In my Navy days I was a carrier sailor, not a submariner. But I still heard the story about the valor of the submarine USS TANG, sunk in the middle of a furious battle in 1944 by one of its own faulty torpedos with the loss of all but nine of its crew. TANG’s skipper, Richard O’Kane, was one of the most successful U.S. sub skippers of WW II; he was awarded the Medal of Honor after he and his surviving crew were released from Japanese captivity at the end of the war.
(In re-reading this essay before posting it, I wonder whether I’ll be guilty of poor taste in using TANG’s epic saga as a motif for a far less-heroic tale. But many of you will have never heard of either TANG or O’Kane, and you should, so here goes.)
Compuware, a mainframe computer software vendor, seems to have been hit by several of its own torpedoes. In 2002, it launched a copyright- and trade-secret lawsuit against IBM, its former alliance partner. Not long afterwards, CompuWare’s own assertions were re-directed at them, as part of a class-action securities lawsuit. Last week, Compuware’s motion to dismiss the class-action lawsuit was denied in part, leaving the unfortunate Compuware to the tender mercies of the securities plaintiffs’ bar. See In re Compuware Securities Litigation, _ F. Supp.2d _, 2004 WL 231464 (E.D. Mich. Feb. 3, 2004) (link via Securities Litigation Watch.)
A Rocky Alliance
IBM was and is a major player in the market for mainframe computers. Compuware is a software vendor in the mainframe market. It was (formerly) a “tier one” alliance partner of IBM; as such, it enjoyed access to IBM source code and other proprietary information. One might think of them as sailing in IBM’s wake.
IBM, however, allegedly became dissatisfied with the pricing of Compuware’s software. So, beginning in 1999 and 2000, it developed its own competing software, much to Compuware’s displeasure. In 2002, Compuware filed a copyright- and trade-secret lawsuit against IBM.
Unhappily, just a few weeks later, Compuware pre-announced what the class-action complaint delicately describes as “disappointing financial results.” Its stock price dropped 25% in one day on heavy volume.
A securities class-action plaintiff seized on Compuware’s allegations against IBM. The plaintiff claimed that Compuware had admitted that it knew for a long time that its relationship with IBM was deteriorating — and that it had wrongfully failed to disclose that deterioration.
Torpedo 1 Away: A 1999 Press Release
The class-action plaintiff focused on several of Compuware’s press releases, but one of them stands out. In a press release from 1999, Compuware’s CEO was quoted as saying “I see no significant trends or impediments that would negatively affect our prospects.” (Emphasis added.) No doubt that sentence was actually written by some marketing type, seized by the enthusiasm of the late 90s tech bubble. (Incidentally, Compuware’s executive VP for corporate communications and investor relations was named as one of the individual defendants in the class-action suit.)
But according to the class-action plaintiff, the CEO either knew, or recklessly failed to know, that IBM was a’coming, and therefore his statement was deceptive. Judge Taylor concluded that the plaintiff had made out a plausible case in that regard, commenting that:
Plaintiffs have alleged and provided the most plausible inference that Defendant [and CEO] Karmanos knowingly stated that he saw “no significant trends or impediments” to Compuware’s growth while being fully aware that a company [i.e., IBM] accounting for one-third of the company’s business was becoming increasingly dissatisfied with Compuware’s price structure and that an all-important relationship may well disintegrate at any time, absent correction.
Torpedo 2 Away: The IBM Litigation
Compuware’s 2002 copyright- and trade-secret suit alleged that IBM had started its competing activities back in 1999 and 2000. When Compuware filed its complaint, it also issued a press release that said, among other things, that “We have been considering this distressing issue for quite some time . . . .”
The class-action plaintiff regarded these statements as admissions that Compuware knew about its problems with IBM and had failed to disclose them.
(Shameless Plug Department: For more information about copyrights and trade secrets in computer software — as well as software patents, software licensing, export controls, and related topics — see my one-volume treatise, The Law and Business of Computer Software, published by West Group. Last year I turned over the editing and updating responsibilities to the publisher, but I’m still sentimentally attached to the book.)
The Cautionary Language in
Compuware’s SEC Filings Wasn’t Enough
In its motion to dismiss, Compuware pointed out that it wasn’t as if they hadn’t included cautionary language about IBM in their SEC filings. Some of those filings had listed a number of significant competitors (not including IBM), then mentioned that IBM also made competitive products and there could be no assurance IBM would not offer significant competing products in the future.
Judge Taylor didn’t buy it, at least for purposes of determining whether the plaintiff was entitled to keep working toward an eventual jury trial:
With regard to future events, uncertain figures, and other so-called soft information, a company may choose silence or speech elaborated by the factual basis as then known — but it may not choose half-truths. [Citations and internal quotation marks omitted.] IBM’s introduction of the Fault Analyzer and File Manager programs not only signaled the release of directly competing products, but were accompanied by a staunch refusal to share indispensable source code information. Clearly, a good relationship had ended.
In light of this, Defendants’ choice to disclose anything about that relationship in its press releases and SEC filings mandated full disclosure concerning the benefits, as well as the impediments, to realizing the full potential of that relationship.
* * *
Defendants’ statement that “there can be no assurance that IBM will not choose to offer significant competing products in the future,” implied that IBM’s development of competing software was a possibility as opposed to an actuality, and therefore, this statement does not qualify as meaningful cautionary language. The court finds that the 10-K filings did not satisfy Defendants’ obligation to warn investors of risks and negatives as significant as those which were actually realized.
(Emphasis and paragraphing edited.)
Motion to Dismiss Denied
The judge denied Compuware’s motion to dismiss the class-action lawsuit in most respects. The denial order said:
Contrary to the assumptions underlying Defendants’ arguments, the relevant issue here is not what Plaintiffs can prove, but rather whether what they have alleged creates a plausible inference that Defendants acted or spoke with the requisite state of mind. . . . [I]n this instance, it is hard to imagine a complaint that could better withstand a motion to dismiss. The court finds that Plaintiffs have submitted a well-crafted, well-pled complaint, stating sufficient facts to create a plausible inference that Defendants knowingly misstated or omitted material information. Therefore, Defendants’ Motion to dismiss must fail.
(Citations omitted.)
Possible Lessons
In the classic book The Right Stuff, Tom Wolfe recounts that whenever a test pilot crashed and burned, his surviving colleagues — bathed as they were in the certainty of their own infallibility and immortality — often reacted along the lines of: How could he have been so stupid?
We might be tempted to say the same about Compuware. But can we? What could Compuware have done differently? That’s hard to say. Here are some thoughts:
Press releases: Obviously it would have been better if Compuware’s press release hadn’t had the CEO saying he saw no significant negative trends. That’s an example of a categorical statement, which you’re usually better off avoiding when possible. (All categorical statements are bad, including this one.) But at the time, Compuware’s CEO may well have genuinely believed that he saw no negative trends.
SEC filings: Obviously, you have to do your best to make a full and fair disclosure of known material information in your SEC filings. But for all we know, at the time, Compuware’s executives might have been genuinely optimistic that they could patch up their relationship with IBM. Moreover, they had to face the choice of just how much to disclose about their relationship with IBM. Conceivably, if they had disclosed more than they did, the mere act of disclosure might have damaged the relationship even further, possibly causing more harm than good to the company and its shareholders.
Plaintiffs’ lawyers always have the benefit of hindsight. Executives, in contrast, have to make actual business-judgment calls, usually on the basis of limited information.
But even so, companies — especially their marketing people — would do well to keep Compuware’s troubles in mind when they’re drafting press releases and SEC filings.
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