GREGORY A. MARKEL (pro hac vice) ([email protected])...

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APPENDIX OF UNPUBLISHED AUTHORITIES; CASE NO. C-04-4908

GREGORY A. MARKEL (pro hac vice) ([email protected]) RONIT SETTON (pro hac vice) ([email protected]) AMANDA KOSOWSKY (SB # 214282) ([email protected]) CADWALADER, WICKERSHAM & TAFT LLP One World Financial Center New York, NY 10281 Telephone: (212) 504-6000 Facsimile: (212) 504-6666 and MORGAN LEWIS & BOCKIUS, LLP MICHAEL J. LAWSON (SB # 66547) ([email protected]) VINCENT P. FINIGAN, JR. (SB # 053517) ([email protected]) One Market Spear Street Tower San Francisco, CA 94105-1126 Telephone: (415) 442-1000 Facsimile: (415) 442-1001 Attorneys for Defendant Banc of America Securities LLC

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION In re UTSTARCOM, INC. SECURITIES LITIGATION

Case No. C-04-4908 –JW(PVT) APPENDIX OF UNPUBLISHED AUTHORITIES IN SUPPORT OF BANC OF AMERICA LLC’S MOTION TO DISMISS Date: September 11, 2006 Time: 9:00 a.m. Dept: 8, 4th Floor Judge: Hon. James Ware Date Comp. Filed: April 13, 2006 Trial Date: None set

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 of 163

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APPENDIX OF UNPUBLISHED AUTHORITIES; CASE NO. C-04-4908

Table of Contents

1. Abbell Credit Corp. v. Bank of America Corp., No. 01 C 2227, 2002 WL 335320 (N.D. Ill. Mar. 1, 2002)

2. In re Exodus Communications, Inc. Securities Litigation, No. C 01-2661 MMC, 160, 163, 2005 WL 1869289 (N.D. Cal. Aug. 5, 2005)

3. In re Netopia, Inc. Sec. Litig., No. C-04-03364 RMW, 2005 WL 3445631 (N.D. Cal. Dec. 15, 2005)

4. In re Oak Technology Securities Litigation, No. 96-20552SW, 1997 WL 448168 (N.D. Cal. Aug. 1, 1997)

5. In re Portal Software, Inc. Sec. Litig., No. C-03-5138 VRW, 2005 WL 1910923 (N.D. Cal. Aug. 10, 2005)

6. In re Silicon Storage Tech., Inc. Sec. Litig., No. C 05-0295-PJH, 2006 WL 648683 (N.D. Cal. Mar. 10, 2006)

7. In re TyCom Ltd. Securities Litigation, No. 03-CV-1352-PB, 02-MDL-1335-PB, 2005 WL 212767 (D. N.H. Sept. 2, 2005)

8. In re Valence Tech. Sec. Litig., No. C 94-1542-SC, 1995 WL 274343 (N.D. Cal. May 8, 1995)

9. In re Valence Tech. Sec. Litig., No. C 95-20459 JW, 1996 WL 37788 (N.D. Cal. Jan. 23, 1996)

10. In re WRT Energy Sec. Litig., Nos. 96 CIV. 3610 and 96 CIV. 3611 (JFK), 1999 WL 178749 (S.D.N.Y. Mar. 31, 1999)

11. Stack v. Lobo, Civ. No. 95-20049 SW, 1995 WL 241448 (N.D. Cal. Apr. 20, 1995)

12. Zishka v. American Pad & Paper Co., No. 3:98-CV-0660-M, 2000 WL 1310529 (N.D. Tex. Sept. 13, 2000)


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 (Cite as: Not Reported in F.Supp.2d)

© 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works.

Briefs and Other Related Documents

United States District Court, N.D. Illinois, Eastern Division.

ABBELL CREDIT CORP., an Illinois corporation, Merle Hay Mall, an Iowa limited partnership,

Westgate Village Shopping Center, an Illinois limited partnership, and J. William Holland, an individual,

Plaintiffs, v.

BANK OF AMERICA CORPORATION, a Delaware corporation, Banc of America Securities, L.L.C., a Delaware corporation, and Matt Williams,

an individual, Defendants. No. 01 C 2227.

March 1, 2002.

MEMORANDUM OPINION AND ORDER LINDBERG, Senior District J. *1 Defendants Bank of America Corporation, Banc of America Securities, and Matt Williams have moved to dismiss plaintiffs' second amended complaint. For the reasons stated below, Bank of America Corporation's motion is granted, and Banc of America Securities' and Williams' motion is granted in part and denied in part.

I. Factual Background In considering a motion to dismiss, the court must accept as true all well-pleaded facts and must draw all reasonable inferences from those allegations in plaintiff's favor. MCM Partners, Inc. v. Andrews-Bartlett & Assoc., Inc., 62 F.3d 967, 972 (7th Cir.1995). According to the allegations in the second amended complaint, plaintiff Abbell Credit Corporation (“Abbell”) is the managing agent for plaintiffs Merle Hay Mall (“Merle Hay”) and Westgate Village Shopping Center (“Westgate”). Plaintiff J. William Holland (“Holland”) is the managing general partner of Merle Hay and Westgate, and is the chairman of Abbell's board of directors. Defendant Banc of America Securities (“BAS”) is a securities brokerage enterprise, and a wholly-owned subsidiary of defendant Bank of America Corporation (“BAC”). Matt Williams is a registered securities broker employed by BAS.

Since 1940, Abbell has maintained a banking and investment relationship with BAC and its predecessors. Merle Hay and Westgate maintain a banking relationship and accounts with BAC and BAS. Among its other duties, Abbell is responsible for investing excess cash balances generated by Merle Hay and Westgate. Abbell effectuated these investments through BAS or its predecessor entity. Since 1984, Abbell has invested the excess cash balances by purchasing commercial paper with a maturity date of less than sixty days. For each such transaction, Abbell only purchased short-term commercial paper recommended by BAS as creditworthy and having the highest quality rating of A1/P1. Plaintiffs' investment criteria and strategies have not varied since 1984. On at least one occasion, Abbell has requested that BAS prepay a piece of commercial paper prior to maturity. At that time, BAS prepaid to Abbell the principal amount of its investment at the discount rate available on the trade date for the number of days from the date of purchase to the refund date. BAS charged Abbell a nominal fee for the prepayment. BAC has been the dealer of Pacific Gas & Electric (“PG & E”) commercial paper since 1985. In October 2000, BAC provided a $1 billion credit facility to underwrite PG & E's commercial paper program. In November 2000, PG & E authorized the public issuance of commercial paper in the total amount of $1.85 billion. On November 28, 2000, Williams telephoned Abbell's controller, and recommended that Abbell purchase PG & E commercial paper for Merle Hay and Westgate. Williams stated that PG & E offered a sixty-day commercial paper at a discount rate of 6.4%, with a maturity date of January 29, 2001. Williams further stated that “the PG & E commercial paper was rated A1/P1, that PG & E just basically supplies the West Coast with electricity and that California would never turn out the lights on PG & E.” *2 Based on the information provided by Williams, and his recommendation, Abbell purchased two pieces of PG & E commercial paper on behalf of Merle Hay and Westgate, for a total of approximately $1 .95 million. Following the purchase, BAS did not




send Abbell a commercial paper memorandum, which would have confirmed the terms of the agreement and included a general description of financial credit available to the issuer. Abbell would typically receive such a commercial paper memorandum seven to ten days after a purchase of commercial paper. PG & E's financial condition deteriorated in December 2000 and early January 2001. On December 14, 2000, BAS's energy analysts stopped recommending PG & E commercial paper as creditworthy. In early January 2001, Abbell learned of BAC's $1 billion credit facility, and that that credit facility formed the primary reason for PG & E's commercial paper's A1/P1 rating. Between January 8 and January 12, 2001, Abbell sought the prepayment of the PG & E commercial paper from Williams, who declined. On January 15, 2001, Williams advised Abbell that the commercial paper could not be prepaid, and that the market price was $0.75 per purchase dollar. On January 17, 2001, the PG & E commercial paper was downgraded to junk status, and PG & E defaulted on the commercial paper set to mature on that date. Eventually, on January 22, 2001, Abbell sold the PG & E commercial paper to BAS for $0.50 per purchase dollar. This lawsuit followed. Plaintiffs' second amended complaint alleges claims under Section 10(b) of the Securities Exchange Act of 1934 against all defendants, and alleges claims under Section 12(1) of the Securities Act of 1933, the Illinois Securities Law, and claims of fraud, negligence, and breach of contract against BAS and Williams.

II. Discussion When ruling on a motion to dismiss under Fed.R.Civ.P. 12(b)(6), the court must consider “whether relief is possible under any set of facts consistent with the allegations of the plaintiff's complaint.” Pokuta v. Trans World Airlines, Inc., 191 F.3d 834, 839 (7th Cir.1999). That is, if it is possible to hypothesize a set of facts that would entitle the plaintiff to relief, consistent with the allegations in the complaint, dismissal under Rule 12(b)(6) is inappropriate. See Graehling v. Village of Lombard, Ill., 58 F.3d 295, 297 (7th Cir.1995). “[A]lthough plaintiffs can plead conclusions, the conclusions must provide the defendant with at least minimal notice of the claim.” Jackson v. Marion County, 66 F.3d 151, 154 (7th Cir.1995). A plaintiff can “plead himself out of court by alleging facts which show that he has no

claim.” Id.

A. Existence of a Duty Plaintiffs seek to hold defendants liable for failing to disclose that BAC provided a credit facility to PG & E, that BAC was the underwriter dealer of the PG & E commercial paper, and that BAC would profit from sales of PG & E commercial paper. According to plaintiffs, these omissions led plaintiffs to believe that PG & E was in sound financial condition when it was not. BAS and Williams argue that all claims against them should be dismissed because the second amended complaint does not allege that they had a duty to disclose the information. BAC also argues that it had neither a direct duty to disclose the information to plaintiffs, nor a duty to ensure that BAS disclosed the information. *3 Several of plaintiffs' claims in the second amended complaint require proof of a duty. An omission of a material fact is actionable under Section 10(b) and Rule 10b-5 only if the defendant has a duty to disclose that fact. Chiarella v. United States, 445 U.S. 222, 230 (1980); Congregation of the Passion v. Kidder Peabody & Co., 800 F.2d 177, 182 (7th Cir.1986). In addition, a common law fraud claim based on an omission or concealment of a material fact requires there to have been a duty to speak. Lidecker v. Kendall College, 550 N.E.2d 1121, 1124 (Ill.App.Ct.1990); Warner v. Lucas, 541 N.E.2d 705, 706 (Ill.App.Ct.1989). Finally, duty is an element of any negligence claim. See Advincula v. United Blood Servs., 678 N.E.2d 1009, 1015 (Ill.1996). A fiduciary duty arises between a broker and a customer only when the dealings between them “presuppose a special trust or confidence .” Congregation of the Passion, 800 F.2d at 182. Thus, a broker generally is not the fiduciary of his customer unless the customer entrusts the broker with discretion to select the customer's investments. Carr v. CIGNA Securities, Inc., 95 F.3d 544, 547 (7th Cir.1996). The second amended complaint alleges that Abbell had been investing in commercial paper through BAS or its predecessor since 1984, and that Abbell relied upon BAS and the BAS representative exclusively for information and recommendations relating to investments in commercial paper. At this stage in the proceedings, the court cannot say that it appears beyond doubt that plaintiffs can prove no set of facts in support of their claims against BAS and Williams that would entitle them to relief. These




allegations are sufficient to withstand a motion to dismiss based on a lack of duty as to the claims against BAS and Williams. The court's conclusion is different as to plaintiffs' claim against BAC. The court disagrees with plaintiffs' claim that BAC owed them a direct duty to disclose information regarding its role as underwriter and dealer of the PG & E commercial paper, and PG & E's financial problems. While plaintiffs may have maintained a banking and investment relationship with BAC dating from 1940, they do not allege that they had any contact with BAC relating to the transaction at issue, other than that payment for the commercial paper was made from plaintiffs' BAC bank accounts and that the commercial paper then was “delivered to Bank of America safekeeping .” FN1 Plaintiffs do not allege that BAC solicited them to buy the PG & E commercial paper, or that plaintiffs sought BAC's advice on the transaction. The court is not aware of any duty of a bank to monitor how its customers use funds on deposit with the bank, or to monitor the types of instruments it stores for customers. Plaintiffs' use of BAC's banking services in processing their purchase of PG & E commercial paper is not a contact sufficient to impose on BAC a duty to review plaintiffs' investment decision and make disclosures relating to that decision.

FN1. This information is contained in confirmation documents attached as exhibits to the second amended complaint, and is therefore part of the complaint. See Fed.R.Civ.P. 10(c).

*4 Nor did BAC have a duty to ensure that its subsidiary, BAS, disclosed information to plaintiffs. As a general rule, a parent corporation is not liable for the acts or omissions of its subsidiary. See United States v. Bestfoods, 524 U.S. 51, 61 (1998). Although a parent corporation has the power to control its subsidiary, see Esmark, Inc. v. N.L.R.B., 887 F.2d 739, 757 (7th Cir.1989), that power does not translate into a duty to control. The second amended complaint does not allege, and plaintiffs do not argue, that corporate formalities should be disregarded in this case. Because Count VIII does not allege an omission of a material fact that BAC was obligated to disclose, it does not state a claim against BAC under Section 10(b) and Rule 10b-5 that could be granted. Accordingly, Count VIII is dismissed. B. Section 10(b) and Rule 10b-5 (Counts II and VIII)

BAS and Williams contend that Count II should be dismissed because plaintiffs fail to satisfactorily explain why Williams' statement that the PG & E commercial paper had an A1/P1 rating was misleading, as required by the Private Securities Litigation Reform Act (“PSLRA”). See 15 U.S.C. § 78u-4(b)(1). Plaintiffs respond that the second amended complaint alleges that Williams' representation that the PG & E commercial paper was rated A1/P1 was misleading because Williams failed to disclose that this rating was based on BAC's credit facility rather than on PG & E's financial stability, that BAC was the underwriter and dealer of the PG & E commercial paper, and that BAC would profit from sales of PG & E commercial paper. This explanation is sufficient to withstand a motion to dismiss. BAS and Williams may find plaintiffs' explanation unconvincing, but the issue of whether a statement or omission is material requires a “highly fact-dependent analysis” that in this case is unsuitable for decision at this early stage of litigation. See Searls v. Glasser, 64 F.3d 1061, 1066 (7th Cir.1995). BAS and Williams also challenge Count II on the basis that plaintiffs fail to sufficiently allege that defendants acted with scienter. The PSLRA requires plaintiffs in securities fraud cases to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). The Seventh Circuit has yet to address just how rigorous this pleading standard is. Cases in the Northern District of Illinois have generally followed the Second Circuit's pleading standard, which requires plaintiffs to allege facts either (1) showing that the defendant had both motive and opportunity to commit fraud; or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness. See, e.g., In re Westell Techs., Inc., No. 00 C 6735, 2001 WL 1313785, at *10 (N.D.Ill. Oct. 26, 2001); Danis v. USN Communications, Inc., 73 F.Supp.2d 923, 937 (N.D.Ill.1999); Rehm v. Eagle Fin. Corp., 954 F.Supp. 1246, 1253 (N.D.Ill.1997). *5 To show strong circumstantial evidence of recklessness, a plaintiff must point to “highly unreasonable” conduct: “an extreme departure from the standards of ordinary care...to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.” Rehm, 954 F.Supp. at 1255. Plaintiffs argue that the complaint alleges strong circumstantial evidence of recklessness against BAS and Williams in that PG & E's financial instability was an objectively obvious




danger that BAS and Williams knew about or should have known about through their close relationship with PG & E. The second amended complaint also alleges that BAS knew or should have known about PG & E's financial instability “[b]ased on Bank of America's position as the lead underwriter dealer of the commercial paper program and BAS's position as seller of the commercial paper.” These allegations are insufficient to establish strong circumstantial evidence of recklessness on the part of Williams and BAS. Contrary to plaintiffs' argument, the second amended complaint does not allege that BAS and Williams had any relationship with PG & E. More importantly, the second amended complaint imputes BAC's knowledge to its subsidiary without providing any concrete factual basis for doing so. Nor do plaintiffs sufficiently allege scienter by showing that BAS and Williams had a motive and opportunity to defraud. Simply alleging a motive and opportunity is not enough to satisfy the scienter requirement of the PSLRA; the facts alleged still must give rise to a strong inference of scienter. See 15 U.S.C. § 78u-4(b)(2); see also Chu v. Sabratek Corp., 100 F.Supp.2d 815, 823 (N.D.Ill.2000). Plaintiffs contend that Williams and BAS were motivated to conceal material facts by the profits they and BAC would earn in selling PG & E commercial paper. However, a plaintiff cannot allege scienter based merely on motivating factors that would be true for nearly all companies; it is presumed that defendants act in their economic self-interest. Rehm, 954 F.Supp. at 1253; see also, e.g., Phillips v. LCI Int'l, Inc., 190 F.3d 609, 621-23 (4th Cir.1999) (desire to retain position on corporation's board and obtain higher stock price constituted insufficient motive); In re Brightpoint, Inc. Secs. Litig., No. IP99-0870-C-H/G, 2001 WL 395752, at *14 (S.D. Ind. Mar. 29, 2001 (desire to gain reputational and monetary benefits from positive public perception of company constituted insufficient motive); In re Next Level Sys., Inc., No. 97 C 7362, 1999 WL 387446, at *9 (N.D.Ill. Mar. 31, 1999) (desire to maintain reputation in capital markets and retain access to financing constituted insufficient motive). Plaintiffs also argue that Williams and BAS were motivated to defraud by their desire to avoid financial exposure caused by PG & E's deteriorating financial condition. A subsidiary's desire to benefit its parent could constitute a valid motivation. See Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 771-72 (1984) (“the subsidiary acts for the benefit of the parent...[I]n reality a parent and a wholly owned subsidiary always have a ‘unity of purpose or a

common design.” ’). However, plaintiffs' argument on this point requires the court to assume the very fact that plaintiffs are trying to establish: plaintiffs seek to show that BAS and Williams knew of PG & E's financial instability by arguing that BAS and Williams were trying to help BAC avoid financial exposure due to PG & E's financial instability. Although BAS and Williams undoubtedly had the opportunity to defraud plaintiffs, given the longstanding investment relationship that plaintiffs allege, the motives plaintiffs allege do not rise to the level that permits a strong inference of scienter. Therefore, Count II must be dismissed. C. Securities Act of 1933, Section 12(1) (Count III)

*6 BAS and Williams next seek the dismissal of Count III of the second amended complaint, which alleges that BAS and Williams offered and sold unregistered securities in violation of Section 12(1) of the Securities Act of 1933, 15 U.S.C. § 771(a)(1). BAS and Williams argue that plaintiffs' earlier statements in this case that the commercial paper was exempt from the registration requirement constitute a judicial admission on the issue, and that in any event, the PG & E commercial paper was not required to be registered. FN2 BAS and Williams contend that the following of plaintiffs' statements, made in plaintiffs' motion to reconsider this court's order dismissing a portion of their first amended complaint, constitute judicial admissions: “The PG & E Commercial Paper was exempt from the registration requirements under Section3(a)(3) and therefore exempt from the prospectus requirement,” and “The reason why a formal prospectus was not issued is because the commercial paper was and is exempt from the registration requirements of the statute under Section 3(a)(3).” BAS and Williams argue that these statements prevent plaintiffs from now claiming that the PG & E commercial paper was subject to the registration requirements.

FN2. BAS and Williams also take issue with the allegation in Count III that they offered and sold unregistered securities by offering to “prepay” the PG & E commercial paper on January 15, 2001. Plaintiffs appear to have abandoned this portion of their claim, since they do not respond to defendants' argument that defendants' offer to buy the commercial paper from plaintiffs prior to maturity would make defendants purchasers in that transaction, rather than sellers.




The court disagrees that plaintiffs' statements constitute judicial admissions. Counsel's legal conclusions do not constitute judicial admissions. See Dabertin v. HCR Manor Care, Inc., 68 F.Supp.2d 998, 1000 (N.D.Ill.1999). In addition, Federal Rule of Civil Procedure 8(e)(2) allows plaintiffs to pursue inconsistent theories of recovery in the same lawsuit. Thus, a claim made early in a lawsuit that is later superceded by an inconsistent one is not a judicial admission. Moriarty v. Larry G. Lewis Funeral Dirs., Ltd., 150 F.3d 773, 777-78 (7th Cir.1998). Plaintiffs' argument supporting their claim of a violation of Section 12(2) of the Securities Act of 1933 does not prevent them from now claiming a violation of Section 12(1). BAS and Williams also argue that the second amended complaint does not contain allegations that the PG & E commercial paper was required to be registered, and argue that plaintiffs must rebut a presumption that commercial paper with a maturity under nine months is exempt from the registration requirements. Section 3(a)(3) of the 1933 Securities Act exempts from registration “[a]ny note...which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months...” 15 U.S.C. § 77c(a)(3). This exemption has been interpreted to apply only to short-term, prime quality negotiable commercial paper that is of a type not ordinarily purchased by the general public. See Sanders v. John Nuveen & Co., 463 F.2d 1075, 1079-80 (7th Cir.1972). The burden of establishing an exemption is on the party that claims it. Securities and Exch. Comm'n v. Ralston Purina Co., 346 U.S. 119, 126 (1953). *7 At this stage, reading the second amended complaint in the generous light that it must, the court finds that the allegations in the second amended complaint could support plaintiffs' position that the PG & E commercial paper was subject to the registration requirement. Plaintiffs allege that BAS and Williams sold PG & E commercial paper, an unregistered security, and that that sale violated the prohibition against sales of unregistered securities. Since a security with a maturity of less than nine months is not necessarily exempt from the registration requirement, plaintiffs do not plead themselves out of court by alleging the short-term nature of the PG & E commercial paper. BAS' and Williams' motion to dismiss Count III is denied.

D. Illinois Securities Act (Count IV)

BAS and Williams next argue that plaintiffs' claim under the Illinois Securities Law should be dismissed because it is not pled with particularity, as required by Federal Rule of Civil Procedure 9(b). The allegation in the second amended complaint that defendants “engaged in deceptive practices” in violation of the Illinois Securities Law is identical to plaintiffs' claim in their first amended complaint, a claim that BAS and Williams did not challenge in their first motion to dismiss. BAS and Williams nevertheless contend in their reply brief that they have not waived this challenge. According to BAS and Williams, the second amended complaint removes an allegation that Williams represented the PG & E commercial paper to be creditworthy from the factual background section of the first amended complaint, a change which in turn impacts the deceptive practice allegation in the Illinois Securities Law claim. In their motion to dismiss the second amended complaint, however, BAS and Williams did not challenge plaintiffs' new characterization of Williams' statements as applied to the Illinois Securities Law claim, but rather confined their challenge to the vagueness of the allegation of “deceptive practice.” This argument should have been brought in the motion to dismiss the first amended complaint; since it was not, it is waived. See Fed.R.Civ.P. 12(g). BAS' and Williams' argument regarding the effect of the changed factual background section, appearing for the first time in their reply brief, is also waived. See Estate of Phillips v. City of Milwaukee, 123 F.3d 586, 597 (7th Cir.1997); Petri v. Gatlin, 997 F.Supp. 956, 977 (N.D.Ill.1997).

E. Fraud (Count V) BAS and Williams contend that Count V, alleging fraud, is fatally deficient under Rule 9(b) because it does not specify the content of the alleged failure to disclose material facts or misrepresentation. The court disagrees. Rule 9(b)'s particularity requirement means supplying the “who, what, when, where, and how: the first paragraph of any newspaper story.” DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.1990). Essentially, a plaintiff must specify which defendant “said what to whom and when.” Ackerman v. Northwestern Mut. Life Ins. Co., 172 F.3d 467, 471 (7th Cir.1999). The second amended complaint




alleges that in recommending that plaintiffs purchase PG & E commercial paper, Williams failed to inform plaintiffs that BAC's credit facility formed the primary reason for the commercial paper's A1/P1 rating, a fact that plaintiffs claim would have been material to an assessment of whether the commercial paper was creditworthy. This allegation adequately supplies the “what,” as required by Rule 9(b). *8 BAS and Williams also argue that Count V fails to allege the elements of a common law fraud claim. To establish common law fraud under Illinois law, a plaintiff must show that: (1) the defendant made a false statement of material fact, (2) the defendant knew that the statement was false, (3) the defendant made the statement intending to induce the plaintiff to act, (4) the plaintiff relied on the truth of the statement, and (5) the plaintiff's damages resulted from that reliance. Connick v. Suzuki Motor Co., 675 N.E.2d 584, 591 (Ill.1996). BAS and Williams contend that the second amended complaint does not allege facts that Williams knew to be false or that he intended to induce plaintiffs to act on his false statement. The second amended complaint alleges that Williams called Abbell's controller to solicit Abbell's business, and in making his recommendation that Abbell purchase PG & E commercial paper: knowingly failed to inform [Abbell's controller] of material facts and misrepresented the material facts regarding Bank of America and BAS's due diligence investigation of PG & E, PG & E's creditworthiness and the basis for the A1/P1 rating assigned to PG & E's Commercial Paper. These allegations are sufficient to withstand a motion to dismiss.

F. Breach of Contract (Count VII) Finally, BAS and Williams argue that Count VII, alleging breach of contract, should be dismissed because plaintiffs fail to allege that they performed their obligations under the contract. Defendants presented this argument in their initial motion to dismiss, albeit obliquely, in the context of arguing that plaintiffs had not alleged the existence of a contract. As this court previously ruled, under liberal federal notice pleading rules, plaintiffs have sufficiently alleged the elements of a breach of contract claim at this stage. See Petri, 997 F.Supp. at 965-66 (finding that hypothesis that plaintiffs had fulfilled their contractual obligations was consistent with allegations in complaint). The motion to dismiss Count VII is denied.

ORDERED: BAS' and Williams' motion to dismiss is granted in part and denied in part: the motion is granted as to Count II, and denied as to Counts III through VII. BAS' and Williams' motion for judgment on the pleadings is denied, as the pleadings are not yet closed. See Fed.R.Civ.P. 12(c). BAS' and Williams' motion to strike Count I is granted. BAC's motion to dismiss is granted. BAC's motion to strike is denied as moot. N.D.Ill.,2002. Abbell Credit Corp. v. Bank of America Corp. Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 Briefs and Other Related Documents (Back to top) • 2002 WL 32677293 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to Defendants' Motion to Formulate and Simplify Certain Issues Pursuant to Rule 16(c) of the Federal Rules of Civil Procedure (May 29, 2002) • 2002 WL 32677297 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to Defendants' First Request for Admission of Facts and Genuineness of Documents (May 29, 2002) • 2002 WL 32677287 (Trial Pleading) Amended Answer to Second Amended Complaint (May 23, 2002) • 2002 WL 32677282 (Trial Pleading) Answer to Second Amended Complaint (Mar. 18, 2002) • 2002 WL 32677269 (Trial Motion, Memorandum and Affidavit) Reply of Bac in Support of Its Motion to Dismiss and/or Strike (Feb. 4, 2002) • 2002 WL 32677277 (Trial Motion, Memorandum and Affidavit) Reply of Bas and Williams in Support of Their Motion to Dismiss and/or Strike and/or for Judgment on the Pleadings (Feb. 4, 2002) • 2002 WL 32677257 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to the Motion of Bank of America Corporation to Dismiss and/or Strike (Jan. 25, 2002) • 2002 WL 32677263 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to Defendants' Motion to Dismiss and/or Strike and/or for Judgment on the Pleadings (Jan. 25, 2002) • 2001 WL 34666671 (Trial Pleading) Second Amended Complaint (Nov. 16, 2001) • 2001 WL 34666664 (Trial Pleading) Amended Complaint (May 25, 2001) • 1:01CV02227 (Docket) (Mar. 29, 2001) • 2001 WL 34666661 (Trial Pleading) Complaint (2001)




END OF DOCUMENT


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d)



United States District Court,N.D. California. In re EXODUS COMMUNICATIONS, INC.

SECURITIES LITIGATION No. C 01-2661 MMC, 160, 163.

Aug. 5, 2005.

Elizabeth P. Lin, Milberg Weiss Bershad & Schulman LLP, Kevin J. Yourman, Leigh Anne Parker, Weiss & Yourman, Michael David Braun, Braun Law Group, P.C., Los Angeles, CA, John K. Grant, Connie Cheung, Ex KanoS. Sams, II, Milberg Weiss Bershad Hynes & Lerach LLP, Reed R. Kathrein, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA, Joseph H. Weiss, Weiss & Lurie, New York, NY, William S. Lerach, Lerach Coughlin Stoia Geller & Robbins LLP, San Diego, CA, for Plaintiffs. Elizabeth E. Karnes, Morgan Lewis & Bockius, Jennifer Jarratt Massey, Brobeck, Phleger & Harrison LLP, Rebecca Justice Lazarus, Gibson, Dunn & Crutcher, San Francisco, CA, David Malcolm Furbush, O'Melveny & Myers LLP, Menlo Park, CA, Jonathan C. Dickey, Paul J. Collins, Gibson, Dunn & Crutcher LLP, Palo Alto, CA, John D. Van Loben Sels, Quinn Emanuel Urquhart Oliver & Hedges LLP, Redwood Shores, CA, for Defendants. ORDER GRANTING IN PART AND DENYING IN PART UNDERWRITER DEFENDANTS' MOTION

TO DISMISS; GRANTING INDIVIDUAL DEFENDANTS' MOTION TO DISMISS

CHESNEY, J.

(Docket Nos. 160, 163) *1 This Document Relates To: ALL ACTIONS Before the Court are the two separate motions to dismiss filed by (1) defendants Goldman, Sachs & Co. (“Goldman Sachs”), Merrill Lynch & Co. (“Merrill Lynch”), Morgan Stanley Dean Witter (“Morgan Stanley”), and J.P. Morgan (collectively, “Underwriter Defendants”); and (2) defendants Ellen M. Hancock (“Hancock”), R. Marshall Case (“Case”), Sam S. Mohamad (“Mohamad”), Dick Stoltz (“Stoltz”), Herbert A. Dollahite (“Dollahite”),

Adam W. Wegner (“Wegner”), Beverly Brown (“Brown”), and William Yeack (“Yeack”) (collectively, “Individual Defendants”), each of whom is a former officer of Exodus Communications, Inc.FN1 Each motion seeks dismissal of plaintiffs' Third Amended Consolidated Class Action Complaint, pursuant to the Private Securities Litigation Reform Act of 1995 (“PSLRA”) and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. On April 29, 2005, plaintiffs filed a Corrected Third Amended Consolidated Class Action Complaint (“Third Amended Complaint” or “TAC”). The Court granted the parties leave to file supplemental memoranda addressing the impact of the amendments on the pending motions to dismiss and, after such supplemental memoranda were filed, took the motions under submission as of May 13, 2005. For the reasons set forth below, the Court GRANTS in part and DENIES in part the Underwriter Defendants' motion, and GRANTS the Individual Defendants' motion.

FN1. The positions held by the Individual Defendants during the relevant time period are as follows: (1) Hancock, CEO and Chairman of the Board (through September 2001); (2) Case, Executive Vice President of Finance and CFO (through May 2001); (3) Mohamad, President of Worldwide Sales; (4) Stolz, temporary CFO (effective May 2001); (5) Dollahite, Executive Vice President of Customer Services, Support and Quality; (6) Wegner, Senior Vice President of Legal and Corporate Affairs, General Counsel, and Secretary; (7) Brown, Executive Vice President and CMO (through May 2001); (8) Yeack, Executive Vice President of Managed and Professional Services. (See TAC ¶ ¶ 27-34, 87.)

BACKGROUND

The above-titled action is a purported class action brought on behalf of those individuals and entities who purchased securities issued by Exodus Communications, Inc. (“Exodus”) between April 20, 2000 and September 25, 2001, inclusive (the “class period”). (See TAC ¶ 1.) FN2




FN2. Other than procedural history, the following facts are taken from the Third Amended Complaint and, for purposes of the instant motion, are presumed true.

Exodus “operated Internet Data Centers (‘IDCs') that leased space to Exodus's customers to place (‘co-locate’) the computer servers that ran the customers' Internet operations.” (See TAC ¶ 2.) Exodus also “provided broadband access and other design and management services to support commercial Internet operations.” (See id.) On June 20, 2001, Exodus announced that its results for the second quarter of 2001 and for the fiscal year 2001 FN3 would be below prior expectations, whereupon the price of Exodus's stock fell almost 50%. (See TAC ¶ ¶ 93-94.) On July 12, 2001, the first of many complaints against Exodus was filed in this district.

FN3. As noted in the Court's prior order of dismissal, Exodus's fiscal year ends on December 31 and, consequently, its first quarter ends March 31 and its second quarter ends June 30. (See Order Granting Underwriter Defendants' Motion To Dismiss With Leave to Amend; Granting Individual Defendants' Motion to Dismiss with Leave to Amend (“Dismissal Order”), filed August 19, 2003, at 2 n. 2.)

On September 25, 2001, the last day of the class period, the Wall Street Journal published an article stating that Exodus's bankruptcy was forthcoming, whereupon Exodus's stock, which had traded as high as $179 per share during the class period, fell to $0 .17 per share. (See TAC ¶ 18.) The following day, September 26, 2001, Exodus filed for bankruptcy. (See id.) On December 13, 2001, plaintiffs filed a Consolidated Class Action Complaint, alleging claims against Hancock, Case, Stoltz, Dollahite, and Wegner, for violation of § § 10(b) and 20(a) of the Securities and Exchange Act of 1934 (“Exchange Act”). A Corrected Consolidated Class Action Complaint (“Consolidated Complaint” or “CAC”) was filed April 17, 2002. By order filed May 28, 2002, the Court granted the defendants' motion to dismiss the Consolidated Complaint, finding plaintiffs had failed to adequately plead that any of the alleged statements were false or misleading at the time they were made, and that plaintiffs had failed to

plead facts sufficient to raise an inference that defendants had made the alleged false or misleading statements with the requisite state of mind. Plaintiffs were afforded leave to amend. *2 On July 11, 2002, plaintiffs filed their First Amended Consolidated Class Action Complaint (“First Amended Complaint” or “FAC”), which significantly expanded the scope of the litigation. The First Amended Complaint increased the class period from 11 weeks (March 30, 2001 to June 20, 2001) to 73 weeks (April 20, 2000 to September 25, 2001). (Compare CAC ¶ 1 with FAC ¶ 1.) In addition, the First Amended Complaint added two new plaintiffs, Thomas Welch and Martin Fox, and seven new defendants, three of whom are former officers of Exodus, specifically, Mohamad, Brown and Yeack, and four of whom are the Underwriter Defendants, who were underwriters of Exodus's February 6, 2001 secondary stock and note offerings (“February Offerings”). The First Amended Complaint included a new claim under § § 11 and 15 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § § 77k, 77o, against former Exodus CEO Hancock, as well as new claims against the Underwriter Defendants, for violation of § 10(b) of the Exchange Act and § 11 of the Securities Act. The new claims against Hancock and the Underwriter Defendants were based on allegedly false statements made in the registration statements and prospectuses issued in connection with the February Offerings. On August 19, 2003, the Court granted the motions filed by the Underwriter Defendants and the Individual Defendants to dismiss the First Amended Complaint, and afforded plaintiffs leave to amend. The Court dismissed all claims against the Underwriter Defendants because plaintiffs failed to allege facts sufficient to demonstrate conformity with the statute of limitations. The Court also held that the § 10(b) claims against the Underwriter Defendants were subject to dismissal because plaintiffs failed to adequately allege scienter or that the statements in the Registration Statements were false when made. The Court dismissed the § 11 claims against the Underwriter Defendants, with leave to amend, because plaintiffs failed to adequately allege falsity with the particularity required by Rule 9(b). The Court dismissed plaintiffs' § 10(b) claims against the Individual Defendants because plaintiffs failed to adequately allege scienter and that the allegedly false and misleading statements were false when made. As an additional basis for dismissal, the Court held that plaintiffs had failed to allege sufficient facts to demonstrate that the following claims were timely:




(1) the § 10(b) claims against the Individual Defendants as alleged by class members who purchased securities between April 20, 2000 and March 31, 2001; and (2) the new § 10(b) claims asserted against Mohamad, Yeack, and Brown that were based on statements made between March 31, 2001 and June 20, 2001. The Court dismissed the § 11 claim against Hancock because plaintiffs failed to plead sufficient facts to show the claim was timely and failed to adequately allege falsity. Finally, the Court dismissed plaintiffs' claims for violation of § 20(a) of the Exchange Act and § 15 of the Securities Act because such claims were dependent on a violation of § 10(b) or § 11, and plaintiffs had not adequately alleged a violation of either statute. *3 On October 20, 2003, plaintiffs filed a Second Amended Consolidated Class Action Complaint (“Second Amended Complaint”). On November 25, 2003, before defendants responded to the Second Amended Complaint, plaintiffs filed a motion for leave to file a Third Amended Complaint. The Court granted the motion on January 12, 2004, and plaintiffs filed their Third Amended Consolidated Class Action Complaint on January 15, 2004. Defendants thereafter filed the instant motions to dismiss. On March 8, 2005, while the motions to dismiss were under submission, plaintiffs filed a motion for leave to amend their Third Amended Consolidated Class Action Complaint to add one line of text and one exhibit. On April 18, 2005, the Court granted the motion and afforded the parties leave to file supplemental memoranda addressing the impact of the amendments on the pending motions to dismiss. Plaintiffs' Corrected Third Amended Consolidated Class Action Complaint was filed April 29, 2005. The motions to dismiss were taken under submission as of May 13, 2005, once the supplemental memoranda were filed.

LEGAL STANDARDS

A. Rule 12(b)(6) A motion to dismiss under Rule 12(b)(6) cannot be granted unless “it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” See Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). Dismissal can be based on the lack of a cognizable legal theory or the absence of sufficient

facts alleged under a cognizable legal theory. See Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 (9th Cir.1990). Generally, a district court, in ruling on a Rule 12(b)(6) motion, may not consider any material beyond the pleadings. See Hal Roach Studios. Inc. v. Richard Feiner And Co., Inc., 896 F.2d 1542, 1555 n. 19 (9th Cir.1990). Material that is properly submitted as part of the complaint, however, may be considered. See id. Documents whose contents are alleged in the complaint, and whose authenticity no party questions, but which are not physically attached to the pleading, also may be considered. See Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir.1994). In addition, the Court may consider any document “the authenticity of which is not contested, and upon which the plaintiff's complaint necessarily relies,” regardless of whether the document is referred to in the complaint. See Parrino v. FHP, Inc., 146 F.3d 699, 706 (9th Cir.1998). Finally, the Court may consider matters that are subject to judicial notice. See Mack v. South Bay Beer Distributors, Inc., 798 F.2d 1279, 1282 (9th Cir.1986). In analyzing a motion to dismiss, the Court must accept as true all material allegations in the complaint, and construe them in the light most favorable to the nonmoving party. See NL Industries, Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir.1986). In analyzing a motion to dismiss, the Court may disregard factual allegations if such allegations are contradicted by the facts established by reference to exhibits attached to the complaint. See Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir.1987). Conclusory allegations, unsupported by the facts alleged, need not be accepted as true. See Holden v. Hagopian, 978 F.2d 1115, 1121 (9th Cir.1992).

B. Section 10(b) and the PSLRA *4 Section 10(b) of the Exchange Act provides that “[i]t shall be unlawful for any person ... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe [.]” See 15 U.S.C. § 78j(b). Rule 10b-5 provides: It shall be unlawful for any person ... (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to




make the statements made, in light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5. The elements of a § 10(b)/Rule 10b-5 claim are (1) “a material misrepresentation (or omission)”; (2) “scienter, i.e., a wrongful state of mind”; (3) “a connection with the purchase or sale of a security”; (4) “reliance”; (5) “economic loss”; and (6) “ ‘loss causation,’ i.e., a causal connection between the material misrepresentation and the loss.” See Dura Pharmaceuticals, Inc. v. Broudo, --- U.S. ----, ----, 125 S.Ct. 1627, 1631, 161 L.Ed.2d 577 (2005). False statements in a registration statement are actionable under § 10(b) as well as under § 11. See Herman & Maclean v. Huddleston, 459 U.S. 375, 387, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983) (“We hold that the availability of an express remedy under Section 11 of the 1933 Act does not preclude defrauded purchasers of registered securities from maintaining an action under Section 10(b) of the 1934 Act.”) Any class action complaint alleging securities fraud in violation of the Exchange Act is subject to the heightened pleading standards set forth in the Private Securities Litigation Reform Act of 1995 (“PSLRA”). See In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 973-74 (9th Cir.1999). Under the PSLRA, for all claims based on misrepresentations or omissions, plaintiffs must “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” See 15 U.S.C. § 78u-4(b)(1). Plaintiffs “must provide all the facts forming the basis for [their] belief in great detail.” See Silicon Graphics, 183 F.3d at 983. FN4 The PSLRA also requires that “the complaint shall, with respect to each such act or omission alleged to violate [the Exchange Act], state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” See 15 U.S.C. § 78u-4(b)(2). The required state of mind is “deliberate recklessness, at a minimum.” See Silicon Graphics, 183 F.3d at 974. Plaintiffs “must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct.” See id. They “must state specific facts indicating no less

than a degree of recklessness that strongly suggests actual intent.” See id. at 979. If the challenged statement in question is forward-looking, however, the requisite state of mind is “actual knowledge.” See No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 931 (9th Cir.2003) (quoting 15 U.S.C. § 78u-5(c)(1)).

FN4. “Allegations are deemed to have been made on information and belief until the plaintiffs demonstrate that they have personal knowledge of the facts.” In re The Vantive Corp. Sec. Litig., 283 F.3d 1079, 1085 n. 3 (9th Cir.2002).

*5 In determining whether scienter has been adequately alleged, the Court must examine the totality of plaintiffs' allegations. See America West, 320 F.3d at 938. The Court must consider “ ‘all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs.” 'Seeee id. (quoting Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir.2002)). “District courts should consider all the allegations in their entirety, together with any reasonable inferences that can be drawn therefrom, in concluding whether, on balance, the plaintiffs' complaint gives rise to the requisite inference of scienter.” Gompper v. VISX, Inc., 298 F.3d at 897. To establish a strong inference of scienter, the allegations must show that an inference of fraud is “ ‘the most plausible of competing inferences.” ’ See id. (quoting Helwig v. Vencor, Inc., 251 F.3d 540, 553 (6th Cir.2001) (en banc)). Because “falsity and scienter in private securities fraud cases are generally strongly inferred from the same set of facts,” the Ninth Circuit has incorporated the falsity and scienter requirements “into a single inquiry.” See Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir.2001); see also America West, 320 F.3d at 932 (noting the court “generally examines the falsity and scienter requirements at the same time.”) In conducting this inquiry, a court is to determine whether “particular facts in the complaint, taken as a whole, raise a strong inference that defendants intentionally or with deliberate recklessness made false or misleading statements to investors.” See Ronconi v. Larkin, 253 F.3d at 429. “The most direct way to show both that a statement was false when made and that the party making the statement knew that it was false is via contemporaneous reports or data, available to the party, which contradict the statement.” See Nursing Home Pension Fund, Local




144 v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir.2004).

C. Section 11 of the Securities Act Section 11 “creates a private remedy for any purchaser of a security if ‘any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein not misleading.” ’ See In re Daou Systems, Inc. Sec. Litig., 411 F.3d 1006, 1027 (9th Cir.2005) (quoting 15 U.S.C. § 77k(a)). “Under § 11 of the Securities Act of 1933 ... any signer of [a] registration statement, any partner or director of the issuer, any professional involved in preparing or certifying the statement, and any underwriter of a registration statement may be liable[.]” Kaplan v. Rose, 49 F.3d 1363, 1371 (9th Cir.1994). “The plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment.” See Daou, 411 F.3d at 1027 (citation omitted); see also Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983) (“If a plaintiff purchased a security issued pursuant to a registration statement, he need only show a material misstatement or omission to establish his prima facie case.”) *6 Significantly, scienter is not a requirement for liability under § 11, and “defendants will be liable for innocent or negligent material misstatements or omissions.” See Daou, 411 F.3d at 1027 (citation omitted). Defendants to a § 11 claim, other than the issuer, can establish a “due diligence” defense if they show that after reasonable investigation they had reasonable grounds to believe, and did believe, that, at the time the registration statement became effective, the statements were true and there was no material omission. See Kaplan v. Rose, 49 F.3d at 1371 (citing 15 U.S .C. § 77k(b)(3)(A)).

DISCUSSION: UNDERWRITERS' MOTION TO DISMISS

As noted, the Third Amended Complaint alleges causes of action against the Underwriter Defendants for violation of § 10(b) of the Exchange Act and

Rule 10(b)(5), and violation of § 11 of the Securities Act. Plaintiffs allege that the Underwriter Defendants are liable under both § 10(b) and § 11 because the registration statements and prospectuses issued in connection with the February Offerings (collectively “Registration Statements”) FN5 contained the following false and misleading statements: (1) “We believe that the acquisition [of GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our network, our customer support, sales and professional services organizations, and expands our customer base”; FN6 (2) Exodus achieved revenues of $280.4 million for the quarter ended December 31, 2000, and $818.4 million for fiscal year 2000; (3) “[Exodus has] established a diverse base of customers and continues to focus on supporting the strong demand from the enterprise market”; and (4) Exodus had 4500 customers under contract. (See TAC ¶ ¶ 72-73, 345-346 (alterations in original).) FN7

FN5. The Third Amended Complaint states that “[m]uch of the language in the Registration Statement and Prospectus for the note offering was similar to that contained in the Prospectus for Exodus's secondary public offering.” (See TAC ¶ 73.) In their papers, the parties do not differentiate between the two registration statements and prospectuses.

FN6. “On September 28, 2000, Exodus entered into a definitive merger agreement to acquire GlobalCenter, an indirect wholly owned subsidiary of Global Crossing North America, Inc.” See TAC ¶ 56.

FN7. Except as indicated, plaintiffs do not purport to quote these statements directly.

In their Motion to Dismiss, the Underwriter Defendants raise three principal arguments: (1) both of the causes of action are barred by the applicable one-year statute of limitations; (2) plaintiffs have failed to adequately allege a § 11 claim because plaintiffs have failed to allege falsity with the particularity required by Rule 9(b) of the Federal Rules of Civil Procedure; and (3) plaintiffs have not adequately alleged a § 10(b) claim because plaintiffs have failed to adequately allege falsity and scienter under the requirements of the PSLRA. A. Statute of Limitations: Section 10(b) and Section




11 Claims The Court previously has held that the instant claims under § 10(b) and § 11 are timely if they were brought “within one year of either actual discovery or inquiry notice” of the facts constituting the alleged violations. (See Dismissal Order at 8.) As to inquiry notice, the Court, relying on the Ninth Circuit's discussion in Berry v. Valence, 175 F.3d 699, 703-04 (9th Cir.1999), held that it would apply “the Tenth Circuit's formulation,” as set forth in Sterlin v. Biomune Systems, 154 F.3d 1191, 1201 (10th Cir.1998). (See Dismissal Order at 8.) Under that standard, “ ‘inquiry notice ... triggers an investor's duty to exercise reasonable diligence and ... the one-year statute of limitations begins to run once the investor, in the exercise of reasonable diligence, should have discovered the facts underlying the alleged fraud.” ’ See Valence, 175 F.3d at 704 (quoting Sterlin, 154 F.3d at 1201) (ellipses in original). Thus, a court must ask (1) whether an event/publication “raise[d] sufficient suspicion of fraud to cause a reasonable investor to investigate the matter further,” and (2) when “a reasonably diligent inventor [should] have discovered the facts underlying the alleged fraudulent activity.” See Valence, 175 F.3d at 704. “If the answer to the first question is yes, the answer to the second question would determine when the statute of limitations began to run.” Id. *7 For purposes of the statute of limitations, the question of when a reasonably diligent investor did discover or should have discovered the alleged wrongdoing is a question of fact, rarely to be decided as a matter of law. See Mosesian v. Peat Marwick, 727 F.2d 873, 877 (9th Cir.1984) (“The question of when [alleged wrongdoing] was or should have been discovered is a question of fact. It may be decided as a matter of law only when uncontroverted evidence irrefutably demonstrates plaintiff discovered or should have discovered the fraudulent conduct.”) (internal citations and quotations omitted). Nevertheless, “a plaintiff must affirmatively plead sufficient facts in his complaint to demonstrate conformity with the statute of limitations.” See Toombs v. Leone, 777 F.2d 465, 468 (9th Cir.1985). As noted, plaintiffs' claims against the Underwriter Defendants are based on alleged misstatements in the Registration Statements for the February Offerings. Because plaintiffs first asserted claims against the Underwriter Defendants in the First Amended Complaint, which was filed on July 11, 2002, plaintiffs' claims against the Underwriter Defendants

are timely if plaintiffs should have discovered the facts underlying those claims no earlier than July 11, 2001. See Valence, 175 F.3d at 704. The Court previously dismissed the § 10(b) and § 11 claims against the Underwriter Defendants because plaintiffs failed to allege any facts from which one could determine “at what point a reasonably diligent investor should have discovered the relevant facts underlying plaintiffs' claims against the Underwriter Defendants,” and failed to set forth the nature and scope of their investigation of the facts underlying their claims against the Underwriter Defendants. (See Dismissal Order at 12.) Plaintiffs now allege, in the Third Amended Complaint, that they did not discover, until December 2001, “the possibility that the Underwriter Defendants may have underwritten Exodus's offerings pursuant to a false and misleading Registration Statement and Prospectus.” (See TAC ¶ 319.) According to the complaint, plaintiffs Martin Fox and Thomas Welch, the only named plaintiffs who claim to have purchased stock or notes in, or traceable to, the February Offerings, (see TAC ¶ 25), first contacted plaintiffs' counsel on July 18, 2001 and August 23, 2001, respectively. (See TAC ¶ 317.) Thereafter, plaintiffs allege, they “diligently attempted to locate individuals with knowledge of Exodus's business practices.” (See id.) According to plaintiffs, it was not until their investigator's interview with CW6, on December 4, 2001, at which CW6 stated that Exodus was not bringing in any new customers at the end of 2000, that plaintiffs first suspected that fraudulent conduct might have begun prior to the second quarter of 2001. (See id.) On December 10, 2001, plaintiffs allege, they spoke with CW9, Vice President of Facilities in Exodus's Santa Clara office, who informed plaintiffs that, in plaintiffs' words, “Exodus's management dismissed his capital report and continued to build additional IDCs when they knew that Exodus did not have the capital to cover the expenses of these expansions.” (See id. ¶ 320.) Plaintiffs contend this statement led them “to believe that there was a possibility that statements contained in the registration statements issued in connection with Exodus's February 2001 secondary stock and note offerings were false and misleading.” (See id.) In addition, according to plaintiffs, unspecified “defendants fraudulently concealed their activities.” (See id. ¶ 316.) If a reasonably diligent investor would not have discovered the facts underlying plaintiffs' claims against the Underwriter Defendants until at least July 11, 2001, one year before the first complaint




containing claims against the Underwriter Defendants was filed, plaintiffs' claims against the Underwriter Defendants are timely. See Valence, 175 F.3d at 704. *8 The Underwriter Defendants move to dismiss plaintiffs claims on the ground that plaintiffs still fail to adequately allege that their claims are timely. To the extent defendants contend the complaint must be dismissed unless plaintiffs have alleged facts sufficient to determine at what point a reasonably diligent investor should have discovered the relevant facts underlying plaintiffs' claims against the Underwriter Defendants, recent Ninth Circuit authority holds to the contrary. In Livid Holdings Ltd. v. Salomon Smith Barney, 403 F.3d 1050 (9th Cir.2005), the Ninth Circuit addressed the statute of limitations argument raised by the defendants therein, even though it had not been addressed by the district court, as a possible alternative ground for affirming the district court's dismissal of the complaint. See id. at 1058-60. The Ninth Circuit found it was “not evident, based on the allegations in the complaint,” that “Livid should have been aware of the fraud one year before it filed its complaint.” See id. at 1059-60. There, the plaintiff, Livid, had alleged it first learned, approximately fourteen months before the complaint was filed, of a bankruptcy proceeding that triggered its first suspicion of fraud and an investigation. See id. at 1060. Livid also alleged that it did not have actual notice of the alleged fraud until approximately ten months before the complaint was filed, when it received a report from the independent auditor for the bankruptcy proceeding. See id. at 1059. The Ninth Circuit noted that “financial problems alone are generally insufficient to suggest fraud” and that “the filing of the bankruptcy petition alone seems unlikely to satisfy the inquiry-plus-due diligence standard, especially since ... [the] question of what a reasonably prudent investor should have known is particularly suited to a jury determination.” See id. at 1060. Rather than finding the complaint subject to dismissal because Livid had failed to allege facts sufficient to determine when a reasonable investor would likely have learned of the alleged fraud, the Ninth Circuit held that it could not decide as a matter of law “whether Livid should have been on notice of the alleged fraud one year before the complaint was filed.” See id. The Ninth Circuit concluded that “[b]ecause the record does not establish that the statute of limitations for the federal securities claim has run, we refuse to affirm the district court on this alternative ground.” See id . at 1058. The Underwriter Defendants further argue that allegations contained in plaintiffs' earlier-filed

complaints contradict their allegation that they learned only in December 2001 that the allegedly fraudulent conduct might have begun prior to the second quarter of 2001. The Court, however, previously has rejected the Underwriter Defendants' arguments that such prior allegations demonstrate plaintiffs were aware of their potential claims against the Underwriter Defendants prior to July 12, 2001. (See Dismissal Order at 11-12.) *9 The Underwriter Defendants also contend that plaintiffs were on inquiry notice of their claims against the Underwriter Defendants as early as June 20, 2001, when Exodus announced its “disastrous” second quarter of 2001 results. (See TAC ¶ 93.) Poor financial results for one quarter do not necessarily suggest that earlier statements were fraudulent, however. See Livid, 403 F.3d at 1060 (noting that “financial problems alone are generally insufficient to suggest fraud”); see also Gray v. First Winthrop Corp., 82 F.3d 877, 881 (9th Cir.1996) (noting “poor financial performance, standing alone, does not necessarily suggest securities fraud” and may be explained “by poor management, general market conditions, or other events unrelated to fraud, creating a jury question on inquiry notice”). Moreover, even assuming that Exodus's June 20, 2001 announcement was sufficient to trigger inquiry notice of the possibility of fraud in earlier financial statements, such as those contained in the Registration Statements for the February Offerings, the statute of limitations would not begin running on that date, but would only trigger a duty to begin an investigation. See Valence, 175 F.3d at 704. The statute of limitations would not begin to run until the date when “a reasonably diligent inventor [should] have discovered the facts underlying the alleged fraudulent activity.” See id. Plaintiffs allege that their counsel began investigating after plaintiffs contacted them, but that the investigation did not lead plaintiffs to suspect wrongdoing by the Underwriter Defendants until December 2001. (See TAC ¶ 319.) The Underwriter Defendants do not suggest, let alone specify, what plaintiffs should or could have done that would have alerted them to the facts underlying their causes of action against the Underwriter Defendants before the expiration of the relevant three-week period between the date of Exodus's June 20, 2001 announcement and July 11, 2001, one year prior to the filing of the first complaint that contained claims against the Underwriter Defendants. The issue of when a reasonably diligent investor should have discovered the facts underlying plaintiffs' claims against the Underwriter Defendants may be decided




on a motion to dismiss only where “the facts needed for determination of when a reasonable investor of ordinary intelligence would have been aware of the existence of fraud can be gleaned from the complaint and papers ... integral to the complaint.” See LC Capital Partners, LP v. Frontier Insurance Group, Inc., 318 F.3d 148, 157 (2nd Cir.2003) (ellipsis in original). This is not such a case. The Court cannot conclude, as a matter of law, that a reasonably diligent investor should have discovered wrongdoing in connection with the February Offerings within three weeks of Exodus's June 20, 2001 announcement of its second quarter of 2001 financial results. See, e.g., Livid, 403 F.3d at 1060 (noting the “question of what a reasonably prudent investor should have known is particularly suited to a jury determination”). *10 Accordingly, the Underwriter Defendants' motion to dismiss the § 10(b) and § 11 claims asserted against it, on the ground they are time-barred, will be DENIED.

B. Section 11 Claim: Sufficiency of Pleading The parties dispute whether the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure FN8 apply to plaintiffs' § 11 claim against the Underwriter Defendants. The Court previously has held that plaintiffs' § 11 claim, as alleged in the First Amended Complaint, was subject to the pleading requirements of Rule 9(b) because the § 11 claim sounded in fraud. (See Dismissal Order at 28-29.) Plaintiffs now argue that they have amended their § 11 claim to make clear that their allegations of fraud relate only to their § 10(b) claim.

FN8. When a complaint contains allegations of fraud, Rule 9(b) of the Federal Rules of Civil Procedure requires that plaintiffs: (1) specify the alleged fraudulent representations; (2) allege the representations were false when made; (3) identify the speaker; (4) state when and where the statements were made; and (5) state the manner in which the representations were false and misleading. SeeIn re GlenFed, Inc. Secur. Litig., 42 F.3d at 1547 n. 7.

Although a plaintiff alleging a claim under § 11 need not, as noted above, allege scienter or fraudulent conduct, the Ninth Circuit has held that “the particularity requirements of Rule 9(b) apply to

claims brought under Section 11 when ... they are grounded in fraud.” See In re Stac Electronics, 89 F.3d 1399, 1404-05 (9th Cir.1996). The Ninth Circuit further has clarified that where “fraud is not an essential element of the claim, and where allegations of both fraudulent and non-fraudulent conduct are made in the complaint,” only “allegations (‘averments') of fraudulent conduct” must satisfy the heightened pleading requirements of Rule 9(b), while “allegations of non-fraudulent conduct need satisfy only the ordinary notice pleading standards of Rule 8(a).” See Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1105 (9th Cir.2003). As further stated in Vess: “ ‘Where averments of fraud are made in a claim in which fraud is not an element, an inadequate averment of fraud does not mean that no claim has been stated. The proper route is to disregard averments of fraud not meeting Rule 9(b)'s standard and then ask whether a claim has been stated.” ’ See id. (internal quotation and citation omitted) (emphasis in original). Nevertheless, the Ninth Circuit made clear that where a plaintiff “allege[s] a unified course of fraudulent conduct and rel[ies] entirely on that course of conduct as the basis of a claim ... the claim is said to be ‘grounded in fraud’ or to ‘sound in fraud,’ and the pleading of that claim as a whole must satisfy the particularity requirement of Rule 9(b).” See id. at 1103-04 (citing Stac, 89 F.3d at 1404-05). In the instant case, the Court found that the First Amended Complaint made “no effort to distinguish between the Underwriter Defendants and the Individual Defendants, but rather allege[d] a unified course of fraudulent conduct as to all ‘defendants,’ averring consistently and repeatedly that the defendants knew the statements in question were false and misleading when made.” (See Dismissal Order at 29.) The Court noted that plaintiffs had pointed to “no allegations in the FAC to the effect that the false and misleading statements in the Registration Statements were either negligent or innocent misrepresentations, because no such allegations exist.” See id. at 30. Finally, relying on Stac, the Court rejected plaintiffs' contention that by pleading their § 10(b) and § 11 claims in separate counts, they adequately alleged a factual basis for their § 11 claim that was not based on fraud. See id.; see also Stac, 89 F.3d at 1405 n .2 (holding that although plaintiff had “specifically disclaimed any allegations of fraud with respect to its Section 11 claims,” such “[n]ominal efforts are unconvincing when the gravamen of the complaint is plainly fraud and no effort is made to show any other basis for the claims levied at the Prospectus.”)




*11 Since the Court's dismissal of the First Amended Complaint, the Ninth Circuit has issued its opinion in Daou, in which the Ninth Circuit discussed Vess and Stac in the context of determining whether the pleading standards of Rule 9(b) applied to the § 11 claim at issue in Daou. See Daou, 411 F.3d at 1027-28. The Ninth Circuit noted that “Rule 9(b) may prove fatal to 1933 Securities Act claims ‘grounded in fraud’ when the complaint makes a ‘wholesale adoption’ of the securities fraud allegations for purposes of the Securities Act claims.” See id. at 1028. The Ninth Circuit found such “wholesale adoption” present in Daou because the complaint alleged a fraudulent scheme by all defendants, and incorporated all allegations previously averred in the complaint for purposes of all of the claims. See id. at 1028. Moreover, the plaintiffs in Daou “never rel[ied] on such conduct as negligence or mistake in stating their claims.” See id. By contrast, in the instant case, the Third Amended Complaint contains significant new amendments to the § 11 claims that distinguish those claims from the § 11 claims alleged in the First Amended Complaint, and from those at issue in Daou and Stac. While the First Amended Complaint had alleged, for example, that all “defendants ... participated in an egregious accounting fraud ... including ... falsifying Exodus's financial results” (see, e.g., FAC ¶ 1), the Third Amended Complaint largely eliminates such all-inclusive references to “defendants” and replaces them with references to “Individual Defendants.” (See, e.g., TAC ¶ 44 (“Individual Defendants embarked on a scheme to defraud by, among other things, ... falsifying Exodus's financial results”) .) As a result, plaintiffs no longer allege that the Underwriter Defendants participated in all of the fraudulent conduct allegedly engaged in by the Individual Defendants. Further, plaintiffs now expressly allege that the Underwriter Defendants acted negligently by failing to conduct due diligence as to the veracity of the statements contained in the Registration Statements and only allege in the alternative that the Underwriter Defendants acted with knowledge or deliberate recklessness because they were aware that Exodus's financial results and forecasts were false due to improper revenue recognition practices and Exodus's failure to conform with GAAP. (See TAC ¶ ¶ 305-306.) Finally, plaintiffs now expressly disclaim any allegations of fraud in their cause of action for violation of § 11 (see TAC ¶ 343), set forth in that count all the specific conduct alleged to violate § 11, and do not incorporate in that count any of the other factual allegations set forth in the complaint, (see TAC ¶ ¶

343-355.) After itemizing the allegedly false and misleading statements and omissions contained in the Registration Statements for the February Offerings, plaintiffs allege that the Underwriter Defendants “owed to the purchasers of Exodus securities the duty to make a reasonable and diligent investigation of the statements contained in the [Registration Statements] at the time [they] became effective, to assure that those statements were true and that there was no omission to state material facts required to be stated in order to make the statements contained therein not misleading.” (See TAC ¶ 354.) Unlike the plaintiffs in Daou, plaintiffs here expressly allege that the Underwriter Defendants were negligent by failing to conduct a reasonable investigation into the statements contained in the Registration Statements and do not incorporate their allegations of fraud into their claim for violation of § 11. Unlike the plaintiffs in Stac, plaintiffs here make more than a “nominal effort” at disclaiming fraud as a basis for the § 11 claims, and expressly allege a separate basis for their § 11 claims and their § 10(b) claims. *12 As a result of the amendments to the complaint, plaintiffs have made sufficiently clear their intent to assert two alternative theories of liability against the Underwriter Defendants based on misstatements in the Registration Statements: (1) a § 11 claim based on negligent or innocent misrepresentations or omissions, (see TAC ¶ ¶ 306, 343-355), and (2) a § 10(b) claim based on fraud, (see TAC ¶ ¶ 305, 356-362). Rule 8(e)(2) of the Federal Rules of Civil Procedure expressly permits plaintiffs to state claims in the alternative. See Fed.R.Civ.P. 8(e)(2) (“A party may set forth two or more statements of a claim or defense alternately or hypothetically, either in one count or defense or in separate counts or defenses.”) There is no requirement that the claims be consistent. See Fed.R.Civ.P. 8(e)(2) (“A party may also state as many separate claims or defenses as the party has regardless of consistency.”) Thus, plaintiffs' assertion of separate claims against the Underwriter Defendants for violation of § 10(b) and § 11, based on the same conduct, but alleging differing states of mind, is expressly permitted by Rule 8. Moreover, the Supreme Court has recognized that “some conduct actionable under Section 11 may also be actionable under Section 10(b).” See Herman & MacLean v. Huddleston, 459 U.S. at 383. “[T]he availability of an express remedy under Section 11 of the 1933 Act does not preclude defrauded purchasers of registered securities from maintaining an action under Section 10(b).” See id. at 387 (emphasis added). In short, nothing in the statutory scheme




precludes plaintiffs from proceeding against the Underwriter Defendants under both § 10(b) and § 11. The Ninth Circuit has held, where plaintiffs choose not to allege “a unified course of fraudulent conduct,” but rather to allege “some fraudulent and some non-fraudulent conduct,” that “only the allegations of fraud are subject to Rule 9(b)'s heightened pleading requirements.” See Vess, 317 F.3d at 1104. “To require that non-fraud allegations be stated with particularity merely because they appear in a complaint alongside fraud averments ... would impose a burden on plaintiffs not contemplated by the notice pleading requirements of Rule 8(a).” See id. at 1104. “Allegations of non-fraudulent conduct need satisfy only the ordinary notice pleading standards of Rule 8(a).” See id. In the instant case, as noted, plaintiffs base their § 11 claims entirely on negligent or innocent misrepresentations, and base their § 10(b) claims against the Underwriter Defendants on fraudulent misrepresentations. In Vess, the Ninth Circuit held that the district court erred in dismissing the plaintiffs' entire complaint for failure to comply with Rule 9(b) because the state law claims at issue therein were based on both fraudulent and non-fraudulent conduct and, thus, the allegations did “not rely entirely on a unified fraudulent course of conduct.” See id. at 1105-06. The Ninth Circuit, in Stac, held that Rule 9(b) applies to § 11 claims only where such claims sound in fraud, citing approvingly a Fifth Circuit case in which that court held that Rule 9(b) applies to § 11 claims that are based on fraud rather than negligence. See Stac, 89 F.3d at 1405 (citing Melder v. Morris, 27 F.3d 1097, 1100 n. 6 (5th Cir.1994)). Here, because plaintiffs' § 11 claims are based on negligent and innocent misrepresentations, not fraud, and the complaint specifically alleges that plaintiffs “expressly disclaim any allegations of fraud” in connection with the § 11 claim, the Court finds Rule 9(b) does not apply. See Lone Star Ladies Investment Club v. Schlotzsky's, Inc., 238 F.3d 363, 369 (5th Cir.2001) (finding Rule 9(b) inapplicable to § 11 claim where complaint alleged plaintiffs did “not assert that defendants [were] liable for fraudulent or intentional conduct and disavow[ed] any allegation of fraud”); see also Holmes v. Baker, 166 F.Supp.2d 1362, 1371-74 (S.D.Fla.2001) (holding Rule 9(b) not applicable to § 11 claims based on erroneous financial statements in Prospectus because no allegation of scienter; applying Rule 9(b) to § 10(b) claim based on fraudulent financial statements); see also In re JDS Uniphase Corp.

Securities Litigation, 2005 WL 43463 at *9 (N.D.Cal. Jan.6, 2005) (holding Rule 9(b) inapplicable to § 11 claim even though “many of the allegations in the [complaint] sound in fraud” because § 11 claim was based on failure to conduct reasonable investigation and plaintiffs expressly disclaimed “any allegations based on fraud or deliberate recklessness”); In re Turnstone Systems Inc. Securities Litigation, No. C-01-1256 SBA, slip op. at 23-37 (N.D.Cal. Feb. 4, 2003) (surveying case law at length and declining to apply Rule 9(b) to § 11 claim based on allegations of negligence where the “gravamen of the [complaint] is fraud but the allegations underlying the Securities Act claims have been segregated out from those underlying the Exchange Act claims and do not aver fraud”).FN9

FN9. Although the Turnstone opinion has not been published, plaintiffs have submitted a copy of the opinion as Exhibit Q to their Compendium of Unpublished Decisions Cited in Plaintiffs' Oppositions to Defendants' Motions to Dismiss the Third Amended Consolidated Complaint.

*13 As noted, a plaintiff states a § 11 claim by alleging “(1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment.” See Daou, 411 F.3d at 1027 (citation omitted). “Allegations of non-fraudulent conduct need satisfy only the ordinary notice pleading standards of Rule 8(a).” See Vess, 317 F.3d at 1104. Plaintiffs adequately allege specific misrepresentations and omissions contained in the Registration Statements, and further allege how those misrepresentations and omissions were misleading. (See, e.g., TAC ¶ ¶ 306, 343-355). Nothing more is required. Accordingly, the Underwriter Defendants' motion to dismiss the § 11 claim asserted against them will be DENIED.

C. Section 10(b) Claim: Sufficiency of Pleading The Underwriter Defendants contend that plaintiffs have not adequately pleaded a § 10(b) claim as to any of the allegedly false statements made in the Registration Statements because plaintiffs have failed to establish falsity and scienter with the particularity required by the PSLRA.




As noted, plaintiffs allege that four statements in the Registration Statements were false or misleading when made: (1) “We believe that the acquisition [of GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our network, our customer support, sales and professional services organizations, and expands our customer base”; (2) Exodus achieved revenues of $280.4 million for the quarter ended December 31, 2000, and $818.4 million for fiscal year 2000; (3) “[Exodus has] established a diverse base of customers and continues to focus on supporting the strong demand from the enterprise market”; and (4) Exodus had 4500 customers under contract. (See TAC ¶ ¶ 72-73 (alterations in original).)

1. Statement Regarding Exodus's January 2001 Acquisition of GlobalCenter

Plaintiffs allege that the following statement in the Registration Statements was false and misleading when made: “We believe that the acquisition [of GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our network, our customer support, sales and professional services organizations, and expands our customer base.” (See TAC ¶ 72.) The Court previously held that plaintiffs failed to adequately allege that the above-referenced statement was false because plaintiffs did not allege any facts that suggested that management's statements of belief therein were untrue or misleading. (See Dismissal Order at 15.) In the First Amended Complaint, plaintiffs had alleged the statement was false and misleading because (1) Exodus's internal due diligence team had strongly recommended against the acquisition of GlobalCenter; (2) Exodus's Board of Directors was against the acquisition; (3) GlobalCenter's data centers in Tokyo, Sydney and London, and pending openings in Paris and Munich, all experienced substantial shortage in demand; and (4) the acquisition was nevertheless pushed through by Hancock because she wanted GlobalCenter for its two IDCs in Manhattan. (See FAC ¶ 146.) Plaintiffs allege no new facts about the GlobalCenter transaction in the Third Amended Complaint. Indeed, in their opposition, plaintiffs state: “While plaintiffs still believe that defendants' statements concerning the GlobalCenter acquisition were false and misleading, for the purpose of this opposition, plaintiffs will focus on the remaining three statements.” (See Opp. at 11 n. 5.)

*14 As plaintiffs thus effectively concede that they cannot state more facts about the GlobalCenter transaction to demonstrate the falsity of the statement about that transaction in the Registration Statements, the Court finds plaintiffs again have failed to allege with the particularity required by Rule 9(b) that such statement was false or misleading when made.

2. Statements Regarding Revenue Plaintiffs allege that the statements that Exodus had revenues of $280.4 million for the fourth quarter of 2000 and $818.4 million for fiscal year 2000 were false because Exodus had engaged in four types of accounting improprieties: (1) recording revenue prior to rendering services; (2) recording revenue on cancelled or non-renewed contracts; (3) recording revenue from transactions in which collectability was not probable; and (4) recording revenue and assets in conjunction with “bogus” barter transactions and failing to disclose such transactions. (See TAC ¶ 264.) In dismissing the First Amended Complaint, the Court found plaintiffs had not adequately alleged that the statements in the Registration Statements as to Exodus's revenue in the fourth quarter of 2000 and fiscal year 2000 were false and misleading when made, because plaintiffs failed to allege the amounts by which the revenues reported in the Registration Statements were misstated and failed to make “specific factual allegations regarding material accounting improprieties that affected the revenue statements contained in the Registration Statements.” (See Dismissal Order at 17-18 (citing In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1091 (9th Cir.1999).) Plaintiffs now allege that the Registration Statements overstated Exodus's fourth quarter of 2000 revenues by $25 million and its fiscal year 2000 revenues by $70 million. (See TAC ¶ 128.) The Underwriter Defendants argue, however, that plaintiffs still have not alleged “any particular amount associated with any particular accounting theory at any particular point in time,” (see Motion at 24), and, thus, have not adequately alleged that the revenue statements in the Registration Statements were false or misleading when made. Under GAAP, “revenue must be earned before it can be recognized.” FN10 See Daou, 411 F.3d at 1016 (emphasis omitted). “When pleading irregularities in




revenue recognition, plaintiffs should allege (1) such basic details as the approximate amount by which revenues and earnings were overstated; (2) the products involved in the contingent transaction; (3) the dates of any of the transactions; or (4) the identities of any of the customers or [company] employees involved in the transactions.” See id. (internal quotations omitted, brackets in original). “Plaintiffs need not allege each of those particular details,” however, but “must allege enough information so that a court can discern whether the alleged GAAP violations were minor or technical in nature, or whether they constituted widespread and significant inflation of revenue.” See id. at 1017 (internal quotation and citation omitted). “ ‘[A] general allegation that the practice[ ] at issue resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation.” ’ See id. at 1016. Rather, “although overstatement of revenues in violation of GAAP may support a plaintiff's claim of fraud, the plaintiff must show with particularity how the adjustments affected the company's financial statements and whether they were material in light of the company's overall financial position.” See id. at 1018.

FN10. Plaintiffs allege that Exodus's revenue recognition policy required the following four essential criteria to be met before revenue could be recognized: (1) “[p]ersuasive evidence of an arrangement exists”; (2) “[d]elivery has occurred or services have been rendered”; (3) “[t]he fee for the arrangement is fixed or determinable”; and (4) “[c]ollectability is reasonably assured.” (See TAC ¶ 133.)

*15 As the challenged statements in the Registration Statements address Exodus's revenues in fiscal year 2000, the Court examines the Third Amended Complaint for specific factual allegations of improprieties in revenue recognition in 2000.

a. Recording revenue prior to rendering services Plaintiffs allege that Exodus had a practice, in fiscal year 2000, of generating “installation reports, which triggered the onset of monthly invoicing and revenue recognition” before installation had begun. (See TAC ¶ ¶ 153, 154(b).) Plaintiffs allege that CW10, a credit and collections analyst for Exodus from July 1998 through June

2001, (see id. ¶ 126(j)), states that all customers were subjected to false installation reports and this practice “enabled Exodus to begin invoicing and recognizing revenue right after new sales were entered into, rather than to delay the process until installation was actually completed.” (See id. ¶ 154(c).) Further, according to plaintiffs, CW12, a senior collections specialist at Exodus from late 1999 through September 2001, (see id. ¶ 126(l)), states that “customers that ordered new installations in IDCs were consistently invoiced prior to installations having been completed, and many times prior to even beginning.” (See id. ¶ 155(a).) As an example, plaintiffs allege that a document titled “Cu. Open Orders by Customer-by Customer; Period: 02-00 as of 03/07/00,” pertaining to a customer identified as “Customer Nbr. 000661,” states that several items were installed on “1/1/1900,” which, plaintiffs allege, was a “place holder” indicating that the installation had not yet occurred. (See id. ¶ 155(b).) FN11 In addition, plaintiffs allege that, according to CW11, an Exodus credit and collections analyst from August 1999 through June 2001, (see id. ¶ 126(k)), Exodus had a “practice of inputting false installation dates in order to begin billing customers.” (See id. ¶ 156.)

FN11. Plaintiffs do not allege, however, that this customer was billed prior to installation.

Plaintiffs, however, do not, in any fashion, identify a single customer that was billed during fiscal year 2000 prior to installation, nor do plaintiffs attempt to quantify the amount by which this alleged practice overstated revenues in fiscal year 2000 or the fourth quarter of 2000. As noted, a “general allegation” that a particular practice “resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation”; rather, “the plaintiff must show with particularity how the adjustments affected the company's financial statements and whether they were material in light of the company's overall financial position.” See Daou, 411 F.3d at 1016, 1018. Accordingly, the Court finds plaintiffs have not alleged with the particularity required by Rule 9(b) that the statements of revenues for fiscal year 2000 and the fourth quarter of 2000 contained in the Registration Statements were false and misleading when made as a result of Exodus's alleged practice of billing customers prior to installation.

b. Recording revenue on cancelled or non-renewed




contracts *16 Plaintiffs allege that Exodus's billing system would invoice customers “in perpetuity” unless someone specifically input a change to a particular customer's billing, and that Exodus had a practice of not contacting customers to verify cancellations for purposes of changing the order system and discontinuing invoicing. (See TAC ¶ 146.) According to plaintiffs, “[w]hen customers were finally contacted by Exodus for payment, their response to Exodus, if any, would simply be that they were not going to pay the bill and were told they did not have to.” (See id. ¶ 146(b).) Plaintiffs allege that, according to CW10, “invoicing would continue even though the customer's equipment had been pulled out and Exodus was no longer performing services.” (See id. ¶ 147(b).) Plaintiffs allege that CW10 “believes that approximately 80% of the revenue reported by Exodus” from fiscal year 2000 through the end of the Class Period was largely fraudulent. (See id. ¶ 147(d).) Plaintiffs allege that CW11 “recalled that it was a common, daily occurrence for collectors to contact customers about old [accounts receivable], and be told that the customer had cancelled months earlier.” (See id. ¶ 148(a).) CW11 estimated that as much as 40% of the revenue recognized from late 2000 through Exodus's bankruptcy in September 2001 was uncollectable, “[b]ased on the number of accounts in the Solomon system during the Class Period, and the fact that about half of those invoiced had actually cancelled.” FN12 (See id. ¶ 148(c).) Plaintiffs allege no estimate obtained from either CW10 or CW11 of the revenue improperly recognized in fiscal year 2000 or the fourth quarter of 2000 on previously-cancelled contracts, nor do they allege that CW10 or CW11 identified any particular customer who cancelled during that time period yet continued to receive invoices from Exodus that were recorded as revenue.

FN12. Plaintiffs allege that “Solomon” is an Exodus “financial database.” (See TAC ¶ 232(a).)

According to plaintiffs, CW21, who held various management positions for Exodus from 1999 through 2003, (see TAC ¶ 126(u)), experienced difficulties in obtaining approval from Exodus's management to stop invoicing for cancelled contracts in 2001. (See TAC ¶ 149(a).) Such allegations do not support plaintiffs' allegation that revenues were overstated in 2000 due to Exodus's failure to stop invoicing on cancelled contracts.

According to plaintiffs, CW22 performed data entry and processed orders provided by Exodus's sales organization from 1999 to April 2001, and thereafter was one of two Exodus employees responsible for processing cancellations. (See TAC ¶ 126(v).) Plaintiffs allege that CW22 first became aware of a significant number of cancellations in November and December of 2000 and personally experienced a large number of cancellations “ordered by customers months earlier,” but which had not been processed through the Siebel system. FN13 (See id. ¶ 151(a).) In addition, plaintiffs allege that, according to CW22, “in the first part of the 1Q01, many of the customers booked at the end of the 4Q00 were cancelling-claiming that they had never ordered the services, or that they were not aware of how high the charges were, and could not afford the monthly program.” (See id. ¶ 151(i).) Plaintiffs further allege that CW22 told them that, prior to April 2001, “the vast majority of customer cancellations were routinely delayed for months, until the credit and collections department discovered through communications with the customers that the customers had pulled out months earlier and had notified salespersons,” and that “credits owed to these customers were routinely not processed for posting against these overcharges.” (See id. ¶ 151(c).) Plaintiffs allege that when CW22, in April 2001, became one of two persons responsible for processing cancellations, there were “stacks and stacks and piles on the floor” of outstanding cancellation request forms prepared by the credit and collections department that had not yet been processed, some of which were more than a year old and the majority of which had been prepared “months earlier.” (See id. ¶ 151(e)-(f).) Plaintiffs, however, set forth no estimate obtained from CW22 of the revenue improperly recognized in fiscal year 2000 or the fourth quarter of 2000 on previously-cancelled contracts, nor do they allege that CW22 identified any particular customer who cancelled during that time period yet continued to receive invoices from Exodus that were recorded as revenue.

FN13. According to plaintiffs, the Siebel system is Exodus's “order management system,” (see TAC ¶ 154(a)), and an “installation database,” (see id. ¶ 232(a).)

*17 Plaintiffs allege that CW25, an Exodus customer support representative responsible for resolving disputes with “high profile and strategic account customers,” (see TAC ¶ 126(y)), told them that in late 2000, it routinely took six months to process a




cancellation and that the cancelling customer would continue to be billed during that period. (See TAC ¶ 152(a).) Again, however, plaintiffs set forth no estimate obtained from CW25 of the revenue improperly recognized in fiscal year 2000 or the fourth quarter of 2000 on previously-cancelled contracts, nor do they allege that CW25 identified any particular customer who cancelled during that time period yet continued to receive invoices from Exodus that were recorded as revenue. CW23, an Exodus finance analyst from August 2000 to May 2001 who was responsible for performing collections, (see TAC ¶ 126(w)), allegedly became aware between August and December 2000, that Exodus had a “huge issue” with continuing to bill customers who had cancelled services either completely or in part. (See TAC ¶ 178(a).) CW23 estimated that from the fall of 2000 through the end of the class period, approximately 75% of customer accounts receivable were not legitimately owed by Exodus customers. (See id. ¶ 178(b).) Plaintiffs, however, allege no estimate obtained from CW23 of the revenue improperly recognized in fiscal year 2000 or the fourth quarter of 2000 on previously-cancelled contracts, nor do they allege that CW23 identified any particular customer who cancelled during that time period yet continued to receive invoices from Exodus that were recorded as revenue. In sum, although plaintiffs have alleged a general practice by Exodus of failing to promptly process cancellations during fiscal year 2000 and thereafter, they have not attempted to identify the amount of revenue improperly recognized in 2000 as a result of that practice. Moreover, although plaintiffs have alleged a general practice by Exodus of billing customers after cancellation, they have not identified any customers who were improperly billed in 2000 after cancellation, nor have they alleged that Exodus recorded the amount of any such bills as revenue. Accordingly, the Court finds plaintiffs have not alleged with the particularity required by Rule 9(b) that the statements of revenues for fiscal year 2000 and the fourth quarter of 2000 contained in the Registration Statements were false and misleading when made as a result of Exodus's alleged practice of billing customers after cancellation. See Daou, 411 F.3d at 1016-18.

c. Recording revenue from transactions in which collectability was not probable

Plaintiffs allege that Exodus's revenue was overstated in the Registration Statements because Exodus, beginning in 2000, was extending credit to non-creditworthy customers. (See TAC ¶ ¶ 141-145.) The Third Amended Complaint alleges two new examples of non-creditworthy customers, Alta Vista and Vulcan. (See TAC ¶ 142.) *18 With respect to Alta Vista, plaintiffs allege that Alta Vista did not stop making payments to Exodus until the first quarter of 2001. (See id. ¶ 142(i).) There is no allegation that Alta Vista was experiencing financial difficulties at any earlier date, and thus no allegation that Exodus improperly recognized revenue from Alta Vista in 2000. With respect to Vulcan, plaintiffs allege that Vulcan became a customer as of the first quarter of 2000, and continued to be carried as a customer until the end of 2001, when “the revenue associated with the deal, approximately $1 million, was written off because Vulcan had never paid.” (See id. ¶ 142(ii). Although plaintiffs allege “some” of the Vulcan revenue “was improperly recognized because Exodus was not performing any services,” plaintiffs fail to allege when Exodus ceased performing services. Moreover, that Vulcan ultimately failed to pay its bill provides no basis for inferring that it was not credit worthy at the time the deal was entered into or that the Underwriter Defendants were aware that Vulcan was not creditworthy at the time the Registration Statements were issued. In addition to their allegations with respect to Alta Vista and Vulcan, plaintiffs allege that Freerealtime.com was a “high risk contract” (see TAC ¶ 143(e)(ii); plaintiffs allege that Freerealtime.com became an Exodus customer in 2000 and “always presented a ‘hard collection” ’; plaintiffs do not allege, however, that any revenue attributable to Freerealtime.com was improperly recognized. (See TAC ¶ 143(e)(ii).) Additionally, according to plaintiffs, when Federal Liaison Service (“FLS”) had problems with Exodus's equipment and refused to pay its bills for more than a year after the problem was solved, CW21 wanted to shut down the equipment in January 2001, but was told by his supervisor that he would have to obtain permission first from Exodus's executives. (See TAC ¶ 144(b).) Plaintiffs fail to allege, however, that any revenue from FLS was improperly recognized in 2000. Moreover, nowhere in plaintiffs' complaint do they allege the amount by which Exodus's alleged extension of credit to non-creditworthy customers




allegedly resulted in overstated revenue for fiscal year 2000 and for the fourth quarter of 2000, nor do they explain how they calculated their estimate that all revenue recognition improprieties combined resulted in overstated revenues of $70 million for fiscal year 2000. (See TAC ¶ 128.) Accordingly, the Court finds plaintiffs have not alleged with the particularity required by Rule 9(b) that the statements of revenues for fiscal year 2000 and the fourth quarter of 2000 contained in the Registration Statements were false and misleading when made as a result of Exodus's extension of credit to non-creditworthy customers from whom collectability was not probable. d. Recording revenue and assets in conjunction with “bogus” barter transactions and failing to disclose

such transactions *19 The Court previously found plaintiffs had failed to adequately allege that statements in the Registration Statements that Exodus had revenues of $280.4 million for the fourth quarter of 2000 and $818.4 million for fiscal year 2000 were false due to Exodus's recording of revenue and assets in conjunction with “bogus” barter transactions and failing to disclose such transactions. (See Dismissal Order at 17-18.) The Court noted that only one such barter transaction was alleged as having been conducted during fiscal year 2000, and the transaction involved such a small dollar amount that statements about that transaction would not have been material. (See id. at 18.) The Underwriter Defendants again move to dismiss plaintiffs' claim, to the extent it is based on improper recording of revenue from barter transactions, on the ground plaintiffs have failed to allege any additional barter transactions during fiscal year 2000. Plaintiffs do not address their allegations as to barter transactions in their opposition. Accordingly, the Court finds plaintiffs have not alleged with the particularity required by Rule 9(b) that the statements of revenues for fiscal year 2000 and the fourth quarter of 2000 contained in the Registration Statements were false and misleading when made as a result of Exodus's recording of revenue and assets in conjunction with “bogus” barter transactions and failing to disclose such transactions.

3. Statement Regarding Demand for Services

Plaintiffs allege the statement that Exodus “continues to focus on supporting the strong demand from the enterprise market” FN14 was false or misleading when made because “Exodus was not seeing strong demand from the enterprise market.” (See TAC ¶ 76.)

FN14. As noted in the Court's Dismissal Order, the term “enterprise market” refers to customers other than “dot com” customers. (See Dismissal Order at 22 n. 17.)

In the First Amended Complaint, as noted in the Dismissal Order, plaintiffs had alleged that (1) according to certain specified former Exodus employees, by late 2000 and early 2001, Exodus was experiencing weakness in sales, cancellations and a drop in demand, (see FAC ¶ ¶ 133-140), and (2) Exodus's own bankruptcy disclosure statement later acknowledged that “[b]eginning in late 2000 and early 2001 ... a substantial number of Exodus's traditional enterprise clients delayed-and in some cases canceled-purchase decisions,” (see FAC ¶ 141). (See Dismissal Order at 18-19.) The Court found plaintiffs had failed to allege falsity with the requisite particularity because they had failed to allege “any facts as to particular cancellations, how any such cancellations related to Exodus's overall business, or whether such cancellations were in the enterprise market.” (See Dismissal Order at 20.) Defendants argue that plaintiffs' new allegations in the Third Amended Complaint are similar to those previously rejected by the Court as inadequate. Plaintiffs allege that CW17, who joined Exodus in January 2001 and regularly sat in on Exodus's weekly sales meetings, recalled that “the primary topic addressed at these meetings was ‘we're losing business.” ’ (See TAC ¶ 216.) CW17 also allegedly learned in these sales meetings that Exodus “lost several large potential deals in December 2000 because customers had pulled out due to the economic downturn.” (See id.) Defendants correctly point out that these allegations do not bear specifically on the strength of demand in the enterprise market. *20 Plaintiffs allege that CW23 “refuted that Exodus was increasing its customer base because of enterprise customers” because, according to CW23, the majority of new customers “that Exodus counted toward an alleged increase in customer base during 1Q01 and 2Q01 were actually upgrades for existing accounts provided at no cost.” (See TAC ¶ 218.) As such statements do not focus on the period prior to




the issuance of the Registration Statements, they permit no inference that Exodus's statement in the February 2001 Registration Statements that there was “strong demand from the enterprise market” was false at the time it was made. Moreover, CW23 is alleged to have been a finance analyst who “performed collections in the credit and collections department” (see TAC ¶ 126(w)) and plaintiffs do not allege that CW23 had personal knowledge of the demand for Exodus's services in the enterprise market prior to the date of the Registration Statements. The Third Amended Complaint contains somewhat more substantial allegations relating to CW16, who is alleged to have been responsible for creating detailed proposals in response to requests for proposals (“RFPs”) from potential customers in the enterprise market from July 1999 through February 2003. (See TAC ¶ ¶ 126(p), 217(a).) According to plaintiffs, CW16 noticed a decline in RFPs beginning in the third quarter of 2000, and a notable drop in the fourth quarter of 2000. (See id. ¶ 217(b).) CW16 also allegedly estimated that the number of proposals produced in response to RFPs fell from about six in January 2001 to three or four per month in March and April, and such proposals generally were in response to RFPs received a quarter or two earlier. (See id .) Although such allegations may suffice to allege with particularity that Exodus was experiencing a drop in RFPs from new enterprise customers at the time the Registration Statements were issued, they say nothing about demand from Exodus's existing enterprise customers. Consequently, plaintiffs have not alleged with particularity that Exodus's overall demand from enterprise customers was dropping at the time it stated that there was strong demand from the enterprise market in the Registration Statements. Accordingly, the Court finds plaintiffs again have failed to allege with the particularity required by Rule 9(b) that said statement was false or misleading when made.

4. Statement Regarding Number of Exodus Customers

Plaintiffs allege the statement that Exodus had 4500 customers (see TAC ¶ 72) was false or misleading when made because that number “included customers who were not active, who had cancelled and who had no ability to pay,” (see TAC ¶ 76.) Plaintiffs further allege that although Exodus's “installation database, Siebel, may have reflected approximately 4500 ‘customers,” ’ the “financial database” known as

“Solomon” identified only 3500 active customers. (See TAC ¶ 232(a).) Plaintiffs allege that the difference between the two numbers indicates that the approximately 1000 additional customers in the Siebel database reflected “potential deals input by the sales organization, as well as potential customers who had never closed the deal with Exodus.” (See id.) *21 The Court previously found these allegations insufficient to allege falsity with particularity because, among other deficiencies, plaintiffs failed to allege the date on which the Solomon database reflected only 3500 customers. (See Dismissal Order at 23.) In their Third Amended Complaint, plaintiffs have not alleged that date. Accordingly, plaintiffs again have failed to allege with the particularity required by Rule 9(b) that the statement in the Registration Statements that Exodus had, at that time, 4500 customers was false or misleading when made.

5. Scienter The Court dismissed the First Amended Complaint because “even assuming the statements in the Registration Statements were false or misleading, plaintiffs fail to offer any facts sufficient to demonstrate that the Underwriter Defendants acted with the requisite state of mind in making the statements.” (See Dismissal Order at 13.) Plaintiffs' allegations in the Third Amended Complaint similarly are insufficient under the PSLRA to raise a strong inference that the Underwriter Defendants intentionally or with deliberate recklessness made false or misleading statements to investors. As noted, the PSLRA requires the complaint to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” See 15 U.S.C. § 78u-4(b)(2). The Ninth Circuit has held that the required state of mind is “deliberate recklessness, at a minimum,” and that plaintiffs “must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct.” See Silicon Graphics, 183 F.3d at 974. In determining whether scienter has been adequately alleged, the Court must examine the totality of plaintiffs' allegations and consider “ ‘all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs.” ’ See America West, 320 F.3d at 938. To establish a strong




inference of scienter, the allegations must show that an inference of fraud is “ ‘the most plausible of competing inferences.” ’ See Gommper v. VISX, 298 F.3d at 897. The Third Amended Complaint contains only three new alleged facts relating to the state of mind of any of the Underwriter Defendants, each of which relates only to Goldman Sachs. As plaintiffs have failed to allege any new facts relating to the state of mind of Merrill Lynch, Morgan Stanley, or J.P. Morgan, plaintiffs' § 10(b) claims against those defendants again will be dismissed for failure to adequately allege scienter. With respect to Goldman Sachs, plaintiffs allege the following new facts. First, plaintiffs allege that a Goldman Sachs research analyst sent an internal email on February 23, 2001, less than three weeks after the February Offerings, stating: I have drafted a note that highlights our concerns yet does not translate into the lowering of numbers for specific companies. Considerations include: (1) we believe that most of our cost back-end loaded 2001 numbers have to come down, (2) exds [EXODUS] is a major offender of back-end loading, but to lower numbers right after selling equity @ $18.50 could be a problem. *22 (See TAC ¶ 74.) The Underwriter Defendants correctly argue that plaintiffs have misquoted this email. The actual email states: “most of our cos back-ended loaded 2001 numbers have to come down.” (See Underwriter Defendants' Request for Judicial Notice, Ex. Q (emphasis added).) FN15 The Underwriter Defendants contend that “cos” is an abbreviation for “companies” and not a misspelling of “costs”, and that the reference in the email to “back-end load[ing]” “was used to demonstrate that the revenue estimates for these companies would require a big third and fourth quarter revenue performance-“back-end loaded,” using industry jargon-for the companies to meet their forecasts.” (See Underwriter Defendants' Motion at 34.) Plaintiffs dispute this interpretation. The Court cannot resolve the parties' dispute about the meaning of this email on a motion to dismiss. Regardless of whether the email refers to back-end loaded costs or back-end loaded revenues, however, it is clear that the writer is concerned only about Exodus's “2001 numbers.” (See TAC ¶ 74.) Thus, the email provides no basis for inferring that Goldman Sachs was aware of problems with Exodus's financial results for 2000 at the time of the February Offerings and acted with scienter in publishing the Registration Statements for

the February Offerings.

FN15. The Court, in ruling on a motion to dismiss, may consider documents whose contents are alleged in the complaint, and whose authenticity no party questions, but which are not physically attached to the pleading. See Branch v. Tunnell, 14 F.3d at 454.

Plaintiffs also allege that, on April 17, 2001 and April 27, 2001, two months after the February Offerings, Goldman Sachs issued analyst reports identifying Exodus as a “recommend” buy, Goldman Sachs' highest investment classification. FN16 (See TAC ¶ 80.) According to plaintiffs,

FN16. Defendants also move for dismissal of any § 10(b) claim plaintiffs may be alleging based on statements in these analyst reports. The Court does not reach those arguments as plaintiffs have not clearly set forth such a claim in their complaint.

Internal Goldman Sachs' reviews demonstrate that Goldman Sachs was in fact aware of the analyst's biased and misleading reports, recognizing that the analyst in question “has subordinated personal preferences on recommendations for ‘commercial’ [i.e., banking] reasons,” that “[o]ne gets the sense that he's been held captive to the agenda of other ... were he allowed to exercise independent investment thesis, he would have had a decidedly different take of this group's prospects,” and that “while I understand he communicates what he really thinks to a sele[c]t few, his public ratings have been an embarrassment to the firm.” (See TAC ¶ 80 (alterations in original).) Plaintiffs do not set forth the date of the alleged internal reviews, and do not allege that the reviews addressed concerns about the analyst's recommendations and reports with respect to Exodus. Even assuming the quoted internal reviews expressed concern with respect to the analyst's public views about Exodus, there is no allegation that these concerns were raised prior to the February Offering. In short, these allegations permit no inference that Goldman Sachs acted with scienter in publishing the Registration Statements for the February Offerings. Finally, plaintiffs allege that the Securities and Exchange Commission filed a complaint against Goldman Sachs on April 28, 2003 for “biased and




misleading analyst coverage, specifically including Goldman Sachs' coverage of Exodus,” and “for violating rules of the National Association of Securities Dealers (NASD) and the New York Stock Exchange,” and that Goldman Sachs settled said complaint. (See id. ¶ ¶ 15, 75 and TAC Ex. D.) The mere filing of a complaint, absent any findings that the allegations of the complaint are true, can provide no basis for a strong inference of scienter by Goldman Sachs at the time of the February Offerings. *23 Accordingly, plaintiffs' § 10(b) claim against each of the Underwriter Defendants is subject to dismissal for failure to adequately allege scienter.

D. Summary In sum, the Court will (1) DENY the Underwriter Defendants' motion to dismiss plaintiffs' § 10(b) and § 11 claims as time-barred; (2) DENY the Underwriter Defendants' motion to dismiss plaintiffs' § 11 claims as inadequately pleaded under Rule 9(b); and (3) GRANT the Underwriter Defendants' motion to dismiss plaintiffs' § 10(b) claims for failure to adequately plead falsity and scienter under Rule 9(b) and the PSLRA.

DISCUSSION: INDIVIDUAL DEFENDANTS' MOTION TO DISMISS

The Third Amended Complaint asserts a claim for violation of § 10(b) of the Exchange Act and SEC Rule 10(b)(5) against each of the Individual Defendants, and a claim for violation of § § 11 and 15 of the Securities Act against Hancock only. (See TAC ¶ ¶ 343-362Plaintiffs also assert a claim against each of the Individual Defendants for violation of § 20(a) of the Exchange Act for acting “as controlling persons of Exodus.” (See TAC ¶ ¶ 363-365.) The Individual Defendants raise four principal arguments in their motion to dismiss: (1) plaintiffs fail to state a § 10(b) claim because they have failed to adequately allege falsity or scienter as to any of the statements alleged to be false, and because the PSLRA's Safe Harbor provisions insulate the forward-looking statements in question from liability; (2) plaintiffs are barred by the statute of limitations from asserting (a) the § 10(b) claims based on statements made in the expanded class period; (b) the claims against Brown, Mohammad, and Yeack; and (c) the § 11 claim against Hancock; (3) the § 11 claim against Hancock fails for the reasons set forth in the Underwriter Defendants' motion to dismiss; and (4) the § 20(a)

and § 15 claims fail because plaintiffs have not adequately pleaded, and are not able to plead, control person liability. The Court will begin its analysis with the Individual Defendants' arguments with respect to the statute of limitations.

A. Statute of Limitations The Individual Defendants argue that the plaintiffs are barred by the statute of limitations from bringing (1) the claims for violations in the period from April 20, 2000 to March 31, 2001 (the expanded class period first alleged in the First Amended Complaint), (2) the claims asserted against Mohamad, Yeack, and Brown, and (3) the § 11 claim against Hancock. As noted, the instant claims under § 10(b) and § 11 are timely if they were brought within one year of either actual discovery or inquiry notice of the facts constituting the alleged violations. “[I]nquiry notice triggers an investor's duty to exercise reasonable diligence and the one-year statute of limitations begins to run once the investor, in the exercise of reasonable diligence, should have discovered the facts underlying the alleged fraud.” ' See Valence, 175 F.3d at 704 (quoting Sterlin, 154 F.3d at 1201) (internal punctuation omitted). Thus, a court must ask (1) whether an event/publication “raise[d] sufficient suspicion of fraud to cause a reasonable investor to investigate the matter further,” and (2) when “a reasonably diligent inventor [should] have discovered the facts underlying the alleged fraudulent activity .” See Valence, 175 F.3d at 704. “If the answer to the first question is yes, the answer to the second question would determine when the statute of limitations began to run.” Id.

1. Claims Based on Violations During Expanded Class Period

*24 As noted, plaintiff's First Amended Complaint asserted claims on behalf of persons and entities who purchased Exodus securities between April 20, 2000 and September 21, 2001, whereas the class period alleged in the initial Consolidated Complaint covered purchases made between March 31, 2001 and June 20, 2001, a substantially shorter period. Defendants argue that the one-year statute of limitations bars the claims raised by those members of the newly-alleged class who purchased securities between April 20, 2000 and March 31, 2001.




For the reasons set forth in the discussion respecting the Underwriter Defendants' motion to dismiss, supra, plaintiffs have adequately pleaded facts demonstrating conformity with the statute of limitations as to plaintiffs' claims for wrongdoing between April 20, 2000 and March 31, 2001. See TAC ¶ ¶ 319-321, 331-34 (setting forth allegations that plaintiffs did not suspect wrongdoing occurring prior to the second quarter of 2001 until confidential witness interviews conducted in December 2001).FN17

FN17. The Court disregards plaintiffs' allegations that defendants “fraudulently concealed their activities,” (see TAC ¶ 316), as the Supreme Court has held that equitable tolling is “fundamentally inconsistent” with the limitations period for securities violations. See Lampf, 501 U.S. at 363; see also Pincay v. Andrews, 238 F.3d 1106, 1110 (9th Cir.2001) (describing fraudulent concealment as form of equitable tolling).

2. Claims Against Mohammad, Yeack and Brown

Plaintiffs' claims against Mohammad, Yeack and Brown were first asserted in the First Amended Complaint, which was filed July 11, 2002, more than one year after Exodus's June 20, 2001 announcement that its results for the second quarter of 2001 and for the fiscal year would be below prior expectations. The Court previously dismissed plaintiffs' claims against Mohammad, Yeack and Brown, with leave to amend, because plaintiffs failed to allege any reason for their failure to assert claims against Mohammad, Yeack and Brown in their prior complaints. Plaintiffs now allege they did not discover the possibility that Mohammad was involved in the alleged fraud until November and December 2001, when they interviewed CW6, CW7, and CW9, who informed plaintiffs that Mohammad “gave directions to the sales teams,” gave “account executives ‘marching orders' with respect to selling Exodus's products and services,” and “played a tremendous part in Exodus's downfall.” (See TAC ¶ ¶ 325-26.) According to plaintiffs, CW6 also told plaintiffs that, prior to the second quarter of 2001, Exodus was not bringing in any new customers. (See id. ¶ 325.) With respect to Yeack and Brown, plaintiffs allege they did not discover the possibility these defendants were involved in the alleged fraud until June 2002.

According to plaintiffs, CW1 told them, in June 2002, that Yeack and Brown both attended weekly executive staff meetings during the first and second quarters of 2001, at which CW1 repeatedly raised with management his concerns about improper recognition of revenue associated with continuing billings for non-paying or cancelled customers. (See TAC ¶ ¶ 323, 329.). The Individual Defendants argue that the facts alleged in support of plaintiffs' claims against Mohammad, Yeack and Brown are identical to those alleged against the other Individual Defendants and, accordingly, plaintiffs cannot claim plaintiffs were not similarly on notice as to their claims against Mohammad, Yeack and Brown at the time the initial complaints were filed. The Individual Defendants also point out that plaintiffs could easily have determined that Mohammad, Yeack and Brown were officers of Exodus by reviewing Exodus's March 31, 2001 Form 10-K. The issue is not whether plaintiffs were able to determine that Mohammad, Yeack and Brown were officers, however, but whether plaintiffs were alerted to facts suggesting Mohammad, Yeack and Brown were involved in the alleged fraud. Plaintiffs now allege specific facts as to the dates on which they first suspected Mohammad, Yeack and Brown of having engaged in wrongdoing. As all such dates are within one year of the date plaintiffs filed their First Amended Complaint, i.e., the first complaint in which plaintiffs alleged claims against Mohammad, Yeack and Brown, the Court finds plaintiffs have adequately pleaded compliance with the statute of limitations with respect to their claims against said defendants.

3. Section 11 Claim Against Hancock *25 For the reasons discussed earlier with respect to the Underwriter Defendants' motion to dismiss, plaintiffs likewise have adequately pleaded facts demonstrating conformity with the statute of limitations as to plaintiffs' § 11 claim against Hancock. Compare TAC ¶ ¶ 319-321 (setting forth allegations that plaintiffs did not suspect wrongdoing by the Underwriter Defendants in connection with the February Offerings until December 2001) with TAC ¶ ¶ 331-334 (setting forth similar allegations as to why plaintiffs did not suspect wrongdoing by Hancock in connection with the February Offerings until December 2001).

B. Sufficiency of Pleading: Section 10(b) Claim




As noted, in assessing whether plaintiffs have adequately pleaded a § 10(b) claim under the PSLRA, the court “must determine whether particular facts in the complaint, taken as a whole, raise a strong inference that defendants intentionally or with ‘deliberate recklessness' made false or misleading statements to investors.” See Ronconi v. Larkin, 253 F.3d at 429. “Where pleadings are not sufficiently particularized or where, taken as a whole, they do not raise a ‘strong inference’ that misleading statements were knowingly or with deliberate recklessness made to investors, a private securities fraud complaint is properly dismissed under Rule 12(b)(6).” See id. Plaintiffs' § 10(b) claims against the Individual Defendants are based on a series of public statements by Exodus, beginning with its announcement of its first quarter of 2000 financial results on April 20, 2000, and ending with its September 26, 2001 announcement that it had filed for Chapter 11 bankruptcy. (See TAC ¶ ¶ 45-118.) Additionally, plaintiffs' § 10(b) claims are based on a series of statements to the press by Hancock in August and September 2001. (See TAC ¶ ¶ 102-111.) The Third Amended Complaint contains no public statements by Exodus that were not alleged in the First Amended Complaint, but does allege several statements to the press by Hancock that were not alleged in the First Amended Complaint, specifically, an interview published August 3, 2001 by Business Week Online, (see id. ¶ 103), an interview published August 13, 2001 by Network World, (see id. ¶ 104), and an interview broadcast on CNN's Moneyline on August 23, 2001. (See id. ¶ 108). The Court previously dismissed the entirety of plaintiffs' § 10(b) claims for failure to adequately allege falsity and scienter. The Individual Defendants move again to dismiss the § 10(b) claims, and argue that plaintiffs' additional allegations fail to cure the deficiencies identified by the Court in its prior Dismissal Order.FN18

FN18. The Court's analysis of the Individual Defendants' motion has been made more difficult by plaintiffs' decision not to specifically address each of the subparts of the Individual Defendants' arguments, but rather to set forth their argument against dismissal in four subparts that do not directly correspond with the arguments made by the Individual Defendants.

1. Statements Regarding Exodus's Standards as to Customer Creditworthiness

In its prior complaint, plaintiffs alleged that Exodus's March 31, 2001 Form 10-K contained the following statements: (1) “We do not enter into arrangements unless collectability is reasonably assured at the outset”; (2) “Existing customers are subject to ongoing credit evaluations based on payment history and other factors”; and (3) “If it is determined that collectability is not reasonably assured, revenue is recognized on a cash basis.” (See FAC ¶ 78.) The Court previously dismissed plaintiffs' claim that these statements were false or misleading when made, and that the Individual Defendants knew about, or were deliberately reckless as to, such falsity, for the reasons set forth at length in the Court's Dismissal Order. (See Dismissal Order at 33-38.) *26 In dismissing the claim, the Court first rejected plaintiffs' reliance on statements by Hancock's successor as Exodus's CEO, Richard Krause (“Krause”), which were published on September 28, 2001 and October 1, 2001, that Exodus had acquired “customers who don't qualify to be customers,” (see TAC ¶ 137), because such statements reflected an assessment made six months after the March 31, 2001 Form 10-K and thus did not indicate knowledge of falsity at the time the 10-K statements were made. The Court further found the statements by Krause did not indicate when Exodus acquired the “customers who don't qualify to be customers,” and thus provided no basis for inferring that the statements in the March 31, 2001 Form 10-K were false when made. (See Dismissal Order at 33-34.) Plaintiffs now allege that in correspondence dated April 29, 2002, Krause's successor, Joe Stockwell, discussed “the extraordinary steps taken by the [Exodus bankruptcy] Estate between September 2001 and the end of January 2002 to clean up bad receivables.” (See TAC ¶ 139.) Plaintiffs' reliance on this additional statement, made more than six months after Krause's statements, similarly is unavailing, for the same reasons set forth above with respect to Krause's statements. The Court, in its Dismissal Order, also found plaintiffs' allegations with respect to information obtained from CW1 and CW10 inadequately pleaded. (See Dismissal Order at 34-36.) The Court found that plaintiffs had failed to allege specific facts sufficient to support CW1's belief that Exodus had non-creditworthy customers and a lack of proper bad-debt reserves, as well as CW10's belief that Hancock and Mohammad regularly approved high-risk customers




that had been rejected by the Credit and Collections Department and Finance Department. See id. at 34. In particular, the Court noted that plaintiffs failed to allege the number of non-creditworthy customers, the identity of any such customers, the amount by which Exodus's bad-debt reserves were insufficient, the amount of revenue attributable to such customers, and whether such customers failed to pay their bills. See id. at 34-35. With respect to the handful of customers alleged in the First Amended Complaint to have been high-risk or non-creditworthy, the Court found that plaintiffs had failed to allege specific facts as to why those customers were thought to have been non-creditworthy. See id. at 35. Plaintiffs now point to two additional customers they contend were non-creditworthy, specifically, Alta Vista and Vulcan. (See TAC ¶ 142.) Plaintiffs allege that Alta Vista “became insolvent and stopped making payments” in the first quarter of 2001 and thereafter CW1 called Alta Vista's CFO to discuss Alta Vista's outstanding invoices. (See id. ¶ 142(i).) Following that meeting, according to plaintiffs, Alta Vista “restructured the deal,” and within a quarter, “kicked Exodus out.” (See id.) Far from suggesting fraud, plaintiffs' allegations with respect to Alta Vista demonstrate only that when Alta Vista had trouble paying its bills, Exodus promptly responded and addressed the issue. *27 With respect to Vulcan, plaintiffs allege that Vulcan was an Exodus customer from the first quarter of 2000 through the end of 2001, “when the revenue associated with the deal, approximately $1 million was written off because Vulcan had never paid.” (See TAC ¶ 142(ii).) According to CW1, plaintiffs allege, “some” of the revenue attributable to Vulcan was improperly recognized “because Exodus was not performing any services and because Vulcan was already well in default-perhaps one or two quarters-on Exodus A/R.” (See id.) According to plaintiffs, CW1 “attempted to get in touch with responsible management at Vulcan and could not get his calls returned.” (See id.) Plaintiffs, however, allege no facts to suggest Vulcan was not creditworthy at the time it entered into any contract with Exodus, or that Exodus failed to conduct ongoing credit evaluations. Indeed, the allegations suggest that Exodus attempted to contact Vulcan when it did not pay its bills, and ultimately stopped performing services for Vulcan as a result of its failure to pay. Finally, plaintiffs' allegation that “some” revenue associated with Vulcan was improperly recognized is not pleaded with the particularity required by Rule 9(b).

The Third Amended Complaint contains allegations with respect to an additional source, CW21, a former Exodus employee who managed the project managers in the Austin/Dallas data centers. (See TAC ¶ 144.) According to plaintiffs, CW21, in the beginning of 2000, saw customers' credit applications for IDC space, which included their credit report statements. (See id.) Although many of these customers had no income and less than $30,000 in assets, plaintiffs allege, Mohammad pressured the finance department to approve their applications. (See id.) Plaintiffs fail to identify any of these customers by name, other than Live Oak Telecom, and allege no facts to suggest that the amount of services provided to these customers exceeded their ability to pay. Consequently, plaintiffs fail to adequately allege how Exodus's creditworthiness standards were not met by extending services to such customers. According to plaintiffs, CW21 also observed that non-creditworthy customers “who were not or could not make payments were not shut down and, instead, continued to be billed.” (See TAC ¶ 144(b)The only customer specifically identified, however, is Federal Liaison Services (“FDS”), who, plaintiffs allege, “would not pay because the equipment it ordered was not compatible with the co-located equipment.” (See id.) Although plaintiffs allege that FDS continued not making payments for more than a year after the compatibility problem was solved, (see id.), plaintiffs' allegations with respect to FDS suggest that FDS disputed its bills because of concerns with Exodus's performance, not that FDS was not a creditworthy customer. Plaintiffs further allege that although CW21 wanted to shut down FLS' equipment in January 2001, his boss told him that he first would have to obtain executive permission to do so. (See id.) Plaintiffs do not allege that such permission was sought and denied. *28 Plaintiffs also allege as new material that, according to CW5, Hancock would “frequently” approve non-creditworthy customers in order to record revenues. (See id. ¶ 145.) According to plaintiffs, CW5 described one instance in which service to a customer who owed approximately $700,000 was terminated, but Hancock and Case ordered the customer's service restored immediately; service was restored, billing continued, and collection was not made. (See id. ¶ 145.) Because plaintiffs fail to allege the name of the customer, the date service was terminated and restored, or the circumstances




surrounding the termination and restoration of service, this incident is not alleged with the particularity required by Rule 9(b). See Daou, 411 F.3d at 1016. In their prior complaint, plaintiffs included allegations that the statements respecting collectability were false because Exodus was in fact seeking to collect a large amount of unpaid debt from its customers, which allegations the Court found inadequately pleaded. (See Dismissal Order at 36.) The Court found inadequately pleaded plaintiffs' allegation that CW2, a former Exodus Employee who worked in a “Collection Task Force” set up by Exodus, “learned that in 2001, Exodus was trying to collect close to $500 million in debts from customers,” and that “[a]mong the debts the Collections Task Force attempted to collect included American Airlines, which owed between $5 and $7 million to Exodus.” (See FAC ¶ 116; Dismissal Order at 36.). In particular, the Court found such allegations were insufficient to demonstrate falsity or scienter because plaintiff failed to provide the requisite facts respecting CW2's source of information. (See Dismissal Order at 36.) The Third Amended Complaint includes no new allegations about the source of CW2's information. (See TAC ¶ 172.) The Third Amended Complaint does, however, allege that “a spreadsheet from Exodus's new system, Oracle, ... corroborates that, on August 31, 2001, a team of Exodus collectors were attempting to collect over $551 million of receivables from over 5,000 customers.” (See id.) FN19 Plaintiffs allege that the above-referenced Oracle spreadsheet further shows that of the $551 million Exodus was attempting to collect, more than $50 million was 91-120 days past due, more than $85 million was 121-180 days past due, and more than $122 million was more than 180 days past due. (See id. ¶ 168.) Plaintiffs attach to the Third Amended Complaint a declaration from Patrick A. Rueckert, manager of Exodus's Texas Sales Project Management, authenticating the Oracle spreadsheet and attesting that the information contained therein was current as of August 9, 2001. (See TAC App. Ex. E.) As the Oracle spreadsheet demonstrates that more than $122 million in accounts receivable was more than 180 days past due on August 9, 2001, such amounts were also more than 30 days past due on March 31, 2001, the date of Exodus's Form 10-K, in which the challenged statements about collectibility were included. Moreover, $122 million was a significant portion of Exodus's total accounts receivable, as the Oracle spreadsheet states that the amount of current accounts receivable as of August 9, 2001 was $108 million.

(See TAC App. Ex. B at 78.) Nonetheless, plaintiffs have failed to adequately allege that the statements about collectability in Exodus's March 31, 2001 Form 10-K were false at the time they were made, because the Oracle spreadsheet says nothing about whether collectability was reasonably assured at the time Exodus began providing services to such customers or whether Exodus subjected its customers to ongoing credit evaluations, and provides no information as to how the past due accounts receivable were recognized as revenue.

FN19. Although paragraph 172 of the Third Amended Complaint states that further allegations about the Oracle spreadsheet may be found in paragraph 85, such allegations actually appear in paragraph 168. The spreadsheet itself is attached to the complaint as Exhibit B.

*29 Finally, in the Court's Dismissal Order, the Court found inadequately pleaded plaintiffs' allegation that CW5, the Senior Manager of Credit and Collections for Exodus, (see FAC ¶ 104(e)), prepared a reserve report “for the March 2001 close,” which report “showed that 40% of the overall accounts receivable was not collectable.” (See Dismissal Order at 37-38 (quoting FAC ¶ 135).) The Third Amended Complaint does not materially expand on these allegations. (See TAC ¶ 219.) Accordingly, the Court finds plaintiffs have not adequately pleaded that the Individual Defendants' statements about collectability of Exodus's accounts receivable were false and misleading at the time they were made.

2. Statements Regarding Exodus's Revenue Recognition

Plaintiffs assert that Exodus's financial results, as stated in Exodus's 10Q reports regarding Exodus's first quarter of 2000 through its first quarter of 2001,FN20 were false or misleading because Exodus recognized revenue in violation of GAAP and SEC rules by engaging in four types of accounting improprieties: (1) recording revenue prior to rendering services; (2) recording revenue on cancelled or non-renewed contracts; (3) recording revenue from transactions in which collectability was not probable; and (4) recording revenue and assets in conjunction with bogus barter transactions and failing to disclose such transactions. (See TAC ¶ 264.) The




Individual Defendants move to dismiss plaintiffs' § 10(b) claim, to the extent such claim is based on such allegations, on the ground that plaintiffs have not adequately alleged any material misstatement of Exodus's revenues and fail to make any showing that the Individual Defendants knew of either the existence, or the amount, of any such misstatements.

FN20. Specifically, plaintiffs allege that the following reported financial results were false: (1) first quarter of 2000 revenues of $134.1 million and EBITDA profit of $1.7 million (see TAC ¶ ¶ 45, 48); (2) second quarter of 2000 revenues of $179.6 million and EBITDA profit of $8.6 million (see TAC ¶ ¶ 52, 54); (3) third quarter of 2000 revenues of $229.6 million and EBITDA profit of $20.2 million (see TAC ¶ ¶ 57, 60); (4) fourth quarter of 2000 revenues of $280.4 million and EBITDA profit of $26.5 million (see TAC ¶ 70, 78); and (5) first quarter of 2001 revenues of $348.7 million and EBITDA profit of $5.5 million (see TAC ¶ ¶ 82, 91).

As noted, “[w]hen pleading irregularities in revenue recognition, plaintiffs should allege (1) such basic details as the approximate amount by which revenues and earnings were overstated; (2) the products involved in the contingent transaction; (3) the dates of any of the transactions; or (4) the identities of any of the customers or [company] employees involved in the transactions.” See Daou, 411 F.3d at 1016 (internal quotations and citations omitted; alteration in original). “Plaintiffs need not allege each of those particular details,” however, but “must allege enough information so that a court can discern whether the alleged GAAP violations were minor or technical in nature, or whether they constituted widespread and significant inflation of revenue.” See id. (internal quotation and citation omitted). A “general allegation” that a particular practice “resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation.” See id. Rather, “although overstatement of revenues in violation of GAAP may support a plaintiff's claim of fraud, the plaintiff must show with particularity how the adjustments affected the company's financial statements and whether they were material in light of the company's overall financial position.” See id. at 714. *30 Accordingly, the Court turns to each of the accounting improprieties alleged by plaintiffs in the

Third Amended Complaint.

a. Recording Revenue Prior to Rendering Services The Court previously has dismissed plaintiffs' § 10(b) claim against the Individual Defendants, to the extent such claim was based on an alleged practice of recording revenue prior to rendering services, because plaintiffs failed to adequately allege the source of the confidential witnesses' knowledge of such practice, and because plaintiffs failed to allege facts with sufficient particularity to show the reported financial results were false when made or that any of the Individual Defendants had knowledge of such falsity. (See Dismissal Order at 44-45.) The Ninth Circuit has held that information obtained from confidential witnesses may provide a basis for a securities fraud complaint if the “sources are described with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged and the complaint contains adequate corroborating details.” See Daou, 411 F.3d at 1015 (internal quotations omitted). Plaintiffs have amended the complaint to allege that CW10 “is a former Exodus employee who was responsible primarily for running credit checks on prospective customers and who worked closely with collectors,” (see TAC ¶ 154), and that CW12 is “a former Exodus collector,” (see TAC ¶ 155). Neither allegation adequately sets forth an explanation as to how the confidential witnesses obtained knowledge about Exodus's revenue recognition practices. Plaintiffs also add a new allegation that Exodus regularly input an installation date of 1/1/1900 into the Solomon database FN21 as “a ‘placeholder’ which indicated to Exodus internally that the items ordered were ‘not installed.” ’ (See TAC ¶ 155(b).) Plaintiffs allege that a document titled “Cu. Open Orders by Customer-by Customer; Period: 02-00 as of 03/07/00,” pertaining to a customer identified as “Customer Nbr. 000661” indicates that several items were installed on “1/1/1900.” (See id.) Plaintiffs do not allege, however, that this customer was billed prior to installation and, indeed, does not allege the name of any customer who was billed by Exodus prior to installation based on an installation date, according to the Solomon database, of “1/1/1900.”

FN21. As noted above, plaintiffs allege that the Solomon database is an Exodus




“financial database.” (See TAC ¶ 232(a).) In addition, plaintiffs add a new allegation that, according to CW11, an Exodus credit and collections analyst from August 1999 through June 2001, (see id. ¶ 126(k)), Exodus had a “practice of inputting false installation dates in order to begin billing customers.” (See id. ¶ 156.) Plaintiffs fail to allege, however, the name of any customer that CW11 identified who was billed prior to installation, the details of any such transaction, or the amount by which any such pre-installation billing affected Exodus's financial statements. *31 Accordingly, the Court finds plaintiffs have not successfully amended their complaint to state a § 10(b) claim based on fraudulently recognizing revenue prior to installation. b. Recording Revenue on Cancelled or Non-renewed

Contracts Plaintiffs claim that Exodus's financial statements were fraudulent as a result of a practice by Exodus of continuing to recognize revenue based on orders that had been cancelled, and of entering into “side agreements” with customers, by which customers who cancelled their contracts with Exodus would continue to be billed but were permitted to ignore the invoices. (See TAC ¶ 146.) The Court previously dismissed this claim because “plaintiffs fail[ed] to identify any particular customer who was billed subsequent to cancellation and/or who entered into a side agreement, let alone the dates of any such transactions or the amount of revenue involved.” (See Dismissal Order at 45-46.) In the Third Amended Complaint, plaintiffs add allegations obtained from CW21 and CW12. Although CW21 and CW12, according to plaintiffs, observed Exodus continuing to invoice customers after the customers cancelled their contracts, (see TAC ¶ ¶ 149-150), plaintiffs do not allege any particular customer, of which CW21 or CW12 was aware, who was billed after cancellation. Plaintiffs also add allegations relating to CW22, “a former Exodus employee who processed orders in the sales group and then became one of two employees in the cancellations department formed in April 2001.” (See TAC ¶ 151.) CW22, according to plaintiffs, was aware, in November and December 2000, of a large number of cancellations “ordered” by customers months earlier, but which had not been processed.

(See TAC ¶ 151(a).) According to CW21, “the vast majority of customer cancellations were routinely delayed for months,” and Exodus continued to book revenue on hundreds of accounts that had actually been cancelled for months. (See id. ¶ 151(b)-(c).) In April 2001, according to plaintiffs, CW22 processed at least 125 cancellations, the majority of which came from cancellation requests prepared months earlier, and he continued to process hundreds of such cancellations into the summer of 2001. (See id. ¶ 151(f).) Plaintiffs again fail to identify any particular customer who was billed subsequent to cancellation and/or who entered into a side agreement, the dates of any such transactions, or the amount of revenue involved, much less the amount by which such practice of post-cancellation billing affected Exodus's financial results. Defendants argue that Exodus disclosed in its Form 10Q for the first quarter of 2001 that it sold its “services under contracts that typically [had] a minimum term of one year,” (see Individual Defendants' Request for Judicial Notice (“RJN”) Ex. 23 at 11), and that plaintiffs fail to explain how customers can unilaterally cancel their contracts and why Exodus was not entitled to bill a customer for the entire period of their contract. Defendants also point out that plaintiffs themselves appear to recognize that early termination of a contract required approval from Exodus, in that plaintiffs allege that at least one customer cancelled its contract “but waited for approval of the cancellation from Exodus.” (See TAC ¶ 5.) The Court agrees that plaintiffs fail to allege whether the contracts in question were cancelled prior to the end of their term and, if so, why Exodus was not entitled to continue to bill customers for the duration of the contractually-agreed term. *32 Accordingly, the Court finds plaintiffs have not successfully amended their complaint to state a § 10(b) claim based on fraudulently recognizing revenue on cancelled or non-renewed contracts.

c. Recording Revenue from Transactions in which Collectability Was Not Probable

Plaintiffs allege that “it was common practice for Exodus to enter into contracts with customers that had limited capital resources, many of which were Internet companies on the verge of bankruptcy.” (See TAC ¶ 268.) According to plaintiffs, “[t]hese transactions were in violation of GAAP and SEC rules as the collectibility was not reasonably assured.” (See id.) The Court previously dismissed,




as inadequately pleaded, plaintiffs' § 10(b) claims to the extent such claims were based on the recording of revenue from transactions in which collectability was not probable. (See Dismissal Order at 46.) Plaintiffs have amended their allegations to allege that Exodus “failed to establish sufficient reserves for its deteriorating accounts receivable.” (See TAC ¶ 269.) According to plaintiffs, in March 2001, CW5 prepared a reserve report for Exodus's management, including Wegner, Dollahite, Case and Hancock, which showed that 40% of the overall accounts receivable was not collectible. (See id. ¶ ¶ 219, 270.) Plaintiffs allege that, according to CW21, the Individual Defendants initiated “Project Resolve” at the beginning of April 2001, in an attempt to collect as much cash as possible on outstanding customer balances.” (See TAC ¶ 270.) According to CW21, Project Resolve targeted 275 customers with disputed balances, who were chosen because they represented the best chance of collecting cash. (See id. ¶ 272.) Plaintiffs allege that the goal of the project was to negotiate with the customers who had disputed balances “in order to come to an agreement on how much the customer would remit to Exodus immediately.” (See id.) According to CW21, the progress of Project Resolve was monitored via a database titled “Project Resolve Summary Tracking Database”; as of April 4, 2001, that database identified $23.4 million in disputed balances relating to the targeted 275 customers, and identified that amount as constituting 52.1% of the “Outstanding Past Due” accounts receivable for that group of customers. (See id. ¶ ¶ 165-167, 274 and Ex. A.) Because Exodus considered the targeted 275 customers as its best chance for collection, plaintiffs contend, the Individual Defendants knew that at least 52.1% of Exodus's accounts receivable were uncollectible. (See id. ¶ 275.) Plaintiffs estimate that Exodus's accounts receivable reserve was only $23.8 million in the first quarter of 2001 and allege that it rose to $114 million by the third quarter of 2001, which, according to plaintiffs, was 32.1% of Exodus's outstanding accounts receivable. (See id. ¶ ¶ 276-77.) Plaintiffs allege: “Based on the information contained in the ‘Project Resolve Summary Tracking Database’ as well as the bad debt and revenue reserve reports that showed 40% of Exodus's gross A/R was uncollectible, Individual Defendants knew that Exodus should have recorded an accounts receivable reserve of at least $95 million by March 31, 2001 (1Q01), if not sooner.” (See id. ¶ 277.) *33 Plaintiffs' new allegations with respect to Project Resolve add nothing to their allegations that Exodus

improperly recognized revenue from transactions from which collection was not reasonably assured. Plaintiffs do not allege that Exodus was aware of any problems with collectability as to any of the 275 customers involved in Project Resolve at the time revenue was recognized. In addition, the mere fact that a bill was disputed does not support the inference that revenue from that transaction was improperly recognized. Moreover, there is nothing to suggest the existence of Project Resolve itself was part of a fraudulent scheme. To the contrary, it suggests that Exodus was making a good faith effort to resolve billing disputes. Finally, with respect to Exodus's calculation of reserves for doubtful accounts, plaintiffs acknowledge that the first quarter of 2001 reserve for doubtful accounts was not included in Exodus's Form 10-Q and plaintiffs allege no basis for concluding that the reserve was $23.8 million at the end of the first quarter of 2001. (See TAC ¶ 276 and n. 6.) Nor do plaintiffs allege a basis for their conclusion that the reserve should have been at least $95 million at that time. (See id. ¶ 277.) Accordingly, plaintiffs fail to state a § 10(b) claim based on (1) improper recognition of revenue from transactions from which collectability was not reasonably assured, (2) the existence of Project Resolve, or (3) Exodus's calculation of reserves for doubtful accounts receivable. d. Recording revenue and assets in conjunction with

barter transactions Plaintiffs allege that the Individual Defendants engaged in a fraudulent scheme “to improperly gross up revenues based on fictitious or over valued reciprocal/barter transactions.” (See TAC ¶ 278.) According to plaintiffs, “Exodus violated GAAP and SEC rules by recording revenue on its reciprocal (roundtrip)/barter transactions because the transactions had no economic substance as the companies merely entered into the reciprocal arrangements so that Exodus could artificially inflate its revenues.” (See id .) Plaintiffs point to transactions with Oracle, Innoventry, Niku and Yahoo as examples of improper revenue recognition. (See id . ¶ ¶ 207-209.) The Court previously has dismissed these allegations with respect to the Oracle, Innoventry, and Niku transactions as inadequately pleaded. (See Dismissal Order at 46-49.) Plaintiffs' allegations with respect to the Yahoo transaction did




not appear in the First Amended Complaint. The Court previously dismissed plaintiffs' claim based on the Oracle transaction because the transaction was alleged to have occurred during the fourth quarter of 1999, outside the class period. (See Dismissal Order at 47.) Plaintiffs now allege that CW1, who was responsible for financial accounting and reporting for the Professional Services organization, “believes” that Exodus wrote off the cost of the Oracle licenses in the first quarter of 2001 as a bad debt and expense and that, although revenue on the Oracle transaction was recorded in 1999, Exodus “improperly reported an overvalued asset (useless Oracle licenses) on its financial statements during the Class Period, through at least December 2000.” (See TAC ¶ 207(a).) As defendants correctly point out, plaintiffs have failed to allege the basis for CW1's “belief” that the Oracle licenses were written off in the first quarter of 2001. As noted, the PSLRA requires that if an allegation is made on information and belief, “the complaint shall state with particularity all facts on which that belief is formed.” See 15 U.S.C. § 78u-4(b)(1). Moreover, as defendants also point out, even if the $5 million Oracle licenses were improperly reported as assets, that amount is only 0.1% of the $3.9 billion in assets Exodus reported as of December 31, 2000, and only 0.2% of the $2.1 billion increase in assets reported from December 31, 1999 to December 31, 2000. (See Individual Defendants' RJN Ex. 22 at 15.) To the extent plaintiffs seek to allege that the amount of the Oracle transaction is material, the complaint fails to allege facts sufficient to support such allegation. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (“[T]o fulfill the materiality requirement ‘there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” ') Accordingly, plaintiffs have failed to adequately amend their § 10(b) claim based on the Oracle transaction. *34 The Court previously dismissed plaintiffs' claim with respect to the Innoventry transaction because plaintiffs failed to adequately allege CW1's personal knowledge of the transaction. (See Dismissal Order at 47.) Plaintiffs now admit that CW1 “does not now have a clear recollection” of the Innoventry transaction. (See TAC ¶ 207(b).) Accordingly, plaintiffs have failed to adequately amend their § 10(b) claim based on the Innoventry transaction. The Court previously dismissed plaintiffs' claim with

respect to the Niku transaction because plaintiffs failed to adequately allege the particulars of the transaction, the source of CW1's knowledge thereof, the materiality of the transaction, or the Individual Defendants' knowledge of any improper motive behind the transaction. (See Dismissal Order at 48.) As plaintiffs fail to allege any new facts about the Niku transaction, plaintiffs have failed to adequately amend their § 10(b) claim based on said transaction. With respect to the Yahoo transaction, plaintiffs allege that, on January 9, 2002, Yahoo filed a “response” in Exodus's bankruptcy proceedings, which indicated that Yahoo's purchase of services from Exodus, pursuant to a Master Service Agreement entered into in October 1998, “was dependent upon a commitment by Exodus to purchase Yahoo! services.” (See TAC ¶ 209.) In particular, plaintiffs allege that Yahoo stated, in its filing in the bankruptcy court, that Exodus “agreed to purchase Yahoo! services equal to ten percent (10%) of Yahoo!'s payments to [Exodus].” (See id.) As defendants correctly point out, there is no allegation that the revenues from the Yahoo agreement were booked within the class period, or that the agreement was improper in any way. As plaintiffs themselves recognize, barter transactions do not necessarily violate GAAP. (See TAC ¶ 281 (citing APB 29).) Accordingly, plaintiffs fail to state a § 10(b) claim based on improper recognition of revenue and assets from barter transactions.

3. Statements Regarding Number of Exodus Customers

Plaintiffs allege that Exodus's April 26, 2001 press release, in which Exodus announced its first quarter of 2001 results, fraudulently misrepresented the number of its customers. (See TAC ¶ ¶ 82, 232.) According to plaintiffs, Exodus's representations that it had approximately 4000 customers at the beginning of the quarter, and 4526 customers at the end of the quarter, were overstated by approximately 1000 customers because the reported numbers of customers included both potential customers and customers who had cancelled. (See TAC ¶ ¶ 82, 232.) The Court previously dismissed plaintiffs' § 10(b) claim, to the extent such claim was based on misrepresentations about the number of Exodus's customers, because plaintiffs failed to adequately allege facts showing that the customer count was false when made or facts giving rise to the requisite strong inference of scienter. (See Dismissal Order at




38-39.) *35 Plaintiffs continue to allege that the Solomon database contained only 3500 active customers, (see TAC ¶ 232(a)), but, as in the First Amended Complaint, plaintiffs fail to allege the date(s) on which the Solomon database contained 3500 customers. Plaintiffs add a new allegation that CW25 “recalls that by the end of the 2Q01, the number of actual active customers totaled between 1500 and 2000.” (See TAC ¶ 152(a).) The number of customers at the end of the second quarter of 2001, however, fails to demonstrate the falsity of Exodus's statements about the number of its customers at the end of the first quarter of 2001. Finally, plaintiffs' allegations that, in July 2001 or later, adjustments were made to the Solomon and Siebel customer databases to delete customers who had cancelled or were inactive, (See TAC ¶ ¶ 232, 234), permit no inference that Exodus's statements in April 2001 about the number of its customers were false when made. Accordingly, plaintiffs fail to state a § 10(b) claim based on Exodus's April 2001 statement about the number of its customers.

4. Processing of Customer Credits In the Third Amended Complaint, plaintiffs add new allegations that Exodus's financial results during the class period were overstated because Exodus failed to timely credit customers who were overbilled. (See TAC ¶ 193.) Plaintiffs allege that, according to CW12, a former Exodus collections specialist from 1998 through September 2001, (see id. ¶ 126(I)), Exodus Controller Suzanne Colvin, at meetings during late 2000 and at the end of the first quarter of 2001, told collectors that credits were not being issued because Exodus needed the revenue for its financial reports. (See id. ¶ 194.) According to CW12, plaintiffs allege, it was typical for Colvin to advise collectors at monthly meetings that management did not want to approve credits because of the adverse impact such credits would have on Exodus's financial reports. (See id.) Plaintiffs also allege that CW11, a former Exodus credit and collections analyst, (see id. ¶ 126(k)), recalled that Exodus “carried a huge backlog of credits for all types of over-billing and disputed charges, most of which went for months and even quarters without being authorized[.]” (See id . ¶ 195.) Plaintiffs cite a number of internal emails identifying

specific customers who are alleged to have been overbilled, and whose accounts were not immediately credited. (See id. ¶ 159.) Plaintiffs do not attempt to quantify, however, how the delayed processing of customer credits affected Exodus's financial reports. As noted, a “general allegation” that a particular practice “resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation.” See Daou, 411 F.3d at 1016. Although plaintiffs have, in this instance, identified the customers, plaintiffs also must show with particularity how the overstatement of revenues affected the company's financial statements and whether the overstatement was material in light of the company's overall financial position. See id. at 1018. *36 Accordingly, plaintiffs fail to state a § 10(b) claim based on the allegation that Exodus had a practice of delaying processing of customer credits.

5. Massaging of Financial Results In the Third Amended Complaint, plaintiffs add new allegations, based on “messages posted on a Yahoo board for Exodus alumni,” (see TAC ¶ 198), that Exodus “massaged its financial results by failing to use ‘real’ numbers.” (See id.) Plaintiffs identify the authors of the postings only by first name, and fail to allege their positions at Exodus, or the basis for their knowledge of the information posted on the Yahoo message board. As noted above, “personal sources of information relied upon in a complaint should be described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” See Daou, 411 F.3d at 1015 (internal quotation and citation omitted). As plaintiffs fail to do so, they fail to state a § 10(b) claim based on the allegation that Exodus “massaged” its financial results.

6. Delaying Recording of Expenses Plaintiffs add new allegations, in their Third Amended Complaint, that, according to CW1, Colvin “routinely kept track of expenses that were recorded in the wrong period and documented such expenses on an ‘ATF’-or ‘After the Fact’-report.” (See TAC ¶ 201According to plaintiffs, based on information provided by CW1, a January 2001 ATF report “reflects $5.3 million of expenditures that were ‘out of period’,” of which amount, “at least $800,000 should have been fully expensed during 4Q00.” (See




TAC ¶ 202.) Plaintiffs do not allege any specific expenses that were recorded in the wrong period, however. Plaintiffs also fail to allege any facts from which one could infer that the expenses were recorded in the wrong period as part of a fraudulent scheme, rather than as the result of mere oversight. Accordingly, plaintiffs fail to state a § 10(b) claim based on the allegation that Exodus delayed recording expenses.

7. Misdating Checks Plaintiffs allege that, in Exodus's bankruptcy proceedings, the bankruptcy judge noted, on September 3, 2003, that Krause, Exodus's new CEO, had testified that backdating of checks had occurred at Exodus. (See TAC ¶ 204.) Plaintiffs further allege that “[a]lthough the specific misdating of checks event discussed by [the bankruptcy judge] appears to have occurred after Exodus filed for bankruptcy, it is significant in that it sheds light on the character of the Company's management and its corporate culture, which apparently viewed such improper conduct as ‘business as usual.” ’ (See id.) Plaintiff also allege that “the misdating of checks apparently was also standard business practice at Exodus during the Class Period because Storagenetworks alleged, in its complaint against Exodus, ... that misdating of checks took place during the alleged time period.” (See id.; see also id. ¶ 181.) *37 Plaintiffs fail to allege any incident during the class period in which Exodus misdated a check and, indeed, appear to concede they are unaware of any such occurrence. Accordingly, plaintiffs fail to state a § 10(b) claim based on the allegation that Exodus misdated checks as part of a fraudulent scheme.

8. Sanrise Transaction In the First Amended Complaint, plaintiffs alleged that Exodus improperly recognized revenue on a January 2001 transaction with Sanrise. (See FAC ¶ 111(f).) The Court previously dismissed plaintiffs' § 10(b) claim, to the extent such claim was based on such allegations, because plaintiffs failed to respond to defendants' arguments. (See Dismissal Order at 47 and n. 36.) In the Third Amended Complaint, plaintiffs allege

that Exodus and Sanrise entered into an agreement on December 28, 2000, pursuant to which Sanrise “acquired the data storage operations and equipment of Exodus, and became the outsource provider of Data Vault brand backup and restoration services to Exodus customers in its IDCs.” (See TAC ¶ 210.) According to plaintiffs, the “purchase price” was 8,450,000 shares of Sanrise preferred stock valued by Exodus at $25 million, a promissory note “in the amount of $17.5 million,” and $5 million in cash. (See id.) Elsewhere in the Third Amended Complaint, plaintiffs allege that the transaction included a promissory note of “approximately $20 million.” (See id. ¶ 69.) Plaintiffs allege that Exodus made false and misleading statements in reporting the Sanrise transaction. (See id. ¶ 211.) First, plaintiffs allege, the total consideration for the transaction was $47.5 million, not $55.1 million as Exodus reported in its Form 10-Q for the period ending March 31, 2001. (See id .; see also Individual Defendants' RJN Ex. 23 at 6.) Next, according to plaintiffs, the value of the Sanrise preferred stock “was at best undeterminable and significantly overstated.” (See TAC ¶ 211.) In addition, plaintiffs allege that GAAP required Exodus to “defer any gain and recognize it on the cash basis as any proceeds are received” because Sanrise was in “very poor financial health.” (See id.) Further, plaintiffs allege that Exodus ultimately “returned the preferred stock and did not receive full value for the note[.]” (See id. ¶ 212.) Finally, plaintiffs allege, a January 23, 2001 press release about the Sanrise transaction was false and misleading “because it created the impression that Sanrise made a straight purchase of Exodus's Data Vault assets when in fact the parties had entered into a two-year license agreement that provided for Sanrise to operate the Data Vault services business.” (See id. ¶ 69.) As defendants point out, plaintiffs make conflicting allegations as to the amount of consideration Sanrise agreed to pay Exodus. (Compare id. ¶ ¶ 69, 210.) Plaintiffs also contradict themselves as to whether Sanrise purchased assets from Exodus or entered into a lease. (Compare id. ¶ ¶ 69, 210.) Moreover, plaintiffs fail to cite a single document, witness, or other source in support of their allegations as to the content and value of the Sanrise transaction. As noted, when an allegation of fraud is made on information and belief, the PSLRA requires a




plaintiff to support its claim by alleging “with particularity all facts on which that belief is formed.” See 15 U.S.C. § 78u-4(b)(1). “Allegations are deemed to have been made on information and belief until the plaintiffs demonstrate that they have personal knowledge of the facts.” Vantive, 283 F.3d at 1085 n. 3. As plaintiffs do not allege the source of their information with respect to the content and value of the Sanrise transaction, plaintiffs have failed to plead with the requisite particularity their § 10(b) claim based on the Sanrise transaction.

9. Statements Regarding Adequacy of Funding and Risk of Bankruptcy

a. Adequacy of Funding

*38 Plaintiffs allege that Exodus, in a press release issued April 26, 2001, stated it was “fully funded to achieve its current business plan.” (See TAC ¶ 82.) On the same date, plaintiffs allege, Hancock, in a conference call with analysts, stated: “[W]e have a fully funded business plan.” (See id. ¶ 83.) According to plaintiffs, these statements were false and misleading because the Individual Defendants “were aware that Exodus was woefully short of funds required to achieve its business plan.” (See id. ¶ 252.) In particular, plaintiffs allege that Exodus had been presented with proposed business plans in March and August 2000, which proposals showed that Exodus needed “$3.2 billion to accomplish the goals set forth by the executive staff,” and that Exodus executives “balked at these numbers” because, at the time, Exodus had only $750 million. (See id. ¶ 254.) The Court previously dismissed plaintiffs' § 10(b) claim, to the extent such claim was based on such allegations, on the ground plaintiffs had failed to adequately allege the statements, that Exodus, in April 2001, had a fully funded business plan, were false when made. (See Dismissal Order at 50-51.) Although plaintiffs have amended their allegations, the amendments do not address the deficiencies noted in the Court's Dismissal Order. Accordingly, the Court finds plaintiffs have failed to plead with the requisite particularity their § 10(b) claim, to the extent such claim is based on Exodus's April 2001 statements about the adequacy of its funding.

b. Risk of Bankruptcy

In the First Amended Complaint, plaintiffs alleged that various representations made by Hancock in articles published on August 27, 2001, August 28, 2001 and September 3, 2001, respecting whether Exodus would file for bankruptcy, were false when made. (See FAC ¶ ¶ 92, 93.) Plaintiffs quoted from only two of the articles: an article published in Information Week on August 27, 2003, which reported Hancock as saying: “We're viable ... We have sufficient cash”; and an article published in the San Jose Mercury News on August 28, 2001, which stated: “Exodus Chief Executive Ellen Hancock says the company is in no danger of filing Chapter 11. ‘We are capable of handling the debt and paying for the debt,’ she says.” (See id.) Plaintiffs further alleged that Hancock resigned on September 4, 2001, and Exodus filed for bankruptcy on September 26, 2001. (See FAC ¶ 97.) The Court dismissed plaintiffs' § 10(b) claim based on such statements, on the ground the mere temporal proximity between Hancock's statements and Exodus's bankruptcy was insufficient to raise an inference of falsity or scienter under the PSLRA. (See Dismissal Order at 52 (citing Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir2001) (“We have allowed the temporal proximity of an allegedly fraudulent statement to bolster a complaint, but we have never allowed the temporal proximity between the two, without more, to satisfy the requirements of Rule 9(b)”)). *39 In the Third Amended Complaint, plaintiffs allege additional public statements made by Hancock in August and September 2001 about Exodus's financial health. According to plaintiffs, Hancock, in an interview published in Business Week Online on August 3, 2001, stated: “[W]e have not just a viable business, but a great business” and “[w]e have sufficient funding to run the business.” (See TAC ¶ 103.) In an interview published August 13, 2001 by Network World, plaintiffs allege, Hancock stated: “[W]e do like the business we're in and we believe that we have sufficient cash to run it.” (See id. ¶ 104.) Plaintiffs further allege that, in an August 23, 2001 interview on CNN's Moneyline, Hancock stated, “We have sufficient cash to take us into next year.” (See id. ¶ 108.) In addition, plaintiffs allege that in an article published September 3, 2001 in Computer Reseller News, Hancock was quoted, as follows: “The promise of increased business counters claims that Exodus is in financial straits,” Hancock says. “We say that we're healthy, we say that we have sufficient cash, and we say that we brought in $200 million of new business in the first quarter and $200 million in the second quarter,” she says. “We increased our customer base, and we're bringing in




very good, large customers. We indicated that we'd be cash-[earnings per share]-positive next year.” “Even if Exodus doesn't find more funding, it still has enough cash to survive until it reaches profitability,” Hancock adds. “The plan says we have enough money to get there.” (See id. ¶ 111 (alteration in original).) According to plaintiffs, Hancock further stated in the above-quoted article that Exodus would be profitable within a year. (See id.) Plaintiffs additionally allege that despite Hancock's public assertions in August and September 2001 that Exodus was in no danger of bankruptcy, a document filed in bankruptcy court on October 4, 2001 states that Exodus had entered into an agreement on July 17, 2001 with the law firm of Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden Arps”) by which Skadden Arps agreed to advise Exodus regarding its “financial and operational restructuring efforts” and to represent it “if chapter 11 cases were commenced.” (See id. ¶ 112.) In a declaration filed in the bankruptcy court on October 5, 2001, plaintiffs allege, J. Gregory Milmore of Skadden Arps attested that Skadden Arps had been retained in July 2001 to assist Exodus “in their ... restructuring efforts by, among other things, advising [Exodus] regarding restructuring matters in general and preparing for the potential commencement and prosecution of chapter 11 cases for [Exodus].” (See id. ¶ 239.) Plaintiffs further allege that defendant Wegner testified in the bankruptcy proceedings, on August 8, 2003, that months before Exodus's bankruptcy filing, members of Exodus's management team, including Hancock, had “a few meetings” with Skadden Arps and Lazard Freres Company “about strategic options ... as [Exodus] entered the zone of insolvency.” (See id. ¶ 238.) *40 Plaintiffs' allegations suggest that Exodus was, at the very least, preparing for the possibility of filing bankruptcy proceedings at the same time Hancock was making public statements that Exodus was in good financial health. Plaintiffs do not, however, allege any facts suggesting Hancock's statements about Exodus's finances were false at the time they were made. There is no allegation, for example, that Exodus did not have adequate cash on hand at the time Hancock stated Exodus was adequately financed. As defendants point out, “Exodus could have had ample cash at the time of Ms. Hancock's statement, and still, in a proper and thorough effort by its executives to fulfill their fiduciary duties, have prepared for future contingencies.” (See Motion at

20-21.) Accordingly, the Court finds plaintiffs have failed to plead with the requisite particularity their § 10(b) claim, to the extent such claim is based on Hancock's statements in August and September 2001 about the state of Exodus's financial health. See America West, 320 F.3d at 938 (noting courts must consider “all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs”) (internal quotation and citation omitted); see also Gompper v. VISX, Inc., 298 F.3d at 897 (holding that to establish a strong inference of scienter, the allegations must show that an inference of fraud is “the most plausible of competing inferences”) (internal quotation and citation omitted).

10. Statement re: Price Increase Plaintiffs allege that, in an April 26, 2001 conference call with securities analysts and investors, Hancock indicated that Exodus was increasing its prices despite discounting from competitors, by stating that Exodus had “announced a price increase in the area of [its] infrastructure as well as many of [its] managed professional services.” (See TAC ¶ 84.) Plaintiffs allege that “despite Hancock's assertion that Exodus was increasing prices, Exodus was actually discounting to compete with competitors in the declining market [.]” (See id ¶ 86.) According to CW22, plaintiffs allege, Exodus would waive installation charges and offer up to three months of free service in 2000 and 2001. (See id. ¶ 229.) Plaintiffs further allege that CW7 offered discounts to new and existing customers. (See id. ¶ 230.) In addition, according to plaintiffs, an internal Exodus document dated January 23, 2001 stated that setup charges had been “reduced to reflect the current market.” (See id. ¶ 231.) Hancock's statement that Exodus had increased its prices is not inconsistent with the offering of discounts. There is no allegation, for example, that the base price of Exodus's services did not actually increase, nor is there an allegation that at the same time Hancock was announcing an increase in prices, the frequency and amounts of discounts also increased to the point that the net price of Exodus's services actually dropped. *41 Accordingly, as an increase in prices is not inconsistent with the offering of discounts, plaintiff has not stated a § 10(b) claim based on Hancock's




April 26, 2001 statement that Exodus was increasing its prices.

11. Revenue Forecasts Plaintiffs allege the following statements respecting financial forecasts were false or misleading when made: (1) an October 19, 2000 press release forecasting revenues of approximately $1.8 billion for fiscal year 2001; (2) an April 26, 2001 press release forecasting revenues in the amount of $360 million for Exodus's second quarter of 2001 and $1.5 billion to $1.6 billion for fiscal year 2001; (3) an April 26, 2001 conference call in which Case reiterated these revenue forecasts and stated “we are still confident that we should be able to turn cash EPS positive in the first half of next year,” and Hancock stated that Exodus expected “to turn cash EPS positive during the first half of 2002”; (4) a May 1, 2001 conference call in which Stoltz reaffirmed the revenue forecasts of $360 million for the second quarter of 2001 and $1.5 to $1.6 billion for fiscal year 2001; (5) a May 9, 2001 press release in which Stoltz said: “We believe we can achieve our financial plan by reorganizing and strengthening our operations”; and (6) a June 20, 2001 press release in which Exodus forecasted revenues of $315 million for the second quarter of 2001 and $1.35 billion for fiscal year 2001. (See TAC ¶ ¶ 57, 82-84, 88, 89, 93.) Plaintiffs allege said forecasts were made without a reasonable basis. (See id.) Plaintiffs allege that according to CW1, the controller for Exodus's Professional Services organization, Exodus's public forecasts were substantially higher than its internal forecasts. (See id.) Once a month, according to CW1, a company-wide profit and loss statement (“P & L statement”) was distributed to Hancock, Stoltz, Dollahite, and Case, as well as other Exodus management personnel, which included a forecast for the following year. (See id. ¶ 241(a).) Plaintiffs allege that the forecasts provided to Exodus management were “highly accurate,” but that the public forecasts were “much higher than Exodus's internally projected numbers.” (See id. ¶ 241(e) .) Plaintiffs fail to allege the contents of the above-referenced internal reports, however, and do not allege that any particular internal report contained a forecast that differed from a publicly-issued forecast issued contemporaneously. Accordingly, the Court finds plaintiffs have not alleged with the requisite particularity, based on the allegations derived from CW1, that Exodus's internal

forecasts differed from its publicly-announced forecasts. See Silicon Graphics, 183 F.3d at 985 (holding “a proper complaint which purports to rely on the existence of internal reports would contain at least some specifics from those reports”). In the Third Amended Complaint, plaintiffs add allegations based on information from CW24, an Exodus employee who, in February 2000, became responsible for business forecasting for all professional services, and who, plaintiffs contend, “corroborated that Exodus's public forecasts were inflated.” (See TAC ¶ ¶ 126(x), 242.) According to CW24, the “Regional Business Forecast” spreadsheet and forecasting procedures he had implemented “were subject to false or overstated inputs by sales personnel and management.” (See id. ¶ 242(b).) Said “false or overstated input[s]” are not pleaded with specificity, however, and there is no allegation attempting to quantify the effect of such “false or overstated inputs” on Exodus's revenue forecasts. Similarly, plaintiffs allege that, according to CW24, Exodus booked deals with customers who were in financial trouble and who could not afford the services ordered, (see id. ¶ 242(c)), without alleging, however, that any particular customer was unable to pay, or attempting to quantify the effect of such practice on Exodus's revenue forecasts. *42 Plaintiffs further allege that, according to CW24, revenue for professional services in the Bay Area dropped from $4 million in the first quarter of 2000 to $3.5 million in the second quarter of 2000 and $3.2 million for the third quarter of 2000. (See id. ¶ 242(d)). According to plaintiffs, the Bay Area produced approximately 40% of the revenue for the western region, which, in turn, generated 60-65% of Exodus's overall revenue for professional services. (See id.) Plaintiffs allege that despite the drop in revenue for the Bay Area, Yeack's “stated ‘revenue goal’ for Professional Services was 40% quarter to quarter growth,” while internal forecasting “showed an average 7.5% growth per month during 2Q00 and 3Q00.” (See id.) Plaintiffs fail to allege, however, how the drop in revenue for the Bay Area compared to revenue from other regions in the same periods. In addition, the setting of an internal ‘revenue goal’ of 40% growth is not the equivalent of a public forecast that such growth would actually be achieved. Plaintiffs allege that CW24 and others informed Yeack that Exodus's revenue numbers were not reliable and that many “booked” deals should be removed from the forecasts Exodus used for public projections, but that Yeack consistently instructed




CW24 and other professional services management not to remove anything from the forecasts. (See id. ¶ 242(e).) CW24 does not allege any specific transaction that should have been removed from the forecasts, however, nor does he attempt to quantify the effect that any such practice had on Exodus's public forecasts. According to plaintiffs, CW24 prepared a report on October 5, 2000, titled “BAR ProServ Director's Financial Management Initiative,” when it became clear to him there was no way Exodus could meet its fourth quarter 2000 or fiscal year 2000 projections. (See id. ¶ 242(g).) According to CW24, plaintiffs allege, the purpose of the report was to “urge Exodus's executives to address the continued and increasing accrual and recognition of questionable revenue, and inherent defects in the forecasting process.” (See id.) In response, plaintiffs allege, Yeack told CW24 not to be a “buffoon” and not to report negative information about the sales department's revenue projections.” (See id.) Again, plaintiffs fail to attempt to quantify how Exodus's public forecasts were affected. Accordingly, the Court finds plaintiffs have failed to state a § 10(b) claim based on false and misleading forecasts. 12. Statements Regarding IDC Capacity and Demand Plaintiffs allege the Individual Defendants “falsely created the impression that Exodus's IDCs were full and that demand was robust by stating, for example, on April 26, 2001, that ‘we are opening IDCs to meet known customer demand.” ’ (See TAC ¶ ¶ 84, 244.) Plaintiffs allege such statements were false and misleading when made “because they failed to disclose that Exodus's IDCs were, in fact, operating under capacity.” (See id.) The Court previously dismissed plaintiffs' § 10(b) claim based on such allegations because plaintiffs failed to allege that Exodus had excess IDC capacity in the locations where it proposed to open new IDCs or that Exodus was opening new IDCs without first assessing demand in those particular areas. (See Dismissal Order at 52-55.) *43 In the Third Amended Complaint, plaintiffs add the allegation that CW24 became aware, in December 2000, of a plan by Exodus to “build-out ... a large amount of IDC space in Seattle.” (See TAC ¶ 245(c).) According to plaintiffs, CW24 prepared a budget analysis demonstrating that if the members of

the Seattle sales team all sold 150% of quota, Exodus would need approximately 40,000 square feet of additional IDC space. (See id.) When CW24 pointed out that the IDCs in Seattle already had 140,000 square feet of build out space available, and recommended that Exodus refrain from building more unneeded capacity, plaintiffs allege, Hancock told CW24 to “mind his own business” and Yeack told him that Exodus needed to continue building out space in order to create the illusion of growth and to be perceived as an industry leader. (See id.) There is no allegation, however, that Exodus ever built more IDC space in Seattle, or that the April 26, 2001 statement that Exodus “was opening IDCs to meet known customer demand” was a reference to the opening of new IDCs in Seattle. The only reference in the Third Amended Complaint to the building of new IDCs after April 26, 2001 appears in plaintiffs' summary of a July 26, 2001 Exodus press release, in which Exodus announced that it had built new IDCs in Amsterdam, Dallas, Miami, and Paris. (See id. ¶ 100.) As the complaint still contains no allegation that Exodus had excess IDC capacity in the locations where it proposed to open new IDCs or that Exodus was opening new IDCs without first assessing demand in those particular areas, the Court finds plaintiffs have not stated a § 10(b) claim based on statements relating to IDC capacity and demand.FN22

FN22. The Court notes that plaintiffs have deleted from the complaint their prior allegations with respect to an August 22, 2001 interview with Hancock in which she was asked about excess IDC capacity and explained: “You can't just add up all the [unused hosting] space and say, ‘See you've got all that space left.’ You need the space in the city or county, or you essentially lose business in those geographies. So even though we might have some [extra] space in London, that doesn't help us address the French market or the market in Amsterdam or Germany. Last quarter, we opened four new data centers: one in Amsterdam, one in Paris, one in Dallas and one in Miami. So with all this discussion of glut, we're opening up data centers.” (See FAC ¶ 144(c) (alteration in original).)

13. Scienter: Stock Sales

Plaintiffs allege that the stock sales by the Individual




Defendants demonstrate they engaged “in insider trading,” and that they acted with scienter in making the allegedly false and misleading statements set forth in the Third Amended Complaint. (See TAC ¶ 307.) The Court previously has held that plaintiffs' allegations as to stock sales are insufficient to demonstrate scienter. (See Dismissal Order at 56-59.) FN23 Defendants correctly point out that plaintiffs have not amended their allegations as to stock sales in any material way. Accordingly, assuming, arguendo, that plaintiffs have sufficiently pleaded falsity as to one or more of the statements on which they rely, the Court finds plaintiffs' allegations as to stock sales are insufficient to demonstrate scienter.

FN23. As noted in the Court's prior order, the Ninth Circuit has identified three factors relevant to the question of whether a defendant's stock sales gives rise to an inference of scienter: “(1) the amount and percentage of shares sold by insiders; (2) the timing of the sales; and (3) whether the sales were consistent with the insider's prior trading history.” In re Silicon Graphics, 183 F.3d at 986.

C. Sufficiency of Pleadings: § 11 Claim Against

Hancock As discussed above, the Court is not persuaded by the Underwriter Defendants' motion to dismiss the § 11 claim asserted against them, for the reason that Rule 9(b) has no application to such claim and the complaint satisfies the notice pleading requirements of Rule 8. Unlike the Underwriter Defendants, however, Hancock is alleged to have participated in a broad scheme to defraud investors by, among other things, falsifying Exodus's financial results. (See, e.g ., TAC ¶ 44.) There is no allegation that Hancock acted negligently or mistakenly, in contrast to plaintiffs' allegations of negligence with respect to the Underwriter Defendants. See Daou, 411 F.3d at 1028 (finding Rule 9(b) applicable to pleading § 11 claim where plaintiffs “never rel[ied] on such conduct as negligence or mistake in stating their claims”). The § 11 claim against Hancock, unlike the § 11 claim against the Underwriter Defendants, is thus “grounded in fraud,” and “ ‘the pleading of that claim as a whole must satisfy the particularity requirement of Rule 9(b).” ’ See Daou, 411 F.3d at 1027 (quoting Vess, 317 F.3d at 1103-04); see also Stac, 89 F.3d at 1405 n. 2 (rejecting “nominal efforts” to disclaim allegations of fraud in connection with § 11 claim “where the gravamen of the

complaint is plainly fraud and no effort is made to show any other basis for the [§ 11] claims”). *44 As noted, the Court will grant the Underwriter Defendants' motion to dismiss the § 10(b) claim asserted against them, which claim is based on precisely the same statements that form the basis of the § 11 claim against them, in part because plaintiffs have not adequately alleged falsity with the particularity required by Rule 9(b). For the same reason, as plaintiffs have failed to adequately allege with the particularity required by Rule 9(b) that any of the allegedly false statements contained in the Registration Statements for the February Offerings were false when made, the Individual Defendants' motion to dismiss the § 11 claim asserted against Hancock likewise will be GRANTED.

D. Section 20(a) and Section 15 Claims Plaintiffs assert a claim against the Individual Defendants for violation of § 20(a) of the Exchange Act FN24 based on the allegation that they “acted as controlling persons of Exodus” and “had the power and authority to cause the Company to engage in the wrongful conduct complained of[.]” (See TAC ¶ 364.) Plaintiffs assert a claim against Hancock for violation of § 15 of the Securities Act FN25 “by virtue of her direct and indirect control and domination of Exodus.” (See id. ¶ 343.)

FN24. Section 20(a) provides: “Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.” 15 U.S.C. § 78t(a).

FN25. Section 15 provides: “Every person who, by or through stock ownership, agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with one or more other persons by or through stock ownership, agency, or otherwise, controls any person liable under sections 77k or 77l of this title, shall also be liable jointly and severally with




and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist.” 15 U.S.C. § 77o.

To plead a prima facie case under § 20(a) of the Exchange Act, plaintiffs must plead: “(1) a primary violation of federal securities laws; and (2) that the defendant exercised actual power or control over the primary violator.” Howard v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir.2000). To plead a prima facie case under § 15 of the Securities Act, plaintiffs must likewise plead a primary violation of federal securities laws and that the defendant exercised control over the primary violator. See In re Initial Public Offering Securities Litigation, 241 F.Supp.2d 281, 352 (S.D.N.Y.2003). There can be no liability under § 20(a) or § 15 if a primary violation of § 10(b) or § 11, respectively, is not sufficiently pled. See Heliotrope General Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9th Cir.1999); Klein v. General Nutrition Companies, Inc., 186 F.3d 338, 344 (3 rd Cir.1999). Defendants argue there can be no § 20(a) or § 15 liability based on defendants' alleged control of Exodus, because no primary claim is alleged against Exodus, and that plaintiffs cannot amend their complaint to allege such a claim, due to expiration of the statute of limitations and orders issued in Exodus's bankruptcy proceedings. As noted, the § 20(a) and § 15 claims are based entirely on defendants' alleged control of Exodus. (See TAC ¶ ¶ 343, 364.) Although plaintiffs asserted claims against Exodus itself in their initial complaints, (see Individual Defendants' RJN Ex. 48), plaintiffs did not assert any claim against Exodus in any of the consolidated complaints, including the Third Amended Complaint. The initial Consolidated Class Action Complaint, filed December 13, 2001, approximately two months after Exodus filed bankruptcy proceedings, merely notes Exodus's bankruptcy, and asserts no claims against Exodus itself. (See Consolidated Class Action Complaint ¶ 22.) In the Third Amended Complaint, plaintiffs state that Exodus “is not named as a defendant herein due to its bankruptcy and liquidation.” (See TAC ¶ 35.) *45 The parties dispute whether plaintiffs abandoned their claim against Exodus by failing to include it in the consolidated complaint, and whether bankruptcy

law precludes them from seeking to assert such a claim against Exodus now. The issue, however, is not whether Exodus itself can be held liable for violating the law, but whether the Individual Defendants can be held liable, as controlling persons, for any violations of the law by Exodus. Although a predicate to controlling person liability is proof of a violation of law by the controlled entity, see Howard v. Everex Systems, Inc., 228 F.3d at 1065, the Court has located no case holding that the controlled entity must actually be named as a defendant. In other words, the complaint may allege violations by Exodus, for purposes of control person liability, without seeking to hold Exodus itself liable for those violations. See, e.g., Howard v. Everex Systems, Inc., 228 F.3d at 1060, 1065 (finding officer of bankrupt corporation potentially liable under § 20(a), albeit without discussing impact of bankruptcy); see also In re Hayes Lemmerz Int'l, Inc. Equity Securities Litigation, 271 F.Supp.2d 1007, 1021 n. 11 (E.D.Mich.2003) (“[I]f the complaint states a primary violation by the Company, even if the Company is not named in the complaint as a defendant, then a § 20 claim can stand if the individuals were controlling persons.”); In re Citisource, Inc. Securities Litigation, 694 F.Supp. 1069, 1077 (S.D.N.Y.1988) (denying dismissal of § 20(a) claim where plaintiffs failed to sue primary violator; holding “liability of the primary violator is simply an element of proof of a section 20(a) claim, and that liability need not be actually visited upon the primary violator before a controlling person may be held liable”); Elliott Graphics, Inc. v. Stein, 660 F.Supp. 378 (N.D.Ill.1987); Briggs v. Sterner, 529 F.Supp. 1155, 1770-71 (S.D.Iowa 1981) (holding officers and directors of non-defendant bankrupt corporation may be liable as controlling persons under § 20(a) and § 15). Thus, all that is required for plaintiffs to state a claim for controlling person liability is for plaintiffs to adequately allege that Exodus engaged in a primary violation of the securities laws and that the Individual Defendants (or, in the case of the § 15 claim, Hancock) controlled Exodus. See, e.g., Howard v. Everex Systems, Inc., 228 F.3d at 1065. Plaintiffs have not done so, however. There is no allegation in the complaint that Exodus violated any of the securities laws. Although the complaint alleges, for example, that the Individual Defendants participated in a “scheme to defraud,” (see TAC ¶ 44), there are no allegations that the acts of the Individual Defendants are attributable to Exodus, nor is there any allegation that Exodus otherwise committed violations of the securities laws. Assuming,




arguendo, the Individual Defendants' acts are attributable to Exodus, plaintiffs have not, as explained above, stated a claim against the Individual Defendants for a primary violation of the securities laws. Accordingly, plaintiffs' § 20(a) and § 15 claims must be dismissed.FN26

FN26. Plaintiffs also argue that their § 20(a) and § 15 claims can be based on the Individual Defendants' control over each other. There is no such allegation in the complaint, however.

*46 Accordingly, defendants' motion to dismiss plaintiffs' § 20(a) and § 15 claims will be granted.

E. Dismissal Without Leave to Amend Plaintiffs have had three opportunities to amend their consolidated complaint, and the Court has now dismissed the complaint on three occasions. Other than successfully amending their § 11 claim to disavow an intent to base that claim on fraud, plaintiffs have failed repeatedly to successfully amend their claims. The Court recognizes the Ninth Circuit has held that leave to amend should be granted with “extreme liberality.” See Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1051 (9th Cir.2003). The Court may, however, consider factors such as repeated failure to cure deficiencies by previous amendments in determining whether to grant leave to amend. See id. at 1052 (citing Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 9 L.Ed.2d 222 (1962)); see also In re Read Rite Corp. Securities Litigation, 335 F.3d 843, 845 (9th Cir.2003) (“The district court's discretion to deny leave to amend is particularly broad where plaintiff has previously amended the complaint.”). Here, despite engaging in an extensive factual investigation, plaintiffs have been unable to amend their complaint to state a claim for securities fraud. There is no indication that plaintiffs would be able to do so were the Court once again to grant leave to amend. Accordingly, the Court will dismiss the complaint, with the exception of the § 11 claim against the Underwriter Defendants, with prejudice.

CONCLUSION

For the reasons stated: 1. The Underwriter Defendants' motion to dismiss the § 11 claim asserted against them is DENIED. The Underwriter Defendants' motion to dismiss the § 10(b) claim asserted against them is GRANTED, and said claim is hereby DISMISSED with prejudice. 2. The Individual Defendants' motion to dismiss is hereby GRANTED, and all claims asserted against the Individual Defendants are hereby DISMISSED with prejudice. 3. The Underwriter Defendants shall answer the § 11 claim within 30 days of the date of this order. This order terminates Docket Nos. 160 and 163. IT IS SO ORDERED. N.D.Cal.,2005. In re Exodus Communications, Inc. Securities Litigation Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 Briefs and Other Related Documents (Back to top) • 2005 WL 3142895 (Trial Motion, Memorandum and Affidavit) Defendant Ellen Hancock's Notice of Motion and Motion For: 1) Leave to File A Motion for Reconsideration; 2) Certification Pursuant to ¢ y28 U.S.C. | 1292(b)¢ y¢ r;00002;;LQ;28USCAS1292;1000546;¢ r; and 3) A Stay of Discovery Pending Appeal; and Memorand um of Points and Authorities in Support Thereof (Oct. 12, 2005) • 2005 WL 3142894 (Trial Pleading) Answer of Defendants Goldman, Sachs & Co., Merrill Lynch & Co., Morgan Stanley Dean Witter, and J.P. Morgan to Plaintiffs' Corrected Third Amended Consolidated Complaint (Oct. 11, 2005) • 2005 WL 3142893 (Trial Pleading) Defendant Ellen Hancock's Answer to Plaintiffs' Corrected Third Amended Consolidated Class Action Complaint for Violation of the Federal Securities Laws (Oct. 10, 2005) • 2005 WL 2868440 (Trial Motion, Memorandum and Affidavit) Individual Defendants' Brief in Opposition to Plaintiffs' Motion for Reconsideration of Order Granting Individual Defendants' Motion to Dismiss (Sep. 2, 2005) • 3:01cv02661 (Docket) (Jul. 12, 2001) END OF DOCUMENT


Slip Copy Page 1Slip Copy, 2005 WL 3445631 (N.D.Cal.) (Cite as: Slip Copy)


Briefs and Other Related Documents Only the Westlaw citation is currently available.

United States District Court,N.D. California. In re NETOPIA, INC., SECURITIES LITIGATION

No. C-04-03364 RMW.

Dec. 15, 2005. Michael David Braun, Andrew M. Schatz, Jeffrey S. Nobel, Justin S. Kudler, Tricia Lynn McCormick, Stanley S. Mallison, Robert S. Green, Patrick J. Coughlin, Darren J. Robbins, William S. Lerach, Marc A. Topaz, Richard A. Maniskas, Tamara Skvirsky, Timothy J. Burke, Aaron L. Brody, Jules Brody, Tzivia Brody, for Plaintiffs. Howard S. Caro, Michael Ethan Liftik, Sara B. Brody, Susan D. Resley, Walter F. Brown, Jamaar M. Boyd, for Defendants. ORDER DENYING IN PART AND GRANTING IN PART DEFENDANTS' MOTION TO DISMISS OR

STRIKE WHYTE, J. *1 THIS ORDER RELATES TO: ALL ACTIONS

[Re Docket Nos. 81, 82, 85, 90, 100, 102, 103] Defendants Netopia, Inc., Alan Lefkof, and David Kadish move to dismiss or strike certain portions of the consolidated amended complaint.FN1 Kadish additionally moves to dismiss all claims against him under Fed.R.Civ.P. 12(b)(6). For the reasons given below, the court denies the defendants' motions to dismiss except as to the § 10(b)(5) claim against defendant Kadish, grants the motion as to the § 10(b)(5) claim against defendant Kadish with twenty days leave to amend, grants the motion to strike the allegations in paragraphs twenty-two through thirty-one, and denies the motion to strike other allegations.

FN1. Defendants William Baker and Thomas Skoulis join this motion. Baker makes additional arguments why the motion should be granted; Skoulis does not.

I. BACKGROUND

Plaintiffs constitute a class of all those who purchased Netopia, Inc., common stock from November 6, 2003, to August 16, 2004. They allege that Netopia and four of its officers or former officers-Alan Lefkof, David Kadish, William Baker, and Thomas Skoulis-engaged in fraudulent accounting practices that inflated the price of Netopia stock. After these alleged accounting irregularities came to light, the price of Netopia stock fell, harming the plaintiffs. The current complaint alleges two causes of action: (1) violation of section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and related Rule 10b-5, 17 C.F.R. § 240.10b-5, against all defendants, and (2) violation of section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against all defendants other than Netopia. The complaint contains lengthy narratives about the defendants' alleged wrongdoing in three Netopia transactions or attempted transactions. The first occurrence, referred to by the parties as the “Chicago transaction,” involved an agreement for Netopia to supply Interface Computer Communications, Inc., (“ICC”) with computer products, which ICC would in turn sell to the Chicago public school system. The second occurrence, the “Philadelphia transaction,” was similar: Netopia was to sell ICC $750,000 worth of products, which ICC would then sell to the Philadelphia public school system. In the third occurrence, the “Swisscom transaction,” Netopia allegedly shipped a large quantity of products to Swisscom AG just before the end of a quarter, distorting the picture of Netopia's business that investors received. The Philadelphia transaction is, for the plaintiffs' action, the main event. Plaintiffs allege that in the spring of 2003, Netopia began negotiating with ICC for Netopia to sell ICC software for the Philadelphia public schools. Consol. Am. Compl. (“CAC”) ¶ 32. Peter Frankl was the Netopia salesman in charge of the Philadelphia transaction. Id. By September 2003, the individual defendants were aware that Frankl was possibly going to close a deal that would make the Philadelphia transaction worth at least $500,000. Id. ¶ 34. The Philadelphia school system did not have funds available for the purchase, though, meaning that the purchase would not take place before the end of the financial quarter on September 30, 2003. Id. ¶ 35. Lefkof and Skoulis thought the Philadelphia transaction would help Netopia meet Wall Street




earnings estimates, so had Frankl negotiate a deal with ICC: ICC would give Netopia a purchase order for $750,400 worth of software, but the parties would orally agree that ICC had no obligation to pay Netopia until the Philadelphia schools ordered Netopia's software from ICC and paid ICC. Id. ¶ ¶ 35-45. Kadish drafted a purchase order for the transaction which contained no payment terms, although “Netopia's standard payment terms were ‘net 30.” ’ Id. ¶ ¶ 42-43. *2 This deal began to unravel almost immediately. Netopia's accounting department (apparently unaware of the oral contingency) sent ICC a letter asking ICC to confirm to KPMG LLP, Netopia's outside auditors, that ICC owed Netopia $750,400 for software. Id. ¶ 46. ICC responded by sending Frankl a letter confirming that ICC did not owe Netopia anything for the Philadelphia transaction until the Philadelphia school system ordered software from ICC and paid ICC for the software; Frankl received this letter on October 7, 2003. Id. ¶ ¶ 47-50. In late October, the Philadelphia school system made clear that it was not willing to purchase Netopia software anytime soon. Id. ¶ ¶ 51-52. KPMG learned that Netopia had not received the $750,400 and asked “Baker, Kadish and Lefkof about whether is was appropriate to recognize” revenue from the purchase order. Id. ¶ 54. On November 5, 2003, Netopia reported its financial results for the quarter and financial year ending September 30, 2003. Id. ¶ 58. The $750,400 from the Philadelphia transaction was reported as income for the quarter and was the difference between Netopia reporting a net loss or net income for the quarter. Id. Netopia's stock price rose immediately afterwards. Id. ¶ 59. From November 10 and December 10, 2003, each of the individual defendants sold off hundreds of thousands of dollars worth of Netopia stock. Id. ¶ 64. Netopia continued its efforts to get the Philadelphia school system to purchase software. Id. ¶ ¶ 65-66. In March 2004, Frankl and Skoulis tentatively brokered a deal whereby the Philadelphia schools would agree to purchase $375,000 worth of Netopia software, but Gateway Inc. would be added as a second middleman and take a 10 percent fee. Id. ¶ 66. Baker began asking ICC to start making payments since the sale was likely to go through. Id. ¶ 68-74. On April 27, 2004, ICC sent Baker and Frankl and e-mail reiterating that ICC's payments to Netopia were contingent on ICC being paid by the Philadelphia school system (and now Gateway), and that Netopia

could expect a payment of around $300,000 in mid-June. Id. ¶ 75. In May 2004, Gateway received a purchase order from the Philadelphia school system for $375,000 worth of Netopia software. Id. ¶ 81. A month later, Gateway sent ICC a purchase order for the software in the amount of $337,500 .FN2 Id.

FN2. This amount represents the $375,000 price the Philadelphia school system was paying, less the 10 percent fee ($37,500) due to Gateway.

Baker, meanwhile, was still pressing ICC to pay Netopia $750,000. Id. ¶ 82. ICC's president, David Andalcio, informed Frankl that it would send Netopia about $50,000 at the end of June. Id. ¶ 83. Lefkof, apparently expecting ICC to adhere to its earlier statement about paying in mid-June, had Imelda Farrell, Netopia's “Corporate Controller,” send Andalcio a letter proposing that ICC pay Netopia $750,400 in installments from June 28, 2004, to September 15, 2004. Id. ¶ ¶ 84-87. The next day, June 18, 2004, Andalcio called Farrell, rejecting the proposed payment plan. Id. ¶ 88. “Kadish then came to Ms. Farrell's desk, stood over Ms. Farrell and put the phone to his ear as well, and whispered answers into Ms. Farrell's ear for her to say in response to Mr. Andalcio's remarks.” Id. (Plaintiffs do not disclose the contents of this conversation.) *3 A week later, Andalcio e-mailed Baker that Andalcio was uncomfortable with the situation and had sought the advice of legal counsel. Id. ¶ 91. Andalcio wrote that, on the advice of counsel, ICC would not make any payments on the old purchase order, and requested a new purchase order that reflected all terms of the agreement between ICC and Netopia. Id. On July 1, 2004, Kadish e-mailed Andalcio that Netopia was willing to accept $337,500 as settlement of all claims between them, and enclosed an agreement to that effect dated June 30, 2004. Id. ¶ 93. Kadish stated that if ICC did not sign and return the proposed agreement by the next day, the “offer to compromise” would “be deemed withdrawn.” Id . Andalcio responded the next day that his legal counsel had advised him not to sign the proposed agreement because ICC had done nothing wrong. Id. ¶ 94. On July 22, 2004, the audit committee of Netopia's board of directors announced that it was investigating Netopia's dealings with ICC. Id. ¶ 96. Two months later, KMPG resigned as Netopia's outside auditor and withdrew its support for Netopia's financial




statements for the year ending September 30, 2003. Id. ¶ 111. Skoulis and Frankl were fired, and Baker was forced to resign. Id. ¶ ¶ 97-98.

II. ANALYSIS A. All defendants' motion to dismiss certain portions

of the complaint The defendants move to dismiss “allegations about the Chicago transaction, Swisscom, and certain loss causation allegations because they do not allege facts upon which a claim for relief can be based.” Defendants have not moved to dismiss either cause of action, and neither the Chicago transaction nor the Swisscom transaction corresponds directly to either the plaintiffs' § 10(b) or § 20(a) causes of action. By its own terms, there does not appear to be any way to grant partial dismissal of a claim under Fed.R.Civ.P. 12(b)(6). The defendants have not presented the court with any case where a court has dismissed under Fed.R.Civ.P. 12(b)(6) only part of a complaint except individual causes of action, nor can the court find such a case. The plaintiffs conceded at oral argument that a motion to strike would be a more appropriate way to obtain the result they seek. The court assumes that Fed.R.Civ.P. 12(b)(6)'s language “failure to state a claim” means the rule should not be used on subparts of claims; a cause of action either fails totally or remains in the complaint under Fed.R.Civ.P. 12(b)(6). See Charles Alan Wright & Arthur R. Miller, Federal Pleading & Procedure § 1358 (3d. ed.2004); but see Drewett v. Aetna Cas. & Sur. Co., 405 F.Supp. 877, 878 (W.D.La.1975) (Fed.R.Civ.P.12(b)(6) “may be used to challenge the sufficiency of part of a pleading such as a single count or claim for relief.”). The defendants do not claim that the plaintiffs' § 10(b) or § 20(a) causes of action are missing an essential element. The defendants' motion to dismiss allegations about the Chicago and Swisscom transactions are therefore denied. *4 Defendants also move to dismiss allegations that drops in Netopia's stock price in January, February, and April 2004 stemmed from a September 30, 2003, overstatement of Netopia's financial condition. As these time periods also do not correspond to a particular cause of action, the court likewise denies this portion of the defendants' motion to dismiss. The court also declines to treat this motion to dismiss as one for summary judgment.

B. All defendants' motion to strike certain portions of

the complaint The defendants move, in the alternative, to strike the allegations relating to the Chicago and Swisscom transactions, as well as the January, February, and April 2004 price drops. A court may strike “any redundant, immaterial, impertinent, or scandalous matter.” Fed.R.Civ.P. 12(f). Motions to strike “are disfavored by the courts, and should not be granted unless it is clear that the matter to be stricken can have no possible bearing upon the subject matter of the litigation.” Naton v. Bank of Cal., 72 F.R.D. 550, 551 n. 4 (N.D.Cal.1976). The defendants indicate they are concerned about the scope of discovery if the complaint is this sprawling; the court can imagine other reasons the defendants want less in the complaint, such as a desire to cut down on negative publicity associated with this lawsuit. The Chicago transaction appears to have been completed by September 2002. See CAC ¶ ¶ 30-31. This is well over a year before the beginning of the class period (November 6, 2003). The four pages of allegations covering the Chicago transaction are immaterial under Fed.R.Civ.P 12(f) because they are not necessary for the plaintiffs to state their § 10(b) or § 20(a) causes of action. The presence of the Chicago transaction allegations in the CAC risks “delay[ ] and confusion of the issues.” See Fantasy, Inc. v. Fogerty, 984 F.2d 1524, 1528 (9th Cir.1993). The court will grant the defendants' motion to strike the allegations concerning the Chicago transaction, paragraphs twenty-two through thirty-one of the CAC. Because, though, of the Chicago transaction's similarity to the Philadelphia transaction, aspects of the Chicago transaction may still be relevant to the plaintiffs' case. The court will not strike the allegations concerning the Swisscom transaction or the price drops because they occurred during the class period.

C. Kadish's motion to dismiss all causes of action against him

Kadish moves to dismiss both causes of action against him.

1. The section 10(b) cause of action




“To state a claim under Section 10(b), 15 U.S.C. 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b5, [plaintiffs] must allege: (1) a misstatement or omission (2) of material fact (3) made with scienter (4) on which [plaintiffs] relied (5) which proximately caused their injury.” DSAM Global Value Fund v. Altris Software, Inc., 288 F .3d 385, 388 (9th Cir.2002). Securities fraud is subjected to a heightened pleading standard. First, allegations of securities fraud are subject to the particularity obligations imposed by Fed.R.Civ.P. 9(b). GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1545 (9th Cir.1994). Fed.R.Civ.P. 9(b) provides that “[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition[s] of mind may be averred generally.” Second, under the Private Securities Litigation Reform Act (the “Reform Act” or the “PSLRA”), Pub.L. No. 104-67, 202 Stat. 737 (1995) (codified at 15 U.S.C. § § 77k, 771, 77z-1, 77z-2, 78a, 78j-1, 78t, 78u, 78u-4, 78u-5), a plaintiff alleging a § 10(b) claim must “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1). *5 Kadish claims the allegations that he violated § 10(b) contain two fatal defects: there is no allegation he made a false statement, and the allegations of scienter are inadequate. Plaintiffs claim they have met the heightened standard because the Ninth's Circuit group publication doctrine,FN3 see Wool v. Tandem Computers, Inc ., 818 F.2d 1433, 1440 (9th Cir.1987), survived the Reform Act. In Wool, the Ninth Circuit held that “[i]n cases of corporate fraud where the false or misleading information is conveyed in prospectuses, registration statements, annual reports, press releases, or other ‘group-published information,’ it is reasonable to presume that these are the collective actions of the officers. Under such circumstances, a plaintiff fulfills the particularity requirement of Rule 9(b) by pleading the misrepresentations with particularity and where possible the roles of the individual defendants in the misrepresentations.” Id. (citations omitted). The Ninth Circuit has yet to address the issue of whether the group-published information doctrine survives the Reform Act, and other courts are divided on the question.FN4 See Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 364 (5th Cir.2004).

FN3. This doctrine is also referred to as the “group pleading doctrine.” See In re Oxford Health Plans, Inc., 187 F.R.D. 133, 142 (S.D.N.Y.1999).

FN4. It appears that in no case from the Northern District of California has the Reform Act been found to have abrogated the group-published information doctrine, though few have analyzed the issue extensively. See In re Adaptive Broadband Sec. Litig., 2002 U.S. Dist. LEXIS 5887, *52-53 (N.D.Cal.2002) (Conti, J.) (“[T]he doctrine has not been specifically abrogated, and is still good law in this Circuit.”); In re Secure Computing Corp. Sec. Litig., 120 F.Supp.2d 810, 821 (N.D.Cal.2000) (Wilken, J.) (“[T]he majority of the district courts in the Ninth Circuit that have addressed the issue have concluded that the group published information presumption survives the PSLRA”); In re Network Associates, Inc., Sec. Litig., 2000 WL 33376577, *13 (N.D.Cal.2000) (Alsup, J.) (finding that allegations against defendants do not satisfy even the group-published information doctrine and dismissing for failure to state a claim).

This court feels that the better view is that the Reform Act precludes reliance on the group-published information doctrine in this case. As noted in GlenFed, Fed.R.Civ.P. 9(b) and the Reform Act constitute separate pleading hurdles in securities fraud cases. Pleading group-published information may still satisfy “the particularity requirement of Rule 9(b),” but it does not satisfy the more rigorous requirements of 15 U.S.C. § 78u-4(b)(1). One district court noted that the continued vitality of the judicially created group-published doctrine is suspect since the PSLRA specifically requires that the untrue statements or omissions be set forth with particularity as to “the defendant” and that scienter be plead in regards to “each act or omission” sufficient to give “rise to a strong inference that the defendant acted with the required state of mind.” 15 U .S.C. § 78u-4(b) (emphasis added). To permit a judicial presumption as to particularity simply cannot be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each act or omission by the defendant. Allison v. Brooktree Corp., 999 F.Supp. 1342, 1350 (S.D.Cal.1998).




According to the plaintiffs, paragraphs 100 and 129 of the CAC contain allegations that Kadish made false statements. Opp'n at 26-27. This paragraph from the CAC is representative of what plaintiffs claim sufficiently pleads Kadish violated § 10(b): On April 19, 2004, after the close of trading in the market, Netopia issued a press release (the “April Press Release”). The April Press Release (which listed Defendant Baker as the “contact” person and quoted Defendant Lefkof), inter alia, reported a net loss for the second fiscal quarter of $1.6 million, or a loss of $0.07 per share and “trade receivables, net” of $15.185 million. Each of the Individual Defendants directly participated in the drafting of the April Press Release. On April 19, 2004, following the issuance of the April Press Release, Defendants Lefkof and Baker conducted a conference call (the “April Conference Call”) with securities analysts and investors, in which Defendants, inter alia, represented the net income, revenue and accounts receivable results reported in the April Press Release. Each of the Individual Defendants participated in the drafting of the prepared remarks stated at the outset of the April Conference Call. *6 CAC ¶ 100(e); see also id. ¶ ¶ 100(a)-(d), 129. Such allegations do not, under the Reform Act, sufficiently plead that Kadish made a false statement, as the plaintiffs cannot rely on the group-published information doctrine. Plaintiffs therefore have not stated a § 10(b) claim against Kadish because the CAC does not contain an adequate allegation that he made a false statement. Furthermore, the allegations that Kadish acted with scienter are also defective. The Reform Act sets a high standard for pleading scienter: In any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. 15 U.S.C.A. § 78u-4(b)(2). The Ninth Circuit has held that the required state of mind in securities fraud cases is “deliberately reckless or conscious misconduct,” and that allegations of “mere motive and opportunity” are insufficient. In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th Cir.1999).

Plaintiffs' allegations do not create “a strong inference” Kadish was aware that ICC did not owe Netopia $750,400 before the last alleged misstatements of April 19, 2004.FN5 Anything Kadish knew after that date (roughly paragraph seventy-one of the factual section of the CAC and thereafter) is not directly relevant to Kadish's scienter. Kadish claims that the allegations in the CAC support an inference that he was unaware of the fraud of Lefkof, Baker, Skoulis, and Frankl. Mot. at 19. The court agrees that the CAC is not inconsistent with the theory that Kadish was unaware of the fraud; the CAC therefore does not “give rise to a strong inference that” Kadish was aware of the fraud.

FN5. The statements alleged to be actionable under § 10(b) occurred on November 5, 2003; December 19, 2003; January 20, 2004; February 17, 2004; and April 19, 2004. CAC ¶ 100.

Plaintiffs have alleged that in September 2003, Kadish drafted a $750,400 purchase order for the Philadelphia transaction and e-mailed it to other Netopia employees with the message “Here is the form of PO we will receive.” CAC ¶ 43. This draft purchase order contained no payment terms, although plaintiffs allege that “Netopia's standard payment terms were ‘net 30.” ’ Id. ¶ ¶ 42-43. Plaintiffs also claim they have alleged that Kadish was involved in the cover-up of the true nature of the Philadelphia transaction. Opp'n at 29. This is doubtful. The complaint contains an allegation that Skoulis told Frankl to tell Andalcio that “ ‘everyone knows' (i.e., Lefkof, Kadish and Baker)” that the Philadelphia transaction contained a hidden contingency. CAC ¶ 46. This falls far short of creating a strong inference that Kadish actually knew of the contingency; plaintiffs have merely alleged that somebody told somebody else to tell yet a third person that Kadish knew. Likewise, in April 2004 that “Kadish [was] becoming extremely concerned about the fact that Netopia was still carrying the $750,400 as part of its reported accounts receivables,” id. ¶ 67, that Kadish sought to have ICC “enter into a payment plan” for the $750,400, id. ¶ 68, or that Kadish was making things difficult for Baker, id. ¶ 71, are not inconsistent with the theory that Kadish was unaware of the contingency and trying to ensure Netopia was paid $750,400 Kadish believed ICC owed. *7 Kadish whispering into the ear of Farrell while she spoke to Andalcio is certainly suspicious, but plaintiffs do not provide the substance of Kadish's




instructions to Farrell. Plus, this call occurred on June 18, 2004, after the last alleged misstatement on April 19, 2004. Kadish's stock sales alone are inadequate to create a strong inference that Kadish acted with scienter. Kadish's late 2003 stock sales were made after Netopia had released favorable financial information; as the Ninth Circuit has noted, corporate officers often sell stock after such announcements. Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1037 (9th Cir.2002). Plaintiffs make much of the fact that Kadish did not sell any stock for the forty-four months preceding his late 2003 sales. Opp'n at 29. As Kadish points out, selling stock shortly after the announcement that Netopia had its first positive-income quarter since mid-2000 is not inherently suspicious. See Mot. at 22. “Although unusual or suspicious stock sales by corporate insiders may constitute circumstantial evidence of scienter, insider trading is suspicious only when it is dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” Silicon Graphics, 183 F.3d at 986. While his sale of 63 percent of his Netopia holdings in late 2003 is “dramatically out of line with [his] prior trading practices,” the preceding forty-four months in which Kadish sold no stock largely corresponds with a period in which Netopia reported net losses each quarter. Therefore, in light of the lack of allegations showing Kadish had “undisclosed inside information,” Kadish's sales are not necessarily suspicious. Finally, plaintiffs allege that Kadish's temporary assignment as the salesman for the Swisscom account in late 2003 FN6 creates a strong inference that Kadish was aware of misstatements related to the Swisscom transaction. Plaintiffs allege that Netopia shipped “millions of dollars” worth of software to Swisscom via boat “in the final days of December 2003.” CAC ¶ 116. Accounting rules apparently dictated that Netopia recognize the revenue from the boat shipments as soon as they were sent, which was in December 2003. See id. ¶ 116. Plaintiffs nonetheless claim that recognizing such revenue in December 2003 distorted Netopia's financial picture, because Swisscom would need that much less product in the next quarter. Opp'n at 28-29. Plaintiffs, however, do not allege anything other than Lefkof appointed Kadish to manage the Swisscom account; there is no allegation that Kadish ordered the timing or method of the shipment, or was even aware software was shipped to Swisscom. This is insufficient under the Reform Act to show Kadish acted with the requisite

scienter.

FN6. Plaintiffs refer to the quarter ending December 31, 2003, as “the first quarter of 2004,” CAC ¶ 117, which appears to comport with Netopia's financial year-end of September 30, see id. ¶ 58. Plaintiffs thus seem to allege that the firing of Karl-Heinz Mumm and the assignment of Kadish to the Swisscom account occurred “in the early part of” October, November, and December 2003. See id. ¶ 177.

Even though the plaintiffs' pleading of Kadish's scienter is inadequate when considered piecemeal, the court must also consider “whether the total of plaintiffs' allegations, even though individually lacking, are sufficient to create a strong inference that defendants acted with deliberate or conscious recklessness.” Lipton, 284 F.3d at 1038. Considering the allegations of the CAC against Kadish as a whole, the court is compelled to decide that plaintiffs have not created a strong inference that Kadish acted with scienter. The drafting of the purchase order and the whispering into Farrell's ear are particularly suspicious, but significant details are omitted from the pleading of these actions. That many of Kadish's alleged actions are consistent with either Kadish being part of a conspiracy with the other defendants or Kadish working against the conspiracy prevents a strong inference from being drawn either way. As plaintiffs have not created a strong inference Kadish acted with scienter, the § 10(b) claim against him must be dismissed.FN7

FN7. Plaintiffs did not raise allegations that Kadish engaged in insider trading in violation of Rule 12b-5 until their opposition to Kadish's motion to dismiss. See Opp'n at 27-28. Plaintiffs cannot add an insider trading claim in such a manner, and the court will not consider it further in connection with the current motion.

2. The section 20(a) cause of action

*8 Under § 20(a) of the Exchange Act, Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling




person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. 15 U.S.C. § 78t(a). The Ninth Circuit has held that “[i]n order to prove a prima facie case under § 20(a), plaintiff must prove: (1) a primary violation of federal securities laws ... and (2) that the defendant exercised actual power or control over the primary violator.” Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (2000). Whether a defendant such as Kadish “is a controlling person is an intensely factual question, involving scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions.” Kaplan v. Rose, 49 F.3d 1363, 1382 (9th Cir.1994) (internal quotation marks and citations omitted). “[I]n order to make out a prima facie case, it is not necessary to show actual participation or the exercise of actual power; however, a defendant is entitled to a good faith defense if he can show no scienter and an effective lack of participation.” Howard, 228 F.3d at 1065. The defendant bears the burden of proving he “acted in good faith and did not directly or indirectly induce the violations.” Id. Here, plaintiffs have made out a prima facie case for a § 20(a) violation by Kadish. The first element is met: Defendants do not challenge that the CAC contains an adequately-stated claim for a § 10(b) violation by Skoulis. The second element is also met: Plaintiffs allege that Skoulis reported to Kadish. CAC ¶ 11. Kadish bears the burden proving good faith, which he cannot meet solely with the ambiguous allegations of the CAC.

D. Plaintiffs' request for leave to amend their complaint

Plaintiffs request leave to amend their complaint if any portion of defendants' motion is granted. The court will grant this request. However, the Ninth Circuit has noted that complaints in securities fraud cases can be needlessly verbose. Expressing frustration with one 113-page complaint, the Ninth Circuit stated that To say that the drafting is infelicitous puts matters too kindly. The complaint is cumbersome almost to the point of abusiveness. We see nothing to prevent the district court, on remand, from requiring, as a matter of prudent case management, that plaintiffs streamline and reorganize the complaint before allowing it to serve as the document controlling

discovery, or, indeed, before requiring defendants to file an answer. Complaints fashioned as this one is are an unwelcome and wholly unnecessary strain on defendants and on the court system. *9 In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1554 (9th Cir.1994) (en banc ). This court has similar feelings regarding the plaintiffs' fifty-page complaint, and understands the defendants' attempt to prune the complaint down to a manageable size through their motion to dismiss or strike. The complaint is needlessly cumbersome; plaintiffs do not need anywhere near fifty pages to state two causes of action against five defendants, even under the heightened pleading standards of the Reform Act. In their opposition to the defendants' motion to dismiss or strike, the plaintiffs filed a thirty-two-page memorandum of points and authorities. Ten of these pages are a summary of the factual allegations of the complaint. See Opp'n at 4-14. This ten-page summary appears to the court to be a much more useful version of the complaint, and shows that the plaintiffs can present the complaint in a shorter form. “[A]s a matter of prudent case management,” the court will order plaintiffs to file a streamlined version of their complaint which does not exceed thirty-five pages within twenty days of the date of this order. Plaintiffs may include in their complaint amended allegations against defendant Kadish.

III. ORDER For the foregoing reasons, the court (1) grants Kadish's motion to dismiss the § 10(b) cause of action against him with twenty days leave to amend; (2) grants the defendants' motion to strike paragraphs twenty-two through thirty-one of the CAC; (3) otherwise denies the defendants' motion to dismiss or strike; and (4) orders plaintiffs to file a streamlined version of their complaint not exceeding thirty-five pages within twenty days of the date of this order. N.D.Cal.,2005. In re Netopia, Inc., Securities Litigation Slip Copy, 2005 WL 3445631 (N.D.Cal.) Briefs and Other Related Documents (Back to top) • 2006 WL 1042236 (Trial Pleading) Answer of Defendant Thomas Skoulis to Second Consolidated




Amended Complaint (Mar. 10, 2006) Original Image of this Document (PDF) • 2006 WL 733605 (Trial Pleading) Defendant William D. Baker's Answer to Plaintiffs' Second Consolidated Amended Complaint for Violation of the Federal Securities Laws (Feb. 6, 2006) • 2006 WL 733604 (Trial Pleading) Defendants Netopia, Inc., Alan B. Lefkof, and David A. Kadish's Answer to Second Consolidated Amended Complaint (Feb. 3, 2006) • 2006 WL 440710 (Trial Pleading) Class Action Second Consolidated Amended Complaint (Jan. 3, 2006) • 2005 WL 3607711 (Trial Motion, Memorandum and Affidavit) Reply Memorandum in Further Support of Motions to Dismiss Or, in the Alternative to Strike Allegations From, Plaintiffs' Consolidated Amended Complaint (Nov. 18, 2005) • 2005 WL 3383080 (Trial Motion, Memorandum and Affidavit) Memorandum of Points and Authorities in Opposition to all Defendants' Motions to Dismiss And/Or Strike (Oct. 13, 2005) • 2005 WL 2613820 (Trial Motion, Memorandum and Affidavit) Notice of Motion and Motion to Dismiss, or in the Alternative to Strike Allegations From, Plaintiffs' Consolidated Amended Complaint (Aug. 29, 2005) • 5:04cv03364 (Docket) (Aug. 17, 2004) END OF DOCUMENT


Not Reported in F.Supp. Page 1Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.)


Only the Westlaw citation is currently available. United States District Court, N.D. California. In re OAK TECHNOLOGY SECURITIES

LITIGATION. No. 96-20552 SW.

Aug. 1, 1997.

ORDER DISMISSING CONSOLIDATED AMENDED COMPLAINT WITH LEAVE TO

AMEND SPENCER WILLIAMS, Senior District Judge. *1 This litigation is a consolidated securities class action lawsuit filed on behalf of purchasers of the common stock of Oak Technology, Inc. (“Oak”) during the period of July 27, 1995 through May 22, 1996 (the “Class Period”) against Oak, twelve officers and directors of Oak, and Hambrecht and Quist, Inc. (“H & Q”). On May 21, 1997, after hearing oral argument, the Court took under submission the Oak Defendants' (Oak and the twelve individual Defendants) motion to dismiss Plaintiffs' Consolidated Complaint and Hambrecht and Quist's motion to dismiss Plaintiffs' Consolidated Complaint. After carefully considering the papers, arguments of counsel, and legal authority, the Court concludes that Plaintiffs have failed to plead their claims with particularity as required by Fed.R.Civ.P. 9(b) and the Securities Litigation Reform Act of 1995 (“Reform Act”). 15 U.S.C. § 78u-4. Therefore, the Court DISMISSES Plaintiffs' Consolidated Complaint with leave to amend.

I. BACKGROUND Oak manufactures and sells controller chips and related products for CD-ROM and other multimedia products for use in personal computers. In February 1995, Oak completed its initial public offering of common stock, issuing 5.5 million shares. Oak conducted a secondary offering in May 1995, issuing 4.6 million additional shares. H & Q participated as an underwriter in both the initial and secondary offerings. Oak reported record earnings for the first three quarters of fiscal year 1996 and Oak common stock reached a high of $30 3/4 per share in late February 1996. On May 22, 1996, Oak reported to the public that it expected a loss for the fourth quarter

of fiscal year 1996. The next day Oak's stock declined from $16 1/2 per share to $12 1/2 per share. Between July 9, 1996 and September 5, 1996 four federal class action lawsuits were filed against Oak alleging violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)(5).FN1 On December 18, 1996, this Court consolidated the four federal actions for all purposes. Plaintiffs filed a Consolidated Amended Complaint (“Consolidated Complaint”) on January 31, 1997.

FN1. Additionally, six class action lawsuits were filed against Oak in California State Superior Court for the County of Santa Clara.

The Consolidated Complaint alleges that during the Class Period, July 27, 1995 through May 22, 1996, Oak, certain officers and directors of Oak, and H & Q conducted a fraudulent scheme and course of business in order to artificially inflate the market price of Oak common stock. Plaintiffs assert that throughout the Class Period Oak and its officers and directors deceived the public by materially misstating revenue and earnings, failing to adjust its financial records for obsolete inventory, and engaging in “sham” transactions with related parties in violation of Generally Accepted Accounting Principals (“GAAP”). The Consolidated Complaint also states that during the Class Period Defendants made misrepresentations regarding the demand for Oak's CD-ROM controller chips and the status of new Oak products in addition to releasing positive forecasts for revenue and earnings throughout fiscal 1996 and 1997. Plaintiffs contend that Defendants engaged in this conduct to inflate the market price of Oak's stock while selling “massive” amounts of personal Oak stock holdings. *2 In response to the Consolidated Complaint, the Oak Defendants filed a motion to dismiss pursuant to Fed.R.Civ.P. 12(b). In their motion, the Oak Defendants assert that Plaintiffs claims, as alleged in the Consolidated Complaint, fail because: (1) Plaintiffs fail to allege any false statements with sufficient particularity as required by Rule 9(b) and the Reform Act; (2) the allegedly false statements in analysts reports cannot be attributed to the Oak




Defendants; (3) the Consolidated Complaint does not allege sufficient facts to establish scienter; (4) Plaintiffs' claims based on omissions are precluded by the bespeaks caution doctrine; (5) several of the allegedly false statements are non-actionable positive statements of optimism; (6) several of Plaintiffs' claims are based on accurate reports of historical fact; (7) several claims are based on non-actionable allegations of corporate mismanagement; (8) Plaintiffs fail to plead facts to show loss causation; and (9) Plaintiffs section 20(a) claim fails because the Consolidated Complaint fails to state a claim for primary liability or allege controlling person liability with particularity. H & Q filed a separate motion to dismiss contending that Plaintiffs' claims against H & Q fail because the Consolidated Complaint does not allege specific facts showing that H & Q lacked a reasonable basis for its reports. H & Q also asserts that Plaintiffs cannot maintain their claims against H & Q because H & Q does not owe a duty to Plaintiffs in regard to the allegedly misleading reports because H & Q disseminated the reports only to its clients.

II. LEGAL STANDARDS

A. Rule 12(b)(6) Standard A complaint should only be dismissed under Rule 12(b)(6) of the Federal Rules of Civil Procedure where it appears beyond doubt that no set of facts could support plaintiff's claim for relief. Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir.1987), cert. denied, 484 U.S. 944, 108 S.Ct. 330, 98 L.Ed.2d 358 (1987). A complaint may be dismissed as a matter of law for two reasons: (1) lack of a cognizable legal theory, or (2) insufficient facts under a cognizable theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir.1984). In reviewing a motion under Rule 12(b)(6), all allegations of material fact are taken as true and must be construed in the light most favorable to the non-moving party. Durning, 815 F.2d at 1267. However, “conclusory allegations of law and unwarranted inferences are insufficient to defeat a motion to dismiss for failure to state a claim.” In re Verifone Sec. Litig., 11 F.3d 865, 868 (9th Cir.1993).

B. Section 10(b) and Rule 10b-5 Claims

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, makes it unlawful to use in connection with “the mails or facilities of interstate commerce” any “manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.” Rule 10b-5, promulgated under section 10(b), prohibits the making of “any untrue statement of a material fact” or the omission of a material fact that would render any statements made misleading in the light of circumstances under which they were made. 17 C.F.R. § 240.10b-5(b). The elements of Rule 10b-5 claim are: (1) a false statement or ar omission of a material fact; (2) reliance; (3) scienter; and (4) resulting damages. Paracor Finance v. General Elec. Capitol Corp., 96 F.3d 1151, 1157 (9th Cir.1996). If one of these elements is not present, the claim fails. Id.

C. Pleading Requirements *3 Complaints alleging fraud must meet the heightened pleading standards of Fed.R.Civ.P. 9(b), which requires that “in all averments of fraud or mistake the circumstances constituting fraud or mistake shall be stated with particularity.” As part of the recently enacted Securities Litigation Reform Act of 1995 (“Reform Act”), Congress clarified and strengthened the particularity requirements of Rule 9(b) as applied in the context of federal securities class action lawsuits. Now, to survive a motion to dismiss, a complaint for violation of the federal securities laws must meet the heightened pleading requirements which are set forth in the Reform Act. 15 U.S.C. § 78u-4(b). First, the complaint must specify each false or misleading statement. 15 U.S.C. § 78u-4(b)(1). To satisfy this requirement, a complaint must “state precisely the time, place, and the nature of the misleading statements, misrepresentations, and specific acts of fraud.” Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir.1994), cert. denied, 516 U.S. 810, 116 S.Ct. 58, 133 L.Ed.2d 21 (1995). Second, the Reform Act requires that the complaint state the reasons why each statement is false or misleading. 15 U.S.C. § 78u-4(b)(1). In some cases involving fraud, a plaintiff may explain why a statement is false or misleading by merely pointing to facts that were later revealed which, due to their nature, were necessarily in existence at the time the statement was made. In re GlenFed, Inc. Sec. Litig.,




42 F.3d 1541, 1548 (9th Cir.1994) (discussing the example of a house built on a landfill). Securities fraud cases, however, typically involve an intervening event, such as a decline in consumer demand for the company's products or the appearance of new competitors, that occurs between the time of the statement and the time the sobering facts are revealed. Id. “In the face of such intervening events, a plaintiff must set forth, as part of the circumstances constituting fraud, an explanation as to why the disputed statement was untrue or misleading when made.” Id. at 1548-49. This is most easily accomplished by identifying inconsistent contemporaneous statements or information made by or available to the defendants. Id. at 1549. Third, with respect to each act or omission, the complaint must set forth particular facts that give rise to a strong inference that defendant acted with the required state of mind. 15 U.S.C. § 78u-4(b)(2). To satisfy this requirement, the complaint must allege either (1) specific facts demonstrating that the defendant had a motive and an opportunity to commit fraud or (2) specific facts constituting circumstantial evidence of conscious behavior or recklessness if the statement is not forward-looking. These allegations of scienter cannot be conclusory in nature. Rather, they must constitute a substantial factual basis to support a “strong inference” that the defendant acted with the required state of mind. These particularity requirements may be relaxed as to matters peculiarly within the defendants' knowledge and plaintiffs may allege such matters on the basis of information and belief. Wool v. Tandem Computers Inc., 818 F.2d 1433, 1439 (9th Cir.1987). However, if an allegation regarding a statement or omission is made on information and belief, the Reform Act requires that the complaint state with particularity all facts on which the belief is formed. 15 U.S.C. § 78u-4(b)(1).

III. DISCUSSION *4 In reviewing Plaintiffs' claims, the Court finds two general deficiencies that pervade the Consolidated Complaint. First, Plaintiffs mistake quantity for particularity. Instead of providing particularity as to each statement and each Defendant's involvement in the alleged fraud, Plaintiffs attempt to meet the requirements of Rule 9(b) and the Reform Act by alleging a myriad of misleading statements and naming fourteen defendants as participants in the scheme to defraud. Apparently, Plaintiffs believe

that the sheer volume of their allegations gives credibility to their claims. However, in the end, Plaintiffs succeed only in clouding any well-founded claims with numerous unsupported and conclusory claims. Second, Plaintiffs fail to adequately explain why any of the statements were false when made. “In order to allege the circumstances constituting fraud plaintiff must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of falsehood.” GlenFed, 42 F.3d at 1549. The Consolidated Complaint sets forth numerous “adverse material facts” but contains only conclusory allegations that the “adverse material facts” were in existence or known by Defendants at the time the allegedly misleading statements were made. Further, the Consolidated Complaint is devoid of specific allegations of contemporaneous facts or information showing when the adverse facts arose. Thus, the Court can only conclude that Plaintiffs' allegations of falsity derive from later, sobering revelations made by Oak at the end of the Class Period.FN2 As such, Plaintiffs claims fail to meet the requirements of Rule 9(b) and the Reform Act because “it is clearly insufficient for plaintiffs to say that the later, sobering revelations make the earlier, cheerier statement a falsehood.” GlenFed, 42 F.3d at 1548.

FN2. The Consolidated Complaint provides that in April and May of 1996, Oak reported weakening sales for CD-ROM controller products, due in part to the transition to 6X and 8X speed drives, excess inventory and failure to increase sales of multimedia products. Consolidated Complaint ¶ ¶ 100 and 104.

In addition to these two general deficiencies, the Consolidated Complaint suffers from several specific shortcomings which are described below.

A. The Form of Plaintiffs' Allegations As an initial matter, Plaintiffs' presentation of their allegations of false and misleading statements makes it unreasonably difficult for the Court and Defendants to interpret Plaintiffs' claims. Instead of identifying each allegedly false statement in one paragraph and explaining why each statement was false when made




in the following paragraph, the Consolidated Complaint groups several allegedly false statements, often citing long passages with little, if any, explanation in the surrounding text of which particular statements were false and why they were false. Consolidated Complaint ¶ ¶ 54-72, 74-81, 83-93.FN3 At the conclusion of each of these groups of false and misleading statements, the Consolidated Complaint sets forth the conclusory allegation that the statements “were false and misleading when made” and lists “material adverse information” that was not disclosed by Defendants. ¶ ¶ 73, 82, 95.

FN3. All subsequent paragraph references are to the Consolidated Complaint.

*5 For example, paragraphs 54 through 72 of the Consolidated Complaint present seven pages of selected statements allegedly made by Oak or analysts during the time period from July 26, 1995 through September 1995. However, the vast majority of adverse facts pertaining to all of these statements are lumped together in paragraph 73. Thus, the burden is on the reader to sort out the statements and match them with the corresponding adverse facts to solve the “puzzle” of interpreting Plaintiffs' claims. This “puzzle-style” pleading has been consistently criticized by the courts as an “unwelcome and wholly unnecessary strain on defendants and the court system.” In re GlenFed, 42 F.3d 1554; See also, Strassman v. Fresh choice, Inc., 1995 WL 743728, *4 (N.D.Cal. Dec.7, 1995). Given the level of experience of Plaintiffs' counsel, the Court cannot understand why Plaintiffs' claims are alleged in this manner. Moreover, now that the Court has stated its dissatisfaction with this pleading tactic, any amended complaint that employs this form of pleading will be summarily dismissed as improper under Fed.R.Civ.P. 8.

B. False and Misleading Statements Plaintiffs allege that during the Class Period Defendants conducted a scheme to defraud by publishing false and misleading statements in press releases, articles, analysts' statements, and reports. According to the Consolidated Complaint, these statements included false information concerning: (1) CD-ROM controller chip demand and sales; (2) the transition from 2x and 4x to 6x and 8x speed drives; (3) revenues from multimedia products; and

(4) unreserved inventory.

1. CD-ROM Controller Chip Demand and Sales Plaintiffs allege that throughout the Class Period Defendants falsely represented that demand for Oak's CD-ROM controller chips was “red hot,” “exceptional” and “increasing” and that sales from the CD-ROM controller chips would generate strong earnings growth in fiscal 1996. ¶ ¶ 54, 56, 67, 72, 75, 76, 87 and 92. According to the Consolidated Complaint, Defendants made these statements knowing that certain large customers, including Toshiba, were beginning to manufacture controller chips internally and that other customers, including Mitsumi, Hitachi, Creative Technologies and NEC, had informed Oak that they would be dramatically decreasing their purchases from Oak. ¶ ¶ 7 and 73. However, Plaintiffs merely allege, without providing any supporting contemporaneous factual allegations, that these adverse facts arose before Defendants made the allegedly misleading statements. These conclusory allegations do not satisfy the requirements of Rule 9(b) and the Reform Act. Plaintiffs must allege with particularity when this information was passed to Defendants and what was said. When amending their pleading', Plaintiffs should, at a minimum, include the following information: (1) when Toshiba informed Oak of its intent to produce the chips internally; (2) when Toshiba reduced their purchases as a result of internal production; (3) when Mitsumi, Hitachi, Creative Technologies and NEC informed Oak that they would be decreasing their purchases; (4) when these customers decreased their purchases; and (5) the approximate amount of these “dramatic” reductions in purchases. *6 Plaintiffs also allege that Defendants became aware of the decline in demand for Oak's CD-ROM chips through internal reports, presentations, and regularly scheduled meetings. General allegations of internal reports, presentations and meetings do not, however, satisfy the pleading requirements for federal securities fraud class actions. Hockey v. Medhekar, 1997 WL 20374, *7 (N.D. Cal. April 15, 1997); Stack v. Lobo, 903 F.Supp. 1361, 1370 (N.D.Cal.1995). Further, adding the boilerplate assertion that the reports and presentations were “regularly prepared” does not provide the requisite particularity. Stack, 903 F.Supp. at 1370. Rather, to satisfy the pleading requirements of Rule 9(b) and the Reform Act, Plaintiffs must identify specific reports or presentations and what information was conveyed




in the reports or presentations. Here, Plaintiffs identify one presentation made by Ben Taniguchi, vice president of the Optical Storage Business Unit, at a meeting on October 25, 1995. During the presentation, Taniguchi allegedly “showed that the sales of Oak's CD-ROM chips would decline sharply, commencing early in calendar year 1996.” ¶ 78. While these allegations adequately identify the time and preparer of the internal report, they provide only vague and conclusory information concerning the content of Taniguchi's presentation. Further, Plaintiffs fail to explain how the information in Taniguchi's presentation differed from statements made by Defendants following the presentation. Therefore, Plaintiffs' claims of misleading statements regarding CD-ROM controller chip demand are insufficient.

2. Transition from 2X and 4X to 6X and 8X Speed Drives

Plaintiffs allege that Defendants falsely stated that Oak was prepared for the transition to 6X and 8X speed drives, was experiencing no problems with the transition, and continued to benefit from the transition from double speed to quad speed drives. Further, they allege that Oak's fourth generation CD-ROM controller, the OTI-910, supported multiple drive speeds of 4X, 6X, and 8X, was well received and would show strong growth during fiscal 1996. ¶ ¶ 54, 56, 58, 76, 86 and 87. To demonstrate the falsity of these statements Plaintiffs allege that the OTI-910 was not new but just a reworked version of a prior Oak product and “did not work on multiword DMA and did not support full performance mode 3.” ¶ ¶ 73(a) and 82(j). However, Plaintiffs fail to explain how these alleged shortcomings in the OTI-910 demonstrate that Oak's transition to 6X and 8X speed drives was failing or that the OTI-910 controller was defective or not well received. Thus, Plaintiffs have not sufficiently specified the reason or reasons why the statements concerning transition to 6X and 8X speed drives were misleading as required by the Reform Act. 15 U.S.C. § 78u-4(b)(1).

3. Revenue from Multimedia Products Plaintiffs also allege that Defendants misled the public by predicting that Oak's multimedia products would start generating revenue in early fiscal 1996 and would contribute to strong revenue growth throughout 1996 and continue into 1997. ¶ ¶ 54, 56,

87, and 92. For projections such as these to be actionable under the federal securities laws, Plaintiffs must demonstrate that the statement was not genuinely believed, that there was no reasonable basis for that belief, or that the speaker was aware of “undisclosed facts tending to seriously undermine the accuracy of the statement.” In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir.1989). In other words, Plaintiffs must allege facts showing that Defendants lacked a reasonable basis for their predictions. Further, these allegations, as with any allegations of fraud, must be pled with particularity. *7 In the Consolidated Complaint, Plaintiffs make the conclusory allegations that Oak was experiencing “great difficulties” developing its new multimedia products and that existing multimedia products “were not doing well.” ¶ ¶ 73, 82 and 95. However, Plaintiffs fail to provide any specific allegations to support their conclusory assertions. Thus, Plaintiffs claims of misleading projections concerning Oak's multimedia products clearly do not meet the particularity requirements of Rule 9(b) and the Reform Act. Plaintiffs also allege that Defendants misled the public by stating in an annual report, “[w]e believe that the substantial synergies among our areas of expertise, including opportunities for product integration, provide us with a competitive advantage in the multimedia marketplace” and “[w]e develop our core technologies using a consistent set of design tools, with an emphasis on building scalable and reusable functional blocks.” ¶ ¶ 61 and 63. Plaintiffs contend that these statements were materially false because Oak's CD-ROM unit used different tools and methodologies than Oak's MPEG and 3-D units and because Oak's blocks were not reusable, scalable or functional. ¶ ¶ 62 and 64. These allegations are insufficient for two reasons. First, Plaintiffs fail to show why the statements were false. Stating that there are “substantial synergies” is not a representation that all of Oak's business units use the same tools and methodologies. Thus, alleging that one business unit uses different tools than two other business units does not demonstrate that Defendants' statements regarding synergies were false. Additionally, Plaintiffs' assertion that “the blocks developed by the various business units were not scalable, reusable functional blocks,” is ambiguous, unsupported and conclusory. ¶ 64. Second, vague or amorphous statements cannot serve as a basis for liability. Raab v. General Physics




Corp., 4 F.3d 286, 288-90 (4th Cir.1993); In re Syntex Corp., 855 F.Supp. at 1095; Strassman, 1995 WL 743720 at *5. Such statements are inactionable because reasonable investors do not consider them important in making investment decisions. Raab, 4 F.3d at 289-90. Here, the statements regarding “synergies” and product integration are general, amorphous comments about Oak's efforts to integrate its various products and do not refer to any particular products or even particular business units. No reasonable investor would rely on such vague statements, “and they are certainly not specific enough to perpetrate fraud on the market.” Id. at 290. Thus, to the extent that Plaintiffs rely on these statements of “synergies” and product integration to establish liability, Plaintiffs' claims are dismissed with prejudice.

4. Unreserved Inventory The final category of allegedly misleading statements warrants minimal commentary. Plaintiffs allege that Defendants misled the public when they made assurances that Oak was not accumulating excess inventory of its CD-ROM controllers and that controller chip inventory was under control. ¶ ¶ 54 and 87. However, Plaintiffs fail to specify the reason or reasons why these assurances were false. Instead, they rely on the conclusory allegation that “Oak's inventories of the OTI-910 were increasing greatly, and Oak would be forced to take writeoffs of this inventory.” ¶ 82(m). Pleading securities fraud in such a conclusory manner is well below the standards set by the Reform Act.

C. Financial Fraud *8 Plaintiffs allege that during the Class Period Defendants committed financial fraud by: (1) recognizing revenues in violation of GAAP; (2) engaging in “sham” transactions with related parties; and (3) failing to recognize a loss on excess inventory and purchase commitments in violation of GAAP. To adequately state a claim for accounting fraud, Plaintiffs must plead facts sufficient to support a conclusion that Defendants prepared fraudulent financial statements and that the alleged financial fraud was material. In re Ross Systems Sec. Litig., [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363 at 90,498 (N.D.Cal.1994). Although Plaintiffs need not specify the exact dollar amount of each error, they must identify particular transactions underlying Defendants' alleged accounting

deficiencies. In re Wells Fargo Sec. Litig., 12 F.3d 922, 926-27 (9th Cir.1993), cert. denied sub nom., Wells Fargo & Co. v. Greenwald, 513 U.S. 917, 115 S.Ct. 295, 130 L.Ed.2d 209 (1994); In re Ross Systems Sec. Litig., Fed. Sec. L. Rep. ¶ 98,363 at 90,499. PCH1H 1. Improper Revenue Recognition Plaintiffs allege that Oak improperly recognized revenues on sales where it granted unconditional rights of return and extended payment terms with assurances that the customer could return unsold products. ¶ 117. According to the Consolidated Complaint, Oak offered these terms to its “chief Japanese, Singapore and Taiwanese customers,” resulting in approximately $75 million in overstated revenues. Id. In a separate paragraph, Plaintiffs state that Mitsumi Electric, Behavior Tech Computer, and NEC were “among” Oak's chief customers in Japan, Singapore, and Taiwan. ¶ 116. These allegations do not reach the level of particularity required for maintaining claims based on fraudulent financial statements. To adequately plead financial fraud based on improper revenue recognition, Plaintiffs must allege, at a minimum, some particular transactions where revenues were improperly recorded, including the names of the customers, the terms of specific transactions, when the transactions occurred, and the approximate amount of the fraudulent transactions. Merely providing the names of “chief customers” and estimating the net effect of the alleged improper revenue recognition does not suffice.

2. Related Party Transactions Plaintiffs allege that during fiscal 1995 and the first three quarters of fiscal 1996, an entity named EDEE, along with another company, Takaya, engaged in material transactions with Oak. ¶ 121. Plaintiffs further allege that Oak “controlled” EDEE, which was located in the same building as Oak's Japanese subsidiary, and that Oak used EDEE to “park” inventory. Id. Therefore, according to Plaintiffs, Oak violated GAAP by failing to disclose the nature and effect of these related party transactions. Once again, Plaintiffs allegations are plagued with ambiguities. Plaintiffs fail to identify the nature of the “material transactions” or the amount of any such transactions. Plaintiffs also conclude that Oak controlled EDEE without providing any explanation or allegations to support this conclusion. Lastly, the Consolidated Complaint contains no information to




elucidate Takaya's role in the alleged accounting fraud or the relationship between Takaya, EDEE and Oak. Thus, Plaintiffs provide a feeble basis for their claims of fraudulent related transactions and fall well short of meeting the pleading requirements of 9(b) and the Reform Act.

3. Excess Inventory and Purchase Commitments *9 Plaintiffs allege that in summer and fall of 1995 Oak committed to purchase millions of dollars worth of wafers during fiscal 1996 and thereafter. ¶ 124. Plaintiffs further allege that at the time the Oak Defendants issued the financial statements for the second and third quarters of fiscal 1996, Defendants knew that, due to lack of demand for Oak's controller chips, Oak did not need and would be unable to sell the wafers it was obligated to purchase. Id. Thus, Plaintiffs assert that the Oak Defendants should have recognized a loss on its purchase commitments and that failure to do so constituted a violation of GAAP. Id. This claim of financial fraud regarding excess wafers attempts to impose liability for a difficult business decision: when to recognize a loss on inventory that a company may not use. According to Plaintiffs, Defendants violated GAAP by failing to recognize a loss for its purchase commitments during second and third quarters of fiscal 1996. However, “GAAP is not a set of rules ensuring identical treatment of identical transactions; rather, it tolerates a range of reasonable treatments, leaving the choice among alternatives to management.” In re Cirrus Logic Sec. Litig., 946 F.Supp. 1446, 1457 (N.D.Cal.1996). Thus, at the pleading stage, a plaintiff must allege facts sufficient to support a finding that the accounting decision is the result of fraud and not “merely the difference between two permissible judgments.” Glenfed, 42 F.3d at 1549. Here, the Consolidated Complaint does not contain any specific allegations to support the claim that Defendants committed fraud by failing to recognize a loss in the second and third quarters. Rather, the Consolidated Complaint merely sets forth the conclusory allegation that Defendants should have recognized a loss earlier because they were aware that demand for Oak's controller chips was “weakening severely and continuing to weaken.” ¶ 124. Thus, Plaintiffs once again fail to meet the particularity requirements of Rule 9(b) and the Reform Act.

D. Liability of the Individual Oak Defendants

In the Consolidated Complaint, Plaintiffs seek to impose liability not only against Oak and the officers who released the allegedly misleading statements but also against Oak's outside directors and various divisional vice presidents of Oak. Plaintiffs assert that these Defendants are responsible for the allegedly misleading statements even though none of the statements can be directly attributed to them on the grounds that: (1) they participated in the scheme to defraud; (2) they are responsible for the statements under the group published information doctrine; and (3) they sold stock while in possession of material inside information.

1. Scheme to Defraud Plaintiffs allege that each of the outside director and vice president Defendants, “as persons selling Oak common stock, were direct participants in the scheme to defraud.” ¶ ¶ 25-32. Plaintiffs' general allegations of Defendants' fraudulent assistance are misguided. *10 Pursuant to the Supreme Court's ruling in Central Bank v. First Interstate Bank, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), this Court, along with several other courts in this district, have held that secondary liability claims based on allegations of “conspiracy” are not actionable under section 10(b). Stack v. Lobo 1995 WL 241448, *10 (N.D.Cal. Apr.19, 1995); In re Syntex Corp. Securities Litigation, 855 F.Supp. 1086, 1097-98 (N.D.Cal.1994). Here, Plaintiffs' “scheme” allegations are no more than a thinly disguised attempt to avoid the impact of the Central Bank decision. See, e.g., Stack, 1995 WL 241448 at *10 (dismissing the plaintiffs' “scheme” claims with prejudice) In re Gupta Corp. Securities Litigation, 1994 WL 748988, *28 (N.D.Cal. Dec.9, 1994) (rejecting the plaintiffs' attempts to recharacterize non-actionable conspiracy claims as “scheme” claims, and dismissing such claims with prejudice). Accordingly, Plaintiffs' claims of participation in a “scheme” to defraud investors must be dismissed.

2. Group Pleading Exception Rule 9(b) requires a plaintiff to attribute fraudulent acts or statements to a particular defendant. Schreiber Distributing v. Serv-Well Furniture Co.,




806 F.2d 1393, 1401 (9th Cir.1986). However, the Ninth Circuit has recognized an exception to this rule: In cases of corporate fraud where the false or misleading information is conveyed in prospectuses, registration statements, annual reports, press releases, or other “group-published information,” it is reasonable to presume that these are the collective actions of the officers. Under such circumstances, a plaintiff fulfills the particularity requirement of Rule 9(b) by pleading the misrepresentations with particularity and where possible the roles of the individual defendants in the misrepresentations. Wool, 818 F.2d at 1440. Notwithstanding the group pleading exception to Rule 9(b), Plaintiffs must still set forth the circumstances constituting the fraud. That is, the group pleading exception does not excuse Plaintiffs from setting forth the time, place and content of the alleged misstatements, GlenFed, 42 F.3d at 11547-48, as well as an explanation of why each of those statements was false when made. Id. at 1549. As explained above, Plaintiffs have not alleged with sufficient particularity that Oak's statements were false when made. If, upon amendment, Plaintiffs can state with particularity why Oak's statements were false when made, Plaintiffs may seek to establish the liability of the outside director Defendants for those statements. However, in order to establish the liability of the outside director defendants for Oak's allegedly misleading statements, Plaintiffs must satisfy the requirements for the group pleading exception in the Ninth Circuit: “To rely upon the ‘group published information’ presumption, Plaintiffs' complaint must contain allegations that an outside director either participated in the day-to-day corporate activities, or had a special relationship with the corporation, such as participation in preparing or communicating group information at particular times.” In Re GlenFed, 60 F.3d 591, 593 (9th Cir.1995). Moreover, the allegations concerning the outside director Defendants' involvement with Oak must satisfy the particularity requirements set forth by the Reform Act. *11 Here, with regard to all of the outside director Defendants, Plaintiffs allege that “because of [their] positions with Oak, they knew the adverse non-public information about Oak's business, finances, products, markets and present and future business prospects.” ¶ ¶ 29, 30, 31, 32. However, general allegations that outside directors were “privy to inside information” are insufficient to establish their liability for alleged

misstatements. In re Interactive Network, Inc. Sec. Litig., 948 F.Supp. 917, 921 (N.D.Cal.1995). Plaintiffs further allege that Defendants King, Black, and Tomlinson, as members of the Audit Committee of Oak's Board of Directors, “reviewed and approved the issuance of Oak's false financial statements during fiscal 1996.” ¶ ¶ 31, 32. However, Plaintiffs fail to allege these Defendants' specific roles in the review and approval of the allegedly false financial statements. Allegations that outside directors merely held positions on committees responsible for the preparation and disclosure of a corporation's finances are insufficient to set forth the circumstances constituting fraud with particularity. In re GlenFed, Inc., 60 F.3d 591, 593 (9th Cir.1995); Rubin v. Trimble, 1997 WL 227956, at *19 (N.D.Cal.). Thus, their conclusory allegation does not meet the stringent pleading requirements of Rule 9(b) and the Reform Act. Plaintiffs further make the conclusory allegation that “Ko was involved in the day-to-day operations of Oak.” ¶ 29. Again, this general allegation does not satisfy the strict pleading requirements of Rule 9(b) and the Reform Act. Plaintiffs also fail to allege with particularity that Mr. Hsu was involved in Oak's day-to-day operations, or that he prepared or communicated group information to the public. Thus, with regard to each of the outside director Defendants, the Consolidated Complaint fails to allege facts demonstrating their operational involvement with Oak, a prerequisite for group pleading. To establish the liability of the vice president Defendants under the group pleading exception, Plaintiffs must satisfy a necessarily stricter requirement. Since all of the inside officers in a corporation, by virtue of their positions, are involved in daily corporate activities, merely pleading as much is not sufficient to establish their liability under the group pleading exception. To establish the liability of these Defendants for Oak's allegedly misleading statements, Plaintiffs must plead that these vice presidents were directly involved “not only in the day-to-day affairs of [Oak] in general but also in [the preparation of its] financial statements in particular.” Wool, 818 F.2d at 1440. The existing Complaint does not allege that these Defendants participated in the preparation or communication of allegedly misleading information. Thus, Plaintiffs have failed to establish the liability of the vice president Defendants under the group pleading exception.




3. Insider Trading *12 Plaintiffs also argue that even if the outside director and vice president Defendants did not personally make false and misleading statements to the public, and even if the group pleading exception is inapplicable, these Defendants are nonetheless liable under 10b-5 for failing to disclose adverse non-public information known to them when they sold their stock. ¶ ¶ 12, 14, 133. In their allegations of insider trading, Plaintiffs rely on Chiarella v. U.S., 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1979), in which the Supreme Court established that rule 10b-5 not only bars fraudulent statements, but in some contexts requires disclosure of facts known to an insider. “[A] corporate insider must abstain from trading in the shares of his corporation unless he has first disclosed all material inside information known to him.” Chiarella, 445 U.S. at 227. Plaintiffs, however, confuse distinct theories of recovery under Rule 10b-5. While an action for insider trading is indeed an application of Rule 10b-5, it is not the same as an action based on misleading statements. Insider trading involves a failure to disclose material information; it does not concern any affirmative misrepresentation. Moreover, an allegation of insider trading does not permit alleged misstatements to be attributed to a group. Thus, Plaintiffs cannot attribute Oak's alleged misrepresentations to the outside director and vice president Defendants merely by alleging insider trading. Further, even as a separate theory of recovery under 10(b)-5 Plaintiffs' claims of insider trading fails. While the outside director and vice president Defendants, as Oak “corporate insiders,” had a duty to disclose material information when selling their shares in Oak,” Plaintiffs fail to specify what material information these Defendants possessed. Plaintiffs' general allegation that, “because of [their] ... position[s] with Oak,” each of the outside director and vice president Defendants “knew the adverse non-public information about Oak's business, finances, products, markets and present and future business prospects,” 1 25-32, does not satisfy the strict pleading requirements of Rule 9(b) and the Reform Act. As explained above, Plaintiffs have not sufficiently specified the “adverse non-public information.” Additionally, Plaintiffs have not pled

with specificity that they traded contemporaneously with Defendants. Silicon Graphics, 1996 WL 664639, at *9. Thus, Plaintiffs claims of insider trading must be dismissed.

E. H & Q's LIABILITY Defendant H & Q contends that it cannot be liable to Plaintiffs, who were not clients of H & Q, for the allegedly misleading statements in its analysts' reports. In response, Plaintiffs rely on the holdings of Warshaw v. Xoma Corp., 74 F.3d 955 (9th Cir.1996) and Fecht v. Price Co., 70 F.3d 1078 (9th Cir.1995), for the proposition that if a company may be held liable for publicly disseminating false information through a securities analyst, then a securities analyst itself must also be liable to the public at large for that same information. However, neither Warshaw nor Fecht involved claims against securities analysts. Rather, these cases established that where a public company “intentionally used [securities analysts] to disseminate false information to the investing public, ... [it] cannot escape liability simply because it carried out its alleged fraud through the public statements of third parties.” Warshaw, 74 F.3d at 959. *13 Here, Plaintiffs seek to extend the holdings of Warshaw and Fecht. In so doing, they draw an abrupt and unwarranted conclusion: “Given that Oak itself ... can be held liable for using H & Q's analyst reports as a conduit to the market, it is ridiculous to suggest that H & Q is immune from liability for disseminating its own misrepresentations through those same analyst reports.” Plaintiffs' Opposition at 16 (emphasis omitted). Yet, Plaintiffs' assessment is based on nothing more than their own normative judgment. In fact, they do not offer any competent authority supporting the contention that a securities analyst owes any duty at all to non-clients. See In re Valence Technology Securities Litig., 1996 WL 3778, *9 (N.D.Cal. January 23, 1996). Nevertheless, this Court will address the issue of H & Q's potential and actual liability in this case.

1. Omissions in Analyst Reports H & Q cannot be liable to Plaintiffs under section 10(b) for any omissions in its analyst reports. The Supreme Court has held that silence in connection with a purchase or sale of securities may indeed operate as a fraud, “[b]ut such liability is premised upon a duty to disclose arising from a relationship of




trust and confidence between parties to a transaction.” Chiarella, 445 U.S. at 230. Plaintiffs do not allege that any such relationship existed here. No named plaintiff was a client of H & Q. Moreover, Plaintiffs do not allege that H & Q sold any Oak stock during the class period; H & Q, that is, was not a “part[y] to [any] transaction” involving Oak stock. Thus, H & Q did not owe Plaintiffs a duty to disclose adverse facts, and it cannot be liable to Plaintiffs for any omissions in its analyst reports.

2. Fraud on the Market Doctrine While securities analysts cannot be liable to non-clients for omissions in their analyst reports, they can be liable for affirmative misstatements in those reports. The “fraud on the market doctrine” provides a basis for such liability. “In the usual claim under Section 10(b), the plaintiff must show individual reliance on a material misstatement. Under the fraud on the market theory, the plaintiff has the benefits of a presumption that he has indirectly relied on the alleged misstatement, by relying on the integrity of the stock price established by the market.” In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113-14 (9th Cir.1989). While the fraud on the market doctrine relaxes the proof required for the reliance element in class action securities fraud litigation, In re MDC Holdings Securities Litig., 754 F.Supp. 785, 800 (S.D.Cal.1990), it does not excuse plaintiffs from the strict pleading requirements of Rule 9(b) and the Reform Act. To adequately allege fraud, a plaintiff must set forth an explanation as to why the disputed statements were false or misleading when made. GlenFed, 42 F.3d at 1549. “This can be done most directly by pointing to inconsistent contemporaneous statements or information (such as internal reports) which were made by or available to defendants.” Id. *14 Here, Plaintiffs allege that by disseminating false information, H & Q committed a fraud on the market. However, they do not plead with the requisite particularity. Plaintiffs fail to cite specifically any internal documents or other contemporaneous facts indicating that H & Q did not believe its projections concerning Oak's performance. Instead, they merely recite portions of H & Q's analysts' reports and declare them fraudulent. ¶ ¶ 57, 70, 79, 88, 93, 97, 102. Even before the Reform Act heightened the pleading requirements in securities fraud litigation, the Ninth Circuit rejected this style of pleading: It is insufficient merely to “set forth conclusory

allegations of fraud ... punctuated by a handful of neutral facts.” Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir.1985). Thus, the existing Complaint fails to establish H & Q's liability for alleged misstatements in its analyst reports.

3. Control Person Liability Plaintiffs also contend that H & Q is liable as a control person of Mr. Hsu, who is himself liable, they argue, as a control person of Oak, for the alleged false and misleading statements inflating Oak's stock price. To state a claim for control person liability, Plaintiffs must establish (1) a primary violation of the federal securities laws, and (2) “ ‘control’ by the alleged controlling person.” FN4 First Interstate Bank of Denver v. Pring, 969 F.2d 891, 897 (10th Cir.1992).

FN4. In the regulations of the Securities and Exchange Commission (SEC), “control” is defined as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. § 230.405.

Here, as noted above, Plaintiffs fail to allege with particularity that Oak made any actionable misstatements. Where, as here, there are no primary violations pled with particularity, all secondary liability claims must fail as well. See Stack v. Lobo, 1995 WL 241448 at *10. Furthermore, Plaintiffs have not adequately alleged that H & Q was a controlling person of Mr. Hsu and that Mr. Hsu, in turn, was a controlling person of Oak. In general, the determination of who is a controlling person for purposes of liability under section 20(a) is “an intensely factual question,” Arthur Children's Trust v. Keim, 994 F.2d 1390, 1396 (9th Cir.1993), involving “scrutiny of the defendant's participation in day-to-day affairs of the corporation and the defendant's power to control corporate actions.” Kaplan v. Rose, 49 F.3d 1363, 1383 (9th Cir.1994). While Plaintiffs correctly note that section 20(a) “premises liability solely on the control relationship,” First Interstate Bank, N.A. v. Pring, 969 F.2d 891, 897 (10th Cir.1992); see also Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1575 (9th Cir.1990), they fail to recognize the requirement that the circumstances of that “control




relationship” be pled with particularity. Here, again, Plaintiffs have not satisfied the strict pleading requirements of Rule 9(b) and the Reform Act. As explained above, Plaintiffs do not allege with particularity that Mr. Hsu, an outside director of Oak, “participated in Oak's day-to-day operations,” or that he had “power to control [Oak's] corporate actions.” Kaplan, 49 F.3d at 1383. Thus, Plaintiffs fail to establish the “control relationship” between Mr. Hsu and Oak required for control person liability. *15 Moreover, Plaintiffs fail to plead with particularity the “control relationship” between H & Q and Mr. Hsu. Plaintiffs allege that “[b]y reason of H & Q's position as underwriter, broker-dealer and market maker and its substantial ownership of Oak common stock, H & Q had the power and authority ... to cause Hsu to engage in the wrongful conduct complained of herein.” ¶ 144. However, H & Q's “position” “does not create any presumption of control,” Arthur Children's Trust, 994 F.2d at 1397 (quoting 4 Louis Loss & Joel Seligman, Securities Regulation, 1724 (1990)) (emphasis in original), and does not by itself sustain an allegation of control person liability. In their general allegations, Plaintiffs do not delineate H & Q's involvement in Mr. Hsu's “day-to-day affairs” or how H & Q controlled Mr. Hsu's involvement with Oak. Furthermore, Plaintiffs fail to address the distinction between Hambrecht and Quist Asia Pacific, an overseas entity in which H & Q holds a minority interest, and H & Q itself. Thus, Plaintiffs do not satisfy the pleading requirements with respect to the “control relationship” necessary for control person liability. In sum, the chain running from H & Q to Oak through Mr. Hsu has two very weak links. Plaintiffs have not sufficiently alleged a control relationship between Mr. Hsu and Oak. Similarly, they have not adequately specified the control relationship between H & Q and Mr. Hsu. Therefore, Plaintiffs fail in their ultimate attempt to establish a control relationship between H & Q and Oak.

4. The Scheme to Defraud Finally, Plaintiffs argue that Defendants, in their efforts “to substantially assist” the “huge insider sales” of Oak stock, 34(c), participated in a “scheme” designed to defraud the investing public. As explained above, pursuant to the Supreme Court's ruling in Central Bank, secondary liability claims

based on allegations of “conspiracy” are not actionable under section 10(b). Thus, Plaintiffs' claims of H & Q's participation in a “scheme” to defraud investors must be dismissed.

IV. CONCLUSION For the foregoing reasons, the Court orders that the Consolidated Complaint is hereby DISMISSED. Plaintiffs may amend their complaint, in accordance with this order, within thirty (30) days. IT IS SO ORDERED. N.D.Cal.,1997. In re Oak Technology Securities Litigation Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) END OF DOCUMENT


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) (Cite as: Not Reported in F.Supp.2d)



United States District Court,N.D. California. In re PORTAL SOFTWARE, INC SECURITIES

LITIGATION No. C-03-5138 VRW.

Aug. 10, 2005.

Mario Alba, Cauley Geller Bowman & Rudman LLP, Robert M. Rothman, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, Melville, NY, Robert A. Jigarjian, Robert S. Green, Jenelle Welling, Green & Jigarjian LLP, San Francisco, CA, Jonathan M. Stein, Cauley Geller Bowman & Rudman, LLP, Boca Raton, FL, for Plaintiffs. Nina F. Locker, Peri Beth Nielsen, Wilson Sonsini Goodrich & Rosati, Palo Alto, CA, Joseph M. Barton, Solomon B. Cera, Gold Bennett Cera & Sidener LLP, San Francisco, CA, for Defendants.

ORDER WALKER, Chief J. *1 Plaintiffs in this securities fraud class action face the unenviable task of complying with the stringent pleading requirements imposed on such actions. All too frequently, and once again here, plaintiffs attempt this endeavor by a complaint replete with evidentiary detail, but only a loose (and the court thinks too loose) connection between the wrongful conduct alleged and its effect on the class. The Supreme Court has recently reminded lower federal courts that the heart of a fraud on a securities market is the proximate causal link between the misstatement or omission alleged and the resulting impact on the security's price. Dura Pharms Inc. v. Broudo, --- U.S. ----, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). Despite the rather forgiving interpretation of Dura in this circuit, see In re Daou Systems, Inc. Securities Litigation, 411 F.3d 1006, 2005 WL 1431833 (9th Cir. June 21, 2005), the operative pleading here fails to make this connection. Because plaintiffs will be allowed to amend, the court emphasizes the need for plaintiff to allege facts that link defendants' alleged wrongdoing to the class injury. A much shorter, but targeted, pleading may well be more effective in making this connection than the rather distended pleading now at bar. But there are other shortcomings in their pleadings that plaintiffs need to address and it

is to these that the court devotes the bulk of this order.

I Plaintiff John Romeo (Romeo) and plaintiff Pipefitters Local 522 & 633 Pension Fund Trust (Pipefitters) (collectively, plaintiffs), purporting to represent investors who purchased securities of Portal Software Inc (Portal) between May 20, 2003, and November 13, 2003, inclusive (the “class period”), bring this action under the Securities Exchange Act of 1934 (the “ '34 Act”) and the Securities Act of 1933 (the “ '33 Act”). Plaintiffs allege that defendants Portal, John Little (Little), Howard A Bain III (Bain) and Arthur C Patterson (Patterson) (collectively defendants) violated the Generally Accepted Accounting Principals (GAAP) by artificially inflating the price of Portal's stock and making false and misleading statements on which plaintiffs relied, thereby incurring substantial financial loss from purchasing Portal stock at fraudulently inflated prices. Defendants' move to dismiss (Doc # 115) plaintiffs' third consolidated amended complaint (TCAC; Doc # 111) for failure to meet the particularity requirement imposed by FRCP 9(b) and the Private Securities Litigation Reform Act (PSLRA) (amendments to the '33 and '34 Acts). Plaintiffs oppose the motion, asserting that the TCAC states sufficiently particularized claims under § 10(b) and § 20(a) of the '34 Act, as well as claims under § § 11, 12(a)(2) and 15 of the '33 Act. The court heard argument on these motions on July 7, 2005. Based upon the parties' arguments and the applicable federal law, the court concludes that: (1) the allegations in plaintiffs' complaint are not pled with sufficient particularity under the PSLRA and FRCP 9(b); (2) the allegations are not sufficient to support a strong inference of scienter under the PSLRA; (3) defendants' forward-looking statements are protected by the PSLRA's safe harbor provision; (4) claims under the '33 Act sound in fraud and therefore fail with the '34 Act claims. Accordingly, the court GRANTS defendants' motion to dismiss in its entirety.

II




*2 The factual and procedural history is derived from the TCAC and presumed true for purposes of this motion. Gompper v. VISX, Inc., 298 F.3d 893, 895 (9th Cir.2002). Portal provides billing and subscriber management solutions to its clients primarily through its “Infranet” software. Portal charges companies “license fees” for the Infranet product, as well as “service fees” for system implementation, consulting, maintenance and training. Prior to 2001, the majority of Portal's customer base consisted of “dot-com” start-up companies. Following the dot-com market crash of 2001, Portal lost many of its customers and incurred financial losses during fiscal 2002-2003 that wiped out more than 96% of Portal's equity. Portal subsequently began to market its Infranet product to more established and sophisticated business customers, including telecommunications providers. These new clients required greater customization of the software than had the dot-com startups, which in turn affected the way in which Portal could recognize license fee revenues. Pursuant to GAAP, if a software provider rewrites portions of its product to conform to a client's unique needs, it may not fully recognize the revenue on the license of software until such substantial modification has been performed. Whereas Portal had historically been able to recognize revenue at the time it delivered its Infranet product to the dot-coms, the greater customization required by these new, more established clients required Portal to defer recognizing revenue from much of its contracts until customization was complete. Plaintiffs allege that during the class period, Portal began to manipulate its license fees so it could recognize more revenue “up-front.” TCAC at ¶ ¶ 41-42. To support their allegations that Portal improperly recognized revenue prematurely and in violation of GAAP, plaintiffs rely on information from four unnamed former Portal employees: (1) a controller; (2) a “Senior Business Analyst” ' (3) an accounts receivable and revenue assurance assistant; and (4) a “Senior Marketing Manager.” TCAC at ¶ ¶ 41-54. The first three employees detail three different methods of accounting fraud allegedly undertaken by Portal management during the class period, while the Senior Marketing Manager alleges ongoing product problems and a decreasing market for key elements of Portal's software offering. The information provided by the former controller involved Portal's method for recognizing licensing revenue. Historically, Portal preliminarily offered its customers a “developmental license,” which

consisted of a trial version of the software for a few key employees. Portal would charge only a “nominal” amount for this first license. Then, if the client wished to obtain the full Infranet product, Portal would sell the client a “production license” and charge for the bulk of the contract. After fiscal 2004, plaintiffs allege that Portal simply charged a greater portion of the contract price under the developmental license, even though it was still only a trial version and significant modifications yet were to be performed under the production license. Plaintiffs also allege that Portal's outside accountants, Ernst & Young, disapproved of this new split license arrangement and reversed Portal's position, a determination which ultimately caused the shortfall in earnings and resulting stock price decline. TCAC at ¶ 43. *3 Next, the former Senior Business Analyst asserts that he was instructed by company officials, including Bain, to falsify revenue recognition studies to justify premature recognition of revenue. Under GAAP, when a software contract provides for both licensing and services, such as software modification and implementation, the revenue from each element can only be recognized as it is performed, so long as the “fair value” of each element is determinable. If the fair value of each element is not determinable, than recognition of the entire contract must be deferred until all elements have been delivered, or until such time as the fair value of the remaining elements are determinable. The Senior Business Analyst avers that when attempting to discern the fair value of elements of a software arrangement, he was directed by the management to “reverse engineer” the study to reach predetermined results. This employee, who ceased employment several months before the end of the class period, alleges that he was instructed to falsify revenue recognition studies with regard to contracts performed in “Greece, Italy, Columbia [sic] and Spain,” including a contract with “Columbia [sic] Mobile.” TCAC at ¶ 48. The third former employee on whom Plaintiffs rely is an accounts receivable and revenue assurance assistant employed during the class period. She alleges that “revenues related to [Portal's] contracts with Onstar ... [were] materially overstated during the third quarter of fiscal 2004.” TCAC at ¶ 49. Specifically, the former employee alleges that Portal would recognize revenue from the support, maintenance and upgrade elements of the software contract, even though the work had not yet been performed. This employee asserts that she obtained this knowledge because one of her duties of




employment was to reclassify the prematurely recognized revenue for future quarters. She claims that she talked to her manager about her concerns with the way Portal was classifying revenue, and was subsequently dismissed from her position. TCAC at ¶ 49. Finally, plaintiffs proffer the testimony of a Senior Marketing Manager to substantiate their allegations that Portal was misrepresenting the demand for its product and concealing significant technical problems with its applications. Specifically, the marketing employee stated that portions of Portal's billing software were being rendered obsolete by Customer Relationship Management (CRM) applications sold by vendors like SAP and Siebel. TCAC at ¶ ¶ 51-52. Moreover, Portal's Infranet product was having difficulty interfacing with these CRM applications, resulting in unexpected costs and delays for Portal. TCAC at ¶ ¶ 53-54. Plaintiffs allege that Portal's management failed to disclose these technical difficulties and the declining demand for Portal's product during the class period, thus concealing the true state of Portal's financial health. Plaintiffs' complaint alleges that the accounting fraud described above was undertaken by defendants to inflate Portal's reported revenue numbers, which were then used by defendants to create false and misleading statements regarding Portal's financial health and future business prospects. According to plaintiffs, these false and misleading statements artificially inflated Portal's stock price and allowed defendants to complete a $60 million secondary offering on September 12, 2003. Plaintiffs' claims for violations of the '33 Act are based on alleged false and misleading statements made in the registration statement and prospectus issued in connection with the secondary offering. TCAC at ¶ ¶ 142-165. Plaintiffs' claims for violations of the '34 Act are based on alleged false and misleading statements disseminated to the investing public via SEC filings and press releases. TCAC at ¶ ¶ 166-181. *4 After the close of the market on November 13, 2003, defendants announced that-due to contract delays, revenue recognition deferrals and service execution issues-Portal expected net losses of $0.36 to $0.40 per share for the third quarter fiscal 2004. These losses were in contrast to the net profits of $0.04 per share that Portal had previously projected for the quarter. Subsequent to the November 11, 2003, announcement, the price of Portal's common shares plummeted 42% to $8.77 in after hours trading. TCAC at ¶ 75. Plaintiffs allege that this

decline in Portal's stock price at the end of the class period was “a direct result of the nature and extent of [d]efendant's prior misrepresentations, omissions and fraudulent conduct concerning [Portal's] adverse business and financial conditions finally being revealed to investors and the market” and that plaintiffs “were damaged as a proximate result thereof.” TCAC at ¶ 76.

III As a preliminary matter, the court considers defendants' request for judicial notice (RJN, Doc # 119) regarding certain documents attached to the declaration of Randolph Gaw in support of defendants' motion (Gaw Decl, Doc # 116). Defendants contend that all the documents so attached are the proper subject of judicial notice pursuant to FRE 201. Exhibits N through U to the Gaw declaration are Form 4s filed with the SEC regarding the stock sales of the individual defendants and other corporate officers and directors, while exhibits A through H are the SEC filings of defendant Portal. Defendants contend that the court is authorized to take judicial notice of documents filed with the SEC. The court agrees that judicial notice of such documents is proper. See, e g, Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1276 (11th Cir.1999); Allison v. Brooktree Corp., 999 F.Supp. 1342, 1352 n3 (SD Cal 1998). This conclusion is bolstered by the fact that courts are specifically authorized, in connection with a motion to dismiss a securities fraud complaint, to consider documents and filings described in the complaint under the incorporation by reference doctrine. See, e g, Ronconi v. Larkin, 253 F.3d 423, 427 (9th Cir.2001); In re Silicon Graphics Securities Litigation, 183 F.3d 970, 986 (9th Cir.1999). Thus, the court takes notice of all the documents attached to the Gaw declaration that were filed with the SEC. Exhibits I through M are Portal press releases, which defendants claim contain “safe harbor” warnings regarding any forward-looking statements in the press releases. Judicial notice of these exhibits is proper because the court is required to consider “any cautionary statement accompanying [a] forward-looking statement, which [is] not subject to material dispute, cited by the defendant.” 15 USC § 78u-5(e). In addition, the court may take judicial notice of information that was publicly available to reasonable investors at the time the defendant made the allegedly false statements. See In re The First Union Corp




Securities Litigation, 128 F Supp 871, 883 (WD NC 2001). This is true of press releases, even if they were not explicitly referenced in the complaint. See Wietschner v. Monterey Pasta Co., 294 F Supp 2d 1102, 1108-09 (N.D.Cal.2003). *5 Exhibit V to the Gaw declaration is the “Statement of Position 97-2 Software Revenue Recognition.” This is an accounting statement issued by the American Institute of Certified Public Accountants. RJN Doc # 19 at 4. Courts may take judicial notice of documents that are alleged in the complaint and whose authenticity no party questions, even when not attached to the complaint. See Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir.1994). Finally, at oral argument on July 7, 2005, plaintiffs submitted to the court three additional documents and requested that the court take judicial notice of them in considering this motion. Doc # 130. These documents include (1) a Portal press release dated June 30, 2005; (2) Portal's Form 8-K filed with the SEC on June 27, 2005; and (3) Portal's Form 10-Q for the quarter ending October 31, 2004, filed with the SEC on April 25, 2005. Id. The court takes notice of these documents, which are all public filings capable of judicial notice.

IV

Standard of Review FRCP 12(b)(6) motions to dismiss essentially “test whether a cognizable claim has been pleaded in the complaint.” Scheid v. Fanny Farmer Candy Shops, Inc., 859 F.2d 434, 436 (6th Cir.1988). FRCP 8(a), which states that plaintiff's pleadings must contain “a short and plain statement of the claim showing that the pleader is entitled to relief,” provides the standard for judging whether such a cognizable claim exists. Lee v. City of Los Angeles, 250 F.3d 668, 679 (9th Cir.2001). This standard is a liberal one that does not require plaintiff to set forth all the factual details of his claim; rather, all that the standard requires is that plaintiff give defendant fair notice of the claim and the grounds for making that claim. Leatherman v. Tarrant County Narcotics Intell & Coord Unit, 507 U.S. 163, 168, 113 S.Ct. 1160, 122 L.Ed.2d 517 (1993) (citing Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). To this end, plaintiff's complaint should set forth “either direct or inferential allegations with respect to all the material elements of the claim”. Wittstock v. Van Sile, Inc., 330 F.3d

899, 902 (6th Cir.2003). Under Rule 12(b)(6), a complaint “should not be dismissed for failure to state a claim unless it appears beyond doubt that plaintiff can prove no set of facts in support of [her] claim which would entitle [her] to relief.” Hughes v. Rowe, 449 U.S. 5, 9, 101 S.Ct. 173, 66 L.Ed.2d 163 (1980) (citing Haines v. Kerner, 404 U.S. 519, 520, 92 S.Ct. 594, 30 L.Ed.2d 652 (1972)); see also Conley, 355 U.S. at 45-46. All material allegations in the complaint must be taken as true and construed in the light most favorable to plaintiff. See Silicon Graphics, 183 F.3d at 980 n10. But “the court [is not] required to accept as true allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” Sprewell v. Golden State Warriors, 266 F.3d 979, 988 (9th Cir.2001) (citing Clegg v. Cult Awareness Network, 18 F.3d 752, 754-55 (9th Cir.1994)). Review of a FRCP 12(b)(6) motion to dismiss is generally limited to the contents of the complaint, and the court may not consider other documents outside the pleadings. Arpin v. Santa Clara Valley Transportation Agency, 261 F.3d 912, 925 (9th Cir.2001). The court may, however, consider documents attached to the complaint. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995). If a plaintiff fails to attach to the complaint the documents on which the complaint is based, a defendant may attach such documents to its motion to dismiss for the purpose of showing that the documents do not support plaintiff's claim. In re Autodesk, Inc. Securties Litigation, 132 F Supp 2d 833, 837 (N.D.Cal.2000) (citing Branch v. Tunnel, 14 F.3d 449, 454 (9th Cir.1994)). This permits the court to consider the full text of a document that the plaintiff's complaint only partially quotes. Autodesk, 132 F Supp 2d at 838 (citing In re Stac Electronics Securities Litigation, 89 F.3d 1399, 1405 n4 (9th Cir1996), cert. denied, 520 U.S. 1103, 117 S.Ct. 1105, 137 L.Ed.2d 308 (1997)). Additionally, “[t]he court need not * * * accept as true allegations that contradict matters properly subject to judicial notice * * *.” Sprewell, 266 F.3d at 988 (citing Mullis v. United States Bankr Ct., 828 F.2d 1385, 1388 (9th Cir.1987)). *6 But these liberal pleading standards described above have been substantially tightened in the context of securities litigation, as will be discussed infra.

V




The TCAC alleges five causes of action. For the first and second causes of action, plaintiffs allege violations of sections 11 and 12(a)(2) of the '33 Act against all defendants. Plaintiffs' first and second causes of action are based on the registration statement Portal filed for its secondary public offering (SPO) in September 2003. Plaintiffs' third cause of action alleges control liability under section 15 of the '33 Act against Little, Bain and Patterson (the “individual defendants”). Plaintiffs' fourth cause of action alleges violations of section 10(b) of the '34 Act and Rule 10b-5 promulgated thereunder against all defendants. Lastly, plaintiffs allege control liability under section 20(a) of the '34 Act against the individual defendants. The court will first address first plaintiffs' claims under the '34 Act before turning to the claims brought under the '33 Act.

A Section 10(b) and 20(a) of the Exchange Act of 1934

Section 10(b) of the '34 Act and SEC Rule 10b-5, promulgated thereunder, make it unlawful for any person, in connection with the purchase or sale of any security, to (1) engage in fraud or (2) make an untrue statement regarding a material fact or (3) make a misleading statement by omitting a material fact. 15 U.S.C. § 78j(b); 17 CFR § 240.10b-5. Consequently, the elements of a Rule 10b-5 claim are: (1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss. See Dura, 125 S Ct at 1633. Claims brought under Section 10(b) and Rule 10b-5 must first meet the particularity requirements of FRCP 9(b). In re Stac, 89 F.3d at 1404; see also In re GlenFed Inc. Securities Litigation, 42 F.3d 1541, 1545 (9th Cir.1994) (en banc). Rule 9(b) requires a plaintiff alleging fraud to “set forth what is false or misleading about [the] statement[ ] and why it is false.” GlenFed, 42 F.3d at 1548. Second, a complaint must satisfy the more stringent requirements imposed on securities fraud pleadings by the PSLRA. Specifically, the PSLRA requires that a complaint: (1) “specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading * * * ” (15 USC § 78u-4(b)(1)); (2) with respect to any such allegations

based upon information and belief, “state with particularity all facts on which that belief is formed” (15 USC § 78u-4(b)(1)); and (3) “with respect to each act or omission * * * state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind” (15 USC § 17u-4(b)(2)). The required state of mind, or scienter, is met where the complaint alleges that the defendants made the false or misleading statements either intentionally or with deliberate recklessness.” In re Daou Systems, Inc. Securities Litigation, 411 F.3d 1006, 2005 WL 1431833 (9th Cir. June 21, 2005) (citing Silicon Graphics, 183 F.3d at 974) (emphasis added). In securities cases, falsity and scienter “are generally inferred from the same set of facts and the two requirements may be combined into a unitary inquiry under the PSLRA.” In re Vantive Corp. Securities Litigation, 283 F.3d 1079, 1091 (9th Cir.2002) (citations omitted). *7 Even if plaintiffs meet these heightened pleading requirements, however, the PSLRA carves out a safe harbor from liability if the alleged false or misleading statements were forward-looking and accompanied by meaningful risk warnings. 15 USC § 78u-5(c); see also In re Splash Technology Holdings, Inc Securities Litigation, 2000 U.S. Dist LEXIS 15369, *16 (ND Cal) (Splash I ). An analogous doctrine (which predates the enactment of the PSLRA) is the “bespeaks caution” doctrine, which allows a court to rule as a matter of law that defendant's forward-looking statements contained enough cautionary language or risk disclosure to protect against liability. See, e g, Provenz v. Miller, 102 F.3d 1478, 1493 (9th Cir.1996). If a defendant's statements are immunized under either doctrine, dismissal of the complaint is appropriate. See id; Splash I, 2000 U.S. Dist LEXIS at *29. Defendants challenge the sufficiency of plaintiffs' '34 Act claims on several grounds: (1) plaintiffs' complaint lacks the specificity needed to plead accounting fraud; (2) plaintiffs fail to plead facts raising a strong inference of scienter; and (3) defendants' statements are protected by the PSLRA's safe harbor provision. Before turning to the issue of safe harbor, the court will address the defendants' first two contentions under the “unitary inquiry” advocated in this circuit, as “falsity and scienter are generally inferred from the same set of facts * * *.” In re Vantive, 283 F.3d at 1091.

1




Defendants contend that the TCAC should be dismissed because plaintiffs have not adequately pled facts to support their allegations of accounting fraud or to support a strong inference of scienter. “If properly pled, overstating of revenues may state a claim for securities fraud, as under GAAP, revenue must be earned before it can be recognized.” In re Daou, 2005 WL 141833 at *5 (citations omitted) (emphasis in original). Plaintiffs must plead facts sufficient to support a conclusion that defendants “prepared the fraudulent financial statements and that the alleged financial fraud was material.” See id (quoting In re Peerless Systems, Corp. Securities Litigation, 182 F Supp 2d 982, 991 (S.D.Cal.2002). Although violations of GAAP standards may provide evidence of scienter, see id, the complaint must allege GAAP violations with sufficient particularity to support a strong inference of scienter. See, e g, In re McKesson HBOC, Inc. Securities Litigation, 126 F Supp 2d 1248, 1273 (N.D.Cal.2000) (“[w]hen significant GAAP violations are described with particularity in the complaint, they may provide powerful indirect evidence of scienter. After all, books do not cook themselves.”.) The inquiry focuses on the specificity of the allegations; “a general allegation that the practices at issue resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation.” In re Daou, 411 F.3d 1006, 2005 WL 1431833 at *5 (quoting Greebel v. FTP Software, Inc., 194 F.3d 185, 203-04 (1st Cir.1999). *8 The Ninth Circuit recently instructed that complaints stating sufficiently particular accounting irregularities should include: “(1) such basic details as the approximate amount by which revenues and earnings were overstated; (2) the products involved in the contingent transaction; (3) the dates of any of the transactions; or (4) the identities of any of the customers or [company] employees involved in the transactions.” In re Daou, 411 F.3d 1006, 2005 WL 1431833 at *6 (citations and internal quotation marks omitted). Although the complaint need not provide each and every detail described above, it should enable a court to determine whether the alleged fraud “constituted widespread and significant inflation of revenue.” Id. Before reaching the substance of plaintiffs' complaint, the court notes that plaintiffs' allegations are derived, in large part, from information provided by confidential witnesses. The Ninth Circuit requires a particular inquiry to determine if the use of such confidential sources satisfies the PSLRA. See In re

Daou, 411 F.3d 1006, 2005 WL 1431833 at *4. The inquiry focuses on whether unnamed sources of information in the complaint are described “with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” Nursing Home Pension Fund, Local 114 v. Oracle Corp., 380 F.3d 1226, 1233 (9th Cir.2001) (quoting Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir.2000)). These personal sources need not be named so long as the information they provide is adequately corroborated by other facts. Silicon Graphics, 183 F.3d at 985. In In re Daou, the Ninth Circuit recently adopted the First Circuit's “suggested criteria for assessing reliability of confidential witnesses.” In re Daou, 411 F.3d 1006, 2005 WL 1431833 at *4. These criteria include “the level of detail provided by the confidential sources, the corroborative nature of the other facts alleged (including from other sources), the coherence and plausibility of the allegations, the number of sources, the reliability of the sources, and similar indicia.” In re Cabletron Sys. Inc., 311 F.3d 11, 29 (1st Cir.2002). Moreover, when a complaint relies on unnamed employees, courts generally look for specific descriptions of the employee's relevant duties and responsibilities to evaluate the reliability of their information. See, e g, In re Daou, 411 F.3d 1006, 2005 WL 1431833 at *4 (finding that confidential witnesses were described with a “large degree of particularity” where, in all cases, their job description and responsibilities were delineated, and in some cases, plaintiffs identified the executive to whom the employee reported); see also In re Northpoint Communications Group, Inc., 221 F Supp 2d 1090, 1097 (N.D.Cal.2002) (holding that a second amended complaint cured some specificity problems of original complaint where it set out, in addition to job titles and tenure of confidential witnesses, their responsibilities at the company). *9 The TCAC relies in large part upon information provided by three unnamed former Portal employees to substantiate allegations that defendants were engaging in accounting fraud in order to overstate revenue. Plaintiffs identify these employees by either their titles or their positions in the company, but generally fail to describe with any particularity the duties of each employee, or how or why they came to be familiar with the information they provide. Despite plaintiffs' failure to specify each employee's duties, in some cases the employees' accounts themselves describe their relevant duties in the course of relating elements of the alleged accounting fraud. Consequently, the court cannot adopt wholesale the




allegations provided by the unnamed employees in plaintiffs' complaint. Rather, in determining whether the TCAC adequately pleads violations of the securities laws, the court will rely only on factual allegations which evince reliability through detail, context and corroboration. With these legal principles in mind, the court turns to plaintiffs' allegation that Portal engaged in accounting fraud by falsely inflating revenues to conceal Portal's precarious financial condition. Specifically, plaintiffs allege that defendants prematurely recognized revenue by (1) improperly categorizing licensing revenue, (2) overstating purported billing rates to recognize greater costs on delivered elements of a contract, (3) manipulating the fair value amount attributable to undelivered items and (4) recognizing revenue before project milestones were approved by customers. Plaintiffs allege that defendants manipulated license agreements into two parts and improperly priced the first part of the license with the bulk of the contract fee so that they could recognize the revenue prematurely. TCAC ¶ ¶ 41-43. In support of this allegation, plaintiffs rely entirely on information provided by a former controller. Id. Yet, the former controller's account does not contain inherent indicia of reliability. First, her employment with Portal ended almost a year before the class period even began. TCAC ¶ 41. Consequently, her entire account of Portal's fraudulent revenue recognition practices during the class period are based on second-hand reports from company “insiders.” Id ¶ 43. Although she has personal knowledge to support her descriptions of Portal's revenue recognition practices prior to the class period, it is the allegations that Portal made fraudulent changes to these recognition practices during the class period that require “a reasonable conviction in the informant's basis of knowledge.” In re NorthPoint, 221 F Supp 2d at 1097. Hence, plaintiffs must describe the job title, job description, duties, and dates of employment for the controller's sources before this information can be deemed reliable. Plaintiffs have made no attempt to provide such information about any of the controller's “insiders,” and consequently, plaintiffs' allegations regarding improperly bifurcated contracts are not pled with sufficient particularity. *10 Plaintiffs' next allegations-that defendants “cooked” revenue numbers to recognize revenue prematurely-are somewhat better supported. The TCAC identifies a “Senior Business Analyst” who worked at Portal until July 2003, two months into the

class period. Although the complaint again fails specifically to describe this employee's job duties, to whom he reported, or in which department he worked, his account ameliorates the shortfall. As part of his employment, the analyst asserts that he was required to “reverse engineer” revenue recognition studies to reach a predetermined result. TCAC ¶ 45. Moreover, the analyst asserts that he was personally directed to create these false studies by defendant Bain, the CFO. Id ¶ 47. These fabrications involved falsely selecting high billing rates to inflate revenues for work already performed on contracts (Id ¶ 46) or falsely calculating a low value for undelivered elements so that greater revenue could be attributed to the elements already delivered (Id ¶ 47). Although the Senior Business Analyst only identifies one customer by name for whom he created false revenue recognition studies (Columbia Mobile), he alleges that he was “required to perform analyses that matched management's predetermined results for work performed in * * * Greece, Italy, Columbia and Spain in connection with at least six of Portal's major contracts” and that Portal booked $5 million in revenue as a result of these contracts. Id ¶ 48. Based on his personal involvement in fraudulent activity at the behest of Bain, the court concludes that these allegations potentially support a claim under the '34 Act. Moreover, the court finds that the specificity of the account indicates a level of reliability. Yet because the analyst's account provides no indication of how these alleged manipulations affected Portal's financial earnings statements, further corroboration is necessary to meet the heightened pleading requirements of the PSLRA. Next, the TCAC alleges that defendants engaged in improper revenue recognition through testimony of an accounts receivable and revenue assurance assistant who allegedly worked at Portal during the class period. TCAC ¶ 49. Again, this employee's account self-identifies her duties and basis for knowledge, mitigating the TCAC's failure to do so. For example, the assistant specifies that “one of [her] duties was to reclassify revenue for future quarters.” Id ¶ 49. It was through this work, she alleges, that she came to learn that Portal was improperly recognizing revenue from software licensing contracts. Id. The assistant explains her basis for knowledge: “I have been working with revenue recognition for 12 years, and I understand the way revenue is supposed to be recognized.” Id. The assistant's account also alleges a particular contract, with Onstar, for which Portal “materially overstated [revenues] during the third quarter of fiscal 2004.”




TCAC ¶ 49. In the Ninth Circuit, “although overstatement of revenues in violation of GAAP may support a plaintiff's claim of fraud, the plaintiff must show with particularity how the adjustments affected the company's financial statements and whether they were material in light of the company's overall financial position.” In re Daou, 411 F.3d 1006, 2005 WL 1431833 at *7. In In re Daou, the panel found that the plaintiff adequately described how “allegedly premature [revenue] recognition affected Daou's financial bottom line” where the complaint pled “the approximate amount by which revenues and earnings were overstated, * * * the dates of some of the transactions and the identities of the customers and the company employees involved in the transactions.” Id at *8. For example, the plaintiffs in In re Daou alleged that only $5.9 million was eligible for recognition in the third quarter of 1997, 48% less than the $11.3 million that Daou publicly reported. Id. *11 In contrast, the TCAC is bereft of such comparisons. Only the Senior Business Analyst alleges a dollar amount-$5 million-for prematurely recognized revenue. Even this figure is unconnected to identified customers or dates, much less a specific quarterly report against which to assess its materiality. Although the accounts receivable assistant allegedly reclassified improperly booked revenues, she does not indicate how much revenue was reclassified or how this affected Portal's financial statements. The controller's statements, lacking in personal knowledge, also fail to specify how much revenue the allegedly improper licensing contracts allowed Portal to recognize prematurely, and how that affected Portal's bottom line. The TCAC also alleges that defendants engaged in accounting fraud by recognizing “license and service fees under * * * service arrangements prior to customer approval of specific project milestones in violation of the Company's publicly stated revenue recognition practices and policies” and in violation of GAAP. TCAC ¶ 50. To support this allegation, plaintiffs refer only to defendants' disclosure, subsequent to the class period, that it was excluding $700,000 of previously reported revenue for fiscal 2004 due to a customer's refusal to approve project milestones. TCAC ¶ 84. Defendants argue that this disclosure related to a contract performed after the class period, but plaintiffs provide information indicating the restatement related to fiscal 2004. TCAC ¶ 84. Even assuming this revenue was

originally announced during the class period, the court finds that plaintiffs' single example of defendants announcement of revenue prior to customer approval does not raise a strong inference of scienter. Plaintiffs allege that defendants also violated the '34 Act by materially misrepresenting the declining demand for Portal's products and services and failing to disclose severe interface problems that delayed delivery and increased costs. TCAC ¶ ¶ 51-54. Support for this allegation, however, comes from only one unnamed employee, a Senior Marketing Manager, who worked for only two months of the class period. From this employee's title, the court might infer such a position would afford knowledge of the market for Portal's product. Thus, this account could conceivably provide evidence of the “shrinking market and role for billing software applications.” Id ¶ 52. In addition, the employee identifies two vendors, SAP and Siebel, that offered products that “displaced the role previously provided” by aspects of Portal's billing software. Id ¶ 51. But the specificity ends there. The employee fails to identify any of “Portal's large telecommunications customers” for whom customer service applications were no longer required as part of Portal's billing software. Id. And, although the marketing manager alleges that Portal was spending too much time and money due to “excessive bugs and/or interface problems with other applications,” these allegations fail to indicate any specific customers, contracts, or dates. Id ¶ 54. *12 The court finds that plaintiffs' allegations of accounting fraud and material misrepresentations are not pled with sufficient particularity and, consequently, do no raise a strong inference of scienter. Plaintiffs, however, present an alternative basis for demonstrating scienter; the complaint focuses on defendants' stock sales and Portal's SPO to show that defendants had the motive and opportunity to mislead investors deliberately. As discussed in the next section, however, these allegations fail to plead a violation of section 10(b) adequately.

2

Scienter To demonstrate motive, plaintiffs allege that defendants engaged in insider trading during the class period. The PSLRA “neither prohibits nor endorses the pleading of insider trading as evidence of




scienter, but requires that the evidence meet the ‘strong inference’ standard.” Greebel, 194 F.3d at 197. While “trading at suspicious times or in suspicious amounts” is probative of scienter, the trading must be “unusual, well beyond the normal patterns of trading by those defendants.” Id. Under this standard, the court questions plaintiffs' reliance on the stock sales attributable to “company insiders” to demonstrate defendants' motive to conduct accounting fraud or issue misleading statements. First, defendant Little sold no personal stock. Defendant Bain sold 4,000 shares after exercising 7,500 stock options, which means he did not sell 3,500 shares. Plaintiffs focus on “89,157 shares of Portal common stock” sold by “Portal insiders.” TCAC at ¶ 65. Most of these “insiders,” however, are not named defendants, nor do plaintiffs allege they were involved in the fraudulent activity. Moreover, plaintiffs' reliance on “suspicious” stock sales ultimately fails because the stock sales do not appear suspicious at all. For example, plaintiffs focus on the period from May 28, 2003, to July 2, 2003, which was “immediately after” the first earnings announcement of the class period-but also after the announcement of an alliance with Microsoft. TCAC at ¶ 65. Although plaintiffs allege that Portal common stock was artificially inflated during this period, they do not allege that the deal with Microsoft was improper. In fact, plaintiffs ignore the legitimate, positive effect the Microsoft deal might have had on Portal's stock or the role the Microsoft deal might have had in the executives' decision to sell. No attempt is made to delineate the “artificiality” of Portal's stock during this period, which is especially curious since it appears that Portal's stock actually dropped by several dollars after the first earnings announcement of the class period. TCAC at ¶ 140 (Charting NASDAQ Index). Moreover, plaintiffs fail to demonstrate that the timing of the stock sales was “suspicious” where the TCAC does not provide a comparison of these sales with the executives' “normal patterns of trading.” Greebel, 194 F.3d at 197. By contrast, plaintiffs' contention that defendants were motivated to inflate artificially Portal's stock price in the short term in order to conduct a successful secondary public offering and obtain much-needed operating capital does allege facts of a palpable motive for fraud. In fact, Portal raised $60 million in September, just two months before Portal's stock plummeted by over 40%. Plaintiffs allege that Portal's finances were such that the $60 million was

absolutely necessary to keep Portal a “going concern.” Plaintiffs' Opposition at 21. Accordingly, this motive evidence is stronger than the generic “desire to raise capital” which can be attributed to every company. Metricom, 2004 U.S. Dist LEXIS 7834 at *110. But in the Ninth Circuit, such motive pleading must be combined with allegations of other “red flags” to be probative. In re Vantive, 283 F.3d at 1097. As discussed above, plaintiffs' allegations of accounting fraud lack sufficient particularity and cannot be combined with this alleged motive to establish a strong inference of scienter.

3

Safe Harbor *13 In their motion to dismiss, defendants argue at great length that plaintiffs' TCAC does not adequately plead claims based on false projections or opinions. Defendants are correct that the PSLRA carves out a safe harbor from liability for forward-looking statements that are accompanied by meaningful cautionary language. 15 USC § 78u-5(c); see also In re Copper Mountain Securities Litigation, 311 F Supp 2d 857, 866 (N.D.Cal.2004)(Walker, J). Under the analogous “bespeaks caution” doctrine, a court may also find as a matter of law that “defendant's forward-looking statements contained enough cautionary language or risk disclosure to protect against liability.” Id at 866. Mere boilerplate or generic warnings, however, are insufficient; “[t]he cautionary warning ought to be precise and relate directly to the forward-looking statements at issue.” Id at 882. Moreover, this court has previously found that “vague and * * * run-of-the-mill corporate optimism” is not actionable because no reasonable investor would rely on “mere puffery.” Id at 868-69. A close reading of plaintiffs' TCAC reveals that the vast majority of plaintiffs' allegations of “materially false and misleading statements” focus on defendants' statements regarding present or historical facts, such as Portal's past quarterly earnings based on (1) allegedly inflated revenues (TCAC ¶ ¶ 58, 60, 64, 66, 67); (2) Portal's past and current revenue recognition policies that plaintiffs allege misrepresented the way in which Portal was recognizing revenue (TCAC ¶ ¶ 61-64, 68-70); (3) omissions of past and current facts regarding declining sales and product demand as well as difficulties marketing Portal's product (TCAC ¶ 64e-f); and (4) omissions of the present fact that Portal




was experiencing severe technical problems with its core products, which were eroding its revenue stream (TCAC ¶ 64g). But neither the PSLRA's safe harbor provision nor the bespeaks caution doctrine are applicable to statements of historical fact. See e g, Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 403 F.3d 1050, 1056-57 (9th Cir.2005). In fact, the only forward-looking statements that plaintiffs allege were false or misleading when made are the revenue projections for fiscal 2004 and the subsequent quarter's revenue projections that accompanied Portal's public announcement of financial results for the quarter just concluded. See TCAC ¶ 58 (May 20, 2003, announcement of financial results for quarter ending May 2, 2003); TCAC ¶ 66 (August 19, 2003, announcement of financial results for quarter ending August 1, 2003). These announcements were made in press releases and included defendants' statements that Portal expected revenues to grow by “10-12%” over the prior year and that Portal would “return to pro forma earnings” within the current fiscal year. TCAC ¶ 58. Both of these statements concerned “a projection of revenues” and “future economic performance” and thus were clearly forward-looking statements under the PSLRA. 15 USC § 78u-5(i); Copper Mountain, 311 F Supp 2d at 880. The court now turns to plaintiffs' argument that defendants' forward-looking statements are unprotected by the PSLRA's safe harbor provision or the bespeaks caution doctrine because (1) the statements were not accompanied by meaningful cautionary language and (2) defendants knew they were false when made. *14 The court finds that defendants' forward-looking statements were accompanied by cautionary language that was sufficiently specific and meaningful to warn investors of the risks that actually materialized. First, defendants' May 20 and August 19 press releases-which contained the 10-12% profit projection and “return to pro forma earnings” statements-each included “safe harbor” warnings that the statements were forward-looking and subject to uncertainties and risk. Gaw Decl; Exs I and J. Moreover, these press releases specified a number of factors which might effect the projections, including the migration to “larger, multi-year deals, which * * * may dampen near-term growth * * * and add[ ] to the volatility of license revenues.” Id. In addition to those warnings contained in the press releases, both press releases referred investors to the Form 10-K for additional warnings. Gaw Decl; Ex C.

at 31 (“These and other factors are described in detail in our Annual Report on Form 10-K for the fiscal year ended January 31, 2003 * * *.”). Thus, the information in the Form 10-K was incorporated into the “total mix of information in the document” available to reasonable investors, even though the Form 10-K did not actually accompany the press releases. Copper Mountain, 311 F Supp 2d at 876 (citing Fecht v. The Price Co., 70 F.3d 1078, 1082 (9th Cir.1995). The Form 10-K contained several pages of detailed and explicit warnings regarding Portal's dependance on a few large customers, the risks associated with long implementation periods, and the numerous variables which could adversely affect revenue recognition for any quarter. Also, the Form 10-K warned that Portal would begin offering “products and services for a ‘bundled’ price, such that a separate price would not be identified for the product and service components. Such a change may significantly delay the timing of our revenue recognition.” Gaw Decl; Ex C at 31 (emphasis added). Because these warnings hew to the actual deficiencies that caused Portal's earnings shortfall-“contract delays and revenue recognition deferrals” with existing large customers-they provided sufficiently specific and material warnings to immunize defendants' forward-looking statements. See Copper Mountain, 311 F Supp 2d at 882. Plaintiffs also assert that, regardless of cautionary language, defendants are liable for their forward-looking statements because they knew them to be false and misleading when made. Plaintiffs are correct that a forward-looking statement cannot be immunized under the PSLRA if it was made with “actual knowledge * * * that the statement was false or misleading.” 15 USC 78u-5(c)(1)(B). In this case, however, plaintiffs' argument is unavailing because plaintiffs have failed to demonstrate that the defendants knew that Portal would not achieve 10-12% growth or return to pro forma earnings within the year when the press releases were issued. As discussed above, the TCAC is deficient, in part, in that it fails to allege facts showing how the alleged accounting adjustments materially affected the company's financial statements. See supra IV(A)(1)(i). These facts are necessary not only to plead adequately accounting fraud or scienter on the part of defendants, but also to demonstrate that the defendants knew at the time the earnings projections were announced that Portal could not meet those projections. Accordingly, Defendants' cannot be liable for the forward-looking statements in the May 20 and August 19, 2005, press releases, and plaintiffs' claims premised on these statements must be




dismissed.

4

20(a)

Control Liability *15 Section 20(a) provides for “controlling person liability.” To establish such liability, plaintiffs must first demonstrate the existence of a violation under Section 10(b)-the “primary violation.” Copper Mountain, 311 F Supp 2d at 883 (citation omitted). “[I]n the absence of a viable claim under Section 10(b), any remaining Section 20(a) claims must be dismissed.” Id (citations omitted). Because the court has determined that plaintiffs have failed to state claims under Section 10(b), plaintiffs have “no basis upon which to premise a Section 20(b) claim” and the Section 20(b) claims must also be dismissed.

B

Section 11, 12(a)(2) and 15 of the Securities Act of 1933

Plaintiffs also bring claims against defendants for violations of the '33 Act arising out of Portal's secondary public offering in September 2003. In contrast to claims brought under the '34 Act, section 11 of the '33 Act creates a private remedy for a purchaser of a security where “any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statement therein not misleading.” 15 USC § 77k(a). “The plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his or her investment.” In re Stac, 89 F.3d at 1403-04. “No scienter is required for liability under § 11; defendants will be liable for innocent or negligent material misstatements or omissions.” Id (citations omitted) '33 Before addressing the substance of the '33 Act claims, the court must first determine if they

are time barred.

1

Relation Back Defendants challenge the timeliness of plaintiffs' '33 Act claims. Section 13 of the '33 Act requires that claims under sections 11 and 12(a)(2) be brought “within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.” 15 USC § 77m. Plaintiffs' first complaint, filed on November 20, 2003, did not include '33 Act claims. These claims were not added until the second amended complaint (SAC), filed on March 30, 2005 (sixteen months later). Defendants argue that plaintiffs discovered the conduct giving rise to the '33 Act claims at least when the first complaint was filed. Consequently, defendants argue that the '33 Act claims are time-barred. Plaintiffs seek to avoid this bar by asserting that the new claims in the SAC “relate back” to the initial complaint under FRCP 15(c)(2). Rule 15(c)(2) states that an amended complaint relates back to the initial one for statute of limitations purposes if the “claim or defense asserted in the amended pleading arose out of the conduct, transaction, or occurrence set forth * * * in the original pleading.” The crux of this inquiry is “whether the opposing party has been put on notice about the claim or defense raised by the amended pleading.” SEC v. Seaboard Corporation, 677 F.2d 1301, 1314 (9th Cir.1982). This court previously observed that the class notice for the '34 Act claims would have put investors with '33 Act claims on notice. Doc # 100. It follows that defendants were also put on notice of the potential for '33 Act claims arising from the same set of facts.

2

Sound in Fraud *16 Section 11 does not contain an element of fraud, yet a complaint may be subject to the particularity requirements of Rule 9(b) if it “sounds in fraud.” Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 (9th Cir.2003). If the complaint alleges “a unified course of fraudulent conduct and rel[ies] entirely on that course of conduct as the basis of a claim * * *




the claim is said to be ‘grounded in fraud’ or to ‘sound in fraud,’ and the pleading of that claim as a whole must satisfy the particularity requirement of Rule 9(b).” Id at 1103-1104. In the TCAC, plaintiffs have made an artful attempt to avoid this requirement by carefully compartmentalizing the counts under the '33 Act and '34 Act. Whereas the '34 Act claims allege that defendants knowingly or recklessly engaged in a fraudulent scheme to overstate revenues, for example, the '33 Act claims merely allege that revenues were negligently overstated. Yet the Ninth Circuit has rejected this approach, finding that such “nominal efforts are unconvincing where the gravamen of the complaint is plainly fraud.” In re Stac, 89 F.3d at 1405. The court finds that plaintiffs' Section 11 claim clearly “sounds in fraud.” Despite plaintiffs' pains to avoid Rule 9(b), it is clear that the factual allegations upon which the entire complaint rests allege knowing, reckless and willful conduct. For example, plaintiffs allege that defendants “negligently overstated [revenue] due to the Defendants' manipulation of the purported billing rates of Portal's employees.” TCAC ¶ 145(d). Yet plaintiffs' factual allegations supporting the manipulation of billing rates unequivocally describes the conduct as intentional and knowing. Id ¶ ¶ 47, 48. It strains credulity that plaintiffs should allege that the overstatement of revenues was merely “negligent” when it was a allegedly a direct result of defendants' willful manipulation. Plaintiffs cannot avoid the theory they posit throughout the complaint: that defendants fraudulently schemed to inflate revenues. Accordingly, the court finds that the claims under the '33 Act sound in fraud, and therefore fail with the '34 Act claims to meet the heightened pleading requirements of the PSLRA and Rule 9(b).

V

Conclusion For the reasons stated above, the court GRANTS defendants' motion to dismiss in its entirety. Doc # 115. Plaintiffs' TCAC is DISMISSED, but plaintiffs may file an amended complaint remedying the pleading deficiencies identified in this order and complying with the following instructions. An amended complaint should specify those

misstatements plaintiffs allege were false or misleading, including with regard to each statement: (1) the date made; (2) the speaker; (3) the content; (4) the falsity; (5) the basis for plaintiffs' allegation of falsity; and (6) scienter. The amended complaint should also specify any omissions of fact that defendants were bound to disclose, including with respect to each omission: (1) the date the information became known to the public; (2) the facts omitted; (3) the date the duty to disclose arose; (4) the basis for claiming that omitted information was known to defendants; (5) the basis for claiming that defendants had a duty to disclose; and (6) scienter. Finally, in light of Dura, plaintiffs should endeavor to tether all allegations in the complaint to the price movement of Portal's stock during the class period. Any amended complaint must be filed within sixty (60) days of the date of this order. *17 IT IS SO ORDERED. N.D.Cal.,2005. In re Portal Software, Inc. Securities Litigation Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) Briefs and Other Related Documents (Back to top) • 2006 WL 728111 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Opposition to Defendants' Motion to Dismiss Fourth Consolidated Amended Complaint (Feb. 8, 2006) • 2004 WL 2160168 (Trial Motion, Memorandum and Affidavit) Plaintiff's Opposition to Defendants' Motion to Dismiss the Consolidated Amended Complaint (Sep. 30, 2004) • 2004 WL 2160162 (Trial Motion, Memorandum and Affidavit) Response of Roxanne Googin to Motion of John Romeo for Consolidation, Appointment of Lead Plaintiff and Approval of Selection of Lead and Liaison Counsel (Mar. 25, 2004) • 2004 WL 2160159 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of Roxanne Googin's Motion for Consolidation of Related Actions, for Appointment as Lead Plaintiff and for Approval of Selection of Lead Counsel (Jan. 20, 2004) • 2003 WL 23795725 (Trial Pleading) Class Action Complaint for Violations of Federal Securities Laws (Nov. 20, 2003) END OF DOCUMENT





United States District Court,N.D. California. In re SILICON STORAGE TECHNOLOGY, INC.,

SECURITIES LITIGATION. No. C 05-0295 PJH.

March 10, 2006.

Patrick J. Coughlin, Azra Z. Mehdi, Darren J. Robbins, William S. Lerach, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, Christopher T. Heffelfinger, Julie Juhyun Bai, Berman Devalerio Pease & Tabacco, P.C., Joseph J. Tabacco, Jr., Nicole Lavallee, Berman Devalerio Pease Tabacco Burt & Pu, San Francisco, CA, Jason S. Cowart, Marc I. Gross, Stanley M. Grossman, Patrick V. Dahlstrom, Pomerantz Haudek Block Grossman & Gross LLP, New York, NY, for James M. Baker on Behalf of Himself and all others Similarly Situated, Louisiana District Attorneys' Retirement System. Eunice Jooyoun Lee, Jonathan B. Gaskin, Robert P. Varian, Orrick, Herrington & Sutcliffe LLP, San Francisco, CA, for Silicon Storage Technology Inc.

ORDER GRANTING MOTION TO DISMISS PHYLLIS J. HAMILTON, J. *1 THIS ORDER RELATES TO: ALL ACTIONS Defendants' motion to dismiss the consolidated amended complaint came on for hearing before this court on January 18, 2006. Plaintiffs appeared by their counsel Jason S. Cowart, and defendants appeared by their counsel Robert P. Varian and Jonathan B. Gaskin. Having read the parties' papers and carefully considered their arguments, and good cause appearing, the court hereby GRANTS the motion as follows

INTRODUCTION This is a proposed class action alleging violations of the federal securities laws. The plaintiff class consists of all those who purchased shares of common stock in defendant Silicon Storage Technology, Inc. (SST) from April 21, 2004, to December 20, 2004. Plaintiffs allege that SST and six of its officers or

former officers-defendants Bing Yeh, Yaw Wen Hu, Jack K. Lai, Yasushi Chikagami, Isao Nojima, and Derek Best-misled investors by overstating SST's inventory value, by making false statements about the company's sales prices, and by failing to disclose that the company lacked adequate internal controls to ensure that inventory was properly valued. Plaintiffs assert that they were harmed when SST's stock price fell more than 22.5%, following an announcement that SST would write down the value of a portion of its inventory. The consolidated amended class action complaint (“CAC”) alleges a cause of action for violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and related Rule 10b-5, 17 C.F.R. § 240.10b-5, against all defendants; and for violation of § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against the six individual defendants.

BACKGROUND SST is based in Sunnyvale, California, where it operates three major facilities. According to periodic reports filed by SST with the SEC, the company is a leading supplier of “flash memory” semiconductor devices for the digital consumer, including networking, wireless communications, and Internet computing markets. SST offers over 90 products based on its “Super-Flash” design and manufacturing process technology, and also licenses its technology to leading semiconductor companies for use in various applications. Revenue from the sale of these products contributed approximately 50% of the company's revenue during the proposed class period. During the proposed class period, defendant Bing Yeh (“Yeh”) was SST's President and Chief Executive Officer; defendant Yah Wen Hu (“Hu”) was SST's Executive Vice President and Chief Operating Officer; defendant Derek Best (“Best”) was Senior Vice President for Sales and Marketing; defendant Yasushi Chikagami (“Chikagami”) was an outside director; defendant Isao Nojima (“Nojima”) was Senior Vice President, Standard Memory Product Group; and defendant Jack K. Lai (“Lai”) was Chief Financial Officer. Plaintiffs allege that throughout the class period, defendants made materially misleading statements




concerning the value of SST's inventory, which in turn caused the company's statements of gross profit, net income, and total assets to be materially misleading. Plaintiffs claim that defendants knew or should have known that prices of competing flash memory products sold by Intel and AMD had been declining during the class period, that SST's inventory should have been valued at levels well below those reported by defendants, and that the company's gross profits, net income, and total assets were therefore overstated. *2 Plaintiffs allege that defendants failed to disclose that SST's valuation system lacked sufficient controls to ensure accuracy, and that its valuation process was completely arbitrary. Plaintiffs assert that “the truth began to emerge” after the market closed on December 20, 2004, at which point SST announced it would write down the value of its inventory by $20-$25 million. On this news, the price of the company's shares, which had closed at $7.01 before the announcement, fell to a low of $5.43 the following day, a drop of 22 .5%.

DISCUSSION

A. Legal Standard A court should dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim only where it appears beyond doubt that plaintiff can prove no set of facts in support of the claim which would entitle the plaintiff to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Williamson v. Gen'l Dynamics Corp., 208 F.3d 1144, 1149 (9th Cir.2000). All allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party. Gompper v. VISX. Inc., 298 F.3d 893, 895 (9th Cir.2002). Review is generally limited to the contents of the complaint. Allarcom Pay Television. Ltd. v. Gen. Instrument Corp., 69 F.3d 381, 385 (9th Cir.1995). However, material that is properly presented to the court as part of the complaint may be considered as part of a motion to dismiss. Lee v. City of Los Angeles, 250 F.3d 668, 688-89 (9th Cir.2001). If a plaintiff fails to attach to the complaint the documents on which it is based, defendant may attach to a Rule 12(b)(6) motion the documents referred to in the complaint to show that they do not support plaintiff's claim. Id. In addition, whether requested or not, the court may take judicial notice of facts that are

capable of accurate and ready determination by resort to sources whose accuracy cannot be questioned. See Fed.R.Evid. 201; see also In re Silicon Graphics, Inc., Sec. Litig., 183 F.3d 970, 986 (9th Cir.1999).

B. Defendants' Motion to Dismiss Defendants seek an order dismissing the CAC for failure to state a claim. Section 10(b) of the Securities Exchange Act provides, in part, that it is unlawful “to use or employ in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.” 15 U.S.C. § 78j(b). SEC Rule 10b-5, promulgated under the authority of § 10(b), makes it unlawful for any person to use interstate commerce (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. *3 17 C.F.R. § 240.10b-5. To plead securities fraud under Section 10(b) of the 1934 Act, plaintiffs must allege (1) a misstatement or omission (2) of material fact (3) made with scienter (4) on which plaintiffs relied (5) which proximately caused the plaintiffs' injury. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 388 (9th Cir.2002). Similarly, the elements of a Rule 10b-5 claim are (1) a material misrepresentation (2) made with scienter (3) in connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss. In re Daou Sys., Inc., Sec. Litig., 411 F.3d 1006, 1014 (9th Cir.2005). Under § 20(a) of the 1934 Act, joint and several liability can be imposed on persons who directly or indirectly control a violator of the securities laws. 15 U.S.C. § 78t(a). Violation of § 20(a) is predicated on a primary violation under the 1934 Act. Heliotrope Gen'l, Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9th Cir.1999). Plaintiffs alleging a claim




that individual defendants are “controlling persons” of a company must allege 1) that the individual defendants had the power to control or influence the company, 2) that the individual defendants were culpable participants in the company's alleged illegal activity, and 3) that the company violated the federal securities laws. Durham v. Kelly, 810 F.2d 1500, 1503-04 (9th Cir.1987); see also Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir.2000). Defendants argue that the § 10-b claim should be dismissed for failure to allege fraud with particularity, and that the § 20 claim should be dismissed because plaintiffs fail to state a claim for primary liability. Defendants also contend that dismissal is required because the facts before the court demonstrate that the inventory write-down could not have taken place prior to the fourth quarter of 2004, because the demand for and pricing of flash memory had been increasing, while SST's cost had been declining. Defendants assert the fact that the write-down was appropriate in 4Q 2004 but not before is also confirmed by an audit completed by PricewaterhouseCoopers after the December 20, 2004, announcement. Generally, the Federal Rules of Civil Procedure require that a plaintiff in federal court give a short, plain statement of the claim sufficient to put the defendant on notice. See Fed.R.Civ.P. 8(a). However, Rule 9 imposes a particularized pleading requirement on a plaintiff alleging fraud or any claim premised on fraud. See Fed.R.Civ.P. 9(b) (in actions alleging fraud, “the circumstances constituting fraud or mistake shall be stated with particularity”). Under Rule 9(b), the complaint must allege specific facts regarding the fraudulent activity, such as the time, date, place, and content of the alleged fraudulent representation, how or why the representation was false or misleading, and in some cases, the identity of the person engaged in the fraud. In re GlenFed Sec. Litig., 42 F.3d 1541, 1547-49 (9th Cir.1994). Because the plaintiff must set forth what is false or misleading about a particular statement, he must do more than simply allege the neutral facts necessary to identify the transaction; he must also explain why the disputed statement was untrue or misleading at the time it was made. Yourish v. California Amplifier, 191 F.3d 983, 992-93 (9th Cir.1999). *4 This case is also controlled by the provisions of the Private Securities Litigation Reform Act (“PSLRA”), which was enacted by Congress in 1995

to establish uniform and stringent pleading requirements for securities fraud actions, and “to put an end to the practice of pleading ‘fraud by hindsight.” In re Silicon Graphics, 183 F.3d at 958. The PSLRA heightened the pleading requirements in private securities fraud litigation by requiring that the complaint plead both falsity and scienter with particularity. In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1084 (9th Cir.2002); see also In re Daou Sys., 411 F.3d at 1014. If the complaint does not satisfy these pleading requirements, the court, upon motion of the defendant, must dismiss the complaint. 15 U.S.C. § 78u-4(b)(3)(A).

1. Falsity Defendants argue that the CAC does not adequately allege falsity because it does not plead facts showing that the alleged false statements were false when made. Under the PSLRA-whether alleging that a defendant “made an untrue statement of a material fact” or alleging that a defendant “omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading”-the complaint must specify each statement alleged to have been false or misleading, specify the reason or reasons why each such statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, state with particularity all facts on which that belief is formed. 15 U.S.C. § 78u-4(b)(1). Plaintiffs allege that defendants made false and misleading statements concerning SST's sales prices, inventory values, and accounting controls during the class period, in connection with the release of SST's quarterly financial returns for the first, second, and third quarters of fiscal year 2004, as follows: On April 21, 2004, the first day of the class period, SST stated in a press release that its inventory was worth $69.9 million as of the end of the first quarter of 2004.FN1 On May 7, 2004, SST filed its Form 10-Q for 1Q 2004 with the SEC. The Form 10-Q, which was signed by Yeh and Lai, repeated the statement that SST's inventory was worth $69.9 million as of the end of 1Q 2004. The 10-Q also stated that the company's gross profit in the first quarter had been $38.1 million, that its net income had been $14.2 million, and that its total assets were $435 million. See CAC ¶ 53.

FN1. The CAC alleges that Yeh also held a




conference call on April 21, 2004, in which he stated that SST had experienced “firming” sales prices in the first quarter of 2004 and that the company expected SST's average selling prices to “continue to improve” in the second quarter. However, at the hearing, plaintiffs' counsel indicated that plaintiffs did not include this statement as one of the allegedly false and misleading statements.

On July 21, 2004, defendants allegedly announced in a press release that average selling prices were “firming” in 2Q 2004, and that the value of SST's inventory had increased from $69.9 million in 1Q 2004 to $91 million in 2Q 2004. On August 5, 2004, SST filed its Form 10-Q for 2Q 2004 with the SEC. The Form 10-Q, which was signed by Yeh and Lai, repeated the statement that the value of SST's inventory was $91 million as of the end of 2Q 2004. The 10-Q also stated that SST's gross profit in 2Q 2004 had been $48.7 million, that its net income had been $22 million, and that its total assets were $466 million. See CAC ¶ 58. *5 On October 20, 2004, SST issued a press release announcing its results for 3Q 2004. The company stated that revenue had decreased to $112.2 and that average sales prices had declined by 7 per cent. It also stated that the value of SST's inventory was $138 million. In a conference call held the same day, Yeh allegedly stated that SST had no intention of writing down its inventory for the fourth quarter of 2004. On November 15, 2004, SST filed its Form 10-Q for 3Q 2004 with the SEC. The Form 10-Q, which was signed by Yeh and Lai, repeated the statements that revenue had decreased to $112.2 million, that average sales prices had declined by 7 per cent, and that SST's inventory was valued at $138 million. The 10-Q also stated that SST's gross profit in 3Q 2004 had been $39.5 million, that its net income had been $14.5 million, and that its total assets were $482.2 million. See CAC ¶ ¶ 67, 69, 73. Plaintiffs allege that these statements were false and misleading because the value of SST's inventory was actually less than the amounts stated-$69.9 million in 1Q 2004, $91 million in 2Q 2004, and $138 million in 3Q 2004-and that consequently, SST's gross profit, net income, and total assets were less than the amounts stated. CAC ¶ ¶ 54, 59, 70. They also assert that the statement that SST did not plan to write down its inventory in 4Q 2004 was false and misleading because defendants knew or should have known that the prices of flash memory manufactured

by SST's competitors AMD and Intel had been declining during the first three quarters of 2004, that the value that was assigned to SST's flash memory was inflated, and that SST would soon have to write down the value of its inventory. CAC ¶ 74. In the present motion, defendants assert that the claim of fraud alleged in the CAC-that defendants defrauded investors by not announcing the intended write-down earlier than they did-was based solely on SST's announcement in December 2004 that it would take an inventory write-down due to changed market conditions, and provides a classic example of pleading “fraud by hindsight.” Defendants contend that the CAC fails to allege falsity because it does not specify why, how, or by how much the inventory valuations allegedly exceeded the “correct” valuations; does not indicate what valuation might have been required at a given time; does not identify any product, or class of products or components in SST's inventory; provides no allegations as to the cost or market price at which any product or component was, or should have been, carried on SST's books; and alleges no contemporaneous facts demonstrating why the statements were false or misleading at the time they were made. Defendants also argue that the CAC is deficient because it is largely pled on information and belief, but fails to include a statement of “all facts” on which that belief is based, in contravention of the requirements of the PSLRA. In addition, defendants assert that other than the allegations that Yeh made two statements in conference calls, and that Yeh and Lai signed SST's Form 10-Qs, the CAC does not allege that any particular defendant made any of the statements at issue. *6 In opposition, plaintiffs argue that the CAC adequately pleads falsity. They contend that the CAC identifies material misstatements relating to SST's flash memory inventory values in the first, second, and third quarters of 2004 (citing to CAC ¶ ¶ 53, 58, 67, 69, 73). They maintain that the CAC explains why these statements were false, based on contemporaneous facts-including allegations that SST's inventory valuation system lacked sufficient controls to ensure accuracy, that defendants were told that this system was overstating value, that defendants stated that market prices were rising or stabilizing at a time that such prices were in fact plummeting, and that defendants made these statements without also disclosing that their inventory valuation process was “completely arbitrary.”




Plaintiffs also point to SST's 2004 Form 10-K, filed with the SEC on March 31, 2005, in which both SST and its outside auditors stated, As of December 31, 2004, [SST] did not maintain effective controls over accounting for and review of the valuation of inventory, the income tax provision and related balance sheet accounts and licensing revenue because [SST] lacked a sufficient complement of personnel and a level of accounting expertise that is commensurate with [SST's] financial reporting requirements. Specifically, [SST] lacked sufficient controls over the write down of inventory to the lower of cost or market, accounting for complex licensing contracts with multiple elements, and processes and procedures related to the determination and review of the quarterly and annual tax provisions in accordance with generally acceptable accounting principles in the United States.... [T]his deficiency could result in a material missatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, that this control deficiency constitutes a material weakness. Plaintiffs assert that there is no requirement that the CAC specify SST's sales prices or inventory valuations on a product-by-product basis. They claim that the cases cited by defendants say only that such information is but one way to establish falsity. They argue that when contemporaneous facts are cited with sufficient specificity to demonstrate that the statements at issue were false, it is not necessary to also include details about specific products in the inventory valuation. The court finds that the CAC fails to allege falsity with particularity as required by the PSLRA and Rule 9(b). While plaintiffs have identified each statement alleged to be false or misleading, they have not stated with particularity why each statement was false at the time it was made. Plaintiffs allege that the statements about SST's inventory were false because the market price for various types of flash memory was declining during the period between April and December 2004. Plaintiffs assert that from March 2004 through April 21, 2004, the price for which AMD was selling one type of 32-megabyte flash memory, which competed with products sold by SST, steadily declined from $12.50 to just over $10.00, while another type of AMD's 32-megabyte flash memory declined from $16.50 to under $8.00. During the same period, the

price of one type of 32-megabyte flash memory sold by Intel, which competed with products sold by SST, steadily declined from $21.50 to under $15.00. *7 Plaintiffs allege further that the average sales price of flash memory fell for every week during the period June 13, 2004, through July 31, 2004, and continued to fall for every week thereafter until at least August 31, 2004. Plaintiffs assert that defendants knew or should have known that the prices of various types of flash memory sold by AMD and Intel, which competed with products sold by SST, from April through July 2004-specifically, that the price for which AMD was selling one type of 4-megabyte flash memory declined from $1.50 to less than $1.35; the price of one type of AMD's 8-megabyte flash memory declined from $3.38 to $1.75; the price of two types of AMD's 16-megabyte flash memory declined from around $3.75 to around $2.75; and the price of one type of 32-megabyte flash memory sold by Intel steadily declined from over $19.00 to under $7.50. Finally, plaintiffs allege that the prices of flash memory sold by AMD and Intel, which competed with products sold by SST, declined from April through October 2004-specifically, that the price for which AMD was selling one type of 1-megabyte flash memory declined from $1.63 to under $1.00; the price of one type of AMD's 4-megabyte flash memory declined from $1.50 to $1.15; the price of one type of AMD's 8-megabyte flash memory declined from $3.38 to $1.50; the price of two types of AMD's 16-megabyte flash memory declined from over $3.75 to under $2.48; the price of one type of AMD's 32-megabyte flash memory declined from over $10.00 to less than $5.00. Plaintiffs also assert that when Intel announced its 3Q 2004 results on October 12, 2004, the company indicated that because flash memory sales prices had fallen, and there was no reason to believe they would increase, it would write down the value of its flash memory inventory. See CAC ¶ 72. However, the CAC states no facts regarding comparable products in SST's inventory or the cost or market price of those products.FN2 Nor does the CAC state the reasons that the values stated at the time of the quarterly reports for 1Q 2004, 2Q 2004, and 3Q 2004 were inaccurate. For example, the CAC contains no allegations of contemporaneous conditions or statements by defendants that contradict SST's statements regarding inventory valuations, and identifies no internal report that contradicts the valuations or suggests that they might be fraudulent.




FN2. Stating the cost or market value of the products in SST's inventory would be one way-though not the only way-to allege contemporaneous facts showing that the statements regarding inventory valuation were false when made.

Plaintiffs simply allege, in essence, that because SST wrote down its inventory in December 2004, the statements about inventory made prior to that time must have been false because the inventory turned out not to be worth what SST had previously said it was worth. This is, as defendants argue, a classic example of pleading fraud by hindsight-a type of pleading that the PLSRA was specifically enacted to eliminate. The allegations in the CAC regarding the decline in prices for flash memory produced by AMD and Intel do not support the claim that defendants made false statements regarding SST's financial results during the first three quarters of 2004, for the reason that the SST documents referenced in the CAC indicate that most of the inventory charge was taken on SST's 8-megabit and 16-megabit flash memory, while the AMD and Intel products at issue were 4-megabyte, 8-megabyte, 16-megabyte, and 32-megabyte flash memory. Thus, the AMD and Intel flash memory was not, as the CAC alleges, a type of flash memory that “competed with” products sold by SST.FN3

FN3. Moreover, the October 12, 2004, Intel earnings release cited in CAC ¶ 65, a copy of which is attached to defendants' Supplemental Request for Judicial Notice, says nothing about flash memory prices, about any decline in such prices, or about any inventory write-down pertaining to flash memory products.

*8 The allegations in the CAC that SST's inventory valuation system lacked sufficient controls to ensure accuracy and that its inventory valuation process was “completely arbitrary,” and that defendants were told that this system was overstating value, are based on two sources-first, on information allegedly obtained by plaintiffs from their “confidential informants,” and second, on a statement in SST's 2004 Form 10-K that SST had not maintained effective controls over accounting for and review of the valuation of inventory, and a statement by SST to the same effect in the same Form 10-K.

The allegations relating to information obtained from plaintiffs' confidential informants do not plead particularized facts showing that the statements regarding the value of SST's inventory were false when made because, as explained more fully below in the discussion of scienter, the informants were not employed at SST during the proposed class period, and because the CAC does not allege particularized facts indicating that the informants had personal knowledge regarding the truth or falsity of the statements made in 2004 regarding the valuation of SST's inventory. See In re Daou Sys., 411 F.3d at 1015. Under the PSLRA, “the complaint must contain allegations of specific ‘contemporaneous statements or conditions' that demonstrate the intentional or the deliberately reckless false or misleading nature of the statements when made.” Ronconi v. Larkin, 253 F.3d 423, 432 (9th Cir.2001). The allegations relating to information obtained from the confidential informants does not meet this standard. The statements concerning internal controls made by SST and SST's external auditors PricewaterhouseCoopers in SST's 2004 10-K do not support plaintiffs' claim that defendants made materially false statements during the proposed class period. First, as defendants note, this same boilerplate language is used in internal control review reports filed by numerous other technology companies, as such review is mandated by Section 404 of Sarbanes-Oxley. In the present case, SST and its auditors used what appears to be standard phrasing, noting that in the future, the control deficiency “could” result in a material misstatement to the company's financial statements. This is not a contemporaneous fact that shows that the statements about SST's inventory valuation were false when made in connection with the release of financial results for the first three quarters of 2004. Moreover, SST's auditor PricewatershouseCoopers issued an unqualified audit opinion, identified no errors in the interim financials, and did not require SST to restate any of the quarters prior to 4Q 2004.

2. Scienter Defendants argue that the CAC should be dismissed because it fails to plead particularized facts that strongly suggest actual intent to deceive, manipulate, or defraud. Under the PSLRA, whether alleging that a defendant “made an untrue statement of material fact” or alleging that a defendant “omitted to state a




material fact,” the complaint must, with respect to each alleged act or omission, “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2); see also In re Vantive, 283 F.3d at 1084. By requiring particularized, detailed allegations showing a strong inference of scienter, the PSLRA was intended to “eliminate abusive and opportunistic securities litigation.” Gompper, 298 F.3d at 897. *9 In the Ninth Circuit, the required state of mind is “deliberate or conscious recklessness.” In re Silicon Graphics, 183 F.3d at 979. Mere motive and opportunity are not sufficient. Id. Recklessness satisfies scienter under § 10(b) “only ... to the extent that it reflects some degree of intentional or conscious misconduct.” Id. at 977. In assessing whether plaintiffs have sufficiently pled scienter, the court should consider “whether the total of plaintiffs' allegations, even though individually lacking, are sufficient to create a strong inference that defendants acted with deliberate or conscious recklessness.” No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 938 (9th Cir.2003) (citation and quotation omitted); see also Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 948-49 (9th Cir.2005) (district court should evaluate scienter based on “totality of the allegations”). On a Rule 12(b)(6) motion to dismiss a complaint brought under the PSLRA, when considering whether plaintiffs have shown a strong inference of scienter, the district court must also consider “all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs.” Gompper, 298 F.3d at 897 (noting the “inevitable tension ... between the customary latitude granted the plaintiff on a [12(b)(6) ] motion to dismiss ... and the heightened pleading standard set forth under the PSLRA). In other words, the court must consider all the allegations in their entirety in concluding whether, on balance, the complaint gives rise to the requisite inference of scienter. Id. Plaintiffs assert that the “totality of the allegations” set forth in the CAC establish that defendants knowingly overvalued SST's inventory. First, plaintiffs contend that the allegations in the CAC regarding information obtained from six informants establish scienter because those allegations show the personal involvement and “hands-on” management of the individual defendants. Second, plaintiffs argue that the CAC pleads facts showing that defendants

knew, or had access to facts that should have made them aware, that the price of flash memory was declining in the industry generally, and that the value assigned to flash memory in SST's inventory should therefore have been reduced. Third, plaintiffs assert that scienter is shown by allegations of defendants' motive to keep the price of SST's stock high, reflected in insider sales of stock during the class period, the SST board of directors' authorization of a stock repurchase program in July 2004, and SST's acquisition of another company in October 2004. Finally, plaintiffs argue that defendants' scienter is also shown by the allegations that defendants violated Generally Accepted Accounting Principles (GAAP) and various unspecified SEC regulations, regulations of national stock exchanges, and customary business practices.

a. confidential informants *10 The CAC alleges that the information provided by five confidential informants, and a sixth identified informant, shows the individual defendants' personal involvement in, and “hands-on” management of, SST's business. In pleading fraud under the PSLRA, plaintiffs may rely on anonymous sources for information, so long as they plead “corroborating details” when allegations are based on non-public information. In re Silicon Graphics, 183 F.3d at 985; see also In re SeeBeyond Techs. Corp. Sec. Litig., 266 F.Supp.2d 1150, 1159 (C.D.Cal.2003). “[P]ersonal sources of information relied upon in a complaint should be ‘described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” ’ Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1233 (9th Cir.2004) (quoting Novak v. Kasaks, 216 F.3d 300, 314 (2nd Cir.2000)). When plaintiffs rely on facts beyond the information provided by the confidential witnesses, they need not name their sources as long as the additional facts provide an adequate basis for believing that the defendants' statements were false. Id. Defendants argue that the information provided by the six informants adds nothing to support the claims in the CAC, because no informant worked at SST during the class period, because the informants were all low-level employees far removed from management decisions, and because the informants report guesses, opinions, and suppositions instead of facts. Defendants also contend that plaintiffs fail to allege particularized facts showing that each




individual source occupied a position such that he or she would possess the information alleged. Plaintiffs respond that the proposed class period simply functions to define the plaintiff class, but does not restrict the universe of relevant or actionable facts in the case. They contend that while scienter itself must always be contemporaneous with the alleged misstatements, the facts supporting an inference of scienter will not always be. In other words, plaintiffs argue that the fact that none of the informants worked at SST during the proposed class period is not significant, because pre-class period awareness of events can be relevant to show awareness of certain facts and therefore to demonstrate scienter. The court finds that the allegations regarding the six informants do not create a strong inference that defendants acted with deliberate or conscious recklessness with regard to the alleged false statements concerning SST's inventory valuations and financial performance during the first three quarters of 2004. The court first notes three ways in which the allegations are generally insufficient. First, the CAC fails to plead with particularity that each individual informant occupied a position such that he or she would possess the information alleged, and the allegations regarding such information are therefore insufficiently reliable. *11 Second, none of the six informants was employed at SST during the proposed class period; and the only one of the six who worked at the company at all in 2004 admittedly did not know what SST was reporting as inventory. Thus, none of the informants was in a position to know whether defendants overstated the value of SST's inventory when the company's financial results were reported for the first three quarters of 2004. The statements regarding events that occurred during the period 2000 through 2003 cannot substitute for the required particularized showing of scienter in 2004. While it is true that facts relating to pre-class period events may in certain circumstances contribute to the creation of an inference of scienter, see, e.g., Zelman v. JDS Uniphase Corp., 376 F.Supp.2d 956, 970 (N.D.Cal.2005), there must be some connection between that scienter and the earlier events. Here, the issue is not pre-class period statements made by defendants, which can be said to create a strong inference of scienter in connection with false or misleading statements made during the class period, but rather a number of largely irrelevant statements

by informants who were not present at SST at the time of the alleged misrepresentations, and who appear to have little information regarding either the valuation of the inventory or the defendants' alleged “scheme” to misstate the value of the inventory. The information provided by these informants concerns events that predated and had no apparent connection with the alleged misstatements regarding the valuation of SST's inventory. Finally, the CAC alleges that one of the informants provided at least two of the defendants with “excess inventory reports,” and that at least two of the informants attended “meetings” at which the participants discussed issues relating to the amount and type of products held in inventory, and to the valuation of inventory. These allegations are insufficient in light of the Ninth Circuit's decisions in In re Silicon Graphics, In re Vantive, and In re Daou Sys.. In In re Silicon Graphics, the court rejected the plaintiff's attempt to establish scienter through general allegations that the defendants had received internal reports, including daily reports, monthly financial reports, “Stop Ship” reports, and “Flash Reports.” Id. at 984-98 & n. 14. The court held a plaintiff can rely on the existence of reports as a means of establishing knowledge only if the complaint includes “adequate corroborating details”-such as plaintiff's sources of information with respect to the reports, how the plaintiff learned of the reports, who drafted the reports, and which officers at the company received them, in addition to “an adequate description of their contents.” Id. at 985. In In re Vantive, the plaintiffs attempted to establish such scienter by adverting to the defendants' “hands-on” management style, their “interaction with other corporate officers and employees, their attendance at management and board meetings, and reports generated on a weekly and monthly basis. Relying on In re Silicon Graphics, the Ninth Circuit held that such allegations did not adequately establish that the defendants had knowledge of the supposedly “true but concealed” circumstances. In re Vantive, 283 F.3d at 1087-88. *12 As in Silicon Graphics and In re Vantive, plaintiffs in the present case have failed to cite to any specific report, to mention any dates or contents of reports, or to allege their sources of information about any reports. The allegations are similarly deficient, for the same reasons, with respect to the defendants' attendance at meetings and their “hands-




on” managerial style. See also In re Daou Sys., 411 F.3d at 1022. The court will now discuss each of the informants. Plaintiffs identify Confidential Informant No. 1 (CI # 1) as a “business control analyst” employed at SST from February 2000 through April 2004, who was “part of a team that monitored inventory on a daily basis.” According to CI # 1, SST had “a poor and unreliable system in place for managing and monitoring inventory.” He/she asserts that defendants Yeh, Hu, and Tsai FN4 “called the shots” and micro-managed the system, including issues related to inventory valuation, and that Hu created his own databases and spreadsheets to track and value inventory on a daily basis, even though SST kept track of inventory in a separate software application. With regard to inventory, this informant believed that “whatever it was that the company was reporting was way off the mark” (emphasis added). He/she indicated that SST continued to manufacture large amounts of flash memory, even though there were “no buyers” because the company's officers and directors feared the company would lose its manufacturing vendors to competitors if they slowed down their production lines. CAC ¶ 46-47

FN4. The CAC does not assert a claim against a defendant “Tsai.”

The CAC provides only a sketchy description of CI # 1's job duties, claiming that he/she was “part of a team that monitored inventory on a daily basis.” However, plaintiffs do not identify the other members of this “team,” and, more significantly, do not explain what they mean by “monitored inventory.” Such a job description could include anything from counting widgets in a box, to moving inventory from place to place in a warehouse, to filling customer orders, to preparing spread sheets showing the types and amount of product in inventory. It is apparent from the allegations that CI # 1 had no personal knowledge of what SST was reporting as inventory, but the CAC does not even provide particularized detail sufficient to show what this informant knew with regard to inventory management. Moreover, in view of CI # 1's claim that SST had a “poor and unreliable system in place for managing and monitoring inventory,” it is difficult to see how any job relating to monitoring inventory would have provided CI # 1 with knowledge of facts creating a strong inference that defendants acted with deliberate

or conscious recklessness. It is also not clear how Yeh, Hu, and Tsai could have “micro-managed” a “poor and unreliable” system. Finally, plaintiffs provide no basis for CI # 1's opinion that SST continued to manufacture large amounts of flash memory, despite the alleged absence of buyers, because “officials” feared that SST would otherwise lose its manufacturing vendors to competitors. Plaintiffs do not explain how CI # 1 learned about the alleged fears of these officials, or even who the officials were. *13 Plaintiffs identify Confidential Informant No. 2 (CI # 2) as an “inventory control analyst” employed at SST from February 2000 through August 2002. CI # 2 reported to the director of manufacturing systems, and was responsible for receiving inventory shipments, tracking inventory locations, and ensuring that the actual products in inventory matched those identified in SST's databases. According to CI # 2, the Finance Department at SST was excluded from the inventory valuation process. Instead, “the vice presidents of the individual units (and in particular [d]efendant Hu),” made the inventory valuation decisions. CI # 2 claimed that these valuations were made “regardless of actual price” and that the overall valuation process was “arbitrary, with only some relation to reality.” In this informant's opinion, the defendants were “unwilling to decrease the value assigned to inventory” because doing so would be an admission of their own “engineering mistakes” or “business errors.” He/she considered it was a “pride issue”-that defendants created a culture of “hear-no-evil-see-no-evil.” CAC ¶ 48. The CAC provides some description of CI # 2's duties, although in vague terminology (“receiving shipments,” “tracking inventory location”) suggesting that CI # 2 functioned more as a warehouse or manufacturing plant clerk than as an employee with some personal knowledge of inventory valuation. However, this informant left SST in August 2002, and the CAC alleges no facts showing a basis for any personal knowledge regarding the valuation of inventory during the proposed class period. In particular, the CAC provides no connection between CI # 2's assertion that the inventory valuation process was “arbitrary” between February 2000 and August 2002, and plaintiffs claims that defendants knowingly misrepresented the value of SST's inventory during the period between April and December 2004. CI # 2's statement that the Finance Department was excluded from the valuation process is contradicted by CI # 4's statement that former CFO Jeff Garon




(“Garon”) was involved in the decisions regarding valuation, and is further contradicted by the allegation in the CAC that defendant Lai, CFO during the proposed class period, was a participant in the alleged fraudulent misstatement of inventory values. In addition, CI # 2's claim that the valuations were made by “the vice presidents of the individual business units” and “in particular [d]efendant Hu” does not provide sufficient detail regarding who actually made the valuation decisions, how CI # 2 knows who made the decisions, or how he/she knows that the decisions were made “regardless of actual price.” Finally, plaintiffs provide no basis for CI # 2's opinion that defendants would not decrease the value assigned to inventory because they were unwilling to admit their own engineering mistakes or business errors. Indeed, the CAC states no facts showing that CI # 2 was qualified to psychoanalyze defendants' motivations with regard to inventory valuation. *14 Plaintiffs identify Confidential Informant No. 3 (CI # 3) as an individual employed at SST from 2000 through June 2003, who was also employed as a “production control manager” from 1997 through 2000.FN5 At SST, CI # 3 was responsible for “tracking shipments and inventory.” He/she is “certain” that “the vice presidents” were intimately aware of the amount and type of products held in inventory because he “participated in” twice-monthly meetings with “these individuals” concerning this subject. CAC ¶ 49.

FN5. It is not clear from the CAC whether CI# 3 worked at SSI during the entire period from 1997 through 2003, or whether he/she was a production control manager at some other company during the period 1997 through 2000, and began working at SST in 2000.

Plaintiffs describe this informant's duties only briefly, without any indication of what is meant by “production control” or “tracking shipments and inventory.” From plaintiffs' description, it is impossible to tell whether CI # 3 was employed, for example, as an inventory clerk, entering data regarding products placed in inventory and shipped out to customers; or as a shipping or mailroom clerk, simply packaging products removed from inventory and shipping them to customers; or in some other capacity. Thus, it is impossible to tell whether this informant has any relevant personal knowledge. Moreover, CI # 3 left his/her employment at SST in

June 2003, and the CAC states no facts showing a basis for any personal knowledge regarding the valuation of inventory during the proposed class period. In addition, the allegations regarding CI # 3's participation in meetings with “vice-presidents” lack sufficient particularized detail to provide a basis for attributing to CI # 3 any personal knowledge regarding inventory or inventory valuation. The CAC does not provide the dates of the meetings, or identify the attendees or the substance of the matters discussed. Nor does the CAC identify the “vice-presidents” whom CI # 3 believed were “aware” of the amount and type of products held in inventory, or provide any facts showing a basis for CI # 3's belief that these individuals had this knowledge. Plaintiffs identify Confidential Informant No. 4 (CI # 4) as a “controller” employed at SST from October 1995 through April 2003. This informant worked directly for Garon, the then-CFO. CI # 4 is “certain” that defendant Yeh and defendant Hu reviewed and monitored the inventory numbers “very, very carefully” and that defendant Hu and “defendant Garon” (actually not a defendant) were responsible for “the final decision about what value to place on products held in inventory.” CI # 4 “participated in” monthly and quarterly meetings where inventory valuation “was discussed” with Yeh, Garon, Hu, and defendant Best, plus “a former cost accountant” and “business unit managers,” and claims that participants in these meetings would “go back and forth and argue” over whether certain products held in inventory were sellable, and if so, for what amount of money. According to this informant, there were a “ton of red flags” where inventory was concerned, as warnings were frequently raised within the company that products held in inventory were out-of-date or overvalued. CAC ¶ 50. *15 Plaintiffs do not describe this informant's job duties, simply stating that he/she was a “controller” who worked with SST's former CFO. From this description, it is impossible to tell whether CI # 4 had a basis for personal knowledge of the facts alleged. Moreover, CI # 4 left his/her employment at SST in April 2003, and the CAC alleges no facts showing any basis for personal knowledge regarding the valuation of inventory during the proposed class period. Nor does the CAC provide any particularized facts showing that CI # 4 had any basis for the opinion that defendants Yeh and Hu reviewed and monitored the inventory numbers “very, very carefully” or that Hu and CFO Garon were responsible for decisions regarding inventory valuation. The CAC asserts that CI # 4 participated in




monthly and quarterly meetings in which inventory valuation was discussed, but does not provide the dates of any meetings, or identify the attendees (apart from Yeh, Garon, Best, and Hu) or any details of the matters discussed, or of the alleged arguments among the meeting participants regarding inventory valuation. Plaintiffs identify Confidential Informant No. 5 as employed at SST “through 2003” (no indication of starting date) as an operations analyst, responsible for “tracking and locating excess inventory.” In CI # 5's opinion, SST “often manufactured excess products” because the executives wanted to build up inventory, not because there was any actual market demand for those products. He/she recalled that the operations department repeatedly told upper management that products held in inventory were “not moving.” He/she claims to have provided Yeh and Best with excess inventory reports that included recommendations concerning the likelihood that products held in inventory could actually be sold. CAC ¶ 51. Plaintiffs describe this informant's duties only briefly, without any indication of what is meant by “tracking and locating excess inventory.” Moreover, CI # 5 left his/her employment at SST at the end of 2003, and the CAC alleges no facts showing any basis for personal knowledge regarding events that occurred during the proposed class period. CI# 5 refers to “excess inventory reports” that he/she allegedly provided to Yeh and Best, but the CAC provides no details regarding the author of the reports, or the dates or contents of the reports, other than as stated above. In addition, plaintiffs provide no particularized facts showing that CI # 5 had any basis for his/her opinion that SST manufactured excess products because SST's “executives” wanted to build up inventory. With regard to the claim that the “operations department” repeatedly communicated to “upper management” that products in inventory could not be sold, the CAC does not provide any details regarding the identity of the employees in the operations department, the identity of the individuals in upper management, the dates of these alleged communications, or any details concerning the inventory at issue. *16 Informant Brian Thiemer was employed at SST from 2001 through 2003 as a “quality assurance engineer” in the company's “inventory control” department. He was responsible for “a variety of issues related to the [c]ompany's inventory, including inventory valuation.” He claimed that he regularly

informed his manager Andy Arata (then-director of quality assurance) and unidentified “senior management” that the company needed to decrease the value it was placing on its inventory because such values did not reflect actual market prices. He believed that “some inventory” was obsolete and worth only 10% to 20% of its accounted-for value. He indicated that his recommendations were consistently and systematically ignored and rejected by “senior management” and/or Arata, and that his frustration concerning the company's unwillingness to accurately and truthfully value its inventory led him to quit SST in 2004. CAC ¶ 52. Plaintiffs describe Thiemer's job duties only briefly, stating only that he was responsible for a “variety of issues” related to inventory, including inventory valuation. However, plaintiffs do not explain Thiemer's role in the valuation of inventory, or provide any particularized facts that would provide a basis for creating a strong inference that defendants acted with deliberate indifference. Moreover, Thiemer left his employment at SST at the end of 2003, and the CAC alleges no facts showing any basis for personal knowledge regarding inventory valuation during the proposed class period. Thiemer claims to have “regularly” communicated to his manager and unidentified “senior management” that SST's inventory was overvalued, but as with CI # 5, the CAC does not provide the dates of these alleged communications, or any details concerning the inventory at issue. In addition, there is no indication as to who is meant by “senior management.” Thiemer also claims that “some inventory” was obsolete, but plaintiffs provide no detail about this allegedly obsolete product-not the type, the quantity, or the value. The allegations regarding these confidential informants do not, as plaintiffs contend, show defendants' personal involvement in, and “hands-on” management of, inventory valuation or any other particular aspect of SST's business, and do not plead the particularized facts required to show scienter under the PSLRA.

b. knowledge of general decline in prices of flash memory

Plaintiffs contend that defendants' knowledge that SST's inventory should have been written down earlier than it was is shown by the fact that they knew, or should have been aware, that the selling




prices of flash memory were declining in the industry during the class period. With regard to 1Q 2004, the CAC asserts that defendants knew or should have been aware that from March 2004 through April 21, 2004, the selling prices of AMD's and Intel's 32-megabyte flash memory had declined. The CAC also alleges that defendants knew or should have known that Forbes reported on May 24, 2004, that the prices of flash memory had declined because manufacturers such as Intel and Samsung were offering price reductions in order to win customers; and that CBS News reported on June 3, 2004, that while Intel's flash memory sales had suffered in 2003, its sales were increasing in 2004 and Intel was winning market share. See CAC ¶ 56. *17 With regard to 2Q 2004, the CAC asserts that defendants knew or should have been aware that the average sales price of various types of flash memory sold by AMD and Intel fell for every week during the period June 13, 2004, through July 31, 2004, and continued to fall thereafter until at least August 31, 2004. Plaintiffs also claim that defendants knew or should have known that financial analyst WR Hambrecht reported on June 8, 2004, that flash memory prices in 2Q 2004 were 5 per cent lower than they had been in 1Q 2004 and were likely to continue to decline in 3Q 2004. Plaintiffs assert that in response to competition in the flash memory market, SST was forced, by July 2004, to lower its prices on some types of flash memory by as much as 4 per cent. See CAC ¶ 61. With regard to 3Q 2004, the CAC asserts that defendants knew or should have been aware that the price of various types of flash memory sold by AMD was declining, and that the value assigned to flash memory in SST's inventory should therefore have been reduced. Plaintiffs also allege that defendants knew or should have known that when Intel announced its 3Q 2004 results on October 12, 2004, it also indicated that because flash memory sales prices had fallen, and there was no reason to believe they would increase, it would write down the value of its flash memory inventory. See CAC ¶ 72. Defendants argue that this market pricing information is irrelevant, as the details do not concern SST products or prices, and do not even involve products that competed with the 8-megabit SST products that were the focus of the write-down. They also assert that the October 12, 2004, Intel earnings release cited in the CAC says nothing whatsoever about flash memory prices or any purported decline in prices, or any inventory write-down pertaining to flash memory

prices, but rather reports an inventory write-down as a result of “lower chipset unit costs,” having nothing to do with the selling prices of flash memory. The court finds that the allegations regarding a decline in prices for AMD and Intel flash memory do not create a strong inference of scienter. The CAC does not plead particularized facts showing that defendants did in fact know these details of industry prices, news reports, and financial analysts' reports. Moreover, as previously indicated, the flash memory produced by AMD and Intel did not have the same capacity as the flash memory produced by SST, and the products therefore were not competitive. The CAC does not explain the relevance of a drop in price of 8-megabyte, 16-megabyte, and 32-megabyte flash memory to the valuation of SST's inventory of 8-megabit flash memory.

c. motive to inflate price of stock The CAC alleges that defendants' scienter is shown by their motive to inflate the price of SST's stock, and that this motive is shown by defendants' insider trading, by SST's announcement of a stock repurchase in July 2004, and by SST's announcement of its acquisition of another company in October 2004. In the Ninth Circuit, motive and opportunity, standing alone, are not sufficient to establish scienter. See In re Silicon Graphics, 183 F.3d at 974 (facts that indicate a motive to commit fraud and opportunity to do so may provide some reasonable inference of intent, but they are not sufficient to establish a strong inference of deliberate recklessness). However, motive can be considered as part of the “totality of the allegations” regarding scienter.

i. insider trading *18 The CAC alleges that defendants motive to keep price of stock high, as shown by insider sales of stock, by Nojima on June 2, 2004, on November 17, 2004, and on December 8, 2004; by Best on August 12, 2004; and by Chikagami on December 14, 15, and 16, 2004. Plaintiffs assert that the timing of the November and December 2004 stock sales was suspicious in view of the fact that the company announced on December 20, 2004, that it expected to take a $20-$25 million inventory charge and write down the value of certain products held in inventory to their estimated market value, and that the gross margin for 4Q 2004 was expected to be in the range of 1% to 3%, compared with previous estimates of




between 25% and 32%. The PSLRA “neither prohibits nor endorses the pleading of insider trading as evidence of scienter, but requires that the evidence meet the ‘strong inference’ standard.” In re Daou Sys., 411 F.3d at 1022 (citation and quotation omitted). Stock trades are only suspicious when “dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” In re Silicon Graphics, 183 F.3d at 986. To evaluate suspiciousness of stock sales, the court should consider the amount and percentage of shares sold, the timing of the sales, and whether the sales were consistent with prior trading history. Nursing Home, 380 F.3d at 1232. Here, it appears that most of SST's officers and directors sold no stock during the proposed class period, and that just as many insiders purchased stock as sold. Yeh and Lai-the only defendants specifically alleged to have made false or misleading statements are not alleged to have sold any stock. Best sold no shares, but rather transferred some previously pledged stock as collateral for a loan. Lai and Hu purchased-not sold-stock during the class period. Collectively, defendants sold less than 2% of their total holdings, and SST itself purchased $15 million worth of its own stock during the class period, at prices plaintiffs allege were inflated by its own fraud. Only Nojima and Chikagami sold stock. Nojima's sales were not out of the ordinary, as those sales were consistent with his trading pattern and sales for the preceding seven years. Although Nojima sold no shares in 2003, he did sell shares every other year starting in 1998, as shown by his Form 4s filed with the SEC. Thus, Nojima's sales are insufficient to create a strong inference of scienter. Foreign-based outside director Chikagami, who is not alleged to have personally made any false statement, did sell a substantial amount of his holdings (total of 66%), and he is the only officer or director whose stock sales are even marginally suspicious under the Silicon Graphics standard. However, in view of the fact that he owned a relatively small number of shares compared with the officers of the company, the fact that he did not sell all his shares, the fact that no one else's sales appear suspicious, and the fact that other insiders actually purchased shares during the proposed class period, the court finds that Chikagami's sales are insufficient to creating a strong inference of scienter.

*19 Moreover, even if the court were to find that the timing or amount of the stock sales was suspicious, “stock sales are helpful only in demonstrating that certain statements were misleading and made with knowledge or deliberate recklessness when those sales are able to be related to the challenged statements.” In re Vantive Corp., 283 F.3d at 1093. Because the CAC fails to plead particularized facts showing that defendants made false or misleading statements, such “insufficient allegations of fraud ... have a spillover effect” on an analysis of insider sales. Id.

ii. SST's stock repurchase The CAC alleges that defendants' motive to keep the price of SST's stock high is also shown by the announcement on July 29, 2004, that SST's board of directors had authorized a stock repurchase program of up to $15 million worth of the company's common stock. The CAC does not explain how either this announcement or the repurchase program creates a strong inference of scienter.

iii. SST's acquisition of G-Plus The CAC alleges that defendants' motive to keep the price of SST's stock high is further shown by the announcement on October 18, 2004, that SST had signed an agreement to acquire substantially all the assets of privately-owned G-Plus, Inc., pursuant to which SST agreed to issue approximately $26 million in SST stock to G-Plus. The deal closed on November 5, 2004. Plaintiffs claim that it was in the interest of the company to keep its share price higher in order to facilitate this stock-financed transaction. Allegations that defendants engaged in routine business activities or were motivated by concerns that are shared by all companies and executives is not sufficient to establish scienter. See Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1038 (9th Cir.2002) (“[i]f scienter could be pleaded merely by alleging that officers and directors possess motive and opportunity to enhance a company's business prospects, virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions”). SST's acquisition of G-Plus is an example of the type of routine activity and generic motive that cannot serve as a basis for alleging securities fraud. The fact of this merger or buy-out, standing alone, is




insufficient to create a strong inference of scienter. Moreover, even if the court were to find that this acquisition provides some small support for an inference of fraud, the fact of the buy-out would have to be considered in the context of the fact that SST and several of its officers purchased millions of dollars of SST stock during the class period, at prices that plaintiffs claim were inflated by fraud.

d. alleged violations of GAAP The CAC alleges that defendants' scienter is shown by their violation of Generally Accepted Accounting Principles (GAAP)-specifically, certain principles set forth in FASB Statement of Concepts Nos. 1 and 2 FN6-and also by their violation of the requirements of unidentified “SEC regulations, regulations of the national stock exchanges and customary business practices” to disclose the sort of adverse information that was allegedly concealed by defendants during the class period.

FN6. As alleged in the CAC, these are (a) the principle that interim financial reporting should be based on the same accounting principles used to prepare annual financial statements; (b) the principle that financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions; (c) the principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and effects of transactions, events, and circumstances that change resources and claims to those resources; (d) the principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to stockholders for the use of enterprise resources trusted to it was violated; (e) the principle that reporting should provide information about an enterprise's financial performance during a period; (f) the principle that financial reporting should be reliable in that it represents what it purports to represent was violated; (g) the principle of completeness, which means that nothing is left out of the information that may be necessary to insure that it validly represents underlying events and conditions; (h) the principle that

conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. CAC ¶ 94.

*20 Violation of GAAP standards can provide evidence of scienter. In re Daou Sys., 411 F.3d at 1016. However, “[t]o support even a reasonable inference of scienter, much less a strong inference, the complaint must describe the violations with sufficient particularity: a general allegation that the practices at issue resulted in a false report of company earnings is not a sufficiently particular claim of misrepresentation.” Id. (citations and quotations omitted). Put another way, simple allegations of failure to follow GAAP do not establish scienter, because scienter requires more than a misapplication of accounting principles. See, e.g., In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir.1994)). In order to distinguish “deliberate recklessness” from “ordinary carelessness,” allegations of GAAP violations must be augmented by facts that shed light on the mental state of the defendants, rather than conclusory allegations that defendants must have known of the accounting failures because of the degree of departure from established accounting principles. See DSAM, 288 F.3d at 390-91. The CAC alleges that “[i]n order to inflate the price of [SST] stock, [d]efendants intentionally and/or with deliberate recklessness overstated the value of flash memory held in inventory in violation of [GAAP],” and then simply proceeds to list a number of accounting principles that were allegedly violated by this overvaluation. CAC ¶ ¶ 91-94. However, the GAAP allegations contain no facts that shed light on the mental state of the defendants, and as the CAC fails generally to allege scienter, the allegations of GAAP violations contribute nothing. In order to plead facts showing a strong inference of fraud, plaintiffs must provide detail-not merely, as here, simply recite various GAAP provisions and allege in general terms that the defendants failed to comply with them. The CAC does not identify any transaction by name or date, does not specify any dollar amounts, does not identify any product or class or products that should have been written down sooner under these various accounting principles, does not state what the appropriate write-down would have been, or when it should have been taken, or why a write-down should have been taken in that amount at that time. Although




the CAC refers to the GAAP provision requiring that inventory be carried on the balance sheet at the lower of “cost” or “market value,” the CAC says nothing about either the cost or the market value of SST's inventory, and says nothing about how or when the defendants purportedly became aware of the allegedly improper accounting practices, but rather simply refers to general declines in market prices of flash memory products throughout the industry.FN7

FN7. Plaintiffs acknowledge that “GAAP, as set forth in Accounting Research Bulletin (‘ARB’) No. 43, Chapter 4, Inventory Pricing, requires that inventories be recorded at the lower of cost or market .” CAC ¶ 93. At the hearing, however, plaintiff's counsel conceded that plaintiffs were unable to provide any information regarding the cost or market value of SST's inventory. As explained above, that deficiency is one reason that plaintiffs' allegations of GAAP violations are insufficient to create a strong inference of scienter. That is not to say that plaintiffs would not theoretically be able to plead facts sufficient to create a strong inference of intent or deliberate recklessness in the absence of details regarding cost or market value, just that the facts as pled are not adequate to show GAAP violations as circumstantial evidence of scienter, under applicable Ninth Circuit authority. See, e.g., DSAM, 288 F.3d at 390-91.

In In re Daou Sys., the Ninth Circuit relied on the combination of “widespread and significant” inflation of revenue and “specific allegations of [top executives'] direct involvement in the production of false accounting statements” to find the complaint raised a strong inference of scienter. In re Daou Sys., 411 F.3d at 1016, 1020, 1023. By contrast, the CAC makes no specific allegations of defendants' direct involvement, and instead relies on their general involvement in the management of SST and their alleged knowledge that the inventory valuation was “arbitrary .”

e. group pleading *21 As a final basis for dismissal, the court finds that the claims against the individual defendants fail because the CAC pleads no facts showing that any individual defendant made any statement with scienter. The CAC does not allege that defendants

Hu, Chikagami, Nojima, or Best made any false statements at all, and does not plead facts sufficient to create a strong inference that defendants Yeh and Lai made false statements with scienter. As a defendant corporation can be deemed to have the requisite scienter for fraud only if the individual corporate officer making the statement has the requisite level of scienter, the claims against SST also fail on this basis. Plaintiffs contend that the CAC establishes the individual defendants' scienter regarding inventory valuation, citing to ¶ ¶ 46-52 of the CAC (the “confidential informant” allegations), where plaintiffs argue, they have alleged that Yeh, Lai, Hum Nojima, and Best were “participating in monthly and quarterly meetings in which inventory valuations were determined;” and where they have also alleged that defendants “excluded the finance department from the valuation process” and that Hu created his own database and spreadsheet to track and value inventory. Plaintiffs assert that allegations of a “detail-oriented management style” make it reasonable to infer that the individual defendants became aware of the falsity of statements related to critical business functions. They note that Yeh and Lai signed the 10-Qs for 1Q 2004, 2Q 2004, and 3Q 2004, that Yeh made all false oral statements (referring to the October 20, 2004, conference call), and that the CAC alleges that the other defendants played active roles in the inventory valuation process. Thus, they argue, all defendants are therefore liable for the false statements regarding the inventory valuations under the group pleading doctrine, which holds that there is a presumption that allegedly false and misleading group published information is “the collective action of officers and directors.” The PSLRA requires, with regard to each false or misleading statement or material omission, that the complaint “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2) (emphasis added). While the Ninth Circuit did rule in a pre-PSRLA case, Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir.1987), that “it is reasonable to presume” that false or misleading information contained in prospectuses, registration statements, annual reports, press releases, or other “group-published information” can be attributed to the “collective actions of the officers” of the corporation, and that a securities fraud plaintiff “fulfills the particularity requirements of Rule 9(b) by pleading




the misrepresentations with particularity and where possible the roles of the individual defendants in the misrepresentations,” id. at 1440, the Ninth Circuit has not spoken in any officially published opinion on the question whether the “group pleading” doctrine applies to allegations of scienter in a case governed by the PSLRA.FN8

FN8. Other circuits have spoken on this issue, notably the Fifth Circuit in Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 364-65 (5th Cir.2004) (noting conflict among the courts, and holding that “[t]he ‘group pleading’ doctrine conflicts with the scienter requirement of the PSLRA”); see also Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 602-03 (7th Cir.2006); Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1017-18 (11th Cir.2004).

*22 The court is aware that some judges in this district have either applied the group-published presumption without substantive analysis in cases controlled by the PSLRA, or have found that the presumption has survived the enactment of the PSLRA. See, e.g., In re Omnivision Techs., Inc., 2005 WL 1867717 at *5 (N.D.Cal., July 29, 2005); In re Adaptive Broadband Sec. Litig., 2002 WL 989478 at *52-53 (N.D.Cal., April 2, 2002); In re Secure Computing Corp. Sec. Litig., 120 F.Supp.2d 810, 821 (N.D.Cal.2000). Other judges, however, have concluded that plaintiffs must state with particularity facts indicating that an individual defendant was directly involved in the preparation of allegedly misleading statements published by an organization, and have found the group-published presumption inappropriate in light of the pleading standards imposed by the PSLRA. See, e.g., In re Netopia, Inc., Sec. Litig., 2005 WL 3445631 at *5-6 (N.D.Cal., Dec.15, 2005); In re ESS Technology, Inc. Sec. Litig., 2004 WL 3030058 at *12 (N.D.Cal.2004). Until such time as the Ninth Circuit does speak on this issue, this court interprets the above-cited provision of the PSLRA as requiring that plaintiffs plead facts showing scienter as to each defendant individually. In other words, plaintiffs must allege the required state of mind as to each defendant who made an allegedly misleading statement.

3. Loss Causation Defendants argue that the CAC fails to plead loss

causation, asserting that the boilerplate language in the CAC is substantially identical to the language found inadequate by the Supreme Court in Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 125 S.Ct. 1627, 1630, 161 L.Ed.2d 577 (2005). The CAC alleges that the overvaluation of inventory and later disclosure of the lack of internal controls that led to the overvaluation caused a 22.5% decline in the price of SST's stock price. The court finds that the allegations in the CAC do meet the requirements of Dura.

4. Control Person Liability Adequate pleading of a primary violation of § 10(b) is required for a plaintiff to adequately plead control liability under § 20(a). See 15 U.S.C. § 78t. Because the CAC fails to state a claim for primary liability under § 10(b) or Rule 10b-5, the court finds that the claim for control person liability must be dismissed.

CONCLUSION In accordance with the foregoing, the motion to dismiss the consolidated amended complaint is GRANTED, for failure to allege falsity with particularity, and for failure to allege scienter as to any defendant. The totality of plaintiffs' allegations are insufficient under the heightened pleading standard of the PSLRA to raise a strong inference that defendants acted with deliberate or conscious recklessness in issuing statements regarding the value of SST's inventory or in failing to disclose that SST lacked adequate internal controls to ensure that inventory was properly valued. The dismissal is WITH LEAVE TO AMEND, and any amended complaint shall be filed no later than April 14, 2006. *23 Notwithstanding the fact that the dismissal is with leave to amend, the court questions whether plaintiffs will be able to state a claim. The gravamen of plaintiffs' complaint as presented in the CAC is that SST mismanaged the valuation of its inventory, and then failed to disclose that mismanagement. The allegation that defendants should have written down the inventory earlier than they did, or should have disclosed that SST's valuation system was “arbitrary,” is essentially a claim that there were material deficiencies in SST's inventory control procedures. Generally speaking, incidents of fiduciary misconduct and internal mismanagement are not by themselves sufficient to trigger liability under the Exchange Act. Santa Fe Indus., Inc. v.




Green, 430 U.S. 462, 478-80, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977). IT IS SO ORDERED. N.D.Cal.,2006. In re Silicon Storage Technology, Inc. Slip Copy, 2006 WL 648683 (N.D.Cal.) Briefs and Other Related Documents (Back to top) • 2005 WL 3607720 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Memorandum in Support of their Opposition to Defendants' Motion to Dismiss the Consolidated Amended Class Action Complaint (Nov. 4, 2005) Original Image of this Document (PDF) • 2005 WL 451836 (Trial Pleading) Complaint for Violation of the Federal Securities Laws (Jan. 20, 2005) • 3:05cv00295 (Docket) (Jan. 20, 2005) • 2005 WL 2868820 (Trial Motion, Memorandum and Affidavit) Defendants' Memorandum of Points and Authorities in Support of Motion to Dismiss Plaintiffs' Consolidated Amended Class Action Complaint (Jan. 4, 2005) END OF DOCUMENT


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d)


Briefs and Other Related Documents NOT FOR PUBLICATION

United States District Court,D. New Hampshire. Rosemarie STUMPF

v. Neil R. GARVEY, et al.

In re TYCOM LTD. SECURITIES LITIGATION No. 03-CV-1352-PB, 02-MDL-1335-PB.

Sept. 2, 2005.

James V. Bashian, Law Office of James V. Bashian PC, Fairfield, NJ, for Rosemarie Stumpf.

MEMORANDUM AND ORDER BARBADORO, J. *1 This class action arises from a decision by Tyco International Ltd. to sell off a minority interest in one of its subsidiaries, TyCom Ltd. Plaintiffs purchased shares of TyCom stock, either pursuant to a July 26, 2000 Registration Statement and Prospectus (“Prospectus”) for TyCom's initial public offering (“Offering”), or on the open market between July 26, 2000 (“Effective Date”) and December 17, 2001 (“Class Period”). Plaintiffs claim that defendants Tyco, TyCom, L. Dennis Kozlowski, Mark H. Swartz, and Neil R. Garvey devised a scheme to fraudulently reap more than $200 million in cash from the July 26, 2000 offering of common shares in TyCom, a wholly owned subsidiary of Tyco. Plaintiffs also claim that analysts employed by the Underwriters of the Offering issued false reports in furtherance of the scheme. Plaintiffs elaborate on their claim in their consolidated complaint FN1 (“Complaint”), by alleging that the Prospectus was materially false and misleading because it both misrepresented that the demand for undersea fiber-optic cable bandwidth, TyCom's sole product, was increasing, and failed to disclose that the market for bandwidth was already saturated with unused capacity. Plaintiffs allege that these materially false and misleading statements fraudulently induced them to purchase TyCom stock at an inflated price during the Class Period. Plaintiffs also charge that defendants continued their misconduct during the Class Period by engaging in fraudulent revenue swaps to artificially inflate the

price of TyCom stock and boost the company's profits. According to plaintiffs, the underwriters of the TyCom Offering, Goldman, Sachs & Co. (“Goldman Sachs”), Citigroup Global Markets, Inc. (f/k/a Salomon Smith Barney Inc.)(“SSB”), and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill Lynch”) (collectively, “Underwriters”) were complicit in this scheme, failed to disclose conflicts of interest, and issued false statements in their analysts' reports to inflate the value of TyCom stock.

FN1. This case began as two separate actions filed in the United States District Court for the District of New Jersey: Stumpf v. Garvey, filed on July 24, 2003, and O'Loughlin v. Garvey, filed on September 26, 2003. On October 30, 2003, the Judicial Panel on Multidistrict Litigation (“MDL”) issued a Conditional Transfer Order transferring Stumpf v. Garvey to this court pursuant to 28 U.S.C. § 1407. By order dated November 10, 2003-prior to date on which the MDL transfer order became final-the New Jersey District Court consolidated the two cases, approved the parties' selection of lead counsel, and appointed Mark Newby as lead plaintiff. The consolidated complaint was filed on December 13, 2004.

In Count I, plaintiffs assert claims against all defendants based on § 11 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77(k), and against Tyco and the individual defendants based on § 15 of the Securities Act. 15 U.S.C. § 77(o). In Count II, plaintiffs assert claims against all defendants except Merrill Lynch based on § 10(b) of the Securities and Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and against Tyco and the individual defendants based on § 20(a) of the Exchange Act. 15 U.S.C. § 78t(a). Defendants have moved to dismiss the Complaint on a variety of grounds. FN2

FN2. Tyco, TyCom, and Garvey filed a motion to dismiss the Complaint (Doc. No. 384). Kozlowki filed a separate motion to dismiss (Doc. No. 391), but joined in the legal arguments set forth by Tyco, TyCom




and Garvey. Goldman Sachs, SSB, and Merrill Lynch also filed a separate motion to dismiss (Doc. No. 392), joining in Tyco's arguments and setting forth additional arguments for dismissal. I address the arguments presented in all three motions.

I. BACKGROUND

A. Tyco's Telecommunications Cable Business

Prior to April 1997, Tyco manufactured undersea fiber optic telecommunications cable in its Simplex Technologies unit. Simplex's major customer was AT & T Submarine Systems Inc. (“SSI”), whose principal business was designing and laying undersea cable systems to connect to land-based cable systems. On April 11, 1997, Tyco and AT & T announced that they had entered into an agreement for Tyco to acquire SSI. Tyco explained that SSI would operate in conjunction with its Simplex unit to become a fully integrated manufacturer, designer, and servicer of undersea fiber optic cable systems. Tyco completed the purchase on July 1, 1997, and renamed the new entity Tyco Submarine Systems Ltd. Tyco Submarine was later renamed TyCom. At the time, Tyco owned 100% of the stock in TyCom. *2 Tyco's merger of Simplex and SSI was perfectly timed to benefit from the growth in telecommunications companies that sought to own undersea cable systems. TyCom's revenue thus grew from $375.5 million in fiscal 1997 to $1.28 billion in fiscal year 1998, and $1.63 billion in fiscal year 1999. TyCom's revenue in the first six months of fiscal year 2000 was $1.27 billion. This growth was fueled primarily by contracts with four of TyCom's largest customers, Level 3 Communications, 360networks, Global Crossing, and Flag Telecom. These customers raised cash to fund their operations through a series of public offerings in which the Underwriters were participants. B. Tyco's Decision to Sell Off a Minority Interest of

TyCom After an open-house for telecommunications research analysts in the fall of 1999, TyCom's management decided to sell off a minority interest in the company and construct the TyCom Global Network (“TGN”). The company later conducted “town hall meetings” at TyCom's various locations to increase its employees' awareness of the TyCom Offering. TyCom senior

marketing director, James F. Brennan, who in 1990 had been convicted of bank fraud, played a central role in the Offering.FN3

FN3. The First Circuit Court of Appeals affirmed Brennan's bank fraud conviction. See United States v. Brennan, 994 F.2d 918, 930 (1st Cir.1993).

C. Pre-Offering Demand For Undersea Bandwidth

Most of the cable that TyCom and other companies installed in 1999 and 2000 was unused “dark fiber” at the time of the Offering. “Dark fiber,” as opposed to “lit fiber,” is fiber that is laid undersea, but has not yet been connected to land, often due to a lack of demand. Based on a massive build-out of capacity by Global Crossing, 360networks, and Level 3, there was sufficient bandwidth capacity to meet anticipated future demand several times over. In fact, at the time of the Offering, the only demand for capacity on the TGN was from companies such as Qwest, Global Crossing, and Level 3, who themselves had excess bandwidth capacity, but were interested in “swapping” their excess capacity for capacity on the TGN.FN4 Furthermore, those companies treated the capacity transferred in swap transactions as revenue-producing sales, even though no money changed hands.

FN4. “Swaps” are reciprocal transactions in which two telecommunications companies exchange capacity on each other's network. Swaps “may be entered into for legitimate reasons, i.e. to acquire access on networks in a market that a company wishes to enter in exchange for capacity that has yet to be sold and is not otherwise in use (‘dark fiber’). However, swap transactions can also be [used] by a company seeking to defraud investors or its creditors to create the impression that the company is selling capacity when it is merely unloading useless dark fiber on one of its networks in exchange for useless dark fiber on a competitor's network,” thereby inflating the company's bottom line. In re Flag Telecom Holdings, Ltd. Sec. Litig., 352 F.Supp.2d 429, 461 (S.D.N.Y.2005) ( “Flag II” ).

According to a senior director of global sales at TyCom (“Employee E”), the company's network engineers and other employees involved in designing




the TGN were “queasy” about the lack of sufficient market demand to support an additional global network, and therefore strongly advised against the spin-off. Compl. ¶ 74. According to Employee E, at the time of the Offering, bandwidth capacity had already surpassed demand and the price of bandwidth was plummeting. Id. ¶ 75. Another TyCom employee, a shore-end installation engineer (“Employee G”), who was responsible for installing submarine and terrestrial fiber optic cable systems, including the TGN, stated that in the late 1990s there was “more than enough capacity.” Id. ¶ 78. He added that concerns within TyCom and Tyco about waning demand and excess bandwidth capacity were not disclosed to the public, and instead, TyCom's marketing and sales division “continued to forecast a huge market” to potential investors. Id. ¶ 79. *3 A former director of technology for TyCom (“Employee I”) similarly stated that concern over bandwidth demand at the time of the Offering was widely expressed among TyCom employees. Compl. ¶ 84. TyCom's deputy director of global sales from 1997 to 2004 (“Employee D”) stated that despite the efforts of the sales staff, coupled with almost weekly price reductions, no bandwidth was sold from the beginning of 2000 until the middle of 2001. Id. ¶ 85. TyCom's executives, including Garvey, were well aware that no sales of bandwidth had been made immediately prior to the Offering and that there were few expressions of interest from potential customers. Id. ¶ 86. A terminal engineer (“Employee J”) responsible for activating cables, and hence available bandwidth, stated that in many of the terminals only 1/32 of the capacity was being utilized and that TyCom was absorbing cancellations in contracts by assuming ownership of the capacity that had been installed and completed. Id. ¶ 87.

D. TyCom's Public Offering On January 17, 2000, Tyco announced that, in response to rapidly increasing market demand for undersea bandwidth, it planned to develop TyCom into a publicly traded company for the purpose of designing, building, installing, operating, and maintaining its own global undersea fiber-optic communications network. Compl. ¶ 97. The TGN was to be the “largest and most advanced global undersea telecommunications fiber optic network.” Id. Tyco common stock rose by $5.125 per share the next day, in part due to investor enthusiasm for the proposed offering. Id. ¶ 98. On July 26, 2000, TyCom filed an amended Registration Statement and

final Prospectus with the Securities and Exchange Commission (“SEC”) for the initial offering of 61,130,435 shares of TyCom common stock at $32 per share. Id. ¶ 99. Goldman Sachs, SSB, and Merrill Lynch were the co-lead underwriters of the Offering. Id. ¶ 101. Tyco planned to sell 14% of its interest in TyCom. Id. ¶ 102. The Prospectus represented that $1,654,115,224 of the $1,854,115,000 in estimated net proceeds from the Offering would be used “toward the deployment of the first phase of the TyCom Global Network.” Compl. ¶ 100. According to the Prospectus, the principal elements of TyCom's business strategy were to deploy the TGN to address increasing demand, transform into a provider of undersea bandwidth services, and deliver customer-driven network solutions. Id. ¶ 108. The Prospectus added that the TGN was likely to be successful because, based on research conducted by the Yankee Group, global demand for undersea bandwidth capacity on the transatlantic route was expected to increase “at a compound annual growth rate of approximately 123% from 2000 through 2005,” and demand on the transpacific route was expected to “increase at a compound annual growth rate of 129%” over the same period. Id. ¶ 109.

E. The Yankee Group Forecasts *4 Prior to the Offering, TyCom sent a Request for Quotation (“RFQ”) to the Yankee Group, a telecommunications and networking research and consulting firm, asking for the preparation of “a demand analysis for various traffic destinations” for the period from 2000 through 2009. Compl. ¶ 90. In the RFQ, TyCom informed the Yankee Group that “[TyCom] had already completed a basic Global Supply and Demand-side analysis” and that it “would like [the Yankee Group] to use this analysis as a starting point” for its own analysis. Id. The RFQ emphasized that “the Yankee Group's final presentation is expected to be a validation of previous [TyCom] efforts ... intended to serve [in anticipated SEC filings] as an objective third-party view of global demand for network capacity.” FN5 Id. The RFQ was “carbon copied” to members of TyCom's senior management, including Andrew Kowalik, TyCom's head of strategic information. Id. ¶ 92.

FN5. The RFQ further stated that after the Yankee Group performed its “own demand analysis,” it would be required to “evaluate




the [TyCom] Demand model and projections, and then render an assessment as to its approach and consolidations” and “improve its own model if warranted....” Compl. ¶ 91.

Employee H, a former global forecast analyst who worked for TyCom from 1998 to 2002, learned from Kowalik that the Yankee Group's forecasts predicted much larger demand growth than TyCom's internal analyses because the Yankee Group had relied on TyCom's falsely inflated projections.FN6 Compl. ¶ 93. In February 2000, TyCom's “Final View” of the market projected that demand for the transatlantic routes would increase at an average of 51.25% per year between 2001 and 2005. Id. ¶ 94. Similarly, demand for the transpacific routes for the same period was projected to increase yearly by an average of 81.25%. Id. The Yankee Group's demand projections for the same period were significantly higher: it projected 71% average annual growth in the transatlantic region and 85.75% average annual growth in the transpacific region. Id. ¶ 95. Employee B indicated that the Yankee Group's projections were inflated by the inclusion of non-revenue-producing reciprocal bandwidth swaps and did not reflect actual end-user demand. Id. ¶ 96.

FN6. Employee H also alleges that Kowalik told her that the Underwriters had explained to him and other senior TyCom executives what the sales and revenue projections had to be in order to induce investors to buy shares of TyCom and then instructed Kowalik to “come back with the numbers to support those forecasts.” According to Employee H, Kowalik then reported these “falsely inflated demand numbers” to the Yankee Group. Com pl. ¶ ¶ 88-89.

F. Post-Offering Trading in TyCom Stock

On July 27, 2000, TyCom stock rose by $4.52 per share as investors reacted positively to the Offering. Compl. ¶ 195. Beginning on August 21, 2000, the Underwriters commenced analyst coverage of TyCom.FN7 Id. ¶ 197. Craig Irvine of Merrill Lynch initiated coverage of TyCom with a near-term rating of “accumulate,” a long-term rating of “buy,” and a 12-to 18-month target price of $60 per share. Id. ¶ 198. Irvine reiterated this rating on October 7, 2000. Id. Similarly, Frank Governali of Goldman Sachs initiated coverage of TyCom with a rating of “recommend list” and a 12-month target price of $60

per share. Id. ¶ 199. Governali reiterated his “recommend list” rating and the $60 price per share in his October 18, 2000 report. Id. ¶ 207.

FN7. Under SEC regulations, the Underwriters were prohibited from issuing research reports for twenty-five days following the Offering.

Jack Grubman of SSB echoed these ratings, initiating coverage with a “Speculative Buy” rating and a 12 to 18 month target price of $75 per share. Compl. ¶ 200. Grubman estimated that during the fiscal year ending September 2000, TyCom's revenue would grow by 55.3% to $2.3 billion. Id. He added that demand for undersea bandwidth was expected to exceed supply and that TyCom was an attractive investment. Id. *5 In response to the August 21, 2000 analyst coverage, TyCom stock closed on August 21, 2000 at $42.875, up from the previous day's close of $37.75, on volume that was approximately three times the prior week's average daily volume. Compl. ¶ 206. TyCom stock closed at a high of $45.438 on September 1, 2000. Id. ¶ 207. On January 16, 2001, TyCom announced a “major” $82.5 million capacity sale on the transatlantic route of the TGN to DishnetDSL Limited of India (“DishnetDSL”). Compl. ¶ 208. The following day, TyCom announced its financial results for the quarter ending December 31, 2000, and reported that the company's “strong earnings” were “driven by the supply of third-party systems and sales of capacity on the TGN.” Id. ¶ 209. On February 23, 2001, TyCom issued a press release stating that “the transatlantic portion of the TyCom Global Network (TGN), scheduled to be placed in service in July 2001, will have its capacity increased sooner than planned to meet demand for larger bandwidth increments, including wavelengths.” Id. ¶ 212. Likewise, in an April 18, 2001 press release, TyCom announced capacity sales on both the transatlantic and transpacific routes. Compl. ¶ 214. TyCom shares rose by $3.72, or 26%, to $18.25 per share in response to this news. Id. ¶ 215. On April 26, 2001, Governali reiterated his “recommend list” rating of TyCom stock, but reduced the price target to $40 per share. Id. ¶ 250. TyCom made similar announcements related to capacity sales in May, June, July, and August 2001. Id. ¶ ¶ 216-22. TyCom attributed its strong performance during this period to




its ability to generate capacity sales. Id. In his July 18, 2001 report, Grubman reiterated his “buy” rating for TyCom stock. Id. ¶ 190. Several weeks later, however, in his August 8, 2001 report, Grubman downgraded TyCom to “neutral.” Id. ¶ 254.

G. TyCom's Swap Transactions According to Employee K, a senior manager of terminal commissioning and network design, TyCom was swapping capacity on the TGN with capacity on other carrier networks and recognizing these swaps as revenue, in violation of Generally Accepted Accounting Principles (“GAAP”), particularly Accounting Principles Board Opinion No. 29 (“APB No. 29”).FN8 Compl. ¶ 227. Employee H confirmed that TyCom would take a large block of dark fiber and exchange it for dark fiber on another company's proposed cable network. Id. ¶ 228. Similarly, Employee C, project manager at TyCom's Morristown, New Jersey facility, reported that TyCom swapped capacity without the auditors' knowledge in an effort to boost revenue.FN9 Id. ¶ 229.

FN8. APB No. 29 requires that exchanges of non-monetary assets be accounted for by calculating the fair value of the asset given up or the asset received, whichever is more readily determinable. See In re Flag Telecom Holdings, Ltd. Sec. Litig., 308 F.Supp.2d 249, 263 (S.D.N.Y.2004) ( “Flag I” ).

FN9. According to Employee B, during the fourth quarter of fiscal year 2001, TyCom discussed appropriate accounting treatment of its bandwidth swaps with its outside auditor PricewaterhouseCoopers (“PwC”). PwC informed TyCom that it would not issue an opinion letter on TyCom's financial statements classifying the swaps as revenue. Compl. ¶ 257.

An internal company document establishes that the purported sale to Dishnet announced on January 16, 2001 was in fact a swap of capacity, and indicated that DishnetDSL was not carrying traffic. Compl. ¶ 230. Moreover, the same document reveals that TyCom also engaged in capacity swaps with Qwest and Emergia and the total value of all non-swap lease transactions through mid-September 2002 was only $3,436,651. Id. ¶ ¶ 231-32.

H. TyCom's Stock Prices Fall *6 From a high price of $45.4375 on September 1, 2000, TyCom's stock began a long decline in value to a low closing price of $7.41 on September 27, 2001, as a result of a series of partial disclosures concerning reduced demand, oversupply, and declining prices for bandwidth. Compl. ¶ 243. An article titled “Trouble in Octopus Garden,” in the March 1, 2001 edition of America's Network, attributed the decline in the price of TyCom stock to the oversupply of bandwidth and the resulting plummeting prices, and cautioned that TyCom was running the “risk of running itself into the ground.” FN10 Id. ¶ 244. TyCom stock closed at $18.04 per share the next day, after having traded as high as $25.09 the week before, and the company announced that it would buy back as much as $500 million in common stock on the open market. Id. ¶ ¶ 246-47. TyCom's buy-back temporarily buoyed the price per share, but the decline soon resumed, and TyCom stock closed at $9.99 on April 4, 2001. Id. ¶ ¶ 248-49.

FN10. On March 1, 2001, TyCom competitor 360networks reported that it had lost $355 million, or 55 cents per share, for the year that ended December 31, 2000. Accordingly, 360networks announced that it was scaling back its forecasts for profit, revenue, and capital spending. Compl. ¶ 245.

Similarly, a June 22, 2001 article in The Wall Street Journal Online reported that prices for bandwidth were falling “as much as 60%” and that the “amount of underused long-haul fiber capacity in the U.S. is about 97%.” Compl. ¶ 253. On October 4, 2001, Tyco announced an initial offer to exchange the TyCom shares it did not already own at an exchange rate of .2997 shares of Tyco common stock per share of TyCom stock. Compl. ¶ 258. Before trading opened on October 19, 2001, Tyco and TyCom announced that they had entered into a definitive agreement whereby a Tyco subsidiary would reacquire the outstanding minority interest in TyCom at a ratio of .3133 shares of Tyco common stock for every outstanding share of TyCom stock. Id. ¶ 260. On December 17, 2001, the date of the merger, Tyco common stock closed at $55.80 per share, making the effective acquisition price of the merger $17.48 per share. Id. ¶ 261. Employee B




suspects that Tyco acquired the minority interest in TyCom to avoid having TyCom issue separate audited financial statements that would have revealed the lack of demand for TyCom's bandwidth and the extent to which the purported swap transactions did not qualify for revenue recognition under GAAP. Id. ¶ 262.

II. STANDARD OF REVIEW Defendants challenge the Complaint pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b). When considering a motion to dismiss pursuant to Rule 12(b)(6), I must “accept as true all well-pleaded allegations and give plaintiffs the benefit of all reasonable inferences.” Cooperman v. Individual Inc., 171 F.3d 43, 46 (1st Cir.1999)(citing Gross v. Summa Four, Inc., 93 F.3d 987, 991 (1st Cir.1996)). However, while a court “deciding a motion to dismiss under Rule 12(b)(6) ... must take all well-pleaded facts as true ... it need not credit a complaint's ‘bald assertions' or legal conclusions.” Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1216 (1st Cir.1996) (quoting Wash. Legal Found. v. Mass. Bar Found., 993 F.2d 962, 971 (1st Cir.1993)). A well-pleaded complaint must contain “factual allegations ... respecting each material element necessary to sustain recovery under some actionable legal theory.” Glassman v. Computervision Corp., 90 F.3d 617, 628 (1st Cir.1996)(internal quotations and citations omitted). A motion to dismiss under Rule 12(b)(6) should not be granted unless it “presents no set of facts justifying recovery.” Cooperman, 171 F.3d at 46 (citing Dartmouth Review v. Dartmouth Coll., 889 F.2d 13, 16 (1st Cir.1989)). *7 Special pleading requirements apply to fraud claims. Fed.R.Civ.P. 9(b) states that “[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity.” “Rule 9(b) also requires that a plaintiff's averments of fraud specify the time, place, and content of the alleged false or fraudulent misrepresentations.” United States ex rel. Karvelas v. Melrose-Wakefield Hosp., 360 F.3d 220, 226 (1st Cir.2004). Moreover, when a cause of action sounding in fraud is based on “information and belief,” Rule 9(b) requires the plaintiff to plead sufficient supporting facts to permit a conclusion that the alleged belief is reasonable. See id. In contrast, “[m]alice, intent, knowledge and other conditions of minds or a person may be averred generally.”

Fed.R.Civ.P. 9(b). A plaintiff who alleges securities fraud under § 10(b) of the Exchange Act must also satisfy the heightened pleading standards of the PSLRA. To plead a material misrepresentation or omission under the PSLRA the complaint must “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement is made on ‘information and belief,’ the complaint shall state with particularity all facts on which the belief is formed.” 15 U.S.C. § 78u-4(b)(1). To be actionable as securities fraud, “the statements alleged to be misleading must be misleading to a material degree.” In re Cabletron Sys., Inc., 311 F.3d 11, 27 (1st Cir.2002). A fact is material “if it is substantially likely ‘that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” ’ Id. at 34 (quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988)). Finally, the PSLRA requires that a securities fraud claim plead facts with particularity that are sufficient to give rise to a “strong inference” of scienter. 15 U.S.C. § 78u-4(b)(2). Section 11 of the Securities Act creates a right of action for damages by securities purchasers when registration statements contain untrue statements of material fact or material omissions, and plaintiffs can trace their shares to those registration statements. 15 U.S.C. § 77k(a). Because fraud is not an essential element of a § 11 claim, a plaintiff asserting such a claim typically need only satisfy the liberal pleading requirements of Fed.R.Civ.P. 8(a). See Giarraputo v. Unumprovident Corp., 2000 WL 1701294, *9 (D.Me. Nov.8, 2000). Furthermore, unlike § 10(b), § 11 does not require an allegation of scienter.

III. ANALYSIS Defendants have launched a multi-pronged attack on the sufficiency of the Complaint. I evaluate the merits of each argument in turn.

A. Section 10(b) Although the Complaint includes many allegations that mirror those offered by the Lead Plaintiffs in the Tyco securities action pending in this court, see In re Tyco Int'l Ltd. Sec. Litig., 2004 DNH 154 (Oct. 14,




2004)(“Tyco II” ), the core allegations in this case, and those challenged most vigorously by defendants, are that (1) TyCom publicly represented that demand for bandwidth was “increasing” and was expected to continue to increase, even though TyCom knew that the existing supply of available bandwidth greatly exceeded demand projections; (2) TyCom failed to account for improper, non-revenue-producing swap transactions; and (3) analysts employed by the Underwriters issued materially false and misleading reports on TyCom and other telecommunications companies. I consider these arguments in light of the PSLRA's pleading requirements.

1. The Tyco Defendants FN11

FN11. The Tyco Defendants include Tyco, TyCom, Garvey, Kozlowski, and Swartz.

a. Failure to Plead False Statements or Omissions

(i) Statements Concerning Demand for Bandwidth

*8 The Tyco Defendants, in an argument joined by the Underwriters, first contend that the § 10(b) claim premised on the demand for bandwidth demand should be dismissed because plaintiffs have failed to plead facts demonstrating that the statements in the Prospectus concerning bandwidth were untrue when they were made. They further argue that, even if plaintiffs adequately alleged that the statements were false when made, such statements are not actionable. Neither argument is persuasive. First, plaintiffs have adequately alleged that the statement in the Prospectus that TyCom would deploy the TGN to “address the increasing demand for undersea fiber optic bandwidth” and other statements related to bandwidth demand were materially false and misleading. The Complaint charges that TyCom knew at the time of the Offering both that any anticipated increase in bandwidth demand would be insignificant when compared to the market's already-existing oversupply, and that the gap between demand and supply would be more pronounced if TyCom were to complete the TGN. Plaintiffs support their position by citing to the statements of several former TyCom employees who were involved with the Offering and development of the TGN. For example, these former employees state that “most of the fiber that was laid by TyCom and

other companies in 1999 and 2000 was dark at the time of the Offering and awaiting demand for capacity,” that “the only demand that TyCom experienced for the TGN at the time of the Offering was from companies ... [that] themselves had excess capacity and were interested in ‘swapping’ their excess capacity for capacity on the TGN,” and that “there were multiples of sufficient bandwidth capacity to meet future demand.” Compl. ¶ ¶ 70-71, 73. The former employees add that only 1/32 of the capacity was being used and the price of bandwidth was rapidly declining. These allegations are more than sufficient to establish that at the time of the Offering, statements that demand was increasing were materially false and misleading. Furthermore, I am not persuaded by the argument that defendants' statements concerning the demand for bandwidth are non-actionable “puffery,” and are further rendered immaterial by the “bespeaks caution” doctrine, such that a reasonable investor would not have relied on the identified statements concerning the demand for bandwidth in light of the extensive and detailed cautionary language in the Prospectus. Although courts have refused to find “material” as a matter of law “loosely optimistic statements that are so vague, so lacking in specificity ... that no reasonable investor” would rely on them, Shaw, 82 F.3d at 1217, the statements at issue here are not merely vague statements of hope. See In re Boston Tech. Inc. Sec. Litig., 8 F.Supp.2d 43, 60 (D.Mass.1998). Rather, they are specific and concrete statements concerning the market for bandwidth demand. See id. They are therefore actionable under § 10(b). See id. Additionally, the First Circuit has held that the “bespeaks caution” defense applies only to forward-looking statements and is inapplicable where, as in this case, the statements at issue include false or misleading representations of present fact. See In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187, 213 (1st Cir.2005). Here, the Prospectus falsely represented that the TyCom Offering and related implementation of the TGN was undertaken to “address the increasing demand for undersea fiber optic bandwidth” existing in the telecommunications market at the time of the Offering. Compl. ¶ 108. This statement and other similar statements in the Prospectus are representations of the then-existing state of the bandwidth market and are conceivably in direct contradiction to TyCom's alleged knowledge that bandwidth capacity already far exceeded demand. Id. ¶ ¶ 117-19. *9 I thus conclude that TyCom represented in the Prospectus that demand for bandwidth capacity was




growing at the time of the Offering and that plaintiffs have adequately pleaded facts demonstrating that these statements were false when made. I further conclude that the cautionary language in the Prospectus is insufficient to have rendered the statements concerning bandwidth non-actionable.

(ii) Improper Swap Transactions The Tyco Defendants similarly challenge the § 10(b) claims based on reciprocal swap transactions, arguing that these claims should be dismissed because plaintiffs have failed to plead facts showing that these transactions were improper. As the court in Flag II explained, reciprocal swap transactions are improper when a company “is merely unloading useless dark fiber on one of its networks in exchange for useless dark fiber on a competitor's network,” thereby falsely inflating the company's bottom line. 352 F.Supp.2d at 461. Plaintiffs allege that after the Offering, defendants misrepresented that TyCom had entered into contracts for sale of capacity on the TGN totaling approximately $560 million. Compl. ¶ ¶ 208-22. According to plaintiffs, these contracts consisted almost entirely of reciprocal swaps with other telecommunications companies that did not qualify for revenue recognition. Id. 226-29. In particular, plaintiffs identify three separate improper swaps that TyCom misrepresented as “sales” qualifying for revenue recognition: DishnetDSL ($82.5 million); Qwest ($140 million); and Emergia ($40 million). Id. Plaintiffs support these allegations with statements from four former TyCom employees and an internal TyCom document, Exhibit B, which identifies three multi-million-dollar transactions as improper swaps. For example, with respect to the DishnetDSL and Qwest transactions, Exhibit B indicates “[c]ustomer not carrying traffic.” Likewise, with respect to the Qwest and Emergia transactions, Exhibit B notes that the deals involved exchanges for capacity. Moreover, Exhibit B indicates that the DishnetDSL transaction was a “swap type deal to show revenue.” Plaintiffs further allege that during the fourth quarter of fiscal 2001, TyCom's auditor, PwC, refused to issue an opinion letter on TyCom financial statements that classified TyCom's reciprocal swap transactions as revenue. Compl. ¶ 257; see also Compl. ¶ 234 (pointing to an e-mail quoted in the Global Crossing complaint, 02 Civ. 910(GEL)(S.D.N.Y.), indicating TyCom's willingness to participate in fraudulent transactions intended to inflate its reported financial

results). Finally, as plaintiffs point out, TyCom acknowledged in its Form 10-K for the year ending September 30, 2003 that total TyCom net revenue for its TGN business in fiscal year 2001 was only $1.7 million-substantially below defendants' representation during the Class Period. I therefore conclude that the plaintiffs have met the PSLRA's requirement that a claimant plead with particularity defendants' false and misleading statements by describing the improper reciprocal swaps entered into to artificially inflate revenue. See Flag II, 352 F.Supp.2d at 463 (noting also that plaintiff pled facts demonstrating that many companies were inflating revenues by entering into improper reciprocal swap transactions).

b. Scienter *10 The Tyco Defendants, joined by the Underwriters, next argue that plaintiffs' § 10(b) claim concerning the demand for bandwidth and swap transactions should be dismissed for failure to plead facts giving rise to a “strong” inference of scienter, as is required by the PSLRA. “Liability under section 10(b) and Rule 10b-5 ... requires scienter, a mental state embracing intent to deceive, manipulate or defraud.” Cabletron, 311 F.3d at 38 (internal quotation marks omitted). To prove scienter, “a plaintiff must show either that the defendant[s] consciously intended to defraud, or that they acted with a high degree of recklessness.” Stone & Webster, 414 F.3d at 193 (internal quotation marks omitted); see Cabletron, 311 F.3d at 38 (explaining that scienter also “may extend to a form of extreme recklessness that ‘is closer to a lesser form of intent” ’) (citation omitted). In the First Circuit, there is no “rigid formula for pleading scienter,” and courts employ a “ ‘fact-specific approach’ that proceeds case by case.” Id. (citation omitted). Accordingly, while scienter can be established through direct evidence of “conscious wrongdoing,” a plaintiff may also “combine various facts and circumstances indicating fraudulent intent-including those demonstrating motive and opportunity-to satisfy the scienter requirement.” Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir.2002). The Complaint's allegations concerning demand for bandwidth and those concerning the improper reciprocal swap transactions are interrelated and interdependent. In effect, plaintiffs allege that the improper swap transactions were used to falsely




inflate TyCom's revenue, thus propping up stock prices, in order to perpetuate the fraudulent scheme that was initiated when defendants misrepresented the market for undersea bandwidth prior to the Offering. As a result, the facts plaintiffs offer to support a strong inference of scienter with respect to the claims premised on demand for bandwidth apply with equal force to support a strong inference of scienter with respect to the improper swap transactions.FN12

FN12. The Underwriters are in a different position. Plaintiffs have not provided sufficient facts to support a strong inference that the Underwriters acted with scienter with respect to the improper swap transactions. In fact, plaintiffs fail to allege that the Underwriters were aware of these transactions at all.

Plaintiffs have identified several factors that, taken together, are sufficient to support a strong inference that Tyco, TyCom, and the individual defendants acted with scienter. First, plaintiffs allege that the underlying motive for the TyCom Offering was to allow Kozlowski and Swartz to personally profit and to generate funds to forgive unauthorized, interest-free loans that they had obtained from Tyco. Plaintiffs combine these allegations of motive and opportunity with claims that defendants, armed with knowledge of the imbalance between the demand for and supply of bandwidth, falsified internal demand projections and enlisted the Yankee Group to use these artificially inflated projections to provide an “objective third-party view of global demand for network capacity” intended for use in SEC filings that themselves were false. They add that TyCom engaged in improper swap transactions with other bandwidth providers to further perpetuate the fraud. Finally, plaintiffs allege that the individual defendants engaged in unusual trading of Tyco stock at suspicious times. Collectively, these allegations plead enough culpable facts to support the strong inference that the individual defendants acted with scienter. This inference can be imputed to Tyco and TyCom as well. *11 The Underwriters, however, are in a different position. First, plaintiffs impermissibly group together Merrill Lynch, Goldman Sachs, and SSB in their allegations, claiming that the “Underwriter Defendants” instructed Kowalik to falsify TyCom's projections of market demand. Compl. ¶ ¶ 88-89. 123, 204. Under the PSLRA, a plaintiff is required to

plead particularized facts that support a strong inference of scienter with respect to each defendant. See In re Cross Media Mktg. Corp. Sec. Litig., 314 F.Supp.2d 256, 263 (S.D.N.Y.2004) (dismissing claim where complaint “d[id] not adequately plead that each Defendant acted with ‘the required state of mind” ’); Tyco II, 2004 DNH 154 (noting that the group pleading doctrine “does not relieve a plaintiff of the duty to plead sufficient facts as to each defendant to support a strong inference that the defendant acted with scienter”) (emphasis added). Second, plaintiffs allege that Goldman Sachs analyst Governali and SSB analyst Grubman knew that there was no demand for bandwidth “by virtue of their access to senior TyCom management prior to and after the Offering, and their relationship with the other large bandwidth companies in the industry.” Compl. ¶ 204. However, sweeping and conclusory allegations that a defendant “must have known” the facts giving rise to an alleged fraud are insufficient to sustain an inference of scienter. See, e.g., Maldonado v. Dominguez, 137 F.3d 1, 10 (1st Cir.1998)(finding generalized imputations of knowledge insufficient); Orton v. Parametric Tech. Corp., 344 F.Supp.2d 290, 306 (D.Mass.2004)(rejecting “vague assertion that a defendant must have known about the fraud by virtue of his position of authority” to plead a strong inference of scienter). Finally, plaintiffs' unsubstantiated and conclusory assertions that Grubman was the “engineer” of TyCom's “scheme,” Compl. ¶ 7, and that he worked with TyCom executives to “devise[ ] a new business plan” for TyCom, id. ¶ 8, are similarly insufficient to support a strong inference of scienter. Plaintiffs' allegations that at an open-house Grubman told Garvey that Tyco could sell off a minority interest in TyCom and “retain the profit” from a fiber-optics network and that they should “get a handle on the company's hidden value” and “turn all of it into gold,” id. ¶ 54, demonstrate only that Grubman was optimistic about TyCom's ability to succeed and be profitable in the telecommunications market. I therefore conclude that plaintiffs have not pleaded sufficient facts to demonstrate that the Underwriters acted with scienter with respect to the claims involving the demand for bandwidth.

c. Loss Causation The Tyco Defendants' next argument in favor of dismissal of the § 10(b) claim is that even if plaintiffs have adequately pleaded actionable




misstatements and scienter, their § 10(b) claim must nevertheless be dismissed because they have failed to adequately plead loss causation.FN13 To survive a Rule 12(b)(6) challenge to a § 10(b) claim, a plaintiff must allege that “the act or omission of the defendant alleged to violate [§ 10(b) ] caused the loss for which the plaintiff seeks to recover damages.” 15 U.S.C. § 78u-4(b)(4); see Dura Pharms., Inc. v. Broudo, --- U.S. ----, ----, 125 S.Ct. 1627, 1631, 161 L.Ed.2d 577 (2005) (defining loss causation as a “causal connection between the material misrepresentation and the loss”). Hence, to properly plead loss causation, a plaintiff must allege “that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security.” Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2d Cir.2005).

FN13. Defendants also contend that plaintiffs' failure to properly plead loss causation with respect to the Exchange Act claims establishes their affirmative defense of “no loss causation” with respect to the § 11 and § 15 claims. See, e.g., In re DNAP Sec. Litig., 2000 WL 1358619, at *3 (N.D.Cal. Sep.14, 2000)(dismissing claim, noting loss causation is an affirmative defense that may be raised on a motion to dismiss).

*12 As the Supreme Court recently explained, plaintiffs cannot adequately plead loss causation merely by alleging that they purchased securities at artificially inflated prices. Dura Pharms., 125 S.Ct. at 1630. Rather, a plaintiff must show that he “suffered an economic loss fairly attributable to the public airing of the alleged fraud.” D.E. & J L.P. v. Conaway, 284 F.Supp.2d 719, 748-49 (E.D.Mich.2003), aff'd, 2005 WL 1386448 (6th Cir. June 10, 2005)(unpublished). Defendants argue that plaintiffs have failed to point to any corrective disclosure followed by an immediate drop in the price of TyCom stock, and, as a result, the only reasonable inference that can be drawn from the Complaint is that any decline in price during the class period was caused by the crash of the telecommunications market. Plaintiffs respond that they have satisfied the pleading requirement by alleging that “defendants' fraudulent misrepresentations and omissions caused the price of TyCom stock to be artificially inflated, so that when, over time, the true facts came out regarding TyCom's prospects and the state of demand for bandwidth

generally, facts that were at odds with defendants' prior representations, the stock lost value and investors suffered a loss.” Pls.' Opp. to Issuer Defs.' Mot. to Dismiss at 51. I agree. In Dura, the Supreme Court explained that a plaintiff's allegations of loss causation under § 10(b) are only subject to the pleading standards of Fed.R.Civ.P. 8(a)(2) requiring “a short and plain statement of the claim showing that the pleader is entitled to relief.” 125 S.Ct. at 1634. The Court further explained that because “ordinary pleading rules are not meant to impose a great burden upon a plaintiff,” it “should not prove burdensome ... to provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind.” Id. Here, plaintiffs allege that, based on defendants' fraudulent misrepresentations, they purchased TyCom stock at an artificially high price. They further allege that when the truth surfaced regarding the glut of bandwidth supply that was swamping market demand and driving bandwidth prices down, stock prices dropped and they suffered losses. Plaintiffs contend that these losses were caused by defendants' material misstatements regarding the demand for and supply of undersea bandwidth.FN14 Hence, plaintiffs' economic loss was the decline in the value of their stock that was the result of TyCom's misrepresentation of the market for bandwidth. What was initially concealed from TyCom investors, and what ultimately resulted in plaintiffs' losses, was the knowledge that, at the time of the Offering, the demand for bandwidth would not, and in fact could not, keep pace with the supply, which was increasingly flooding the market with capacity. When this information was disclosed, the price of TyCom stock, like the prices of other telecommunications stock, declined. In this case, the entire market for telecommunications stock reacted negatively to the revelation. Consequently, plaintiffs' showing that their loss was fairly attributable to the public airing of the true state of the bandwidth market, which had been falsely misrepresented to them by defendants, provides the causal link required by Dura.FN15

FN14. The Complaint's remaining allegations, those that mirror the claims asserted by the plaintiffs in Tyco II, include claims that the Prospectus was materially false and misleading because it failed to disclose: (1) that Tyco's executives were




engaged in systematic looting of the company; (2) that Tyco's executives were financially motivated to use the proceeds of the Offering to satisfy unauthorized loans; (3) that Tyco's reported success was the result of systematic accounting fraud; (4) pervasive analysts' conflicts; and (5) that defendants failed to notify investors of James Brennan's participation in the TyCom offering and his criminal record. Plaintiffs have not pleaded any facts that during the class period these alleged misrepresentations or omissions were disclosed to the market and that there was a resultant drop in the value TyCom stock following the disclosure. Hence, plaintiffs have not sufficiently alleged that their losses were caused by these purportedly fraudulent statements and omissions, and therefore cannot be the basis for plaintiffs' § 10(b) claim here.

FN15. This case is distinguishable from Lentell. In Lentell, the Second Circuit explained that “when the plaintiff's loss coincides with a marketwide phenomenon causing comparable losses to other investors, ... a plaintiff's claim fails when it has not adequately pleaded facts which, if proven, would show that its loss was caused by the alleged misstatements as opposed to intervening events.” 396 F.3d at 174 (internal quotations omitted). Here, the collapse of the market for telecommunications stock was arguably not an intervening event, but rather the proximate result of defendants' misrepresentation of the demand for and supply of bandwidth capacity.

*13 I therefore conclude that these allegations, if assumed to be true, are sufficient at this stage of the proceedings establish that the drop in TyCom's stock price was causally related to defendants' misrepresentation both with respect to the projected market demand for bandwidth and the significant excess of bandwidth supply. Dura Pharms., 125 S.Ct. at 1634. Even if, as defendants maintain, there had been an intervening event that interrupted the chain of causation, such a determination is a matter of proof after discovery, either at summary judgment or at trial, and is not to be decided here on a Rule 12(b)(6) motion to dismiss. Lentell, 396 F.3d at 174. Accordingly, the Tyco Defendants' motion to dismiss for failure to plead loss causation is denied. FN16

FN16. Plaintiffs also charge that the individual defendants, Kozlowski, Swartz, and Garvey, violated § 20(a) of the Exchange Act. Section 20(a) imposes derivative liability on defendants who “control” primary violators of securities laws. See 15 U.S.C. § 78t(a). A necessary element of a control person claim under § 20(a) is a primary violation of the securities laws. See, e.g., Greebel, 194 F.3d at 207; Suna v. Bailey Corp., 107 F.3d 64, 72 (1st Cir.1997). The Tyco Defendants have not challenged the sufficiency of the § 20(a) claim except to the extent that this claim depends on the existence of an underlying violation of § 10(b). Hence, because the Tyco Defendants' motion to dismiss the § 10(b) claim is denied, the § 20(a) claim remains viable.

2. The Underwriter Defendants

a. Analyst Conflicts

In addition to joining the Tyco Defendants in their arguments in favor of dismissal of the § 10(b) claim, the Underwriters add that plaintiffs' claim that the Prospectus failed to disclose analyst conflicts must be dismissed. The crux of this allegation is that defendants had a duty to disclose in the Prospectus that there was a conflict of interest between the Underwriters' investment banking and research departments. See Compl. ¶ ¶ 164-94. In response, the Underwriters argue that plaintiffs have failed to plead a single fact showing that conflicts existed concerning TyCom.FN17 Although plaintiffs devote nearly thirty paragraphs in the Complaint to allegations that conflicts of interest between the investment banking and research divisions of Goldman Sachs and SSB resulted in the publication of biased research reports on companies in the telecommunications industry, they offer no facts connecting these alleged conflicts to TyCom. In fact, as the Underwriters argue, plaintiffs' only allegations related to TyCom are the general assertions that Goldman Sachs and SSB were the underwriters of the TyCom Offering and that their analysts later issued positive research reports on TyCom. Such conclusory allegations are insufficient under the PSLRA and Rule 9(b). See Podany v. Robertson Stephens, Inc., 318 F.Supp.2d 146, 156 (S.D.N.Y.2004); In re Merrill Lynch & Co. Research




Reports Sec. Litig., 272 F.Supp.2d 243, 252-53 (S.D.N.Y.2003)(“Merrill II” )(dismissing claim that mutual fund purchased securities to obtain investment banking business where plaintiffs alleged only that defendants performed investment banking services for, and issued analyst reports on, companies whose securities were held by the fund). Moreover, virtually all of plaintiffs' allegations that there were conflicts at Goldman Sachs and SSB are based on documents or communications that post-date the TyCom Offering. They therefore cannot support a claim that the Prospectus for the Offering was false and misleading. See, e.g., Compl. ¶ 173 (e-mails from “August 2000”); id. ¶ 179 (communications in “December 2000,” “early 2001,” and “February 2001”); id. ¶ 187 (e-mail from “June 2001”).

FN17. The Tyco Defendants also argue that there was no obligation on the part of TyCom or Tyco to disclose analyst conflicts in the Prospectus, and that any duty to disclose a conflict resides with the analyst or underwriter. See, e.g., Fogarazzo v. Lehman Bros., Inc., 341 F.Supp.2d 274, ---- (S.D.N.Y.2004). I agree. Item 508(l)(1) of Regulation S-K (17 C.F.R. § 229.508(l)(1)), cited by plaintiffs require that underwriters of securities disclose “any transaction that the underwriter intends to conduct during the offering that stabilizes, maintains, or otherwise affects the market price of the offered securities.” Similarly, Regulation M, Item 101 (17 C.F.R. § 242.101(a)) makes it “unlawful” for an underwriter of a security to “attempt to induce any person to bid for or purchase” a covered security during the applicable restricted period. These regulations impose no duty to disclose on issuers.

*14 Finally, plaintiffs' attempt to rely on Rule 508(1)(1) of Regulation S-K and Rule 101 of Regulation M is unavailing. Rule 508(1)(1) requires that the Prospectus disclose any transaction that the underwriter intends to conduct during the offering that stabilizes, maintains, or otherwise affects the market price of the offered securities.” 17 C.F.R. § 229.508(1)(1). (Emphasis added). Likewise, Rule 101 prohibits an “attempt to induce” the purchase of “a covered security” (i.e., the security being offered, see 17 C.F.R. § 242.100(b)). 17 C.F.R. § 242.101(a). Plaintiffs' strained attempt to characterize research published on other companies in the telecommunications industry as a “transaction”

intended to affect the market price of TyCom or an “attempt to induce” the purchase of TyCom stock is unpersuasive. See In re Salomon Analyst Level 3 Litig., 350 F.Supp.2d 477, 493 n. 13 (S.D.N.Y.2004)( “Level 3” )(“The Level 3 Complaint also alleges that SSB's policies induced Grubman to issue ‘inflated recommendations' on other companies besides Level 3.... As with the conflicts allegations generally ... they cannot satisfy the particularity requirements of Rule 9(b) and the PSLRA for fraud or false statement of opinion as to the Level 3 reports.”); Podany, 318 F.Supp.2d at 157-58. I therefore conclude that plaintiffs' allegations regarding the Underwriters' duty to disclose analyst conflicts are insufficient to satisfy the pleading requirements of a § 10(b) claim.

b. Statements Contained In Analyst Reports FN18

FN18. The Complaint points to three research reports authored by Goldman Sachs analyst Governali: (1) an August 21, 2000 report in which Governali included TyCom on a “recommend list,” with a 12-month price target of $60 per share, Compl. ¶ 199; (2) an October 18, 2000 report reiterating the “recommend list” rating and the $60 price target, id. ¶ 207; and (3) an April 26, 2001 report reiterating the “recommend list” rating, but reducing the price target to $40 per share. Id. ¶ 250. The Complaint also identifies three reports authored by SSB analyst Grubman: (1) an August 21, 2000 report rating TyCom as a “Speculative Buy” and setting a 12-18 month price target of $75 per share, Compl. ¶ 200; (2) a July 18, 2001 report reiterating the “buy” rating, id. ¶ 190; and (3) an August 8, 2001 report downgrading Tycom to “neutral.” Id. ¶ 254.

The Underwriters next argue that the § 10(b) claim against Goldman Sachs and SSB must fail because plaintiffs have failed to plead a false statement in the TyCom analyst reports and have also failed to plead with particularity facts creating a strong inference of scienter or loss causation. Plaintiffs' § 10(b) theory against Goldman Sachs and SSB is based on allegations that their analysts, Governali and Grubman, issued materially false and misleading reports concerning TyCom after the




Offering, and on other companies prior to the Offering, in an attempt to inflate the value of companies in the telecommunications market. In their opposition to the Underwriters' motion to dismiss, plaintiffs add that the analysts' biased research reports on securities in TyCom's industry “had the effect of inflating the public's perception of the value of ... the securities of issuers, such as TyCom, that competed in the same market.” Pls.' Opp. To Underwriters' Mot. to Dismiss at 20-21. At the heart of this theory is the claim that the Governali and Grubman were motivated to falsify their research reports and ratings to make them appear more favorable than their honestly-held opinions about the companies and their stocks. See Level 3, 350 F.Supp.2d at 483. The Underwriters first argue that plaintiffs have failed to plead a false statement in the TyCom analyst reports as required by Rule 9(b) and the PSLRA. The Underwriters also argue that plaintiffs cannot base a claim on analyst reports concerning other issuers and other securities. I agree with both arguments. *15 Liability under § 10(b) can be predicated on statements of opinion where “it can be shown not merely that a proffered opinion was incorrect or doubtful, but that the speaker deliberately misrepresented his actual opinions.” Level 3, 350 F.Supp.2d at 489 (internal citations omitted). To survive a motion to dismiss on a false statement of opinion claim, however, “a plaintiff must allege with particularity ‘provable facts' to demonstrate that the statement of opinion is both objectively and subjectively false.” FN19 Id.; see Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1095-96, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991). Hence, the fatal flaw in plaintiffs' allegations that Governali and Grubman issued false and misleading reports with respect to other telecommunications companies prior to the TyCom Offering, and with respect to TyCom after the Offering, is that plaintiffs have failed to plead facts showing that either Governali or Grubman did not believe the recommendations and other statements in the reports at the time they were made.FN20 See also In re Credit Suisse First Boston Corp. (Agilent Techs., Inc.) Analyst Reports Sec. Litig., 2005 WL 852455, at *6 (D.Mass. Mar.31, 2005)(“Agilent Techs.” )(applying Virginia Bankshares and noting that what was missing were “specific allegations of ‘provable facts' that would support the twin inferences required: (1) that the analysts did not believe that Agilent merited a ‘Buy’ rating and (2) that the ‘Buy’ rating was objectively unsupportable”).

FN19. Plaintiffs do not dispute that the ratings and other statements in the analyst reports are recommendations, or, in essence, expressions of the analysts' opinions.

FN20. Indeed, it is not enough to allege only “that an opinion was unreasonable, irrational, excessively optimistic, not borne out by subsequent events, or any other characterization that relies on hindsight.” Level 3, 350 F.Supp.2d at 489.

With respect to Governali, plaintiffs allege that his reports did not reflect his true opinion, and were thus false and misleading, because he had “private misgivings about the telecommunications market” and because he “knew that there was no demand for the [TGN]” by virtue of his “access to senior TyCom management ... and [his] relationship with other large bandwidth companies.” Compl. ¶ ¶ 199, 204. In support of these allegations, plaintiffs point to a March 2000 e-mail in which Governali purportedly questioned Global Crossing's earnings guidance and to his August 2000 statement that he was considering a downgrade of a number of Competitive Local Exchange Carriers (“CLECs”). Id. ¶ ¶ 170-71, 173. Unfortunately for plaintiffs, these allegations offer no insight as to what Governali believed about TyCom at the time he published his three reports, and are therefore inadequate to satisfy the pleading requirements of Rule 9(b) and the PSLRA. See Level 3, 350 F.Supp.2d at 492; Podany, 318 F.Supp.2d at 153-54; In re Merrill Lynch & Co. Research Reports Sec. Litig., 273 F.Supp.2d 351, 355 (S.D.N.Y.2003), aff'd, 396 F.3d 161 (2d Cir.2005)(“Merrill I” )(noting that “e-mails concerning securities other than 24/7 and Interliant fail to meet the Rule 9(b)(let alone the PSLRA) pleading requirements necessary to allege that Merrill Lynch made fraudulent statements in reports concerning 24/7 or Interliant”). Likewise, plaintiffs' attempt to impute to Governali knowledge that there was no demand for the TGN on the basis of his “access to Tycom management” is inadequate to establish that he did not believe his reports on TyCom when he issued them. See Maldonado, 137 F.3d at 10. *16 Plaintiffs' attempt to plead that Grubman's three reports did not reflect his honest opinion regarding TyCom suffers from similar defects and is therefore equally inadequate. Here, plaintiffs seek to support their charge that Grubman did not believe his TyCom reports by citing two e-mails authored by other SSB employees. This pleading approach is insufficient.




Level 3, 350 F.Supp.2d at 491 (noting that reliance on “mischaracterizations of e-mails written by other SSB employees” is “plainly insufficient” to plead falsity of analyst report). First, plaintiffs cite an e-mail from an SSB investment banker, stating that “TyCom gives the appearance of being conservative with respect to multiples relative to the comps despite a very aggressive mode” to support their charge that Grubman concealed his use of aggressive assumptions. Compl. ¶ 203. Yet, the e-mail refers only to TyCom's assumptions, not Grubman's. Plaintiffs have not pleaded any facts concerning Grubman's assumptions, aggressive or otherwise, nor have they explained how the use of aggressive assumptions could be misleading if the report disclosed the assumption on which it was based. Plaintiffs also rely on a February 28, 2001 e-mail in which another SSB employee allegedly noted that in addition to the securities of several other issuers, “[I][a]lso don't like TyCom or 360 (Tsix).” Compl. ¶ 255. Again, plaintiffs' reliance is misplaced. This e-mail reveals nothing about what Grubman believed with respect to his TyCom recommendations and there is no indication that Grubman authorized, approved, agreed with, or even was aware of this communication. See Nolte v. Capital One Fin. Corp., 390 F.3d 311, 315-16 (4th Cir.2004). These e-mails thus cannot support plaintiffs' claim. Plaintiffs also rely on the bald assertion that the analysts' positive buy ratings on TyCom common stock were the undisclosed quid pro quo for the underwriting retention, but fail to offer a single fact in support of this claim. Moreover, the remainder of plaintiffs' allegations are derived from regulatory investigations concerning telecommunications companies other than TyCom. In fact, plaintiffs have not pointed to a single contemporaneous fact to support their contention that the analysts' reports were not reflective of their authors' true opinions. Rather, plaintiffs rely on general allegations that Governali and Grubman had “private misgivings” about the telecommunications industry, as well as e-mails written by other SSB employees that purport to represent Grubman's true opinion about TyCom. These allegations are insufficient under Rule 9(b) and the PSLRA. Finally, to adequately plead a § 10(b) claim, a plaintiff must state with particularity facts sufficient to raise a “strong” inference of scienter. 15 U.S.C. §

78u-4(b)(2); Greebel v. FTP Software, Inc., 194 F.3d 185, 196 (1st Cir.1999). Although in the typical case, falsity and scienter are different elements, under a false-statement-of-opinion theory, the two requirements are essentially identical. Level 3, 350 F.Supp.2d at 490. Consequently, where, as here, “the facts alleged are insufficient to support an inference of subjective disbelief in the opinions expressed, they are likewise insufficient to support any inference of scienter, let alone a strong one.” Agilent Techs., 2005 WL 852455, at *8. Plaintiffs' § 10(b) claim premised on false analyst reports is thus dismissed.FN21

FN21. As I noted above, the Underwriters also challenge the § 10(b) claim premised on false analyst report on the alternative ground that plaintiffs' have failed to plead loss causation as to these reports. I need not address this argument, however, because I conclude that plaintiffs have failed to establish that the statements in the report were false when they were made.

B. Section 11

*17 Section 11 of the Securities Act “imposes liability on signers of a registration statement and on underwriters, among others, if the registration statement ‘contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” ’ Glassman, 90 F.3d at 623 (quoting 15 U.S.C. § 77k(a)). Typically, fraud is not an element of a claim under § 11, and a plaintiff asserting such a claim “may avoid altogether any allegations of scienter or reliance.” Shaw, 82 F.3d at 1223. Consequently, claims asserted under § 11 need only satisfy the pleading standards of Rule 8(a), requiring “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a). If, however, a complaint attempts to establish violations of § 11 and § 10(b) through allegations of a unified course of fraudulent conduct, the complaint is said to “sound in fraud,” and the more rigorous pleading requirements of Rule 9(b) will apply to the § 11 and § 10(b) claims alike. See id.; Giarraputo, 2000 WL 1701294, at *9. In this case, plaintiffs urge that their § 11 claims do not “sound in fraud,” and therefore should not be subjected to the pleading requirements of Rule 9(b). The Underwriters counter that with respect to plaintiffs' claims based on demand for bandwidth and failure to disclose analyst conflicts and false




statements in analyst reports, fraud is at the very heart of the allegations. I find the Underwriters' argument on this point persuasive. Despite plaintiffs' boilerplate disclaimer excluding those allegations that sound in fraud from their § 11 claim, they cannot avoid the strictures of Rule 9(b) where their core allegations allege a fraudulent scheme. Here, the specific factual allegations on which Count I is based aver that defendants “deliberately misrepresented TyCom's projections of market demand in the [P]rospectus in order to defraud investors,” Compl. ¶ 142, and that the Underwriters “specifically directed Andrew Kowalik to falsify his projections.” Id. ¶ 204. Likewise, predictive statements and projections are actionable only if the speaker did not believe the statements when they were made. See Boston Tech., 8 F.Supp.2d at 54 (noting that “optimistic predictions ‘that prove to be off the mark'-even the most specific ones-are not actionable ... unless there was intentional deception on the part of the defendant”). I therefore conclude that, at least as to these allegations, fraud plainly lies at the core of the claim. See Hayduk v. Lanna, 775 F.2d 441, 443 (1st Cir.1985). Moreover, as to the allegations concerning analyst conflicts and false statements in analyst reports, plaintiffs must establish that the analysts knowingly misrepresented their actual opinions when they issued the reports. See Level 3, 350 F.Supp.2d at 490 (explaining that “[a]dequately alleging the falsity of a statement [of opinion] ... is the same as adequately alleging scienter.”). Accordingly, plaintiffs' § 11 claims concerning demand for bandwidth, analyst conflicts, and false reports must satisfy Rule 9(b).

1. Tyco Defendants *18 The Tyco Defendants challenge the sufficiency of plaintiffs' § 11 claim based on statements in the Prospectus concerning the demand for bandwidth. As I explained in Part III.A.1.a. above, plaintiffs' allegations concerning bandwidth demand and improper swap transactions are sufficient to satisfy the strict and rigorous pleading requirements of Rule 9(b) and the PSLRA. It therefore follows that these allegations also satisfy the requirements of Rule 9(b) in the context of a § 11 claim. I thus decline to dismiss plaintiffs' § 11 claim premised on demand for bandwidth.FN22

FN22. Plaintiffs also charge Kozlowski,

Swartz, and Garvey with violation of § 15 of the Securities Act. Like § 20(a) of the Exchange Act, § 15 imposes derivative liability on defendants who “control” primary violators of securities laws. See 15 U.S.C. § 77o. Hence, a necessary element of a control-person claim under § 15 is a primary violation of the securities laws. See, e.g., Greebel, 194 F.3d at 207; Suna v. Bailey Corp., 107 F.3d 64, 72 (1st Cir.1997). The Tyco Defendants challenge the § 15 claim only to the extent that it depends on the existence of an underlying violation of § 11. Thus, because the Tyco Defendants' motion to dismiss the § 11 claim is denied, the § 15 claim remains viable.

2. Underwriter Defendants

As I explained in Part III.A.2. above, plaintiffs' allegations concerning the failure to disclose analyst conflicts and false statements in analyst reports are insufficient under Rule 9(b) in the § 10(b) context. Accordingly, they are also insufficient to satisfy Rule 9(b)'s requirements as to plaintiffs' § 11 claim. Moreover, even under the much less demanding requirements of Rule 8(a), plaintiffs' vague and conclusory allegations concerning analyst conflicts and false statements in the reports would be insufficient to support their § 11 claim.

C. Statute of Limitations As an alternative ground for dismissal of the claims based on demand for bandwidth, defendants argue that these claims are time-barred. Claims brought under § 11 and § 15 of the Securities Act must be brought “within one year after discovery of the untrue statement or the omission, or after such discovery should have been made through the exercise of reasonable diligence,” and “no later than three years after the security was bona fide offered to the public....” 15 U.S.C. § 77m; see Dodds v. Cigna Sec., Inc., 12 F.3d 346, 349 (2d Cir.1993); In re Tyco Int'l, Ltd., Sec. Litig., 185 F.Supp.2d 102, 115 (D.N.H.2002). Similarly, claims brought under § 10(b) and § 20(a) of the Exchange Act prior to July 30, 2002 had to have been commenced within “one year after the discovery of the facts constituting the violation and within three years after such violation.” FN23 Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991) (§ 10(b) claims); Dodds, 12 F.3d




at 350 (§ 20(a) claims).

FN23. Under Section 804 of the Sarbanes-Oxley Act of 2002 (“SOX”), Pub.L. No. 107-204, 116 Stat. 745 (2002), § 10(b) claims commenced after July 30, 2002 are subject to a two-year statute of limitations. The Tyco Defendants argue that SOX's two-year limitation period does not apply retroactively to revive already time-barred claims such as the § 10(b) claim here. See Foss v. Bear, Stearns & Co. ., 394 F.3d 540, 542 (7th Cir.2005); In re Enter. Mortgage Acceptance Co., Sec. Litig., 391 F.3d 401, 410 (2d Cir.2004). Because I conclude that plaintiffs' § 10(b) claim based on the demand for bandwidth was timely under the pre-SOX one-year statute of limitations, I need not determine if the SOX two-year limitations period applies to this case.

A two-part test is used in the First Circuit to determine when a plaintiff has sufficient notice of a securities fraud claim to trigger the one-year limitations period. Young v. Lepone, 305 F.3d 1, 8 (1st Cir.2002). First, the party invoking the statute of limitations defense “must demonstrate that sufficient ‘storm warnings' FN24 of fraud were on the horizon to trigger a duty to inquire further.” Tyco II, 2004 WL 2348315, at *18 (citing Young, 305 F.3d at 8). If the defendant meets this burden, the plaintiff must then produce evidence establishing that even a reasonably diligent investigation would not earlier have produced sufficient evidence to permit the filing of a legally viable complaint. Id. Because “[t]he multifaceted question of whether storm warnings were apparent involves issues of fact,” and the “circumstances of each case must be explored independently,” in certain cases it may not be appropriate to resolve this issue on a motion to dismiss.” Id. (also noting that “[i]n the archetypical case ... it is for the factfinder to determine whether a particular collection of data was sufficiently aposematic to place an investor on inquiry notice”).

FN24. “Storm warnings” exist “[w]hen telltale warning signs augur that fraud is afoot,” such that if the warning signs are “sufficiently portentous,” they may, “as a matter of law be deemed to alert a reasonable investor to the possibility of fraudulent conduct.” Young, 305 F.3d at 8.

*19 The original complaint in this action was filed on July 24, 2003. FN25 Defendants argue that the original complaint is untimely because it was filed more than one year after plaintiffs could have discovered the fact giving rise to their claims related to the demand for bandwidth. Plaintiffs dispute defendants' assertion that a March 1, 2001 article in America's Network, an April 12, 2001 article in Business Wire, and an April 17, 2001 Tyco press release put investors on notice that statements in the July 26, 2000 Prospectus may have been false such that they could have filed a viable claim within one year.

FN25. A second, similar complaint was filed in a separate action on September 23, 2003. After the two related cases were consolidated, the consolidated Complaint was filed on December 13, 2004.

Plaintiffs urge that these articles, which did not mention TyCom by name, merely notified TyCom investors that the market for undersea bandwidth was not then as robust as defendants had projected, and thus could not have alerted investors to the fact that statements in the Prospectus were false at the time they were made. Such generalized statements, plaintiffs argue, were insufficient to have put them on inquiry notice. See In re DaimlerChrysler AG Sec. Litig., 269 F.Supp.2d 508, 515 (D.Del.2003)(rejecting notice inquiry where the articles cited by defendants did not discuss “lawsuits that had been previously filed, official investigations that were being conducted, or allegations and incontrovertible objective evidence of fraud”); Thompson v. Metro. Life Ins. Co., 149 F.Supp.2d 38, 51 (S.D.N.Y.2001)(two dozen articles reflecting “general public awareness” of industry wrongdoing insufficient to put plaintiffs on inquiry notice). Plaintiffs further argue that it was not until September 2002, when Tyco issued a press release detailing Kozlowski and Swartz's misconduct and announcing that it had filed suit against them, that they had reason to suspect that the statements in the Prospectus were false at the time they were issued. According to plaintiffs, this was the first “storm cloud” to cast a pall over the statements in the Prospectus. Following this disclosure, plaintiffs assert that they timely launched an investigation into statements contained in the TyCom Prospectus and filed their initial complaint on July 24, 2003, well within one year of the storm warnings. If plaintiffs are correct, and at this juncture I must accept as true their well-pleaded facts, I agree that their claims are




not barred by the one-year statute of limitations.

IV. CONCLUSION For the reasons set forth above, the motions to dismiss as to Tyco, TyCom, Garvey, Kozlowski, and Swartz are denied (Doc. Nos. 384 & 391). The Underwriters' motion to dismiss (Doc. No. 392) is granted. SO ORDERED. D.N.H.,2005. Stumpf v. Garvey Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 Briefs and Other Related Documents (Back to top) • 2006 WL 1356289 (Trial Motion, Memorandum and Affidavit) Supplemental Memorandum of Tyco International Ltd. in Opposition to Plaintiff's Motion to Remand and in Support of its Cross-Motion to Dismiss the Complaint (May 1, 2006) Original Image of this Document (PDF) • 2006 WL 1356288 (Trial Motion, Memorandum and Affidavit) Memorandum in Support of Certain Defendants' Motion for an Order Establishing Deposition Protocol (Apr. 25, 2006) Original Image of this Document (PDF) • 2006 WL 1044914 (Trial Pleading) Answer of Goldman, Sachs & Co., Citigroup Global Markets Inc., and Merrill Lynch, Pierce Fenner & Smith, Incoporated to the Consolidated Securities Class Action Complaint (Apr. 10, 2006) Original Image of this Document (PDF) • 2006 WL 1028916 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of Lead Plaintiffs' Motion for Partial Summary Judgment as to Liability on Claims against Tyco International, Ltd. under Section 11 of the Securities Act of 1933 (Apr. 4, 2006) Original Image of this Document (PDF) • 2006 WL 1044907 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Motion for A Protective Order Preventing Tyco International, Ltd. from Charging an Unjustified and Exorbitant Sum for its Document Production (Apr. 4, 2006) Original Image of this Document (PDF) • 2006 WL 1044908 (Trial Motion, Memorandum and Affidavit) Assented-To Motion of Lead Plaintiffs to File Documents Under Seal - Level I (Apr. 4, 2006) Original Image of this Document (PDF) • 2006 WL 1044909 (Trial Motion, Memorandum

and Affidavit) Lead Plaintiffs' Motion for Partial Summary Judgment as to Liability on Claims against Tyco International, Ltd. under Section 11 of the Securities Act of 1933 (Apr. 4, 2006) Original Image of this Document (PDF) • 2006 WL 1044911 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of Lead Plaintiffs' Motion to Compel the Production of Documents by Defendant Tyco International Ltd. (Apr. 4, 2006) Original Image of this Document (PDF) • 2006 WL 1044913 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Motion to Compel the Production of Documents by Defendant Tyco International, Ltd. (Mar. 31, 2006) Original Image of this Document (PDF) • 2006 WL 1333548 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Motion to Compel the Production of Documents by Defendant Tyco International, Ltd. (Mar. 31, 2006) Original Image of this Document (PDF) • 2006 WL 1044905 (Trial Motion, Memorandum and Affidavit) Plaintiff's Assented-To Motion Concerning Application of Stipulated Protective Order as Clarified (Mar. 28, 2006) Original Image of this Document with Appendix (PDF) • 2006 WL 1044895 (Trial Motion, Memorandum and Affidavit) Lead Plaintiff's Memorandum of Law in Support of Motion for Class Certification (Mar. 8, 2006) Original Image of this Document (PDF) • 2006 WL 1044893 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Supplemental Memorandum in Further Support of its Motion for Class Certification (Mar. 6, 2006) Original Image of this Document (PDF) • 2006 WL 1044891 (Trial Motion, Memorandum and Affidavit) Supplemental Memorandum of Tyco International Ltd. in Opposition to Lead Plaintiffs' Motion for Class Certification (Feb. 24, 2006) Original Image of this Document (PDF) • 2006 WL 691289 (Trial Motion, Memorandum and Affidavit) Supplemental Memorandum of Tyco International Ltd. in Opposition to Lead Plaintiffs' Motion for Class Certification (Feb. 24, 2006) • 2006 WL 318872 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Pricewaterhousecoopers LLP in Further Support of its Motion for Summary Judgment on Loss Causation (Jan. 26, 2006) • 2006 WL 1044890 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Pricewaterhousecoopers LLP in Further Support of its Motion for Summary Judgment on Loss Causation (Jan. 23, 2006) Original Image of this Document (PDF)




• 2006 WL 1044887 (Trial Motion, Memorandum and Affidavit) Memorandum of Law of the Ballard Plaintiffs in Opposition to Defendant Michael A. Ashcroft's Motion to Dismiss the Complaint (Jan. 17, 2006) Original Image of this Document (PDF) • 2006 WL 318853 (Trial Motion, Memorandum and Affidavit) Memorandum of Law of the Ballard Plaintiffs in Opposition to Defendant Michael A. Ashcroft's Motion to Dismiss the Complaint (Jan. 17, 2006) • 2006 WL 1044885 (Trial Motion, Memorandum and Affidavit) Answer of Neil Garvey to the Consolidated Securities Class Action Complaint (Jan. 13, 2006) Original Image of this Document (PDF) • 2006 WL 1044886 (Trial Motion, Memorandum and Affidavit) Answer of Tycom and Tyco International Ltd. to the Consolidated Securities Class Action Complaint (Jan. 13, 2006) Original Image of this Document (PDF) • 2005 WL 3742068 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Memorandum of Law in Opposition to Pricewaterhousecoopers LLP's Motion for Summary Judgment on Loss Causation (Dec. 23, 2005) • 2005 WL 3970088 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Memorandum of Law in Opposition to Pricewaterhousecoopers Llp's Motion for Summary Judgment on Loss Causation (Dec. 23, 2005) Original Image of this Document (PDF) • 2005 WL 3742064 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' Memorandum of Law in Opposition to Defendant Dennis Kozlowski's Motion to Dismiss in Part the Second Amended Complaint (Nov. 18, 2005) • 2005 WL 3742065 (Trial Motion, Memorandum and Affidavit) Memorandum of New Jersey Fund Plaintiffs in Opposition to Defendant Mark Belnick's Motion to Dismiss in Part the Second Amended Complaint (Nov. 18, 2005) • 2005 WL 3742066 (Trial Motion, Memorandum and Affidavit) Memorandum of New Jersey Fund Plaintiffs in Opposition to Defendant Frank E. Walsh Jr.'s Motion to Dismiss in Part the Second Amended Complaint (Nov. 18, 2005) • 2005 WL 3970150 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' Memorandum of Law In Opposition to Defendant Dennis Kozlowski's Motion to Dismiss In Part the Second Amended Complaint (Nov. 18, 2005) Original Image of this Document (PDF) • 2005 WL 3970152 (Trial Motion, Memorandum and Affidavit) Memorandum of New Jersey Fund Plaintiffs in Opposition to Defendant Frank E. Walsh Jr.'s Motion to Dismiss in Part the Second Amended

Complaint (Nov. 18, 2005) Original Image of this Document (PDF) • 2005 WL 3742060 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' Memorandum of Law in Opposition to Pricewaterhousecooper's Motion to Dismiss in Part the Second Amended Complaint (Nov. 11, 2005) • 2005 WL 3970145 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' Memorandum of Law in Opposition to Pricewaterhousecooper's Motion to Dismiss in Part the Second Amended Complaint (Nov. 11, 2005) Original Image of this Document (PDF) • 2005 WL 3742059 (Trial Motion, Memorandum and Affidavit) Memorandum of Pricewaterhousecoopers LLP in Support of its Motion for Summary Judgment on Loss Causation (Nov. 8, 2005) • 2005 WL 3970144 (Trial Motion, Memorandum and Affidavit) Memorandum of Pricewaterhousecoopers Llp in Support of its Motion for Summary Judgment on Loss Causation (Nov. 8, 2005) Original Image of this Document (PDF) • 2005 WL 3742073 (Trial Pleading) L. Dennis Kozlowski's Answer to the Complaint (Nov. 4, 2005) • 2005 WL 3742074 (Trial Pleading) Answer (Nov. 4, 2005) • 2005 WL 3970143 (Trial Pleading) L. Dennis Kozlowski's Answer to the Complaint (Nov. 4, 2005) Original Image of this Document (PDF) • 2005 WL 3742056 (Trial Motion, Memorandum and Affidavit) Memorandum of Defendants Tyco International Ltd., Tycom Ltd. And Neil R. Garvey in Opposition to Lead Plaintiff's Motion For Clarification (Oct. 20, 2005) • 2005 WL 3742057 (Trial Motion, Memorandum and Affidavit) Memorandum of the Underwriter Defendants in Opposition to plaintiffs' ''""motion for Clarification"' (Oct. 20, 2005) • 2005 WL 3970138 (Trial Motion, Memorandum and Affidavit) Memorandum of Defendants Tyco International Ltd., Tycom Ltd. and Neil R. Garvey in Opposition to Lead Plaintiff's Motion for Clarification (Oct. 20, 2005) Original Image of this Document (PDF) • 2005 WL 3970139 (Trial Motion, Memorandum and Affidavit) Opposition of Tyco International Ltd., Tycom Ltd., and Neil R. Garvey to Lead Plaintiff's Motion for Clarification (Oct. 20, 2005) Original Image of this Document (PDF) • 2005 WL 3970140 (Trial Motion, Memorandum and Affidavit) Memorandum of the Underwriter Defendants in Opposition to Plaintiffs' ""Motion for Clarification'' (Oct. 20, 2005) Original Image of this Document (PDF)




• 2005 WL 3970141 (Trial Motion, Memorandum and Affidavit) Opposition of the Underwriter Defendants to Plaintiffs'""Motion for Clarification'' (Oct. 20, 2005) Original Image of this Document (PDF) • 2005 WL 3970137 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Defendant Michael A. Ashcroft in Support of his Motion for Revision of the Court's October 14, 2004 Order, or Alternatively, for Judgment on the Pleadings (Oct. 19, 2005) Original Image of this Document (PDF) • 2005 WL 3742055 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Defendant Michael A. Ashcroft in Support of His Motion for Revision of the Court's October 14, 2004 Order, or Alternatively, for Judgment on the Pleadings (Oct. 18, 2005) • 2005 WL 3742054 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Opposition to: Defendant Michael Ashcroft's Motion for Revision of Court Order or, Alternatively, for Judgment on the Pleadings; Motion of L. Dennis Kozlowski for Revision of Court Order; and Defendants Frank E. Walsh and Mark A. Bel nick's Joinders in Tyco International, Ltd.'s Motion for Revision of Court Order or, Alternatively, for Judgment on the Pleadings (Sep. 23, 2005) • 2005 WL 3970136 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Opposition To: Defendant Michael Ashcroft's Motion for Revision of Court Order Or, Alternatively, for Judgment on the Pleadings; Motion of L. Dennis Kozlowski for Revision of Court Order; and Defendants Frank E. Walsh and Mark A. Bel nick's Joinders in Tyco International, Ltd.'s Motion for Revision of Court Order Or, Alternatively, for Judgment on the Pleadings (Sep. 23, 2005) Original Image of this Document (PDF) • 2005 WL 3970135 (Trial Motion, Memorandum and Affidavit) Lead Plaintiff's Memorandum of Law in Support of Motion for Clarification (Sep. 21, 2005) Original Image of this Document (PDF) • 2005 WL 3742070 (Trial Pleading) L. Dennis Kozlowski's Answer to the Complaint (Sep. 16, 2005) • 2005 WL 3970131 (Trial Pleading) L. Dennis Kozlowski's Answer to the Complaint (Sep. 15, 2005) Original Image of this Document (PDF) • 2005 WL 3742048 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Memorandum of Law in Opposition to Tyco International, Ltd.'s Motion for Revision of Court Order or, Alternatively, for Judgment on the Pleadings (Aug. 5, 2005) • 2005 WL 3970128 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Memorandum of Law

in Opposition to Tyco International, Ltd.'s Motion for Revision of Court Order Or, Alternatively, for Judgment on the Pleadings (Aug. 5, 2005) Original Image of this Document (PDF) • 2005 WL 3970129 (Trial Pleading) Answer of Tyco International Ltd. to the Complaint (Aug. 5, 2005) Original Image of this Document (PDF) • 2005 WL 3742046 (Trial Motion, Memorandum and Affidavit) Tyco Defendants' Memorandum in Opposition to Lead Plaintiffs' Motion for Class Certification (Jul. 11, 2005) • 2005 WL 3970087 (Trial Motion, Memorandum and Affidavit) Tyco Defendants' Memorandum in Opposition to Lead Plaintiffs' Motion for Class Certification (Jul. 11, 2005) Original Image of this Document (PDF) • 2005 WL 3970086 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of Defendant Frank E. Walsh, Jr.'s Motion to Dismiss in Part the Second Amended Complaint (Jul. 1, 2005) Original Image of this Document (PDF) • 2005 WL 4018440 () Declaration of Jairaj Bridglal Pachai (Jun. 23, 2005) Original Image of this Document (PDF) • 2005 WL 850786 (Trial Motion, Memorandum and Affidavit) Motion of the Underwriters to Dismiss the Consolidated Class Action Complaint (Mar. 11, 2005) • 2004 WL 3770745 (Trial Pleading) Consolidated Securities Class Action Complaint (Dec. 13, 2004) Original Image of this Document (PDF) • 2004 WL 2157238 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Law of Defendants L. Dennis Kozlowski and Mark H. Swartz in Further Support of Their Motion to Dismiss (Sep. 13, 2004) • 2004 WL 481754 (Trial Motion, Memorandum and Affidavit) Memorandum of Law of Nominal Defendant Tyco International Ltd. in Support of its Motion to Dismiss Plaintiffs' Second Consolidated and Amended Derivative Complaint (Feb. 26, 2004) • 2004 WL 481755 (Trial Motion, Memorandum and Affidavit) Nominal Defendant Tyco International Ltd.'s Motion to Dismiss Second Amended Derivative Complaint (Feb. 26, 2004) • 2002 WL 33009227 () Declaration of John W. Peavy III in Support of Defendant's Memorandum in Opposition to Lead Plaintiffs' Motion for Class Certification (Aug. 23, 2002) Original Image of this Document (PDF) END OF DOCUMENT


Not Reported in F.Supp. Page 1Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793 (Cite as: Not Reported in F.Supp.)


United States District Court,N.D. California.

In re VALENCE TECHNOLOGY SECURITIES LITIGATION.

No. C 94-1542-SC.

May 08, 1995. ORDER RE: DEFENDANTS' MOTION TO DISMISS

I. INTRODUCTION *1 This matter concerns a securities class action lawsuit brought on behalf of all persons who were purchasers of the common stock of Valence Technology, Inc. (“Valence”) between May 7, 1992 and August 10, 1994. The matter is now before the court on all of the defendants' motions to dismiss. The court finds that the Valence defendants' motion to dismiss is GRANTED in part, DENIED in part; the underwriters Montgomery and Alex. Brown' motions to dismiss are GRANTED in part and DENIED in part. The individual defendants' motions to dismiss are GRANTED in part, DENIED in part.

II. BACKGROUND Valence is a company engaged in the research, development and production of advanced lithium polymer rechargeable batteries for use in a variety of consumer electronic products, including cellular telephones, portable computers, and automobiles. In July, 1990, the company acquired battery technology from the Mead Corporation for approximately $2 million.FN1 Wishing to convert lithium polymer battery technology into lightweight, energy-efficient batteries, the company began research and development of battery prototypes based on Mead's technology.FN2 The company issued three public offerings. It made its initial public offering in May 1992, and made additional stock offerings in November, 1992 and December, 1993. The offering materials for each public offering included a prospectus, containing an extensive discussion of the risks Valence posed to investors.FN3 Prior to these public offerings, the

primary Valence shareholders were Dawson, who founded the company in 1989,FN4 and Carl Berg, who contributed significantly to the initial investment. Montgomery Securities (“Montgomery”) acted as the underwriter for Valence's initial public offering in May 1992 and for a common stock offering in November 1992. Montgomery and Alex. Brown & Sons Incorporated (“Alex. Brown”) were the co-lead underwriters of Valence's December 1993 common stock offering. Research analysts employed by Montgomery issued reports regarding Valence, three of which are referenced in plaintiffs' complaint. Valence was never able to create a commercially viable battery. Plaintiffs allege defendants slowly released this information to the public so as to avoid a sudden drop in stock prices. For example, on May 3, 1994, Valence announced that it was unable to satisfy Motorola's product specifications and stated that the company did not know when or if it would be able to satisfy the terms of the highly publicized $100 million supply contract. Following this announcement, the price of Valence stock dropped 50% to close at $5.25 per share. On June 16, 1994, Valence announced that it was unable to manufacture batteries that met the product specifications of the much heralded $35 million Hewlett-Packard contract -- a contract Valence had entered into five months earlier. Valence's stock plunged an additional 36% to close at $3.81. On August 9, 1994, Valence announced it was abandoning its goal of manufacturing batteries utilizing the lithium metal anode technology altogether. *2 Plaintiffs allege the defendants, along with the underwriters, committed fraud-on-the-market by misrepresenting to the investing public the true nature of the battery's development and commercial viability. Plaintiffs claim defendants knew at all times commercial mass production and usage of the batt ery product was an illusion; yet decided to defraud investors so as to profit in the millions through insider sales and commission. Plaintiffs note how Valence's stock, which at one point traded as high as $25.00 per share, now trades in the $3.00 range.FN5 Further, plaintiffs claim, throughout the Class Period, insiders sold their shares while the prices were improperly inflated in order to recoup their investment and simultaneously turn a profit. Plaintiffs' allege securities fraud claims against




Valence Technology, Inc.; Christine A. Russell, Chief Financial Officer; Dale R. Shackle, Vice President and Chief Technical Officer; David M. Butte, Vice President, Marketing; William J. Muscidae, Vice President, Operations; Calvin L. Reed, who was Chairman of the Board of Directors, Chief Executive Officer, and Chief Operating Officer at various times; and Carl E. Berg, who helped found Valence and was a member of the Board of Directors since September, 1991 (collectively “Valence defendants”); the underwriters Montgomery and Alex. Brown (collectively the “underwriters”), as well as Lev M. Dawson, founder and Chief Executive Officer until April, 1993, Chairman of the Board of Directors until October, 1993; and Alan F. Shugart, outside director since March, 1992 (“individual defendants”). FN6 ,FN7 In essence, all of the defendants argue the complaint should be dismissed because (1) the “bespeaks caution” doctrine adopted by this court and the Ninth Circuit mandates dismissal when extensive and specific risk factor disclosures exist in the prospectuses or related documents and neutralize any possible misrepresentations, see In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994) (“WOW”); (2) securities laws did not require Valence to predict failure or disparage its research and development efforts through continuous disclosures; (3) plaintiffs fail to plead the circumstances constituting fraud with the particularity required by the Ninth Circuit; (4) Valence's risk disclosures and the defendants' substantial investment time, effort, and money in developing the battery technology negate any inference of scienter; (5) most of the challenged statements are either vague statements of optimism, which are not actionable; and (6) plaintiffs fail to plead a claim under Section 12(2) of the Securities Act of 1933.

III. LEGAL STANDARD

A. Rule 12(b)(6) Motion A complaint should not be dismissed under Fed. R. Civ. P. 12(b)(6) “unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Wool v. Tandem Computers Inc., 818 F.2d 1433, 1439 (9th Cir. 1987). *3 A complaint may be dismissed as a matter of law

for two reasons: (1) lack of a cognizable legal theory or (2) insufficient facts under a cognizable theory. Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 (9th Cir. 1990). Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir. 1984). When reviewing a motion to dismiss, all the allegations of material fact are taken as true and construed in the light most favorable to the non-moving party. Abramson v. Brownstein, 897 F.2d 389 (9th Cir. 1990). However, legal conclusions, deductions or opinions couched as factual allegations are not entitled to a presumption of truthfulness. Jones v. Comm. Redevelopment Agency, 733 F.2d 646 (9th Cir. 1984). When ruling on a motion to dismiss, the court may consider a variety of documents in addition to the complaint. First, the court may consider documents attached to the complaint. Durning v. First Boston, Corp., 815 F.2d 1265, 1267 (9th Cir. 1987), cert. denied, 484 U.S. 944 (1987). Second, the court may consider “documents whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the pleading.” Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir.), cert. denied, 114 S.Ct. 2704 (1994). Third, the court may review “public disclosure documents required by law to be and which actually have been filed with the SEC.” Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991), cert. denied, 112 S.Ct. 1561 (1992).

B. Rule 9(b) Requirements Allegations of fraud must satisfy the requirements of Fed.R.Civ.P. 9(b) to survive a motion to dismiss. Because § 10b-5 claims sound in fraud, they must meet the particularity requirements of Rule 9(b). Rule 9(b) provides that: In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally. The intent of Rule 9(b) is to “prevent the filing of claims merely to discover unknown wrongs.” In re GlenFed, Inc. Sec. Litig., 11 F.3d 843, 847 (9th Cir. 1993), reh'g granted, 42 F.3d 1541 (9th Cir. 1994) (citing Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985)). To satisfy Rule 9(b), securities class action plaintiffs must allege fraud with enough particularity to give




defendants notice of the specific charges against them so that defendants may respond to the charges. Kaplan v. Rose, Fed. Sec. L. Rep. (CCH) ¶ 98,422, 90,874 (9th Cir. 1994); Neubronner v. Milken, 6 F.3d 666, 671-72 (9th Cir. 1993). A complaint satisfies this standard if it states precisely the time, place, and nature of the misleading statements, misrepresentations, and specific acts of fraud. Kaplan, Fed. Sec. L. Rep. (CCH) ¶ 98,422 at 90,874; Neubronner, 6 F.3d at 672. The requirements of Rule 9(b) may be “relaxed as to matters peculiarly within the opposing party's knowledge,” if the plaintiffs cannot be expected to have personal knowledge of the facts prior to discovery. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987) (citations omitted). However, where the plaintiffs have received documentation that they could rely on in their complaint, such information may be considered when analyzing the particularity of the allegations.

IV. DISCUSSION

A. Fraud Allegations -- § 10(b) Claims *4 In analyzing the § 10(b) claims made against the various defendants, the court will look at the § 10(b) claims as they relate to the three categories of defendants. Within those three categories, the court will analyze the various types of statements that remain actionable.

1. Valence Defendants Plaintiffs' principal contention is that Valence actively concealed from its prospectuses and other public disclosures (1) the very nature of their battery product; (2) its development status; and (3) the improbability of its commercial success within any of the time frames contemplated from the very outset. The crux of plaintiffs' complaint centers on the very first paragraph of the “Prospectus Summary” of each prospectus which states: The Company has completed basic research for its batteries, has manufactured limited quantities of working prototypes and is presently developing the enhancements necessary to support commercial introduction of its products. (emphasis added). Plaintiffs argue this statement was blatantly false

when made; basic research had not been completed and Valence was never capable or close to capable of commercial production. Plaintiffs contend fundamental flaws in the battery's technology existed at the time the statement was made, including basic problems in determining the proper chemical formulation for a viable and manufacturable polymer electrolyte. Plaintiffs allege Valence misled investors to believe they had moved beyond a preliminary stage in product development (had completed basic research), and were more focusing on commercial production of the battery (available as soon as 1994). Plaintiffs claim that the omission of such information and accompanying misrepresentations misled investors into relying on these misstatements and subsequently buying improperly inflated stock. Plaintiffs' complaint extensively describes the sequence of events occurring during the twenty-seven month Class Period. Plaintiff sets out to describe how Valence was created, how the scheme operated, how the individual defendants participated in the scheme to defraud the public, including how the defendants used securities analysts and press to feed false information to public investors, and how these analysts/underwriters actively or recklessly acquiesced. The complaint then analyzes each of the prospectuses, Valence's press releases, the underwriters' analyst reports, and articles in various journals. Plaintiffs point out the allegedly false statements made in the various documents, noting how Valence either had no reasonable basis to make the statement, deliberately made the false statement, or if the statement was made by a third party, had a duty to disclose the adverse information to neutralize the misleading positive reports coming from third parties. As noted above, to satisfy Rule 9(b), plaintiffs need to state more than the statements were false when made. They must provide some specific factual support for their contentions, listing not only the content, date, and document in which the misstatement appeared, but the manner in which such representations were false and misleading. Wool, 818 F.2d at 1439.

a. Existing Adverse ConditionsFN8 *5 Plaintiffs' principal contention is that Valence misled the public by stating in their prospectuses they had completed “basic research” and were about to engage in commercial production, based on their limited manufacturing of working prototypes and




present development of the enhancements necessary to support commercial introduction of its products.FN9 Plaintiffs also contend defendants misrepresented that they were using a “solid” polymer electrolyte, as opposed to liquid polymer electrolytes. Plaintiffs claim the gel-like substance they used had the characteristics of a liquid and experienced the same capability and safety problems suffered by liquid polymer electrolytes. Thus, to tout that Valence was using a revolutionary “solid” based battery, with all the accompanying benefits, was materially misleading. While plaintiffs spend most of the complaint listing the various misstatements, plaintiffs rely on three paragraphs in their complaint to set forth how and why these assertions were false or misleading. See ¶ ¶ 62-65. ¶ 61 sets forth the following statements made in the prospectuses: [L]ithium polymer battery under development will offer a number of significant advantages over currently available rechargeable batteries including: -- Longer Operating Time: ... The Company's current prototype lithium polymer battery is capable of operating approximately four times longer on a single charge than standard NiCad [nickel-cadium] batteries of comparable weight. -- Size and Weight: ... The Company's current prototype lithium polymer battery delivers equal power from a battery that consumes approximately one-third of the volume and one-quarter of the weight of today's commonly used rechargeable batteries. --Rechargeable Characteristics: ... The Company's current prototype lithium polymer battery is capable of over 150 deep discharge cycles and over 300 partial discharge cycles, with no loss of capacity due to partial discharge and recharge. ¶ 61. ¶ 62 comments on the falsity of these statements. ¶ 62 also sets forth how Valence falsely described its batteries as containing a “flexible solid polymer electrolyte” which had reduced “weight, volume, and safety problems.” “The Company's lithium polymer technology avoids [the] risks associated with liquid electrolytes.” Plaintiffs contend Valence actually used a gel-like substance that created the same problems facing liquid electrolytes, thus, falsely represented the use of a solid. The court finds that allegations concerning existing adverse conditions and technical problems known to Valence at the time prospectuses and press releases were issued, but not disclosed to the public, are actionable.

i. basic research According to plaintiffs, to have truthfully completed basic research, Valence would have had to demonstrate: (i) a true, liquid-free solid electrolyte battery; (ii) significant and positive cycle life and safety data on actual size prototypes for the particular application; (iii) a scaleable manufacturing plan; and (iv) a competitive cost structure. ¶ 62. *6 The court finds plaintiffs have specified with enough detail why Valence's statements regarding completion of basic research may have been misleading; thus, these allegations survive a motion to dismiss. A reasonable investor could have thought basic research included these aspects, and knowledge that they had not yet been in fact performed could have materially altered one's investment decisionmaking. See Hanon v. Dataproducts, 976 F.2d 497, 504 (9th Cir. 1992).

ii. longer operating time Plaintiffs contend that defendants failed to reveal that its prototype, represented by Valence as capable of operating four times longer on a single charge than a NiCad battery, was, in fact, a miniature, incomplete, undersized laboratory battery, designed and tested in Valence's laboratory at a low discharge rate, inadequate for the majority of Valence's targeted markets, and could not be converted into a mass-produced battery acceptable by Valence customers. ¶ 62. Once again, the court finds plaintiffs have specified with enough detail to survive a motion to dismiss how defendants' statements regarding longer operating time could be misleading, or that the omission of this information could have materially persuaded a reasonable investor's decision.

iii. size and weight Plaintiffs contend defendants overstate and misrepresent the actual performance and energy density characteristics of batteries which could be feasibly manufactured given the state of Valence's technology. Plaintiffs allege the prototype used was a miniature, incomplete, undersized laboratory battery that was unlikely to meet requirements in power output, cycle life, safety, environmental impact, and




cost. Plaintiffs claim if the battery were to work at all, the battery would have only a 2-to-1 advantage in weight and a 1.5-to-2 times advantage in volume, not one-third the volume and one-quarter the weight touted by Valence. The court finds plaintiffs adequately specify how these statements could be misleading.

iv. recharge characteristics Plaintiffs contend defendants failed to reveal that the prototype which purportedly was capable of 150 to 300 discharges, was specifically optimized in Valence's laboratory for the primary purpose of maximizing recharging criteria without regard to other factors such as weight and energy density. ¶ 62. Defendants allegedly failed to disclose that the prototype (1) could not lead to the mass production of a battery which Valence customers would accept for commercial use in any electronic or other application and (2) was capable of only 100 or so discharge-recharge cycles, far below current NiCad technology. The court finds omission of such technical problems, if true, could be actionable, at least to survive a motion to dismiss. See Hanon, 976 F.2d at 501 (finding issue of fact as to whether statements in first quarter report praising the Dataproducts' printer were false and misleading because they were made when Dataproducts knew the printer had severe technical problems).

v. solid vs. gel *7 Plaintiffs contend Valence falsely labelled the battery as composed of a “solid” polymer electrolyte, when it was actually a jelly-like substance which faces the same leakage and safety problems as a liquid electrolyte. ¶ 62. Plaintiffs contend Valence failed to disclose that all attempts to utilize a truly solid electrolyte which would provide suitable ion transfer at room temperature had failed. In addition, ¶ 63 states how Ralph Brodd, Valence's then marketing director, falsely distinguished Valence's “solid” lithium battery from other organic lithium polymers, the latter of which can leak and even explode or catch fire if punctured. Plaintiffs claim the Valence battery contained the same organic lithiums, with the same mechanical and chemical instability. The court finds plaintiffs' allegations of falsity in

disclosing the medium of the substance, i.e., solid v. gel or liquid, are specific enough to satisfy Rule 9(b). Determination of the true state of the substance, and whether such labelling was false or misleading, in order to find a supportable cause of action, is better left for summary judgment or determination by a trier of fact. The next step is to determine if plaintiffs' allegations of existing adverse conditions are actionable under 10(b). Section 10(b)-5, 17 C.F.R. § 240.10b-5, enacted pursuant to Section 10(b) of the Securities Act of 1934, makes it unlawful “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” To successfully allege securities fraud under § 10(b)-5, plaintiffs must allege reliance on a material misstatement, and scienter. See Hanon v. Dataproducts Corp., 976 F.2d 497, 506-07 (9th Cir. 1992). Plaintiffs allege reliance using the fraud-on-the-market theory. “In the usual claim under Section 10(b), the plaintiff must show individual reliance on a material misstatement. Under the fraud on the market theory, the plaintiff has the benefit of a presumption that he has indirectly relied on the alleged misstatement, by relying on the integrity of the stock price established by the market.” In re Apple Computer Securities Litigation, 886 F.2d 1109, 1113-14 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990). To prevail in a fraud on the market case, “the plaintiff must demonstrate that a particular statement, when read in light of all the information then available to the market, or a failure to disclose particular information, conveyed a false or misleading impression.” In re Convergent Tech. Sec. Lit., 948 F.2d 507, 512 (9th Cir. 1991). Defendants may respond to a claim of fraud-on-the-market by asserting that the information allegedly withheld from the market had in fact entered the market. Apple, 886 F.2d at 1114. The court finds plaintiffs have adequately pled reliance on the alleged misstatements. The complaint states plaintiffs allegedly purchased stock in reliance on the misstatements and were subsequently damaged when the stock prices, at one time improperly inflated, dropped in value dramatically. Given the presumption accompanying the fraud-on-the-market theory, plaintiffs' allegations demonstrate reliance to survive a motion to dismiss.




*8 To establish § 10(b)-5 liability, plaintiffs must also show that the defendants acted with scienter, that is “a mental state embracing intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), reh'g denied, 425 U.S. 986 (1976). To establish scienter, the Ninth Circuit requires a showing of either an actual intent do defraud or “a recklessness that is only one step down from intent.” Kaplan v. Rose, Fed. Sec. L. Rep. (CCH) ¶ 98,422 (citing Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990), cert. denied, 499 U.S. 976 (1991). Scienter is defined as an intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. at 193-94 n.12; In re GlenFed, 11 F.3d at 847. To satisfy this definition, a complaint must allege facts showing conduct “involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or seller that is either known to the defendant or is so obvious that the actor must have been aware of it.” Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc), cert. denied, 499 U.S. 976 (1991) (citations omitted). In general, Rule 9(b) allows scienter to be pled generally. While some courts have required the facts pled support a strong inference of fraudulent intent, see O'Brien v. National Property Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991), the Ninth Circuit has refused expressly to adopt this stricter standard as it relates to scienter. See GlenFed, 42 F.3d at 1545. The Valence defendants contend certain facts present in this case negate plaintiffs' allegations of scienter. Specifically, defendants claim any inference of scienter is negated by substantial risk disclosures, defendants' “extraordinary” effort to develop the battery, which included devoting substantial amounts of time and money on the company, and stock sales, which do not show insiders selling their stock irregularly. The court is unpersuaded by defendants' arguments. Any company bent on defrauding the public could purposely inject their prospectuses with risk disclosures to shield themselves from future liability. Further, devotion of time and resources may help negate an inference of scienter for purposes of summary judgment or determination by a trier of fact, but it does not dismiss the claim in its entirety at this stage in the litigation. Plaintiffs may aver scienter generally, which they have successfully done.FN10 Because the court also finds plaintiffs adequately plead reliance on alleged misstatements, the

allegations of fraud, based on existing adverse conditions, also survive a motion to dismiss based on § 10(b) of the Securities Act as against Valence defendants.

b. Statements of General Optimism and Puffery The Valence defendants assert several of plaintiff's allegations listed in the complaint represent general and vague expressions of optimism that are mere puffery and, thus, not actionable under the securities laws. Alfus v. Pyramid Tech. Corp., 745 F.Supp. 1511, 1519 (N.D.Cal. 1990). *9 Statements of belief and optimism, like projections, may be actionable under federal securities law. Apple, 886 F.2d at 1113; Hanon, 976 F.2d at 501; In re Verifone, 11 F.3d 865, 870 (9th Cir. 1993). Numerous courts have held, however, that general statements of optimism about the future and “puffing” about the company or product are not actionable. In re Syntax Corp. Sec. Litig., 855 F.Supp. 1086, 1095 (N.D.Cal. 1994); Alfus v. Pyramid Tech. Corp., 745 F.Supp. 1511, 1519 (N.D.Cal. 1990); Raab v. General Physics Corp., 4 F.3d 286, 289-90 (4th Cir. 1993). “Professional investors, and most amateur investors as well, know how to devalue the optimism of corporate executives, who have a personal stake in the future success of the Company.” In re Verifone Sec. Litig., 784 F.Supp. 1471, 1481 (N.D.Cal. 1992), aff'd, 11 F.3d 865 (9th Cir. 1993) (citing Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 515 (7th Cir. 1989)). A projection or statement of belief may be actionable where one of three implied factual assertions is inaccurate: “‘(1) that the statement is genuinely believed, (2) that there is a reasonable basis for that belief, and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement.”’ Hanon, 976 F.2d at 501 (quoting Apple, 886 F.2d at 1113). As noted, defendants assert many of the alleged fraudulent statements asserted by plaintiffs are merely vague statements of corporate optimism and are not actionable. Further, they claim plaintiffs fail to plead sufficient facts demonstrating defendants did not genuinely and reasonably believe their statements of general optimism when they were made, or that they were aware of specific undisclosed facts that undermined the accuracy of such statements. Some of the statements include: ¶ 66 -- “We are very excited about the tremendous




potential for lithium polymer batteries ... We believe the superior performance characteristics of these batteries will make them a strong competitive alternative to existing and emerging technologies in a number of additional markets including personal computers, portable telephones, camcorders, and portable electronic entertainment products.” ¶ 72 -- “We are very excited about the tremendous potential for lithium polymer batteries.” ¶ 75 -- “The significance of a business partner like Motorola can't be overestimated. One of the world's largest consumers of rechargeable batteries, Motorola provides Valence with an extraordinary opportunity to quickly gain acceptance for its products in this important portable electronics market.” ¶ 78 -- [in response to a negative Forbes article], “Sour grapes ... They don't know when I started, and they don't know where I am ... Our process is easier to manufacture than theirs. They can believe what they want.” ¶ 79 -- “We are loyal to our cause and excited about our prospects. As you know the market offers a tremendous opportunity and we believe our technology is superior.” *10 ¶ 83 -- “I think Valence has gotten off to an excellent beginning during its formative stages.” ¶ 103 -- “This agreement provides us with the opportunity to apply our technology in another market.” The court finds ¶ 66, ¶ 75, ¶ 78, and ¶ 83 are actionable in that, when taking plaintiffs' allegations as true that defendants were aware of serious technical difficulties, the speaker was aware of undisclosed facts tending to seriously undermine the accuracy of these statements. The court finds the remaining statements ¶ 72, ¶ 79, and ¶ 103, even taking plaintiffs' allegations as true, are too vague and merely demonstrate general optimism; thus, are not actionable. These statements relate more to Valence's long-term prospects than current position. Accepting plaintiff's allegation that basic research had not been completed when the statements were released, defendants could have genuinely believed that their battery would one day be commercially viable. Certainly enough research could have been done so as not to seriously undermine the accuracy of these optimistic statements, whether forward-looking or not. See Apple, 886 F.2d at 113. Further, a reasonable investor could devalue the optimism ringing in each of these statements. Accordingly, these statements of optimism are not actionable under § 10(b) 5, and the

claims related to them are dismissed without leave to amend. In re Caere Corporate Sec. Litig., 837 F.Supp. 1054, 1058 (N.D.Cal. 1993).

c. Group Published Information In the Ninth Circuit, allegations of securities fraud based on claims of allegedly false and misleading statements in “prospectuses, registration statements, annual reports, press releases, or other ‘group published information”’ may rely on a presumption that these statements are the collective work of those individuals within the company with direct involvement in the day-to-day affairs of the company. Wool, 818 F.2d at 1440. Under the group pleading presumption, plaintiffs may satisfy the specificity requirements of Rule 9(b) by pleading the alleged misrepresentations with particularity and indicating the roles of individual defendants in the alleged misrepresentations where possible. Id. The Valence defendants apparently concede group pleading applies to statements made in the prospectuses and press releases, but contest its application to analyst reports and articles published by third parties. To hold corporate defendants liable for the statements of third party analysts, plaintiffs must allege facts suggesting that the corporation “sufficiently entangled itself with the analysts' forecasts to render those productions ‘attributable to it.”’ Elkind v. Myers, Inc., 635 F.2d 156, 163 (2d Cir. 1980). Courts in this district have held that in order to plead entanglement with the specificity required by Rule 9(b), plaintiffs must identify at least the time, place, and nature of the alleged entanglement activity. See e.g., In re VeriFone, 784 F.Supp. at 1487. Specifically, plaintiffs must (1) identify specific forecasts and the insider who adopted them; (2) point to specific interactions between the insider and the analyst which gave rise to the entanglement; and (3) state the dates on which the acts which allegedly gave rise to the entanglement occurred. Caere, 837 F.Supp. at 1059. It is not sufficient to allege that defendants provided analysts with the information on which the analysts' reports were based. Plaintiffs must also allege that defendants had some measure of control over the content of their final report or projection issued by the analysts. Caere, 837 F.Supp. at 1059; VeriFone, 784 F.Supp. at 1486; In re Software Publishing Sec. Litig., Fed.Sec.L.Rep. (CCH) ¶ 98,094, 98,762 (N.D.Cal. 1994); In re Syntax Corp., 855 F.Supp. at 1097. Accordingly,




corporate defendants can only be held responsible for analysts' reports where the defendants have had some opportunity to review and correct the reports, or otherwise placed their imprimatur on the report. Alfus v. Pyramid Tech. Corp., 764 F.Supp. 598, 603 (N.D.Cal. 1991) (Alfus II). *11 Plaintiffs allege the analysts, relied in substantial part upon information provided by and statements and reports made publicly by the company, information provided privately to them by the Company, and assurances by the company that information in the analysts' reports was not at material variance from the Company's internal knowledge of its operations and prospects. ¶ 53. Plaintiffs also allege defendants communicated regularly with analysts via conference calls, meetings, and analyst briefings. ¶ 54. Plaintiffs also state copies of drafts of the whole or parts of these reports were provided to Valence and its top officers before they were released. The drafts were allegedly reviewed and approved by them. ¶ 56. Plaintiffs finally claim Valence endorsed these reports by allowing them to be published. ¶ 56. The court finds plaintiffs adequately plead defendants' entanglement with the analyst reports to survive a motion to dismiss. The court finds plaintiffs stated facts with sufficient particularity to show both how the Valence defendants adopted the reports and why the Valence defendants could have had no reasonable basis to believe the projections could come true. See In re Verifone, 784 F.Supp. at 1487. Unlike the plaintiffs in Caere, the plaintiffs here already set forth the nature of the fraud, demonstrating how the Valence defendants lacked a reasonable basis to believe the third party projections could come true. See Caere, 837 F.Supp. at 1058-59. For the same reasons, the court also finds plaintiffs' allegations that defendants failed to correct certain statements or forecasts made in articles are actionable. See ¶ ¶ 68-71, 74, 77, 78, 86-89, 91. While Valence was not responsible for policing the published statements of third-parties, see Elkind, 635 F.2d at 162, plaintiffs' allegations suffice to show how Valence adopted the statements,FN11 lacked a reasonable basis to believe the projections, and may have had a duty to correct these statements. See Alfus, 764 F.Supp. 598, 603 (N.D.Cal. 1988).

2. The Underwriters

a. Analysts Reports In order to state a 10(b) claim against Montgomery and Alex. Brown for their analyst reports, plaintiffs must plead specific facts showing that at the time of publication “one of three implied factual assertions is inaccurate: ‘(1) that the statement is genuinely believed, (2) that there is a reasonable basis for that belief, and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement,”’ Hanon, 976 F.2d at 501, or otherwise allege some actual participation in the fraud. In re Xoma Corp. Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶ 96,491, at 92,161 (N.D.Cal. 1994). Defendants contend plaintiffs' generic allegations are insufficient to meet the requirement of particularity. The court notes plaintiffs fail to set forth why Montgomery, not Valence, lacked a reasonable basis for the projections in its May 28, 1992 report. And, regarding its March 1, 1993 report, the complaint only sets out conclusory allegations that “Montgomery could not and did not have a reasonable basis for forecasting such earnings given the actual state of Valence's technology.” ¶ 82. The same holds true for the September 8, 1993 Montgomery report. ¶ 88. *12 As to Alex. Brown, plaintiffs do not point with any specificity to a misleading statement in their report and the reasons why they lacked a reasonable basis to make the projection at the time it was made. ¶ 104 quotes a brief passage from a January 26, 1994 report, which projected long-term profitability for Valence. There is no mention of Alex. Brown's January 19, 1994 report. See ¶ 101. With regard to both underwriters, plaintiffs must produce more than conclusory claims. See ¶ 70, 82, 88, 93. If anything, plaintiffs' complaint supports Montgomery's defense that Montgomery could have had a reasonable basis for their projections, since they relied on Valence, who, according to the complaint, “intentionally and recklessly misled securities analysts as part of the plan and scheme to inflate artificially the market price of Valence's common stock.” ¶ 54. The complaint also states, In writing their reports about Valence, these analysts relied in substantial part upon information provided by ... the Company, and assurances by the Company that information in the analysts' reports was not at material variance from the Company's internal knowledge of its operations and prospects.




¶ 53. It does not necessarily follow that because Valence knew all along of insurmountable technological problems, Montgomery was aware of and participated in the fraud. See In re Verifone, 784 F. Supp. at 1491. Plaintiffs allege, however, that the underwriters failed in their due diligence efforts to either discover the problems or they discovered them and chose to disregard them. ¶ 6, ¶ 46. The court finds these paragraphs constitute conclusory allegations and lack the necessary specificity to satisfy Rule 9(b). Accordingly, the underwriters' motions to dismiss based on allegations of fraud are granted. Plaintiffs are granted thirty (30) days leave to amend their complaint to better specify why the underwriters lacked a reasonable basis for statements made in the reports, or otherwise issued the reports in bad faith, thus, showing active participation in fraud.

b. Roadshows The court finds plaintiffs' allegations against the underwriters as it relates to the roadshows also fail to satisfy Rule 9(b) specificity. Nowhere in the complaint do plaintiffs mention the time, place, date, or individual who made the misstatement during the roadshows. Plaintiffs also fail to allege with specificity the exact misstatement. Accordingly, plaintiffs allegations of fraud against the underwriters based on roadshows are dismissed. Plaintiffs are granted thirty days (30) leave to amend their complaint.

3. Individual Defendants

a. Lev Dawson While Dawson was the founder and initial director of Valence, in April of 1993, Dawson became an outside director of Valence. In October of 1993, Dawson severed all ties with Valence, save $1.5 million in stock. Dawson apparently concedes he is liable under the group pleading doctrine for statements made prior to April, 1993, but moves the court to dismiss him from any liability for statements made post-April, 1993. Plaintiffs argue Dawson is liable for statements made during the entire 27-month class period under the group pleading doctrine. *13 Plaintiffs contend Dawson still falls under the

group pleading doctrine when he was an outside director and shareholder because of the “special relationship” that existed due to Dawson's participation in drafting the documents containing alleged misrepresentations. ¶ 121; In re Ross Sys. Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶ 98,363 at 90,496 (N.D.Cal. 1994). The court finds that because Dawson was the CEO for the first four years of the company's existence, and because plaintiffs sufficiently allege Dawson's active participation in drafting some of the documents that contained misstatements, facts could be presented to demonstrate a special relationship between Dawson and Valence even when he was an outside director or significant shareholder. Accordingly, plaintiffs' claim of fraud against Dawson post-April, 1993 survive a motion to dismiss. Plaintiff will have to present evidence, however, of this special relationship to survive summary judgment. Moreover, because the court finds that plaintiffs have sufficiently linked the analysts reports to the Valence defendants, the reports are also subject to the group pleading doctrine as they relate to Dawson. See In re RasterOps Corp. Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶ 98,467 at 91,194 (N.D.Cal. 1994). Dawson also moves the court to dismiss specific statements made by Dawson. See ¶ ¶ 66, 67, 70, 72, 75, 78, 79.FN12 With regard to ¶ 66, ¶ 75, and ¶ 78, the court finds the statements contained therein actionable against Dawson. See discussion supra. ¶ 72 and ¶ 79 are too vague to be relied on by a reasonable investor; thus, are not actionable. ¶ 67 (“shipments are expected to begin in August ... test models of electrified Cadillac Allantes could hit the road next year”) is actionable as it involves specific forecasts the accuracy of which could be undermined given the existence of undisclosed, adverse conditions. ¶ 70 does not connect a misstatement to Dawson specifically, but is actionable under the group pleading doctrine.

b. Alan Shugart Shugart moves to dismiss all § 10(b) claims raised against him. Shugart argues plaintiffs fail to satisfy Rule 9(b) in that their only allegations directed at Shugart are that he was an outside director, on a committee, and that in his capacity as a director he signed three Registration Statements. Shugart claims these facts alone do not invoke the group pleading doctrine. The court disagrees.




While the court may not be satisfied with plaintiffs' allegations if they only mentioned Shugart's position as an outside director and member of the company's audit and compensation committees, plaintiff highlights Shugart's role in signing all three Registration Statements in conjunction with the prospectuses. FN13 The court finds the above facts, considered altogether, give rise to plaintiffs' ability to discover facts demonstrating a “special relationship” between Shugart and Valence. Thus, the court finds plaintiffs satisfy the group pleading doctrine as it relates to Shugart and their fraud claims against Shugart are actionable at this stage in the proceedings.

c. Carl Berg *14 Carl Berg requests the court to dismiss all claims against him. The court finds for the same reasons Shugart's motion to dismiss is denied, Berg's motion to dismiss is also denied.

4. The “Bespeaks Caution” Doctrine All defendants argue that under the “bespeaks caution” doctrine, the extensive and specific risk factor disclosures in the prospectuses, as well as analyst reports, rebut any claim that the disclosures were false or misleading. In In re Worlds of Wonder Sec. Lit., 35 F.3d 1407 (9th Cir. 1994) (“WOW”), the Ninth Circuit expressly adopted the “bespeaks caution” doctrine in securities fraud litigation. As this court and the Ninth Circuit held, the bespeaks caution doctrine presumes that a challenged disclosure is not misleading: ... [t]he doctrine holds that where a prospectus contains adequate cautionary language disclosing specific risks, no reasonable inference can be drawn that a statement regarding those risks was misleading. Id. at 1413 (quoting WOW, 814 F.Supp. 850, 859 (N.D.Cal. 1993) (Conti, J.)). Under the “bespeaks caution” doctrine, as adopted in this circuit:... economic projections, estimates of future performance, and similar optimistic statements in a prospectus are not actionable when precise cautionary language elsewhere in the document adequately discloses the risks involved. It does not matter if the optimistic statements are later found to have been inaccurate or based on erroneous assumptions when made, provided that the risk disclosure was conspicuous, specific, and adequately

disclosed the assumptions upon which the optimistic language was based. Id. (quoting 814 F.Supp. at 858). Further, the doctrine precludes efforts to bicker over cautionary disclosures or attack isolated statements taken out of context. As the Ninth Circuit stated, “[t]he doctrine reflects the unremarkable proposition that statements must be analyzed in context.” Id. at 1414 (quoting Rubenstein v. Collins, 20 F.3d 160, 167 (5th Cir. 1994)). While WOW was decided at summary judgment, the Ninth Circuit recognized that the bespeaks caution doctrine could be applied at the pleading stage: [t]he bespeaks caution doctrine provides a mechanism by which a court can rule as a matter of law (typically in a motion to dismiss for failure to state a cause of action or a motion for summary judgment) that defendants' forward-looking representations contained enough cautionary language or risk disclosure to protect the defendant against claims of securities fraud. Id. at 1413 (quoting Donald C. Langevoort, Disclosures that “Bespeaks Caution”, 49 Bus. Law. 481, 482-83 (1994) (emphasis added). The bespeaks caution doctrine says in essence that if possibly misleading statements are accompanied by cautionary language addressing the particular misleading fact, then the cautionary language neutralizes any detrimental effect the possibly misleading statement could have on the investor. In In re Donald Trump Casino Securities Lit., 7 F.3d 357, 372 (3d. Cir. 1993), cert. denied, 114 S.Ct. 1219 (1994), the district court addressed the applicability of the bespeaks caution doctrine at the motion to dismiss stage. The court turned to the Supreme Court's language in Virginia Bankshares, Inc. v. Sandberg, 111 S.Ct. 2749 (1991), which stated “not every mixture with the true will neutralize the deceptive. If it would take a financial analyst to spot the tension between the one and the other, whatever is misleading will remain materially so, and liability should follow.” Id. at 2760. The Third Circuit noted how this notion comported with the general principle of the bespeaks caution doctrine, *15 because it merely underscores that when the subject of a misrepresentation or omission is such that the accompanying language does not diminish the importance of the misrepresentation or omission to the investor, the misrepresentation or omission remains actionable. In a word, a misrepresentation or omission is actionable when materially misleading.




In re Donald Trump, 7 F.3d at 373. The court went on to note that materiality involves a context-specific analysis such that warnings and cautionary language will sometimes suffice to render the allegedly misleading misrepresentation or omission immaterial as a matter of law. But if a reasonable investor would not offset the misleading effect with the accompanying cautionary statement, then the bespeaks caution doctrine is unavailable as a defense. Thus, the court must look to see if the cautionary language negated the potentially misleading effect of such statements as basic research had been completed and a solid polymer electrolyte was used. If we find no reasonable juror could conclude that the subject projection materially influenced a reasonable investor, then a motion to dismiss is proper because plaintiff has failed to state a claim. Id. Defendants contend that their prospectuses and accompanying risk disclosures put investors on immediate notice that Valence was a high risk investment, and that there were no assurances a commercially viable battery could be produced. In particular, the prospectuses disclosed that: -- Valence was a “development stage company” with only a “prototype” battery; -- The Company had lost money since its inception and expected to incur substantial operating losses for at least the next several years; -- To achieve profitability, Valence would have to develop, manufacture and market its battery products, and there was no assurance that any battery product could be developed or manufactured at an acceptable cost; -- Significant work remained to be undertaken to refine the Company's lithium polymer battery technology and to configure batteries to meet commercial requirements. -- There could be no assurances that any such products would be successfully developed, meet applicable regulatory standards, be capable of being produced in commercial quantities at acceptable costs or be successfully marketed; -- There was no assurance that Valence's batteries would gain market acceptance; a number of companies with substantially greater resources were developing competing battery technologies; and the Company would have to develop a sizeable sales staff, product support capabilities, and distribution channels; -- Valence would have to rely on a limited number of Original Equipment Manufacturing (“OEM”) customer relationships, which were not assured;

-- Valence would have to overcome numerous and formidable obstacles in order to manufacture commercial quantities of its lithium polymer battery, although neither Valence nor any other company had experience in manufacturing such a battery; *16 -- Valence would have substantial future capital needs, with no certainty of obtaining the necessary funding; -- There were significant product and manufacturing safety risks. Defendants argue that contrary to plaintiffs' claim, these and other disclosures in the prospectuses unmistakably informed any potential investor of the obstacles to the development of the battery, the company's sole potential product. Plaintiffs respond that defendants' “risk factors” fail to bespeak caution because they did not alert investors to then existing adverse conditions regarding battery development. According to plaintiffs, defendants' reliance on the “bespeaks caution” doctrine is misplaced because the misrepresentations and omissions concern adverse conditions already present and contemporaneously known to defendants, which were purposely and wrongfully withheld from the public, as opposed to forward-looking projections. The court finds plaintiffs' principal allegations concern existing misrepresentations, not forward-looking misrepresentations, thus, the “bespeaks caution” doctrine is inappropriate at this stage of the litigation. If, after discovery is completed, plaintiffs cannot present enough evidence of misstatements regarding existing adverse information to either state a claim or create an issue of fact, and may only rely on forward-looking information not already dismissed based on puffery, see supra, then the “bespeaks caution” doctrine may require dismissal of plaintiffs' action in its entirety.FN14

B. § 15 and § 20 Claims Sections 15 and 20 impose liability upon persons who control corporations committing violations of federal securities law. See 15 U.S.C. § 77o; 15 U.S.C. § 78t(a). “The purpose of these sections is to impose liability on persons who might attempt to evade liability under common law principles utilizing “dummies” that would act in their place and under their control.” WOW, 694 F.Supp. 1427, 1435 (N.D.Cal. 1988).




Plaintiffs assert § 20(a) liability against defendants Dawson, Berg, Reed, and Shugart. Plaintiffs assert § 15 liability against defendants Dawson, Berg, Reed, Shugart, and Russell. Generally a director or officer is not automatically liable as a controlling person. Burgess v. Premier Corp., 727 F.2d 826, 832 (9th Cir. 1984). “There must be some showing of actual participation in the corporation's operation or some influence before the consequences of control may be imposed.” Id. The director or officer does not have to be intimately involved with the day-to-day operations of the company; they do, however, have to exert some control over the company or participate in the corporations' operations. In re Xoma, Fed. Sec. L. Rep. (CCH) ¶ 96,491, at 92,163. The status of an alleged controlling person is insufficient by itself to state a claim of power or culpable participation. “Where there is an allegation, however, of influence or actual participation in the corporation's operation, and where the allegedly misleading statements are part of ‘group-published information’ it is reasonable to presume at the pleading stage that corporate officers and directors are ‘controlling persons.”’ WOW, 721 F.Supp. at 1148-1149; Wool, 818 F.2d at 1441 (“the issue of control is a complex question of fact requiring a close examination of the particular situation and organization ... [[[and the] test for establishing control should be construed liberally and flexibly”). *17 The court finds plaintiffs have adequately pled “controlling persons” for purposes of surviving a motion to dismiss as it relates to all the officers and directors, named in the complaint, including Shugart and Berg. Because the court finds all these defendants can fall under the group pleading doctrine at this point in the litigation, plaintiffs' complaint survives a motion to dismiss as it relates to § 15 and § 20 claims.

C. 12(2) Claims Section 12(2) imposes liability on persons who offer or sell securities by means of any prospectus containing material misrepresentations or omissions. WOW, 721 F.Supp. at 1147. The Supreme Court has defined “seller” narrowly, holding that “liability extends only to the person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owners.” Pinter v. Dahl, 486 U.S. 622, 647

(1988). Moreover, § 12(2) liability will not be imposed on participants only “collateral” to the offer or sale. Alleging that a defendant was a “substantial factor” in causing the sale is not sufficient to impose § 12(2) liability; the defendant himself must have solicited the sale in question. Pinter, 486 U.S. at 654. The court finds plaintiffs state a claim under § 12(2) as it relates to both the Valence defendants and underwriters.

1. The Underwriters Applying the Pinter standard to the underwriters, in conjunction with the standard used for a 12(b)(6) motion, the court finds a set of facts establishing the underwriters as “sellers” is clearly plausible, based on plaintiffs' allegations in the complaint. For example, ¶ 46 states Montgomery agreed to orchestrate a multi-city roadshow shortly before the initial and follow-up public offerings, during which it and Valence officials would travel to many cities to present highly favorable information about the company. See WOW, 721 F.Supp. 1140, 1148 (N.D.Cal. 1989) (finding that allegations that underwriters “orchestrated and controlled the sales and distribution process ... is sufficient at this initial pleading stage to assert § 12(2) liability over these defendants”).FN15 Plaintiffs have pled how the underwriters had a financial interest in the sales and allegedly solicited sales through reports and roadshows. See Moore v. Kayport Package Exp., Inc., 885 F.2d 531, 537 (9th Cir. 1989) (finding lawyers and accountants not liable under § 12(2) because investors failed to allege these defendants played any role in soliciting the purchases). The underwriters argue plaintiffs fail to point to any actual sales by the underwriters to a named plaintiff. While the court notes plaintiffs do not present a model pleading of a § 12(2) claim, plaintiffs do satisfy Rule 8(a)(2) which provides that a pleading which sets forth a claim for relief shall contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” Moore, 885 F.2d at 539 (finding plaintiffs adequately pled § 12(2) claim as it related to stockbrokers).

2. Valence Defendants and Individual Defendants *18 Whether the Valence defendants and individual defendants qualify as “sellers” within the meaning of § 12(2) is not so evident. In Pinter, the Court held that § 12(2) liability “extends only to the person who successfully solicits the purchase, motivated at least




in part by a desire to serve his own financial interests.” 486 U.S. at 647. Plaintiffs argue Berg, Dawson, and Shackle were identified in the complaint as selling stockholders at the November 1992 Offering, thus constitute “sellers,” and the other defendants had a financial interest either for themselves or for the company, solicited purchases, thus were “sellers.” The court finds it cannot dismiss this plaintiffs' § 12(2) claims against the Valence and individual defendants based on the complaint. Facts could be presented to demonstrate these defendants solicited the sale of Valence securities in three public offerings for their own financial interest or financial interest of Valence. See Craftmatic Sec. Litig. v. Kraftshow, 890 F.2d 628, 638 (3d Cir. 1989). For example, most defendants, save Shugart, owned stock in Valence, thus, could have had a personal financial interest. Further, Dawson, Reed, Berg, and Shugart all signed the Registration Statements. See In re Proxima Corp. Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶ 98,236 at 99,619 (S.D.Cal. 1994) (holding since the prospectus itself is a solicitation document, those individuals who signed the Registration Statement (all the directors) effectively were soliciting the public to purchase the company's stock). Lastly, as controlling persons, i.e., Dawson, Berg, Reed, Shugart, and Russell, they may be liable under § 12(2). In re Sahlen & Associates, Inc. Sec. Litig., 773 F.Supp. 342, 364 (S.D.Fla. 1991) (citing Hollinger v. Tital Capital Corp., 914 F.2d 1564, 1578 n.32 (8th Cir. 1990), cert. denied, 499 U.S. 976 (1991)) (“One may be liable for a § 12(2) violation as a ‘controlling person’ even though he himself is not a “seller” under that provision”). Plaintiffs have demonstrated defendants could be controlling persons. The court finds it cannot be said that at this point, plaintiffs can prove no facts that would entitle them to relief. Conley v. Gibson, 355 U.S. at 45-46. Thus, these claims shall remain actionable against all defendants. The court notes, however, plaintiffs' evidence will have to focus on the existence of evidence of solicitation with respect to each individual defendant.

D. Montgomery's Motion to Strike ¶ 47 Montgomery moves to strike ¶ 47, which contains statements insinuating improper conduct by Montgomery in connection with other offerings, pursuant to Fed. R. Civ. Pro. 12(f). Rule 12(f) states a court may strike from the pleading any redundant,

immaterial, impertinent or scandalous matter. The rationale behind granting motions to strike is to “avoid ... prejudice to a party by preventing a jury from seeing the offensive matter or giving the allegation any unnecessary notoriety.” 5A Charles A. Wright and Arthur R. Miller, Federal Practice and Procedure § 1382, at 715 (2d ed. 1990). Montgomery claims these allegations bear no relation to Valence and have no purpose other than to inflame the reader and damage Montgomery's reputation. Plaintiffs argue the references to other Montgomery offerings are necessary to show Montgomery's motive and intent. *19 The court finds that these allegations of past improper conduct are unnecessary and prejudicial evidence prematurely introduced. Under the Federal Rules, a complaint shall contain a “short and plain statement of the claim showing that the pleader is entitled to relief.” Rule 8(a)(2). “[P]leading evidence is not favored under the federal rules and evidentiary allegations may be stricken, particularly if ... prejudicial.” Wright & Miller, § 1383 at 720-21. Moreover, as this court already noted, under GlenFed, scienter (i.e., motive and intent), may be pled generally. Plaintiffs have pled scienter generally. The court sees no reason why such prejudicial evidence should be inserted at the pleading stage. Plaintiffs may bring forth specific evidence of motive and intent at the summary judgment stage. Accordingly, Montgomery's motion to strike ¶ 47 is granted.

V. CONCLUSION For the foregoing reasons, the court finds that (1) the Valence defendants' motion to dismiss is GRANTED in part, DENIED in part. (2) Montgomery and Alex. Brown' motions to dismiss are GRANTED in part, DENIED in part. The underwriters' motions to dismiss the § 10(b) claims is GRANTED, with the court granting plaintiffs thirty (30) days leave to amend the complaint. The underwriters' motion to dismiss the § 12(2) claims is DENIED. (3) Alan Shugart's motion to dismiss is GRANTED in part, DENIED in part. (4) Carl Berg's joinder in the above motions to dismiss is GRANTED in part, DENIED in part.




(5) Montgomery's motion to strike ¶ 47 is GRANTED. IT IS SO ORDERED.

FN1. Mead had allegedly invested $10 million in attempting to develop a technology aimed at overcoming the significant safety and cycle life problems associated with pairing the highly reactive and potentially explosive metal lithium with a solid polymer electrolyte to make a plastic sheet-like battery. ¶ 36.

FN2. The acquisition agreement with Mead included a provision that if Valence was unable to commercially introduce its lithium-based rechargeable battery by January 1, 1997, Mead could terminate the agreement and rights granted thereunder would revert to Mead.

FN3. These risk disclosures are set forth in greater detail at infra Part IV.A.4.

FN4. The company was originally incorporated under the name Ultracell, Inc.. In March, 1992, the name was changed to Valence Technology, Inc.

FN5. Valence has since abandoned its efforts to create this solid polymer lithium-based battery, refocusing its research and development efforts on different technology.

FN6. Plaintiffs recently dismissed Roberts without prejudice.

FN7. Carl Berg also moves the court to dismiss all claims against him in his individual capacity.

FN8. Defendants concentrate the majority of their argument on the fact that much of the complaint simply catalogs the development and manufacturing difficulties Valence encountered; as if the mere existence of these problems constituted securities fraud. Defendants also argue plaintiffs were never misled as to the commercial capability of the prototype battery cells, given the abundance of risk disclosures. Defendants focus on the wrong

issue. The question at this stage is whether Valence withheld or misrepresented facts that a reasonable investor would have found material, thus, making the misstatements or omissions actionable. Plaintiffs allege that Valence misled investors into believing their product was at a much more advanced stage in development than Valence knew it to be. Plaintiffs also claim the very risk factors defendants claim shield them from liability are themselves misleading and false. Under a 12(b)(6) motion, the court must accept these allegations as true and instead analyze whether they are pled properly and create an actionable claim.

FN9. Nowhere in plaintiffs' papers or complaint is there adequate support for the contention that defendants knew from the company's inception that a commercially viable battery was impossible. Accordingly, plaintiffs' claims are limited to alleged misrepresentations made after Valence began research and development of its battery, and the allegation contained in ¶ 5 (“Commercial mass production was always an illusion.”) is dismissed with prejudice.

FN10. The court notes this case is distinguishable from Ross, cited by defendants. Unlike the court in Ross, this court finds plaintiffs' conclusory allegations are supported with a factual basis. See ¶ ¶ 62-65.

FN11. For example, ¶ 67 discusses a Business Journal article containing alleged misstatements that Valence later adopted as a press release.

FN12. As noted before, plaintiffs adequately plead why these statements were allegedly false when made. See ¶ ¶ 62-65, ¶ 40, and discussion supra.

FN13. The registration statement is the basic disclosure document. 15 U.S.C. § § 77f, 77g.

FN14. Because the court finds this doctrine inapplicable at this stage in the litigation, there is no need for the court at this time to address the applicability of the doctrine to the analyst reports.




FN15. The court does not find the Supreme Court's holding in Gustafson v. Alloyd Co., Inc., 115 S. Ct. 1041, (1995) requires dismissal of the underwriters for plaintiffs' § 12(2) claim. The Court in Gustafson held that § 12(2) does not apply to private placement transactions. Here, plaintiffs base their claims on sales arising out of three separate public offerings based on misleading prospectuses. Accordingly, Gustafson is distinguishable and has no effect on this court's holding.

N.D.Cal. 1995 In re Valence Technology Securities Litigation Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793 END OF DOCUMENT





United States District Court, N.D. California. In re VALENCE TECHNOLOGY SECURITIES

LITIGATION. No. C 95-20459 JW.

Jan. 23, 1996.

Joseph J. Tobacco, Jr., Jeffrey W. Lawrence, Berman, DeValerio, Pease & Tobacco, San Francisco, CA, William S. Lerach, Patrick J. Coughlin, Milberg Weiss Bershad Hynes & Lerach, San Diego, CA, and Reed R. Kathrein, San Francisco, CA, for Plaintiffs. Tower C. Snow and James A. Lico, Brobeck, Phleger & Harrison, San Francisco, CA, for Defendant Lev M. Dawson. Robert P. Feldman, Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA, for Defendants Valence Technology, Inc., Christine Russell, Dale R. Shackle, David M. Butze, William J. Masuda, Calvin L. Reed and Carl E. Berg. Melvin R. Goldman, Paul T. Friedman, and Robert W. Orlowsky, Morrison & Foerster, San Francisco, CA, for Defendant Montgomery Securities.

ORDER GRANTING DEFENDANT MONTGOMERY SECURITIES' MOTION TO DISMISS THIRD AMENDED COMPLAINT;

GRANTING DEFENDANT ALEX. BROWN & SONS, INC.'S MOTION TO DISMISS THIRD

AMENDED COMPLAINT WARE, District Judge. *1 The motion of Defendant Montgomery Securities and the motion of Defendant Alex. Brown & Sons, Incorporated to dismiss Plaintiffs' Third Amended Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6), were submitted to the Court on December 8, 1995. The court has read the moving and responding papers and considered the oral argument of counsel. Based upon all pleadings filed to date, as well as on the oral argument of counsel, the Court GRANTS Defendant Montgomery Securities' motion and GRANTS Defendant Alex. Brown & Sons' motion.

INTRODUCTION

This action is a securities class action brought on behalf of all persons who purchased the common stock of Valence Technology, Inc. between May 7, 1992 and August 10, 1994. The action was transferred from the San Francisco Division, Judge Samuel Conti, and reassigned to the San Jose Division, Judge James Ware. In their Third Amended Complaint, Plaintiffs allege (1) violations of Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 of the Securities Act of 1933 against all defendants; (2) violations of Section 20(a) of The Exchange Act against some of the individual defendants and Valence; (3) violations of Section 12(2) of the Securities Act against certain individual defendants, Valence and the underwriters, Montgomery Securities and Alex. Brown & Sons; and (4) violations of Section 15 of the Securities Act against some of the individual defendants. Defendants Montgomery Securities and Alex. Brown & Sons, Incorporated now move to dismiss with prejudice the allegations against them in Plaintiffs' Third Amended Complaint (TAC).FN1

BACKGROUND FN2 Valence is a company engaged in the research, development and production of advanced lithium polymer rechargeable batteries for use in a variety of consumer electronic products, including cellular telephones, portable computers, and automobiles. Lev Dawson founded Valence in March 1989. The company was originally incorporated under the name Ultracell, Inc. In March 1992, the name was changed to Valence Technology, Inc. In July 1990, the company acquired battery technology from the Mead Corporation for approximately $2 million. Valence then began research and development of battery prototypes based on Mead's technology. The acquisition agreement with Mead included a provision that if Valence was unable to commercially introduce its lithium-based rechargeable battery January 1, 1997, Mead could terminate the agreement and rights granted thereunder would revert to Mead. Valence wished to convert lithium polymer battery technology into lightweight, energy-efficient batteries.




Valence made its initial public offering (“IPO”) in May 1992, and made additional stock offerings in November 1992 and December 1993. Each public offering included a prospectus, which contained an extensive discussion of the risks Valence posed to investors. Before these public offerings the primary Valence shareholders were Dawson and Carl Berg, who had also contributed significantly to the initial investment. Montgomery Securities (“Montgomery”) acted as the underwriter for Valence's IPO in May 1992 and for a common stock offering in November 1992. Montgomery and Alex. Brown & Sons Incorporated (“Alex. Brown”) were the co-lead underwriters of Valence's December 1993 common stock offering. Research analysts employed by Montgomery issued reports regarding Valence. Plaintiffs reference three of these reports in their Third Amended Complaint. *2 Valence was not able to create a commercially viable battery. When this information was released to the public, Valence's stock prices dropped dramatically. Plaintiffs allege that Defendants, along with the underwriters, committed fraud on the market by misrepresenting to the investing public the true nature of the battery's development and commercial viability. Plaintiffs claim that Defendants knew at all times that commercial mass production and usage of the battery product was an illusion and yet they decided to defraud investors so as to obtain profits in the millions through insider sales and commission. Plaintiffs note that Valence's stock, which at one point traded as high as $25 per share, dropped to $3.00.FN3 Plaintiffs allege that securities fraud claims against Valence Technology, Inc. various officers and employees FN4 and the underwriters, Montgomery and Alex. Brown. The underwriters Montgomery and Alex. Brown were added as defendants in September 1994. They moved to dismiss Plaintiffs' First Amended Complaint and in May 1995, Judge Conti granted the underwriters' motions to dismiss the section 10(b) claims with leave to amend and denied the motions to dismiss the section 12(2) claims. After a motion by the underwriters to reconsider the ruling on the section 12(2) claims, Judge Conti dismissed these claims with leave to amend on September 19, 1995. While the motion for reconsideration was pending, Plaintiffs filed a second amended complaint. The hearings on the underwriters' motions to dismiss were vacated to allow Plaintiffs to file the operative Third

Amended Complaint responding to the Court's orders dismissing with leave to amend. Plaintiffs filed the Third Amended Complaint on October 19, 1995. Montgomery and Alex. Brown now move to dismiss this complaint on the grounds of failure to state a claim and for lack of particularity in pleading the fraud claim.

LEGAL STANDARDS A claim may be dismissed as a matter of law for one of two reasons: “(1) lack of a cognizable legal theory or (2) insufficient facts under a cognizable legal theory.” Robertson v. Dean Witter Reynolds, Co., 749 F.2d 530, 534 (9th Cir.1984). “A complaint cannot be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Moore v. City of Costa Mesa, 886 F.2d 260, 262 (9th Cir.1989). “[A] complaint should not be dismissed if it states a claim under any legal theory, even if the plaintiff erroneously relies on a different legal theory.” Haddock v. Board of Dental Examiners, 777 F.2d 462, 464 (9th Cir.1985). “All material allegations in the complaint are to be taken as true and construed in the light most favorable to the non-moving party.” Sanders v. Kennedy, 794 F.2d 478, 481 (9th Cir.1986); NL Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir.1986). However, the Court will not accept wholly conclusory allegations. In re VeriFone Securities Litig., 11 F.3d 865, 868 (9th Cir.1993); Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir.1981), cert. denied, 454 U.S. 1031 (1981). The Court need not accept legal conclusions asserted in the complaint even if pled as “facts.” Papasan v. Allain, 478 U.S. 265, 286 (1986). *3 When ruling on a motion to dismiss, a district court may consider certain documents. The court may consider documents attached to the complaint. “If a complaint is accompanied by attached documents, the court is not limited by the allegations contained in the complaint. These documents are part of the complaint and may be considered in determining whether the plaintiff can prove any set of facts in support of his claim. Durning v. First Boston Corp., 815 F.2d 1265, 1276 (9th Cir.1987), cert. denied, 484 U.S. 944 (1987) (citations omitted). The court may also consider “documents whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached




to the pleadings.” Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir.), cert. denied, 512 U.S. 1219, 114 S.Ct. 2704 (1994). This does not convert the motion to dismiss into a motion for summary judgment. Id. (citing Romani v. Shearson Lehman Hutton, 929 F.2d 875, 879 n. 3 (1st Cir.1991)). Finally, a district court deciding a motion to dismiss a securities fraud action “may review and consider public disclosure documents required by law to be and which actually have been filed with the SEC....” Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2nd Cir.1991), cert. denied, 503 U.S. 960, 112 S.Ct. 1561 (1992).

DISCUSSION

A. Section 12(2) Allegations Section 12(2) of the Securities Act imposes liability on sellers of securities sold “by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading....” 15 U.S.C. § 77l. Defendants Montgomery and Alex. Brown contend that Plaintiffs have failed to amend their section 12(2) claims as directed by Judge Conti after the most recent motions to dismiss. Initially, Judge Conti denied Defendants' motions to dismiss Plaintiffs' § 12(2) claims. However, the United States Supreme Court decided Gustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061 (1995), during the briefing schedule for the initial motions to dismiss in this case. After a motion for reconsideration, the Court determined that it should revisit the sufficiency of Plaintiffs' allegations as to the § 12(2) claims. See September 19, 1995 Order at 7. In the September 1995 order, Judge Conti held that “the complaint is devoid of any allegations that these named plaintiffs actually purchased stock through any of the public offerings or that their purchases were directly traceable to the public offerings. Without more specificity, plaintiffs' section 12(2) claims are not actionable.” September 19, 1995 Order at 10. The Court also determined that “the named plaintiffs have not alleged with sufficient particularity that either (1) they purchased Valence stock directly through one of the three public offerings, either on the offering date or within 90 days thereafter, or (2) a nexus exists between their

aftermarket purchase and the public offerings so as to state a claim under § 12(2).” Id. *4 Plaintiffs' third amended complaint, filed on October 20, 1995, contains no amended allegations as to thirteen of the fourteen named plaintiffs. The TAC does not allege a purchase by any of the named plaintiffs in the May 1992 IPO or the November 1992 secondary public offering. The amended allegations refer only to Plaintiff Bergelson and only to a stock purchase on December 22, 1993, the day of Valence's third offering. Defendants Montgomery and Alex. Brown thus contend that as plaintiffs have had the opportunity to amend their allegations as to the May 1992 IPO or the November 1992 secondary public offering, and have failed to do so, all claims as to those offerings should be dismissed with prejudice. The Court agrees. The Court hereby dismisses with prejudice all § 12(2) claims as to all plaintiffs other than Bergelson. As to the purchase by Bergelson, the TAC states: On December 22, 1993, plaintiff Bergelson purchased 200 shares of Valence stock on or directly traceable to the Company's secondary public offering. The purchase price of the stock was $15.25, the price the offering stock reached by the early afternoon of December 22. In connection with this purchase, Mr. Bergelson received and reviewed Valence's prospectus for the December 22 offering. Mr. Bergelson purchased this stock through the open market with the assistance of Prudential Securities, a brokerage firm which made a market for Valence stock. Third Am.Compl. ¶ 20(n). As the allegations on their face demonstrate that Plaintiff did not purchase in the Valence public offering, Plaintiffs appear to be claiming that a nexus exists between this aftermarket purchase and the public offering on December 22, 1993. However, Plaintiffs cite no authority for their proposition that § 12(2) supports liability for transactions “traceable” to a public offering. The Supreme Court has stated that “... the liability imposed by § 12(2) [ ] cannot attach unless there is an obligation to distribute the prospectus in the first place (or unless there is an exemption).” Gustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061, 1067 (1995). The purchase at issue in this case required no prospectus and no exemption applies. The Court also held that “[t]he intent of Congress and the design of the statute require that § 12(2) liability be limited to public offerings.” Id. at 1071. Cases subsequent to Gustafson have held that




section 12(2) applies only to initial public offerings. See e.g., Stack v. Lobo, 903 F.Supp. 1361, 1375 (N.D.Cal.1995). The Court is persuaded that § 12(2) applies only to a transaction which requires a prospectus to be delivered. The language in Gustafson makes irrelevant whether the transaction is “traceable” to a public offering. Accordingly, the Court hereby dismisses with prejudice Plaintiffs' § 12(2) claims as to Plaintiff Bergelson for failure to state a claim.

B. Section 10(b) Allegations Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful to: *5 directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange- ... (b) [t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest of the for protection of investors. 15 U.S.C. § 78j. Rule 10b-5, promulgated under § 10(b) provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, (1) to employ any device, scheme, or artifice to defraud, (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of circumstances under which they were made, not misleading, or (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. 17 C.F.R. § 240.10b-5 (1993). To state a claim for securities fraud, a plaintiff must allege “(1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused his injury.” McGonigle v. Combs, 968 F.2d 810, 817 (9th Cir. (1992), cert. dismissed, 506 U.S. 948, 113, S.Ct. 399 (1992); see also In re Apple Computer Sec.

Litig., 886 F.2d 1109, 1113 (9th Cir.1989), cert. denied, 496 U.S. 943 (1990). Allegations of fraud must satisfy the requirements of Federal Rule of Civil Procedure 9(b) to survive a motion to dismiss. Because Section 10b-5 claims sound in fraud, they must meet the particularity requirements of Rule 9(b), which provides: “In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other general condition of mind of a person may be averred generally.” The intent of Rule 9(b) is to “prevent the filing of claims merely to uncover unknown wrongs.” In re GlenFed Securities Litig., 11 F.3d 843, 847 (9th Cir.1993) reh'g granted, 42 F.3d 1541 (9th Cir.1994) (citing Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir.1985)). In cases of corporate fraud, the requirements of Rule 9(b) may be “relaxed as to matters peculiarly within the opposing party's knowledge” since the plaintiffs cannot be expected to have personal knowledge of the facts constituting the wrongdoing. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir.1987).

1. Montgomery

a. Analyst Reports Defendant Montgomery contends that Plaintiffs' section 10(b) claims based on allegedly misleading statements contained in three analyst reports should be dismissed because (1) plaintiffs have failed to add allegations to the TAC which plead with particularity why Montgomery allegedly lacked a reasonable basis for the statements in its analyst reports at the time they were made; (2) many of the statements are merely vague statements of optimism, which are not actionable as a matter of law; and (3) there is no authority for Plaintiffs' argument that analysts owe a duty for allegedly misleading statements in analyst reports that are not alleged to have been distributed to the public.

(1) Reasonable Basis *6 Montgomery contends that Plaintiffs have not altered their allegations with respect to the analyst reports despite Judge Conti's determination that “plaintiffs' complaint supports Montgomery's defense




that Montgomery could have had a reasonable basis for their projections, since they relied on Valence, who, according to the complaint, ‘intentionally and recklessly misled securities analysts as part of the plan and scheme to inflate artificially the market price of Valence's common stock.’ ” In re Valence Technology Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,794. To allege fraud with particularity, a plaintiff must set forth more than the neutral facts necessary to identify the transaction. The plaintiff must set forth what is false or misleading about a statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading. A plaintiff might do less and still identify the statement complained of, indeed, the plaintiff might do less and still set forth some of the circumstances of the fraud. But the plaintiff cannot do anything less and still comply with Rule 9(b)'s mandate to set forth with particularity those circumstances which constitute the fraud. In re GlenFed, Inc. Securities Litig., 42 F.3d 1541, 1548 (9th Cir.1994) (en banc). Defendant also contends that although Plaintiffs expand on their allegations about Montgomery's technical consultant, Dr. Digby Macdonald, these allegations merely state that Macdonald, as well as Montgomery relied upon Valence, and thus these allegations do not rectify the pleading deficiencies Judge Conti previously identified in his May 8, 1995 order. In re Valence Technology Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,794. In that order, Judge Conti determined that “[i]t [does] not necessarily follow that because Valence knew all along of insurmountable technological problems, Montgomery was aware of and participated in the fraud.” Id. at 92795 (citing In re VeriFone Sec. Litig., 784 F.Supp. 1471, 1481 (N.D.Cal.1992), aff'd 11 F.3d 865 (9th Cir.1993)). Judge Conti then held that although Plaintiffs alleged that the underwriters had failed in their due diligence efforts to discover the problems or chose to disregard them, that these allegations lacked the specificity required by Federal Rule of Civil Procedure 9(b). Id. at 92,795. In the TAC, Plaintiffs allege that: On or about February 24, 1992, Montgomery retained Dr. Digby Macdonald ostensibly to assist in a review of Valence's battery project and a comparison with competing battery technologies. Notwithstanding the many technical and performance aspects such a

review would entail, Montgomery gave Macdonald only four work days to complete his project.... [Macdonald admitted that] his analysis was less than satisfactory, involving only a review of technical documents primarily supplied to him directly by Valence or indirectly through Montgomery management ... Macdonald, however, was not permitted to perform any independent testing of the Valence prototypes or the competing batteries. *7 [When] Macdonald began drafting his report to Montgomery of his assessment ... he had no independent knowledge of the performance characteristics of the Valence battery nor the composition of its electrolyte, which Valence heralded as a revolutionary technological breakthrough. Third Am.Compl. ¶ ¶ 67-68. Plaintiffs allege that Macdonald communicated his concerns about the foundations for his conclusions, deleted his earlier assessment that sufficient data existed to permit a meaningful analysis of Valence's battery and competitors' technology, and cautioned Montgomery that laboratory-based evaluations were warranted. Plaintiffs also allege that Montgomery was aware of, but ignored, Macdonald's concerns and refused to give him the opportunity to conduct further laboratory-based analysis, but directed Macdonald to review the IPO prospectus for technical accuracy. Finally, Plaintiffs allege that Macdonald had another opportunity to undertake independent analysis when he visited Valence's facilities on April 11, 1992, but the testing was conducted under Valence's control. Third Am.Compl. ¶ ¶ 69-71. Montgomery argues that even if Macdonald stated that the data he was to analyze was “of unknown quality and uncertain foundation,” that Plaintiffs have not alleged that Macdonald knew that any of this data on which he based his analysis was fraudulent. Plaintiffs respond that “the Complaint's specific allegations regarding Montgomery and Alex. Brown demonstrate their own knowing or reckless disregard for the truth about Valence and their active participation in promoting false and misleading statements to the investment community.” Plaintiffs' Opposition p. 19 (emphasis in original). Plaintiffs' allegations, however, merely conclude that Montgomery and Alex. Brown were reckless. Alleging that Montgomery did not have a reasonable basis for the statements in the reports is not the same as alleging facts which show that Montgomery knew, for example, that Valence's assurances were deceptive. The Court need not accept legal conclusions asserted in the complaint even if pled as




“facts.” Papasan v. Allain, 478 U.S. 265, 286 (1986). Moreover, as in the first amended complaint, Plaintiffs continue to allege that: In writing their reports about Valence, these analysts relied in substantial part upon information provided by and statements and reports made publicly by [Valence], information provided privately to them by [Valence], and assurances by [Valence] (and in Montgomery's case, further assurances channeled through the ill-founded work of an “independent” battery consultant) that information in the analysts' reports was not at material variance from [Valence's] internal knowledge of its operations and prospects. Third Am.Compl. ¶ 53. Thus, as in the first amended complaint, Plaintiffs allege in the TAC that the analysts and underwriters relied upon Valence, which allegedly assured them that the reports were accurate. Accordingly, the Court agrees with Defendant Montgomery that Plaintiff has not cured the pleading deficiencies of the first amended complaint as they have not alleged any additional facts to show that Montgomery lacked a reasonable basis for the statements in the analyst reports or that the reports were not issued in good faith.

(2) Statements of Optimism *8 Defendant Montgomery contends that Plaintiffs cannot state a claim based on any of the portions of Montgomery analyst reports quoted in the TAC, as these passages are too vague and subjective to be actionable as a matter of law. Plaintiffs allege that three statements made by Montgomery are misleading even though they may appear to be merely general optimistic statements. Plaintiffs correctly contend that “... projections and general expressions of optimism may be actionable under the federal securities laws.” In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir.1989), cert. denied, 496 U.S. 943 (1990) (citations omitted). The Ninth Circuit continued in Apple: A projection or statement of belief contains at least three implicit factual assertions: (1) that the statement is genuinely believed, (2) that there is a reasonable basis for that belief, and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement. A projection or statement of belief is actionable to the extent that one of these implied factual assertions is inaccurate.

In re Apple, 886 F.2d at 1113 (citing Marx v. Computer Sciences Corp., 507 F.2d 485, 490 (9th Cir.1974)). The statements at issue are contained in paragraphs 64, 91 and 97. Paragraph 64 refers to a May 28, 1992 report by Montgomery which indicates that Valence has developed and is in the early manufacturing stage of the battery and that it utilizes a solid polymer electrolyte. Plaintiffs allege that statements in Paragraph 64 are false because Valence never used a solid polymer electrolyte. Plaintiff also contends that the cost of the raw materials alone exceeds the report's estimate for the entire finished battery. Paragraph 91 refers to Montgomery's March 1, 1993 report which stated that Valence's lithium polymer battery technology is the “leader” in the rechargeable battery market, that the product has the best price-performance characteristics of any technology Montgomery had reviewed, that Valence has met all investor expectations and should continue to do so. Paragraph 97 refers to a September 8, 1993 Montgomery report which states that Valence had received funding and technical validation from potential end-users of the battery and that Montgomery believed that Valence's longer-term outlook remains quite attractive. Defendants, however, contend that Plaintiffs fail to plead any facts which suggest that Montgomery did not have a reasonable basis for the statements in the reports. In fact, Plaintiffs continue to plead that the analysts relied in substantial part on information provided by Valence and that Valence assured them that “information in the analysts' reports were not at material variance from [Valence's] internal knowledge of its operations and prospects.” TAC ¶ 53. Plaintiffs were permitted to amend their complaint to specify why the underwriters lacked a reasonable basis for statements made in the report. In re Valence Technology Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,795. Since that order, Plaintiffs have filed two amendments; however, they still do not plead any facts which tend to show that the underwriters' reports lacked a reasonable basis at the time they were made or were not issued in good faith. Accordingly, the Court hereby dismisses all Plaintiffs' section 10(b) claims against the underwriters to the extent that they are based on misstatements in analysts' reports. In re GlenFed, Inc. Securities Litig., 42 F.3d 1541, 1549 (9th Cir.1994) (en banc) (plaintiffs must “elaborate




circumstances contemporary to the alleged false statement to explain how and why the statement was misleading when made.”

(3) Analyst Reports-Duty to Non-Clients *9 Defendants contend that Plaintiffs fail to state a claim under section 10(b) on Plaintiffs' theory that a brokerage firm is liable to the entire marketplace, rather than just to its own clients for omissions in its analyst reports. Montgomery contends that it cannot be liable under section 10(b) for omissions in its analyst reports unless it breached a duty that it owed to Plaintiffs. The Supreme Court has held that silence in connection with a purchase or sale of securities may operate as a fraud, “[b]ut such liability is premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction.” Chiarella v. United States, 445 U.S. 222, 230 (1980). Plaintiffs do not allege that any named plaintiff was a client of Montgomery or that any named plaintiff read or relied upon any statements in any of Montgomery's analyst reports, nor do they allege that any of Montgomery's reports were issued to the general public. Instead, Plaintiffs contend that because Montgomery and Alex. Brown chose to speak to the investment community through their analysts' reports, that they accepted a duty to disclose materially adverse facts. Plaintiffs do not cite any competent authority to support this contention.FN5 Accordingly, the Court hereby dismisses these allegations with prejudice.

b. Roadshow Presentation Allegations The allegations in the first amended complaint as to Roadshow Presentations were dismissed because “[n]owhere in the complaint do plaintiffs mention the time, place, date, or individual who made the misstatement during the roadshows. Plaintiffs also fail to allege with specificity the exact misstatement.” In re Valence Technology Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,975. The TAC alleges that “Macdonald's inadequately supported ‘conclusions' found their way into Valence's IPO and subsequent prospectuses and Montgomery's and Alex. Brown's analysts' statements and salespersons' pitches.” Third Am.Compl. ¶ 7. This allegation plainly fails to meet the specificity requirements of Federal Rule of Civil Procedure 9(b).

Plaintiffs also allege that: ... Montgomery continued to advance Macdonald's ill-founded “assessment” while knowing or recklessly disregarding the inaccuracy and falsity of the statements and comparisons it generated. As a result, Valence was successful in selling its stock in the public offering. Montgomery also agreed to help orchestrate a multi-city “roadshow” shortly before the initial and follow-on public offerings, during which it and Company officials traveled to several cities to present highly favorable information about the Company. Much of the misleading technical information in these roadshows derived from Macdonald's flawed work and his presentation to Montgomery salespersons in mid-April 1992. These presentations helped create a strong demand for the stock so that more shares could be sold at a higher price, thus financially benefitting Montgomery, the Company, and ultimately the defendant insiders who sold their shares on the November, 1992 offering. *10 Third Am.Compl. ¶ 47. The Ninth Circuit has recently reaffirmed the GlenFed standard for pleading in a securities fraud action: In a securities fraud action, a pleading is sufficient under Rule 9(b) if it identifies the circumstances of the alleged fraud so that the defendant can prepare an adequate answer. This notice requirement is satisfied by allegations of the “time, place and nature of the alleged fraudulent activities.” When a fraudulent statement is alleged, the ‘plaintiff must set forth what is false or misleading abut [the] statement, and why it is false.’ In other words, the plaintiff must “set forth, as part of the circumstances constituting fraud, an explanation as to why the disputed statement was untrue or misleading when made.” Thus GlenFed requires a plaintiff to plead evidentiary facts and the court to consider what inferences these facts will support-despite the pitfalls and inefficiencies of such an analysis at the pleading stage[ ] and whether they are sufficient to satisfy the specificity requirement of Rule 9(b) as interpreted by GlenFed. Fecht v. The Price Company, No. 93-55541, 1995 U.S.App. LEXIS 32320, at *11 (9th Cir. Nov. 20, 1995). The Ninth Circuit also held that [a] plaintiff may also satisfy Rule 9(b) with allegations of circumstantial evidence if the circumstantial evidence alleged explains how and




why the statement was misleading when made. Thus, when there is an intervening event which might account for the conflict between the alleged misrepresentation and the current state of facts ... a plaintiff may satisfy Rule 9(b) by alleging inconsistent contemporaneous statements indicating that the defendant knew all along that the earlier statement was false, or by showing that the conflict does not merely result from the earlier statement's being based on a different but equally permissible business judgment. Id. at *12-13 (9th Cir. Nov. 20, 1995) (citing In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548-49 (9th Cir.1994) (en banc)).FN6 Plaintiffs argue in their opposition that they have adequately alleged in paragraph 47 that the roadshows were part of the Defendants' scheme to defraud. However, the allegations are conclusory; they do not meet the specificity requirements of Federal Rule of Civil Procedure 9(b). FN7 The section 10(b) claims are dismissed to the extent that they are based on roadshow allegations.

c. “Scheme to Defraud” Allegations In Paragraphs 40 through 47 of the TAC, Plaintiffs allege what they term “The Scheme.” The allegations in paragraphs 40 to 43 allege that Valence, through its controlling shareholders, “create[d] an aura of legitimacy” in order to promote the stock. Paragraph 47 contains Plaintiffs' roadshow allegations, which the Court has already determined are insufficient to state a claim. Other than the roadshow allegations, Montgomery is mentioned only in paragraphs 44 to 46, which allege that Montgomery and Valence's controlling shareholder and top management agreed that Montgomery would act as the lead underwriter; that Montgomery issued favorable reports that helped to maintain the market price of the stock; that Montgomery agreed to do “follow-up” offerings; and that in return for their services, Montgomery requested and received an indemnification agreement and liability insurance coverage from Valence. These allegations are conclusory. The Court need not accept such allegations. In re VeriFone Securities Litig., 11 F.3d 865, 868 (9th Cir.1993); Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir.1981), cert. denied, 454 U.S. 1031 (1981). *11 Even if the Court were to draw an inference that these allegations constitute a claim of conspiracy or scheme to defraud, the claim must still be dismissed.

Defendant Montgomery contends that the allegations that it participated in a “scheme to defraud” is merely an attempt to state a cause of action for section 10(b) “aiding and abetting.” Defendant contends that aiding and abetting liability has been explicitly rejected by the Supreme Court in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 1448 (1994). Central Bank held that there can be no cause of action for aiding and abetting under section 10(b). Id. at 1446-48. Many courts, including those in this district, have held that “conspiracy” or “scheme” allegations are not actionable under section 10(b) after Central Bank. See, e.g., Stack v. Lobo, 903 F.Supp. 1361 (N.D.Cal.1995) (citing In re Syntex Corp. Sec. Litig., 855 F.Supp. 1086, 1097 (N.D.Cal.1994); In re RasterOps Corp. Sec. Litig., [Current Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,467 at 91,195 (N.D.Cal.1994); In re Ross Sec. Litig., [1994-1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,363 at 90,495 (N.D.Cal.1994)). Courts have dismissed claims alleged as “schemes” on the grounds that they were merely non-actionable conspiracy claims that had been recharacterized. See, e.g., In re Gupta Sec. Litig., [Current Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,612 at 91,783-34 (N.D.Cal.1994). The Court also finds persuasive In re MTC Elec. Technologies Shareholders Litig., 898 F.Supp. 974 (E.D.N.Y.1995), which concludes: “[I]f Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement in order to be held liable under Section 10(b). Anything short of such conduct is merely aiding and abetting, and no matter how substantial that aid may be, it is not enough to trigger liability under Section 10(b).” Id. at 987.

2. Alex. Brown & Sons Defendant Alex. Brown joins in Montgomery's arguments as to Plaintiffs' section 10(b) claims and additionally contends that Plaintiffs have failed to rectify the pleading inadequacies identified by Judge Conti in the first amended complaint. Specifically, Alex. Brown contends that Plaintiffs cannot allege Alex. Brown's participation in fraud with the specificity required by Federal Rule of Civil Procedure 9(b) as required by the Ninth Circuit in In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir.1994) (en banc).

a. Analyst Reports




Alex. Brown argues that the allegations in the TAC are almost identical to those dismissed by Judge Conti in his May 8, 1995 order as too conclusory to state a claim. In particular, Alex. Brown argues that the only statement directly attributed to it in the TAC is “a two line excerpt from Alex. Brown's January 26, 1994 analyst report [and this is] language that Judge Conti has already held could not support a section 10(b) claim.” The TAC contains two paragraphs relating to Alex. Brown's analyst report. Paragraph 117 states: *12 On January 26, 1994, Alex. Brown issued a report based on information furnished by Valence management. Alex. Brown initiated coverage of Valence with a “buy” recommendation, citing a “Large Profit Opportunity.” The report stated: [W]e expect the Company to turn profitable in F4Q 1995, with EPS of $.02. Our FY1996 estimate of $2.00 reflects ... that [the Company] should begin to generate large production volumes in the F4Q 1995. Paragraph 117 of the TAC is identical to paragraph 104 of the FAC. Judge Conti has already determined that this language is not sufficient to state a claim as Plaintiffs failed to specify why Alex. Brown lacked a reasonable basis for the statement or why the report was issued in bad faith. In re Valence Technology Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,795. Paragraph 114 of the TAC states: Having chosen to avoid discovering and then disclosing the readily apparent problems listed above, the underwriters apparently felt no constraint about what could and would be said about Valence, thereby allowing known false statements to continue to be circulated. For example, Alex. Brown initiated coverage of Valence on January 19, 1994 by issuing a “buy” rating to further the scheme and course of conduct complained of herein. However, this rating turned on false and misleading descriptions of the Valence battery's performance capabilities, its purported safety, and unfounded and unreasonable projections for revenues equaling $500 million by fiscal year 1996. See ¶ ¶ 66-74, 79. Alex. Brown's willful ignorance and reckless disregard of the truth allowed it to headline its report with the false promise of “Large Profit Opportunity From A Better Battery.” Alex. Brown contends that Plaintiffs still have not identified any statements by Alex. Brown as false or misleading, or why such statements are false. The

Court agrees that the language in the TAC as to Alex. Brown is conclusory and thus fails to state a claim. Although Plaintiffs have added language to what was paragraph 104 of the first amended complaint, Paragraph 114 of the TAC does not allege evidentiary facts as required by GlenFed. The allegations in the TAC as to Alex. Brown still fail to set forth what is false or misleading about the statement and why it is false. There are no facts upon which the court may draw inferences. Fecht v. The Price Company, No. 93-55541, 1995 U.S.App. LEXIS 32320, at *11 (9th Cir. Nov. 20, 1995); In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548-49 (9th Cir.1994) (en banc). Moreover, despite having several opportunities to add facts to their pleadings to support their claims against Alex. Brown, Plaintiffs have failed to do so. Accordingly, the Court hereby dismisses with prejudice all section 10(b) allegations against Defendant Alex. Brown that are based on misrepresentations contained in analysts reports.

b. Roadshow Presentation Allegations *13 The TAC's allegations as to Defendant Alex. Brown are conclusory and fail to meet the specificity requirements of Federal Rule of Civil Procedure 9(b). Alex Brown was involved only in one follow-on offering and Plaintiffs have pleaded no facts which suggest a connection between Alex. Brown and the alleged misstatements at roadshows. As stated above, despite having many opportunities to add facts to their pleadings to support their claims against Alex. Brown, Plaintiffs have failed to do so. Accordingly, the Court hereby dismisses with prejudice all section 10(b) claims against Defendant Alex. Brown which are based on roadshow allegations.

c. “Scheme to Defraud” Allegations The scheme to defraud allegations against Defendant Alex. Brown are not alleged with the specificity required by Federal Rule of Civil Procedure 9(b). Plaintiffs have had several opportunities to amend their allegations against Alex. Brown and have failed to allege Alex. Brown's participation in fraud with the specificity required by the Ninth Circuit in In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir.1994) (en banc). In any event, as set forth above, such allegations fail to state a claim after Central Bank. Accordingly, the Court dismisses with prejudice all allegations against Alex. Brown based on a scheme to




defraud.

CONCLUSION The Court hereby GRANTS Defendant Montgomery Securities' motion to dismiss and GRANTS Defendant Alex. Brown & Sons' motion to dismiss. All claims against Defendants Montgomery and Defendant Alex. Brown are hereby DISMISSED WITH PREJUDICE. IT IS SO ORDERED.

FN1. Defendant Valence Technology, Carl E. Berg, Calvin L. Reed, Christine A. Russell and Lev M. Dawson have joined in Montgomery Securities and Alex. Brown & Sons' Motion to Dismiss Plaintiffs' claims for violation of Section 12(2) of the Securities Act of 1933. Defendant Alan F. Shugart has joined Defendant Montgomery Securities' Motion to Dismiss Plaintiffs' Third Amended Complaint. Also, Defendant Alex. Brown & Sons and Defendant Montgomery Securities join in each others' motions.

FN2. The background is taken from The Honorable Samuel Conti's September 19, 1995 order.

FN3. Valence has since abandoned its efforts to create this solid polymer-based battery, refocusing its research and development efforts on different technology.

FN4. Christine A. Russel, Chief Financial Officer; Dale R. Schackle, Vice President and Chief Technical Officer; David M. Butze, Vice President, Marketing; William J. Masuda, Vice President, Operations; Calvin L. Reed, one-time Chairman of the Board of Directors, Chief Executive Officer, and Chief Operating Officer; Carl E. Berg, who helped found Valence and member of the Board of Directors since September 1991; Lev. M. Dawson, founder and Chief Executive Officer until April 1993, Chairman of the Board of Directors until October 1993; and Alan F. Shugart, outside director since March 1992.

FN5. Plaintiffs cite In re Wells Fargo Sec.

Litig., 12 F.3d 922, 933 (9th Cir.1993), cert. denied, 513 U.S. 917, 115 S.Ct. 295 (1994) and Hanon v. Dataproducts Corp., F.2d 497, 504 (9th Cir.1992). However, these cases do not address the issue of liability grounded upon analyst statements.

FN6. Plaintiffs filed a statement of recent decision, directing the Court's attention to this recent Ninth Circuit case.

FN7. The court rejects Plaintiffs' argument that the roadshow presentations are “closely guarded secrets.” Defendants correctly point out that if the information is not disclosed, Plaintiffs can not contend that any allegedly misleading statements could affect the market price of Valence stock. In any event, the paragraphs referring to roadshows in the TAC fail even to set forth the content of the alleged misstatements. Plaintiffs also argue that they have obtained “various scripts, repeating numerous falsehoods highlighted in the complaint, [which] evidence that the roadshows were designed to further the fraud.” Plaintiffs represent that they attach this material to a declaration in support of their opposition. However, on a motion to dismiss, the Court may not consider these documents. “Generally, a district court may not consider any material beyond the pleadings in ruling on a Rule 12(b)(6) motion.” Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555 n. 19 (9th Cir.1990). The Court will not consider the material filed by Plaintiffs, as it declines to treat this motion as one for summary judgment. See Fed.R.Civ.P. 12(b)(6).

N.D.Cal.,1996. In re Valence Technology Securities Litigation Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) Briefs and Other Related Documents (Back to top) • 5:95CV20459 (Docket) (May. 03, 1994) END OF DOCUMENT


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d)



United States District Court, S.D. New York. In Re WRT ENERGY SECURITIES LITIGATION

No. 96 CIV. 3610(JFK), 96 CIV. 3611(JFK).

March 31, 1999. Milberg Weiss Bershad Hynes & Lerach LLP, New York, Of Counsel: David Bershad, Esq., Richard H. Weiss, Esq., Kim E. Miller, Esq., Baskin, Bennett & Komkov, L.L.P., Austin, TX, Of Counsel: James D. Baskin, Esq., Leon V. Komkov, Esq., David B. Kahn & Associates, Ltd., Northfield, Of Counsel: David B. Kahn, Esq., Mark E. King, Esq. , Henry F. Field, Ltd., Chicago, IL, Of Counsel: Henry F. Field, Esq. , for Plaintiffs. Well, Gotshal & Manges LLP, New York, Of Counsel: Joseph S. Allerhand, Esq., Beth J. Jacobwitz, Esq., for Defendants Oppenheimer & Co., Inc. Cadwalader, Wickersham & Taft, New York, Of Counsel: Dennis J. Block, Esq., for Defendant Schroder Wertheim & Co., Incorporated. Miller & Wrubel P.C., New York, Of Counsel: Martin D. Edel, Esq., Porter & Hedges, L.L.P., Houston, TX, Of Counsel: Mark K. Glasser, Esq., for Defendants Steven S. McGuire, Samuel C. Guy, Ronald E. Hale, Jr., Dominic Man-Kit Lam, and James T. Rash. Lane & Mittendorf LLP, New York, Of Counsel: Robert J. Luddy, Esq. , Leonard Violi, Esq., for Defendant The Scotia Group, Inc.

OPINION AND ORDER KEENAN, District J. *1 Before the Court are the motions to dismiss the Third Amended Consolidated Class Action Complaint pursuant to Fed.R.Civ.P. 12(b)(6) and 9(b), of defendants Steven S. McGuire, Samuel C. Guy, Ronald E. Hale, Jr., Dominic Man-Kit Lam, and James T. Rash (collectively, the “Individual Defendants”); defendants Oppenheimer & Co., Inc. (“Oppenheimer”) and Schroder Wertheim & Co. Incorporated (“Schroder”) (collectively, the “Underwriter Defendants”); and The Scotia Group, Inc. (“Scotia”).FN1 For the reasons set forth below, the Court now grants the motions of the Underwriter Defendants and Defendants Guy, Lam, and Rash, but

denies the motions of Scotia and Defendants McGuire and Hale.

FN1. Plaintiffs have also requested permission to communicate with persons who purchased senior notes of WRT Energy Corporation in the February 1995 public offering of such notes, and requested that the Court regulate communications between certain class members and Goldin Associates, L.L.C, the Liquidation Trustee in the WRT bankruptcy. The parties, by letters dated February 19, 1999 and March 1, 1999, have informed the Court that a decision issued on January 22, 1999 by the Bankruptcy Court for the Western District of Louisiana has mooted these requests. The Court, therefore, will not address these applications.

BACKGROUND

This is an action brought on behalf of a putative class of individuals who purchased securities of WRT Energy Corporation (“WRT”), a now-bankrupt oil and gas producer,FN2 during the period from October 20, 1993 through October 27, 1995 (the “Class Period”). During the time period at issue in this action, McGuire was Chairman of the Board and Chief Executive Officer of WRT, Guy was a Director of WRT and its Executive Vice President, Hale was WRT's Chief Financial Officer, and Lam and Rash were Directors of WRT. Defendants Oppenheimer and Schroder were co-underwriters of an offering of WRT securities, acted as market makers in those securities, and served as analysts of WRT securities. Defendant Scotia is a petroleum engineering firm which prepared an estimate of WRT's oil and gas reserves in connection with various offerings of WRT securities during the Class Period.

FN2. On February 14, 1996, WRT filed a voluntary petition for bankruptcy in the United States Bankruptcy Court for the Western District of Louisiana. By Order dated March 24, 1997, the Court severed from this action all claims asserted against WRT.




Plaintiffs commenced these consolidated actions on December 18, 1995 by filing two separate class action complaints in the United States District Court for the Southern District of California. Those actions subsequently were consolidated by Stipulation and Order dated May 2, 1996, and transferred to this Court by Order of United States District Judge Barry T. Moskowitz dated May 7, 1996. Plaintiffs filed an Amended Complaint on July 26, 1996. On October 25, 1996, they filed a Second Amended Complaint with the consent of all parties for the sole purpose of adding Scotia as a defendant. The Second Amended Complaint was dismissed by Order and Opinion on September 9, 1997, but Plaintiffs were given leave to replead. The Third Amended Consolidated Class Action Complaint (the “Complaint”), dated October 24, 1997, alleges the following claims against Defendants: (1) that Defendants violated § 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), and Rule 10b-5 of the rules promulgated by the Securities Exchange Commission (“SEC”) thereunder; (2) that the Individual Defendants violated § 20(a) of the 1934 Act; (3) that Defendants violated § 11 of the Securities Act of 1933 (the “1933 Act”) in connection with the offering of Senior Notes in February 1995 (the “Senior Notes Offering”); (4) that the Individual Defendants McGuire and Hale violated § 11 of the 1933 Act in connection with an offering of preferred stock in October 1993; (5) that the Underwriter Defendants violated § 12(a)(2) of the 1933 Act in connection with the Senior Notes Offering; and (6) that the Individual defendants violated § 15 of the 1933 Act. *2 The facts alleged in the Complaint, accepted as true for purposes of the instant motions, are as follows. WRT was an oil and gas producer which specialized in acquiring and revitalizing “mature” oil and gas fields located primarily in Southern Louisiana. WRT claimed that it could exploit the natural resources in these fields, where previous owners had failed, through the use of unique technology used to revitalize non-productive oil and gas wells. Plaintiffs claim that during the Class Period the Individual and Underwriter Defendants issued a series of positive statements concerning the business and operations of WRT that were false and misleading, and for which there was no reasonable basis. The claims against Scotia stem from certain reports Scotia prepared that estimated WRT's

reserves of oil and gas. Generally, Plaintiffs claims of wrongdoing by Defendants fall into seven categories: (1) the overstatement and/or exaggeration of the success WRT had in its revitalizing activities, a core aspect of WRT's business; (2) the misrepresentation of the technological capacities WRT had at its disposal; (3) the overstatement of WRT's reserves in oil and gas; (4) the overstatement of WRT's net worth during the Class Period; (5) the misrepresentation of the capabilities of WRT's management; (6) WRT's “looting” of corporate funds; and (7) WRT's inflated representations about WRT's future performance. See Compl. ¶ 29. Plaintiffs also claim that WRT's financial statements were not prepared in accordance with Generally Accepted Accounting Principles (“GAAP”). See id. ¶ ¶ 90-102. In total, Plaintiffs identify nearly thirty documents in which these allegedly misleading statements were made. These include: (1) press releases dated November 22, 1993, April 7, 1994, April 14, 1994, May 17, 1994, August 2, 1994, November 1, 1994, January 5, 1995, April 11, 1995, May 10, 1995, and May 31, 1995, see id. ¶ ¶ 33, 36, 37, 38, 42, 44, 51, 68, 70, 72; (2) prospectuses and registration statements issued in October 1993, January 1994, December 1994, and February 1995, see id. ¶ ¶ 30-32, 34, 48-49, 53-62; (3) reports to WRT shareholders in March 1994 and May 1995, see id. ¶ ¶ 35, 69; (4) SEC filings dated April 14, 1994, May 20, 1994, August 12, 1994, November 14, 1994, March 31, 1995, May 12, 1995, and August 14, 1995, see id. ¶ ¶ 37, 39, 42, 46, 64-65, 71, 76; (5) statements by defendant McGuire on July 29, 1994 and October 2, 1995, see id. ¶ ¶ 41, 77; (6) statements and reports by Schroder dated September 23, 1994, November 4, 1994, November 28, 1994, January 13, 1995, and April 7, 1995, see id. ¶ ¶ 43, 45, 47, 52, 67; (7) reports by Oppenheimer dated March 6, 1995, April 4, 1995, June 14, 1995, and June 29, 1995, see id. ¶ ¶ 63, 66, 74, 75; and (8) public announcements by WRT on November 28, 1994 and December 20 and 29, 1994. See id. ¶ ¶ 47, 50. Chronologically, the alleged misrepresentations and omissions described in the Complaint are as follows. On October 20, 1993, WRT commenced a public offering of approximately 1.1 million shares of preferred stock at $25 per share, for which WRT received more than $25 million in proceeds. See id. ¶ 30. Plaintiffs claim that the Prospectus and Registration Statement for this offering falsely stated that WRT had “demonstrate[d] its ability to use its technology to find previously untapped reservoirs in




shut-in or abandoned wells and return such wells to commercial production”; that WRT used “advanced ... production practices to increase production rates”; that “its technology-based approach” gave it an “advantage” over other oil and gas producers; that WRT was “the only oil and gas producer in the United States that own[ed] and operate[d] a complete set of radioactive logging tools and also ha[d] in-house capacity to re-evaluate previously completed wells using such technology”; and that WRT had “significantly improved production rates in many of the wells” on which it had applied its technologies. Id. ¶ 31. The Prospectus also “spoke glowingly” about the qualifications of WRT's management, and overstated WRT's proved oil and gas reserves as of December 31, 1992. The data concerning WRT's reserves were derived from a report prepared by Scotia. Id. ¶ 32. *3 In January 1994, WRT again raised capital through an offering of 806,000 shares of WRT common stock which yielded more than $8,000,000. The Prospectus for this offering falsely stated that WRT had successfully employed “advanced technologies to increase production rates” in abandoned wells, misrepresented the quality of WRT's management, and again overstated its reserves based on a report prepared by Scotia. Id. ¶ 34. Plaintiffs claim that WRT's misrepresentations continued throughout 1994. WRT repeatedly emphasized its success due to its “proprietary technologies” in its 1993 annual report to shareholders, id. ¶ 35; a May 17, 1994 WRT press release, id . ¶ 38; and a July 29, 1994 statement over the Dow Jones newswire. Id. ¶ 40. In the Dow Jones newswire, defendant McGuire stated: “We have over 90% success rates of bringing wells back to life.” Id. In an April 7 press release, WRT overstated its reserves. Id. ¶ 36. WRT's annual report, filed on April 14, and its quarterly reports, filed on May 20, August 12, and November 14, falsely stated that WRT's net worth was close to $50 million, at a time when WRT's financial situation was “extremely precarious.” Id. ¶ ¶ 39, 42, 46. The quarterly reports were signed by Defendants McGuire and Hale, and McGuire, Hale, and Guy signed the annual report. Plaintiffs claim that on September 23, 1994, Defendant Schroder issued a report which stated, without any reasonable basis, that: WRT Energy is the first of a new breed of independent oil and gas producers that focus on innovative production technology. The company employs proprietary technology to increase oil and

gas reserves and production from mature oil fields .... Our estimate for 1995 cash flow is $2.85 per share .... There currently are no other companies that we are aware of that can realize the same value as WRT in their targeted acquisitions. Id. ¶ 43. In a November 4, 1994 report, Schroder again stated that WRT had been using “proven and proprietary technologies to increase oil and gas reserves and production from mature oil fields.” Id. ¶ 45. Plaintiffs claim that these statements began after Schroder and WRT entered into a “financial advisory” agreement in July 1994.FN3 Id. ¶ 43.

FN3. These claims concerning Schroder's statement are typical of Plaintiffs' claims against Schroder, and therefore the Court will not list all of Plaintiffs' claims concerning statements made by Schroder.

In December 1994, WRT publicly offered for sale another 489,500 shares of WRT common stock. Plaintiffs claim that the Prospectus for that offering repeated many of the previous claims about the success of WRT's technology, but failed to warn investors that WRT's “advanced” “proprietary” technologies already were failing. Id . ¶ ¶ 48-49. The Prospectus also included Scotia's statement of WRT's proved oil and gas reserves as of December 31, 1993, which Plaintiffs allege were overstated. Id. ¶ 48. The crux of Plaintiffs' allegations stem from WRT's Senior Notes Offering. On February 28, 1995, WRT commenced a public offering of 100,000 Units, each consisting of $1,000 principal amount of Senior Notes and eight Warrants. Oppenheimer and Schroder acted as co-underwriters for this offering and participated in drafting the Prospectus. *4 Plaintiffs allege that the Prospectus and registration statement filed in connection with the Senior Notes Offering contain misrepresentations that cover all aspects of WRT's wrongful conduct. The Prospectus misrepresents WRT's technological methods and success. It falsely stated that “[w]ells that have been shut-in or abandoned” are re-entered with “technologically advanced” equipment and that “[a]pplication of the Company's technologies ... has resulted in substantial increases in overall production rates, oil and gas reserves and cash flow ... [and] the Company has had an 84% success rate in identifying and developing commercial oil and gas reserves in shut-in wells.” Id. ¶ ¶ 53-54. Plaintiffs claim that the unrevealed reality, however, was that the “majority of




the[ ] well revitalization efforts were failures because they did not pay back the costs of the revitalization efforts.” Id. ¶ 54. In actuality, only 40% of the revitalization efforts were successful. Id. The Prospectus also overstated the use and success of WRT's vaunted hydrocyclone technology. Id. ¶ 55. Plaintiffs claim that three internal memoranda prepared by Scotia personnel, dated June 2, 1994, February 1995, and July 17, 1995, see id. ¶ 3, and an examination of WRT's reserve reports, see id. ¶ 83, confirm these claims. The registration statement filed in connection with the Senior Notes Offering contained estimates of WRT's oil and gas reserves as of September 30, 1994. Plaintiff's claim that these estimates prepared by Scotia were materially overstated, as evidenced by the fact that on April 6, 1996 WRT was forced to reduce its estimated reserve figures by 100%. See id. ¶ ¶ 58-59. Plaintiffs allege that the materials filed in connection with the Senior Notes Offering contained other misrepresentations and critical omissions. The materials did not reveal that WRT was receiving less than full market value for the gas and oil it sold, thereby jeopardizing the financial well-being of WRT. Id. ¶ 56. Plaintiffs claim that due to, inter alia, “bogus” accounting methods, see id. ¶ ¶ 90-102, the materials vastly overstated the net worth of WRT. Id. ¶ 60. The materials also promoted the talents of WRT's management team. Id. ¶ 61. Plaintiffs further claim that despite WRT's “looting of millions of dollars of WRT's funds,” the materials advised investors that the proceeds of the Senior Notes Offering would be used to purchase additional oil and gas properties and to repay WRT's debt. Id. ¶ 62. Less than one month after underwriting WRT's Senior Notes Offering, Oppenheimer initiated coverage on WRT with an “analyst's buy” rating. This began a series of statements and analyst reports by Oppenheimer that, similar to Schroder's reports, contained alleged misstatements concerning the WRT's technology and its prospects for growth. These statements and reports are listed above. For example, on April 4, 1995, Oppenheimer issued a report stating the following: *5 [W]e believe WRT shares deserve to carry a premium multiple to reflect the following competitive advantage: .... Technology Leadership. Utilizing proprietary research, the company has developed well logging and high volume water extraction technologies. This allows the company to significantly increase production and reserves ....

Id. ¶ 66. Cracks in the fabric of WRT started to surface in the spring of 1995. Despite the onset of bad news, however, Defendants portrayed a positive outlook on WRT to the public. In a May 10, 1995 press release, McGuire reported that WRT's results for the first quarter of 1995 were below expectations because of “delays [of acquisition closings] combined with a one-time financing charge of $800,000.” Id. ¶ 70. WRT stated, however, that it “look[ed] forward to significant increases in quarterly oil and gas production.” Id. On June 29, 1995, Oppenheimer reported that recent weakness in the price of WRT securities should be regarded “as a purchase opportunity.” Id. ¶ 75. On October 2, 1995, responding to a drop in the price of WRT securities, McGuire announced that “the Company knows no reason for the precipitous decline in the value of its equity securities.” Id. ¶ 77. On October 27, 1995, in stark contrast to other statements made concerning WRT's business prospects, WRT announced that “it would implement ‘cost reduction programs' and evaluate the ‘liquidity issues' then facing the Company.” Id. ¶ 78. Based on these revelations, WRT's stock price declined sharply. See id. ¶ 79. Throughout 1995, WRT had filed with the SEC the 1994 annual report and the requisite quarterly reports for 1995. These filings all represented that WRT had a net worth of over $50 million. On November 14, 1995, WRT issued its quarterly report, which was signed by Hale. The report disclosed that “it is unlikely that [WRT] will have sufficient cash to meet the ... interest payment on the Senior Notes,” that WRT doubted if it could continue as a “going concern” if current conditions persisted, and that McGuire and Guy had resigned on November 10, 1995. Id. ¶ 80. On April 5, 1996, WRT issued a press release acknowledging that a reexamination of its oil and gas reserves by an outside engineering firm showed that its reserves had been more than 100% overstated and had to be reduced accordingly. See id. ¶ 81. WRT's 1995 annual report, filed on June 12, 1996, revealed that shareholders' equity was a negative $62 million as of December 31, 1995, which was more than $100 million less than the approximately $50 million equity figure represented's in WRT's quarterly report for the quarterly period ending September 30, 1995. See id. ¶ 82.




DISCUSSION Defendants move to dismiss Plaintiffs' claims against them under Fed.R.Civ.P. 12(b)(6) for failure to state a claim and on Fed.R.Civ.P. 9(b) grounds for failure to plead fraud with particularity. The Court first addresses the viability of Plaintiffs' claims under the 1933 Act and then turns to Plaintiffs' 1934 Act claims.

I. Plaintiffs' 1933 Act Claims *6 In the Court's previous Order and Opinion, the Court dismissed the claims under § § 11 and 12 of the 1933 Act because Plaintiffs did not plead that they purchased the WRT securities in question during an initial offering. Therefore, Plaintiffs did not have standing under § § 11 or 12 of the 1933 Act. The § 15 claim under the 1933 Act was also dismissed because that was dependent on the viability of the underlying § § 11 and 12 claims. Plaintiffs have not cured their pleading deficiencies, but nevertheless have included in the Complaint nearly identical claims under the 1933 Act to preserve their rights. The Court hereby dismisses the 1933 Act claims for the same reasons they were dismissed in the Court's previous Order and Opinion.

II. Plaintiffs' 1934 Act Claims Plaintiffs also assert § 10(b) and Rule 10b-5 claims against Defendants. These claims are based on the allegedly false and misleading statements described in the Complaint.FN4 Defendants move to dismiss these claims for failure to state a cause of action under Fed.R.Civ.P. 12(b)(6) and for failure to plead fraud with the particularity required by Fed.R.Civ.P. 9(b). The Court addresses the motions to dismiss the § 10(b) and Rule 10b-5 claims in turn below.

FN4. As Defendants concede, the Private Securities Litigation Reform Act of 1995 does not apply to this action because the Act was passed several days after Plaintiffs filed their initial complaints in these consolidated actions.

A. Defendants' Rule 12(b)(6) Motions

When presented with a Fed.R.Civ.P. 12(b)(6) motion,

the Court's duty is to assess the legal feasibility of the complaint rather than to weigh the evidence that might be offered in support thereof. See, e.g., Geisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir.1980). Accordingly, the Court accepts Plaintiffs' factual allegations as true and draws all reasonable inferences in Plaintiffs' favor. See Cooper v. Pate, 378 U.S. 546 (1964). Therefore, Defendants' motions should be granted only if it appears beyond doubt that Plaintiffs can prove no set of facts in support of their claims which would entitle them to relief. See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974) (citing Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). § 10(b) of the 1934 Act provides that “[i]t shall be unlawful for any person, directly or indirectly by use of any means or instrumentality ... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device.” 15 U.S.C. § 78j(b). Rule 10b-5 prohibits any “artifice to defraud or any act which would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5(a), (c). § 10(b) and Rule 10b-5 were designed as catch-all clauses for fraudulent practices. See Chiarella v. United States, 445 U.S. 222, 226 (1980). To state a claim under § 10(b) and Rule 10b-5, “a plaintiff must plead that ‘in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false representation or omitted to disclose material information and that plaintiff's reliance on defendant's action caused [plaintiff] injury.” In re Time Warner Inc. Sec. Litig., 9 F.3d at 264 (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61 (2d Cir.1985)); see also Royal American Managers, Inc. v. IRC Holding Corp., 885 F.2d 1011, 1015 (2d Cir.1989).

1. The Individual Defendants' and Underwriter Defendants' Motions

*7 The Court, in its previous Order and Opinion in this matter, found that Plaintiffs alleged sufficiently the elements of a § 10(b) and Rule 10b-5 claim based on the false and misleading statements made by these parties. See In re WRT, 96 Civ. 3610, 96 Civ. 3611(JFK), Order and Opinion, Sept. 9, 1997, slip op. at 19-26. The Court finds that in the Complaint Plaintiffs similarly plead the elements of a § 10(b) and Rule 10b-5 claim against the Individual Defendants and the Underwriter Defendants. Although Plaintiffs have added specificity to their allegations in constructing this fourth version of their




complaint, they have not added any new misstatements made by the Underwriter or Individual Defendants. Therefore, the misstatements or omissions that were pleaded sufficiently in the Second Amended Complaint are pleaded sufficiently in the Third Amended Complaint. The success of the Underwriter and Individual Defendants' motions will once again turn on whether Plaintiffs have pleaded scienter with the specificity required by Rule 9(b).

2. Scotia's Motion Scotia argues that the alleged fraudulent statements and omissions attributable to it are not actionable as a matter of law. First, Scotia argues that the risks of investing were disclosed fully in the prospectuses and other registration materials. Although these documents do contain numerous warnings about the risks in investing in WRT, see The Scotia Group, Inc.'s Mem. of Law in Supp. of its Mot. to Dism., at 5-6, those warnings do not bar Plaintiffs' claims as a matter of law. It is well-settled that “cautionary language, if sufficient, renders ... alleged omission[s] or misrepresentations immaterial as a matter of law.” In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371 (3d Cir.1993), cert. denied, 510 U.S. 1178 (1994). This principle, commonly characterized as the “bespeaks caution” doctrine, provides a defense under § 10(b) where a defendant has warned investors specifically, in advance, of risks that later materialize, causing the investor's loss. If the cautionary language cited by the defendant “precisely address[es] the substance of the specific statement or omission that is challenged,” the bespeaks caution doctrine can be “applied at the pleading stage to dismiss securities fraud claims.” In re Prudential Sec. Inc. Ltd. Partnerships Litig., 930 F.Supp. 68, 71-72 (S.D.N.Y.1996) (Pollack, J.). Upon carefully reviewing and considering the cautionary language to which Scotia refers, the Court finds that these warnings do not require dismissal of Plaintiffs' claims. Although the materials that Scotia cites contain generalized warnings about future risks, the gravamen of Plaintiffs' claims is that Scotia failed to reveal adverse information about current conditions, namely that the reserves estimates issued by Scotia vastly overstated WRT's reserves as of the date upon which the reports were issued. The bespeaks caution doctrine does not protect against such failure to disclose current adverse conditions. See Rubinstein v. Collins, 20 F.3d 160, 171 (5th

Cir.1994) (“[T]he inclusion of general cautionary language regarding a prediction would not excuse the alleged failure to reveal known material, adverse facts.”); Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1127 (7th Cir.1993) (“A prospectus stating a risk that such a thing could happen is a far cry from one stating that this had happened. The former does not put an investor on notice of the latter.”), cert. denied, 510 U.S. 1073 (1994); In re Prudential Sec. Inc. Ltd. Partnerships Litig., 930 F.Supp. at 72 (“[C]autionary language does not protect material misrepresentations or omissions when defendants knew they were false when made.”). *8 To the extent that Scotia also argues that dismissal is required because the alleged misstatements or omissions were not material, the Court disagrees. Assuming Plaintiffs' allegations are true, the information that Scotia allegedly failed to disclose would certainly have “significantly altered the ‘total mix’ of information available.” TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). The vast discrepancy between the reserves estimates in Scotia's reports and the amounts that Plaintiffs claim were the reality (100% less than Scotia estimated) would be regarded by the reasonable investor as material. Furthermore, the Court held in the previous Order and Opinion that Plaintiffs' invocation of the “fraud-on-the-market” theory is sufficient to plead reliance. See In re WRT, Sept. 9, 1997, slip op. at 22-23. Therefore, Plaintiffs have sufficiently pleaded reliance on Scotia's misstatements or omissions. Scotia's last argument is that the inclusion of 1934 Act claims against it is procedurally improper. Scotia argues that the Court did not afford Plaintiffs the right to add a 1934 Act claim against Scotia in the most recent amendment. The Court rejects this argument, however, because the Court was not specific as to which claims Plaintiffs were given leave to replead. The Court, in the spirit of Fed.R.Civ.P. 15, was giving Plaintiffs a broad opportunity to replead its complaint. To the extent that Scotia argues that Plaintiffs' 1934 Act claims against Scotia are time-barred, the Court holds that these claims against Scotia, pursuant to Fed.R.Civ.P. 15(c)(2), relate back to the date of the original pleading. The 1934 Act claims against Scotia clearly arise out of the same conduct, transaction, or occurrence that gave rise to the original pleading in this matter.




B. Defendants' Rule 9(b) Motions

The Defendants also contend that Plaintiffs' § 10(b) and Rule 10b-5 claims do not satisfy the heightened pleading standard of Fed.R.Civ.P. 9(b). Federal Rule of Civil Procedure 9(b) provides that “[i]n all averments of fraud ... the circumstances constituting fraud shall be stated with particularity.” To satisfy this rule in pleading a § 10(b) claim, “ ‘the complaint must (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.” ’ Acito v. IMCERA Group, Inc., 47 F.3d 47, 51 (2d Cir.1995) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir.1993)). Further, to plead scienter under Rule 9(b) sufficiently to withstand a motion to dismiss, Plaintiffs must allege facts supporting a strong inference of Defendants' fraudulent intent. See O'Brien v. National Property Analysts Partners, 936 F.2d 674, 676 (2d Cir.1991). There are two ways to plead scienter in the absence of direct knowledge of a defendant's state of mind. “The first approach is to allege facts establishing a motive to commit fraud and an opportunity to do so. The second approach is to allege facts constituting circumstantial evidence of either reckless or conscious behavior.” In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 269 (2d Cir.1993) (citation omitted), cert. denied, 511 U.S. 1017 (1994). Where a plaintiff relies upon the latter method of pleading fraud, “the strength of the circumstantial allegations must be correspondingly greater.” Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir.1987), cert. denied, 484 U .S. 1005 (1988).FN5

FN5. By letter dated February 19, 1999, Plaintiffs claimed that the Second Circuit's recent opinion in Press v. Chemical Investment Servs. Corp., 1999 WL 49367 (2d Cir. Feb. 4, 1999), clarified the requirements for pleading scienter in this Circuit. After carefully reviewing the Press opinion, the Court concludes that the standards governing the instant motion to dismiss are unaffected.

1. The Underwriter Defendants' Motion

*9 The Court dismissed the previous iteration of Plaintiffs' complaint against the Underwriter

Defendants because it did not plead scienter with the specificity required by Fed.R.Civ.P. 9(b). In the instant Complaint, the Court again finds that Plaintiffs have not pleaded the scienter element of a § 10(b) claim. Plaintiffs cannot meet either the motive and opportunity standard or the conscious misbehavior or recklessness standard.

a. Motive and Opportunity Although it is undisputed that the Underwriter Defendants had the “opportunity” to commit fraud, see In re WRT, Sept. 7, 1997, slip op. at 26, they lacked the motive to do so. In its previous Order and Opinion, the Court rejected Plaintiffs' allegations that the Underwriter Defendants were motivated to commit fraud by the prospect of receiving $3.5 million in underwriting fees in connection with the Senior Notes Offering, and unspecified other fees as alleged advisors to WRT. See id. at 26-27. The Court held that it would be unlikely for the Underwriter Defendants' “to risk their reputations in order to generate fees likely amounting to only a small percentage of their annual revenues.” Id. at 27. In the Complaint, Plaintiffs advance the same arguments as before, and add certain new allegations of motive. Plaintiffs' restatement of the old allegations obviously fails, and their new motive allegations fare no better. First, Plaintiffs allege that WRT made payments to brokers as part of a “deliberate and fraudulent scheme to promote its stock.” See Compl. ¶ ¶ 109-13. There is not a single allegation, however, to suggest that Oppenheimer or Schroder, or any individuals associated with Oppenheimer or Schroder, received any such payments to promote the stock. Indeed, these allegations do not mention Oppenheimer or Schroder at all. See id. Next, Plaintiffs contend that because 1994 “was an especially poor year in the underwriting business, the Underwriter Defendants were unusually hungry to book more underwriting business in the beginning of 1995,” and that promoting WRT also enhanced fees earned by Oppenheimer and Schroder as market makers in WRT securities. Id. ¶ 119. Plaintiffs also allege that “[t]he substantial fees to be obtained by Defendants Schroder and Oppenheimer for providing purported consulting services to the Company were a further inducement for those Defendants to participate in the wrongdoing described herein.” Id. ¶ 123. These allegations simply recast the prior ones found to be legally deficient, e.g., that the




Underwriter Defendants participated in a fraud to earn fees. FN6

FN6. Plaintiffs last allegation is that the Senior Notes Offering afforded the Underwriter Defendants an opportunity to curry favor with an influential Louisiana political group to increase the Underwriter Defendants' share of the politically-connected underwriting business in Louisiana. Id. ¶ 120. The Court, however, does not see the need to address such a far-flung, conclusory allegation.

b. Conscious Misbehavior or Recklessness

In bringing claims against the Underwriter Defendants, Plaintiffs are charging third-party advisers with fraud. The Court has just established that Plaintiffs have not met the motive and opportunity standard, therefore Plaintiffs must allege facts approaching a knowledgeable participation in the fraud or a deliberate and conscious disregard of facts. Where third-party advisers are concerned, to meet such a standard the allegations must “approximate an actual intent to aid in the fraud being perpetrated by the [ ] company.” Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 121 (2d Cir.1982). *10 Plaintiffs advance two sets of arguments in their attempt to establish the Underwriter Defendants' conscious misbehavior or recklessness. First, the majority of Plaintiffs' new scienter allegations revolve around the argument that the Underwriter Defendants either knew or recklessly disregarded virtually every single negative fact concerning WRT which plaintiffs have alleged in the Complaint. See Compl. ¶ ¶ 125-144. Plaintiffs allege over and over again that, under ordinary underwriting procedures, Oppenheimer and Schroder should have been able to-or, in fact, did-learn during the course of their due diligence in connection with the Senior Notes Offering of all the alleged negative facts outlined above. See, e.g., id. ¶ ¶ 128, 133, 137, 139. At base, these allegations claim that if Oppenheimer and Schroder had properly done their jobs as underwriters and performed due diligence adequately, they would have uncovered the truth about WRT. These allegations constitute negligence at best, and these types of allegations against an underwriter have always been insufficient to establish scienter under the federal securities laws. In fact, the

Court explicitly rejected this same argument in its previous Order and Opinion. See In re WRT, Sept. 9, 1997, slip op. at 28 (“[T]he allegation that a defendants' due diligence investigation “should have turned up the asserted improprieties in the offering materials” is insufficient to satisfy Fed.R.Civ.P. 9(b).”).FN7

FN7. Plaintiffs also attempt to demonstrate that the Underwriter Defendants must have or should have known about the true facts of WRT's business affairs by referring to two memoranda prepared by Scotia, one dated June 2, 1994 and the other dated February, 1995. See Compl. ¶ ¶ 129, 136, 138, 139. Plaintiffs point to these letters to demonstrate that the problems at WRT were so fundamental that the Underwriter Defendants had to have consciously ignored the truth. This argument, however, is nothing more than another version of Plaintiff's insufficient claim that the Underwriter Defendants should have known the truth about WRT's affairs. These memoranda, therefore, have no effect on the Court's analysis.

Plaintiffs other set of arguments concern the activities of Mark Miller, a former Oppenheimer employee, as described in a report prepared by an examiner appointed in the WRT bankruptcy proceeding (the “Bankruptcy Examiner's Report”). See Compl. ¶ ¶ 114-18. Based on this report, plaintiffs allege that Mark Miller acted as an “ex officio advisor” to WRT and played a “central role” in the relationship between WRT and a company called Tri-Deck which had entered into an agreement with WRT to purchase and distribute WRT oil and gas. According to Plaintiffs' allegations and the Bankruptcy Examiner's Report, the Tri-Deck deal resulted in a loss of approximately $3 million to WRT because WRT had agreed to sell oil and gas Tri-Deck at below market prices. See id. ¶ 115. These new allegations relating to the alleged involvement of Mark Miller with WRT and Tri-Deck have absolutely nothing at all to do with Schroder. Therefore, these claims cannot support a claim against Schroder, and Schroder's motion to dismiss is granted because Plaintiffs have not pleaded scienter with the specificity required by Fed.R.Civ.P. 9(b). But even as to Oppenheimer, these new allegations are unavailing. The timing of Mark Miller's alleged




involvement with Tri-Deck and WRT does not support an inference of scienter with respect to Oppenheimer's role as an underwriter in the Senior Notes Offering. As made clear in the Bankruptcy Examiner's Report itself, Tri-Deck was not even formed until the late Spring of 1995-at least two months after the Senior Notes Offering. Furthermore, there is no allegation that Miller had anything to do with the preparation of any of the Oppenheimer research reports that the Court held were material misstatements or omissions. *11 The Court also rejects Plaintiffs' contention that “Miller's vast knowledge concerning the business and affairs of WRT should be imputed to Defendant Oppenheimer.” Id. ¶ 114. An employee's knowledge may be imputed to a corporation only if such knowledge was acquired by the employee while acting within the scope of employment, and for the employer's benefit, and if such knowledge relates to a matter to which the employee's authority extends. See, e.g., Corrigan v. Bobs-Merrill Co., 228 N.Y. 58, 68-69 (N.Y.1920); Weintraub v. Texasgulf Inc., 564 F.Supp. 1466, 1470 (S.D.N.Y.1983). The Complaint does not allege that Miller attained his “vast knowledge” of WRT's business affairs because of his role as an analyst at Oppenheimer. Instead, the Complaint suggests, and the Examiner's report supports, that Miller attained his knowledge of WRT as an “ex officio advisor” to WRT. See Compl. ¶ 114; Exh. A, at 43-50. Clearly, Miller's role as “ex officio advisor” exceeds the scope of Miller's employment at Oppenheimer, and Oppenheimer did not stand to benefit from Miller's activities that stemmed from such a role. Therefore, these allegations fail to establish Oppenheimer's conscious misbehavior or recklessness, and Oppenheimer's motion to dismiss is granted.

2. Scotia's Motion The Court finds that Plaintiffs have pleaded scienter with the specificity required by Fed.R.Civ.P. 9(b) to withstand Scotia's motion. Specifically, the Court finds that Plaintiffs have met the motive and opportunity standard. It is undisputed that Scotia had the opportunity to commit fraud. The issue is whether Plaintiffs have pleaded that Scotia had the motive to do so. Plaintiffs allege that Scotia's motive lay in a combination of the interrelationship between WRT and Scotia, and Scotia's knowledge of WRT's problems. Plaintiffs claim that despite Scotia's

claimed independence, it was actually a de facto department of WRT. Plaintiffs support this claim by alleging that WRT was Scotia's largest client, accounting for over fifty percent of Scotia's business. See Compl. ¶ 19. Plaintiffs allege that WRT relied heavily on Scotia for advice that most oil and gas companies would make for themselves, including “the wells on which to perform workovers, how to nest perform them, and where and how to best drill new wells.” Id. Furthermore, Plaintiffs allege that WRT owed Scotia $500,000 as of mid-1994, and that in February 1995 Scotia knew that “WRT ran out of cash in mid-1994.” Id. ¶ 60. Lastly, Plaintiffs cite two memoranda prepared by Scotia to demonstrate that Scotia was aware of the problems at WRT. In addition to WRT's cash problems, Scotia was aware that WRT's performance was “hardly stellar,” that its technology was “neither especially high tech nor at this point in time, efficient,” and that WRT's public claims were “lots of noise ” for “very little performance.” Id. ¶ 3 (emphasis in original). *12 Scotia argues that Plaintiffs' allegations are insufficient because they merely claim that Scotia's motive was to generate fees. Although such an argument would be persuasive, see supra part II .B.1.a, the Court finds that Plaintiffs allege Scotia's motive was more than simple fee generation. Plaintiffs' claims are not, similar to its claims against the Underwriter Defendants, that Scotia was motivated to receive fees for the various reports it prepared and to secure future business. Rather, Plaintiffs allege that WRT and Scotia were so interrelated that Scotia's financial viability depended on WRT's success. Scotia's motivation lay not only in receiving compensation for its estimate reports and generating future fees, but also in assuring that past debts owed to Scotia would be paid and that Scotia's most important client prospered. At this stage of the case,FN8 it is not improper to infer that Scotia's financial future was tied to that of WRT. At the very least, Scotia would have lost over fifty percent of its business if WRT folded.

FN8. The Court is in no way finding that WRT and Scotia were as interrelated and interdependent as Plaintiffs claim, and this part of the Court's opinion is not to be used by Plaintiffs in subsequent stages of this litigation as establishing the “law of the case.” The Court is merely assuming that Plaintiffs claims concerning Scotia are true.

Although Scotia cites many cases supporting its




position that Plaintiffs claims are insufficient because their only motive allegation is fee generation/compensation. See Scotia's Mem. in Supp. of Mot. to Dism., at 14-15. These cases, however, are inapposite to the instant situation. In none of the cases cited by Scotia is the third party defendant that is accused of § 10(b) violations so interrelated with, and dependent upon, the company for which the third party performed its services as Scotia is to WRT. Scotia also argues that it was hired to do reserves reports for WRT only, and thus Scotia's assessment of WRT's technology, management, and success cannot be the basis of liability for Scotia. This argument misses the point. Plaintiffs are not claiming that the statements in the Scotia memoranda are independent bases upon which Plaintiffs can establish liability. Instead, Plaintiffs claim that these statements demonstrate that Scotia knew WRT's problems, thereby giving Scotia greater motive to issue favorable reserve reports. The inference that can be properly drawn is that Scotia's knowledge of WRT's problems, when coupled with Scotia's reliance on WRT and the interdependence of the two firms, constitutes motive sufficient to withstand a Rule 9(b) motion.

3. The Individual Defendants' Motion In granting the Individual Defendants' Rule 9(b) motion in the Court's previous Order and Opinion, the Court granted the Individual Defendants' motion because Plaintiffs' allegations against the Individual Defendants were not sufficiently specific. The Court, however, finds that Plaintiffs have cured the pleading defect in the Third Amended Complaint as it pertains to Defendants McGuire and Hale. Although Plaintiffs do not contest the Court's finding in its previous opinion that Plaintiffs have not satisfied the motive and opportunity standard, Plaintiffs correctly assert that the Third Amended Complaint satisfies the conscious misbehavior standard.

a. Conscious Misbehavior or Recklessness *13 Plaintiffs have added over twenty paragraphs to the Complaint that details the acts they claim demonstrate the Individual Defendants conscious misbehavior or recklessness in connection with WRT's material misstatements or omissions. See Compl. ¶ ¶ 125-45. Plaintiffs have also clarified the

allegations that reiterate factual allegations made by Plaintiffs in the Second Amended Complaint. The allegations against the Individual Defendants in the Complaint are not the same jumbled, confused allegations that were advanced in the Second Amended Complaint. Rather, the allegations in the Complaint against the Individual Defendants detail a pattern of misbehavior on the parts of McGuire and Hale that leads to the inference that these Individual Defendants' actions “approximate an actual intent to aid in the fraud” alleged in the Complaint. See Chill v. General Elec. Co., 101 F.3d 263, 269 (2d Cir.1996) (quoting Decker v. Massey-Ferquson, Ltd., 681 F.2d 111, 121 (2d Cir.1982). The Court will analyze Plaintiffs' allegations against each Individual Defendant.

i. Defendant McGuire The Bankruptcy Examiner's report details the role McGuire played in WRT. FN9 As the Examiner Report states, McGuire “was in charge of the operations and apparently ran [WRT's] operations as he saw fit without a division of management responsibilities, decision making authority, or basic accounting and bookkeeping controls” when WRT was first formed. Although such domination is not unusual for small oil and gas companies in their infancy, McGuire's domination continued as WRT became a company that was traded in the public securities markets. See Compl., Exh. A, at 1-2. The Bankruptcy Examiner's Report further concluded that McGuire “gave directors or management only part of the information necessary to make an informed decision,” “acted contrary to the Board of Directors instructions without informing them of his action,” and made commitments and transactions on behalf of WRT without anyone else's knowledge. The Bankruptcy Examiner's Report also stated that WRT's management was “miscast,” with numerous employees working in jobs for which they were unqualified. Id., Exh. A, at 2-3. The report sums up McGuire's role by stating, “[i]n short, McGuire'[s] strong personality dominated the management of [WRT] and no questions were asked.” Id., Exh. A, at 3.

FN9. It is proper for the Court to rely on the Bankruptcy Examiner's Report because it is attached to the Complaint, and as such can be considered in a Rule 12(b)(6) motion.

Based on these conclusions, which are incorporated




into the Complaint, and the numerous press releases and statements directly attributable to McGuire, there can be no doubt that Plaintiffs have adequately pleaded McGuire's conscious misbehavior in connection with WRT's fraudulent conduct. If the Bankruptcy Examiner's Report and the allegations in the Complaint are true, then McGuire orchestrated every detail of the fraud committed by WRT, and can be held liable under the 1934 Act.

ii. Defendant Hale Plaintiffs have also alleged sufficiently Hale's conscious misbehavior. First, Hale was an insider at WRT, and as WRT's CFO he was one of the most important officers of WRT. Hale signed every document submitted to the SEC during the Class Period. Hale, as CFO of WRT, had to have known that the financial information contained in the materials submitted by WRT to the SEC was erroneous. In particular, the misrepresentations of WRT's net worth are directly attributable to Hale because he was the CFO. The Bankruptcy Examiner's Report buttresses this inference about Hale's knowledge of WRT's financial misrepresentations. In the context of an illegal payment made to an outsider, the report states that “[c]learly Hale was aware of the accounting errors and the misleading content of WRT's books. See Compl., Exh. A, at 7. *14 There are other allegations that demonstrate Hale's conscious misbehavior. The Complaint alleges that Hale was involved personally in directing improper payments by WRT. Id. ¶ 142-43. This allegation is supported by the Bankruptcy Examiner's report Id., Exh. A., at 7. Hale also stated in a press release issued on August 2, 1994, a time at which Plaintiffs allege WRT was in serious financial trouble, id. ¶ 60, that “we expect continued increases in production revenues, operating results and cash flow for the remainder of 1994.” Id. ¶ 41. The Court finds that these allegations establish Hale's conscious misbehavior in connection with WRT's fraudulent conduct.

iii. Defendant Guy The only allegations against Guy are that he signed WRT's 1993 annual report, id. ¶ 37, that he signed the Prospectus and registration materials in connection with the senior Notes Offering, id. ¶ 57, that he resigned from WRT with McGuire on November 10, 1995, id. ¶ 80, and that he was

“involved in and intimately familiar with the day-to-day operations and management of WRT,” and therefore must have been aware of the ongoing fraud at WRT. Id. ¶ 141. These allegations, coupled with the Bankruptcy Examiner Report's assessment that McGuire kept many people at WRT in the dark, do not suffice to plead Guy's conscious misbehavior. The Court dismissed such conclusory, unsupported allegations in its previous Order and Opinion in this matter, and Plaintiffs evidently have not discovered new facts that bolster its case against Guy. Therefore, the Individual Defendants' motion as it pertains to Guy is granted.

iv. Defendants Rush and Lam The allegations in the Complaint against Rash and Lam are even weaker than those alleged against Guy. Rash and Lam are not insiders at WRT, and the only allegations against them are that they signed materials submitted to the SEC in connection with WRT's offering of 489,500 shares of common stock in December 1994, id. ¶ 48, and that they signed the materials submitted to the SEC in connection with the Senior Notes Offering. Id. ¶ 53. As stated above, given the clandestine practices of McGuire and their role as outside directors, these allegations do not lead to a conclusion that Rash and Lam's actions approximated an actual intent to aid in the fraud committed at WRT. The Individual Defendants' motion as it applies to Rash and Lam is granted.

III. Leave to Replead The Court determines that, to the extent that the instant motions have been granted, Plaintiffs are not given leave to replead. Plaintiffs have already had two opportunities to plead causes of action against the Underwriter Defendants and Defendants Guy, Rash, and Lam. The Court finds that given the extensive investigation Plaintiffs have conducted in this matter, any further attempt at amending their complaint against these Defendants would be futile. Plaintiffs clearly take exception to the Court's ruling on their 1933 claims, but further amendment will not cure any defect according to the Court's ruling on the standing issue, a matter of law.

CONCLUSION *15 For the reasons stated above, the Underwriter Defendants' motion is granted, Scotia's motion is




denied, and the Individual Defendants' motion is denied as to McGuire and Hale, but granted as it pertains to Guy, Lam, and Rash. Plaintiffs are not given leave to replead the dismissed portions of its complaint. The parties that are still extant in this case shall appear for a status conference at 9:45 AM on April 19, 1999 in Courtroom 20C of the United States Courthouse, 500 Pearl Street, New York, New York. SO ORDERED. S.D.N.Y.,1999. In re WRT Energy Securities Litigation Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 Briefs and Other Related Documents (Back to top) • 1:96cv03611 (Docket) (May. 15, 1996) • 1:96cv03610 (Docket) (May. 15, 1996) END OF DOCUMENT





United States District Court, N.D. California. Larry STACK and Ari Parnes, on behalf of themselves and all others similarly situated,

Plaintiffs, v.

Keith R. LOBO, et al., Defendants. Civ. No. 95-20049 SW.

April 20, 1995.

ORDER DISMISSING PLAINTIFFS' FIRST AMENDED COMPLAINT

SPENCER WILLIAMS, District Judge. *1 In this securities fraud class action, Plaintiffs allege that Quickturn Design Systems, Inc. and its officers and directors (“the Corporate Defendants”), in concert with Morgan Stanley, Hambrecht & Quist and two of their analysts (“the Underwriters”), defrauded investors in violation of § 11 and § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77k & 77l, § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. The Corporate Defendants now move to dismiss Plaintiffs' First Amended Complaint (“FAC”) pursuant to Fed.R.Civ.P. 12(b)(6) and 9(b). The Underwriters have moved for joinder in this motion. Based on the following, the Court GRANTS the Corporate Defendants' motion, and DISMISSES the claims against all Defendants.

BACKGROUND Quickturn is a high-technology company located in Mountain View, California that designs and manufactures verification solutions for the design of integrated circuits and electronic systems. Quickturn's systems allow design engineers to create reprogrammable prototypes used in the fabrication of silicon chips. The Corporate Defendants are officers, directors, and outside directors of Quickturn. Plaintiffs are a group of individual investors who bought Quickturn common stock between December 15, 1993 and January 5, 1995 (the “Class Period”). The facts leading to this lawsuit are as follows. On

December 15, 1993, Quickturn completed an initial public offering (“IPO”) in which the company issued 3.4 million shares of common stock at $12 per share. Morgan Stanley and Hambrecht & Quist served as lead underwriters of the Quickturn IPO. During early and mid-1994, Quickturn's stock price fluctuated in a volatile manner, from a high of $16 1/2 in mid-April to a low of $5 1/4% in mid-July. At the end of 1994, the stock price was slightly more than $13 per share. Then, on January 5, 1995, Quickturn announced that it had taken a $3.7 million bad debt writeoff for sales to two customers who had advised Quickturn of their inability to pay. In response, the stock price fell more than 50 percent to $7 1/4 per share. Plaintiffs filed suit approximately two weeks later, on January 20, 1995, alleging that during the Class Period the Corporate Defendants and the Underwriters participated in a scheme to defraud the investing public by deceiving them about various aspects of Quickturn's current and future financial performance. According to Plaintiffs, Defendants became so desperate to keep pace with their earnings projections that they: 1) committed accounting fraud by making sales to less proven customers, by prematurely and improperly recognizing revenue, and by understating financial reserves for doubtful accounts; 2) issued false and misleading statements about Quickturn's financial situation, projected earnings, and business prospects, and; 3) adopted false and misleading statements made by securities analysts. *2 The Corporate Defendants moved to dismiss the Complaint on February 18, 1995. Subsequently, on March 6, 1995, Plaintiffs amended. The Corporate Defendants, joined by the Underwriters, now move to dismiss Plaintiffs' FAC.

LEGAL STANDARD Under the liberal federal pleading policies, a plaintiff need only give defendant fair notice of the claims against it. Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). A claim should not be dismissed unless it is certain that the law would not permit the requested relief even if all of




the allegations in the complaint were proven true. Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir.1987), cert. denied, 484 U.S. 944, 108 S.Ct. 330, 98 L.Ed.2d 358 (1987). Therefore, for purposes of this motion to dismiss, the Court assumes the truth of all factual allegations in the complaint as well as all reasonable inferences drawn from them. In complaints alleging fraud, however, the heightened pleading standards of Fed.R.Civ.P. 9(b) apply. This rule requires averments of fraud or inequitable conduct to be “stated with particularity.” Fed.R.Civ.P. 9(b). Rule 9(b) does not necessitate pleading of detailed evidentiary matter. Nonetheless, mere conclusory allegations of fraud are insufficient. Moore v. Kayport Package Express, 885 F.2d 531, 540 (9th Cir.1989). The plaintiff must include statements regarding the time place and nature of the alleged fraudulent activities, and must specifically identify what was misrepresented or concealed so as to give the opposing party notice of the particular conduct which is alleged to constitute the fraud. Id. Merely making general conclusory allegations of fraud, and then reciting a list of neutral facts, is not sufficient. Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir.1985). The Ninth Circuit recently clarified the scope of Rule 9(b) pleading requirements as applied to securities fraud actions in the case of In re Glenfed, Inc. Securities Litigation, 42 F.3d 1541 (9th Cir.1994) (en banc). According to the Glenfed court, a plaintiff does not state a claim for securities fraud merely by asserting that a company's revelation of bad news means that “earlier, cheerier” statements must have been false. Id. at 1548. Rather, the plaintiff must plead the specific circumstances of the alleged fraud, including the time, place, and nature of the statements made, and also facts demonstrating how the statements were false or misleading. Id. The Glenfed court further suggested that the most direct way to prove that representations were false when made is to point to inconsistent contemporaneous statements or omissions which contradict the challenged statements. Id. at 1549. In deciding a motion to dismiss, the court is not limited by the allegations contained in the complaint if the complaint is accompanied by attached documents. Such documents are deemed part of the complaint and may be considered in determining whether the plaintiff can prove any set of facts in support of the claim. Durning, 815 F.2d at 1267. The court may also consider “documents whose contents are alleged in a complaint and whose

authenticity no party questions, but which are not physically attached to the pleading.” Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir.1994), cert. denied, 114 S.Ct. 2704, 129 L.Ed.2d 832 (1994).

DISCUSSION I. THE CORPORATE DEFENDANTS' MOTION TO

DISMISS

A. § 10(b) Claims *3 After reviewing the allegations contained in the FAC, the Court finds that Plaintiffs have failed to allege any facts in support of their § 10(b) claims with sufficient particularity to satisfy Fed.R.Civ.P. 9(b). Instead, Plaintiffs have concocted a classic “fraud by hindsight” case. Plaintiffs' FAC contains substantial amounts of boilerplate language, and is devoid of any contemporaneous facts which tend to show that any statements made by the Corporate Defendants or Underwriters were false when made. Plaintiffs' pleading strategy is to allege wrongdoing vaguely and conclusorily in general introductory paragraphs, and then quote verbatim from financial disclosures, press releases, and analysts' reports. In sum, Plaintiffs have done exactly what Glenfed said they could not: they have alleged in a conclusory manner that because Plaintiffs made later sobering statements, their “earlier cheerier” predictions must have been false. See Glenfed, 42 F.3d at 1548. The following sections will explain exactly how Plaintiffs § 10(b) allegations are defective.

1. The Law Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, makes it unlawful to use in connection with “the mails or facilities of interstate commerce” any “manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe....” Rule 10b-5 promulgated under section 10(b) provides as follows: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, (1) to employ any device, scheme, or artifice to defraud,




(2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of circumstances under which they were made, not misleading, or (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5 (1993). Despite the fact that Rule 10b-5 says nothing about intent to defraud or knowledge of falsity, the Supreme Court has ruled that recovery in a private Rule 10b-5 lawsuit requires proof of the defendant's scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S.Ct. 1375, 1381, 47 L.Ed.2d 668 (1976); see also, Aaron v. SEC, 446 U.S. 680, 690, 100 S.Ct. 1945, 1952-1953, 64 L.Ed.2d 611 (1980) (scienter also required in lawsuit brought by SEC). The Hochfelder Court defined this scienter as “a mental state embracing intent to deceive, manipulate, or defraud.” Hochfelder, 425 U.S. at 194, n. 12, 96 S.Ct. at 1381, n. 12.

2. Plaintiffs' Claims Plaintiffs' § 10(b) allegations can be divided into four general categories: 1) accounting fraud; 2) the company's own statements; 3) analysts' reports, and; 4) the “scheme” to defraud. The Court will examine each category of allegations in turn.

a. Accounting Fraud Allegations *4 Plaintiffs claim that the Corporate Defendants engaged in several types of accounting fraud in order to bolster earnings and deceive the investing public about Quickturn's true financial situation and prospects. Based on the following, Plaintiffs have not pled any of their accounting fraud claims with sufficient particularity to satisfy Fed.R.Civ.P. 9(b).

i. The $3.7 Million Writeoff Plaintiffs central allegation is that, during the second quarter of 1994, Defendants improperly recognized $3.7 million in sales revenue “on purported sales of product for which payment was not probable or likely” in violation of standard accounting principles.

FAC, ¶ 104. According to Plaintiffs, Quickturn shipped $3.7 million of its products “to two customers ($2 million to customer A, and $1.7 million to customer B) who did not have the ability or intention to pay,” FAC, ¶ ¶ 104, and recognized these sales as earnings “despite serious doubts as to the collectibility of the revenue, so as to prevent taking a loss in the second quarter.” FAC, ¶ 106. Subsequently, during the fourth quarter of 1994, Quickturn was forced to write off these two sales. The resulting reduction in fourth quarter earnings made Quickturn's stock plummet more than 50 percent, and precipitated the current suit. Plaintiffs' allegations concerning the $3.7 million writeoff fail to state a claim under Rule 9(b). The problem with Plaintiffs' allegations is that they do not explain how or why it was unlikely that the two customers in question lacked the “ability or intention” to pay their bills. Plaintiffs do not name the customers (aside from labelling them customers A and B), or specify any financial difficulties or other reasons why payment was doubtful. Nor does the mere fact that Plaintiffs mention the dollar amount of the writeoff make their allegations adequate. See In re Genentech, Inc. Sec. Litig., [1989-90 Transfer binder] Fed.Sec.L.Rep. (CCH) ¶ 94,901 at 94969 (N.D.Cal.1990) (“The mere listing of dollar amounts in a complaint without identifying any factual allegations to support them is insufficient to withstand a motion to dismiss under Rule 9(b)”).

ii. Adequacy of Reserve for Doubtful Accounts Plaintiffs also allege that Quickturn violated accounting principles by failing to allow adequate reserves for doubtful accounts receivables in its March 31, 1994, June 30, 1994, and September 30, 1994 financial statements. FAC, ¶ 108-110. According to Plaintiffs, these violations are illustrated by the fact that Quickturn's reserve for bad debts did not rise in proportion to the growth in sales to “less creditworthy customers (including foreign customers with whom it had no prior credit experience).” FAC, ¶ 109. The only specific facts pled in support of these allegations are that: 1) Quickturn's reserves decreased from 7% of gross accounts receivable on December 31, 1993 to 4.8% on September 30, 1994, and; 2) the proportion of Quickturn's sales to top 10 customers (such as IBM, Intel, and AMD) declined from 83% in early 1993 to 50%-60% in early 1994. *5 Again, Plaintiffs' allegations are inadequate.




Plaintiffs do not specify who any of these so-called “less creditworthy” customers are, or explain why any of them would be less likely to pay their bills. Nor do Plaintiffs clarify why foreign customers would be more prone to have credit problems, or justify why a declining proportion of sales to top 10 customers means that Quickturn should have increased its allowance for doubtful accounts. Finally, Plaintiffs do not allege any facts showing that Quickturn's decision to set its reserve for doubtful accounts at a certain level was not a permissible business judgment. After all, accounting principles do not require a company to set its reserve for doubtful accounts at any predetermined percentage of accounts receivable. In sum, Plaintiffs allegations are too conclusory to satisfy Rule 9(b), and their statistics are too speculative to raise any inference of fraud.

iii. Restructuring Reserve Next, Plaintiffs claim that Quickturn overstated the $9.4 million “restructuring charge” recorded as part of the PiE merger in June of 1993. FAC, ¶ 111. According to Plaintiffs, by overstating this charge, Quickturn created a “cushion” for future earnings, that it used to falsely portray the company as a more successful enterprise than it actually was. FAC, ¶ 111. Yet again, Plaintiffs' allegations fail for lack of particularity. Plaintiffs have alleged no facts that show the restructuring charge was excessive when recorded. Nor do Plaintiffs single out any particular restructuring charges and specify how they were improper. As such, Plaintiffs' allegations are baldly conclusory, and thus clearly insufficient.

iv. Premature Recognition of Revenue Lastly, Plaintiffs allege that Quickturn violated accounting principles by recording revenue when it signed contracts for sales of its products, instead of at the time of actual shipment. FAC, ¶ 107. According to Plaintiffs, this premature recognition is demonstrated by the fact that “in the second quarter revenue decreased 10.5% from the first quarter, yet receivables increased 6.8%.” Id. Again, Plaintiffs' allegations fail for lack of particularity. Plaintiffs do not name a single customer or sale where Quickturn prematurely

recognized revenue. Compare In re Wells Fargo Securities Litigation, 12 F.3d 922, 926-27 (9th Cir.1993) (allegations which identified nine problem borrowers by name were adequate), cert. denied, 115 S.Ct. 295, 130 L.Ed.2d 209 (1994). Nor do Plaintiffs identify any contemporaneous facts or statements which suggest that Defendants were engaging in premature recognition of revenue. Instead, Plaintiffs rely solely on conclusory accusations, and statistics regarding revenue and receivables which may be indicative of numerous factors aside from accounting fraud. After all, an increase in the ratio of receivables to revenue, without more, does not warrant an inference of fraud. See id. at 926.

b. The Company's Own Statements *6 Plaintiffs also claim that statements made by the Corporate Defendants in numerous press releases, conference calls, and the “pre-offering Roadshow” were false and misleading. As explained below, none of Plaintiffs allegations regarding these statements are adequate. i. Statements About Demand for, Sales of, and Market

Reaction to Quickturn's Products Plaintiffs allege that throughout the Class Period Quickturn's officers made various false statements about the demand for, sales of, and market reaction to Quickturn's products. First, Plaintiffs claim that Quickturn's officers falsely asserted that Quickturn's products were experiencing strong demand and were being sold to a broadening customer base. FAC ¶ ¶ 57, 64, 66, 68, 69, 77, 91. According to Plaintiffs, these statements were false because Quickturn's emulation systems “suffered from a competitive disadvantage” compared to other companies' products due to their high price. FAC, ¶ 76(c). These allegations are insufficient because Plaintiffs do not allege any particular facts showing that Quickturn was having problems selling its products at the time the statements about demand and customer base were made. Second, Plaintiffs contend that on July 14, 1994, Quickturn's officers falsely represented that “large sales not closed in the second quarter would, with one or two exceptions, be closed in the last two quarters of 1994.” FAC, ¶ 77. According to Plaintiffs, Quickturn's officers “did not have any




adequate reason to believe” that these sales would close, because Quickturn was having “fundamental problems in selling ... emulation systems.” FAC, ¶ 101(c). These allegations fail for the same reason as the ones immediately above: Plaintiffs have not pled any facts tending to show that Quickturn's statements were false when made. Third, Plaintiffs refer to statements made by Quickturn officers regarding the introduction of new products: the “Logic Animator” and the “System Realizer”. FAC, ¶ 57, 91, 92. These allegations are inadequate because Plaintiffs do not even allege that these statements were false.

ii. Comparisons of Actual Results to Internal Expectations

Plaintiffs also allege that three of Quickturn's officers made false statements on three occasions that demand for Quickturn's products was “stronger than expected”, and that Quickturn's sales performance was on target. FAC, ¶ ¶ 57, 66, 69. Plaintiffs claim that these statements were false because “sales were, in fact, below levels internally planned or budgeted.” FAC, ¶ 76(d). Again, Plaintiffs allegations are purely conclusory. Plaintiffs do not cite the dates or preparers of any internal forecasts. Nor do they specify the manner in which any forecasts differed from the information divulged in Quickturn's public statements.

iii. Comments About the Industry Next, Plaintiffs claim that Quickturn's officers misrepresented the state of the market for emulation systems by characterizing it as “large and growing”, stating that emulation was accepted as “the preferred system-level verification solution for electronics systems design”, and claiming that “key segments of semiconductors ... have emerged as significant opportunities for emulation technology.” FAC, ¶ ¶ 57, 64. *7 Plaintiffs' allegations are inadequate because they fail to explain how these statements were false. Plaintiffs do not argue that the market for emulation systems was not large and growing or that emulation was not accepted in the market. Nor do Plaintiffs cite any facts in support of such contentions.

iv. Descriptions of the Sales Force Plaintiffs further allege that Quickturn made two statements, in its December 15, 1993 Prospectus and its 1993 10-K, misrepresenting that “the Company employs a highly skilled sales force ... capable of serving the sophisticated needs of prospective customers' engineering and management staffs.” FAC, ¶ ¶ 59, 67. According to Plaintiffs, these statements were untrue when made because Quickturn's sales force was actually plagued with high turnover, lacked adequate training, and was made up of some individuals who had never closed a single sale. Id., ¶ ¶ 75, 76(a)-(b). The only facts pled in support of these allegations are hindsight explanations the Corporate Defendants made during conference calls on July 13, 1994 that “Quickturn stumbled in the 2Q because of sales execution,” that “poor execution in the selling effort caused the closing of 5-6 large orders to slip”, and that “Quickturn did not manage a complex selling process well enough.” FAC, ¶ ¶ 11, 75, 78. Plaintiffs' allegations here once again fail for lack of particularity. Plaintiffs merely allege in a conclusory manner that Quickturn's sales force was inadequately skilled and trained. Plaintiffs do not specify the types of problems involved, state the qualifications that were lacking, or make any comparisons with the sales forces of similar companies. Furthermore, Plaintiffs fail to cite any contemporaneous facts or statements in support of their arguments. Quickturn's later explanations in July of 1994 that poor sales execution was to blame for weak second quarter performance does not establish that problems in sales were evident when the “earlier, cheerier” statements about the “highly skilled” nature of the sales force were made. See Glenfed, 42 F.3d at 1548. Nor does a period of poor sales performance lead to an inference that the sales force was necessarily unskilled and undertrained.

v. Predictions of the Future Lastly, Plaintiffs allege that on six occasions Quickturn's officers falsely represented that Quickturn's earnings would increase and that profitable growth would continue into the future. FAC, ¶ ¶ 57, 61, 66, 69, 77, 92. The officers predicted that “stronger than anticipated demand, combined with tight cost controls would result in accelerating earnings per share for Quickturn in succeeding quarters and that the market for Quickturn's products ... would continue to expand




during the next several years.” FAC. ¶ 57; See also, FAC, ¶ ¶ 66, 69, 92. The officers also stated that Quickturn would “achieve strong continued profitable growth,” FAC, ¶ 61, and made specific projections for earnings per share. FAC, ¶ 57, 77. In support of the falsity of these statements, Plaintiffs allege only that they were made without any “reasonable basis.” FAC, ¶ ¶ 76(i)-(j), 101(l)-(n). *8 These allegations are insufficient because Plaintiffs have failed to plead any facts whatsoever tending to show that these predictions were false when made. Plaintiffs allege only that these statements lacked a “reasonable basis”, without providing any specific support or explanation for how or why that was the case.

c. Analysts' Statements Plaintiff's FAC also alleges that Defendants are liable for misleading projections contained in twenty-seven securities analysts' reports issued by Morgan Stanley, Hambrecht & Quist and Smith Barney. In their motion to dismiss, Defendants respond that: 1) Plaintiffs have failed to sufficiently allege that Defendants adopted the analysts' projections as their own, and; 2) Plaintiffs have failed to show that there was no reasonable basis for the analysts' statements when they were made. The general rule is that a company may be liable for analysts' forecasts which it fostered and reviewed but failed to correct, if it expressly or impliedly represented that the information in the forecasts was accurate or coincided with the company's views. In re Syntex Corp. Securities Litigation, 855 F.Supp. 1086, 1097 (N.D.Cal.1994). For liability to attach, the plaintiff must demonstrate: 1) that a corporate insider adopted the analysts' forecasts, see Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 163 (2d Cir.1980), and; 2) that the insider knew the analysts' forecasts were unreasonable when made yet failed to disclose their unreasonableness to investors. See Wielgos v. Commonwealth Edison, 892 F.2d 509, 516 (7th Cir.1989); In re Verifone Securities Litigation, 784 F.Supp. 1471, 1486-87 (N.D.Cal.1992).

i. Adoption To plead adoption of analysts' statements with a sufficient degree of specificity to satisfy Rule 9(b), a plaintiff must: 1) identify specific analysts' forecasts and name the insider who adopted them; 2) point to

specific interactions between the insider and the analyst which gave rise to entanglement, and; 3) state when these interactions occurred. Syntex, 855 F.Supp. at 1097; In re Caere Securities Litigation, 837 F.Supp. 1054, 1059 (N.D.Cal.1993). Furthermore, entanglement requires a two-way flow of information. Syntex, 855 F.Supp. at 1097. The plaintiff must allege that the insider provided misleading information to an analyst, that the analyst relied on this information in preparing a report, and that the insider somehow endorsed or approved the report prior to or after its publication. See id. (dismissing claims based on analysts' reports because there were “no factual allegations that [the insider] entangled himself with the report prior to or after its publication ... by endorsing or approving the spin its authors put on the information he had disclosed or by attesting to the accuracy of its forecasts or conclusions”). Here, Plaintiffs' FAC contains several generalized paragraphs alleging that certain “senior officers of Quickturn (i.e., Lobo, D'Amour and Ostby) communicate[d] regularly with securities analysts.” FAC, ¶ 41. These communications allegedly included “telephone conference calls, meetings and analyst briefings”, and were conducted to cause the analysts to “disseminate favorable information on Quickturn ... and to falsely present business and prospects of Quickturn to the marketplace thus artificially inflating the market price of Quickturn's stock,” FAC, ¶ 41. According to Plaintiffs, because these senior Quickturn officials reviewed and approved drafts of analysts' reports, the analysts became “conduits ... through which Quickturn provided false information to the marketplace.” FAC, ¶ 44. *9 After these general allegations, Plaintiffs go on to cite and quote liberally from the specific analysts' reports in question, FAC, ¶ ¶ 62, 63, 65, 70, 71, 72, 73, 74, 78, 79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, 90, 93, 94, 95, 96, 97, 98, 99. However, Plaintiffs do not point to specific interactions between Quickturn insiders and analysts which led to each of the reports being issued. Plaintiffs' have failed to plead adoption with particularity for any of the analysts' statements. The general introductory paragraphs of the FAC alone, which allege that a group of three Quickturn insiders made regular contacts with unspecified analysts, are not sufficient to satisfy Rule 9(b). These allegations are far too vague. There are no specific facts pled which suggest a two-way flow of information




between a particular Quickturn insider and a particular analyst on a particular date which led to the publication of a particular report. The only analysts' reports that even come close to satisfying the entanglement requirement are those seven that Quickturn allegedly copied and circulated as part of their “investor relations package.” See FAC, ¶ 42. These reports are quoted in the FAC at ¶ ¶ 62, 64, 70, 73, 81, 83, 87, 96. By reproducing and including these reports in their own stockholder informational materials, Quickturn may have impliedly represented that the information contained in those reports was accurate or reflected the company' own views. See In re RasterOps Corporation Sec. Litig., [1994-95 Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,467, at 91,195 (N.D.Cal. Oct. 31, 1994). However, because Plaintiffs do not identify the particular “investor relations package” or provide the date on which it was sent out, Plaintiffs' allegations with respect to these analysts' reports fail as well.

ii. Unreasonableness Even if Plaintiffs had satisfied the adoption requirement, they have still failed to demonstrate unreasonableness: that the analysts' forecasts lacked a reasonable basis when issued. An analyst's forecast is unreasonable only if, at the time of publication, the speaker: 1) does not genuinely believe the statement; 2) has no reasonable basis for that belief, or; 3) is aware of undisclosed facts tending to seriously undermine the accuracy of the statement. In re Verifone Securities Litigation, 11 F.3d 865, 870-71 (9th Cir.1993). It is not enough that the forecast merely turned out to be incorrect. Id. (“the fact that the prediction proves to be wrong does not render the statement untrue when made.”); Glenfed, 42 F.3d at 1548 (“It is clearly insufficient for plaintiffs to say that the later, sobering revelations make the earlier, cheerier statement a falsehood”). Here, Plaintiffs have merely paraphrased or quoted sections of the analysts' reports, and then alleged generally that all these statements were false or misleading when published. See FAC, ¶ ¶ 76(i)-(j), 101(m)-(n). Plaintiffs do not point to any contemporaneous facts or information that undermine the accuracy or veracity of any particular statements when they were made. Such allegations are not pled with sufficient particularity to withstand scrutiny

under Rule 9(b). See Semegen, 780 F.2d at 731 (it is insufficient to “set forth conclusory allegations of fraud ... punctuated by a handful of neutral facts”).

d. The “Scheme” to Defraud *10 Finally, Plaintiffs argue that Defendants participated in a “scheme” or “course of business” designed to defraud the investing public. Plaintiffs characterize this as an “independent basis for liability” under § 10(b). See Plaintiffs' Opposition, at 15. Plaintiffs' “scheme” claims are misguided for two reasons. First of all, pursuant to the Supreme Court's ruling in Central Bank v. First Interstate Bank, 511 U.S. 164, 114 S.Ct. 1439 (1994), several courts in this district have held that secondary liability claims based on allegations of “conspiracy” are not actionable under § 10(b). Syntex, 855 F.Supp. 1097-98; RasterOps, [1994-95 Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,467, at 91,195; In re Ross Securities Litigation, [1994-95 Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,363, at 90,495 (N.D.Cal. July 21, 1994). Here, Plaintiffs' “scheme” allegations are no more than a thinly disguised attempt to avoid the impact of the Central Bank decision. See, e.g., In re Gupta Corp. Securities Litigation, 1994 WL 748988, *28 (N.D.Cal. Dec. 9, 1994) (rejecting the plaintiffs' attempts to recharacterize non-actionable conspiracy claims as “scheme” claims, and dismissing such claims with prejudice). Second, in the absence of any sufficiently pled, actionable misrepresentations or omissions, there is no basis for liability under § 10(b). See Ross, [1994-95 Binder] Fed.Sec.L.Rep. ¶ 98,363, at 90,495 (there can be no secondary liability under § 10(b) without a primary violation: “In civil cases conspiracy is a theory of liability available only when a completed tort exists”). Where, as here, there are no primary violations pled with particularity, any secondary liability claims must fail as well. For the foregoing reasons, Plaintiffs' “scheme” claims are DISMISSED WITH PREJUDICE.

B. § 11 and § 12(2) Claims Plaintiffs also assert claims under § § 11 and 12(2) of the Securities Act of 1933, 15 U.S.C. § 77k & 77l. Based on the following, Plaintiffs fail to state a claim for relief under either of these statutory sections.




1. Applicability of Fed.R.Civ.P. 9(b)'s Particularity Requirements to § 11 and § 12(2) Claims

Under § 11, 15 U.S.C. § 77k, anyone who buys a security pursuant to a false or misleading registration statement may sue for damages. To prevail, the plaintiff must demonstrate: 1) that the registration statement contained an omission or misrepresentation, and; 2) that the misrepresentation or omission was material. See Verifone, 11 F.3d at 868-69. Under § 12(2), 15 U.S.C. § 771, buyers have an express cause of action for rescission against sellers of securities who make material misrepresentations or omissions “by means of a prospectus or oral communication.” In contrast to § 10(b), liability under both § 11 and § 12(2) does not require scienter. See Kaplan v. Rose, [1994-95 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,422, at 90,874-75 (9th Cir. Oct. 11, 1994) (under § 11, defendants may be held liable for innocent or negligent material misrepresentations or omissions); Ellis v. Carter, 291 F.2d 270, 272 (9th Cir.1961) (§ 12(2) (relieves the plaintiff of proving scienter). *11 Plaintiffs argue that since their § 11 and § 12(2) claims do not allege fraud and do not require scienter, Rule 9(b)'s particularity requirements are not applicable. Plaintiffs are correct. Although some courts have applied Rule 9(b) to § 11 and § 12(2) claims that merely adopt allegations of fraud in a wholesale manner, see Melder v. Morris, 27 F.3d 1097, 1100 n. 6 (5th Cir.1994); Shapiro v. UJB Financial Corp., 964 F.2d 272, 287-88 (3rd. Cir.1992), cert. denied, 113 S.Ct. 365, 121 L.Ed.2d 278 (1992), here Plaintiffs have explicitly excluded their fraud allegations from Counts I and II of the FAC. Instead, they base these counts solely on averments of negligent or innocent material misrepresentations. FAC, ¶ ¶ 116-129. In this situation, where there are no allegations of intentional or willful fraudulent conduct, Rule 9(b) is not applicable. See Phar-Mor, Inc. Securities Litigation, 848 F.Supp. 46, 48 (W.D.Pa.1993) (refusing to apply Rule 9(b) to § 12(2) claim which tracked statutory language, and was worded solely in negligence terms). Therefore, Plaintiffs' § 11 and § 12(2) claims cannot be disposed of under the analysis of Section I.A. above. The Court must decide whether Plaintiffs' § 11 and § 12(2) allegations state a claim for relief under the more lenient notice pleading standards.

2. § 11 Claims

Although neither party specifically addresses the adequacy of Plaintiffs' § 11 cause of action, except to argue over whether Rule 9(b)'s particularity requirements apply to it, Plaintiffs have failed to state a claim under this statutory provision. Section 11 imposes liability only for misrepresentations or omissions contained in “registration statements.” 15 U.S.C. 77k. An SEC registration statement contains a cover letter, a preliminary prospectus, and a technical disclosures section. The final prospectus is not part of the registration statement; it is filed later as a separate document. See 17 C.F.R. § 230.424. Here, Plaintiffs' allege that they bought Quickturn stock that was “issued pursuant to the Prospectus.” FAC, ¶ ¶ 20-21. They go on to cite alleged false and misleading statements contained in Quickturn's December 15, 1993 Final Prospectus. See FAC, ¶ ¶ 58-60. Plaintiffs do not identify any misrepresentations or omissions contained in any part of the registration statement; nor do they state that they bought stock pursuant to such a statement. As such, Plaintiffs' allegations fail to state a claim under § 11. See Shapiro, 964 F.2d at 288-89 (holding that Plaintiffs' allegations that they bought stock pursuant to a “prospectus” did not state a claim under § 11 because a prospectus and a registration statement are “distinctly separate document[s] under the federal securities laws”).

3. § 12(2) Claims In the recent case of Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 115 S.Ct. 1061 (1995), the Supreme Court held that § 12(2) applies only to initial public offerings, not aftermarket transactions. Based on this decision, Defendants argue that Plaintiffs fail to state a claim under § 12(2) because Plaintiffs do not allege that they bought stock in Quickturn's IPO. In response, Plaintiffs argue that, notwithstanding the Supreme Court's decision, they may recover under § 12(2) because: 1) their shares are directly traceable to those issued in Quickturn's IPO, and; 2) their shares should be deemed to be purchases in the offering because they bought them within 90 days thereafter. *12 Plaintiffs' arguments are unpersuasive. Even if the Court were to accept arguendo the proposition




that § 12(2) applies to aftermarket stock purchases bearing a sufficient nexus to an IPO, Plaintiffs have not alleged any facts giving rise to an inference that their shares were either “directly traceable” to Quickturn's IPO or were purchased within 90 days thereof. Plaintiffs have merely alleged that they bought shares issued “pursuant to the Prospectus.” FAC, ¶ ¶ 20-21. Plaintiffs do not provide the dates when they bought their stock, or specify any other circumstances demonstrating a close relationship between their purchases and the IPO. Based on the allegations in the FAC, Plaintiffs could have purchased their stock at any time before the Class Period ended on January 5, 1995, more than a year after the IPO. In sum, because Plaintiffs do not allege any facts demonstrating a nexus between their purchases of stock and the IPO, they fail to state a claim under § 12(2).

II. THE UNDERWRITERS' MOTION TO DISMISS The Underwriters have filed a Notice of Joinder in the current motion, as well as their own separate motion to dismiss scheduled for hearing on May 2, 1995. Since the Court has found that Plaintiffs have not pled any actionable misrepresentations or omissions under § 10(b), § 11, or § 12(2), no claims against the Underwriters survive. Therefore, all claims against the Underwriters are DISMISSED, and the May 2, 1995 hearing date on the Underwriters' motion to dismiss is VACATED.

CONCLUSION Based on the foregoing, all claims in the FAC against all Defendants are DISMISSED as follows: 1) Plaintiffs' claims based on the “scheme” to defraud under § 10(b) are DISMISSED WITH PREJUDICE 2) All of Plaintiffs' other claims are DISMISSED WITH LEAVE TO AMEND. Should Plaintiffs wish to file a Second Amended Complaint, they must do so by May 19, 1995. Thereafter, if both the Corporate Defendants and the Underwriters decide to file motions to dismiss, they should, if possible, coordinate their motions for hearing on the same date. IT IS SO ORDERED.

N.D.Cal.,1995. Stack v. Lobo Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) Briefs and Other Related Documents (Back to top) • 5:95CV20049 (Docket) (Jan. 20, 1995) END OF DOCUMENT


Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2000 WL 1310529 (N.D.Tex.), Fed. Sec. L. Rep. P 91,208 (Cite as: Not Reported in F.Supp.2d)


United States District Court, N.D. Texas, Dallas

Division. Allan ZISHKA, et al., On Behalf of Themselves and

All Others Similarly Situated, Plaintiffs, v.

AMERICAN PAD & PAPER COMPANY, et al. Defendants.

No. 3:98-CV-0660-M.

Sept. 13, 2000.

MEMORANDUM OPINION AND ORDER LYNN, J. *1 This is a securities fraud case, brought as a class action for the period from July 2, 1996 through December 17, 1997, against various persons and entities associated with now bankrupt American Pad & Paper (“Ampad”). Claims are asserted under § 10(b) of the Securities Exchange Act of 1934 (“1934 Act”), SEC Rule 10b-5, and against certain Defendants under § 20(a) of the 1934 Act. The Defendants are large shareholders of Ampad, certain of its officers and directors, the parent of its lending bank, and certain of the underwriters for Ampad's July 2, 1996 Initial Public Offering (“IPO”), who later issued favorable analyst reports on Ampad. The Defendants move to dismiss, claiming that under Fed. R. Civ. P. 9(b) and (12)(b)(6), and the Private Securities Litigation Reform Act (“PSLRA”), Plaintiff's Complaint cannot withstand legal scrutiny. For the reasons discussed below, the Court finds the Complaint deficient and thus GRANTS the Motions to Dismiss, but grants Plaintiffs leave to amend. The challenged Complaint is 136 pages long, but despite its length, many of its allegations are undetailed and conclusory, it is undifferentiated as to the various Defendants, and repeats, multiple times, vague and overly broad allegations. Such an approach is insufficient to satisfy the heightened pleading standards of the PSLRA and Fed. R. Civ. P. 9(b). To state a claim under § 10(b) of the 1934 Act, Plaintiffs must allege (1) a misrepresentation or omission; (2) of a material fact; (3) made with the intent to defraud; (4) on which the Plaintiffs relied; (5) which proximately caused the Plaintiffs' injury.

Williams v. WMX Technologies, Inc, 112 F.3d 175, 177 (5 th Cir.1997). A plaintiff's claims for a violation of § 10(b) of the 1934 Act must satisfy the strict pleading requirements for fraud set out in Fed. R. Civ. P. 9(b) and the PSLRA. Fed. R. Civ. P. 9(b) requires a specification of the alleged fraudulent statements, identification of the speaker, a description of when and where the statements were made, and an explanation of what makes such statements fraudulent. Williams, 112 F.3d at 178. Where, as here, allegations are made on information and belief,FN1 a plaintiff must state with particularity all facts on which the belief is formed. 15 U.S.C. § 78u-4(b)(2).

FN1. Despite the fact that the Complaint purports to be predicated on an investigation by Plaintiffs' counsel, the Court finds that information and belief pleading triggers the specificity requirement.

For this and other similar cases pending before this Court, the Court now adopts standards which it will apply in evaluating Complaints subject to the PSLRA unless: (1) appellate courts whose decisions are dispositive in this district rule that the law mandates otherwise; or (2) Congress amends the PSLRA. First, for proof of scienter, which is “a mental state embracing intent to deceive, manipulate or defraud,” FN2 the Court concludes that scienter can be based upon allegations of “motive and opportunity” as alternative to allegations of “conscious behavior or severe recklessness,” thereby following the lead of most of the other courts in this district. See Branca v. Paymentech, Inc., No. 3:97-CV-2507-L, 2000 WL 145083, at *5 (N.D.Tex. Feb. 8, 2000); Coates v. Heartland Wireless Communications, Inc., 55 F.Supp.2d 628, 642 (N.D.Tex.1999) (“Coates II”); Zuckerman v. Foxmeyer Health Corp., 4 F.Supp.2d 618, 623 (N.D.Tex.1998); STI Classic Fund v. Bollinger Indus., No. 3:96-CV-823-R, 1996 WL 885802, at *1 (N.D.Tex. Oct. 25, 1996), report and recommendation adopted in STI Classic Fund v Bollinger Indus. Inc., 1996 WL 866699 (N.D.Tex. Nov. 12, 1996); accord, Robertson v. Strassner, 32 F.Supp.2d 443, 448 (S.D.Tex.1998). Second, this Court rejects the notion of “group pleading,” and “group publication” and concludes that such concepts, if previously sustainable, did not survive the adoption of PSLRA. Coates v. Heartland




Wireless Communications, Inc., 26 F.Supp.2d 910, 916 (N.D.Tex.1998) ( “Coates 1”). To comply with the PSLRA, Plaintiffs thus must plead with particularity their allegations against each individual Defendant. The Court finds the Complaint at issue here generally deficient for its failure to delineate specifically what each Defendant knew and what each Defendant said. Plaintiffs will be required to replead to remedy such omission.

FN2. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976).

PARTICULAR ASPECTS OF COMPLAINT

*2 The PSLRA requires a plaintiff to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). The Court will thus review the scienter allegations in this Complaint as to each Defendant. Defendants Charles Hanson and Russell Gard, Ampad's Chief Executive Officer and Chief Operating Officer, respectively, sold a total of 100,000 of their shares FN3 on November 10, 1997, for $13 per share. Although Ampad's stock price increased slightly shortly after their sales, it was not long before the stock price dropped substantially.FN4 Plaintiffs allege that Hanson and Gard knew bad news about Ampad was forthcoming, and that they therefore sold enough stock to cover their cost or at least to avoid losses. FN5 The Court finds such allegations sufficient to satisfy the motive aspect of scienter. With respect to Hanson and Gard, given their key roles in the Company, opportunity to defraud is clearly extant.

FN3. During the class period, Hanson and Gard sold 20% of Ampad stock they owned, or 5% of their total stock and options. Five percent has been considered too insignificant to support the “strong inference of fraud” required by the PSLRA, while twenty percent has generally been considered sufficient. Defendants thus urge that the Court should consider Hanson and Gard's options in calculating what percentage of their Ampad stock portfolios Hanson and Gard sold Plaintiff asserts the converse argument. In urging that this Court should take options into account, Defendants cite In Re Credit Acceptance Corp. Sec.

Litig., 50 Supp.2d 662, 677 (E.D.Mich.1999) and In Re Silicon Graphics, Inc Sec. Litig., 183 F.3d 970, 987 (9 th Cir.1999). In both of those cases, however, the courts analyzed the stock sales in detail and rejected the motive and opportunity test for proof of scienter. Here, the Court adopts a more lenient standard, and declines to hold that sales yielding proceeds which appear to have covered Hanson and Gard's costs for all of their Ampad stock investment cannot support a strong inference of fraud. The Court does not have before it admissible record evidence of the option prices, and consequently does not know that exercise of the options was potentially attractive.

FN4. In the IPO, on July 2, 1996, Ampad's stock sold at $15 per share. It fell to $7 3/4 per share on December 17, 1997, the last day of the class period.

FN5. Some of these contentions are referenced in the briefs, not in the Complaint. Plaintiffs are directed to include such allegations in their Amended Complaint, if they intend to rely on them.

With respect to the other individual defendants, the Complaint does not adequately allege scienter as to them. Defendant Lavine, an outside director, bought Ampad stock on November 5, 1997 at $13.19, and apparently did not sell that stock during the class period. (Other non-Defendant officers bought Ampad stock at $12.88 and $12.94 on October 29, 1997 and November 7, 1997, respectively). The other outside directors, Defendants Gay, Wolpow and Watterson, neither bought nor sold stock during the class period. With respect to all of the outside directors, Lavine, Gay, Wolpow and Watterson, a legally sufficient motive is not attributed to them. The fact that they are employees of Bain Capital, which sponsored funds which owned substantial stock in Ampad, is, as a matter of law, insufficient to provide them with a motive to perpetrate a fraud. There is no adequate pleading of claims against them under the higher “conscious behavior or severe recklessness' standard. Further, no individual allegations are asserted against them except for the claim that each of them signed the 1996 10-K, and that all but Watterson signed Ampad's Registration Statement. In light of this Court's rejection of the group pleading/group publication doctrine, those allegations do not state




claims against the outside director Defendants. As to the other individual officer Defendants, Benson and McAleer, Plaintiffs claim that their motive to defraud is founded on their desire for lucrative compensation, under their Ampad employment contracts and for bonuses (Complaint at ¶ 35). The Court finds such allegations insufficient as a matter of law to constitute motive as a basis for establishing scienter. See Melder v. Morris, 27 F.3d 1097, 1102-04 (5 th Cir.1994); Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068-69 (5 th Cir.1994). Neither is the “conscious behavior or severe recklessness' standard satisfied by the allegations against Defendants Benson and McAleer. *3 With respect to the Bain Defendants (Bain Capital, Inc., Bain Venture Capital, a California Limited Partnership, Tyler Capital Fund, L.P., Tyler Massachusetts, L.P., Tyler International L.P. II, BCIP Trust Associates, L.P., and BCIP Associates), Plaintiffs' allegations of legally sufficient motive are similarly lacking. Plaintiffs allege that the Bain Defendants were motivated to commit fraud because they stood to make a substantial profit in the IPO, would benefit from an inflation in the value of their retained holdings, and could expect to obtain large advisory fees in the future. However, the investing Bain defendants retained 10 million Ampad shares, which were not sold even when the stock price exceeded $24. Such facts are wholly inconsistent with the profit motive attributed to the Bain Defendants. If they knew, as Plaintiffs allege, that the Ampad “house of cards” was doomed to fail, they would have disposed of such shares. Bain Capital, Inc. and Bain Venture Capital, respectively, the management company and general partner of the four investment funds, did not own Ampad stock. The Court finds the compensation motive legally insufficient to state a claim. Sufficient allegations of “conscious behavior or severe recklessness” are not stated as to the Bain Defendants; rather, such allegations are unsupportable conclusions without an adequate factual basis. To state a claim under the PSLRA against those parties, Plaintiffs must allege what each of the Bain Defendants knew, who specifically knew it, and when they learned it. Plaintiffs' claims that the Bain Defendants must have known the true facts because the funds, managed by Bain, owned a substantial amount of Ampad stock, and because several Bain employees were directors of Ampad, is legally insufficient. See generally Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068 (5 th

Cir.1994) and Melder v. Morris, 27 F.3d 1097 (5 th Cir.1994). With respect to the Underwriter Defendants, the allegations in the Complaint similarly do not set forth an adequate pleading of motive. There is no proper allegation that during or prior to the IPO the Underwriter Defendants participated in the making of statements they knew or should have known to be false.FN6 The vague hope of future business and the existence of an indemnity do not provide an adequate motive for the contention that the underwriters, later acting as analysts, gave positive outlooks for Ampad's future, despite an alleged belief that such positive spins were false. In fact, on this point, the Plaintiffs appear to be quite inconsistent. The Plaintiffs allege both that the individual analysts were “misled” (Complaint at ¶ 127), and that company insiders reviewed analysts' reports before they were issued and assured the analysts of their accuracy (see Complaint at ¶ 106), but simultaneously urge that the analysts' statements were false, misleading and recklessly made by “defendants.” (Plaintiffs' Brief at 51-53). Such inconsistent and overly broad pleading is insupportable under the PSLRA and Fed. R. Civ. P. 9(b).

FN6. The underwriters are not even alleged to have spoken during the pre-IPO roadshows.

*4 Finally, as to Defendant Bankers Trust Corporation (“BTC”), a New York bank holding company, the allegations against it in the Complaint are also insufficient. Plaintiffs must show how BTC committed the wrongdoing alleged. It is insufficient for the Plaintiffs to allege conclusorily that BTC controlled or conspired with one or both of its subsidiaries, underwriter BT Securities, or Ampad's lender Bankers Trust Company (not named in the Complaint). The allegations in the Complaint regarding the Williamhouse acquisition do not state actionable claims. At page nine, the Ampad prospectus accurately depicted Ampad's performance with (pro forma), and without (actual), Williamhouse's numbers included. As a matter of law, there is nothing deceptive about such a disclosure. To the extent Plaintiffs claim that Williamhouse's costs were inaccurately reported by Ampad (Complaint ¶ 126(a)), Plaintiffs must plead more specifically what the deficiencies with the reporting were, what was known about the deficiencies, when and by whom,




and what effect the alleged misreporting had. The Court finds the Plaintiffs' allegations regarding the LIFO reserve so confusing as to be legally insufficient. In ¶ 50(e) of the Complaint, and at numerous other places as well, Plaintiffs contend that in 1996, Ampad's profits were being adversely affected by declining paper prices. However, the LIFO claim is apparently based on the premise that paper prices were rising (Complaint ¶ 129), that proper LIFO accounting would thus decrease profitability, and that the LIFO reserve thus should have been increased, not decreased. Plaintiffs allege that the reserve was decreased for the third quarter of 1997, when Hanson and Gard made their sales, presumably to artificially inflate Ampad's profitability and thus maximize its stock price and Hanson's and Gard's proceeds. In fact, however, Ampad's LIFO reserves in the third quarter of 1997, although less than the reserves in the first and second quarters of 1997, were still more than twice what they had been in the last quarter of 1996. Plaintiffs' pleadings are insufficient in claiming that anything fraudulent was done with the LIFO reserves in 1997. During oral argument, Plaintiffs' counsel claimed that by the third quarter of 1997, Ampad's LIFO reserve was eliminated altogether. If that were true (and it seems doubtful from the evidence before the Court) and paper prices were decreasing, seemingly no fraud would be demonstrated. In light of the confusing and vague nature of their claims regarding the LIFO reserve, Plaintiffs are directed to replead. The Court notes that the prospectus sets out four pages of risk factors which appear directly at odds with some of the Plaintiffs' allegations of wrongdoing. When Plaintiffs replead, the Court will carefully scrutinize the Complaint for allegations directly at odds with clearly, accurately disclosed risks. Similarly, the Court will not treat as fraudulent statements which merely articulate accurate historical facts. *5 Finally, under Central Bank v. Interstate Bank, 511 U.S. 164 (1994), for a private claimant to state § 10(b) claims, primary violations, not aiding and abetting claims, must be asserted in order to be sustainable. Plaintiffs' allegations against most of the Defendants sound to the Court like aiding and abetting claims. In repleading, Plaintiffs are directed to make clear the basis as to each Defendant for any primary liability allegations under § 10(b). Despite the deficiencies in the Complaint alluded to above, the Plaintiffs have the potential for stating

proper claims actionable under the 1934 Act-particularly if they can support with facts claims that beginning in early 1997, certain Defendants knew, contrary to their public disclosures, that the Williamhouse acquisition was not contributing what they had expected it would add to Ampad's bottom line, that increasing paper prices had a serious potential for adversely affecting Ampad's profitability, and that, contrary to prior public statements, Ampad would not be pursuing new acquisitions and would not be introducing new products. Plaintiffs may attempt to better delineate such claims in their amended pleading. Based on the foregoing discussion, Defendants' Motions to Dismiss the Complaint are granted. To the extent Plaintiffs may cure the deficiencies noted herein, they are given one additional opportunity to do so, by filing an Amended Complaint within forty-five days of the date of this Order. As an attachment to the Amended Complaint, they shall provide a red-lined version, reflecting all additions and deletions made to the original Complaint. Plaintiffs are directed to be specific, to eliminate confusing and repetitive material and to present an amended pleading which states facts with particularity as to each Defendant. The Court will look for weighty allegations in terms of substance, not in terms of the bulkiness of the Amended Complaint. With respect to Bankers Trust Corporation and the outside directors in particular, the Court assumes that Plaintiffs' claims will, if reasserted, be substantially different from what they have asserted on theories which this Court has rejected. Defendants shall then file such further Motions to Dismiss as they deem appropriate, within forty-five days of the date of service of the Amended Complaint. Plaintiffs shall respond within thirty days thereafter, and Defendants shall reply within twenty days thereafter. The Court will then either schedule the matter promptly for argument or rule without argument. All pending Motions to Dismiss are granted; provided, however, Plaintiffs may replead within forty five days of the date of this Order and further briefing, as set out herein, will follow. SO ORDERED. N.D.Tex.,2000. Zishka v. American Pad & Paper Co. Not Reported in F.Supp.2d, 2000 WL 1310529 (N.D.Tex.), Fed. Sec. L. Rep. P 91,208 END OF DOCUMENT


GREGORY A. MARKEL (pro hac vice) ([email protected])...

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