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Fialkov v. Microsoft Corp.

United States District Court, W.D. Washington

December 12, 2014

GAIL FIALKOV, Individually and on Behalf of All Others Similarly Situated, Plaintiff,

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For Seafarers Pension Plans, Oklahoma Firefighters Pension and Retirement System, Movants: Theodore M. Hess-Mahan, LEAD ATTORNEY, Hutchings, Barsamian, Cross and Mandelcorn, LLP, Wellesley Hills, MA; Douglas C McDermott, MCDERMOTT NEWMAN, SEATTLE, WA; Tor Gronborg, ROBBINS GELLER RUDMAN & DOWD LLP (SD), SAN DIEGO, CA.

For Gail Fialkov, Individually and on Behalf of All Others Similarly Situated, Plaintiff: David A Rosenfeld, LEAD ATTORNEY, PRO HAC VICE, ROBBINS GELLER RUDMAN & DOWD LLP (NY), MELVILLE, NY; Francis A DiGiacco, Matthew I Alpert, LEAD ATTORNEYS, PRO HAC VICE, ROBBINS GELLER RUDMAN & DOWD LLP (SD), SAN DIEGO, CA; Theodore M. Hess-Mahan, LEAD ATTORNEY Hutchings, Barsamian, Cross and Mandelcorn, LLP Wellesley Hills, MA; Tor Gronborg, LEAD ATTORNEY, PRO HAC VICE, ROBBINS GELLER RUDMAN & DOWD LLP (SD) SAN DIEGO, CA; Deborah R Gross, LAW OFFICES BERNARD M GROSS PC, PHILADELPHIA, PA; Douglas C McDermott MCDERMOTT NEWMAN SEATTLE, WA.


For Microsoft Corporation, Steven A Ballmer, Peter S. Klein, Tami Reller, Defendants: Jonathan C Dickey, Noah F Stern, Paul J Collins, LEAD ATTORNEYS, PRO HAC VICE, GIBSON DUNN & CRUTCHER (PALO ALTO), PALO ALTO, CA; Oliver Olanoff, LEAD ATTORNEY, Gibson, Dunn & Crutcher LLP, New York, NY; Shane P. Cramer, LEAD ATTORNEY, Arthur W. Harrigan, Jr., CALFO HARRIGAN LEYH & EAKES, LLP, SEATTLE, WA; Kevin J. O'Connor, Collora LLP, Boston, MA; Mark A. Bross, Hinckley Allen & Snyder, LLP, Boston, MA; Michael J Connolly, HINCKLEY ALLEN & SNYDER, BOSTON, MA.

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This matter comes before the Court upon Defendants' Motion to Dismiss Plaintiffs' Consolidated Amended Complaint pursuant to the Private Securities Litigation Reform Act of 1995 (" PSLRA" ) and Federal Rules of Civil Procedure 9(b) and 12(b)(6). Dkt. # 53. Specifically, Defendants Microsoft Corporation (" Microsoft" ) et al. assert that Plaintiffs fail to plead sufficient facts to support the inference that various Microsoft statements were false or misleading when made or that Defendants acted with the requisite scienter. The Court deems oral argument unnecessary. For the reasons stated herein, the Court agrees with Defendants that Plaintiffs have failed to meet the applicable heightened pleading standards and consequently GRANTS Defendants' motion to dismiss.


Plaintiffs filed their initial putative class action complaint on August 12, 2013 in the United States District Court for the District of Massachusetts, alleging that Microsoft and four of its current and former

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executive officers violated federal securities laws by issuing a series of false or misleading statements about Microsoft's Surface RT tablet and the company's inventory of the product. Dkt. # 1. The action was soon thereafter consolidated with a virtually identical putative class action complaint, both of which were transferred to this Court. See Dkt. # 49. The Plaintiffs filed their operative Consolidated Amended Complaint (" CAC" ) on January 24, 2014, asserting causes of action for violation of § 10(b) of the Securities Exchange Act of 1934 (the " Exchange Act" ), 15 U.S.C. 78j(b), and Rule 10b-5, promulgated thereunder, 17 C.F.R. § 240.10b-5, as well as § 20(a) of the Exchange Act, 15 U.S.C. § § 78t(a)-(b).

Plaintiffs consist of purchasers of Microsoft common stock during the period from January 24, 2013 through July 18, 2013 (the " Class Period" ) who were injured by Defendants' alleged violations. See CAC, ¶ 1. Defendants include Microsoft, former CEO Steven A. Ballmer, former CFO Peter S. Klein, and former CFO of the Windows division Tami Reller. All individual Defendants served as Microsoft officers during all or part of the Class period. Id.

Founded in 1975, Microsoft is a software, service, and solutions provider headquartered in Redmond, Washington and traditionally known for its Windows PC operating System and Office applications. Id. at ¶ 12. Historically, Microsoft distributed its products through original equipment manufacturers (" OEMs" ), who purchase licenses for installation of the Windows operating system and other Microsoft products on hardware manufactured by the OEM prior to resale to the end-user. See, e.g., Dkt. # 54 (" Dickey Decl.), Ex. 1, p. 10. Under his leadership as CEO, Ballmer announced a " significant shift" that would reposition Microsoft as a " devices and services company." Id. at Ex. 3, p. 2; CAC at ¶ ¶ 12, 29. In response to the successful release of tablets and touch screen devices by its competitors, accompanied by declining sales of x86 PCs and corresponding demand for Windows operating systems, Microsoft announced in July 2010 that development of a tablet would be its " job one urgency." CAC at ¶ 27. On June 18, 2012, Ballmer unveiled that Microsoft would soon begin manufacturing and selling for the first time its own tablets, the Surface RT and Surface Pro. Id. at ¶ 29.

On October 26, 2012, Microsoft released to market the Surface RT, a device powered by an ARM chipset and running on Windows RT, a scaled down version of Microsoft's new Windows 8 operating system. Id. at ¶ 31. By contrast, Microsoft's Surface Pro tablet, not released until February 2013, would be capable of running the full Windows 8 operating system on an Intel chipset. Id. Microsoft disclosed in its June 2012 Form 10-K filing with the Securities and Exchange Commission (" SEC" ) that the Surface devices would compete directly with products manufactured by Microsoft's OEM partners, to whom it was simultaneously continuing to supply the Windows platform. Dickey Decl., Ex. 5, pp. 13-14.

Plaintiffs admit that Microsoft downplayed expectations for Surface RT sales, which some public commentators forecasted would sell poorly, particularly at the tablet's price point of $499-$699. CAC at ¶ 33. For instance, in November 2012, prior to the Class Period, Ballmer publicly labeled Surface RT sales as " modest." Id. Defendant Reller, appointed to the position of Windows CFO shortly thereafter, elaborated in a November 27, 2012 conference call with analysts: " We chose a quite limited distribution initially so that we could make sure that we were seeing how [the Surface RT] landed." Id. at ¶ 35. Plaintiffs further admit that despite Microsoft's

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efforts to clarify Ballmer's characterization of the tablet's " modest" release, analysts continued to speculate that Surface RT sales were failing to meet expectations. Id. at ¶ 36.

Plaintiffs nonetheless assert that throughout the Class Period, Defendants attempted to assure investors of a successful launch of its Surface RT tablets, which was seen as crucial to the future viability of its Windows division. Id. at ¶ ¶ 29-30. Specifically, Plaintiffs allege that Defendants painted the Surface RT as a driver of its Windows Division revenue and assured investors that its inventory level were within a healthy range, all the while failing to disclose that Microsoft held in excess of five million units of the Surface RT tablet in returned and unsold inventory. Id. at ¶ ¶ 39-43, 46. According to Plaintiffs, this scheme crumbled when on July 18, 2013, at the close of the Class Period, Microsoft was forced to announce that it would take a $900 million charge to account for the unsold RT inventory, reducing the price of the Surface RT by $150 to $349. Id. at ¶ 68. By the close of trading on July 19, 2013, Microsoft's stock had dropped over 11%, from $34.93 to $30.95 per share, representing a market capitalization loss of over $40 billion and the worst sell-off day of Microsoft shares in 13 years. Id. Ballmer's retirement from Microsoft followed shortly thereafter. Id. at ¶ 75.

A. Allegedly False and Misleading Statements Issued During the Class Period

1. January 24, 2013 Conference Call and Form 10-Q

The Class Period began on January 24, 2013, when Microsoft released its second quarter 2013 (" 2Q 2013" ) financial results and hosted a conference call with analysts and investors. CAC, ¶ 39. Among those representing Microsoft on the call were Defendant Klein and Chris Suh, Microsoft's General Manager of Investor Relations. Regarding the 2Q 2013 results for Microsoft's Windows Division, Suh stated on the call that " [w]hile inventory levels ended the quarter at slightly higher levels than the prior year, we believe them to be in a health range given the recent launch of [Windows 8 and Surface RT.] Non-OEM revenue grew over 40%, driven by Windows 8 upgrades, sales of Surface, and double-digit growth in volume of licensing." Id. Plaintiffs also point to several statements by Klein, in which he told participants that Microsoft " recently increased production and expanded distribution [of Surface products] to third-party retail partners" and that " this quarter [Surface] was a contributing factor to the revenue growth in the Windows business." Id. at ¶ ¶ 39-40. He elaborated that Microsoft " obviously had limited distribution this quarter in our stores, and as you know, we're excited about expanding that." Id. at ¶ 40.

Klein specifically addressed Surface RT inventory at several points during the call. First, upon being prompted by a Morgan Stanley analyst who remarked that inventory appeared to be unusually high for the quarter, Klein responded: " Yes, the inventory is a function of both what is happening in the Xbox business and Surface. They're offsetting impacts this quarter. Some of it is from Surface and then some of it is from the Xbox business." CAC, ¶ 41. Upon prompting, he clarified that " in inventory, yes, you're thinking about it right. We saw the normal draw-down from the Xbox business and any offsetting increase there was related to Surface." Id. Toward the end of the call, Klein was further asked by an analyst whether " the Windows outperformance was primarily...due to the inventory build." Klein responded:

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Yes, the three biggest components of the 11% total revenue growth...were the retail upgrades, the sales of Surface, and then multi-year licensing agreements within enterprises. To your point, there was some tailwind from inventory, which was normally, as you highlight, what we see in a launch quarter, and as Chris said, it is within the healthy range that we typically see.

Id. at ¶ 42.

Plaintiff also point to Microsoft's 2013 Form 10-Q, filed with the SEC on January 24, 2013 and approved and certified by Defendants Ballmer and Klein, in which Microsoft reported that " [r]evenue increased, primarily due to the launch of Window 8 and Surface on October 26, 2012." Microsoft similarly reported that revenue decrease resulting from the decline in the x86PC market was " offset in part by sales of Surface and Windows 8 upgrades." Id. at ¶ 43.

Plaintiffs allege that Defendants' positive statements about Surface RT sales were materially misleading when made because Defendants " failed to disclose that Microsoft had in excess of five million units of the Surface RT tablet, including components for the tablets, in returned and unsold inventory." Id. at ¶ 46. Plaintiffs assert that these misleading statements resulted in Microsoft stock trading at artificially inflated prices above $27 per share following January 24, 2013.

2. February 13, 2013 Goldman Sachs Technology & Internet Conference

Plaintiffs next point to remarks made by Defendant Klein at a Goldman Sachs Technology & Internet Conference on February 13, 2013. Addressing questions about Microsoft's experience with the Surface RT, Klein described its launch as " very controlled" and " limited to our stores, and our online, and some limited geographies." He added, " what we've done is to broaden the reach of what we're doing in distribution, get it out there in more geographies, and third party retail so people can actually come in, touch it, and play with it, and really get the full experience so that they really understand it." CAC, ΒΆ 49. Plaintiffs allege that the characterization of the Surface RT launch as " controlled" ...

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