## Facts

- Software Toolworks, Inc. conducted a July 1990 secondary public offering priced at $18.50 per share, raising more than $71 million, with PaineWebber Inc. and Montgomery Securities as underwriters and Deloitte & Touche as auditor.
- Before the offering, Toolworks experienced weak Nintendo sales early in the quarter ending June 30, 1990, but booked large June consignment sales that enabled it to meet earnings expectations.
- During the registration process, Deloitte communicated with the SEC about Toolworks’s revenue recognition for OEM contracts and sent a July 1, 1990 letter describing an OEM “model” contract as representative of Toolworks’s actual contracts.
- Only four of Toolworks’s actual OEM contracts contained the “model” language described to the SEC.
- After the offering, the stock price fell sharply; on October 11, 1990, Toolworks announced substantial losses, and the company later reversed the June consignment sales, indicating earlier earnings had been overstated.
- Investors sued under §§ 11 and 12(2) of the Securities Act of 1933 and § 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, alleging materially false or misleading offering materials and related statements.

## Issues

1. Whether the underwriters were entitled to summary judgment based on reasonable investigation (and lack of scienter) regarding alleged misstatements about Nintendo sales, OEM revenue recognition, the June 1990 quarter results, and SEC correspondence.
2. Whether Deloitte was entitled to summary judgment on claims that it acted with scienter in connection with audited financial statements, SEC correspondence (including the July 1 letter), and statements about the unaudited June 1990 quarter results.

## Decision

- The Ninth Circuit affirmed in part, reversed in part, and remanded.
- As to the underwriters:
  - Affirmed summary judgment regarding alleged misstatements tied to Nintendo sales practices and OEM revenue recognition generally.
  - Reversed summary judgment regarding alleged misstatements tied to the SEC letters and the June 1990 quarter results, finding genuine disputes of material fact on investigation adequacy and scienter.
- As to Deloitte:
  - Affirmed summary judgment on claims based on Deloitte’s audited financial statements due to insufficient evidence of scienter.
  - Reversed summary judgment on claims tied to the SEC letters (including the July 1 “model contract” letter) and the unaudited June 1990 quarter results, finding triable issues on knowing or reckless misconduct.

## Legal Principles

- Summary judgment is improper in securities cases where the record permits a reasonable inference that a defendant knew, or was reckless in not knowing, that statements central to an offering were false or misleading.
- Underwriters may obtain summary judgment on §§ 11 and 12(2) claims where the evidence shows a reasonable investigation as a matter of law; the same evidence may negate scienter for § 10(b)/Rule 10b-5 as to particular alleged misstatements.
- Auditor scienter for § 10(b)/Rule 10b-5 requires evidence supporting an inference of intent to deceive or reckless disregard for the truth; the absence of such evidence can justify summary judgment on audit-opinion-based claims.
- Misrepresentations to the SEC that bear on revenue recognition and reported earnings may be material to investors and can support liability where evidence suggests the statements were knowingly or recklessly false.

## Conclusion

The court upheld summary judgment for the underwriters and Deloitte on certain categories of alleged misstatements, but allowed claims to proceed where evidence could support findings that the underwriters and Deloitte acted knowingly or recklessly in connection with SEC correspondence and disclosures about unusually strong June-quarter results later reversed.


In re Software Toolworks Inc. Securities Litigation, 50 F.3d 615 (9th Cir. 1995)