More Bad News for Microsoft: A Surface Lawsuit

Investors have filed a class action lawsuit against Microsoft, saying the company misled investors on the robustness of the sales of Microsoft Surface RT, the struggling Windows tablet. Plaintiffs say Surface is “an unmitigated disaster.”

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Microsoft's Steve Ballmer and its Surface TabletIt’s bad enough that Microsoft Corp.has a warehouse of unsold Surface tablets and is contending with more bad press about the quality and marketability of its mobility strategy. Now Redmond has to contend with a class-action Surface lawsuit that alleges officers misled investors over the robustness of tablet sales.

Filed earlier this week in a San Diego federal court by investor Gail Fialkov, the lawsuit contends Microsoft purposely embellished the sales, trending numbers and customer satisfaction rates of the Surface tablet, specifically, the RT version. The lawsuit states Microsoft’s rosy language caused people to invest in the company believing Surface would lift the stock price higher.

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“What defendants knew, but failed to disclose to investors ... was that Microsoft’s foray into the tablet market was an unmitigated disaster, which left it with a large accumulation of excess, overvalued Surface RT inventory,” the lawsuit states.

In its most recent quarterly earnings report, Microsoft announced a $900 million charge related to the $150 Surface RT price reduction and unsold inventory of tablets and accessories. The write-off caused Microsoft's stock price to fall 11.4 percent, wiping out nearly $34 billion in the company’s valuation.

The lawsuit, which observers say was inevitable, comes as Microsoft fights to stay in the tablet game. Nearly all of the PC manufacturers have abandoned the Windows RT version, saying that there’s no consumer or commercial market for such devices. Microsoft has also cut the price of its Surface Pro running Windows 8 by $100 through the end of August, a move the company says is to entice back-to-school shoppers.

Microsoft is mum on the lawsuit and its allegations. Specifically named as defendants in the case are CEO Steve Ballmer, former CFO Peter Klein, chief accounting officer Frank Brod and former Windows marketing leader Tami Reller.

In Microsoft’s defense, analysts and legal experts say such lawsuits are inevitable whenever a company’s stock suffers a steep and sudden drop. The firm representing the plaintiffs, Robbins Geller Rudman & Dowd, has a history of representing investors in such matters.

While plaintiffs say Microsoft violated generally accepted accounting practices and, potentially, federal law by not disclosing inventory buildups and sluggish sales, experts say Microsoft may have been justified in believing and stating that it could sell the existing inventory when it made bullish statements about Surface back in April.

Microsoft has yet to disclose actual sales figures for Surface RT and Surface Pro. Industry analysts say Microsoft has sold 1.5 million Surface tablets since the product debuted in October 2012. By comparison, Apple sold 14.5 million iPads in the second quarter of 2013 alone. Microsoft has admitted that it's built too many Surface tablets, which is part of the reason for the inventory backlog.

While Microsoft now acknowledges Surface sales are disappointing, it has yet to fully open up sales throughout its massive reseller channel. Surface is only available through direct sales, select retailers and a handful of direct market resellers. Microsoft says it will continue to expand channel sales of Surface, but won’t give a timeline as to when the tablet will be generally available to resellers.

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