OPINION & ORDER
WILLIAM H. PAULEY III, District Judge:
In October 2014, International Business Machines Corp. ("IBM") announced that it was taking a $2.4 billion write-down in connection with transferring its microelectronics business to another company. Following that announcement — which coincided with the disclosure of disappointing third-quarter operating results — IBM's
This action is brought under Section 10(b) of the Securities Exchange Act and its implementing rule, 10b-5, on behalf of a putative class of investors in IBM common stock between January 22, 2014 and October 17, 2014. The International Association of Heat and Frost Insulators and Asbestos Workers Local #6 Pension Fund filed the original complaint in this action. Subsequently, this Court appointed KBC Asset Management NV and the Operating Engineers Trust Fund as lead plaintiffs. The Amended Complaint names IBM as a defendant, along with Virginia M. Rometty (IBM's President and CEO), Martin Schroeter (IBM's CFO) and James J. Kavanaugh (IBM's Controller).
Defendants move to dismiss the Amended Complaint for failure to state a claim. Defendants' motion to dismiss is granted.
The allegations in the Amended Complaint are presumed true for purposes of this motion. In 2010, IBM established a "2015 Roadmap" strategy to double its earnings per share ("EPS") to $20 within five years. Rometty spearheaded that strategy with Schroeter and Kavanaugh's assistance, and sought to divest IBM of unprofitable business segments.
IBM's microelectronics unit ("Microelectronics") — housed within its Software, Systems and Technology ("STG") business segment — designed and produced microchips at plants (the "Fabs") in East Fishkill, New York and Essex Junction, Vermont. Plaintiffs allege that IBM failed to update the Fabs to be competitive in the market. They marshal confidential witnesses from both facilities to buttress those allegations. For example, a former East Fishkill Senior Engineering Manager states that IBM stopped investing in the facility after 2010 and failed to make necessary infrastructure improvements. Similarly, a former contractor represented that the Essex Junction facility was outdated and no longer produced chips at a profitable scale. Notably, chips manufactured at East Fishkill were used almost exclusively in IBM's mainframes and servers, which were sold by the STG business segment.
Beginning in 2012, Microelectronics suffered significant operating losses. Specifically, between 2012 and 2013, Microelectronics lost $1.358 billion. Toward the end of 2013, STG suffered pretax losses of $507 million, driven by Microelectronics' pretax loss of $720 million. At that point, IBM decided to divest itself of the Microelectronics business segment.
In 2014, IBM engaged Goldman Sachs to assist in its sale of Microelectronics. Of four potential buyers, GlobalFoundries — a competing microchip manufacturer — emerged as the leading candidate. And while it was reported that IBM had initially sought to sell Microelectronics for $2 billion, GlobalFoundries — which was primarily interested in IBM's engineers and intellectual property — wanted to be
On October 20, 2014, IBM announced that it would pay GlobalFoundries $1.5 billion to accept Microelectronics. IBM further disclosed that it would take a $2.4 billion writedown of the entire vale of Microelectronics' assets, as well as $800 million of other unspecified costs. As part of the deal, GlobalFoundries agreed to be the exclusive supplier of certain semiconductors to IBM for the next decade. On the same day that deal was announced, IBM disclosed disappointing third-quarter financial results: sales were down 4%, and operating profits per share were down 10%. Following these announcements, IBM's stock dropped more than 17% from its class-high price of $197.77 per share.
Throughout the class period, Defendants stated consistently that their long-lived assets were tested for impairment, that there were no material impairments of non-financial assets, and IBM was on track to reach its goal of $20 EPS.
To withstand a motion to dismiss, pleadings "must contain sufficient factual matter, accepted as true, to `state a claim to relief that is plausible on its face.'"
Under Fed. R. Civ. P. 9(b), securities-fraud complaints must satisfy heightened pleading requirements, "stating with particularity the circumstances of fraud."
Rule 10b-5, promulgated under Section 10(b) of the Securities Exchange Act, prohibits the "mak[ing][of] any untrue statement of material fact" in connection with the purchase or sale of a security. 17 C.F.R. § 240.10b-5(b). Plaintiffs must allege that the defendant "(1) made misstatements or omissions of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the plaintiff's reliance was the proximate cause of its injury."
Among other arguments, Defendants assert that Plaintiffs fail to: (1) identify any material misrepresentations or omissions; (2) plead scienter; or (3) plead loss causation.
I. Material Misrepresentations or Omissions
The statements that Plaintiffs allege were materially false or misleading fit broadly into three categories: (1) representations that there were no material impairments of non-financial assets; (2) representations that IBM's financials had been prepared in accord with GAAP, and that long-lived assets were properly tested for impairment; and (3) representations that IBM was on track to reach its 2015 Roadmap goal of $20 EPS. Defendants argue that the Amended Complaint does not identify any material misrepresentations because Plaintiffs' assertion that the write-down of Microelectronics' assets should have been recorded earlier rests on a misapplication of GAAP. The relevant GAAP standards for assessing the impairment of long-lived assets are compiled in the Financial Accounting Standards Board's ("FASB's") Accounting Standards Codification ("ASC") 360-10-35.
Whether Microelectronics Constituted an Asset Group Under GAAP
The ASC establishes that "for purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of other assets and liabilities." ASC 360-10-35-23. Thus, a threshold issue is whether Microelectronics constituted an "asset group" under GAAP for purposes of impairment testing. Defendants argue that it did not.
"Varying facts and circumstances will inevitably justify different groupings of assets for impairment review. While grouping at the lowest level for which there are identifiable cash flows for recognition and measurement of an impairment loss is understood, determining that lowest level requires considerable judgment." ASC 360-1-055-35. According to Defendants, Microelectronics was "vertically integrated" into STG because STG's product lines were dependent on Microelectronics' manufacturing activity. Thus, because the specialized chips manufactured by Microelectronics were primarily used in STG's products, which were used across business segments, Microelectronics could not be isolated as a stand-alone asset group.
Plaintiffs counter that Microelectronics' cash flows were both identifiable and largely independent of IBM's other assets and liabilities. With respect to identifiability, IBM's own disclosures demonstrate that it tracked Microelectronics' revenues. For example, IBM reported that "[t]he decrease in external gross profit in 2013 versus 2012 ... was driven [among other things] by lower margins in ... Microelectronics (0.7 points)." (Portnoy Decl. Ex. C (IBM 2013 Annual Report) at 40.) Moreover, on September 30, 2014, IBM independently reported Microelectronics' financial results — pre-tax losses of over $700 million — after designating Microelectronics as a "discontinued operation." IBM deemed Microelectronics a "discontinued operation" because ASC 205-05-1 requires such reporting on any "component of an entity" when it "is classified as held for sale." ASC 205-10-20. Critically, a "component of an entity" is defined as "operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. A component of an entity may be a reportable segment or an operating segment, a reporting unit, a subsidiary, or an
Plaintiffs' argument is supported by
Before determining whether to record an impairment for long-lived assets or an asset group, an entity must determine whether indicators of impairment are present such that the carrying value of the asset or asset group may not be recoverable. ASC 360-10-35-21. The ASC provides a non-exhaustive list of impairment indicators, four of which are relevant to Plaintiffs' allegations here: (1) "a significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition"; (2) "a significant decrease in the market price of a long-lived asset (asset group)"; (3) "a current-period operating or cash flow loss combined with a history of operating or cash flow losses ... with the use of a long-lived asset (asset group)"; or (4) "a current expectation that, more likely than not, a long-lived asset (asset group) will be sold... before the end of its previously estimated useful life." ASC 360-10-35-21. Defendants argue that Plaintiffs fail to plead that any of these impairment indicators were present.
1. Significant Adverse Change in Use or Physical Condition
Plaintiffs' allegations concerning the conditions and uses of the Fabs fail to raise an inference that IBM should have tested for impairment because those allegations do not adequately plead a "significant adverse change" in how the Fabs were "being used" or their "physical condition." Regarding the East Fishkill Fab, it is clear from the Amended Complaint that the factory continued to supply STG with chips. And no authority before this Court indicates that Plaintiffs' allegations regarding underutilized capacity or a furlough of workers should be construed as impairment indicators. As for the Essex Junction Fab, Plaintiffs concede that the plant's equipment was well-maintained. The allegations of obsolescence rely predominantly on critiques that IBM failed to invest enough to produce non-CPU chips at a profitable scale. But these are critiques of Defendants' business model, not actual allegations of obsolescence constituting an impairment indicator under GAAP.
Market Price and Losses
Plaintiffs argue that Microelectronics' losses of $638 million, $720 million, and $619 million in 2012, 2013, and the first three quarters of 2014, respectively, were indicators that impairment testing was necessary. With respect to the losses, Defendants argue that these numbers do not reflect the value generated by Microelectronics' chips that were used internally by IBM and then sold as part of STG products. But this argument is identical to the grouping argument previously addressed.
Defendants also attack Plaintiffs' assertion that Microelectronics' assets were "worthless," arguing that it fails to account for, among other things, the benefit IBM received from GlobalFoundries' agreement to sell IBM's proprietary chips exclusively to IBM for 10 years. But the sufficiency of Plaintiffs' allegations does not turn on their hyperbolic proclamation that Microelectronics' assets were worthless. Rather, it turns on, among other things, the truth of IBM's representations that it tested for impairment whenever events or changes in circumstances indicated that the carrying amount of its long-lived assets may not have been recoverable. Because Plaintiffs have pled that Microelectronics could be construed as a stand-alone asset group, it is plausible that Microelectronics' losses, combined with the allegations that the Fabs' value were significantly depreciated, constituted GAAP impairment indicators.
Likelihood of Sale
The ASC required IBM to test Microelectronics' assets for impairment if the company had "a current expectation that, more likely than not, a long-lived asset (asset group) would be sold or otherwise disposed of significantly before the end of its previously estimated useful life"
By the end of September 2014 — when it was clear that the GlobalFoundries deal would come to fruition — IBM recognized the impairment of the Fabs. Plaintiffs allege that the likelihood of Microelectronics' sale was greater than 50 percent at some point before 2014, as demonstrated by, among other things. IBM's hiring of Goldman Sachs to assist with the sale in early 2014. Plaintiff does not specifically allege when such a sale was more likely than not to occur.
Certainly, Plaintiffs have plausibly pled that Defendants desired to sell Microelectronics before 2014. But Defendants argue compellingly that Plaintiffs do not allege facts indicating that a sale was more likely than not prior to 2014, noting that the Amended Complaint concedes the paucity of interested buyers and seemingly uncertain negotiations late into 2014. The Amended Complaint indicates that three of the four potential buyers never had any interest in acquiring the Fabs and were more focused on IBM's intellectual property and expertise. Likewise, the Amended Complaint indicates that talks with Global-Foundries temporarily broke off as late as July 2014. Given those allegations, Plaintiffs have failed to allege that Defendants should have considered Microelectronics' sale more probable than not prior to 2014.
As discussed above, the Amended Complaint plausibly pleads that Microelectronics' decreased value, combined with its operating losses, may have constituted an impairment indicator under GAAP. However, "[a]llegations of a violation of GAAP ... without corresponding fraudulent intent, are not sufficient to state a securities fraud claim."
Statements Regarding IBM's Accounting
"If all that is involved is a dispute about the timing of the writeoff ... the inquiry [i]s framed by the recklessness
In order to allege scienter, Plaintiffs rely predominantly on (1) the magnitude of the write-down, (2) Microelectronics' crucial role in Defendants' 2015 Roadmap strategy, and (3) the certifications signed by the individual Defendants — mandated by the Sarbanes-Oxley Act ("SOX") — stating that IBM's financial statements were prepared in accord with GAAP. Plaintiffs all but concede that any of those allegations, viewed in isolation, would be insufficient to allege scienter. For example, to the extent Plaintiffs rely on Defendants' desire to achieve the 2015 Roadmap target, such allegations only implicate "[t]he motive to maintain the appearance of corporate profitability," which "does not entail concrete benefits" necessary to plead scienter.
Of course, a "court's job is not to scrutinize each allegation in isolation but to assess all the allegations holistically."
"GAAP tolerates a range of reasonable treatments, leaving the choice among alternatives to management."
Defendants argue that IBM's statements concerning EPS projections fall within the PSLRA's safe harbor for "forward-looking statements."
"The term `forward-looking statement' [includes] a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share."). 15 U.S.C. § 78u-5(i)(1)(A). Thus, Defendants' statements that they were "on track toward [the] 2015 roadmap for operating EPS of at least $20," and "expect[ed] to deliver at least $20 of operating EPS in 2015" were forward-looking statements.
"[B]ecause the safe harbor specifies an `actual knowledge' standard for forwardlooking statements, the scienter requirement for forward-looking statements is stricter than for statements of current fact. While liability for the latter requires a showing of either knowing falsity or recklessness, liability for the former attaches only upon proof of knowing falsity."
For the foregoing reasons, Defendants' motion to dismiss is granted. The Clerk of Court is directed to terminate any pending motions and close this case.