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Scandlon v. Blue Coat Systems: Complaint Dismissed with Leave to Amend

In Scandlon v. Blue Coat Systems, Inc., Robert Scandlon, Jr. brought a class action on behalf of himself and all others similarly situated shareholders (“Plaintiffs”) against Blue Coat Systems, Inc., Brian Nesmith (President and CEO), and Gordon Brooks (CFO, Principal Accounting Officer, and Senior Vice President) (collectively “Defendants”).  No. C 11-4293 RS, 2013 WL 308879 (N.D. Cal. Jan. 25, 2013).  The court found that the claims were factually insufficient under the applicable pleading standards and granted Defendants’ motion to dismiss with leave to amend.  

Plaintiffs claimed that Defendants were liable for fraud under § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5.  Plaintiffs alleged that Defendants knowingly misled investors and securities analysts about the health of the company by being overly optimistic about sales, growth, and prospects.  Plaintiffs also alleged that Nesmith and Brooks had derivative liability for any of Blue Coat’s violations of § 10(b) under § 20(a) of the Exchange Act.

Section 10(b) prohibits the use deceptive devices in connection with the sale or purchase of securities.  For there to be a violation of Rule 10b-5, a plaintiff must show “(1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss.”  To establish scienter, plaintiffs must allege facts that give “rise to a strong inference that the defendant acted with the required state of mind."

The court found that the Plaintiffs’ allegations failed for a number of reasons.  First, the allegations lacked specificity.  Moreover, many of the claims were better characterized as puffery.  The court characterized the claim as an action based upon statements that were “unduly rosy.”  The court, however, reasoned that “[b]usinesses are entitled, however, to synthesize and analyze the available information, and to reach judgments as to how ‘rosy’ things are or are not.”

To evaluate allegations of scienter, a court must look at all of the alleged facts and taking “into account plausible opposing inferences.”  The court found that the Plaintiffs did not adequately plead facts to support an inference of Defendant’s intent to deceive.  The facts also plausibly supported inference that the Defendant incorrectly analyzed the company’s business conditions.  The court also found that since the Plaintiffs did not adequately plead a material misstatement or omission, or allege sufficient facts to show loss causation. 

The court also dismissed the claim under § 20(a) of the Exchange Act because liability was based on the existence of a violation of § 10(b).  Though the Plaintiffs had not alleged adequate facts at that time, the court found it was premature to conclude that proper pleadings were impossible.  As a result, the motion to dismiss was granted with leave to amend the complaint within 30 days.

The primary materials for this case may be found on the DU Corporate Governance website.

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