## Facts

- Ikanos Communications, Inc. designed and sold semiconductor chips used for broadband over copper lines.
- In 2005, Ikanos sold “Version Four” VDSL chips primarily to Sumitomo Electric and NEC, its two largest customers, accounting for about 72% of 2005 revenue.
- Before Ikanos’s March 2006 secondary offering, Ikanos allegedly learned of serious reliability defects in Version Four chips, including failures associated with a manufacturing/assembly change.
- In the weeks preceding the offering, the number and seriousness of chip failures and customer complaints allegedly increased, threatening Ikanos’s relationship with its two principal customers.
- On March 15, 2006, Ikanos completed the secondary offering; Panther Partners purchased shares in the offering.
- The offering documents included general, forward-looking risk disclosures about possible product defects and customer dissatisfaction, but did not describe the alleged then-existing Version Four defect problem or its scope.
- About three months later, Ikanos agreed at its own expense to replace all Version Four chips previously sold to Sumitomo and NEC.
- After the replacement decision, Ikanos reported an approximately $2.2 million net loss and its stock price fell more than 25%.
- Panther sued under §§ 11, 12(a)(2), and 15 of the Securities Act of 1933, alleging that the omission of the known defect problem violated Item 303 of Regulation S-K and made the offering documents materially misleading.

## Issues

1. Whether the proposed amended complaint plausibly alleged that, at the time of the secondary offering, Ikanos knew of a “known trend or uncertainty” it reasonably expected to have a material unfavorable impact on revenues or income requiring disclosure under Item 303 of Regulation S-K.
2. Whether the alleged Item 303 omission plausibly stated claims under §§ 11 and 12(a)(2), such that amendment was not futile and leave to amend should have been granted.

## Decision

- The Second Circuit vacated the district court’s order denying leave to amend and remanded with instructions to permit the amended complaint to be filed.
- The court held the proposed amended complaint plausibly alleged a known, escalating chip defect problem affecting the company’s main revenue sources.
- The court further held that the alleged failure to disclose this known trend or uncertainty could support liability under §§ 11 and 12(a)(2) because the omission could render the offering documents materially misleading.
- The court rejected the argument that generic risk disclosures about possible defects and customer dissatisfaction necessarily cured the alleged omission where the complaint alleged the risk had already materialized in a significant way.

## Legal Principles

- Item 303 of Regulation S-K requires disclosure of known trends or uncertainties that the issuer reasonably expects will have a material favorable or unfavorable impact on net sales, revenues, or income.
- An omission of information required by Item 303 can support Securities Act liability under §§ 11 and 12(a)(2) when the omission makes statements in the registration statement or prospectus materially misleading.
- At the pleading stage, a plaintiff need only allege facts making it plausible that the issuer reasonably expected a material unfavorable impact; certainty of impact is not required.
- Generic, hypothetical risk warnings may be inadequate if the complaint plausibly alleges the issuer knew the risk had already occurred and was materially affecting the company.

## Conclusion

The Second Circuit held that detailed allegations of known, escalating chip defects affecting a revenue-concentrated customer base plausibly triggered Item 303 disclosure duties and could support §§ 11 and 12(a)(2) claims, so denying leave to amend as futile was error.


Panther Partners Inc. v. Ikanos Commc'ns, Inc., 681 F.3d 114 (2d Cir. 2012)