United States District Court, District of Columbia
PLYMOUTH COUNTY RETIREMENT ASSOCIATION, on Behalf of Itself and All Others Similarly Situated, Plaintiff,
ADVISORY BOARD COMPANY, et al., Defendants.
Document No. 18
MEMORANDUM OPINION GRANTING IN PART AND DENYING IN
PART DEFENDANTS' MOTION TO DISMISS
RUDOLPH CONTRERAS UNITED STATES DISTRICT JUDGE
co-lead plaintiffs in this class action, the City of Atlanta
Firefighters' Pension Fund and the City of Atlanta Police
Officers' Pension Fund, assert that The Advisory Board
Company, its Chief Executive Officer, Robert W. Musslewhite,
and its Chief Financial Officer, Michael T. Kirshbaum,
violated Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 by issuing a series of materially false and
misleading public statements in 2015. Those statements
concerned Advisory Board's acquisition of Royall &
Company, and Royall's post-acquisition performance.
According to Plaintiffs, Defendants publicly touted the
Royall acquisition's success and Royall's 2015
performance, knowing that the acquisition and Royall's
performance were unlikely to meet the market's
have asked this Court to dismiss Plaintiffs' complaint.
Defendants argue that none of the challenged statements were
materially false or misleading when made, even if the
statements were wrong in hindsight. Defendants further argue
that to the extent their statements were materially
false or misleading, Defendants did not possess the state of
mind necessary to hold them liable.
combed through Plaintiffs' voluminous allegations and the
relevant record submissions, the Court agrees that most of
Defendants' statements were not false or misleading.
Plaintiffs' challenge of these statements amounts to
inactionable “fraud by hindsight.” On the other
hand, certain statements about Advisory Board's projected
2015 revenues were rendered misleading by Defendants'
failure to tell investors that shortly before the statements
were issued, key executives had left the company. For the
reasons set forth in greater detail below, the Court thus
grants Defendants' motion in part and denies it in part.
Advisory Board and Royall
the Class Period, Advisory Board was a publicly traded
consulting company “that provided
performance-improvement software and solutions to the
healthcare and education industries.” Am. Compl.
(“FAC”) ¶ 18, ECF No. 16. Advisory
Board's profits were driven by its healthcare business.
Id. ¶ 97 (referencing Advisory Board's
“core” healthcare business); Jan. 21, 2015
Advisory Board Prospectus at S-1 (noting that Advisory Board
served over 3, 900 health care organizations and
approximately 600 colleges and universities), Defs.' Mem.
Supp. Mot. to Dismiss (“Defs.' Mem.”) Ex. 4,
ECF no. 18-5. That said, Advisory Board's higher
education business was substantial: At the time of the Royall
acquisition it had 700 unique clients with annual revenue of
$57, 000 per client. FAC ¶ 37. The business
“supported colleges and universities in enrollment
management; academic programming and student learning;
faculty recruitment and retention; student advising and
success; alumni affairs and advancement; and college and
university operations.” Id. ¶ 33.
was a consulting company focused on higher education. See
id. ¶ 36. Royall helped its college and university
clients “strengthen [their] national reputations,
broaden student enrollment, improv[e] overall academic
profiles, and enhance revenue.” Id. It
typically executed multi-year engagements, in which it would
optimize clients' enrollment programs over time. See
id. When it was acquired, Royall had 200 unique clients
with annual revenue of $400, 000 per client. Id.
¶ 37. The nature of Royall's model-comprehensive,
high-margin engagements with fewer clients-meant that client
retention and development were vitally important on a
year-to-year basis. See id. ¶¶ 64-66.
January 9, 2015, Advisory Board finalized its acquisition of
Royall for approximately $871 million; $750 million in cash
and $121 million in Advisory Board stock. Id. ¶
38. Of this purchase price, approximately $660 million was
attributed to Royall's
“goodwill.” See id. ¶¶ 38, 72.
It was the largest acquisition in Advisory Board's
history. Id. ¶ 39. When Advisory Board
announced the acquisition, it projected that Royall would
produce $121 million to $124 million in revenue in 2015, on
15% to 18% growth from 2014 levels. Id. ¶ 40.
The Class Period
in part on information supplied by two confidential
witnesses, Plaintiffs allege that from January 21, 2015
through February 23, 2016 (the “Class Period”),
id. ¶ 1, Defendants made a series of false or
misleading statements and omissions regarding Royall's
performance and its integration into Advisory Board's
business. The touchstone of these allegations is that
Defendants knew of certain developments that would cause
Royall to underperform its revenue projections and fail to
properly integrate with Advisory Board, at least in the
short-term. Plaintiffs claim that Defendants delayed
revealing these developments to investors, which caused
Advisory Board's stock prices to remain higher than they
would have been if the market had full information. When the
other shoe dropped and the market caught wind of Royall's
problems, Advisory Board's stock price plunged. Before
evaluating the merits of Plaintiffs' amended complaint,
the Court will describe the relevant Class Period statements
January 2015 Stock Offering
January 20 and 21, 2015, Advisory Board filed a registration
statement and two prospectuses with the SEC, through which
Advisory Board offered to sell several million shares of
stock. Id. ¶¶ 70-72. These materials
appended Royall's financial statements for the years
ended June 30, 2012, June 30, 2013, and June 30, 2014, and
for the period between June 30, 2014 and September 30, 2014.
Id. ¶¶ 41, 73. The financial statements
reflected Royall's revenue recognition practice described
below, but Advisory Board's filing did not explain that
practice to investors. Id. ¶ 74.
Fourth Quarter 2014
February 11, 2015, Advisory Board issued a press release and
held a conference call to discuss its financial results for
the fourth quarter of 2014. Id. ¶¶ 76-77.
In the press release, Advisory Board projected total 2015
revenues of $780 million to $800 million. Id. ¶
76. Advisory Board further projected that $125 million to
$135 million of that revenue would come from Royall.
Id. During the conference call, Mr. Musslewhite
touted the scalability of Royall's business model,
stating that “[i]n general . . . Royall is a very
high-margin business. We spent a lot of time diligencing
[sic] that to understand the sources of their margin power
and how sustainable they were.” Id. ¶ 78;
Feb. 11, 2015 Earnings Call Tr. at 23, Defs.' Mem. Ex. 6,
ECF No. 18-7. He also added, regarding the acquisition, that
in terms of culture, fit and integration, everything is going
very well. John Nester, Royal & Company's CEO, has
been great to work with and his team is strong. Obviously,
we're only a few weeks in here, but there is a lot of
positive momentum on both sides and we are confident that
this combination is going to yield great success.
FAC ¶ 77. Mr. Kirshbaum echoed Mr. Musslewhite's
comments, but noted that “the revenue synergies”
and “cross-sell potential” of the Royall
acquisition would not “have much impact in calendar
‘15.” Defs.' Mem. Ex. 6 at 23.
Early Royall-Related Issues
after Advisory Board acquired Royall, cracks allegedly began
to form in what Defendants hoped would be a seamless
integration of the two companies. First, Royall's CEO and
CFO unexpectedly left Advisory Board in or around April 2015.
FAC ¶¶ 45, 47, 49. A former Royall Account
Coordinator (“FE 1”) corroborates this
development, stating that he attended a meeting on April 15,
2015 during which the Royall CEO's successor addressed
Royall's employees for the first time. Id.
¶ 45. Plaintiffs claim that several other high-level
Royall employees, including the Chief Technology Officer,
left around the same time. Id. ¶¶ 46,
Second, at some point, Advisory Board discovered a
discrepancy between how Royall accounted for its revenue
before the acquisition and how Advisory Board would account
for Royall's revenue after the acquisition. As a private
company, Royall regularly delayed closing its books for a
given quarter so that it could recognize revenue for
contracts for which work was performed that quarter, but were
not signed or otherwise executed until the next quarter.
See id. ¶¶ 88, 95. Advisory Board, as a public
company, could not delay closing its books in the same
manner. Id. ¶¶ 88, 95. After the
acquisition, Advisory Board corrected this discrepancy by
recognizing $2 million of revenue in third quarter, 2015 that
Royall would have recognized in second quarter, 2015.
Id. ¶ 95. In other words, the revenue
recognition difference was a timing issue that resulted in
revenue shifting from one fiscal period to the next but,
importantly, did not impact the amount of revenue that
Advisory Board could ultimately recognize from Royall's
work. See id. ¶¶ 88, 95.
First Quarter 2015
5, 2015, Advisory Board issued a press release and held a
conference call to discuss its financial results for the
first quarter of 2015. In the press release, Advisory Board
reaffirmed its earlier projection that total 2015 revenues
would be $780 million to $800 million. Id. ¶
80. It did not alter its previous Royall revenue projection.
See May 5, 2015 8-K, Defs.' Mem. Ex. 9 at 7, ECF
No. 18-10. During the conference call, Defendant Musslewhite
stated, in part, that:
Royall & Company is obviously more recent than the other
two [acquisitions], since the [Royall] acquisition only
closed in January, and we always had a longer integration
timeline planned when we acquired them, with the company
running a little bit more independently initially. The good
news here is that integration is moving more quickly than we
had planned, and we are having some key early wins around
introducing Royall's world-class enrollment managed
services to education advisory board members that have an
acute need for enrollment services.
We expect to have more news as the year progresses, but early
signs lead us to feel good about our future prospects for not
only continued cross-selling of Royall solutions to EAB
members and EAB programs to Royall members, but also key
feature focused activity, such as joint new product
development to provide more and more value to the industry
around the student success lifecycle and deepen our
relationships across our joint member base of the early [sic]
1, 000 institutions.
Id. ¶ 81 (first two alterations in original).
In response to an analyst's question regarding
“temporary margin pressures on Royall, ” Mr.
I think initially we said the first year there was obviously
not a great deal of cost synergy. Royall is a high-margin
business. I don't think we expect it to be anything other
than that. We expect it to maybe be able to maintain its
margins. But a lot of the synergies through revenue synergies
would come in out years as we work together to pursue joint
sales efforts, to penetrate cross-sell on both sides and
develop new products off the platform. That was our
expectation. We are pretty early, but those are proceeding as
we would expect.
Id. ¶ 82. Finally, when asked if anything
surprised him regarding Advisory Board's internal
expectations for the first quarter compared to actual EBITDA
and revenue numbers,  Mr. Kirshbaum stated, in relevant part,
that “I think we feel pretty good about pacing for the
year, so nothing surprising to us. . . . For us, we feel like
we are definitely within the zone of pacing and feel pretty
confident in our numbers for the year.” Id.
¶ 83. Finally, Mr. Musslewhite emphasized the
“excitement that we have around Royall and so much
upside . . . .” Id. ¶ 84.
Royall's Falling Client Retention Rates and Poor
Board's acquisition of Royall was motivated, in part, by
the opportunity for Advisory Board to cross-sell Royall's
clients on Advisory Board's products. See id.
¶ 37. According to Plaintiffs, however, it became
apparent by June 2015 that Advisory Board's cross-selling
attempts would be largely unsuccessful in 2015. Id.
¶¶ 61-68. FE 1 attributes this struggle to Advisory
Board's aggressive sales tactics, which “teed
off” Royall's clients. Id. ¶¶
63-65. A second confidential witness (“FE 2”), a
former Royall Senior Data Developer, id. ¶ 47,
proffered that Advisory Board “failed miserably”
at hitting its sales targets, in part, because of competition
between Royall's sales team and Advisory Board's
sales team. Id. ¶ 68.
Board's aggressive sales tactics, Plaintiffs claim, also
negatively impacted Royall's ability to renew its
existing client contracts. Id. ¶ 66. As a
result, according to FE 1, Royall's client retention rate
dropped from its historic level of 95-97% to below 90% in
2015. Id. As a Royall Account Coordinator
responsible for fifteen accounts, FE 1 participated in
meetings and received emails in which the declining renewal
trend was discussed. Id. He stated that the client
account group was “aware of [the trend] by the end of
June 30, [2015, ] because we were talking actively about not
hitting goals and things like that, and retention not looking
as good.” Id. ¶ 67. FE 1 could not
unequivocally state that Advisory Board's upper
management received the same information that he did, but he
posited that “if people on my level were seeing it, I
imagine everybody above us saw [the information] too.”
Second Quarter 2015
August 4, 2015, Advisory Board issued a press release and
held a conference call to discuss its financial results for
the second quarter of 2015. In the press release Advisory
Board slightly reduced the top end of its 2015 revenue
guidance, from $800 million to $790 million. See id.
¶ 87. Advisory Board did not mention its Royall revenue
guidance in the press release, see Aug. 4, 2015 8-K,
Defs.' Mem. Ex. 12, ECF No. 18-13, but Mr. Kirshbaum
clarified during the conference call that that the company
reduced its top end projection “to account for the
impact of Royall performance, ” Aug. 4, 2015 Earnings
Call Tr. at 10, Defs.' Mem. Ex. 13, ECF No. 18-14.
the conference call, Mr. Musslewhite for the first time
discussed hiccups in the Royall integration. FAC ¶ 88.
He stated that “[t]he only exception to an otherwise
strong start to the year is Royall, where we were
disappointed to see slower growth out of the gates than we
expected.” Id. This slower-than-expected
growth, according to Mr. Musslewhite and Mr. Kirshbaum, was
attributable to three factors. First, “the [Royall] CEO
and CFO chose to depart earlier than expected, impacting
sales and up-sells during a critical time and distracting the
organization.” Id. Put simply,
“management turnover.” Id. ¶ 89.
Second, Royall's focus on the acquisition and transition
“took focus away from key commercial activities.”
Id. ¶ 88. Put simply, “[d]eal
distraction.” Id. ¶ 89. Third, Advisory
Board was required to recognize certain revenues in the third
quarter that Royall would likely have recognized in the
second quarter under its pre-acquisition practice.
Id. ¶ 88. Put simply, “lost
timing.” Id. ¶ 89. Royall's
lower-than-expected sales and renewals would cause their
revenues to “be below the low end of” the
company's initial projection “by several million
dollars, ” on a single-digit growth rate. Defs.'
Mem. Ex. 13 at 12, 16.
Kirshbaum further clarified these hiccups. He noted that
“the January through June period is very busy for
Royall as they help schools fill their classes before the May
1 deposit deadline, ” leading to new business and
up-selling opportunities for the company. FAC ¶ 89. The
deal distraction and Royall departures “resulted in not
capturing as many new clients or up-sell opportunities as the
prior years.” Id. Mr. Kirshbaum also noted
that this impact-“fewer new clients and less client
expansion to renew”-would reduce Royall's revenues
for the following twelve months, into 2016. Id.
Musslewhite discussed Royall's management turnover in
greater detail. He said that before the Royall departures,
Advisory Board “had a dialogue with [Royall's
management] around a 5-year term” with a “strong
incentive plan” and an oral commitment. Defs.' Mem.
Ex. 13 at 12. He also noted that Royall's CEO and CFO
were heavily involved in the company's business. They
“had their hands very tightly controlled around if
there was any sales management, it was through those guys in
terms of sitting on top of the business and steering the bus
. . . .” FAC ¶ 91. Royall's “CEO was
also personally involved in a lot of the up-sell and
cross-sell type conversations and had some
relationships.” Id. Advisory Board was
“surprised by” their departure, Defs.' Mem.
Ex. 13 at 12, in “April, early May, ” FAC ¶
Royall's underwhelming performance, Mr. Musslewhite put a
positive spin on the Royall integration. He emphasized that
Advisory Board “remain[s] on track to deliver strong
overall performance as a company this year, ” and that
“we feel very good about the path forward with Royall
closely integrated into EAB and much more closely linked to
our sales, renewals, and new product development teams and
processes.” FAC ¶ 88. He noted that the problems
discussed on the call “are all one-time issues and very
addressable.” Id. “Overall, ”
according to Mr. Musslewhite, “the integration plan is
proceeding ahead of pace.” Id.; see also
id. ¶ 101 (“Therefore we need to continue to
execute on the integration plan.”).
only was the Royall integration plan proceeding ahead of
schedule, according to Mr. Musslewhite, but so was Advisory
Board's plan to cross-sell Royall's customers. In
response to a question regarding the company's
cross-selling strategy, Mr. Musslewhite stated that “on
all sales-related activity we are in there and already
yielding results.” Id. ¶ 102. He added
further that Advisory Board sales teams were “working
closely with the Royall sales teams in terms of relationship
intelligence, in terms of teeing up cross-sell opportunities
and in terms of actually managing pipelines . . . .”
Defs.' Mem. Ex. 13 at 19. Noting that
“[t]here've been a couple of cross-sells already,
” Mr. Musslewhite asserted that “if anything [the
strategy] is probably on a faster schedule than we might have
anticipated at the beginning of the year.” Id.
Defendants acknowledged that multiple factors combined to
cause Royall to underperform in the first half of 2015.
During Royall's critical sales season, from January to
June, Royall's employees were distracted by the Advisory
Board acquisition and were less focused on acquiring new
customers and up-selling existing customers. And Royall's
CEO and CFO, who were typically heavily involved in
Royall's sales, left the company just as the sales season
ramped up. While Mr. Musslewhite and Mr. Kirshbaum
acknowledged that these factors would likely cause Royall to
underperform in the second half of 2015 and into 2016, they
asserted that Royall's underperformance was a
correctible, one-time event. They also asserted that the
Royall integration was on track overall, and that Advisory
Board's cross-selling strategy was ahead of schedule and
after the August 4, 2015 press release and conference call,
Advisory Board's stock price fell 21%, from $59.36 per
share to $46.99 per share. FAC ¶ 96. Analysts attributed
this drop, at least in part, to the Royall hiccups discussed
on the August 4 call, including the departure of Royall's
CEO and CFO. Id. ¶¶ 92-94, 97-99. As one
market analyst put it, “investors seemed to largely
ignore the strength in the [company's] core healthcare
[practice] and focus instead on the Royall sales
weakness.” Id. ¶ 97.
Third Quarter 2015
November 5, 2015, Advisory Board issued a press release and
held a conference call to discuss its financial results for
the third quarter of 2015. In the press release Advisory
Board reaffirmed the 2015 revenue guidance issued in August:
$780 million to $790 million. Id. ¶ 106. During
the conference call, Mr. Musslewhite doubled down on the
positivity he expressed in August regarding the Royall
integration: “When I look at the degree of interaction
between multiple, different functional teams and the amount
of collaboration across commercial, delivery, technology and
central functions like finance, HR and IT, it feels very much
like Royall is just as much a part of the Company as any
other division.” Id. ¶ 107. Because
Advisory Board was “heavily focused on the organization
integration efforts, ” the company “remain[ed]
both on track to deliver [its] expectations for the year and
optimistic about the long-term potential about the
combination of Royall and The Advisory Board.”
allege that Advisory Board did not begin integrating Royall
in earnest until late 2015 or early 2016, despite
Defendants' positive statements through 2015 to the
contrary. See id. ¶ 52. For instance, FE 2
stated that Advisory Board and Royall employees were still
using separate email systems with separate contacts in early
2016. See id. ¶ 53. More importantly, according
to FE 2, the two companies maintained separate sets of
student data through the end of 2015, such that their sales
teams could not easily compare the two client rosters.
See id. ¶ 55. Instead, Advisory Board's
sales team was forced to manually request data from
Royall's team, and vice versa. See id. ¶
56. And through the end of 2015, the two companies used
separate Salesforce software to manage their client
relationships. See id. ¶ 57.
heard a rumor, from a Royall development manager who reported
to the Royall CFO, that “Advisory Board would be
‘basically hands off' of Royall for the first year
after the acquisition.” Id. ¶ 58.
Whatever the reason, FE 2 stated that Advisory Board and
Royall “were basically like two separate
companies” throughout 2015. Id. ¶ 52.
Fourth Quarter 2015: The Corrective Disclosure
February 23, 2016, Advisory Board issued a press release and
held a conference call to discuss its financial results for
the fourth quarter of 2015. In the press release, Advisory
Board announced a net loss of $101.8 million for that
quarter. See id. ¶ 110. The net loss was
“primarily attributable” to a $95.7 million
reduction, or “impairment, ” of Advisory
Board's goodwill associated with Royall. Id.
the conference call, Mr. Musslewhite and Mr. Kirshbaum
revealed the full extent of Royall's problems. Royall
achieved 5% revenue growth in 2015, far lower than the 15% to
21% projected growth. See id. ¶ 112. Royall
produced $118 million in revenue in 2015, lower than the $125
million to $135 million projected revenue. See id.
And Mr. Kirshbaum predicted mid-single-digit revenue growth
for Royall going forward. See id.
after the February 23, 2016 press release and conference
call, Advisory Board's stock price fell another 27%, from
$36.29 per share to $26.50 per share. Id. ¶
118. Again, analysts attributed the stock drop to Advisory
Board's apparently poor returns on the Royall
acquisition. See id. ¶¶ 114-17. For
instance, one analyst wrote:
The fact that Royall only generated $118M in revenue is
painful enough; paying 7x revenue on any business is steep.
That is beside the fact that the business is only growing
mid-single digits. . . . The lack of a real answer here from
management is about as big of a red flag as you can get.
Id. ¶ 115.
Advisory Board shareholder, Plymouth County Retirement
Association, filed the current lawsuit in late 2017. See
generally Compl., ECF No. 1. The Atlanta Pension Funds
thereafter secured the Court's appointment as lead
plaintiffs. See Mot. For Appointment As Lead Pl. at
2, ECF No. 6; Order Appointing Lead Pl. at 1, ECF No. 9.
Shortly after, Plaintiffs filed the amended complaint on
behalf of the proposed class. See generally FAC.
They claim that Defendants' conduct described above
violated Sections 10(b) and 20(a) of the Securities Exchange
Act, and SEC Rule 10b-5. See id. ¶¶
133-42. In response, Defendants filed a motion to dismiss,
which is now ripe for the Court's resolution.
See Defs.' Mot. to Dismiss, ECF No. 18.
10(b) of the Securities Exchange Act of 1934 provides that it
shall be unlawful “[t]o use or employ, in connection
with the purchase or sale of any security registered on a
national securities exchange . . . any manipulative or
deceptive device or contrivance in contravention of such
rules and regulations as the [Securities and Exchange]
Commission may prescribe as necessary or appropriate in the
public interest or for the protection of investors.” 15
U.S.C. § 78j(b). SEC Rule ...