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Plymouth County Retirement Association v. Advisory Board Co.

United States District Court, District of Columbia

March 29, 2019

PLYMOUTH COUNTY RETIREMENT ASSOCIATION, on Behalf of Itself and All Others Similarly Situated, Plaintiff,
ADVISORY BOARD COMPANY, et al., Defendants.

         Re Document No. 18




         The 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 expectations.

         Defendants 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.

         Having 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.


         A. Advisory Board and Royall

         During 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.[1] 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.[2] 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.

         Royall 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.

         On 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.”[3] 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.

         B. The Class Period[4]

         Based 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 and events.

         1. January 2015 Stock Offering

         On 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.

         2. Fourth Quarter 2014

         On 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.

         3. Early Royall-Related Issues

         Soon 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.[5] 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.

         4. First Quarter 2015

         On May 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.[6]

Id. ¶ 81 (first two alterations in original). In response to an analyst's question regarding “temporary margin pressures on Royall, ” Mr. Kirshbaum added:

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, [7] 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.

         5. Royall's Falling Client Retention Rates and Poor Cross-Selling

         Advisory 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.

         Advisory 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.” Id.

         6. Second Quarter 2015

         On 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.

         During 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.

         Mr. 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.

         Mr. 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 ¶ 90.

         Despite 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.”).

         Not 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. at 18.

         In sum, 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 bearing fruit.

         Immediately 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.

         7. Third Quarter 2015

         On 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.” Id.

         8. Delayed Integration

         Plaintiffs 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.[8]

         FE 2 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.

         9. Fourth Quarter 2015: The Corrective Disclosure

         On 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. ¶¶ 110-111.

         During 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.

         Immediately 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.[9]

         C. Procedural History

         An 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.


         Section 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 ...

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