Smilovits v. First Solar, Inc.

          ORDER

          DAVID G. CAMPBELL SENIOR UNITED STATES DISTRICT JUDGE

         This securities fraud class action is set for trial in January 2020. The parties filed nine motions to exclude expert testimony under Federal Rule of Evidence 702 and Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993). The Court ruled on six of the motions in an earlier order. Doc. 674. This order addresses the remaining motions.

         I. Background.

         Defendant First Solar, Inc. produces photovoltaic solar panel modules. Its stock is publicly traded on the NASDAQ stock exchange. Plaintiffs purchased First Solar stock between April 30, 2008 and February 28, 2012 (the “Class Period”). See Doc. 171 at 22.^[1] The Individual Defendants are First Solar officers and executives who purchased or sold First Solar stock during the Class Period while allegedly concealing information from the market about manufacturing and design defects causing faster power loss in certain modules.^[2]

         Steep declines in First Solar's stock price, beginning on July 29, 2010, followed the departure of First Solar's CEO, disappointing financial results, and the release of quarterly financial disclosures reporting the product defects. See Doc. 401 at 7-8. First Solar's stock fell from nearly $300 per share to less than $50 per share during the Class Period. See Id. at 2.

         Plaintiffs allege that Defendants engaged in several acts of fraud during the Class Period, including concealing the product defects, misrepresenting the cost and scope of the defects, and reporting false information on financial statements. Doc. 93 at 7-20. Plaintiffs further allege that when First Solar later disclosed the product defects and attendant financial liabilities to the market, the stock price fell, causing economic loss to Plaintiffs. Id. at 124-41.

         Plaintiffs assert violations of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities Exchange Commission (“SEC”) Rule 10b-5. Id. at 135-36. Section 10(b) “makes it unlawful to ‘use or employ, in connection with the purchase or sale of any security[, ] . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.'” In re Oracle Corp. Sec. Litig., 627 F.3d 376, 387 (9th Cir. 2010) (quoting 15 U.S.C. § 78j(b)). Rule 10b-5 forbids, in connection with the purchase or sale of a security, “the making of any ‘untrue statement of a material fact' or the omission of any material fact ‘necessary in order to make the statements made . . . not misleading.'” Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341 (2005) (quoting 17 C.F.R. § 240.10b-5). The scope of Rule 10b-5 is coextensive with that of § 10(b). See Oracle, 627 F.3d at 387; Stoneridge Inv. Partners, LLC v. Sci.-Atlanta, Inc., 552 U.S. 148, 157 (2008). To establish a violation of § 10(b) and Rule 10b-5, “a plaintiff must prove (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Stoneridge, 552 U.S. at 157.

         Plaintiffs claim that the Individual Defendants are liable for the alleged § 10(b) and Rule 10b-5 violations as “controlling persons” under § 20(a). Doc. 93 at 136, ¶¶ 257-58. To establish a claim under § 20(a), a plaintiff must first prove a primary violation of § 10(b) or Rule 10b-5 and then show that the defendant exercised actual power over the primary violator. See In re NVIDIA Corp. Secs. Litig., 768 F.3d 1046, 1052 (9th Cir. 2014).^[3]

         II. Rule 702 and Daubert Standards.

         Under Rule 702, an expert may offer “scientific, technical, or other specialized knowledge” if it “will assist the trier of fact to understand the evidence, ” provided the testimony rests on “sufficient facts or data” and “reliable principles and methods, ” and “the witness has reliably applied the principles and methods to the facts of the case.” Fed.R.Evid. 702(a)-(d). The proponent of expert testimony has the ultimate burden of showing, by a preponderance of the evidence, that the proposed testimony is admissible under Rule 702. See Cooper v. Brown, 510 F.3d 870, 942 (9th Cir. 2007); Fed.R.Evid. 104(a). The trial court acts as a gatekeeper for expert testimony to assure that it “both rests on a reliable foundation and is relevant to the task at hand.” Daubert, 509 U.S. at 597; see Davis v. McKesson Corp., No. CV-18-1157-PHX-DGC, 2019 WL 3532179, at *3-4 (D. Ariz. Aug. 2, 2019).

         III. Defendants' Motion to Exclude Henderson's Testimony (Docs. 532, 633).

         Plaintiffs retained M. Todd Henderson, a professor at the University of Chicago Law School, to opine on the sales of company stock by the Individual Defendants pursuant to Rule 10b5-1 trading plans (“10b5-1 plans”). Doc. 532-1 at 3. Henderson explains that 10b5-1 plans are meant to provide company executives with the ability to trade for diversification reasons and not on the basis of inside information. Id. at 4. Henderson opines that there are seven “hallmarks” of a valid 10b5-1 plan: (1) a significant time lag between the plan's adoption and the first trade; (2) regularly scheduled trades; (3) sales over long periods of time; (4) sales of relatively consistent size and relatively small amounts compared with overall shareholdings; (5) sales at a range of stock prices; (6) no changes or cancellations of the plan; and (7) a high level of board and general counsel involvement in plan adoption, alteration, and termination decisions. Id. Henderson further opines the Individual Defendants' 10b5-1 plans during the Class Period contained few or none of these hallmarks and are consistent with plans from his empirical research in which insiders earned large abnormal returns based on inside information. Id.

         Defendants move to exclude Henderson's testimony under Rule 702, arguing that his opinions and purported hallmarks are based solely on speculation and fail every prong of Daubert's reliability test. Docs. 532 (lodged sealed motion), 633 (public redacted version). Plaintiffs counter that Henderson is eminently qualified to offer his opinions, that the Daubert reliability factors do not apply to the non-scientific hallmarks, and that the hallmarks satisfy Rule 702's reliability requirements and will assist the jury in deciding whether the Individual Defendants' stock trades were made in good faith or to evade the prohibitions of Rule 10b5-1. Doc. 556 at 6-17.

         A. 10b5-1 Plans and the Need for Expert Testimony.

         Rule 10b5-1 provides an affirmative defense to securities fraud allegations of trading “‘on the basis of' material nonpublic information[.]” 17 C.F.R. § 240.10b5-1. A corporate-insider may defend his trades by showing that they were made pursuant to a “written plan for trading securities” created before he learned of the material non-public information at issue in the suit. Id. at (c)(1)(i)(A). To be valid, the plan must list the amount and price of the securities to be sold or purchased, provide the date of the transactions, and prevent the insider from exercising any subsequent influence over how, when, or whether to effect purchases or sales. Id. at (c)(1)(i)(B). The trade must also have been executed according to the plan's terms. Id. (c)(1)(i)(C). Finally, the plan must have been entered “in good faith and not as part of a plan or scheme to evade the prohibitions of [Rule 10b5-1].” Id. at (c)(1)(ii); see CSX Corp. v. Children's Inv. Fund Mgmt. (UK) LLP, 654 F.3d 276, 303 n.13 (2d Cir. 2011) (“[T]he affirmative defense is available only when the plan to purchase or sell securities was ‘given or entered into in good faith.'”); Elec. Workers Pension Tr. Fund of IBEW Local Union No. 58 v. CommScope, Inc., No. 5:10-CV-00062-RLV, 2013 WL 4014978, at *7 (W.D. N.C. Aug. 6, 2013) (“[Rule 10b5-1] clearly requires a showing of good faith [that] . . . require[s] additional evidence to be presented by Defendants[.]”); Stocke v. Shuffle Master, Inc., 615 F.Supp.2d 1180, 1193 (D. Nev. 2009) (“[A Rule] 10b5-1 trading plan does not provide an absolute defense to a claim of insider trading. Rather, it requires an additional factual finding of good faith.”). A plaintiff may present circumstantial evidence giving rise to an “inference of[] bad faith and scienter for § 10(b) and Rule 10b-5 purposes” by showing that the corporate-insider's trades under a 10b5-1 plan are “unusual” or “suspicious.” In re Enron Corp. Sec., Derivative & ERISA Litig., 258 F.Supp.2d 576, 593 (S.D. Tex. 2003).

         The Individual Defendants claim that their stock trades during the Class Period were proper because they were made largely pursuant to valid 10b5-1 plans. See Doc. 311 at 65-68. Plaintiffs counter that the Individual Defendants engaged in improper insider trading, and that their suspicious trading behavior is relevant evidence of scienter and materiality. Doc. 556 at 10.

         In order for the jury to make an informed analysis of the relevant trades, it will be helpful for them to understand the purpose of 10b5-1 plans and their legal requirements, the various features of such plans in practice, and trading behaviors that may be suspicious. See Doc. 556 at 10-11. Henderson explains that the purpose of his opinions, and his application of the seven hallmarks he identifies for valid 10b5-1 plans, is to help the jury understand such plans and determine whether the Individual Defendants' trading behaviors are suspicious. Doc. 532-3 at 6-7. Because 10b5-1 plans generally are beyond the ken of the average juror, Henderson's expert testimony on these issues will assist the jury in understanding the evidence and determining facts in issue. See In re Novatel Wireless Sec. Litig., No. 08CV1689 AJB RBB, 2012 WL 5463214, at *4 (S.D. Cal. Nov. 8, 2012) (rejecting a Rule 403 challenge to “Henderson's opinion setting forth the ‘seven hallmarks' [because it] describes for the jury the best practices when employing 10b5-1 trading plans”); United States v. Robinson, No. 98 CR 167 DLC, 2000 WL 65239, at *3 (S.D.N.Y. Jan. 26, 2000) (expert testimony on the “‘hallmarks' of financial fraud schemes” would help the jury understand the evidence); United States v. Jergensen, No. 8:16-CR-235(BKS), 2017 WL 11458077, at *4 (N.D.N.Y. Oct. 6, 2017) (same).

         B. The Reliability of Henderson's Hallmarks.

         Defendants contend that Henderson's hallmarks are not reliable because they cannot be tested, have never been published, have no known error rate, and lack general acceptance in the securities regulation field. Doc. 532 at 9-11. But these factors are neither exclusive nor dispositive in a Rule 702 inquiry, see Daubert, 509 U.S. at 593-94, and “may not be pertinent in assessing reliability, depending on the nature of the issue, the expert's particular expertise, and the subject of his testimony[, ]” Primiano, 598 F.3d at 565. As the Supreme Court has explained, although some expert testimony “rests upon scientific foundations, ” in other cases “the relevant reliability concerns may focus upon personal knowledge or experience. Daubert makes clear that the factors it mentions do not constitute a definitive checklist or test.” Kumho Tire Co. v. Carmichael, 526 U.S. 137, 150 (1999) (citations omitted; emphasis in original). The Ninth Circuit likewise holds that “[t]he Daubert factors (peer review, publication, potential error rate, etc.) simply are not applicable to [testimony] whose reliability depends heavily on the knowledge and experience of the expert, rather than the methodology or theory behind it.” United States v. Hankey, 203 F.3d 1160, 1169 (9th Cir. 2000).

         Defendants do not dispute that Henderson is a highly qualified expert in securities regulation. See Doc. 532-1 at 6-7 (Henderson's qualifications); In re Novatel, 2012 WL 5463214, at *4 (“Henderson is qualified pursuant to Rule 702 to testify as an expert regarding the use of 10b5-1 trading plans.”). Henderson's opinions are based on a review of the documents in this case, his position on the Financial Industry Regulatory Authority, his experience as a management consultant advising companies on security regulation matters, his extensive research on thousands of 10b5-1 plans used by various companies over the past decade, and his specialized knowledge in the areas of corporate governance, executive compensation, and insider trading. Id. at 3. Under Rule 702 and Daubert, expert testimony “is reliable if the knowledge underlying it has a reliable basis in the knowledge and experience of the relevant discipline.” Primiano, 598 F.3d at 565 (citation omitted). The Court finds that Henderson's experience in the field of securities regulation generally, and his knowledge about the creation and use of 10b5-1 plans in particular, form a sufficient foundation for his opinions on the purported hallmarks of a valid plan. See In re Novatel, 2012 WL 5463214, at *5 (“Henderson's training, education and practical experience provide a sufficient basis for his opinions regarding 10b5-1 trading plans”); United States v. Barreiro, No. 13-CR-00636-LHK, 2016 WL 259590, at *2 (N.D. Cal. Jan. 21, 2016) (testimony on whether “notes of expenditures have the hallmarks of business or personal expenditures” was within the expert's “specialized knowledge and training as a CPA and a certified fraud examiner”); S.E.C. v. Lines, No. 07 CIV. 11387 (DLC), 2010 WL 2926591, at *1 (S.D.N.Y. July 26, 2010) (rejecting the argument that the expert identified no reliable methodology to support his description of the common characteristics of a “pump and dump scheme” where the expert was “well qualified by years of experience as a regulator to describe this species of securities fraud, and [gave] an extensive and detailed report explaining the hallmarks of such a scheme”). Defendants' criticisms of Henderson's methodology and his purported hallmarks for valid 10b5-1 plans are matters for the jury's consideration in weighing the evidence. See Lines, 2010 WL 2926591, at *1 (the arguments that “many of the characteristics that the expert identifies as associated with pump and dump schemes can also be found in legitimate transactions, and [that] he did not adequately consider factors that tend to show that a transaction is not a pump and dump scheme, may be proper as lines of cross-examination but do not render the testimony inadmissible”).

         Defendants note that “[t]he first time [the] hallmarks appeared in a bulleted list was for an expert opinion on behalf of Plaintiffs[.]” Doc. 532 at 10. But Henderson explains that “the general impression of [the hallmarks], each of them in different forms or different words[, ] was used by [him] countless times before then[.]” Doc. 532-3 at 16. The Court cannot conclude that Henderson developed the hallmarks solely for purposes of litigation.

         Defendants further contend that Henderson's opinions are replete with improper legal conclusions and that his hallmarks are contrary to law because Rule 10b5-1 offers an affirmative defense for individuals who comply with the Rule's three express legal requirements. Doc. 532 at 12, 14-16. But to avail themselves of the affirmative defense, Defendants must show that their 10b5-1 plans were entered “in good faith and not as part of a plan or scheme to evade the prohibitions of [Rule 10b5-1].” 17 C.F.R. § 240.10b5-1(c)(1)(ii). Henderson's opinions about 10b5-1 plans generally, his purported hallmarks of valid plans, and whether the Individual Defendants' trading behavior is suspicious are relevant to the affirmative defense. Henderson states that he will offer no legal opinion on the Individual Defendants' trading plans and behavior or any other issue in the case. Doc. 532-3 at 6, 19-21. Defendants may object at trial if they believe Henderson crosses the line into inadmissible legal opinions. The same is true with respect to any potential opinions on the mental state or credibility of witnesses, which would be improper. See Doc. 532 at 17-18.

         C. Henderson's Analysis of Empirical Studies.

         Henderson discusses empirical studies purportedly showing that “insiders systematically abuse [Rule 10b5-1].” Doc. 532-1 at 5; see Id. at 36-43 (citing M. Todd Henderson, Alan D. Jagolinzer & Karl A. Muller, Offensive Disclosure: How Voluntary Disclosure Can Increase Returns from Insider Trading, 103 Geo L.J. 1275 (2015); Jagolinzer, Alan D., SEC Rule 10b5-1 and Insiders' Strategic Trade, Management Science Quarterly (Feb. 2009)). Henderson opines that “[t]he characteristics of the Individual Defendants' trades under their plans are consistent with plans ...