(CN) - A U.S. Appeals Court has vacated a district court ruling that prevented shareholders from amending a       complaint that accuses Ikanos Communications Inc. of failing to properly disclose known defects in its semiconductor chips during a $120 million stock offering in 2006.
     The three-judge panel for the 2nd Circuit reversed the decision and remanded it back to the district court with instructions to allow Panther Partners Inc. leave to file the amended complaint.
     The panel found the proposed amended complaint "plausibly alleges that the [undisclosed] defect issue, and its potential impact on Ikanos' business, constituted a known trend or uncertainty that Ikanos reasonably expected would have a material unfavorable impact on revenues or income from continuing operations."
     The reversal represents a significant victory for shareholders long mired in a series of procedural battles that date back to 2006 and nearly ended when a district court refused multiple requests to amend the complaint. The court dismissed the first amended complaint for failure to state a claim, stating that, "no plausibly pleaded fact suggests that Ikanos knew or should have known of the scope or magnitude of the defect problem at the time of the secondary offering."
     Lead plaintiff Panther Partners moved for reconsideration, providing a proposed second amended complaint that added allegations that the problem with the defects had become worse in the weeks leading up to the stock offering. It also stated that calls from its two main customers, Sumitomo Electric and NEC, which accounted for 72 percent of Ikanos' revenue, had increased. It wasn't enough for the district court, which reasoned that, "plaintiff's filing of the IPSAC would be futile because its new 'vague' allegations were like the 1AC's allegations."
     The panel disagreed, finding that, "it seems to us possible that Panther could allege additional facts that Ikanos knew the defect rate was above average before filing the registration statement. We urged the court on remand to 'consider all possible amendments' - not just 'proposed amendments' - in reassessing futility."
     According to the ruing written by Circuit Judge Barrington Parker, Ikanos learned of the chips' quality issues in January 2006, three months prior to its stock offering. The March offering resulted in the sale of 5.75 million shares at $20.75 per share. Individual defendants in the suit sold $7.3 million worth of stock. It wasn't until after the stock had been sold that the company learned its chips had an "extremely high" failure rate of 25-30 percent. In July, the company reported a $2.2 million second quarter loss stemming from an agreement to replace all the chips sold to Sumitomo and NEC at Ikanos' expense. The loss caused shares to drop over 25 percent, from $13.85 to $10.24. Expected revenues dipped about $7 million, causing stocks to take another hit, falling from $10.94 to $7.76 per share.
     Panther's second amended complaint says that Ikanos knew the chips were defective and that it most likely would end up having to replace them.
     "It is true that, as alleged, Ikanos did not recall and undertake to replace all the chip sets until June 2006," Parker said. "Nor was the precise 25-30 percent chip failure rate determined until after the secondary offering. But neither of these facts undermines the plausible inference that, at a time when it was receiving an increasing number of calls from these customers and its Board of Directors was discussing the issue, Ikanos was aware of the 'uncertainty' that it might have to accept returns of a substantial volume, if not all, of the chips it had delivered to its major customers. It goes without saying that such 'known uncertainties' could materially impact revenues."