Case 4:02-cv-00853 Document 61-1 Filed 07/28/2003 Page 1 of 73 1 MILBERG WEISS BERSHAD HYNES & LERACH LLP 2 RANDI D. BANDMAN (145212) AZRA Z. MEHDI (220406) 3 SYLVIA WAHBA (197612) 100 Pine Street, Suite 2600 4 San Francisco, CA 94111 Telephone: 415/288-4545 5 415/288-4534 (fax) - and - 6 WILLIAM S. LERACH (68581) 401 B Street, Suite 1700 7 San Diego, CA 92101 Telephone: 619/231-1058 8 619/231-7423 (fax) 9 KAPLAN FOX & KILSHEIMER LLP LAURENCE D. KING (206423) 10 LINDA M. FONG 555 Montgomery Street, Suite 1501 11 San Francisco, CA 94111 Telephone: 415/772-4700 12 415/772-4707 (fax) - and - 13 FREDERIC S. FOX 805 Third Avenue, 22nd Floor 14 New York, NY 10022 Telephone: 212/687-1980 15 212/687-7714 (fax) 16 Co-Lead Counsel for Plaintiffs 17 UNITED STATES DISTRICT COURT 18 NORTHERN DISTRICT OF CALIFORNIA 19 OAKLAND DIVISION 20 21 In re NVIDIA CORPORATION SECURITIES ) Master File No. C-02-0853-CW LITIGATION ) 22 ) CLASS ACTION ) 23 This Document Relates To: ) FIRST AMENDED CONSOLIDATED ) CLASS ACTION COMPLAINT FOR 24 ALL ACTIONS. ) VIOLATION OF THE FEDERAL ) SECURITIES LAWS 25 DEMAND FOR JURY TRIAL 26 27 28 Case 4:02-cv-00853 Document 61-1 Filed 07/28/2003 Page 2 of 73 1 SUMMARY AND OVERVIEW 2 1. This is a securities fraud class action against Nvidia Corporation ("Nvidia" or the 3 "Company") and its senior insiders, on behalf of all persons who purchased the common stock of Nvidia 4 between February 15, 2000 and July 30, 2002, inclusive (the "Class Period").1 5 2. Nvidia operates in a single industry segment: the design, development and marketing of 6 three-dimensional ("3D") graphics, media communication processors and related software for personal 7 computers ("PCs"), workstations and digital entertainment platforms. 8 3. Since the Company went public in 1999, it has enjoyed phenomenal success and was 9 consistently in line with analysts' expectations of revenues and earnings quarter after quarter. Nvidia's 10 former accounting manager, Amy Andren, attributed the Company's ability to meet analysts' expectations 11 to defendants' improper use of various "cookie jar" reserves (bad debt, sales returns, bonus accruals and 12 accounts payable accruals) that were inflated during profitable periods and later reached into and used by 13 defendants when times turned bad. See Andren v. Nvidia Corporation, et al., Case No. CV807900, 14 Complaint (Santa Clara County Super. Ct. May 16, 2002), attached hereto and incorporated herein as 15 Exhibit ("Ex.") 1. 16 4. Defendants2 engaged in the illegal and improper accounting scheme detailed by Andren in 17 order to manipulate Nvidia's earnings and inflate Nvidia's stock price and at the same time sell over $168.6 18 million of Nvidia's stock. Defendants cooked the books and misled the market regarding Nvidia's financial 19 results and ability to maintain continued consistent growth. Defendants created the illusion that Nvidia's 20 profits were rapidly and continuously increasing in line with analysts' expectations when in reality, the 21 Company's profits were erratic and drastically fluctuating. This fluctuation was not what the investors and 22 analysts were expecting based on Nvidia's reported financial results. 23 24 1 The Court's June 11, 2003 Order Granting Defendants' Motion to Dismiss ("Order") dismissed a portion of the claims asserted during this Class Period without leave to amend. Order at 15. In an 25 abundance of caution, and with the intention to maintain all relevant allegations in a single document, plaintiffs include allegations relating to the dismissed claims to preserve plaintiffs' right to appeal the 26 dismissal without leave to amend. The following paragraphs ("¶") contain allegations pertaining to the restatement: 3-12, 43-46, 63-84, 100, 102-111, 116-120, 132-175. 27 2 Defendants are Nvidia and its senior officers, Jen-Hsun Huang, Christine Hoberg, Jeffrey Fisher 28 and Chris Malachowsky, described in ¶¶35-42, infra. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS - C-02-0853-CW - 1 - Case 4:02-cv-00853 Document 61-1 Filed 07/28/2003 Page 3 of 73 1 5. As a result of defendants' accounting manipulations described in this Complaint, defendants 2 caused the annual financial statements (Form 10-Ks) as well as the quarterly financial statements (Form 3 10-Qs) for fiscal year 2000 ("FY00"),3 fiscal 2001 ("FY01"), fiscal 2002 ("FY02") as well as the first 4 quarter in fiscal year 2003 ("1Q03") to be false and misleading. Rather investors and analysts alike relied 5 upon defendants' false statements about the Company's consistent growth in evaluating whether or not to 6 purchase Nvidia stock. 7 6. Defendants manipulated Nvidia's reported financial results during the Class Period by 8 falsifying the Company's books and records. Andren, former Nvidia accounting manager, explained that 9 defendants' scheme included improper accounting practices such as: 10 (a) improperly using various "cookie jar" reserves (bad debt, sales returns, bonus 11 accruals and accounts payable accruals) inflated during profitable periods that defendants later reached into 12 and used when times turned bad; 13 (b) improperly accounting for its inventory; 14 (c) improperly recording revenues each quarter for product shipped to distributors that 15 had not been sold to end users; 16 (d) managing profit margins by manipulating shipments at the end of quarters; and 17 (e) using "back-in" accounting, i.e., instead of compiling revenue and expenses first and 18 using these actual figures to compute gross margins, Nvidia used a targeted gross margin number and then 19 worked backward to achieve those numbers by creating the revenue and expense calculations necessary 20 to achieve the forecasted margins. 21 7. Former Securities and Exchange Commission ("SEC") chairman Arthur Levitt described 22 "cookie jar reserves" as an illusion used to "stash accruals ... during the good times and reach into them 23 when needed in the bad times." Ex. 2. Levitt then described various methods of "Accounting Hocus- 24 Pocus" or "illusions" and defined "Cookie Jar Reserves" as one such illusion: 25 A third illusion played by some companies is using unrealistic assumptions to estimate liabilities for such items as sales returns, loan losses or warranty costs. In doing 26 27 3 Effective January 21, 1998, Nvidia changed its fiscal year-end financial reporting period to a 52- or 53-week year ending on the last Sunday in January. For instance, FY02 ended on January 28, 2002. 28 January 29, 2002 marked the beginning of 1Q03. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS - C-02-0853-CW - 2 - Case 4:02-cv-00853 Document 61-1 Filed 07/28/2003 Page 4 of 73 1 so, they stash accruals in cookie jars during the good times and reach into them when needed in the bad times. 2 Id. Levitt also expressed increasing concern that "the motivation to meet Wall Street earnings expectations 3 may be overriding common sense business practices," making "corporate managers" and others 4 "participants in a game of nods and winks." Id. The SEC's complaint against HealthSouth Corporation 5 and its Chief Executive Officer ("CEO") demonstrates the SEC's position that the manipulating or "fixing" 6 numbers in financial reports to match Wall Street expectations violates federal securities laws. See 7 Securities and Exchange Commission v. HealthSouth Corporation, et al., Civil Action No. 8 CV-03-J-0615-S, Amended Complaint for Injunctive and Other Relief (N.D. Ala. Apr. 3, 2003). Ex. 3. 9 In fact, the SEC brought similar charges against Nvidia. See ¶26, infra. 10 8. Creating and utilizing unnecessary reserves to manage earnings also violates Generally 11 Accepted Accounting Principles ("GAAP") and is expressly forbidden by the SEC. Recently, the SEC 12 found that Microsoft Corporation's ("Microsoft") maintenance of similar undisclosed reserves, accruals, 13 allowances and liability accounts was not in conformity with GAAP and lacked proper documentation and 14 substantiation, as required by the federal securities laws. See In the Matter of Microsoft Corporation, 15 SEC Accounting and Auditing Enforcement Release No. 1563 (June 3, 2002). Ex. 4. In the Microsoft 16 case, the SEC found that senior Microsoft financial personnel relied on their subjective judgments in making 17 adjustments and additions to reserves, without any significant factual support or analysis, such that reserves 18 at the corporate level significantly exceeded the amounts that would have been supported by the 19 information from the operational level. Id. 20 9. As described in ¶¶64-84, defendants here did exactly what the SEC said was wrong in the 21 Microsoft case by arbitrarily causing journal entries to be made to Nvidia's general ledger, without factual 22 support or analysis. These manipulations resulted in reserves being overstated and, hence, public filings 23 based on such financial figures were false. 24 10. Defendants' accounting manipulations of Nvidia's financial reports was so egregious that 25 former accounting manager Andren filed a suit against Nvidia and certain of its senior executives, including 26 defendant Hoberg, alleging that defendants were aware of and maintained "illegal and improper" accounting 27 practices that were in "violation of Securities and Exchange Commission Rule 10-B-5." Ex. 1 at 5, 7, 9. 28 FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS - C-02-0853-CW - 3 - Case 4:02-cv-00853 Document 61-1 Filed 07/28/2003 Page 5 of 73 1 Andren's complaint alleges, among other things, that Nvidia, Hoberg and Controller Richard Cording were 2 aware of and maintained "illegal and improper" accounting practices.