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In Re Portal Software, Inc. Securities Litigation 03-CV-5138

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In Re Portal Software, Inc. Securities Litigation 03-CV-5138 IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA IN RE PORTAL SOFTWARE, INC ) NO . C-03-5138 VRW SECURITIES LITIGATION ) DECLARATION OF DAVID J. ROSS 1. QUALIFICATIONS 1 . I, David J . Ross, am Senior Vice President of Lexecon, a consulting firm that specializes in the application of economics to a variety of legal and regulatory issues . Among the staff and professional affiliates of Lexecon are several prominent academics and a group of full time economists, accountants, computer programmers, and research assistants . At Lexecon, I have specialized in the areas of financial economics and the economics of corporate law. I have worked on hundreds of matters involving a wide variety of financial issues . 2 . I have published a number of articles including articles which , among other things, discuss the economic analysis of securities fraud claims . My curriculum vitae, which contains a list of my publications and other professional activities, is attached as Exhibit A. 3 . I received a B .A. in economics from the University of Chicago in 1983 . In 1985, I received an M.B.A. from the Graduate School of Business at the University of Chicago, having completed the specialization requirements in economics , finance and industrial relations. 4 . I have testified as an expert witness regarding a wide variety o f financial issues in proceedings throughout the United States, including testimony as a n expert witness in cases involving claims of securities fraud . The cases in which I hav e previously testified as an expert are listed on Exhibit A . 1. INTRODUCTION AND SUMMARY OF CONCLUSION S 5 . On May 20, 2003, Portal Software, Inc. ("Portal") issued a press release announcing its financial results for the first quarter of its 2004 fiscal year (i .e., the three months ended May 2, 2003 ). Consolidated Fou rth Amended Complaint ("FCAC") , ¶J 89. On or about June 16, 2003, Portal filed its quarterly report on Form 10-Q with the Securities and Exchange Commission ("SEC") for the three months ended May 2, 2003 (the "Q 1 2004 10-Q") . Id., ¶ 93 . On or about August 19, 2003, Portal announced its second quarter fiscal year 2004 financial results (i .e., results for the three months ended August 1, 2003) . Id., ¶ 101 . On or about September 12, 2003, Portal filed its quarterl y report on Form 10-Q with the SEC for the three months ended August 1, 2003 (the "Q 2 2004 10-Q") . Id., ¶ 104 . 6. On September 12, 2003, Portal Software, Inc . ("Portal") announced that it had completed a secondary offe ring of 4,528,302 shares of its common stock at $13 .25 per share (the "Secondary Offering"), thereby generating $60 million in proceeds. FCAC, ¶j¶ 9 & 33 .' The Secondary Offering shares were registered pursuant to an existing shelf registration statement and a related registration statement an d prospectus supplement that was filed with the SEC on or about September 12, 2003 (th e 1 . All prices and share volumes discussed herein for dates prior to September 29, 2003 have been adjusted to reflect Portal's 1-for-5 reverse stock split effective September 29, 2003 . -2- "Registration Statement") . Id., ¶ 34. The Registration Statement incorporated the Q1 2004 10-Q and the Q2 2004 10-Q by reference . Id., ¶¶ 36 & 40 . 7. Plaintiffs allege that "as a result of Defendants' false statements in the Registration Statement for the September 12, 2003 public offering, [Class members] purchased Portal common stock at artificially inflated prices ." FCAC, ¶ 31 . In particular, plaintiffs allege that the Registration Statement for the Secondary Offerin g was materially misleading because it incorporated the Company's financial statements for the first and second quarters of fiscal 2004, which plaintiffs allege reported revenues that were negligently and materially overstated . FCAC, ¶¶ 44(e)-44(h) & 45. 8 . On November 13, 2003, after the close of regular market trading , Portal announced that it expected net losses of $0.36 - $0 .40 per share for the third quarter of fiscal 2004 versus prior earnings guidance of net profits of $0 .04 per share, due to contract delays and revenue recognition deferrals . FCAC, ¶ 111 . The price of Portal common shares fell from by more than 42% in after-hours trading following the announcement , and opened at $8 .77 on November 14, 2003 (45 percent below the prior day's closing price) . Id., ¶ 113. Plaintiffs allege that this price decline occurred "when the truth began to be publicly revealed about the Company's adverse business and financial condition that had been negligently overstated by Defendants, and [Class members] were damaged as a proximate result." Id., ¶ 31 . Also, see Id ., ¶ 114 . 9 . I have been asked by counsel for the Defendants to analyze the economic evidence as it relates to Plaintiffs' claims . In performing this work, I have received assistance from members of Lexecon's professional staff . As a result of this analysis, I have reached the following principal conclusions : -3- • The economic evidence does not support plaintiffs' claim that the alleged negligent overstatement of revenues in the first two quarters of Portal's fiscal year 2004 artificially inflated the price of Portal stock . • Plaintiffs' losses were caused by Portal's pre-announcement of lower than expected third quarter fiscal year 2004 results, not the alleged negligent overstatement of revenues . I elaborate upon and provide the bases for my principal conclusions in the remainder of this declaration . II. THE ECONOMIC EVIDENCE DOES NOT SUPPORT . PLAINTIFFS' CLAIM THAT THE ALLEGED NEGLIGENT OVERSTATEMENT OF REVENUES IN THE FIRST TWO QUARTERS OF PORTAL'S FISCAL YEAR 2004 ARTIFICIALLY INFLATED THE PRICE OF PORTAL'S STOCK . 10 . As described above, Plaintiffs allege that the alleged negligent overstatement of revenues by defendants during the first and second quarters of Portal's fiscal year 2004 were material and artificially inflated the price of Portal common stock . See ¶ 7 supra. This claim implies that the price of Portal common stock should have increased significantly on the dates the alleged material misrepresentations occurred . To see why, note that in an efficient market, the market price of an actively traded stock reflects all publicly available information about the firm and its future prospects and represents the financial community's best estimate of the present value of those pros- pects.2 As new information becomes available that changes investors' assessment of the firm's prospects, traders buy and sell the stock until its price reaches a level that reflects the new consensus view of the firm's prospects .3 This understanding of how prices of Plaintiffs allege that Portal stock was actively traded on an efficient market (NASDAQ) and that "the market for Po rtal's securities promptly digested current information regarding Po rtal form all publicly available sources and reflected such information in Po rtal' s stock price ." FCAC, ¶¶ 174-175. In an efficient market , stock prices react quickly to new information . Existing empirical studies of ce rtain types of routine disclosures such as earnings -4- actively traded stocks are determined (which is the basis for the "fraud on the market " theory upon which plaintiffs rely) leads to an objective method for determining th e materiality of information to investors . As a matter of economics, information is materia l if it alters investors' expectations concerning a company's future prospects and, thereby , changes the company's stock price ; information that does not change stock prices is no t material. 11 . Therefore, in order to determine whether the economic evidenc e supports plaintiffs' allegations that the alleged misstatements artificially inflated Portal' s stock price, I analyzed whether Portal's stock price increased significantly on the day after the alleged misstatements were made.4 This type of analysis is known as an "even t announcements have found that most of the price adjustment to news takes place within minutes of the announcement . See, for example, J. Patel] and M . Wolfson, The Intraday Speed of Adjustment of Stock Prices to Earnings and Dividend Announcements , 13 J Financial Economics 223-52 (1984) ; J. Aharony & I . Swary, "Quarterly Dividend and Earnings Announcements and Stockholders' Returns : An Empirical Analysis," 35 J. Fin. Econ. (1979) 321 ; S.C . Hillmer and P .L. Yu, The Market Speed of Adjustment to New Information , 7 J Financial Economics 321-45 (1979). 4. 1 also analyzed Portal's stock price reaction during the two-day period that includes both the trading day of and the trading day after the questioned statements and obtained qualitatively similar results to those reported in the text . Use of one-day and two-day windows is appropriate because in an efficient market, stock prices react quickly to new information . Many studies by financial economists have focused on a one or two-day "event window" during which to analyze changes in stock prices in response to new information. See,, C. Woodruff & A. Senchack, "Intradaily Price-Volume Adjustments of NYSE Stocks to Unexpected Earnings," 43 :2 Journal of Finance 467 (1988), at 482 ("we chose the closing price of the trading day following the announcement day to be the fully adjusted price") ; B . Cornell & G . Morgan, "Using Finance Theory to Measure Damages in Fraud on the Market Cases," 37 UCLA Law Review 883 (1990), at 906 ("an observation window of a day or two is long enough") ; J. Macey, G . Miller, M. Mitchell & J. Netter, "Lessons from Financial Economics : Materiality, Reliance, and Extending the Reach of Basic v. Levinson," 77 Virginia Law Review 1017 (1991), at 1031 ("When computing a stock return due to an event, financial economists often define the event period as the two- day period consisting of the announcement day and the following day") ; J .C.
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