Plaintiff shareholders of NutraCea, a public corporation that produces stabilized rice bran to sell as a nutritional supplement, sued CEO Bradley Edson and CFO Todd Crow for violations of Section 10(b) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5 promulgated thereunder, control person liability under Section 20(a) of the Exchange Act, and violations of the Arizona Securities Act. Both Mr. Edson and Mr. Crow moved to dismiss the complaint; the court granted Mr. Crow’s motion as to the Rule 10b-5 claim, but denied the motions in all other respects.
Plaintiff shareholders alleged that defendants misled investors concerning four corporate transactions by attesting to the correctness of NutraCea’s public financial statements, which improperly recognized over $9.6 million in revenue from the transactions. Plaintiffs claim that defendants knew, or were deliberately reckless in not knowing, that NutraCea improperly recognized revenue from four “sale” transactions that did not satisfy the revenue recognition criteria under generally accepted accounting principles.
Under Section 10(b) and Rule 10b-5, plaintiffs must prove the following elements: (1) a material misrepresentation or omission of fact; (2) scienter; (3) a connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. Defendants challenged these claims on the elements of scienter, reliance and loss causation.
The court reviewed the facts of the four transactions in question and determined that the nature of the “sales” were suspicious and helped support a scienter finding. One transaction was actually a pure consignment sale, while another involved a purchaser whose payment was financed by a consultant to, and former officer of, the seller.
The court found that the combination of Mr. Edson’s negotiation of one of the transactions at issue, his monitoring of NutraCea’s revenue recognition, and a personal profit motive created a strong inference of scienter. The court was also persuaded that plaintiffs had met their initial burden of alleging an efficient market in which NutraCea’s shares were traded, providing the foundation for a presumption of reliance on the efficiency of the market. Finally, plaintiffs’ claim of a drop in NutraCea’s stock price after the company’s announcement that it had uncovered improper revenue recognition was sufficient to suggest loss causation. Therefore, Mr. Edson’s motion to dismiss the claims under federal securities law was denied. Similarly, plaintiff’s claim for violation of Section 20(a) of the Exchange Act survived Mr. Edson’s motion to dismiss, as a well pled Section 10(b) and Rule 10b-5 claim against a corporate officer is sufficient to state a primary violation against the corporate entity itself. Finally, the rationale for denying Mr. Edson’s motion to dismiss the federal securities law claims applied with equal force to their state securities law counterparts.
With regard to Mr. Crow, the court granted his motion to dismiss the Section 10(b) claim on the ground that plaintiffs failed to allege, in contrast with their claim against Mr. Edson, particularized facts raising a strong inference that Mr. Crow had actual knowledge of the improper revenue recognition practices. The court, however, denied Mr. Crow’s motion to dismiss the Arizona state law securities claim because, in the court’s view, the Arizona statute broadly authorized liability against any person who potentially “induced” a securities purchase by disseminating false information into the marketplace. (Burritt v. NutraCea, No. CV-09-00406, 2010 WL 668806 (D. Ariz. Feb. 25, 2010))