Plaintiffs bring this federal securities class action against IntraLinks Holdings, Inc.'s ("IntraLinks") and IntraLinks' former CEO and CFO, as well as the individual signatories and underwriters in IntraLinks' April 6, 2011 secondary offering. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act of 1934, and Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. On July 31, 2012, defendants filed a motion to dismiss the consolidated class action complaint.*fn1
Defendants' motion to dismiss is denied. Plaintiffs state a claim under all of the causes of action based on the allegation that defendants made false and misleading statements related to the strength of IntraLinks' business and customer satisfaction, without disclosing the impending loss of its largest customer. However, plaintiffs' claims that defendants made further false and misleading statements related to overbilling customers and revenue classification are insufficient to support any of the alleged claims. These latter allegations fail to state a claim under the Exchange Act of 1934 primarily in their failure to plead loss causation. The latter allegations are also not alleged as part of the Securities Act of 1933 claims.
For purposes of deciding the motion to dismiss, the court accepts the factual allegations in the complaint as true. Ashcroft v. Iqbal, 556 U.S. 662, 678-79 (2009). The defendants challenge many of the allegations based on information from confidential witnesses. The court however finds that the complaint provides sufficient information about each confidential witness's position and to whom they reported, to support the probability that they possessed the alleged information. See Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000). Accordingly, the court also accepts these allegations as true for the purposes of this motion.
The lead plaintiff, Plumbers and Pipefitters National Pension Fund, is a Taft-Hartley, multiemployer defined benefit pension plan. It brings this federal securities class action on behalf of itself and all others who purchased or acquired IntraLinks' common stock from February 17, 2011 through November 11, 2011 ("class period"), or who purchased IntraLinks' common stock pursuant to the registration statement governing the April 6, 2011 secondary offering.
The defendants are divided into two groups according to the causes of action alleged against them. The "Exchange Act Defendants" include IntraLinks; Andrew Damico, IntraLinks' Chief Executive Officer, President, and director during the class period; and Anthony Plesner, Intralinks' Chief Financial Officer and Chief Administrative Officer during the class period. Both Damcio and Plesner signed all of IntraLinks' publicly filed documents during the class period and signed certifications pursuant to the Sarbanes Oxley Act of 2002, vouching for the truthfulness of IntraLinks' filings. Damico resigned from his position on December 15, 2011 and Plesner resigned on May 3, 2012. The complaint alleges these defendants violated Section 10(b) and 20(a) of the Exchange Act, and Section 11, 12(a)(2) of Securities Act of 1933.
The "Securities Act Defendants" include IntraLinks and its board members who signed the registration statement issued for the secondary offering on April 6, 2011: Chairman of the Board, Patrick Wack, Jr., and directors Brian Conway, Peter Gyenes, Thomas Hale, Habib Kairouz, Robert McBride, Harry Taylor, and Damcio. It also includes Plesner, who as CFO and CAO also signed the registration statement. The complaint alleges these defendants violated Sections 11 and 12(a)(2) of Securities Act of 1933.
Finally, the "Underwriter Defendants" include all the investment banks who served as underwriters for IntraLinks' secondary offering on April 6, 2011:
Morgan Stanley & Co. Incorporated, Jefferies & Company, Inc., Lazard Capital Markets LLC, Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., and Pacific Crest Securities LLC. The complaint alleges that these defendants violated Sections 11 and 12(a)(2) of the Securities Act of 1933. Background on IntraLinks
IntraLinks is a public company with stock trading on the New York Stock Exchange ("NYSE"). IntraLinks provides "cloud-based" virtual data rooms ("VDRs"), which are secure web-based workspaces in which customers can easily share large amounts of sensitive information with specified other individuals or entities. Historically, IntraLinks' business was divided between customers who used VDR services for mergers and acquisitions ("M&A") and those who used it for debt capital markets ("DCM"). Its customers were primarily financial services institutions and banks, and its business model was based on short-term contracts for project or transaction-specific subscriptions -- typically three to twelve months.
In 2009, with an eye towards a third attempt to take the company public,*fn2 IntraLinks sought to diversify its business and seek out larger corporate clients who had long-term storage needs. It created a new division called Enterprise which was to include only entities that "used IntraLinks as a repository, renewing its subscription for longer periods of time." The Enterprise division thrived from the outset. In 2009, Enterprise business represented 40% of IntraLinks' 2009 revenue. By September 2010, Enterprise revenue was up 59% year-over-year.
On August 6, 2010, after championing the growth of its Enterprise business division, IntraLinks went public with an offering of 11 million shares at a price of $13 per share.
On April 4, 2011, IntraLinks filed a Form S-1/A Registration Statement with the SEC indicating its intent to sell 7.5 million public shares. On April 6, 2011, IntraLinks filed a prospectus and held a secondary offering where 7.5 million shares were sold at $25.20 per share.
Background on Allegations of Misrepresentations
The complaint alleges that IntraLinks made material misstatements and omissions relating to three aspects of its business. First, plaintiffs claim that IntraLinks failed to disclose that its largest customer, the Federal Deposit Insurance Corporation ("FDIC"), told IntraLinks it would not renew its contract. Second, plaintiffs allege that IntraLinks misclassified business as Enterprise, which was more appropriately classified as DCM or M&A. Finally, the complaint alleges that IntraLinks failed to disclose that it was utilizing antiquated accounting practices which resulted in overcharging customers by 20-30%.
The facts pertaining to these aspects of IntraLinks' business, as alleged in the complaint, will now be described.
In 2000, the FDIC issued a request for proposals ("RFP") seeking VDR services. Pursuant to this process, the FDIC selected IntraLinks and signed a "task order" on October 9, 2000. The task order stated that IntraLinks would provide the FDIC with VDR services for five years with options to renew.
From 2000 to 2006, the FDIC's business provided IntraLinks with revenues between $200,000 and $600,000. Then from 2007 to 2010, IntraLinks' revenue from the FDIC dramatically increased to approximately $13 million per year. In 2009, the FDIC was the source of over 23% of revenue in the Enterprise sector of IntraLinks' business. In 2010, it was over 15% of Enterprises' revenue and over 7% of IntraLinks' total revenue. In comparison, the next largest customer constituted less than 2% of IntraLinks' total revenue.
Given that the FDIC's use of IntraLinks' services increased so dramatically and because IntraLinks was one of the most expensive VDR providers, the FDIC sought to renegotiate its contract in early 2010, but IntraLinks refused. Robert Mullen, the Executive Vice President, said there was "absolutely no way" IntraLinks would renegotiate with the FDIC, and that IntraLinks was "going to put the screws to them." The FDIC allegedly responded by saying they would not renew their contract with IntraLinks.
The FDIC issued a Request for Proposals ("RFP") in order to find an alternative VDR provider in July 2010. On November 18, 2010, Plesner signed a contract modifying task order 16, which stated FDIC was "exercising the final 6-month option period" which would extend the original task order to June 9, 2011. However, plaintiffs concede that this was not actually the final 6 month period, as the task order was amended on May 2011 to extend its effective time period to March 31, 2012.
On November 7, 2011, the FDIC issued a press release stating that it would be using a new vendor for its future VDR projects, but would continue using IntraLinks to wind up existing projects.
Misclassification of Business
Prior to the creation of the Enterprise department, IntraLinks had classified M&A transactions as M&A revenue and DCM transactions as DCM revenue. However, with the creation of the Enterprise division, IntraLinks was no longer properly classifying its revenue streams according to the nature of the specific business transaction -- i.e. M&A, DCM, or Enterprise (longer-term storage and hosting). Instead, IntraLinks would group a customer's different transactions together and classify it as Enterprise, even if one or more of the transactions were more appropriately considered M&A or DCM. They would also group multiple DCM or M&A customers together in order to define the group as Enterprise. Managers were told at many meetings to "group multiple products under a single account relationship" even if unrelated, solely for the purpose of classify it as Enterprise. Sometimes an existing customer who conducted DCM and M&A business would therefore be classified as Enterprise.
Ultimately, while Enterprise was supposed to consist of customers who used IntraLinks for long-term storage, it became the label used for the largest customers or any cross-departmental relationship.
The most dramatic misclassification involved the FDIC. As described above, the FDIC was IntraLinks' largest customer by 2007, and prior to the creation of Enterprise, its business was classified as DCM. In 2009, although there was no change in the business relationship between IntraLinks and the FDIC, the FDIC's business was reclassified as Enterprise.
The complaint appears to argue that the purpose of this misclassification was to make IntraLinks appear to be more diversified and able to attract long-term business. According to the complaint, IntraLinks believed this will help the company be able to conduct a successful initial public offering. Improper Billing Practices
IntraLinks billed its clients on a cost-per-page basis which worked well initially when almost all of its business involved scanning and uploading hardcopy documents. However, in 2009, only around 5% of documents IntraLinks handled were from scanned hardcopies -- the rest were uploaded in an electronic format. IntraLinks tried to adapt to this change by using algorithms to estimate how many pages were equivalent to a megabyte, but the system was disorganized and inaccurate.
In 2009, IntraLinks updated its billing systems and discovered that the old system had been overbilling customers by 20-30%. This finding was brought to the attention of senior management. However, rather than telling customers of the overbilling and switching to the new system, IntraLinks abandoned the new system and made no public disclosures. The complaint alleges that when employees discussed the issues with Plesner he "would get threatening if you tried to dig too hard."
Alleged Misstatements and Omissions
The complaint contains detailed allegations of specific statements issued or made by the Exchange Act defendants, which plaintiffs claim were materially false and misleading. Earlier in this opinion the court summarized the three subjects relating to which the defendants made misrepresentations. The first is the failure to disclose the problems associated with IntraLinks' relationship with the FDIC. The second is the allegation that IntraLinks misclassified business as Enterprise. The third is the failure to disclose that it was over-charging customers. The complaint alleges that the following quotations of statements made or issued by the Exchange Act defendants support these claims of misrepresentation.
The company's February 17, 2011 Form 8-K and corresponding press release highlighted the "significant growth in our Enterprise and Mergers and Acquisitions business." Intralinks also estimated that revenue for 2011 would increase between 16-22%, and stated that the company believed it "has the market opportunity, leadership position and infrastructure to build a large and highly profitable company." February 17, 2011 is the opening date for the "class period" covered by this action.
It its March 23, 2011 Form 10-K IntraLinks again attributed its revenue increases to the growth of its Enterprise business, stating Enterprise was the company's "largest and fastest growing market. We believe that we have a significant opportunity to increase our market share in these core markets." The Form 10-K also commended IntraLinks' strong and stable customer base stating "We believe our customers have a high level of satisfaction, as evidenced by the 104% renewal rate . . . for our subscription contracts during the year ended December 31, 2010."
The company's May 11, 2011 Form 8-K stated: "We remain confident about IntraLinks' outlook. We continue to see strong market demand." IntraLinks projected that for the rest of 2011, "we expect to see a combination of growth, profitability and cash flow that is a standout in the Software-as-a-Service sector." Plesner further stated that that the company would continue to "capitalize on our multi-billion dollar market opportunity that remains highly underpenetrated."
At the conference call of May 11, 2011 to discuss the reported results, Damico partially revealed a ...