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UNITED STATES DISTRICT COURT
DISTRICT OF VERMONT
DAN M. HOROWITZ, Individually and onBehalf of All Others Similarly Situated,
Plaintiff,
vs.
GREEN MOUNTAIN COFFEE ROASTERS,INC., et al.,
Defendants.
)))))))))
)))
No. 2:10-cv-00227-wks(Consolidated)
CLASS ACTION
LEAD PLAINTIFFS OMNIBUS OPPOSITION TO DEFENDANTS GREEN MOUNTAIN
COFFEE ROASTERS, INC.S, LAWRENCE J. BLANFORDS AND FRANCES G.
RATHKES MOTIONS TO DISMISS THE SECOND CONSOLIDATED AMENDED CLASS
ACTION COMPLAINT
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TABLE OF CONTENTS
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I. PRELIMINARY STATEMENT .........................................................................................1
II. INTRODUCTION ...............................................................................................................4
III. STATEMENT OF FACTS ................................................................................................10
A. Senior Management Chose Acquisitions Over Accounting Infrastructureand Reporting Accuracy ........................................................................................10
B. GMCR Used MBlock to Engage in an Inventory Shell Game to BoostFinancial Results....................................................................................................13
1. Defendants Used MBlock to Facilitate Premature Revenue
Recognition................................................................................................14
2. Defendants Used MBlock to Store the Excess Inventory That WasProduced to Improve GMCRs Operating Margins...................................16
IV. ARGUMENT.....................................................................................................................20
A. The SAC Adequately Alleges a Violation of 10(b) .............................................20
1. Applicable Standards on a Motion to Dismiss a 10(b) Claim .................20
2. The SAC Adequately Alleges Numerous False Statements ......................22
3. Defendants Material Misstatements Were Made with Scienter ...............27
a. Applicable Standards for Alleging Scienter ..................................27
b. Defendants Scienter Standard Is Either Incorrect orIncorrectly Applied ........................................................................28
c. Allegations Pertaining to the Core Operations DoctrineAdequately Supplement the SACs Well-Pled ScienterAllegations .....................................................................................33
d. Defendants Were Motivated by an Acquisition for theCompany and their Own Personal Financial Gain.........................37
e. Plaintiffs Have Established Defendants Recklessness .................38
(i) Knowledge of Excess Inventory that ShouldHave Been Written off...........................................38
(ii) Inadequate AccountingInfrastructure/Internal Controls .............................41
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f. The Scienter of Other Senior Officers Is Imputed to GMCR ........45
(i) The Intentional and Reckless Conduct ofGMCRs Vice President of Operations andIts Vice President of Finance Are Imputed tothe Company ..........................................................46
(ii) The Insider Sales of Division PresidentsStacy and McCreary May Be Attributed tothe Company ..........................................................47
B. The SAC Adequately Alleges Control Person Liability Under 20(a)..................49
V. CONCLUSION..................................................................................................................50
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TABLE OF AUTHORITIES
Page
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CASES
Aldridge v. A.T. Cross Corp.,284 F.3d 72 (1st Cir. 2002)......................................................................................................26
Ashcroft v. Iqbal,129 S. Ct. 1937 (2009).............................................................................................................21
ATSI Commcns., Inc. v. Shaar Fund, Ltd.,493 F.3d 87 (2d Cir. 2001).......................................................................................................21
Barrie v. InterVoice-Brite,409 F.3d 653 (5th Cir. 2005) ...................................................................................................39
Bell Atl. Corp. v. Twombly,550 U.S. 544 (2007)...........................................................................................................20, 21
Burstyn v. Worldwide Xceed Grp., Inc.,No. 01 CIV. 1125 (GEL), 2002 WL 31191741(S.D.N.Y. Sept. 30, 2002)........................................................................................................33
Campo v. Sears Holdings Corp.,371 F. Appx 212 (2d Cir. 2010) .............................................................................................37
Chill v. Gen. Elec. Co.,101 F.3d 263 (2d Cir. 1996).....................................................................................................32
City of Brockton Ret. Sys. v. Shaw Grp. Inc.,540 F. Supp. 2d 464 (S.D.N.Y. 2008)......................................................................................32
City of Monroe Emps. Ret. Sys. v. Bridgestone Corp.,399 F.3d 651 (6th Cir. 2005) ...................................................................................................45
Cortec Indus., Inc. v. Sum Holding L.P.,949 F.2d 42 (2d Cir. 1991).......................................................................................................50
Cosmas v. Hassett,886 F.2d 8 (2d Cir. 1989) ............................................................................................33, 34, 35
Dura Pharms., Inc. v. Broudo,544 U.S. 336 (2005).................................................................................................................21
ECA v. J.P. Morgan Chase Co.,553 F.3d 187 (2d Cir. 2009)...............................................................................................21, 27
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Edison Fund v. Cogent Inv. Strategies Fund,Ltd.,551 F. Supp. 2d 210 (S.D.N.Y. 2008)......................................................................................49
Frank v. Dana Corp.,646 F.3d 954 (6th Cir. 2011) ...................................................................................................43
Frederick v. Mechel OAO,No. 11-3666-CV, 2012 WL 1193724(2d Cir. Apr. 11, 2012).......................................................................................................33, 35
Ganino v. Citizens Utils. Co.,228 F.3d 154 (2dCir. 2000).........................................................................................21, 27, 44
Gissin v. Endres,739 F. Supp. 2d 488 (S.D.N.Y. 2010)......................................................................................21
Hart v. Internet Wire, Inc.,163 F. Supp. 2d 316 (S.D.N.Y. 2001)......................................................................................32
In re Am. Bank Note Holographics Sec. Litig.,93 F. Supp. 2d 424 (S.D.N.Y. 2000)..................................................................................34, 44
In re Am. Intl Grp., Inc.,741 F. Supp. 2d 511 (S.D.N.Y. 2010)......................................................................................27
In re Ambac Fin. Group, Inc. Sec. Litig.,693 F. Supp. 2d 241 (S.D.N.Y. 2010), cert. denied(Apr. 29, 2010).......................................41
In re Ashanti Goldfields Sec. Litig.,No. CV 00-0717, 2004 WL 626810 (E.D.N.Y. Mar. 30, 2004) ..............................................38
In re Atlas Air Worldwide Holdings, Inc. Sec. Litig.,324 F. Supp. 2d 474 (S.D.N.Y. 2004)..........................................................................35, 42, 44
In re Bausch & Lomb, Inc. Securities Litigation,592 F. Supp. 2d 323 (W.D.N.Y. 2008)....................................................................................37
In re Bayou Hedge Fund Litig.,534 F. Supp. 2d 405 (S.D.N.Y. 2007), affd sub nom. S. Cherry St., LLC v. HennesseeGrp. LLC, 573 F.3d 98 (2d Cir. 2009).....................................................................................28
In re Bear Stearns Cos., Inc. Sec., Deriv. & ERISA Litig.,763 F. Supp. 2d 423 (S.D.N.Y. 2011)......................................................................................21
In re BISYS Sec. Litig.,397 F. Supp. 2d 430 (S.D.N.Y. 2005)......................................................................................45
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In re Celestica Inc., Sec. Litig.,No. 07 Civ 312, 2010 WL 4159587(S.D.N.Y. Oct. 14, 2010) .........................................................................................................39
In re eSpeed, Inc. Sec. Litig.,457 F. Supp. 2d 266 (S.D.N.Y. 2006)................................................................................35, 42
In re Gen. Elec. Co. Sec. Litig.,No. 09 Civ. 1951, 2012 WL 90191(S.D.N.Y. Jan. 11, 2012)..........................................................................................................27
In re IPO Sec. Litig.,544 F. Supp. 2d 277 (S.D.N.Y. 2008)......................................................................................27
In re JP Morgan Chase Sec. Litig.,363 F. Supp. 2d 595 (S.D.N.Y. 2005)......................................................................................46
In re Lehman Bros. Sec. & ERISA Litig.,799 F. Supp. 2d 258 (S.D.N.Y. 2011)......................................................................................49
In re Marsh & Mclennan,501 F. Supp.2d .........................................................................................................................45
In re Network Assocs., Inc. Sec. Litig.,No. C 99-1729, 2000 WL 33376577(N.D. Cal. Sept. 5, 2000) .........................................................................................................21
In re Nortel Networks Corp. Sec. Litig.,238 F. Supp. 2d 613 (S.D.N.Y. 2003)......................................................................................22
In re NUI Sec. Litig.,314 F. Supp. 2d 388 (D.N.J. 2004) ..........................................................................................46
In re Oxford Health Plans, Inc. Sec. Litig.,51 F. Supp. 2d 290 (S.D.N.Y. 1999)........................................................................................42
In Re Paracelsus Corp. Sec. Litig.,61 F.Supp.2d 591 (S.D. Tex.1998) ..........................................................................................43
In re Peoplesoft, Inc. Sec. Litig.,No. C 99-00472, 2000 WL 1737936(N.D. Cal. May 25, 2000) ........................................................................................................22
In re ProQuest Sec. Litig.,527 F. Supp. 2d 728 (E.D. Mich. 2007).............................................................................23, 38
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In re PXRE Group, Ltd. Sec. Litig.,600 F. Supp. 2d 510 (S.D.N.Y. 2009)..........................................................................22, 29, 30
In re Scholastic Corp. Sec. Litig.,252 F.3d 63 (2d Cir. 2001).................................................................................................27, 38
In re Smith Barney Transfer Agent Litig.,765 F. Supp. 2d 391 (S.D.N.Y. 2011)......................................................................................21
In re Sonus Networks, Inc. Sec. Litig.,No. Civ. A. 04-10294-DPW, 2006 WL 1308165(D. Mass. May 10, 2006) .........................................................................................................45
In re St. Jude Med., Inc. Sec. Litig.,836 F. Supp. 2d 878 (D. Minn. 2011)................................................................................29, 45
In re Take-Two Interactive Sec. Litig.,551 F. Supp. 2d 247 (S.D.N.Y. 2008)......................................................................................45
In re Veeco Instruments Sec. Litig.,235 F.R.D. 220 (S.D.N.Y. 2006) .................................................................................27, 35, 42
In re Wash. Mut., Inc. Sec., Deriv. & ERISA Litig.,694 F. Supp. 2d 1192 (W.D. Wash. 2009)...............................................................................37
In re Winstar Commcns,No. 01 CV 3014, 2006 WL 473885(S.D.N.Y. Feb. 27, 2006)...................................................................................................35, 42
In re WorldCom, Inc. Sec. Litig.,352 F.Supp.2d 472 (S.D.N.Y.2005).........................................................................................45
Janus Capital Grp. v. First Derivative Traders,131 S. Ct. 2296 (2011).....................................................................................................passim
Johnson v. SiemensAG,
No. 09-CV-5310 JG RER, 2011 WL 1304267(E.D.N.Y. Mar. 31, 2011) ........................................................................................................25
Kalnit v. Eichler,264 F.3d 131 (2d Cir. 2001).....................................................................................................32
La. Sch. Emps. Ret. Sys. v. Ernst & Young, LLP,622 F.3d 471,479 (6th Cir. 2010) ............................................................................................49
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Local No. 38 IBEW Pension Fund v. American Express Co.,724 F. Supp. 2d 447 (S.D.N.Y. 2010)................................................................................29, 30
Lormand v. U.S. Unwired, Inc.,565 F.3d 228 (5thCir. 2009) ...............................................................................................2, 49
Matrix Cap. Mgmt. Fund, LP v. BearingPoint, Inc.,576 F.3d 172 (4th Cir. 2009) ...................................................................................................48
Matrixx Initiatives, Inc. v. Siracusano,131 S. Ct. 1309 (2011).............................................................................................................48
Middlesex Ret. Sys. v. Quest Software Inc.,
527 F. Supp. 2d 1164 (C.D. Cal. 2007) ...................................................................................23
Mills v. Polar Molecular Corp.,12 F.3d 1170 (2d Cir. 1993).....................................................................................................25
New Orleans Employees Retirement System v. Celestica, Inc.,455 F. Appx 10 (2d Cir. 2011) ...................................................................................35, 36, 49
New Orleans Emps. Ret. Sys. v. Celestica, Inc.,455 Fed. Appx. 10 (2d Cir. 2011)....................................................................................passim
Norfolk County Ret. Sys. v. Ustian,No. 07 C 7014, 2009 WL 2386156(N.D. Ill. July 28, 2009)...........................................................................................................37
Novak v. Kasaks,216 F.3d 300 (2d Cir. 2000)...................................................................................27, 33, 37, 43
Rombach v. Chang,355 F.3d 164 (2d Cir. 2004)...............................................................................................22, 25
Rothman v. Gregor,220 F.3d 81 (2d Cir. 2000)...................................................................................................1, 41
Ruggerio v. Warner-Lambert Co.,424 F.3d 249 (2d Cir. 2005).....................................................................................................22
Schottenfeld Qualified Assocs., LP v. Workstream, Inc.,No. 05 Civ 7092, 2006 WL 4472318(S.D.N.Y. May 4, 2006)...........................................................................................................37
SEC v. First Jersey Secs., Inc.,101 F.3d 1450 (2d Cir. 1996)...................................................................................................49
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Sgalambo v. McKenzie,739 F. Supp. 2d 453 (S.D.N.Y. 2010)......................................................................................45
Shields v. Citytrust Bancorp, Inc.,25 F.3d 1124 (2d Cir. 1994).....................................................................................................43
Steinberg v. EricssonLM Tel. Co.,No. 07 CV. 9615 (RPP), 2008 WL 5170640(S.D.N.Y. Dec. 10, 2008) ........................................................................................................25
Suez Equity Investors, L.P. v. TorontoDominion Bank,250 F.3d 87 (2d Cir.2001)........................................................................................................45
Teachers Ret. Sys. of La. v. A.C.L.N., Ltd.,No. 01-11814, 2003 WL 21058090(S.D.N.Y. May 15, 2003).........................................................................................................20
Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc.,No. 05 Civ. 1898, 2005 WL 2148919(S.D.N.Y. Sept. 6, 2005)..........................................................................................................34
Teamsters Local 445Freight Div. Pension Fund v. Dynex Capital, Inc.,531 F.3d 190 (2d Cir. 2008)...............................................................................................28, 45
Tellabs, Inc. v. Makor Issues & Rights Ltd.,551 U.S. 308 and 322-24 (2007)......................................................................................passim
Tyler v. Liz Claiborne,814 F. Supp. 2d 323 (S.D.N.Y. 2011)......................................................................................31
Verdi v. Potter,No. 08 Civ 2687, 2010 WL 502959(E.D.N.Y. Feb. 9, 2010)...........................................................................................................43
Winslow v. BancorpSouth, Inc.,No. 3:10-463, 2011 WL 7090820
(M.D. Tenn. Apr. 26, 2011).....................................................................................................37
STATUTES, RULES AND REGULATIONS
15 U.S.C.78j(b)......................................................................................................................................2178u4......................................................................................................................................4378u-4(b)(2).............................................................................................................................21
26 V.S.A. 14 ............................................................................................................................................. 24
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Securities Exchange Act of 193410(b)............................................................................................................................... passim20(a) .......................................................................................................................................49
Federal Rules of Civil ProcedureRule 8(a)...................................................................................................................................22Rule 9(b) ..................................................................................................................................22Rule 10b-5................................................................................................................................21Rule 10b5-1......................................................................................................................3, 4, 13Rule 12(b)(6)............................................................................................................................22Rule 15(a).................................................................................................................................50Rule 501...................................................................................................................................24
SECONDARY AUTHORITIES
3rd Update Margin Calls Cost Green Mountain Chairman, Director, THE WALL STREETJOURNAL (May 8, 2012).............................................................................................................3
B. Strubel, Green Mountain Coffee Roasters Butchered Its Acquisitions,SEEKINGALPHA.COM (June8,2012) ...........................................................................................5
F.E. Ryerson III, Improper Capitalization and the Management of Earnings, 16 ASBBSAnnual Conference, No. 1 (Feb. 2009)......................................................................................9
Green Mountains Margin of Error, THE WALL STREET JOURNAL (May 14, 2012) ........................4
J. Merriam Bitter Beans at Green Mountain Coffee, SEEKINGALPHA.COM (Sept. 30,2010) ........................................................................................................................................20
REUTERS, Court Papers Show SECs Green Mountain Probe Isnt Over (May 30, 2012)..............2
Mulford and E.E. Comiskey, THE FINANCIAL NUMBERS GAME:DETECTING CREATIVEACCOUNTING PRACTICES 136(ed. 2011)....................................................................................8
P. Eavis, Digging Deeper Into Green Mountains Profits, THE NEW YORK TIMES (May 4,2012) ..........................................................................................................................................9
S. Antar Green Mountain Coffees Numbers Submitted to SEC Examiners Dont AddUp, SEEKINGALPHA.COM (July 12, 2012)..................................................................................3
S. Antar, Is Green Mountains Inventory Approaching Toxic Levels?SEEKINGALPHA.COM (May 1, 2012)...........................................................................................5
S. Roychowdhury, Earnings Management Through Real Activities Manipulation, 42 J.OF ACCOUNTING AND ECON. 335-372 (2006) ..................................................................8
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Lead Plaintiffs Mike Shanley, Jerzy Warchol, Robert Nichols, Jennifer Nichols, and Loren Marc
Schmerler (plaintiffs) respectfully respond to the motions to dismiss filed by Green Mountain Coffee
Roasters, Inc. (GMCR or the Company), its CEO, Lawrence Blanford (Blanford), and its CFO,
Frances Rathke (Rathke) (collectively defendants), as follows:
I. PRELIMINARY STATEMENTIn the last round of pleading, the operative complaint almost survived defendants motions to
dismiss. Challenging plaintiffs Consolidated Class Action Complaint (CAC), defendants had
contested only two of the six elements of the Section 10(b) claim falsity and scienter. With respect to
falsity, the Court ruled in plaintiffs favor, finding that the CAC adequately alleged that GMCR,
Blanford and Rathke had each made misstatements of fact in GMCRs public statements and SEC filings
during the Class Period, i.e.,July 28, 2010 to September 28, 2010.1 With respect to scienter, although it
found an innocent reading of events to be, on balance, more compelling than one inferring fraud, see
Order at *40, the Court was troubled by an undocumented, 150-truck shipment to MBlock2 and by the
insider selling of GMCRs two unit presidents. See id. (neither are conclusively explain[ed] by a
benign explanation).
The SAC adds detail to plaintiffs claims in specific areas the Court found weak, as well as
events which occurred since the CAC was filed, both of which shed light on defendants Class Period
misconduct.3 As the new allegations weigh heavily to tip the balance in plaintiffs favor, defendants
motions should be denied. 4
1 See Opinion and Order (Order), dated January 27, 2012 (Dkt. No. 57), at *11-*14.
2 Capitalized terms used herein are as defined in the Second Consolidated Amended Class ActionComplaint (SAC), filed on April 30, 2012 and cited herein as _.
3 Moreover, in the few months since the SACs filing, additional revelations of the fraud caused GMCRsshare price to fall from $48.73 (when the SAC was filed), to below $20. See infra at 2-3.
4 Events occurring after the Class Period can be used to show defendants state of mind during the ClassPeriod, thereby demonstrating scienter. See, e.g., Rothman v. Gregor, 220 F.3d 81, 92 (2d Cir. 2000); see
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GMCR has been under the public cloud of an SEC probe for almost two years.5 The SEC has
likely not concluded its work, in part, because the hits just keep on coming. At the end of the Class
Period, in conjunction with a financing deal, GMCR was forced to disclose both that it had overstated
income for several years (up to and including the Class Period) andthat the SEC was inquiring into
GMCRs relationship with vendor MBlock and the recognition of revenue associated therewith.6 The
repercussions of this fraud have reverberated long thereafter:
In October 2011, one year after the initial disclosure, Greenlight Capitals David Einhorngave a 110-slide presentation on the Company entitled GAAP-uccino (the EinhornReport). The Einhorn Report included confirmation that Class Period inventoryshenanigans described in the earlier-filed CAC had not only occurred, but continuedunabated. 84-92. GMCRs share price fell sharply in response.7
On May 2, 2012, Blanford shockingly claimed that the Companys inability toadequately gauge demand caused GMCR to badly miss revenue estimates and to write-off a significant amount of obsolete inventory a material write-down for the first timeever, according to Rathke contributing to decreased gross margins.8 After a brief
also Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 254 (5thCir. 2009) (partial reliance on alleged factsdating from the post-class period does not amount to fraud by hindsight) (citation omitted).
5 The March 2012 manual issued by the Division of Enforcement indicates that an informal inquiry shouldbecome an investigation if it is not resolved in 60 days. See
http://www.sec.gov/divisions/enforce/enforcementmanual.pdf. A May 30, 2012, REUTERS article, CourtPapers Show SECs Green Mountain Probe Isnt Over, reported that the matter had not died on the vine, assuggested by GMCRs counsel at oral argument. To the contrary, [s]ources close to the SEC investigationtold Reuters the SEC had four people working on the case, including two forensic accountants. See Ex. A tothe Declaration of Coby M. Turner in Support of Lead Plaintiffs Omnibus Opposition to Defendants GreenMountain Coffee Roasters, Inc.s, Lawrence J. Blanfords and Frances G. Rathkes Motions to Dismiss theSecond Consolidated Amended Class Action Complaint (Turner Decl.), served and filed herewith.
6 The Form 8-K states that these disclosures were made pursuant to Regulation Fair Disclosure (Reg. FD),as the information was disclosed privately in conjunction with a debt offering to fund the Van Houtteacquisition. 112. Identifying the disclosures as Reg. FD-related suggests that the public was informed ofthese facts by happenstance.
7See, e.g., Jason Merriams October 21, 2011 article at SEEKINGALPHA.COM, Green Mountain Coffees
Bear Attack Was Overdue, describing a 30% price drop in the days after Einhorns presentation and notingEinhorns bearish thesis reiterated many concerns previously discussed . . . . (Turner Decl., Ex. B).
8See GMCR Q2 2012 Final Earnings Call Transcript at 11 (Blanford: [W]eve just got a lot of moving
parts. And I think we continue to increase our capability, but its gotten even more difficult to put our armsaround [demand].); at 3 (Rathke: margins decreased [a]pproximately 150 basis points due to a higher write-down of finished product and anticipated obsolescence of raw material inventory due to lower-than-anticipated sales of seasonal and certain coffee products); and 12 (Rathke: Again . . . weve never really had
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trading halt, on a reported volume of more than 87 million shares, GMCR stock lost halfof its value in a single day.9
On May 8, 2012, the Company abruptly removed GMCRs founder and Chairman (andformer defendant), Robert Stiller, and Lead Director, William Davis, from theirrespective positions on the Companys Board of Directors for selling 5.55 million sharesof GMCR stock several days earlier, during a period in which they were forbidden totrade.10
On July 9, 2012, correspondence with the SEC concerning the 2011 Form 10-K wasreleased. Commentators noted that GMCRs explanations did not match reported figuresin several respects: profit margins could not be reconciled with GMCRs repeateddisclosure that it makes no profit on brewer sales; and Timothys Coffee incomeexceeded its gross profits for a five-quarter period (including the Class Period).11 For theweek, shares dove 19.6%, from the July 6, 2012 close of $24.50 to just $19.70 one weeklater.12
Adding together the items in the CAC that already troubled the Court (see Order at *40), the new
allegations in the SAC,13 and the events which occurred since the SACs filing, there can be no doubt
any kind of significant issue with ABSO [ph]. I think this is the first quarter that weve really had a purely[ph] significant amount.) (Turner Decl., Ex. C).
9See Yahoo! Historical Price Chart (Turner Decl., Ex. D) (shares tumbled from $49.52 to $25.87).
10 Lead Director Davis committed an additional violation, pledging shares as collateral for a loan in 2012,after the Company expressly forbade this practice as of January 1, 2012. See 3rd Update Margin Calls CostGreen Mountain Chairman, Director, THE WALL STREET JOURNAL (May 8, 2012)(Turner Decl., Ex. E).Also, Starbucks indicated that it informed GMCR of its plan to introduce a single-cup brewer before it waspublicly announced on March 8, 2012; GMCR does not deny that. Thus, Stillers other 2012 sales, for $66.3million in late February not pursuant to a Rule 10b5-1 trading plan could have been improperly made onmaterial, non-public information. See id.
11 Green Mountain Coffee Roasters Profits: Overstated or Misunderstood, THELONGSHORTTRADER.COM(July 10, 2012) (quoting July 9, 2012 comments by Herb Greenberg); S. Antar Green Mountain CoffeesNumbers Submitted to SEC Examiners Dont Add Up, SEEKINGALPHA.COM (July 12, 2012) (Turner Decl.,Exs. F and G).
12See Yahoo! Historical Price Chart (Turner Decl., Ex. D).
13E.g.,additional details about the SEC inquiry in early 2010 (67-70); personal profit motive drove over-
production of inventory because bonuses were tied to operating income margins (75-77, 80); Rathke andother members of senior management decided not to spend the money to make necessary upgrades tocomputer systems (later revealed as a material weakness), and excess inventory was hidden from auditors,shipped needlessly from warehouse to warehouse, counted twice, and/or destroyed in vast quantities (80,89, 91, 103-04).
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that Class Period misstatements were the result of the reckless and self-interested misbehavior of GMCR
and its top personnel. Accordingly, defendants motions to dismiss should be denied in their entirety.
II. INTRODUCTIONDespite repeated materializations of the risks of defendants fraud, and concurrent price declines,
in their motions to dismiss, defendants steadfastly cling to their story: GMCRs rapid growth simply
outpaced the development of the Companys accounting structure14Green Mountain was
experiencing a period of unprecedented growth, and as a result, some lapses occurred in the accounting
department.15 For several reasons, this facile explanation does not hold water.
First, while it may have grown rapidly in recent years, GMCR has been a public company since
1993 and is well-versed in SEC rules and regulations. There have been repeated misstatements in its
SEC filings that have nothing to do with GMCRs recent growth spurt:
Not until after commentator Sam Antar exposed blatant insider trading did the Companyamend some of division president Michelle Stacys Forms 4 to state that her August andSeptember 2010 stock sales the last two of which were made the day afterthe SECissued a document request to GMCR, but a weekbefore GMCR publicly disclosed theSECs request and ongoing inquiry were made pursuant to a Rule 10b5-1 planpurportedly adopted in August 2010. 127-28;
For many years, GMCRs SEC filings the accuracy of which was certified by CFORathke herself falsely represented that Rathke held a CPA license. 18; Turner Decl.Ex. CC; and
GMCR claimed to have made an inadvertent clerical error when it forgot to mention inits February 2012 proxy statement that 770,000 shares of the Companys stock had beenpledged as collateral for a loan by former Lead Director Davis.16
14 Memorandum in Support of GMCR Motion to Dismiss, filed June 14, 2012 (GMCR MTD) (Dkt. No.
77-1) at 37-38.
15 Blanford and Rathkes Memorandum in Support of Motion to Dismiss (Mgt. MTD) (Dkt. No. 76-1) at 2.They also argue that even GMCRs outside auditors failed to initially catch these less than obvious errors.Id. at 19. However, the auditors failure to also uncover material weaknesses calls their audits into question.See n.28 & Turner Decl., Ex. U, infra.
16See Green Mountains Margin of Error, THE WALL STREET JOURNAL (May 14, 2012) (Turner Decl., Ex.
H).
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Second, one commentator recently demonstrated that GMCRs benign story lacks factual
support: prior to their acquisitions, Van Houtte and Diedrich had utilized their resources far more
efficiently than GMCR. Thus, the acquisitions should have resulted in economies of scale and greater
manufacturing efficiency for GMCR, not less.17 Moreover, the failure to quickly integrate acquisitions
also meant that acquirees superior inventory control systems remained in place which should have
resulted in an overall improvement of GMCRs poorer inventory turnover. Instead, GMCRs inventories
rose at an alarming rate, while turnover slowed.18
Although the Court expressly held that the sufficiency of the MBlock allegations with respect to
pleading either falsity or scienter is not essential to a ruling on the adequacy of plaintiffs claims herein,
see Order at *12, *30, *37-*38,19 a single explanation does account for the restatement, the SECs
MBlock investigation, and the events which have unfolded thereafter. However, it is by no means a
benign one: Blanford, Rathke and other senior executives manipulated GMCRs reported net sales and
operating income for a number of years by intentionally overproducing product well in excess of actual
demand to, inter alia, earn bonuses equal to or greater than their annual salaries.20
17See B. Strubel, Green Mountain Coffee Roasters Butchered Its Acquisitions, SEEKINGALPHA.COM (June
8,2012)(comparing revenue to fixed assets, revenue to capital expenditure, and inventory ratios of GMCR,Van Houtte and Diedrich and finding the other two companies superior to GMCR on each metric) (TurnerDecl., Ex. I).
18Id.; see also S. Antar, Is Green Mountains Inventory Approaching Toxic Levels? SEEKINGALPHA.COM
(May 1, 2012). Antar reasoned that because quarterly sales figures almost always exceeded guidance,inventory turns should have improved as the unexpected additional sales pulled products out of inventory.However, GMCRs turn rate has consistently declined since late 2010, with inventory levels rising rathersignificantly. (Turner Decl., Ex. J).
19
Almost as tenaciously as they cling to their growing pains story, defendants continue to misperceive theentire action as revolving around improper revenue recognition for shipments to MBlock. See, e.g., GMCRMTD at 1, 2, 8-10, 12-15, 25-29. Although that is apartof plaintiffs allegations, as the Court noted, theMBlock allegations are as relevant to the element of scienter as they are to falsity. See Order at *12 (Theparties spar vigorously over MBlock, which this opinion takes up in detail in relation to scienter. However,there is little debate that the Q3 Statements, regardless of the MBlock practices, were false GMCR admittedas much in restating them.).
20 All but one of the items restated on December 9, 2010 had the effect of overstating GMCRs net salesand/or operating income for each restated year. See 2010 Form 10-K at iii (Turner Decl., Ex. K).
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Manipulation of Net Sales: GMCR revealed after the Class Period, by an addition to Keurigs
royalty income policy (which GMCR moved, from page 1 of its Forms 10-K for 2007, 2008 and 2009, to
page F-9 of the 2010 Form 10-K), that it recognized royalty income on sales by licensees to Keurig.
53-58. Thus, not only did the restatement first reveal that GMCR manipulated income by simply
ordering K-Cups in excess of actual demand, plaintiffs allege (see64(c), 80) but that it resulted in,
at least, a $1 million income overstatement. 58, 114.
With respect to MBlock revenue recognition, defendants continue to cite to a policy adoptedafter
the Class Period to argue that all of plaintiffs MBlock allegations are irrelevant because revenue is only
recognized on sales to MBlock at the time the product is shipped out to an end-user. See GMCR MTD at
1, 8 (quoting 2010 Form 10-K at 43); Mgt. MTD at 3. However, the relevant revenue recognition policy
in effect during the Class Period, set forth in the 2009 Form 10-K at 32, was completely silenton when
revenue is recognized on sales of brewers and K-Cups to MBlock.21 Despite GMCRs self-serving claim
that its internal investigation found no connection between the restatement and MBlock,22 its 2010 Form
10-K warned that a possible outcome of the SECs probe of GMCRs dealings with MBlock could be
another restatement. 116. Thus, any connection the market drew on September 28, 2010 between the
two pieces of news disclosed a multi-year income overstatement and the SECs MBlock inquiry is, in
fact, accurate. Until the SECs investigation concludes in GMCRs favor, i.e., with no additional
restatement of net sales and operating income, the bright line defendants seek to draw between the
restatement and the SEC inquiry simply does not exist.
21See 2009 Form 10-K at 12: We sell a significant number of brewers and K-Cups to [MBlock] for re-sale
to certain retailers. Receivables from this company were approximately 51% of our consolidated accountsreceivable balance at September 26, 2009, and32: Sales of single-cup coffee brewers are recognized net ofan estimated allowance for returns. The Company estimates the allowance for returns using an average returnrate based on historical experience. Royalty revenue is recognized upon shipment of K-Cups by roasters asset forth under the terms and conditions of various licensing agreements. (Turner Decl., Ex. L).
22 While the Court indicated this was PricewaterhouseCoopers LLPs (PwC) finding, see Order at *35, itappears from the Form 8-K issued on November 19, 2010 that this was the conclusion of the auditcommittees internal investigation, not PwC. (Turner Decl., Ex. M).
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Manipulation of Operating Income: The Court held that the restatement is an admission of a
material misstatement of GMCRs earlier-reported earnings. See Order at *13-*14. Two items,
including the largest, a $7.6 million income overstatement, resulted from incorrect standard cost figures
being used to eliminate inter-company inventory balances. 112, 114. The SAC alleges, in significant
detail, defendants reckless disregard for the fact that GMCRs unconnected, inadequate accounting
systems (since the Keurig acquisition in 2006, the first year of the restatement) produced completely
unreliable figures. This was particularly true with respect to GMCRs inability to track and value
inventory, much of which was stored at MBlock, an entity with poor tracking systems of its own that
allowed GMCRs employees to manage inventory movements at its warehouses. 64-66, 79, 103-04.
During the Class Period, senior management was aware of the later-admitted material weakness
concerning the completeness and accuracy of the accounting for intercompany transactions and the
need to automate certain aspects of the intercompany accounting (117), but nonetheless refused to
upgrade GMCRs systems. Even in the restatement, management only committed to an evaluation of
possible methods to remedy the problem. Id. Auditor PwC expressed no opinion on the merit of this
remediation plan. 118.
As plaintiffs have repeatedly alleged, defendants unreasonably grew GMCRs Class Period
inventories despite a slowdown in projected sales growth. 53-54; see also CAC 54-55. As
explained in the SAC, there was a financial motive to do so, as employee bonuses were tied to production
(64(c), 80), since increased production meant a lower Cost of Goods Sold (COGS) per unit and
allowed GMCR to have the appearance of higher operating margins (see p. 19, infra), and hence, higher
operating income. Unnecessary overproduction was especially attractive for senior management, i.e.,
Blanford, Rathke, and unit presidents McCreary and Stacy, who could practically double their 2010
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salaries (or more than double it, in Blanfords case) by achieving the higher net sales and operating
income targets. Id.23
Linking bonuses to these very metrics is a well-known cause of earnings management:24 Top
officers of GMCR intentionally increased production regardless of demand to improve operating
margins. 80. During the Class Period, as vast quantities of intentionally overproduced inventory
became obsolete, stale coffee was taken away from warehouses, hidden from GMCRs auditors, and then
either given away to farmers, destroyed, or dumped in landfills. 64(c), 74-77, 80.25 Highly suspect
shifting of inventory between GMCR, MBlock and their facilities, including significant amounts of
inventory past its expiration date, was confirmed by the Einhorn Report. 89, 91. However, GMCR
disclosed a write-off of only 0.75% of finished inventory during the Class Period.26
23See DEF 14A, filed January 24, 2011, at 25 (Consistent with prior years [i.e., 2007-2009], the
Compensation Committee again chose net sales and operating income as the financial targets against which tomeasure any annual incentive compensation payable to the named executive officers.). Based uponachieving various targets, Rathke, McCreary and Stacy were thus eligible for bonuses of up to 82.5% of theirbase salaries; Blanford could have received as much as 150% of his base salary in bonus. Id. at 26-27.(Turner Decl., Ex. N).
24See S. Roychowdhury, Earnings Management Through Real Activities Manipulation, 42 J. OF
ACCOUNTING AND ECON.335-372(2006)(so finding);see also C.W.Mulford and E.E. Comiskey, THEFINANCIAL NUMBERS GAME:DETECTING CREATIVE ACCOUNTING PRACTICES 136(ed. 2011) (Financialprofessionals were asked to discuss various earnings management scenarios, one of which perfectly describedthe facts of this case: Production is expanded beyond current requirements in order to capitalize moreoverhead into inventory and by so doing increase incentive compensation for company officers. Thisactivity was judged to be pushing the limits of GAAP flexibility because [a]n inventory buildup absorbscash flow and could raise the possibility of the need for a future inventory write-down. The practice, whichresulted in misleading and fraudulent reporting, was also described as being contrary to codes of businessconduct and/or a corporations ethics policies.) (Turner Decl., Exs. O and P).
25See also Green Mountains coffee distributor brews controversy, a July 2, 2012 article in REUTERS,
recounting past inventory frauds by other companies that warehoused inventory at MBlock. With respect to
GMCRs excess inventories, the article explained: Several former M. Block employees confirmed [theCACs allegations] that the companys warehouses sometimes were overstocked with expired GreenMountain coffee, which led the distributor to encourage periodic giveaways . . . [E]very few months M. Blockwould give out industrial-sized, 44-gallon garbage bags for its employees to fill with single-cup GreenMountain coffee pods.) (Turner Decl., Ex. Q).
26See Form 10-Q, filed August 5, 2010, Unaudited Consolidated Financial Statements, Note 5 ($147.4
million finished goods inventory is net of obsolescence allowance[] of $1,121,000 . . . at June 26, 2010[.])(Turner Decl., Ex. R).
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How was the obsolete inventory accounted for? The Einhorn Report questioned the meteoric
increase of GMCRs purported capital expenditures year-over-year: From $48 million in FY 2009, to
$118 million in FY 2010, to $325-350 million in 2011, and a projected whopping $700-780 million for
FY 2012.27 In an attempt to reconstitute these figures, as later described by Peter Eavis in THE NEW
YORK TIMES, Einhorn estimated how much extra capital expenditure would be needed to produce extra
coffee pods.28 The Einhorn Report found that there was a tremendous gap between the CapEx required
to satisfy actual and projected K-Cup demand and the midpoint of GMCRs projected CapEx $103.1
million for just-ended FY 2011 and an astonishing $426.6 million for FY 2012. See Einhorn Report at
69. Eavis similarly compared the CapEx figures publicly announced for the expansion of buildings at
three plant locations with GMCRs projected CapEx for buildings; the discrepancy was $115 million
($50 million versus $165 million). Both the Einhorn Report and Eavis suggested that GMCR was
improperly capitalizing expenses.29
Whereas both GMCR and MBlock employees described the periodic need to remove significant
amounts of expired coffee from inventory, at a time GMCRs obsolescence write-offs were miniscule,
there is a strong inference that most inventory write-offs were being classified as capital expenditures
during the Class Period, so that they could be taken over time, rather than hitting the income statement all
at once. After the Einhorn Report, the SEC investigation, and commentators embarrassed GMCR into
27See Einhorn Report at 68. (Turner Decl., Ex. S).
28 P. Eavis, Digging Deeper Into Green Mountains Profits, THE NEW YORK TIMES (May 4, 2012) (TurnerDecl., Ex. T).
29 See Einhorn Report at 72: The gap is so large and insufficiently explained that it raises questions aboutwhat is being capitalized . . . ; Eavis: While capital expenditures are a cost for a company, they dont showup all at once in the income statement. A company that wants to make itself look more profitable can takeexpenses that should be immediately counted in the income statement and classify them as capitalexpenditures. This type of earnings manipulation is so common that auditors can be held liable for notuncovering it. See F.E. Ryerson III, Improper Capitalization and the Management of Earnings, 16 ASBBSAnnual Conference, No. 1 (Feb. 2009) (citing 16 SEC Accounting and Auditing Enforcement Releases whereaccountants knew or should have known that management was improperly capitalizing expenses). (TurnerDecl., Ex. U).
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substantially lowering its CapEx projections for 2012,30 following a Q2 2012 sales miss, defendants were
forced to take a significant inventory write-off.
III. STATEMENT OF FACTS31A. Senior Management Chose Acquisitions Over Accounting Infrastructure
and Reporting Accuracy
During the Class Period, defendants assured investors in GMCRs SEC filings that the
Companys financial statements were presented in conformance with GAAP and that the Company
maintained a sound system of internal controls over its financial reporting. 101. In the Companys Q3
2010 Form 10-Q, filed August 5, 2010, Blanford and Rathke certified that they designed and evaluated
these systems and that there were no material weaknesses that could lead to inaccurate reporting. 105.
Not even two months after these certifications were made, a multi-year income overstatement was first
reported. 112. Less than two months after that, investors were told that they could not rely upon four
years of financial reporting. 114. Several weeks later, GMCRs 2010 Form 10-K reported an even
broader restatement than was previously announced and two material weaknesses in internal controls
over financial reporting. 116-17. The SACs allegations demonstrate that senior management was
aware of GMCRs woefully deficient accounting infrastructure when Blanford and Rathke made their
false certifications.
In the years leading up to the expiration of Keurigs patented, single-cup technology, defendants
devised a business plan to address that eventuality. Defendants decided that GMCR would purchase a
30 The Q3 2011 earnings release, filed on Form 8-K on July 27, 2011, indicated that GMCRs CapEx forecastof $650-$720 million might increase to $700-780 million. (Turner Decl., Ex. V). On May 2, 2012, having
already been lowered to $630-700 million, Rathke announced that CapEx would be $525-575 million. SeeTurner Decl., Ex. C at 4.
31 Rather than summarize all facts alleged, this section focuses upon the facts added to those in the CAC toenhance allegations found to be insufficient by the Court. Although relied upon, plaintiffs will not discuss theinsider trading and Lavazza and Van Houtte transactions, the details of the three announcements concerningthe MBlock inquiry and the (ever-increasing scope of the) restatement, or the revelations of GMCRs materialweaknesses over internal control of financial reporting all of which are repeated in the SAC largelyunchanged.
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number of prominent coffee roasters, e.g., Van Houtte, Timothys and Diedrich, to secure brand loyalty
well in advance of 2012, and to make deals with potential competitors, e.g.,Starbucks and Dunkin
Donuts. 35-36.32 The downside of this strategy was explained in the SAC by CW1, a distribution
planning manager who initially came to the Company in 2009 to work on IT projects. At that time, CW1
observed that there was no enterprise resource planning, and no systems in place for warehouse,
transportation, or supply chain management or for inventory control (indeed, none of the warehouses
were linked). 64(a). When CW1 brought this to the attention of her/his superior, Director of Operations
Don Holly, he told CW1 that instead of installing these systems, GMCR would focus upon growth
through acquisition.
Devoting the Companys financial resources to the acquisition of various roasters, to the
exclusion of ensuring that a proper infrastructure was in place to support growth, only served to
exacerbate an inter-company communications problem that existed since GMCR purchased Keurig in
2006. In the SAC, several witnesses explained that because GMCR used PeopleSoft software while
Keurig used Great Plains software, and maintained its own accounting team, Keurig operated somewhat
separately from the rest of the Company. See 103(a)-(c) (CW8, CW9 and CW10). Further
complicating matters, Diedrich had been using Sage MAS-500 software at the time of its acquisition.
CW10, who moved from Diedrich to GMCR and was employed during the Class Period, indicated that
problems with inter-company transfers could arise because of the use of different systems. 103(c).
Newly-located witnesses confirm CW1s assessment that GMCRs computer system deficiencies
and difficulties were far more extensive than just the use of incompatible software by the two divisions.
32 After the submission of the 2011 Form 10-K, the SEC asked GMCR whether patent expirations wouldhave a material impact on GMCRs financial condition and operations. On May 4, 2012, GMCR responded:The Company believes that it has competitive strengths, aside from its intellectual property portfolio, thatenhance its business and mitigate the potential material impact on its financial position and results ofoperations in the future arising from the patent expirations. First, the Company believes that its first moveradvantage allows it efficiencies and scale to support increasing consumer demand at a lower cost than itscompetitors. Additionally, the Company exclusively offers over 200 varieties of K-Cup portion packs,including from a broad variety of meaningful brands. (Turner Decl., Ex. W) (emphasis added).
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These witnesses described SCBUs complete inability to accurately account for both its raw and finished
inventory. According to a buyer who worked at GMCRs Knoxville facility for 18 months (CW12),
there were as many as five different computer systems Microsoft Excel, Microsoft Access, PeopleSoft,
Oracle and Scolari keeping track of inventory. There was no way to prevent inventory from being
double counted,33 and this occurred constantly. Items were removed from inventory without
recordation. As a result, there were repeated reconciliations, but inventory counts were way off.
104(b). These problems were well-known throughout the Company and many people worked to
reconcile the figures from the separate systems. Id. Controller Patricia Bell, Operations Director Jane
Payne and Distribution Manager Dale Pearson were responsible for informing SCBU President
McCreary of the problems and the revised inventory figures. Id.
One of the people responsible for reconciling figures was CW13, a contract employee who
worked in GMCRs Knoxville warehouse during the Class Period, and created and reviewed inventory
reports for both raw and finished products on a daily basis. Like CW12, CW13 stated that inventory
reports were irreconcilable and products that were supposed to be in inventory were missing. It was also
common for system errors to contribute to the need to recount inventory. An employee who reported to
defendant Rathke told CW13 that senior management was aware of the computer problems but refused to
pay for better computer systems. 104(c). (This is exactly what CW1 had been told).
Following interviews with employees of both GMCR and MBlock, the Einhorn Report (Turner
Decl., Ex. S at 93) confirmed and corroborated the accounts of these CWs, stating:
Both GMCR and MBlock use substandard IT systems. Important functions, includinginventory management are performed in Excel spreadsheets which are easy to change,
provide non-standardized analysis, and are prone to material error.
Suggestions to improve operations through the use of technology are met with resistanceinside both organizations.
33 CW11, a marketing manager and MBA who worked for the Company for a year, up to the start of the ClassPeriod, confirmed that there was an inventory double counting problem. 104(a).
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Further evidence that defendants showed a reckless disregard for accounting accuracy is the
number of commentators who constantly pointed out blatant inconsistencies in GMCRs financial filings.
3, 95-97; see also Turner Decl., Exs. B, F, G, I, J, S, and Z. They are neither loons nor conspiracy
theorists, as suggested by defendants. See GMCR MTD at 36 n.17. To the contrary, comments made on
CNBC spurred the SEC into action. Compare96 with S. Antar, To the Securities and Exchange
Commission: Green Mountain Coffee Roasters selectively spills the beans and its numbers still dont add
up, WHITE COLLAR FRAUD (June 6, 2011) (Turner Decl., Ex. X) (a month after Herb Greenburg
questioned whether an apparent reserve reversal allowed GMCR to meet analysts expectations, the SEC
asked about the same anomaly in GMCRs filings). Indeed, GMCR amended the Forms 4 on some of
Michelle Stacys suspicious stock sales to make reference a Rule 10b5-1 plan only afterSam Antar
called her on the carpet for insider trading. 128. Moreover, journalists without a profit motive or an axe
to grind have been muckraking as well. See, e.g., Turner Decl., Ex. Q (REUTERS article about MBlock);
Turner Decl., Ex. T (Peter Eaviss expos in THE NEW YORK TIMES replicated the Einhorn Reports
method of uncovering grossly overstated CapEx figures using public documents). While these articles
do not establish scienter, per se,they most certainly weigh heavily in favor of rejecting defendants
benign explanation of events.
B. GMCR Used MBlock to Engage in an Inventory Shell Game to BoostFinancial Results
One witness (CW11) described MBlock as a catch all for customers [GMCR] didnt ship to
directly. 104(a). Because MBlock played the role of catch all, CW11 indicated that a reason for the
inventory double counting problem was that GMCRs employees could not determine whether
shipments sent to MBlock were sent there for storage or had actually been sold to MBlock. Id. The
CAC initially described in detail how MBlock became a captive warehouse for GMCR.34 As the SAC
34See, e.g., CAC at 63 (MBlock initially became Keurigs distributor in 2003); 67 (MBlocks business
with GMCR grew from 20% to 75% with the execution of a new national contract in mid-2009); 65(a)(GMCR invested in MBlocks infrastructure, with distribution centers opening in 2009 and 2010); 66 (a
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explains, as had others in the past,35 defendants used shipments to MBlock as a catch all to manipulate
both revenues and operating margins.
1. Defendants Used MBlock to Facilitate Premature RevenueRecognition
The bulk of the allegations in the CAC regarding MBlock concerned a single 150-truck shipment
to MBlock on which plaintiffs allege GMCR improperly recognized revenues. CAC 70-71. The Court
found the allegations adequately pled the mechanics of the shipment. However, the Court found
insufficient evidence of both revenue recognition on this shipment and that the named defendants were
aware of the shipment. See Order at *33-*36. New details from CW1 and corroboration from other
witnesses strengthen plaintiffs claim in the SAC.
First, the Court noted that plaintiffs failed to allege that CW1s duties included accounting or that
CW1 had an accounting background. See Order at *33. The SAC alleges that CW1 worked with
accountants for 15 years and was well-versed in the rules concerning revenue recognition. Accounting
responsibilities within CW1s role as a distribution planning manager included profit and loss
determinations, cost allocation and accrual accounting, preparation of accounting timelines and decision-
making concerning returns on investment. 64.
Second, the Court found CW1s account insufficient to allege that revenue had been improperly
recognized on the 150-truck shipment. See Order at *33-*34. In the SAC, CW1 added details that
support such a conclusion: (1) despite CW1s and two managers inability to locate proper paperwork for
the shipment, MBlock picked up 150 truckloads of product at quarter-end in December 2009 (72) a
former GMCR employee indicated that MBlock is known as GMCRs captive company, and would do asGMCR instructed). In the recent REUTERS article focused on MBlock, the author confirmed plaintiffsallegations that MBlock gave up most of its other business to accommodate GMCR. Compare SAC at64(b)-66 with Turner Decl., Ex. Q (Interviews with a dozen former M. Block employees revealed a quicktransition in 2008 from a business that mainly moved small appliances to grocery stores to an increased focuson distributing Green Mountain products.).
35 Turner Decl., Ex. Q (noting that MBlocks warehouses were also used by Sunbeam and iGo Corp. to
perpetrate securities fraud).
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tell-tale sign of revenue recognition fraud; and (2) no payment was ever made and the shipment was on
GMCRs books as an account receivable. Id.
Third, the SAC also addresses the Courts concern that CW1 did not link the highly-unusual
shipment, and the revenue recognized for it, to the individual defendants. See Order at *36. CW1 has
now provided details concerning weekly operations meetings at which CW1 was asked to sometimes
make presentations (and for which CW1 prepared reports and pivot tables for Operations VP Jonathan
Wettstein to present): (1) meetings were held weekly, or more frequently due to constant inventory
adjustments; (2) defendants Blanford and Rathke were in attendance, as well as SCBU President
McCreary, VP of Finance Tina Bissonette, Vermont Operations Manager Dave Tilgner and Multi-Site
Scheduling Manager Dan Redding; and (3) decisions were made with respect to: (a) which products
would be made and where they would be made, (b) locations where product was to be stored, (c) the way
inventory would be transported from facility to facility, and (d) the disposal of excess inventory. 74. It
is reasonable to infer that the 150-truckload shipment would have been discussed at one of these weekly
meetings, given: (a) the tight control over all production and inventory exercised by the participants in
the meetings; and (b) the fact that several participants, to wit, Operations VP Wettstein, SCBU president
McCreary, and Finance VP Bissonette, were all aware of the shipment. 73.
Finally, CW1 previously noted that GMCR ultimately changed its stated revenue recognition
policy because the auditors had found discrepancies. 83; see also CAC 74.36 (Such a change cannot
occur without the knowledge of senior management, in particular Blanford and Rathke, who executed
GMCRs periodic SEC filings.) CW1 additionally recalled that in November and December 2009 the
month of the 150-truck shipment and the month just prior thereto the Companys revenue recognition
36 As explained above, at p.6 & n.20, the Companys stated revenue policy (up to and including the 2009Form 10-K filed in November 2009) was silent on when revenues were recognized on products shippedthrough MBlock, i.e.,brewer and K-Cup sales other than wholesale and consumer direct sales.
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practices and policies had been discussed at the weekly (bi-weekly) meetings attended by Blanford and
Rathke. 74.
Although GMCRs internal investigation found no link between the 2010 restatement and sales
through MBlock (114), GMCR admitted that resolution of the SEC probe may still require a restatement
of revenues from MBlock transactions. 116. The Einhorn Report highlighted the lack of transparency
in GMCRs dealings with MBlock: on the one hand, GMCR describes MBlock as a fulfillment entity
performing a purely administrative function, yet it refuses to disclose its MBlock agreements as material
contracts, as required by SEC regulation. On the other hand, 51% of year-end 2009 accounts receivable
(AR) were on sales to MBlock, and GMCR warned that MBlocks creditworthiness thus exposed
GMCR to significant credit risk. See Turner Decl., Ex. S at 87-88. Forty-seven percent of 2010 year-
end AR was attributed to MBlock. See Turner Decl., Ex. K at 14.
Accordingly, plaintiffs argument that MBlock was used to facilitate premature revenue
recognition has been sufficiently plead in the SAC.
2. Defendants Used MBlock to Store the Excess Inventory That WasProduced to Improve GMCRs Operating Margins
At the start of the Class Period, during its Q3 2010 earnings call, GMCR indicated it was
ramping up inventories to prepare for demand, in the fall and thereafter, exceeding expectations. 53.
As two charts in the SAC demonstrate, there was little evidence to support that statement: Year-over-year
sales guidance showed a significant slowing during the last three quarters of FY 2010, while inventories
sharply increased in the quarters just prior to the Class Period. 53-54. Despite the complete
disconnect between GMCRs sales and inventory trends, GMCRs management did not slow down its
production.
To the contrary, as the CAC initially explained, VP of Operations Wettstein and Director of
Operations Don Holly did not set production levels based upon customer ordering history or demand. As
a result (according to CW1 and CW2), inventory piled up to the rafters at MBlocks facilities and large
quantities of product were stored beyond their expiration dates, much of which had to be destroyed.
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Because of GMCRs control over MBlock and the latters poor inventory control capability (later
confirmed in the Einhorn Report), defendants were able to use MBlock to move around inventory at will.
CAC 65(b)-(d).
The SAC contains additional witness accounts of the extent of overproduction, waste and
destruction of excess inventory. See, e.g., 80 (coffee given to farmers for use as silage or to acidize
their fields, or secretly dumped in land-fills near the Knoxville plant); 89 (deliberate overproduction of
K-Cups); 91 & Turner Decl., Ex. S at 96 (truckloads of expired coffee were shipped from GMCR to
MBlock; at least one third of MBlocks warehouse held expired coffee; emails from GMCRs manager
of demand planning consistently discussed how far over the demand forecast actual production was).
The SAC also adds new witness accounts describing frequent, unexplained transfers among
various GMCR and MBlock sites so many that they outnumbered shipments to customers. For
example, CW7, a Class Period shipping employee in Knoxville, witnessed constant transfers from plant
to plant that were made for no apparent reason e.g., every other month, skids of product were sent to
Vermont only to be returned untouched one to four weeks later and improper movements to MBlock
outside the order management system, by means of material shipping requests. 79; see also 89
(Einhorns corroborating witness interviews: We would do more transferring of inventory than we
physically did shipping; the refusal to ship from multiple locations gave cover for a shell game that
Green Mountain was playing across all its facilities).
In addition to the details set forth below concerning defendants knowledge of and control over
this massive inventory shell game (74), the SAC alleges that efforts to get senior management to
improve inventory tracking capabilities failed because a personal financial motive drove the
overproduction of unneeded inventory. For example, CW1 described attending weekly production
meetings among 20 employees (some attending by webcam), including someone from finance, product
schedulers, site schedulers, site managers, procurement personnel, operations representatives, the
transportation manager, line managers from the roasters, coffee expert Lindsey Bolger, Vermont
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operations manager David Tilgner, Director of Operations Don Holly and Operations VP Wettstein. The
group discussed forecasted demand, inventory levels and what had been sold by SCBU to Keurig and
MBlock. CW1 indicated that Holly, following Wettsteins orders, ignored the information exchanged at
these meetings and did notset production levels based upon ordering history or inventory levels. Instead,
the Company overproduced products and GMCR in particular, the Keurig division (whose Director of
Logistics and Transportation, Mike Neyhus, had the Companys initial relationship with MBlock) sent
MBlock more product than it could immediately ship. 64(c).
On numerous occasions, CW1 confronted Holly and Wettstein about their inventory practices. In
October 2009, they instructed CW1 to use a different inventory calculation method than the one they
knew was standard in the industry, to wit, the ABC method which took into account fast-, medium-
and slow-moving items. Instead, they insisted that inventory be replaced when it fell below a standard
deviation plus three days of working inventory. CW1 told both of them this would result in skewed
overproduction of expensive products that would be carried over into another period and then dumped
when their shelf life expired. 75. Wettstein merely replied that his methodology best met our needs.
CW1 took this to mean that Holly and Wettstein were knowingly manipulating inventory. 76. CW1
had a production employee prepare a report demonstrating why Wettsteins method was flawed.
Although Wettstein and Holly reviewed the report and discussed it with CW1, they refused to use the
correct method. Id. (As indicated at p. 12, supra,the Einhorn Report also found resistance to reforming
inventory processes.)
The SAC also adds details concerning GMCRs efforts to hide the overproduced inventory from
the auditors. CW1 stated that expired coffee was temporarily loaded onto trucks and parked a few blocks
away from the warehouse, to be returned to inventory after the auditors left. CW1 witnessed this on
many occasions, so often that he/she would overhear inventory control employees commenting: Oh, we
must be having an audit. CW1 stated that VP Wettstein was fully aware of these practices, designed to
manipulate the Companys accounting. The Einhorn Report contains corroborating reports from other
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employees, describing product loaded onto trailer trucks to nowhere and odd material movements
and irregularities that occurred around the time of the MBlock inventory audits. 89. (According to
CW7, GMCRs own employees were involved in shifting and managing the inventory at MBlock). One
recalled a phantom shipment of 500,000 brewers, purportedly for a QVC order, immediately prior to
an audit, that was restocked right after the audit. 90.
The SAC also reveals the motivation for the massive overproduction and orchestrated
movements of excess inventory to and fro all employee bonuses were tied to production. 64(c), 80.
For lower level employees, this could range from 25-50% of their annual compensation. Id.37For senior
management, hitting operating margin targets (often accomplished by inventory overproduction to lower
the cost of goods sold per unit), could mean an even greater reward in FY 2010 up to 82.5% of base
pay for Rathke, McCreary and Stacy and up to 150% for Blanford.38 Thus, although they sold no shares
of their stock during the Class Period, leading the Court to question the motivation of defendants
Blanford and Rathke, see Order at *22, GMCRs CEO and CFOs actions and statements were still
driven by personal profit motives.
Ultimately, in the wake of the September 28, 2010 announcement of the SECs probe of
GMCRs key relationship with MBlock and the need to restate millions of dollars of income due to poor
intercompany transaction accounting, GMCR stock lost nearly $6 a share. 113. Investors realized that
37 One commentator found this allegation to be evidence of systemic fraud. In GMCR ProductionBonuses Leading to Overstated Revenue? SEEKINGALPHA.COM (April 9, 2012), Ben Strubel wrote: The bigquestion in our mind was just how far the problems extended in the company . . . [I]t would be nave to thinkGMCRs problems didnt go deeper than just some outdated accounting systems and the pressure of fast
growth. [But, I] want a little more evidence that the problems at GMCR are systemic . . . I believe thatsignificant proof comes from the testimony of several confidential witnesses in the Horowitz class action suit.The witness testified that GMCR instituted a system of bonuses for employees that was based on makingproduction numbers and that these bonuses sometimes made up to 50% of employees pay. Citing the workof a criminologist, Strubel explained how managers who embark down a path of fraud to inflate financialresults use production bonuses to elicit the behavior they want without having to explicitly ask employees tothemselves break the rules. (Turner Decl., Ex. Y) (emphasis added).
38See pp.7-8, supra.
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GMCRs growth figures were too good to be true and one commentator noticed certain line items
where GMCRs numbers just did not add up:
[C]hanges in income producing assets dont jibe with changes in revenues. A 69.4%jump in June 2010 inventories on a -4% drop in sales catches our eye. The build-up inPPE versus sales during review periods also brought a groan. Sure, GMCR has been inacquisition mode lately, but, the added capacity and a build-up of inventory (againstdeclining sales) tells us theyre not getting a decent return from these assets.39
As explained above, this same thesis that CapEx figures were highly questionable in light of the
corresponding level of sales was to be repeated again and again. See, e.g., Turner Decl., Exs. I, S and T
(Einhorn Report, Eaviss expose in THE NEW YORK TIMES, and Strubels discussion of GMCRs very
poor return on investment compared to the acquired roasters). Again, although GMCR asks the Court to
give little weight to commentators and journalists, see GMCR MTD at 36 n.17, the unanimity of their
conclusions over time weighs against any innocent explanations defendants now seek to provide for
GMCRs false financial reporting.
IV. ARGUMENTA. The SAC Adequately Alleges a Violation of 10(b)
1. Applicable Standards on a Motion to Dismiss a 10(b) ClaimMotions to dismiss are generally viewed with disfavor. See Teachers Ret. Sys. of La. v.
A.C.L.N., Ltd., No. 01-11814, 2003 WL 21058090, at *10 (S.D.N.Y. May 15, 2003). When considering
a motion to dismiss, a court must accept all well-pleaded, non-conclusory allegations in the complaint
as true and drawing all reasonable inferences in plaintiffs favor. New Orleans Emps. Ret. Sys. v.
Celestica, Inc., 455 Fed. Appx. 10, 12 (2d Cir. 2011). A complaint need only allege enough factual
matter (taken as true) to suggest that a violation occurred, and a well-pleaded complaint may proceed
even if it strikes a savvy judge that actual proof of those facts is improbable . . . Bell Atl. Corp. v.
Twombly, 550 U.S. 544, 556 (2007) (citation omitted). The pleading need only contain [f]actual
39 J. Merriam Bitter Beans at Green Mountain Coffee, SEEKINGALPHA.COM (Sept. 30, 2010) (TurnerDecl., Ex. Z).
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allegations . . . [sufficient] to raise a right to relief above the speculative level. Id. When there are
well-pleaded factual allegations, a court should assume their veracity and then determine whether they
plausibly give rise to an entitlement to relief. Ashcroft v. Iqbal, 129 S. Ct. 1937, 1940-41 (2009).40
Section 10(b) of the Securities Exchange Act of 1934 provides that it is unlawful to employ any
manipulative or deceptive device in violation of therules and regulations of the SEC in connection
with the purchase or sale of any security. 15 U.S.C. 78j(b). The elements of a claim under 10(b) and
Rule 10b-5 are: (1) a material misrepresentation or omission; (2) scienter; (3) a connection with the
purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. See Dura Pharms.,
Inc. v. Broudo, 544 U.S. 336, 341-42 (2005).
With respect to pleading scienter, the Private Securities Litigation Reform Act of 1995
(PSLRA) raised the bar of notice pleading and requires that, when considered together, all of the facts
alleged must give rise to a cogent and compelling inference that defendants acted recklessly. See
Tellabs, Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308, 314, 319 n.3 and 322-24 (2007); ECA v. J.P.
Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009); 15 U.S.C. 78u-4(b)(2). The required state of
mind, however, can be proven and pled through circumstantial evidence. It will be rare that a wrongdoer
will admit to the required state of mind. The PSLRA calls for a strong inference, not an outright
confession or an airtight case at the pleading stage. In re Network Assocs., Inc. Sec. Litig., No. C 99-
40 As the Court previously noted, in evaluating the sufficiency of the SAC, in addition to materials cited inthe SAC itself, e.g., the Einhorn Report (Turner Decl., Ex. S), a court may consider matters of which a courtmay take judicial notice. Order at *2. Such items include: documents filed with the SEC (ATSI Commcns.,Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2001) (Turner Decl., Exs. K, L, M, N, R, V, W and X);stock prices (Ganino v. Citizens Utils. Co., 228 F.3d 154, 166, n.8 (2dCir. 2000) (Turner Decl., Ex. D),
earnings call transcripts (Gissin v. Endres, 739 F. Supp. 2d 488, 497, n.20 (S.D.N.Y. 2010) (Turner Decl., Ex.C); as well as articles discussing the conduct raised in the complaint. In re Smith Barney Transfer AgentLitig., 765 F. Supp. 2d 391, 397 (S.D.N.Y. 2011) (Turner Decl., Exs. A, B, E-J, Q, T, Y and Z). Plaintiffsalso ask the Court to take judicial notice of a conference proceedings publication and two scholarly articles.(Turner Decl., Exs. O, P, and U). The Court has the authority to consider these items. See In re Bear StearnsCos., Inc. Sec., Deriv. & ERISA Litig., 763 F. Supp. 2d 423, 582 (S.D.N.Y. 2011) (considering, on a motion todismiss, inter alia, journals, industry reports, Congressional testimony and speeches); see also GMCR MTDat 32-36 & nn.15-17 (citing articles, websites, and a letter sent to Greenlight Capitals investors to attack thecredibility of the Einhorn Report).
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1729, 2000 WL 33376577, at *8 (N.D. Cal. Sept. 5, 2000) (citing In re Peoplesoft, Inc. Sec. Litig., No. C
99-00472, 2000 WL 1737936, at *3 (N.D. Cal. May 25, 2000)).
All other elements of a 10(b) claim are still governed by traditional pleading standards under
Fed. R. Civ. P. 8(a) and 9(b). See In re PXRE Group, Ltd. Sec. Litig., 600 F. Supp. 2d 510, 528-29
(S.D.N.Y. 2009).41 Rule 9(b) requires plaintiffs alleging fraud to (1) specify the statements that the
plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were
made, and (4) explain why the statements were fraudulent. Rombach v. Chang, 355 F.3d 164, 170 (2d
Cir. 2004).
GMCRs arguments are once again limited: the Company challenges the SAC only on the basis
of falsity and scienter conceding materiality, nexus, loss causation and damages.42 Acknowledging the
Courts earlier ruling against them, defendants Blanford and Rathke mainly contest scienter. See Mgt.
MTD at 6-20. Because the SAC adds the necessary factual details that the Court previously found
lacking, with respect to both motive and recklessness, defendants targeted attacks fail.
2. The SAC Adequately Alleges Numerous False StatementsDefendants made three categories of materially false and/or misleading statements during the
Class Period: (1) an earnings release, conference call and Form 10-Q filing, containing, inter alia,
misstated financial information for both a 13-week and 39-week period that was eventually restated; (2)
the CEOs and CFOs false Sarbanes-Oxley Act (SOX) certifications of the Form 10-Qs accuracy and
the adequacy of GMCRs internal controls over financial disclosure; and (3) sales figures that were
inflated by improper sales to MBlock.
41 The PSLRA did not alter the time-honored tenets, under Fed. R. Civ. P. 12(b)(6), that motions to dismissare disfavored (see In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613, 621 (S.D.N.Y. 2003)) andthat the Court must accept all factual allegations in the complaint as true, drawing all reasonable inferences inthe plaintiffs favor. See Tellabs, 551 U.S. at 322.
42 If any other element of plaintiffs claim is suddenly challenged on reply, plaintiffs should be given anopportunity to respond. See Ruggerio v. Warner-Lambert Co., 424 F.3d 249, 252 & n.4 (2d Cir. 2005) (soholding).
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With respect to the first category, because GMCRs past financial results were restated, as a
matter of law and under GAAP, they were materially false when initially made. See Order at *11-*12.
Defendants claim that there is no connection between the restatement and the misconduct alleged. See
GMCR MTD at 15-18. Not so. GMCRs woefully inadequate accounting and inventory systems were
the cause of two inter-company consolidation errors reversed in the restatement. 114. No more is
needed to prevail on this element of the 10(b) claim; with or without the MBlock allegations, falsity is
adequately alleged. See Order at *12.
The same holds true for Blanfords and Rathkes certification of the accuracy of the Form 10-Qs
financial reporting.43 As for Blanfords and Rathkes SOX certifications concerning GMCRs internal
controls, rather than their being effective, as each attested on August 5, 2010, GMCR soon thereafter
admitted that there was (at least) one material weakness such that its internal controls were not effective.
114. The Court already held that the systemic flaws revealed by this admission were material
misstatements. Order at *14.
Moreover, from 2003 to 2008, GMCRs Forms 10-K stated that defendant Rathke, GMCRs
CFO, was a certified public accountant. Defendant Rathke personally attested to the accuracy of th
Recommended