Case4:08-cv-02150-CW Document37 Filed12/19/08 Page1 of 188 1 COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP 2 SPENCER A. BURKHOLZ (147029) HENRY ROSEN (156963) 3 ANNE L. BOX (224354) LAURIE L. LARGENT (153493) 4 JULIE A. WILBER (246949) 655 West Broadway, Suite 1900 5 San Diego, CA 92101 Telephone: 619/231-1058 6 619/231-7423 (fax) [email protected] 7 [email protected] [email protected] 8 [email protected] [email protected] 9 Lead Counsel for Plaintiffs 10 [Additional counsel appear on signature page.] 11 UNITED STATES DISTRICT COURT 12 NORTHERN DISTRICT OF CALIFORNIA 13 OAKLAND DIVISION 14 In re YAHOO! INC. ) Master File No. 4:08-cv-02150-CW 15 ) ) CLASS ACTION 16 This Document Relates To: ) ) SECOND AMENDED CONSOLIDATED 17 ALL ACTIONS. ) COMPLAINT FOR VIOLATION OF THE ) FEDERAL SECURITIES LAWS 18 19 DEMAND FOR JURY TRIAL 20 21 22 23 24 25 26 27 28 Case4:08-cv-02150-CW Document37 Filed12/19/08 Page3 of 188 1 2 Page 3 On April 18, 2006, Defendants Issued False and Misleading Statements About Yahoo!’s 1Q 06 Financial Results and Promised Investors that Panama 4 Would Be Done by Year End 95 5 The Truth Begins to Emerge 100 6 CONFIDENTIAL SOURCES 112 7 DEFENDANTS’ KNOWLEDGE AND ADDITIONAL INDICIA OF SCIENTER 137 8 Defendants’ Knowledge of the Fraud 137 9 Overture 138 10 Panama 139 11 Systems and Controls 143 12 Click Fraud 144 13 Additional Indicia of Scienter 146 14 The Individual Defendants and Corporate Insiders Personally Profited from the Fraudulent Scheme 146 15 Executive Compensation 151 16 GAAP Violations 155 17 YAHOO!’S FALSE, MISLEADING AND OMITTED FINANCIAL 18 STATEMENTS AND DISCLOSURES 155 19 Yahoo! Recorded Improper and Unearned Revenue in Violation of SEC SAB Topic 13: Revenue Recognition 156 20 Quantifications of Improper Revenue Recorded by Yahoo! Due to Click Fraud 21 and Distribution Fraud During the Class Period 157 22 Yahoo!’s Inflated Revenue and EPS Were Material in Both Quantitative and Qualitative Respects 160 23 Yahoo!’s Failure to Accrue Liabilities for Obligations Arising from Click Fraud 161 24 Yahoo! Failed to Make Required Disclosures About the Impact of 25 Click Fraud on Its Results 162 26 Defendants Certified False and Misleading Financial Results 166 27 PROXIMATE LOSS CAUSATION/ECONOMIC LOSS 168 28 2ND AMD CONSOIDATED CPT FOR VIOLATION OF THE FED SEC. LAWS - 4:08-cv-02150-CW - ii - Case4:08-cv-02150-CW Document37 Filed12/19/08 Page4 of 188 1 2 Page 3 APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE 172 4 NO SAFE HARBOR EXISTS FOR DEFENDANTS’ STATEMENTS 173 5 LEAD PLAINTIFFS’ CLASS ACTION ALLEGATIONS 173 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 2ND AMD CONSOIDATED CPT FOR VIOLATION OF THE FED SEC. LAWS - 4:08-cv-02150-CW - iii - Case4:08-cv-02150-CW Document37 Filed12/19/08 Page5 of 188 1 INTRODUCTION 2 1. This is a securities class action brought on behalf of all persons who purchased the 3 common stock of Yahoo! Inc. (“Yahoo!” or the “Company”) between April 8, 2004 and July 18, 4 2006 (the “Class Period”) and who suffered billions of dollars of losses due to the wrongdoing 5 alleged herein. The defendants are Yahoo! and Yahoo!’s top four officers, Terry S. Semel 6 (“Semel”), Susan L. Decker (“Decker”), Daniel L. Rosensweig (“Rosensweig”) and Farzad Nazem 7 (“Nazem”). This suit alleges violations of the Securities Exchange Act of 1934 (the “1934 Act”) and 8 Rule 10b-5 of the Securities and Exchange Commission (“SEC”), based on false statements and 9 material omissions concerning Yahoo!’s search marketing business, as well as one of the largest 10 insider trading schemes in history. Throughout the Class Period, defendants knowingly deceived 11 investors regarding the quality of Yahoo!’s paid search products, development of the Company’s 12 new advertising platform and ability to compete in the fast growing internet pay-per-click 13 advertising business. Defendants knowingly deceived investors regarding the performance of 14 Yahoo!’s paid search products and the financial health of the Company by inflating Yahoo!’s 15 financial statements during the Class Period based on improperly recognized advertising revenue 16 within the Company’s search marketing business. 17 2. Yahoo! lagged behind Google Inc. (“Google”) in not only its search engine 18 technology, but also in steadily losing market share to Google in the increasingly profitable search 19 market industry. Defendants were desperate to convince investors that Yahoo!’s business model was 20 succeeding and, most importantly, that its own paid search technology would outpace Google in the 21 emerging pay-per-click advertising business. 22 3. In 2002, Yahoo! bought the Inktomi search engine and, in 2003, purchased Overture 23 Services, Inc. (“Overture”), a search-driven advertising company. In order to stay competitive with 24 Google, Yahoo! had to integrate the Inktomi search engine technology as well as Overture’s search 25 advertising service. By early 2004, Yahoo! had integrated the Inktomi technology well enough to 26 terminate its agreement to use Google’s search technology. At the time, defendants were faced with 27 the more difficult task of integrating the outdated Overture technology. In 2004, during the Class 28 Period, defendants made false and misleading statements to the market that the integration of 2ND AMD CONSOL CPT FOR VIOLATION OF THE FED SEC. LAWS - 4:08-cv-02150-CW - 1 - Case4:08-cv-02150-CW Document37 Filed12/19/08 Page6 of 188 1 Overture’s search marketing technology and operations was “seamless.” In fact, from the time it 2 acquired Overture, defendants failed to disclose that the Overture integration was a disaster and that 3 its search engine and paid search products ( i.e., Sponsored Search, Content Match and Domain 4 Match) sold to Yahoo!’s advertising customers were far inferior to Google’s. Defendants concealed 5 that Yahoo! automatically enrolled its advertising customers in the Content Match and Domain 6 Match paid search products, which resulted in enormous amounts of useless advertising clicks and 7 low quality traffic merely to increase bogus revenues for Yahoo! and its third-party marketing 8 affiliates. 9 4. Upon the acquisition of Overture in 2003 and the initial release of Content Match, 10 Yahoo!’s search marketing business was overwhelmed, and its search technology overloaded, from 11 the massive increase in internet traffic brought by Yahoo! and the fact that Overture’s original 12 technology had not been built to work on a global scale. This resulted in Yahoo!’s Content Match 13 product, which was prematurely rushed to market, producing undesirable results. In addition, a 14 “culture clash” between Yahoo! and Overture employees stymied the integration of Overture. 15 Overture engineers in the Pasadena office left Yahoo! after the acquisition because Company 16 executives refused to provide the necessary resources to upgrade Overture’s technology platform, or 17 were terminated because of Yahoo! and Overture executives’ turf wars. Further, Overture sales 18 personnel competed for business with Yahoo! sales personnel. 19 5. Throughout 2004, as Google’s market share of paid search revenue was increasing 20 and Yahoo!’s was declining, defendants told investors the Overture integration was technically 21 smooth, proceeding as planned and successful – which it was not. The Overture system needed a 22 major technological overhaul: the original technology was hastily created during the internet boom 23 and was not designed to work on a global scale. Signing up paid advertising customers on 24 Overture’s search platform was painfully slow compared to Google’s automated system because 25 placing advertisements through Overture required manual review by Overture employees, whereas 26 new customers could sign up online with Google. Meanwhile, Yahoo! executives and engineers 27 could not decide whether to merge Overture with Yahoo!’s operations or let it remain quasi- 28 2ND AMD CONSOL CPT FOR VIOLATION OF THE FED SEC. LAWS - 4:08-cv-02150-CW - 2 - Case4:08-cv-02150-CW Document37 Filed12/19/08 Page7 of 188 1 independent. During 2004, Yahoo! faced the formidable task of completely overhauling the 2 Overture technology. 3 6. At this point in time, Overture was experiencing its greatest competition to date from 4 Google because Google’s new paid search offering – AdWords – allowed Google to siphon off 5 Overture’s existing and potential new advertising customers and reap increasing paid search 6 advertising revenues. Google’s AdWords product lured advertising customers to purchase keywords 7 through its fully automated system because Google’s system was designed to take into account how 8 much traffic each linked advertisement generated. Overture’s more expensive system allowed less 9 relevant ads to be placed at the top of Sponsored Search results simply because an advertiser bid 10 more for the keyword. This technological superiority drove significant paid search advertising 11 business to Google. Additionally, Google set their minimum bid per keyword lower than Overture, 12 at $.05 – a welcome invitation for advertisers. 13 7. During 2004, despite these devastating problems with the Overture integration and 14 the inadequacies of Yahoo!’s paid search advertising platform, defendant Semel assured investors 15 that the integration was “seamless.” Furthermore, to convince investors that Yahoo!’s paid search 16 products were competitive with Google, defendants assured investors that its Content Match product 17 was “driving overall revenue per search up.” In truth, Yahoo!’s Content Match product produced 18 undesirable, irrelevant results and angered customers. Defendants’ statements that Content Match 19 contributed to a large increase in the volume of clicks, and thus revenue, were false and misleading 20 because Yahoo! should not have been recognizing revenue from a portion of the clicks.