POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2014
Pomerantz recently scored a significant win for investors in a securities class action involving Avid Technology, a software company. Our complaint alleges that Avid, certain of its officers and directors and its long-time outside auditors Ernst & Young committed accounting fraud. On June 27, 2014, U.S District Judge William Young of the District of Massachusetts denied motions to dismiss filed by all the defendants.
This case presents a rare victory for investors on a motion to dismiss where a company has announced that it will have to file restated financial results but, over a year later, had still failed to file them when the complaint in the action was filed (well after the filing of the complaint). In such cases it is often much harder to plead the fraud in sufficient detail, because it is not until the restatements are issued that the company spells out in detail what was wrong with those original results, and why. Even more importantly, the court refused to let Avid’s auditors off the hook for restatements that, when they come, will affect three years’ worth of software contract revenues.
In 2013, Avid announced that it would restate three years’ worth of financial results because it had improperly recognized revenue from post-contract customer support (“PCS”). Avid revealed that it improperly recognized PCS up front, rather than ratably over the life of the contracts, as accepted accounting standards require. Delayed recognition of PCS in this manner is a fundamental accounting rule for software companies such as Avid. Its announcement said that it would conduct a comprehensive review of the accounting treatment for five years’ worth of software contracts.
Avid had not restated its financial results as of the filing of the complaint. The company tried to take advantage of its own delays, claiming that the allegations were not specific enough because they did not identify specific PCS contracts that were mishandled. We were forced to rely on Avid’s disclosures when it originally announced the need to restate its financials, which were not very specific. However, Judge Young was persuaded that Avid’s repeat¬ed statements about proper revenue recognition practic¬es with respect to PCS sufficiently alleged that material misstatements had been made.
With respect to scienter, the court highlighted statements found in con¬ference call transcripts in which Avid’s CEO demonstrated his knowledge of PCS accounting requirements, as well as allegations from a confidential witness who claimed that the CEO himself decided to recognize PCS up front, rather than ratably. The Court also found persuasive our argument that a compelling inference of scienter was bolstered by the magnitude of the restatement—especially considering that, even though a year had passed since announcing the restatement, the restatements was not complete at the time of the motion to dismiss.
Finally, the Court did not let Ernst & Young, Avid’s long-time outside auditors, escape responsibility. The court was persuaded that the length and magnitude of the errors, the systematic lack of internal controls, and the long-standing relationship between the auditors and Avid sufficiently alleged recklessness as to the auditors.
Avid recently filed the restated financial results, and the changes were massive. Before 2011, Avid’s net accu-mulated losses were $495.3 million; after the restatement, Avid’s pre-2011 net losses total $1.246 billion, reflecting a previously-reported understatement of net losses of 60%. Avid made public, only last week, the fact that the restate¬ment dates back to 2005, restates almost $900 million of previously-reported revenues, and involves a whopping 5 million transactions—apparently all, or nearly all, of Avid’s software contracts since 2005. Because Avid’s restate¬ment and on-going internal control failures are broader and deeper (and have come to light later in time) than we could have anticipated, we likely will amend the complaint to encompass the massive fraud revealed by the restatement.
Pomerantz currently is engaged in discovery with the company and its auditors. Depositions are set to begin shortly.