The complaint, filed in U.S. District Court in Seattle in mid-December, alleges that the management and directors of Isilon made untrue statements and omitted facts in its communications to shareholders as Isilon stock fell more than 80% after December 2006, when it went public in a $108 million offering.
The lawsuit names VCs Barry Fidelman, a partner at Atlas Venture, Matthew McIlwain, a managing director at Madrona, and Greg McAdoo, a partner at Sequoia, as defendants. It alleges that they “engaged in acts, practices and a course of business that operated as a fraud or deceit.”
Each VC cited as a defendant declined to comment.
The next step for the plaintiffs will be to compare the restated financials to the financials presented in the IPO prospectus, says attorney Matthew Handley on behalf of law firm
Handley’s firm has been pursuing its own line of inquiry about Isilon’s financials. Handley says that former employees said that they were aware of revenue recognition issues at the time they were employed at Isilon. “This [announcement] gives us a little more to go back to these witnesses with.”
Handley expects his firm to file an updated complaint on March 28 that will contain more information related to the case.
To be sure, class action lawsuits are not unusual when publicly traded companies experience a sharp decline in share price. However, this suit is noteworthy since Isilon was once a high-flying IPO. The stock of the Seattle-based company, which debuted at $13 a share, rose to more than $27 a share within a few weeks of its IPO. Last week, the stock was trading at just under $6 per share.
“There are law firms that have computer programs in which a decline in stock price triggers the word processor,” says Hank Barry, a lawyer with
Isilon estimates that it will adjust $7 million of the $67.4 million of previously reported revenue across three quarters. Isilon found three reasons for the misstated revenue. The company counted some of its sales to resellers as revenue although those resellers had not yet identified customers; it swapped its storage product for another unmentioned company’s software and counted the products it delivered as sales; and it counted some sales before customers ever actually signed over any money.
It’s important to note that it does not appear that any of the three venture firms, which are the largest shareholders in Isilon, has sold any shares in the company. The most recent ownership statements on file show that Atlas holds 14.78 million shares, Sequoia with 11.65 million and Madrona with 10 million—the same positions they held following the company’s December 2006 IPO, according to Thomson Financial (publisher of PE Week). It appears that Madrona distributed a big chunk of its shares to its limited partners in June, but the firm declined to comment.
Had they sold at Isilon’s 52-week high of $25.50, the three venture funds could have raised a combined $929 million. That would have been a hefty return on investment, considering the company raised about $71 million in total venture funding from 2001 through 2006 before it went public.
The only venture firm that appears to have attempted to sell Isilon shares is
Betting on a rebound
But Isilon may not be able to rebound from the beating it has taken in the public market. Wall Street analysts have suggested that the company may be shopping for a strategic acquirer. The company could be worth as much as $350 million in a sale, according to Clay Sumner, an analyst at
The company’s shares might even be a good value investment. “We believe there is value in the company’s technology leadership, and we think the company is a potential acquisition candidate, which is not likely factored into the stock price,” Aaron Schwartz, an analyst at
One hedge fund certainly seems to agree with Schwartz’s assessment.
Artis bought more than 4 million shares, or 6.6% of Isilon’s stock outstanding, worth $20.6 million between Sept. 30 and Dec. 31 last year, documents show.