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9th Cir. Dismisses Shareholder Lawsuit Against NVIDIA for Faulty Chips

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By Mark Wilson, Esq. on October 03, 2014 11:03 AM

NVIDIA Corporation makes a bunch of computer chips, including graphics processing units (GPUs) for all your sweet gaming machines. In 2006, NVIDIA began experiencing problems with some of its chips. NVIDIA initially wasn't sure what the problem was, and issued software updates to run the fans of its graphics cards faster to cool down the cards. But that didn't work.

Finally, HP concluded that the problem was the chips themselves. NVIDIA determined that the problem lay in the composition of a new kind of solder used on its chips. In 2008, NVIDIA told its manufacturers to go back to the old solder.

Problem Solved, Right?

Of course not. In 2008, NVIDIA, as a publicly traded company, filed several forms with the SEC. Included in these forms were statements acknowledging the solder problem, and that it was unable to estimate the total cost of the problem to the company at the time it filed the documents. Two months after making these statements, NVIDIA filed another disclosure in which it estimated the cost of repair and replacement to be $150-200 million. The stock market didn't like this news one bit, and NVIDIA's share price declined by 31%.

I Cry Fraud!

As a result, the plaintiffs in this case, representing all NVIDIA shareholders, filed a lawsuit claiming that NVIDIA knew about the defects and failed to disclose its knowledge, meaning it made materially misleading statements to the SEC. Yes, we're in Securities Exchange Act § 10(b) territory.

The district court dismissed the plaintiffs' claims because they didn't adequately allege scienter, and the Ninth Circuit affirmed. Scienter in securities lawsuits requires the defendant had to have "a mental state embracing intent to deceive, manipulate, or defraud." But in the Ninth Circuit, recklessness qualifies, too.

Plaintiffs' claims rested partially on an SEC regulation requiring disclosure of anything the company knows might negatively impact sales revenues. It's true that the regulation is there, but the Ninth Circuit said failing to make this disclosure, by itself, isn't evidence that NVIDIA acted with the requisite mental state because the regulation involves future predictions, which can't themselves be material or misleading because they don't exist yet.

Put It All Together

Because plaintiffs are alleging fraud, they're in Twombly country, and the district court found that NVIDIA's discrete actions didn't create scienter. Plaintiffs tried to suggest that adding up all the little actions could amount to scienter -- but the Ninth Circuit didn't like that, either. Not because it can't be done, but because, looking at the allegations as a whole, NVIDIA didn't do anything wrong: "once it determined that its liability would exceed its normal reserves, NVIDIA disclosed the problem to investors. Any inference of scienter requires more than this."

Plaintiffs also couldn't muster a narrative in which NVIDIA intentionally withheld information from shareholders. In fact, for most of the time the problem occurred, NVIDIA wasn't sure what was going on, and plaintiffs didn't present sufficient information to suggest that NVIDIA was hiding the true cause of the problem from investors. A set of disgruntled investors lost money due to a manufacturing problem and then tried to invent a fraud where none apparently existed.

Things like this happen; that's the nature of living on the cutting edge.

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