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Class action lawsuit filed against Rackable for alleged violations of securities laws

Attorneys are getting geared up to press a class action against Rackable. There are several attorney announcements out there trying to gather members of the class (google “Rackable class action suit” and you’ll find them). One such announcement reads in part

Rackable logoOn January 16, 2009, a class action lawsuit was filed in the United States District Court for the Northern District of California against Rackable Systems, Inc. (RACK). The complaint alleges violations of federal securities laws, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5, including allegations of issuing a series of material misrepresentations to the market which had the effect of artificially inflating the market price. The class period is from October 30, 2006 through April 4, 2007.

I was interested and looked up the Sections referenced above. Looks like the 10(b) violations are a big stick; from the Wikipedia

It’s hard to overstate the breadth and utility of section 10(b) and Rule 10b-5, in the pursuit of securities litigation. Rule 10b-5 has been employed to cover insider trading cases, but has also been used against companies for price fixing (artificially inflating or depressing stock prices through stock manipulation), bogus company sales to increase stock price, and even a company’s failure to communicate relevant information to investors. Many plaintiffs in the securities litigation field plead violations of section 10(b) and Rule 10b-5 as a “catchall” allegation, in addition to violations of the more specific antifraud provisions in the ’34 Act.

Section 20(a) is “Liability to Contemporaneous Traders for Insider Trading” (from the U of Cincinnati, where you can read the whole act)

Any person who violates any provision of this title or the rules or regulations thereunder by purchasing or selling a security while in possession of material, nonpublic information shall be liable in an action in any court of competent jurisdiction to any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased (where such violation is based on a sale of securities) or sold (where such violation is based on a purchase of securities) securities of the same class.

The proposed class includes anyone who bought Rackable stock between October 30, 2006 and April 4, 2007. Stanford Law School has a summary of the filing, which includes this outline of the beef

The Complaint alleges that throughout the Class Period defendants knew or recklessly disregarded that their public statements concerning Rackable’s business, operations and prospects were materially false and misleading. Specifically, the Complaint alleges that defendants’ public statements were false and misleading or failed to disclose or indicate the following: (1) that the Company was experiencing competitive pressure; (2) that competition was increasing; (3) that, due to increasing competition, the Company was able to maintain and expand its customer base only by aggressively lowering its contract prices; (4) that, as such, the Company was experiencing dramatic erosion of gross margin attainment in the Company’s largest accounts as focused competitors aggressively dropped prices; (5) that price increases for DDR (double data rate) memory were accelerating faster than the Company represented to investors; (6) that, as a result of the above, the Company was unlikely to meet its quarterly gross margin targets; (7) that the Company lacked effective internal and financial controls; and (8) as a result of the foregoing, that statements made by the Company and management during the Class Period concerning the Company’s business, operations and prospects were lacking any reasonable basis.

The period in question looks like this on the Yahoo! Finance chart, during which time RACK dropped from $32-ish to $16-ish in the space of roughly 4 months. The three big price drops in that period are named specifically in the filing.

I think this kind of thing isn’t all that uncommon. In fact I recall it happened to Cray. Back in 2005 an action was filed against Cray alleging “that the defendants had violated the securities laws by knowingly making false or misleading statements to the public.” That suit was dismissed in April 2006.

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