, respectively. Id. ¶ 266
2. Second Quarter 2012
According to the plaintiffs, the public statements touting the financial performance of LSI’s retail and commercial capital assets divisions continued throughout the Class Period, even as internal evaluations showed weaker profits. On May 3, 2012, LSI released its financial results for the second quarter of 2012, which exceeded previous guidance, id. ¶ 110, and the defendant CEO emphasized in the accompanying statement that the “[r]ecord GMV results were primarily driven by growth in the volume of goods sold in [LSI’s] retail supply chain and municipal government marketplaces by existing and new clients, ” id. ¶ 111 (quoting LSI Press Release, dated May 3, 2012) (emphasis in original). Similarly, during the earnings call on the same day, the defendant CFO stated “[o]ur strong results for the quarter were driven by record volumes in both our retail supply chain group, which has its seasonable high in the second quarter, and public sector verticals.”). Id. ¶ 117 (emphasis in original). Despite averments from multiple confidential witnesses that the retail business was already experiencing deteriorating margins due to heightened competition, see, e.g., id. ¶ 69, the defendant CFO downplayed the issue, explaining on an earnings call that “as our mix of business changes . . . more to a consignment model, if we have higher levels of capital assets under the consignment model, that margin just mathematically goes down.” Id. ¶ 119. While the defendant CFO admitted that “margins will bounce around a little bit from quarter-to-quarter, ” he opined that “I do believe that we can maintain the solid margins we have.” Id. (emphasis in original).
On May 9, 2012, LSI announced its acquisition of GoIndustry. Id. ¶ 122. Between May 23, 2012 and June 12, 2012, the defendant CEO sold 170, 300 shares of stock at prices ranging from $63.01 to $64.69, up more than $9 per share from the per share price of $54.93 on May 2, 2012, immediately prior to the announcements. Id. ¶¶ 120, 266.
3.Third Quarter 2012
On July 5, 2012, LSI announced the completion of its acquisition of GoIndustry. Id. ¶ 126. Later that month, on July 31, 2012, LSI announced its third quarter financial results. Id. ¶ 129. During the earnings call with analysts on the same day to discuss the third quarter results, defendant CFO stated that the company’s “strong results for the quarter were driven by record volumes in both our retail supply chain group, which did not slow down from its seasonal high in the second quarter as we continued to add new clients and further penetrate existing clients, and continued growth in our public sector verticals, ” id. ¶ 135 (emphasis in original). The defendants noted the company’s “organic growth” through market share expansion in the commercial market, id. ¶ 137 (quoting defendant CFO on July 31, 2012, earnings call) but omitted reference to compressed margins and the resulting decline in profitability, id. ¶ 67. In contrast to the positive public statements, a former LSI Business Analyst and Contact Center Manager “observed that as the market grew increasingly crowded, Liquidity was forced to renegotiate contracts at a much lower level of profitability-sometimes to the point where the Company was merely breaking even, sometimes to the point where the Company was losing money-just to keep contracts away from competitors.” Id.
In the same release for its 2012 third quarter financial results, LSI described its recent acquisition of GoIndustry as “enhanc[ing] Liquidity Services’ ability to deliver . . . services to large multinational enterprises across North America, Europe and Asia, ” and that GoIndustry’s “blue chip corporate clients are already being integrated into [LSI’s] commercial business.” Id. ¶ 130 (quoting LSI Press Release, dated July 31, 2012) (emphasis in original). Contrary to this positive public image of GoIndustry’s prospects, the plaintiffs allege that several former insiders knew that GoIndustry had deep structural problems, such as “overpromising its clients-i.e., promising to obtain a certain price for its clients’ products, but having to sell them for substantially less than the promised price-leading to missed expected revenue targets, ” id. ¶ 79, and fixed high salaries for the sales representatives, id. ¶ 80, resulting in “$3 million in debt” at the time GoIndustry was acquired, id. ¶ 79. Moreover, the plaintiffs allege that the defendants downplayed the difficulty of transforming GoIndustry into a growth asset, since “three of the top sales reps in the European division left GoIndustry following the acquisition, taking their accounts to competing companies, including a ‘million dollar’ energy account in Germany.” Id. ¶ 80.
4. Fourth Quarter 2012
On November 29, 2012, LSI released financial results for the fourth quarter of 2012 as well as for full fiscal year 2012. Id. ¶ 140. The defendant CEO, on the earnings call with analysts on the same day, repeated that LSI “enjoyed broad-based organic growth” due to market share expansion within the commercial, non-DoD, market, id. ¶ 146, and that acquisitions, such as GoIndustry will drive growth by allowing LSI to expand globally, id. ¶ 147. The defendant CEO noted, however, that “the integration of GoIndustry will require significant upfront investments to fully realize the global assets market opportunity, which will result in a drag on earnings in the first half of fiscal ’13 but will benefit the second half of fiscal ’13 and our long-term growth prospects.” Id. ¶ 146 (emphasis in original).
On December 12, 2012, during LSI’s Investor Day presentation, LSI again promoted its “positioning in the market, ” beyond its DoD contracts, by noting “strong customer loyalty, ” “[s]ignificant expansion with F1000 commercial clients, ” and “[b]uyer annual growth rate of 41.6% over past 10 years, ” id. ¶ 155 (quoting the Investor Day Powerpoint presentation, dated Dec. 12, 2012) (alterations in original), while omitting information that “Liquidity was, in fact, selling merchandise at lower values in an attempt to stay ahead of the competition, ” id. The defendant CFO downplayed competitive forces, stating during the Investor Day presentation that “when you look to the competition, there is a lot of it, but it’s not very formidable.” Id. ¶ 165 (emphasis in original). Investor analysts picked up on these positive messages about LSI’s capability for growth outside of the DoD contracts, and one analyst report noted “[k]ey takeaways include: (1) the Capital Asset business represents a significant global opportunity with GOI, (2) Commercial Retail has significant growth opportunities through deeper client engagement while sales cycle remain long due to complexity/changing industry behavior.” Id. ¶ 167 (quoting analyst report from Janney Montgomery Scott, a financial services firm, dated Dec. 13, 2012) (emphasis in original).
The plaintiffs allege that LSI’s statements in connection with the release of the financial statements for fiscal year 2012 were false and directly contradicted by internal assessments. Multiple confidential sources noted that “as the market grew increasingly crowded, Liquidity was forced to renegotiate contracts at a much lower level of profitability-sometimes to the point where the Company was merely breaking even, sometimes to the point where the Company was losing money-just to keep contracts away from competitors.” Id. ¶ 67; id. ¶¶ 68–70. Several sources revealed that not only were margins “trending downward throughout 2012, ” goods were “often sold at a loss during 2012” in order to keep customers. Id. ¶ 70. In around October 2012, during the Class Period, LSI lost a contract with “a large overstock company to a competitor, ” and the loss led to a ten percent reduction in work force at LSI’s customer Contact Center. Id. ¶ 67.
B. Public Releases in 2013
The plaintiffs allege that the defendants continued to release publicly positive financial news through 2013 even as the defendants knew about weak financial performances in the non-DoD businesses.
1. First Quarter 2013
On January 31, 2013, the defendants released first quarter results for fiscal year 2013. Id.¶ 173. During the earnings call with analysts, the defendant CFO lauded the “retail business” for “perform[ing] extremely well during the first quarter.” Id. ¶ 179 (emphasis in original). In the face of decreased GMV, however, the defendant CFO admitted that product flows from “existing clients . . . are lower than the flows received last year, ” but explained that despite the slower-than-anticipated “ramping up” of new clients, “low double-digit growth in the retail supply . . . business for the rest of the year” was expected as these new clients were brought fully onboard. Id. ¶ 180. While the defendant CFO again touted the “vast opportunities” presented by the GoIndustry marketplace, he also admitted that to take advantage of the opportunity, LSI will be required “to make more investments and restructure an organization that has not had any investments in the last four years.” Id. ¶ 180. On news of the GMV decrease, stock prices dropped more than twenty-two percent. Id. ¶ 182.
On March 5, 2013, when heightened competition had already decreased LSI’s margins, the defendant CFO, on a conference call hosted by Deutsche Bank, repeated the company’s position stated first during the December 12, 2012 Investor Day presentation that “we don’t really have a lot of formidable competition, but we certainly have a lot of competition.” Id. ¶ 185 (emphasis in original).
2. Second Quarter 2013
On May 2, 2013, LSI released the second quarter 2013 financial results. Id. ¶ 187. During the earnings call with analysts, the defendant CEO again attributed the increase in GMV to “the growth in the volume of capital assets in our commercial and government marketplaces” and the “nice growth in the retail side of our business, driving efficiencies there.” Id. ¶ 191 (emphasis in original). In particular the CFO explained that LSI has “signed several large clients during the year, ” that it has “increase[d] the number of programs [LSI is] doing with existing clients, ” and “that’s really driving the growth.” Id. ¶ 193. The defendant CEO, in his statement accompanying LSI’s Form 10-Q, continued to promote the “significant progress” LSI made “integrating GoIndustry, including the award of several new client engagements, ” and anticipated that “[LSI] will exit this fiscal year with GoIndustry operating profitability.” Id. ¶ 189 (emphasis in original).
The plaintiffs allege that the defendants misrepresented material facts about the weakness of LSI’s non-DoD business during this period. According to LSI’s former Director of Global Compensation, between March 2013 and November 2013, the retail segment was “sinking fast, ” and “revenue was only coming in from existing contracts, as Liquidity was unable to secure new contracts.” Id. ¶ 65. At the same time, a “former Director of Global Sales who was employed in Liquidity’s retail division from 2009 through May 2014, observed that even the addition of new business did not translate into profitability for the business segment, as the Company had to purchase the retail products it would sell and then warehouse them at its own cost.” Id. Increasingly, the defendants were forced to “renegotiate contracts” with existing clients at “much lower level of profitability.” Id. ¶ 67; see also Id. ¶ 68 (a former Director of Global Sales “noted that competitors were vying for the same business as Liquidity, and thus the Company was forced to accept lower margins, which negatively ...