Case 3:01-cv-02661-MMC Document 306 Filed 04/24/2006 Page 1 of 3

1 DAVID M. FURBUSH (State Bar No. 83447) DHAIVAT H. SHAH (State Bar No. 196382) 2 ROBERTA L. HARTING (State Bar No. 225067) O’MELVENY & MYERS LLP 3 2765 Sand Hill Road Menlo Park, California 94025 4 Telephone: (650) 473-2600 Facsimile: (650) 473-2601 5 E-Mail: [email protected] [email protected] 6 [email protected]

7 Attorneys for Defendant ELLEN M. HANCOCK 8

9 UNITED STATES DISTRICT COURT

10 NORTHERN DISTRICT OF CALIFORNIA 11

12 In re Master File No. C-01-2661-MMC

13 EXODUS COMMUNICATIONS, INC. DEFENDANT ELLEN HANCOCK’S SECURITIES LITIGATION REQUEST FOR JUDICIAL NOTICE 14 Honorable Maxine M. Chesney 15 Hearing Date: May 5, 2006 16 Time: 9:00 a.m. This Document Relates To: 17 ALL ACTIONS. 18

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DEFENDANT HANCOCK’S REQUEST FOR JUDICIAL NOTICE - C-01-2661-MC

Case 3:01-cv-02661-MMC Document 306 Filed 04/24/2006 Page 2 of 3

1 Pursuant to Federal Rule of Evidence 201, defendant Ellen M. Hancock respectfully 2 requests that this Court take judicial notice of each of the following documents, true and correct 3 copies of which are attached as Exhibits A through D hereto: 4 A. “First Amended Consolidated Class Action Complaint,” In re Exodus, Inc. 5 Securities Litigation, Master File No. C-01-2661-MMC, filed on July 11, 2002 in the United 6 States District Court for the Northern District of California. A true and correct copy of that 7 complaint is hereto attached as Exhibit A. 8 B. “Notice of Motion and Motion of Underwriter Defendants Goldman, Sachs & 9 Co., Merrill Lynch & Co., Morgan Stanley Dean Witter, and J.P. Morgan to Dismiss the First 10 Amended Consolidated Complaint; and Memorandum and Points and Authorities,” In re Exodus, 11 Inc. Securities Litigation, Master File No. C-01-2661-MMC, filed on October 23, 2002 in the 12 United States District Court for the Northern District of California. A true and correct copy 13 of that document is hereto attached as Exhibit B. 14 C. “Plaintiffs’ Opposition to Underwriter Defendants’ Motion to Dismiss,” In re 15 Exodus, Inc. Securities Litigation, Master File No. C-01-2661-MMC, filed on December 18, 16 2002 in the United States District Court for the Northern District of California. A true and 17 correct copy of that document is hereto attached as Exhibit C. 18 D. “Order Granting Underwriter Defendants’ Motion to Dismiss With Leave 19 to Amend; Granting Individual Defendants’ Motion to Dismiss With Leave to Amend,” In re 20 Exodus, Inc. Securities Litigation, Master File No. C-01-2661-MMC, dated August 19, 2003 21 and filed in the United States District Court for the Northern District of California. A true 22 and correct copy of that document is hereto attached as Exhibit D. 23 Exhibits A through D are proper subjects for judicial notice because they have been duly 24 filed in the United States District Court of the Northern District of California, and they are part of 25 the court record in these proceedings and are also public records. See Lee v. City of Los Angeles, 26 250 F.3d 668, 688-690 (9th Cir. 2001). 27 28

DEFENDANT HANCOCK’S REQUEST FOR JUDICIAL NOTICE - C-01-2661-MC

Case 3:01-cv-02661-MMC Document 306 Filed 04/24/2006 Page 3 of 3

1 For the foregoing reasons, defendant respectfully requests that the Court take judicial 2 notice of the documents attached as exhibits hereto.

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4 Dated: April 21, 2006 DAVID M. FURBUSH DHAIVAT H. SHAH 5 ROBERTA L. HARTING O’MELVENY & MYERS LLP 6 7 By: ______/s/ Dhaivat H. Shah 8 Dhaivat H. Shah 9 Attorneys for Defendant ELLEN M. HANCOCK 10

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12 MP1:979993.1 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 - 2 - DEFENDANT HANCOCK’S REQUEST FOR JUDICIAL NOTICE - C-01-2661-MC

Exhibit A (Part 1 of 3) M E

1 MILBERG WEISS BERSHAD HYNES & LERACH LLP 2 REED R. KATHREIN (139304) JOHN K. GRANT (169813 ) 3 EX KANO S. SAMS II (192936) 100 Pine Street, Suite 260 0 4 San Francisco, CA 94111 Telephone: 415/288-4545 5 415/288-4534 (fax ) - and - WEISS & YOURMAN 6 WILLIAM S. LERACH (68581) JOSEPH H. WEIS S 401 B Street, Suite 170 0 551 Fifth Avenue, Suite 1600 7 San Diego, CA 92101 New York, NY 10176 Telephone: 619/231-1058 Telephone: 212/682-3025 8 619/231-7423 (fax ) 212/682-3010 (fax )

9 Co-Lead Counsel for Plaintiffs

10 [Additional counsel appear on signature page .] 11 UNITED STATES DISTRICT COUR T 12 NORTHERN DISTRICT OF CALIFORNIA 1 3

14 PAUL RUTHFIELD, et al., On Behalf of Master File No. C-0 1 -266 1 -MM C Themselves and All Others Similarly Situated, 15. CLASS ACTION Plaintiffs, 16 FIRST AMENDED CONSOL IDATED vs. CLASS ACTION COMPLAINT FOR 17 VIOLATION OF THE FEDERAL ELLEN M. HANCOCK, R . MARSHALL SECURITIES LAWS 18 CASE, SAM S . MOHAMAD, DICK STOLTZ, HERBERT A . DOLLAHITE, ADAM W . 19 WEGNER, BEVERLY BROWN, WILLIAM YEACK, GOLDMAN, SACHS & CO ., 20 MERRILL LYNCH & CO ., MORGAN STANLEY DEAN WITTER AND J.P. 21 MORGAN,

22 Defendants . 23 In re : EXODUS COMMUNICATIONS, INC. 24 SECURITIES LITIGATION

25 This Document Relates To : 26 ALL ACTIONS . 27 DEMAND FOR JURY TRIAL 28 0 0

1 NATURE OF THE CASE

2 1 . This is a class action on behalf of all purchasers of the securities of Exodus

3 Communications, Inc . ("Exodus" or the "Company") between April 20, 2000 and September 25,

4 2001, inclusive (the "Class Period"), seeking remedies under the Securities Act of 1933 (the

5 "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act") . During the Class

6 Period, the defendants identified herein participated in an egregious accounting fraud designed to

-7 deceive investors of Exodus, including, among other things, falsifying Exodus' financial results by

8 wrongfully booking revenues from orders that had been cancelled, invoicing customers for services

9 prior to installation, entering into barter transactions designed solely to boost revenue, and failing

10 to appropriately credit customers when required . Defendants also made highly positive statements

11 concerning Exodus during the Class Period, even though they were aware of serious problems then

12 impacting Exodus, including large amounts of bad debt from uncreditworthy customers and lack of

13 demand for their services .

14 2 . By engaging in this fraud, defendants were able to profit through personal sales o f

15 their Exodus stock, collectively selling over 1 .4 million shares of stock for proceeds of over $72.5

16 million . Defendants were also able to maintain a high credit rating and to obtain much needed

17 funding for Exodus, including successfully completing several offerings for proceeds to Exodus of

18 almost $2 billion . Also, by engaging in this fraud, defendants were able to continue to meet Wall

1 9 Street expectations, continue Exodus' acquisition strategy, delay Exodus' bankruptcy, and maintain

20 their positions, compensation and reputations .

21 3 . Exodus filed for bankruptcy on September 26,200 1 . On September 25, 2001, the da y

22 prior to its bankruptcy filing, the Wall Street Journal published an article stating that Exodus'

23 bankruptcy was forthcoming, causing Exodus' stock price to drop to $0 .17 on record volume of 193

24 million shares. Trading on Exodus shares was halted on September 26, 2001 . Upon resumption of

25 trading on October 5, 2001, Exodus stock dropped further to $0 .10 on high volume of 72 million

26 shares . During the Class Period, Exodus' stock traded for as high as $179 per share .

27

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FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -1- 4 0

1 4. As a result of defendants' fraud, plaintiffs and other investors who acquired Exodus

2 securities during the Class Period acquired their securities at artificially inflated prices and were

3 damaged thereby.

4 JURISDICTION AND VENUE

5 5. This Court has jurisdiction over the subject matter of this action pursuant to 28 U .S .C .

6 §§ 1331 and 1337, §22(a) of the Securities Act, and §27 of the Exchange Act.

7 6. This action arises under §§11 and 15 of the Securities Act and .§ § 10(b) and 20(a) of

8 the Exchange Act and Rule 1Ob-5 promulgated thereunder (17 C .F.R. §240.1Ob-5).

9 7. Venue is proper in this district pursuant to §27 of the Exchange Act and 28 U .S.C.

10 §1391(b) because the acts charged herein, including the dissemination of materially false and

11 misleading information, occurred in this district. Exodus was located in Santa Clara, California. 12 8. In connection with the conduct complained of herein, defendants used

13 instrumentalities of interstate commerce, including the mail and interstate telephone

14 communications, and the facilities of a national securities exchange .

15 THE PARTIES

16 9 . Lead Plaintiffs Michael Klein, Teresi Trucking, Inc ., and William H.. Friedman

17 purchased Exodus securities during the Class Period and were damaged thereby . Plaintiff Thomas

18 Welsh purchased Exodus shares during the Class Period traceable to Exodus' February 6, 2001

19 Registration Statement and Prospectus for its secondary offering . Plaintiff Martin Fox purchased

20 notes during the Class Period issued in connection with Exodus' February 6, 2001 note offering .

21 10. Numerous additional plaintiffs purchased Exodus securities on the open market

22 during the, Class Period and were damaged thereby . These additional plaintiffs, if needed, have

23 stated their willingness and ability to serve as class representatives .

24 11 . Defendant. Ellen M. Hancock ("Hancock") was Exodus' Chief Executive Officer from

25 September 1998, its Chairman of the Board of Directors from June 2000, and its director from April

26 1998 . She also served as the President of Exodus from March 1998 to June 2000 and as the acting

27 Vice President of Marketing of Exodus from July 1998 to October 1998 . She resigned from the

28 Company in September 2001 . She had principal responsibility for important issues facing Exodus' FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -2- r •

1 business, its customer base, and its ability to achieve growth in its revenue and business. Hancock

2 participated in conference calls, gave interviews to reporters, and participated in drafting the

3 Company's press releases and SEC filings . Hancock made many of the statements alleged herein to

4 be false and misleading . During the Class Period, Hancock sold 371,671 shares of Exodus stock at

5 artificially inflated prices of as high as $72 .87 per share, for proceeds of over $8 million .

6 12. Defendant R. Marshall Case ("Case") was Exodus' Executive Vice President of

7 Finance and its Chief Financial Officer from January 2000 until his resignation in May 2001 . Case

8 participated in conference calls, and in drafting the Company's press releases and SEC filings and

9 signed many such documents . Case made many of the statements alleged to be false and misleading .

10 During the Class Period, Case sold 200,000 shares of Exodus stock at artificially inflated prices of

11 as high as $66.31 per share, for proceeds of over $13 million .

12 13 . Defendant Sam S. Mohamad ("Mohamad") was Exodus' President of Worldwide

13 Sales from January 2001 . Previous to that role, he served as Exodus' President of Worldwide Sales

14 and International Field Operations from June 2000 to January 2001, and as the Executive Vice

15 President of Worldwide Sales from December 1998 to June 2000. Mohamad was directly involved

16 in the fraud alleged herein, and he participated in drafting the Company's press releases and SEC

17 filings . During the Class Period, Mohamad sold 247,971 shares of Exodus stock at artificially

18 inflated prices of as high as $87 .70 per share, for proceeds of over $17 million .

19 14. Defendant Dick Stoltz ("Stoltz") was the temporary Chief Financial Officer of Exodus

20 during part of the Class Period. During the Class Period, Stoltz participated in conference calls and

21 in drafting the Company's press releases and SEC filings, and directly participated in Exodus'

22 acquisition of GlobalCenter. Stoltz made many of the statements alleged herein to be false and

23 misleading. Stoltz was a co-founder of Exodus, and served as its Executive Vice President of

24 Finance and Chief Operating Officer prior to the Class Period .

25 15. Defendant Herbert A. Dollahite ("Dollahite") was Exodus' Executive Vice President

26 of Customer Services and Support and Quality from November 1998, and Vice President of Quality

27 from June 1998 to November 1998 . Dollahite was involved in the day-to-day operations of the

28 Company, including issues pertaining to Exodus' Internet Data Center ("IDC") build-out and

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -3- 1 integration of GlobalCenter's operations with Exodus . He also reviewed the Company's SEC filings

2 and press releases and had the ability to revise them prior to their publication. He spoke to analysts

3 concerning the Company during the Class Period, Dollahite sold over 96,800 shares ofExodus stock

4 at artificially inflated prices of as high as $7 .88 per share, for proceeds of approximately $762,784 .

5 16 . Defendant Adam W . Wegner ("Wegner) was Exodus' Senior Vice President of Legal

6 and Corporate Affairs from February 2000, and Exodus' General Counsel and Secretary of Exodus

7 from July 1997. He also served as Exodus' Vice President from October 1998 to January 2000 .

8 Wegner was involved in the day-to-day operations of the Company, and was involved in issues

9 including customer demand and Company strategy . He reviewed the Company's SEC filings and

10 press releases and had the ability to revise them prior to their publication . During the Class Period,

11 Wegner sold over 219,630 shares of Exodus stock at artificially inflated prices of as high as $85 .00

12 per share, for proceeds of approximately $12 million .

13 17. Defendant Beverly Brown ("Brown") was Exodus' Executive Vice President and

14 Chief Marketing Officer from October 1999 until her resignation in May 2001 . Brown participated

15 in the day-to-day operations of the Company, reviewed the Company's SEC filings and press releases

16 and had the ability to revise them prior to their publication . During the Class Period, Brown sold

17 201,360 shares of Exodus stock at artificially inflated prices of as high as $65.88, for proceeds of

18 over $13 million.

19 18 . Defendant William Yeack ("Yeack") was Exodus' Executive Vice President of

20 Managed and Professional Services from August 1999. During the Class Period, Yeak participated

21 in the day-to-day operations ofthe Company, reviewed the Company's SEC filings and press releases

22 and had the ability to revise them prior to their publication . During the Class Period, Yeak sold

23 117,600 shares of his Exodus stock at artificially inflated prices of $64 .91 per share, for proceeds

24 of over $7.63 million.

25 19 . Defendants Hancock, Case, Wegner, DDollahite, Mohamad, Stoltz, Yeack and Brown

26 (collectively, "Individual Defendants"), were officers ofExodus during the Class Period . As ofApril

27 30, 2001, there were 554,028,272 shares of Exodus common stock outstanding and traded in an

28 efficient market on the NASDAQ National Market System. On September 26, 2001, Exodus filed

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC - 4 - 1 for Chapter 11 bankruptcy protection, and is not named as a defendant herein due to its bankruptcy

2 and liquidation.

3 20. The Individual Defendants are liable for the false statements pleaded herein . Where

4 a false and misleading oral statement was made by an individual defendant, the particular individual

5 who made the statement is liable for the statement. Where statements were made as a group, all of

6 the individuals are liable for the false statements as those statements were "group-published"

7 information for which they were responsible.

8 21 . Defendant Goldman, Sachs & Co . ("Goldman") served as an underwriter for the

9 February 6, 2001 Exodus common stock offering and the February 6, 2001 offering of 5-1/4%

10 convertible subordinated notes.

11 22 . Defendant Merrill Lynch & Co . (Merrill Lynch") served as an underwriter for the

12 February 6, 2001 Exodus common stock offering and the February 6, 2001 offering of 5-1/4%

13 convertible subordinated notes .

14 23 . Defendant Morgan Stanley Dean Witter ("Morgan Stanley") served as an underwriter

15 for the February 6, 2001 Exodus common stock offering and the February 6, 2001 offering of 5-

16 1/4% convertible subordinated notes .

17 24. Defendant J . P. Morgan served as an underwriter for the February 6, 2001 Exodus

18 common stock offering and the February 6, 2001 offering of 5-1/4% convertible subordinated notes .

19 BACKGROUND TO THE COMPANY'S BUSINES S

20 25 . Exodus owned and operated Internet Data Centers ("IDCs"), which provided physical

21 space for Exodus' clients to place their servers, along with broadband connectivity and other services

22 needed to run and operate their Internet operations .

23 26. Exodus began offering server hosting and Internet connectivity in late 1995, and

24 opened its first IDC in August 1996 . The Company went public in March 1998 . Billed as a fast

25 growth Company, its high stock price depended upon its growth rate . Exodus' stock price went up

26 985% in 1999, and the stock split four times in just three years of trading.

27 27. Beginning in early 2000, defendants recognized that the market was weakening and

28 that Exodus needed to continue to show exponential revenue growth in order to maintain its credit FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -5- 0 1 0

1 rating and to obtain additional funding. Defendants also recognized that they would personally profit

2 by selling their holdings of Exodus stock at artificially inflated prices . Thus, at the beginning of

3 2000, defendants embarked on a scheme to defraud by, among other things, entering into contracts

4 with non-creditworthy customers, falsifying Exodus' financial results by invoicing customers for

5 services prior to installation, booking revenue from orders that had been cancelled, entering into

6 barter transactions to boost revenue, and failing to appropriately credit customers when required .

7 Defendants also made numerous positive statements about Exodus' business condition and prospects

which were false.

9 28 . As a result of Exodus' improper financial practices , its revenues grew from $52 . 7

10 million in 1998, to $242 million in 1999, and to purportedly $ 818 million in 2000.

11 FALSE AND MISLEADING STATEMENTS

1 2 29. On April 20, 2000, Exodus announced its first quarter financial results, and that th e

13 Company had finally achieved earnings before net interest, taxes, depreciation, and amortizatio n

14 ("EBITDA") profitability, as follows:

15 Exodus Communications, Inc. (NASDAQ:EXDS) today reportedfirst quarter 2000 revenues of $134.1 million, a 346 percent increase over first quarter 1999, and a 1 6 32 percent increase over fourth quarter 1999.

17 Exodus reported a $1.7 million EBITDA profit (earnings before net interest expense, income taxes, depreciation, amortization and other noncash charges) for 18 first quarter 2000, compared to an EBITDA loss of $12 .6 million (excluding one-time acquisition related costs) for fourth quarter 1999 . 19 Net loss was $42.3 million in first quarter 2000, or $0 .23 per share, excluding 20 the impact of amortization of goodwill and intangible assets, and the impact of one-time expenses related to the conversion of convertible subordinated debt . Net 2 1 loss for the quarter was $58 .4 million, or $0 .32 per share, compared with a net loss of $52.9 million, or $0.30 per share, in fourth quarter 1999, and a net loss of $23 .2 22 million, or $0.14 per share, in first quarter 1999 .

23 "This period marked the first quarter that Exodus achieved EBITDA profitability," said Ellen Hancock, president and CEO . " This important milestone 24 indicates the strength of our business model and our ability to generate a return on our investments ." 25 "In addition, we added 545 new IDC customers bringing our total to 2,830 26 IDC customers," said Hancock. "At the same time, our average annualized revenue per IDC customer increased to $220,000 in the first quarter, compared to $196,000 27 in fourth quarter 1999 ."

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FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -6- 0 16

1 "Not only did Exodus go EBITDA positive this quarter but it also was an extremely strong quarter from a new bookings standpoint," said R. Marshall Case, 2 executive vice president, finance and chief financial officer . "Exodus booked $174 million of new annualized recurring revenue in the first quarter. Assuming the 3 backlog is installed today and combined with our current installed customer base, the annualized revenue run rate of recurring revenue would exceed $632 million, 4 which represents a 38 percent increasefrom the prior quarter ."

5 "In order to meet growing market demand, we continue to expand our robust suite of services in systems, networks, content distribution, security, storage 6 management, stress testing and performance monitoring," said Hancock .

7 30. The foregoing statements were false and misleading when made . As set forth below

8 in ¶1 105-129, 152-191, defendants misrepresented Exodus' financial results and failed to disclose

9 that Exodus engaged in improper revenue recognition practices . Further, despite the statement that

1 0 there was growing demand, as set forth below in ¶¶133-144, defendants by this time were already

11 aware that demand for the Company's products was waning . Defendants also misrepresented the

12 number of customers by including customers who were not active, who had cancelled and who had

13 no ability to pay.

14 31 . As a result of defendants' positive but false statements about Exodus, Exodus wa s

15 able to continue its acquisition growth strategy. On April 21, 2000, Exodus invested in the common

1 6 stock of Mirror Image, a privately held provider of content distribution services, for cash payment

17 of $75 million and 7,516,535 shares of its common stock . This investment, at close, was valued at

18 approximately $391 .6 million, including certain professional fees of approximately $6 .5 million.

19 32 . On May 12, 2000, Exodus filed its Form 10-Q for the quarterly period ended March

20 31, 2000, signed by defendants Hancock and Case . The 10-Q showed that Exodus had achieved the

21 following financial results :

22 Cash and cash equivalents $863 million 23 Accounts receivable $90 million 24 Revenues $134 million

25 With respect to the Company's financial presentation, the Form 10-Q stated : 26 The accompanying unaudited condensed consolidated financial statements 27 have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 o f 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -7- t 0

Regulation S-X . Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial 2 statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting 3 only ofnormal recurring adjustments, necessaryfor the fair presentation of the Company's financial position as of March 31, 2000 and the results of its 4 operations and cash flows for the three-month periods ended March 31, 2000 and 1999. 5 With respect to the Company's revenues, the Form 10-Q also stated : 6 Our revenues increased 346% to $134.1 millionfor the three month period 7 ended March 31, 2000from $30.1 million in the same respectiveperiod oftheprior year. Revenues generated by Internet Data Centers increased to $109 .9 million for 8 the three month period ended March 31, 2000 from $28 .5 million in the same respective period of the prior year. This growth in revenues was primarily the result 9 of opening new Internet Data Centers, expanding existing Internet Data Centers, increases in the number of new customers and increases in revenues from existing 10 customers. In addition, revenues generated by professional services increased to $24.3 million for the three month period ended March 31, 2000 from $1 .6 million in 11 the same respective period of the prior year which was primarily due to increases in revenues arising from increases in the number of customers and revenues generated 12 from the acquisition of Cohesive in July 1999 .

1 3 33 . The foregoing statements were false and misleading when made . As set forth below

14 in ¶1 105-129, 152-191, contrary to defendants' representations, Exodus' financial results did not

15 conform with Generally Accepted Accounting Principles ("GAAP"). Further, the Company' s

16 financial results were overstated for the reasons set forth in ¶1 105-129, 152-191 .

1 7 34. On June 23, 2060, The Business Journal published an article that quoted defendant

18 Wegner saying that "our biggest challenge is meeting the demand in front of us," that"we are able

19 to demonstrate we have a viable business model," and that "[once the infrastructure is in place]

20 it does not take longfor services to generate positive cash flow. "

21 35 . The foregoing statements made by Wegner were false and misleading when made.

22 As set forth in ¶1133-144 below, defendants by this time were already aware that demand fo r

23 Exodus' services was waning, that its business model was broken, and that it would have difficult y

24 creating positive cash flow because of Exodus' vast numbers of non-creditworthy customers .

25 36. As a result of defendants' positive but false statements, Exodus' credit rating was

26 raised by Standard & Poors ("S&P") . On June. 26, 2000, in announcing that its credit rating was

27 raised by S&P, Exodus stated the following :

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FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -8- is 0

1 Exodus Communications, Inc. (Nasdaq:EXDS) a leading provider of complex Internet hosting services, today announced that Standard & Poor's (S&P) has raised 2 its corporate credit and senior unsecured debt ratings to single B from single B minus and its subordinated debt rating on the Company to triple C plus from triple C . In 3 addition, S&P assigned its single B rating to Exodus Communications' recently announced $600 million senior note issue due 2010 . This transaction has not yet 4 closed nor has the price been determined .

5 According to S&P, the ratings upgrade, "is based on increased scale in the company's operations, demonstrated performance ofits operating model over the past 6 year, and adequate near-term financial flexibility ." S&P further commented that the Company's ratings outlook is stable. 7 "We are pleased with the ratings upgrade we have received from Standard & 8 Poor's," said Ellen M. Hancock, Exodus(R) chairman and CEO. " We believe this upgrade is a reflection of our continued success and strongfinancial and business 9 management skills."

10 37. As further result of defendants' false and misleading statements , on June 28, 2000,

1 1 Exodus was able to sell approximately $1 .2 billion principle amount in a private offering consisting

12 of $1 billion of 11-5/8% senior notes due 2010 and Euro 200 million aggregate principle amount o f

13 11-3/8% senior notes due 2008 .

14 38. On July 19, 2000, Exodus announced its second quarter 2000 financial results, a s

15 follows :

1 6 Exodus Communications, Inc . (Nasdaq:EXDS) today reported second quarter 2000 revenues of $179.6 million, a 34 percent increase over first quarter 2000, and a 321 17 percent increase over second quarter 1999.

18 Exodus reported an $8.6 million EBITDA profit (earnings before net interest expense, income taxes, depreciation, amortization and other noncash charges) for 19 second quarter 2000, compared to a $1 .7 million EBITDA profit for the first quarter 2000. 20 Net loss was $42.5 million in second quarter 2000, or $0 .10 per share, 2 1 excluding the impact of amortization of goodwill and intangible assets . Total net loss for the quarter was $51 .3 million, or $0 .12 per share, compared with a net loss 22 of $58.4 million, or $0.16 per share, in first quarter 2000, and a net loss of $22.6 million, or $0.07 per share, in second quarter 1999 . All references to earnings per 23 share and share count set forth in this press release are adjusted to reflect Exodus' recent two-for-one stock split which was effected on June 20, 2000. 24 "Not only was the second quarter another exceptionalperiod for Exodus 25 from a revenue, EBITDA and EPS standpoint, but it also marked achievements in a number of key metrics in our business," said Ellen M. Hancock, chairman 26 and CEO. "In the second quarter , our average revenue per IDC customer increased to $259,000 compared to $220,000 in the first quarter 2000 . Additionally, we 27 surpassed the 3,000th IDC customer mark, ending the period with 3,333 IDC customers. " 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -9- 0 0

"The second quarter was also an extremely strong quarter from a new bookings standpoint, which is evidence of the growing demand for our services," 2 said Hancock. "Exodus booked $245 million of new annualized recurring revenue in the second quarter. Assuming the backlog is installed today and combined with 3 our current installed customer base, the annualized revenue run rate of recurring revenue would exceed $877 million, which represents a 39 percent increase from 4 the prior quarter. "

5 "As for improvement to our financial performance, both EBITDA and gross margin dollars increased significantly," said R. Marshall Case, executive vice 6 president, finance and chief financial officer. "Contributing to these results were three new Internet Data Centers - Austin, Boston 2 and New Jersey 2 - which turned 7 EBITDA positive ahead of our same store model of 15 months. Our second quarter performance is evidence of the strength of our business model and management's 8 ability to execute . "

9 39. The foregoing statement was false and misleading when made. As set forth in ¶¶ 105-

1 0 129,152-191 below, defendants misrepresented Exodus' financial results and omitted to disclose that

11 Exodus engaged in improper revenue recognition practices . Further, despite statements that there

12 was growing demand, as set forth below in ¶¶133-144, defendants by this time were already aware

13 that demand for the Company's products was waning . Defendants also misrepresented the number

14 of customers by including customers who were not active, who had cancelled and who had no ability

1 5 to pay.

16 40. Based on defendants' false and misleading statements, on or about July 28, 2000, S& P

17 assigned its B+ bank loan rating to the Company's $600 million senior secured credit facility . In

18 addition, S&P also reaffirmed its B corporate credit and B senior unsecured note ratings on Exodus

19 because "Exodus' profile benefits from a growing number of enterprise customers, who comprise

20 nearly half of revenue, as well as a base of leading Internet companies whose business needs are

21 expanding as electronic commerce becomes more widespread ." S&P further commented that the

22 Company's ratings outlook is stable . According to an Exodus press release regarding the rating :

23 "We are pleased with the new rating and the reaffirmation of the existing ratings we have received from Standard & Poor's," said Ellen M. Hancock, chairman 24 and CEO of Exodus . " We continue to believe these ratings are a reflection of Exodus' growth and strong financial and business management skills ." 25 41 . On August 14, 2000, Exodus filed its Form 10-Q for the quarterly period ended June 26 30, 2000, signed by defendants Hancock and Case. The 10-Q showed that Exodus had achieved the 27 following financial results: 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -10- 1 r

Cash and cash equivalents $520 million Accounts receivable $108 million Revenues $179 million

With respect to the Company's financial presentation, the Form 10-Q stated:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only ofnormal recurring adjustments, necessary for the fair presentation of the Company 's financialposition as of June 30, 2000 and the results 10 of its operations for the three and six month periods ended June 30, 2000 and 1999 and cash flows for the six-month period ended June 30, 2000 and 1999 11 . With respect to the Company's revenues, the Form 10-Q also stated 12 : Our revenues increased 321% and 331% to $179 13 .6 million and $313.7 million, respectively, for the three-month and six-month periods ended June 30, 2000 from $42.6 million and $72.7 million in the same periods of the prior year 14 . Revenues generated by Internet Data Centers increased to $150 .6 million and $260.5 million, respectively, for the three-month and six-month periods ended June 30, 2000 15 from $38.7 million and $67 .2 million in the same periods of the prior year . This growth in revenues was primarily the result of opening new Internet Data Centers, 16 expanding existing Internet Data Centers, increases in the number of new customers and increases in revenues from existing customers 17 . In addition, revenues generated by professional services increased to $29 .0 million and $53 .2 million for the three- month and six-month periods ended June 30, 2000 from $3 1 8 .9 million and $5 .5 million in the same periods of the prior year which was primarily due to increases in revenues arising from increases in the number of customers and revenues generated 19 from the acquisition of Cohesive in July 1999 . 20 42. The foregoing statements were false and misleading when made . As set forth below 21 in ¶¶105-129, 152-191, contrary to defendants' representations, Exodus' financial results did no t 22 conform with GAAP . Further, the Company's financial results were overstated for the reasons se t 23 forth in ¶¶105-129, 152-191 . 24 43 . As a result of defendants' positive but false statements concerning Exodus, Exodu s 25 was able to continue its acquisition growth strategy . On September 28, 2000, Exodus entered int o 26 a definitive merger agreement to acquire GlobalCenter Holding Co ., an indirect wholly owned 27 subsidiary of Global Crossing North America, Inc . As part ofthe transaction, Exodus agreed to for m 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -11- 6 0

a joint venture with Asia Global Crossing Ltd ., an indirect wholly owned subsidiary of Global

2 Crossing Ltd. At the effective time of the merger, Exodus would issue to GlobalCenter stockholders

3 shares of its common stock equal to $6 .525 billion divided by the average closing price of Exodus

4 common stock for the ten trading days prior to the closing of the transaction, subject to a collar .

5 44. On October 19, 2000, Exodus announced its third quarter financial results in a pres s

6 release, as follows:

7 Exodus Communications, Inc . (Nasdaq:EXDS) today reported third quarter 2000 revenues of $229.6 million, a 28 percent increase over the second quarter 2000, 8 and a 238 percent increase over the third quarter 1999 .

9 EBITDA profit (earnings before net interest expense, income taxes, depreciation, amortization and other noncash charges) increased 134 percent to $20 .2 1 0 million for the third quarter 2000, compared to an $8 .6 million EBITDA profit for the second quarter 2000, and a $7.5 million EBITDA loss in the third quarter 1999 . 11 Net loss excluding the impact of amortization of goodwill and intangible 12 assets was $60.6 million in the third quarter 2000, or $0.14 per share. Net loss for the quarter was $69 .5 million, or $0 .17 per share, compared with a net loss of $51 .3 13 million, or $0 .12 per share, in the second quarter 2000, and a net loss of $31 .5 million, or $0 .09 per share, in the third quarter 1999 . 1 4 "Enterprise customers currently represent 53 percent of our total revenues and 15 bookings compared to 39 percent one year ago, as we continue to see more Fortune 1000 companies choose Exodus as the web hosting provider for their mission-critical 16 Internet operations," said Ellen M . Hancock, Chairman and CEO . "In the third quarter, we added 414 Internet Data Center (IDC) customers bringing our total 17 IDC customer count to 3,747. Our average annualized revenue per IDC customer increased to $299,000 in the third quarter compared to $259,000 in the second 18 quarter, reflecting substantial growth from both new and existing customers .

1 9

20 Exodus booked $270 million of new annualized recurring revenue from both new and existing customers in the third quarter. Assuming the backlog is 21 installed today and combined with Exodus' current installed customer base, the annualized revenue run rate of recurring revenue would exceed $1.15 billion, 22 which represents a 31 percent increase from the prior quarter .

23 "In order to meet growing market demands in Chicago and Southern California, we opened two IDCs, which represent 560,000 gross square feet, since 24 the second quarter," said R . Marshall Case, executive vice president, finance and chief financial officer. "In the fourth quarter, we expect to open five additional IDCs, 25 representing approximately 1 .2 million gross square feet, in the Washington, D .C., Santa Clara, New Jersey, Seattle and Boston markets. Overall, we are on track to 26 have an aggregate of 3 .9 million gross square feet in operation by the end of the year." 27 Third Quarter Highlights 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -12- • •

1 Additional operational and financial highlights for the third quarter are as follows :

2 Approximately 40 percent of the world's top web sites are hosted at Exodus . • Over 62,000 servers are hosted at Exodus worldwide . 3 Revenue mix consisted of 44 percent hosting services 4 20 percent Internet connectivity 36 percent managed and professional services . 5 Gross margins were : 31 percent of revenue or $71 .1 million 6 47 percent of revenue or $108 .2 million, excluding depreciation and amortization . 7 18 IDCs are currently EBITDA positive, up from 17 in the second quarter : The Atlanta IDC turned EBITDA positive in eight months . 8 Cash and marketable securities were $1.2 billion at quarter end. • Annualized customer churn was less than two percent 9 Capital expenditures were $521 million and principally represented investments to build and expand IDCs . 10 Days Sales Outstanding was 53 days in the third quarter and is within Exodus'target range. 11

12 Exodus expects revenuefor the fourth quarter 2000 to be in the range of 13 $270 million to $280 million .

14 EBITDA profit is expected to increase from 9 percent of revenue in the third quarter to 11 to 13 percent of revenue for the fourth quarter 2000 . 15 Gross margin for fourth quarter 2000 is expected to be approximately 32 16 percent of revenue, plus or minus one point.

17 Operating expenses for fourth quarter 2000 are expected to decline as a percentage of revenue and represent 42 percent, plus or minus one point. 18 Exodus expects net interest expense to be $47 million to $50 million for the 19 fourth quarter 2000. The rate of sequential growth of net interest expense will be affected by the timing of Exodus' anticipated bank line, which is expected to clos e 20 in the first half of .the fourth quarter. Net interest expense is dependent in part on the timing of capital expenditures, future borrowings, interest rates, cash balances, and 21 the realization of gains on investments .

22 Exodus expects a net loss, excluding the impact of amortization of goodwill and intangible assets, of $60 million to $70 million, or $0.15 per share, plus or minus 23 $0.01 per share, for the fourth quarter 2000 .

24 Depreciation is expected to be approximately $51 million for the fourth quarter 2000 and will be a function of capital spending, which is expected to be 25 slightly in excess of $400 million for the fourth quarter 2000 .

26 On a stand-alone basis, Exodus expects to achieve significant growth and financial results for 2001 as follows : 27 • Revenues of approximately $ 1.8 billion 28 Gross margins of 36 percent to 39 percent of revenue s

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -13- 0 0

1 • EBITDA margin of 19 percent to 22 percen t • Net loss, excluding the impact of amortization of goodwill, of 10 percent to 2 13 percent • Capital expenditures of $800 million to $1 .0 billion 3 • Additional IDC capacity of 1 .5 million to 2.0 million gross square feet 4 "Overall, the third quarter marked significantfinancial achievements as we continued to see strong customer demand for Exodus' core complex web hosting 5 and managed services business, "said Ms. Hancock. "Exodus surpassed $1 billion in annualized recurring revenue, our average revenue per IDC customer more 6 than doubled from 1 8 months ago, and the company reported record EBITDA performance ." 7 45. The foregoing statements were false and misleading when made . As set forth below 8 in ¶¶105 - 129, 152- 191, Exodus' financial results were false due to improper revenue recognition 9 practices and failure to conform with GAAP. Additionally, as set forth below in ¶¶131-132, 10 defendants ' forecasts were made without basis. Further, as set forth below in ¶¶133-132, defendants' 11 statements concerning demand were false and misleading because by this time , defendants were 12 already well aware that demand for Exodus ' services was waning . Defendants also misrepresented 13 the number of customers by including customers who were not active, who had cancelled and who 1 4 had no ability to pay. 15 46. As a result of defendants' positive but false statements , on October 31, 2000, Exodus 16 was able to enter into senior secured credit facilities with a syndicate of banks under which, subject 17 to compliance with the Company's existing indentures and covenants contained in the credit 18 agreement and the satisfaction of customary borrowing conditions, the Company was permitted to 19 borrow up to $600 million. The credit facilities include a revolving credit facility in the aggregate 20 amount of $225 million and two long term loan facilities in the aggregate amount of $375 million . 2 1 A portion of the revolving facility was available at the Company's option, in the form of letters of 22 credit. On October 31, 2000, the Company borrowed an initial $150 million against the term loan 23 facilities . Pursuant to the credit agreement dated October 31, 2000 between Exodus and Chase 24 Manhattan Bank, Exodus had to maintain specific financial ratios, including certain minimum 25 EBITDA each of its quarterly periods ; a certain leverage ratio ; a certain ratio of annualized 26 consolidated EBITDA to consolidated cash interest expense ; could not exceed certain capital 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -14- 0 0

expenditures; and could not permit unrestricted cash to be less than $100 million on any date o n which the leverage ratio was greater than 4.0 to 1 .0.

47. On November 14, 2000, Exodus filed its Form 10-Q for the quarterly period ende d

September 30, 2000, signed by defendants Hancock and Case. The 10-Q showed that Exodu s

achieved the following financial results as of the end of its third quarter 2000:

Cash and cash equivalents $1 .24 billion Accounts receivable $134 million 8 Revenues $229 million 9 The Form 10-Q stated, with regards to its financial statements, that : 10

11 The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S- 12 X. Accordingly, they do not contain all of the information and footnotes required by generally accounting principles for complete financial statements 13 . In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting 14 only of normal recurring adjustments, necessary for the fair presentation of the Company's financial position as of September 30, 2000 and the results 1 5 of its operations for the three- month and nine-month periods ended September 30, 2000 and 1999, and cash flows for the nine-month periods ended September 30, 2000 and 1999 16 . With regards to revenues, the Form 10-Q stated : 17 Revenues (other than installation fees, equipment sales to customers and 18 certain professional services), are generally billed and recognized ratably over the term of the contract, which is generally one year. Installation fees are typically 19 recognized at the time the installation occurs, and equipment sales revenue are typically recognized when the equipments is delivered to the customer or placed 20 into service at an Internet Data Center. The Company sells third party equipment to its customers as an accommodation to facilitate theirpurchase of services 2 1 . Sales of third party equipment account for less than 10% oftotal revenues for all periods presented. One-time professional service fees are typically recognized when its 22 services are rendered. 23 Our revenues increased 238% and 286% to $229.6 million and $543.3 million, respectively, for the three-month and nine-month 24 periods ended September 30, 2000 from $68.0 million and $140. 8 million in the same periods of the prior year. Revenues generated by Internet Data Centers increased to $193 25 .9 million and $454 .4 million, respectively, for the three-month and nine-month periods ended September 30, 2000 from $52 .4 million and $119 26 .7 million in the same periods of the prior year . This growth in revenues was primarily the result of adding approximately 400 new Internet Data Center customers, growth in average 27 annualized revenue per customer to $299,000, expanding existing Internet Data Centers and opening a new Internet Data Center 28 . In addition, revenues generated by

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -15- 0 0

professional services increased to $35 .7 million and $89 .0 million for the three- month and nine-month periods ended September 30, 2000 from $15 .6 million and 2 $21 .1 million in the same periods of the prior year which was primarily due to increases in revenue arising from increases in the number of customers and revenues 3 generated from the acquisition of Cohesive in July 1999 .

4 48 . The foregoing statements were false and misleading when made . As set forth below

5 in ¶¶105-129, 152-191, Exodus' financial results were false because the Company engaged i n

6 improper revenue recognition practices . Further, as set forth below in ¶¶105-129,152-191, contrar y

7 to defendants' representations, Exodus' financial results did not conform with GAAP.

8 49 . On December 7, 2000, Exodus filed a Schedule 14A Proxy Statement in connectio n

9 with the acquisition of GlobalCenter . In the letter to shareholders contained in the Proxy Statemen t

1 0 by Ellen Hancock, Hancock represented that :

11 The Exodus board of directors, after careful consideration, has approved a merger of a wholly owned subsidiary of Exodus with and into GlobalCenter Holding 12 Co . The board of directors believes that this proposed merger will accelerate the pace ofExodus'global expansion and enhance its position as a leader in complex 13 Web hosting and managed services.

14 Exodus believes that combining Exodus and GlobalCenter Holding Co ., two leading Web hosting providers, will enhance Exodus' global Internet Data 15 Center infrastructure, strengthen Exodus' customer support, sales and professional services organizations, expand Exodus' customer base and improve 1 6 Exodus' competitive position . In addition, Exodus believes that the merger will give Exodus a strong presence in Asia, a greater geographic presence worldwide and a 1 7 stronger worldwide network .

1 8 50 . The foregoing statements were false and misleading when made. Contrary t o

1 9 defendants' representation that the GlobalCenter acquisition would enhance Exodus' business, as set

20 forth below in ¶¶145-147, defendants were advised against the GlobalCenter acquisition by Exodus '

21 internal due diligence team.

22 51 . As a result of defendants' positive but false statements, on December 18, 2000 ,

23 Exodus was added to the NASDAQ- 100 Index. In a press release announcing this addition on

24 December 11, 2000, defendants stated :

25 "Exodus is proud and honored to be added to the Nasdaq-100 Index," said Ellen M. Hancock, Exodus' chairman and CEO . "We believe that Exodus' inclusion 26 in the index not only demonstrates the strength of the Company, but also the complex web hosting market. " 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -16- 1 52 . As a result of defendants' positive but false statements, Exodus was able to continue

2 its growth by acquisition strategy. Defendants' positive statements about the GlobalCenter

3 acquisition caused Exodus' shareholders to approve the acquisition, and on January 10, 2001, Exodus

4 acquired GlobalCenter, a provider of complex Internet hosting services, from Global Crossing Ltd.

5 Exodus issued 108,157,200 shares of its common stock and assumed certain GlobalCenter and

6 Global Crossing Ltd . stock options in connection with the acquisition .

7 53. On January 10, 2001, Exodus issued a press release announcing that it had completed

8 the acquisition of GlobalCenter . According to the announcement:

9 Ellen Hancock, chairman and chief executive officer of Exodus, said, "This combination gives us the scale, scope and global presence to extend our leadership 10 position as a mission -critical Web hosting and managed services provider. With GlobalCenter, we have a far larger customer base and an expanded pool of highly 11 skilled and dedicated employees. Combined, we will have approximately 4000 customers to cross-sell Exodus managed services. Our strategic partners include 12 Cisco, Compaq, Dell, Inktomi, Microsoft, Oracle and Sun Microsystems . These characteristics set Exodus apart from other companies in our industry and will enable 13 us to continue to provide leading managed Web hosting solutions and services to our customers while expanding our worldwide network of Internet Data Centers ." 14 54. The foregoing statement was false and misleading when made . Contrary t o 15 defendants' representation that the GlobalCenter acquisition would enhance Exodus' business, as se t 16 forth below in ¶¶145-147, defendants were advised against the GlobalCenter acquisition by Exodus ' 17 internal due diligence team . 18 55. On January 23, 2001, Exodus and SANrise, Inc . together issued a press releas e 19 announcing that SANrise had acquired the assets of Exodus' DataVault Storage Service . According 20 to the press release, SANrise, a privately-held provider of storage solutions had acquired certain 21 assets of, and would be assuming operations for, the service delivery and customer support of the 22 Exodus DataVault tape back-up and restore service business . Terms of the agreement include an 23 Exodus equity investment in SANrise and further expansion of the global alliance between the tw o 24 companies. 25 56. On January 24, 2001, Exodus issued a press release announcing its fourth quarter 26 2000 and fiscal 2000 annual financial results. The press release stated as follows : 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -17- 1 Exodus Communications, Inc. (Nasdaq:EXDS) today reported fourth quarter 2000 revenues of $280.4 million, a 22 percent increase over the third 2 quarter 2000, and a 177 percent increase over the fourth quarter 1999 .

3 EBITDA profit (earnings before net interest expense, income taxes, depreciation, amortization, and other noncash charges) increased 31 percent to $26 .5 4 million for the fourth quarter 2000, compared to a $20.2 million EBITDA profit for the third quarter 2000, and a $16 .7 million EBITDA loss for the fourth quarter 1999 . 5 Net loss excluding the impact of amortization of goodwill and intangible 6 assets was $55 .8 million for the fourth quarter 2000, or $0 .13 per share, compared with a net loss excluding the impact of amortization of goodwill and intangible assets 7 of $60.6 million, or $0 .14 per share, for the third quarter 2000, and a net loss excluding the impact of amortization of goodwill and intangible assets of $48 .2 8 million, or $0 .14 per share, for the fourth quarter of 1999 . Net loss for the quarter was $65 .2 million, or $0.15 per share. 9 Revenues for the fiscal year ended December 31, 2000 increased 238 10 percent to $818.4 million compared to $242.1 million in the prioryear. Exodus(R) reported an EBITDA profit for 2000 of $45 .0 million compared to an EBITDA los s 11 of $44.7 million for the prior year. Net loss for 2000 excluding the impact of amortization of goodwill and intangible assets was $221 .5 million, or $0.54 per 12 share, compared to a net loss excluding the impact of amortization of goodwill and intangible assets of $120 .9 million, or $0 .36 per share, for the prior year. 13 "Enterprise customers currently represent 57 percent of our total revenues and 14 bookings compared to 42 percent one year ago," said Ellen M . Hancock, chairman and CEO. "Our enterprise customers include British Airways ; Hearst Interactive 15 Media; Merrill Lynch & Company; Microsoft Corporation; Novell, Inc .; RR Donnelley & Sons; Sun Microsystems; and Virgin . We are also continuing to see 16 strong demand for our services from other existing customers including Adobe Systems Benelux BC ; Andersen Corporate Tax Solutions ; eBay, Inc. ; Franklin 17 Templeton Companies ; George Lucas Educational Foundation ; Lycos, Europe; and Yahoo! " 18 "Throughout 2000, enterprise customers continued to expand their Web 19 initiatives as a mechanism to lower costs and increase efficiencies," said Hancock . "For example, during the first quarter of 2000 a division of General Electric chos e 20 Exodus as its complex web hosting provider . Three quarters later, Exodus now hosts over 30 additional business segments for General Electric. " 21 ."Not surprisingly, we have seen evidence of weakness among our dot com 22 customers that is reflected in our increase in the fourth quarter churn to three percent annualized," said Hancock. "However, we do believe that enterprises will continue 23 to increase their spending on Web infrastructure and offset the impact of the dot com slowdown ." 24

25 During the fourth quarter, Exodus booked $274 million of new annualize d 26 recurring revenue from both new and existing customers . Assuming the backlog is installed today and combined with Exodus' current installed customer base, the 27 annualized revenue run rate of recurring revenue would exceed $1.34 billion .

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -18- 1 Average annualized revenue per IDC customer increased to $329,000 in the fourth quarter compared to $299,000 in the third quarter, reflecting substantial 2 growth from both new and existing customers.

3 In the fourth quarter, Exodus added a net of 245 Internet Data Center (IDC) customers, bringing the total to approximately 4,000 customers worldwide . 4 New customers during the quarter included Janus Capital; Metropolitan Life Insurance Co .; Wall St. Journal.com's vertical Internet sites ; Royal Caribbean 5 Cruises, Ltd . ; Computerworid, Inc . ; W.R. Hambrecht & Co, LLC ; IKON Office Solutions/Digital Express ; Dominion Bond Rating Service; and FX Alliance LLC. 6 In order to alleviate supply constraints in key markets, Exodus opened 7 seven IDCs, which represent 1 .5 million gross square feet, in the fourth quarter . At the end of the year, Exodus had 30 IDCs worldwide, which represent 4 .1 million 8 gross square feet . With the recently completed acquisition of GlobalCenter, Exodus now has 5.1 million gross square feet in 40 IDCs worldwide . 9 "Revenue from managed and professional services in the fourth quarter broke 10 the $100 million mark, representing 38 percent of revenues, compared to 33 percent in the fourth quarter of 1999," said Hancock. "This growth indicates that our 11 customers are wanting our help in architecting and launching their Internet operations, as well as monitoring, managing and scaling these operations . In the 12 fourth quarter, we further extended the range of our managed services including th e areas of storage, content distribution, security, Managed Web Hosting and Web 13 Application Management. "

14 "We are delighted to report that our professional services bookings increased 19 percent from third quarter 2000," said Hancock. "In the fourth quarter, we added 15 numerous professional services customers including The Boeing Company ; Societe Generale; Absolute Quality; and SilverCyber Tech Inc ., which are not represented in 16 our total IDC customer count . This increase in bookings is a leading indicator of web hosting business in 2001 . " 17 Fourth Quarter Highlights : 18 Additional operational and financial highlights for the fourth quarter are as 19 follows :

20 Revenue mix consisted of. 42 percent hosting services ; 21 38 percent managed and professional services ; 20 percent Internet connectivity. 22 Gross margins were: 32 percent of revenue or $90.9 million; 23 48 percent of revenue or $133 .1 million, excluding depreciation and amortization. 24 The number of EBITDA positive IDCs increased from 18 to 20 . • Cash and marketable securities were $892 million at quarter end, including 25 restricted cash . • Capital expenditures were $526 million and principally represented 26 investments to build and expand IDCs . • Days Sales Outstanding was 55 days . 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -19- 0 0

1 Exodus expects revenuefor the first quarter 2001 to be in the range of $365 million to $380 million . 2 Gross margin for the first quarter 2001 is expected to be approximately 22 to 3 25 percent of revenue . EBITDA is expected to be nominally breakeven.

4 Exodus expects a net loss, excluding the impact of amortization of goodwill and intangible assets, of $140 million to $150 million, or $0 .26 to $0.27 per share. 5 Exodus expects to achieve significant growth and financial results for 2001 6 as follows :

7 • Revenues of approximately $2.0 billion to $2.3 billion . • Gross margins of 29 percent to 32 percent of revenues. 8 • EBITDA margin of $300 million to $350 million . • Net loss, excluding the impact of amortization of goodwill and intangible 9 assets, one time acquisition related charges and gains or losses on equity investments, of $400 million to $450 million, and that the Company 1 0 anticipates that it will turn positive during the fourth quarter of 2001 . • Capital expenditures of $0 .9 billion to $1 .1 billion. 11 • IDC capacity at year-end of approximately 6 .7 million gross square feet . 12 "Our growth in 2001 will be fueled by further innovation in our Web hosting solutions, continued focus on enterprise customers, and expanding our IDC footprint 13 worldwide," said Hancock. "We believe that with our combination of new services, market leading position, and the expected increase in Internet usage, we will be able 14 to successfully manage through short-term fluctuations in the economy and our industry. " 15 57. The foregoing statements were false and misleading when made . As set forth below 16 in ¶¶105-129, 152-191, Exodus' financial results were false because the Company engaged in 17 improper revenue recognition practices . Further, as set forth below in ¶¶133-144, defendants' 1 8 statements were false and misleading because defendants were aware that demand for Exodus' 19 service was weak, and because defendants omitted to disclose that many of Exodus' IDCs were far 20 from being full . Defendants also misrepresented the number of customers by including customers 21 who were not active, who had cancelled and who had no ability to pay. 22 58 . As a result of defendants' positive but false statements, Exodus was able to continu e 23 to successfully obtain financing from the public. On February 6, 2001, Exodus conducted a 24 secondary public offering in which it sold 13 million shares of Exodus common stock at $18.50 per 25 share for proceeds of approximately $229 million (net of offering expenses) . In connection with this 26 public offering, Exodus issued a Registration Statement and Prospectus containing a number of false 27 and misleading statements. Among other things, defendants stated that "We believe that th e 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -20- t •

1 acquisition [of GlobalCenter] enhances our global Internet Data Center infrastructure,

2 strengthens our network, our customer support, sales and professional services organizations, and

3 expands our customer base." The Prospectus also indicated that Exodus had achieved revenues of

4 $280.4 million for the quarter ended December 31, 2000, and $818 .4 million for fiscal year 2000 .

5 The Prospectus also included the financial results for Exodus for the nine months ended September

6 2000. The Prospectus further represented that "[Exodus has] established a diverse base of customers

7 and continues to focus on supporting the strong demand from the enterprise market." Among the

8 representative customers Exodus identified in the Prospectus were iBeam Broadcasting

9 Corporation, Inktomi and Storagenetworks. The Prospectus also falsely claimed that Exodus had

10 4,500 customers under contract that it was serving .

11 59. On February 6, 2001, Exodus also issued $500 million of 5-1/4% convertible

12 subordinated notes due February 15, 2008, in which the Company received proceeds of $485 .4

13 million (net of offering expenses) . On February 16, 2001, the Company issued an additional $75

14 million aggregate principle amount of the 5-1/4% notes upon exercise of the underwriters' over

15 allotment option, in which it received additional proceeds of $72 .9 million (net of offering

16 expenses) . Much of the language in the Registration Statement and Prospectus for the notes offering

17 was similar to that contained in the Prospectus for Exodus' secondary public offering . In the

18 Registration Statement and Prospectus for the notes offering, Exodus also represented that the

19 GlobalCenter acquisition would enhance the Company, that Exodus had a diverse base of

20 customers and had strong demand from the enterprise market, and that Exodus achieved certain

21 financial results in fourth quarter and fiscal 2000. The Prospectus also falsely claimed that

22 Exodus had 4,500 customers under contract that it was serving .

23 60 . The foregoing statements contained in the Prospectuses for Exodus' secondary public

24 offering and notes offering were false and misleading . As set forth below in ¶1105-129, 152-191,

25 defendants were aware the Company's financial results were false due to improper revenue

26 recognition practices and failure to conform with GAAP . Defendants were also aware, as set forth

27 below in ¶¶145-147, that Exodus' internal due diligence team recommended against the

28 GlobalCenter acquisition. As set forth below, defendants were aware that the Company was not FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -21- 0 0

1 seeing strong demand from the enterprise market . Additionally, as set forth below in ¶1129-130,

2 defendants were aware that there were revenue recognition issues with respect to some of Exodus'

3 "representative customers ." Further, in February 2001, Exodus' Solomon database only reflected

4 3,500 customers and of those customers, over 1,000 more were not active and had cancelled

5 according to CW12.

6 61 . On March 30, 2001, Exodus filed its Form 10-K with the SEC for its fiscal year 200 0

7 ending December 31, 2000, signed by CEO Hancock, CFO Case and members of Exodus' Board of

8 Directors. In the Form 10-K, with regards to the GlobalCenter acquisition, defendants represented

9 that "[w]e believe that the acquisition [of GlobalCenter on January 10, 20011 enhances our global

10 Internet Data Center infrastructure, strengthens our network, our customer support, sales and

11 professional services organizations, and expands our customer base ."

12 62. In the Form 10-K, defendants also represented: "We have established a diverse base

13 I of customers and continue to focus on supporting the strong demand from large enterprise

1 4 customers." Defendants further provided a list of representative customers, including iBeam

15 Broadcasting Corporation, Inktomi and Storagenetworks. According to the Form 10-K, none o f

16 Exodus' customers individually represented in excess of 10% of its revenues in 2000 .

17 63. The Form 10-K also indicated that Exodus achieved the following financial result s

18 for fiscal 2000:

19 Cash and cash equivalents $805 million 20 Accounts receivable $175 million 21 Revenues $818 million

22 The Form 10-K also stated, with regards to recognition of revenue, that : 23 We adopted Staff Accounting Bulletin No . 101 ("SAB 101"), Revenue 24 Recognition in Financial Statements, during our fourth fiscal quarter effective January 1, 2000. SAB 101 identifies the following four essential criteria that must be 25 met before revenue can be recognized: 26 • Persuasive evidence of an arrangement exists; 27 • Delivery has occurred or services have been rendered; 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -22- 1 The feefor the arrangement is fixed or determinable; and

2 Collectibility is reasonably assured.

3 Persuasive Evidence of an Arrangement .

4 We document all terms of an arrangement in a written contract signed by the customer prior to recognizing revenue . 5 Delivery Has Occurred or Services have been Performed 6 We perform all services or deliver all products prior to recognizing revenue . 7 Monthly services are considered to be performed ratably over the term of the arrangement. Professional consulting services are considered to be performed whe n 8 the services are complete . Equipment is considered delivered upon delivery to a customer's designated location . 9 The Fee for the Arrangement is Fixed or Determinable 10 A customer's fee is either fixed or determinable under the terms of the written 11 contract prior to recognizing revenue . Fees for most monthly service, professional consulting services, equipment sales and rentals are fixed under the terms of th e 12 written contract . Fees for certain monthly services, including certain portions of networking, storage, and content distribution and caching services, are variable based 13 on an objectively determinable factor such as usage . Such factors are included in the written contract such that the customer's fee is determinable . The customer's fee is 14 negotiated at the outset of the arrangement and is not subject to refund or subject to adjustment during the initial term of the arrangement . 15 Collectibility is Reasonably Assured 16 We determine that collectibility is reasonably assured prior to recognizing 17 revenue. Collectibility is assessed on a customer by customer basis based on criteria outlined by management. New customers are subject to a credit revie w 18 process, which evaluates the customers 'financial position and ultimately their ability to pay. We do not enter into arrangements unless collectibility is reasonably 19 assured at the outset. Existing customers are subject to ongoing credit evaluation s based on payment history and other factors. If it is determined during the 20 arrangement that collectibility is not reasonably assured, revenue is recognized on a cash basis . 21 Multiple-Element Arrangements 22 We enter into multiple-element arrangements, which may include any 23 combination of monthly IDC services, professional consulting services or equipment sales or rentals . Each element of a multiple-element arrangement is evaluated t o 24 determine whether it represents a separate earnings process . In determining whether an element is a separate earnings process, we consider all applicable facts and 25 circumstances including whether we sell or could readily sell the elemen t unaccompanied by other elements . If a multiple-element arrangement can be 26 segmented, revenue is allocated among the multiple-elements based on the fair value of the elements . If an undelivered element is essential to the functionality of a 27 delivered element, no revenue allocated to the delivered element is recognized until that undelivered element is delivered . 28

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1 Revenue recognition for segmented elements of a multiple element arrangement or for separate sales of our product and services offerings is as follows: 2 Fees for Monthly Internet Data Center Services and Related Installation Services 3 We have determined that monthly IDC services represent a separate earnings 4 process because we regularly sell these services unaccompanied by other elements . Revenue is allocated to monthly services based on reliable verifiable and objectively 5 determinable fair value, which is based on fees received when comparable services are sold separately. Revenue from fixed monthly IDC services is recognized ratably 6 over the contract term, generally one year. Revenue from variable monthly ID C services are recognized as the change in factors on which the variable fees are based 7 occurs.

8 We have determined that installation services related to monthly services do not represent a separate earnings process . Therefore, revenue from such installation 9 services are deferred and recognized over the contractual term of the arrangement . Incremental direct costs of such installations are deferred and amortized over the 10 contractual term of the arrangement .

11 Prior to the adoption of SAB 101, we recognized revenue for installation services upon completion of the services and the associated costs as incurred . The 12 cumulative effect of the change in accounting for installation services an d incremental direct costs of these services on all prior years resulted in an $8 .4 million 13 increase in net loss for the year ended December 31, 2000, and is reflected as the cumulative effect of change in accounting principle . Revenue for the year ende d 14 December 31, 2000 includes $8 .8 million that was included in the cumulative effect adjustment. 15 Fees for Professional Consulting Services 16 We have determined that professional consulting services represent a separate 17 earnings process based on the following factors : (i) the services are not essential to the functionality of other elements of the arrangements, (ii) the services can and hav e 18 been sold separately both to existing Exodus IDC customers and non-Exodus IDC customers, and (iii) similar services can and have been performed by the customer 19 or other vendors . Revenue is allocated to professional consulting services based o n reliable, verifiable and objectively determinable fair value, which is based on fees 20 received when comparable services are sold separately . Revenue from professional consulting services is recognized when the services are complete. 21 Fees from the Sale or Rental of Equipment and other products 22 We have determined that the sale or rental of equipment and other products 23 represents a separate earnings process based on the following factors : (i) the equipment and other products can and have been sold or rented separately, (ii) the 24 equipment and other products can be purchased from other vendors, and (iii) the functionality of the equipment and other products is not affected by any undelivered 25 element . Revenue is allocated to, equipment sale or rental based on reliable, verifiable and objectively determinable fair value, which is based on fees received 26 when comparable equipment and other products are sold or rented separately .

27 Revenue from the sale of equipment and other products and from sales type leases is recognized upon delivery to the customer's designated location . Fees from 28 operating leases are recognized on a straight-line basis over the lease term . Revenue FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-0 1 -266 1 -MMC -24- s 0

1 from the sale or rental of equipment and other products was less than 10% of consolidated revenue in each of the years in the three-year period ended December 2 31, 2000.

3 64. With respect to the Company's revenue, the Form 10-K also stated:

4 Our revenues increased 238% to $818.4 million in 2000 from $242.1 million in 1999, and increased 359% in 1999 from $52.7 million in 1998. , The 5 revenue growth reflects increases in hosting, network services and managed services, as a result of increases in new customers, increases in orders from 6 existing customers as well as new revenues arising from our managed services group, including storage management and security services . Revenues directly 7 attributable to IDC's increased to $695 .7 million in 2000 from $199.6 million in 1999, an increase of 249% . TDC revenue increased 282% from $199 .6 million in 8 1999 as compared with $52.3 million in 1998 . We opened 11 new IDCs during 200 0 for a total of 30 at year end . Effective at the closing of the GlobalCenter acquisition 9 on January 10, 2001, we added an additional 10 IDCs. Operating IDCs were 19 and 8 at the end of 1999 and 1998, respectively . At December 31, 2000, we served 10 approximately 4,000 IDC customers compared to approximately 2,300 at December 31, 1999 and 1,000 at December 31, 1998 . Professional services revenue increased 11 188% in 2000 to $122 .8 million from $42 .6 million in 1999 and increased 8,733 % in 1999 from $482,000 in 1998 . The increase from 1999 to 2000 relates to increased 12 demand for our professional service offerings and from 1998 to 1999 from increased demand as well as our acquisition of Cohesive Technology Solutions, Inc . in July 13 1999. We expect our revenues to increase in 2001 from their levels in 2000 as we continue to book new annualized recurring revenue from both new and existing 14 customers, increase the number of operating IDCs, and receive revenues fro m customers acquired in the acquisition of GlobalCenter, which closed on January 15 10, 2001.

16 The 10-K also included an audit report by KPMG dated January 24, 2001, which stated :

17 In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Exodus 18 Communications, Inc. and subsidiaries as ofDecember 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year 19 period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America . Also, in our opinion, the 20 related financial statement schedule, when considered in relation to the consolidatedfinancial statements taken as a whole, presentsfairly, in all material 21 respects, the information set forth therein .

22 65. Soon after filing its Form 10-K, Exodus distributed its Annual Report to Shareholders

23 for fiscal year 2000 . The Annual Report contained a copy of the Company's Form 10-K . It also

24 contained a letter to shareholders signed by Hancock, which stated that "[wje believe we are well

25 positioned ... as customers, technology and even trends demand the proven, market-leading

26 expertise that Exodus has continually demonstrated. "

27 66. The foregoing statements contained in Exodus' Form 10-K and Annual Report were

28 false and misleading when made . As set forth below in ¶¶105-129,152-191, defendants were aware FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -25- 0 0

1 that Exodus' financial results were false due to improper revenue recognition practices and that the

2 Company failed to conform with GAAP . Further, as set forth below in ¶¶145-147, defendants were

3. aware that the Company's internal due diligence team recommended against the GlobalCenter

4 acquisition. Additionally, as set forth below, contrary to defendants' representation, they were aware

5 that Exodus was not experiencing strong demand from enterprise customers . Moreover, as set forth 6 below in ¶¶129-130, defendants were aware Exodus had revenue recognition issues with respect to

7 some of its "representative customers." Defendants also misrepresented the number of customers

8 by including customers who were not active, who had cancelled and who had no ability to pay .

9 67. On April 26, 2001, Exodus announced its first quarter 2001 results via th e

10 Business Wire. According to the Company's press release, Exodus achieved first quarter 2001

11 revenues of $348.7 million, EBITDA profit of $5.5 millionfor the first quarter 2001, and net loss

12 for the first quarter of $649.6 million or $1.21 per share. In the press release, defendants

13 highlighted the strength of the Company and indicated that it was doing well despite the economic

14 slowdown and the dot-com fallout . Defendants represented that among the "key milestones" the 15 Company achieved during the quarter were:

16 • The Company began the quarter with approximately 4,000 IDC customers. During the quarter, it won a number of new customers, acquired many more 17 through the GlobalCenter acquisition, and churned out others. This resulted in a much stronger base of 4,526 IDC customers at the end of the 1 8 quarter....

19 • At quarter end, enterprise customers represented 62 percent of Exodus's total monthly recurring revenues and bookings, compared to 44 percent 20 one year ago as the Company continues to shift its customer base to enterprises. 21

22 "Exodus' business continues to grow, due primarily to its strong business 23 model and customer relationships, " saidEllen M. Hancock, chairman and CEO. "We are benefiting from a flight to quality' as businesses seek to outsource their 24 key operations to experienced, established providers like Exodus. We believe we have reduced our exposure to the dot com slowdown during the quarter by 25 targeting and winning enterprise customers, and the changes in our customer mix during the quarter provide us with an even stronger customer base to build on . We 26 are pleased that we were able to deliver on our bottom line, even in the challenging current economic environment," said Hancock. "Exodus remains focused on 27 delivering the highest quality service and strengthening customer and partner relationships." 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -26- 2 Exodus expects to achieve second quarter 2001 results asfollows:

3 • Revenue of approximately $360 million • Gross margins of approximately 27percent of revenue 4 • EBITDA ofat least $25 million ... • Cash net loss of approximately $110 million to $115 million, or 5 $0.19 to $0.20 per share ...

6 Exodus expects results for 2001 as follows:

7 • Revenues of approximately $1.5 billion to $1.6 billion • Gross margins of approximately 31 % to 33% of revenue • EBITDA ofat least $270 million ... • Cash net loss of approximately $300 million to $320 millio n 9

10 "With over $1 billion in cash, the Company is fully funded to achieve its 11 current business plan and we do not anticipate returning to the debt or equity markets for additional capital to meet our plan," said Hancock. "We are and 1 2 believe we will continue to be in compliance with the covenants of our bank credit facility, under which we currently have borrowings of $150 million ." 13 "We believe the hosting market will continue to grow as more and more 14 companies realize the operating efficiencies and cost savings that can be obtained through utilisation of the Internet and outsourcing . While businesses will continue 15 to use the Internet for business-to-consumer applications, we believe there will be increased growth from business-to-business and business-to-employee applications . 16 The offerings and services that Exodus provides, and our well-trained sales teams, make Exodus today uniquely positioned to take advantage of the changing 1 7 business landscape. We are confident that Exodus is in a sound position to successfully manage through the current fluctuations in the economy and in our 18 industry," concluded Hancock .

1 9 68. On April 26, 2001, Exodus also held a conference call with securities analysts an d

20 investors to discuss its first quarter 2001 results . On the conference call, CEO Hancock represente d

21 that the Company had a strong customer base by stating:

22 We began, the quarter with approximately 4,000 customers . During the quarter, we won a number of new customers, acquired many more through the Global 23 Center acquisition and churned others . This resulted in a much stronger customer base of 4,526 customers at the end of the quarter.. . . 24 On the conference call, Hancock also represented that Exodus was doing well despite the economic 25 slowdown. Hancock stated that "despite the economic slowdown, Exodus was able to leverage its 26 focus on enterprise customers and its market leadership position to continue to grow revenues and 27 push profitability"; that "Exodus is in a sound position to successfully manage through the 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -27- 0 0

1 currentfluctuations in the economy and in our industry"; and that "we are well positioned for the

2 remainder of 2001 and beyond." As stated by Hancock :

3 We are managing within the current economic environment carefully, and we are confident that Exodus is well positioned for continued growth and future 4 profitability. Now the future and its silver lining of the market slowdown is tha t Exodus's competitive position will likely get even stronger for several reasons . First, 5 as a result of having targeted enterprises in the last several years, we believe we have reduced our exposure to the dot com slowdown . Approximately two-thirds of all 6 new bookings in Q 1 came from enterprise customers . Second, the current economic environment has been accelerating the flight to quality. Businesses want to 7 outsource their operations to experienced , established hosting providers like Exodus.. .. Third, we have a clear path to profitability . . . . We currently expect to turn 8 cash EPS positive during the first half of 2002 . And fourth, we have a fully funded business plan . We have $1 .1 billion in cash and cash equivalents at the end of th e 9 quarter, and with our emphasis on improving bottom line performance, we are comfortable that this will be enough to fuel our growth . Unlike many hosting 10 Internet infrastructure companies that are not fully funded, we are not dependent upon a quick market rebound to provide additional financing. 11 During the conference call, Case, the Company's CFO, also stated that Exodus was immune to the 12 economic environment in part because the Company was gaining enterprise customers . As Case 13 stated : 14 Once again, we continue to execute our strategy to pursue and win additional 15 enterprise customers, reducing our exposure to the dot-com slowdown . Enterprise customers represented 62% of our total revenue and bookings as of end of the firs t 16 quarter compared to 57% in the prior quarter and only 44% in the first quarter of 2000. 17 Similarly, Hancock represented : " We continue to win large and enterprise customers based on the 18 strength of our balance sheet, the quality of our services, our leadership position in the industry and 19 the flexibility that we provide to our customers ." 20 69. CFO Case also provided financial guidance for second quarter 2001 and fiscal 2001 . 21 According to Case, the Company expected to achieve in second quarater 2001 $360 million in 22 revenues, gross margin of 27% of revenues, EBITDA of at least $25-$30 million, and cash net 23 loss of $110-$115 million, or $0.19 to $0.20per share. With regards to fiscal 2001, Case stated that 24 the Company expected to achieve $1.5-$1.6 billion in revenues, gross margin of 31%-33%, 25 EBITDA of at least $270 million, and cash net loss of $300-$325 million . Case also stated that 26 "the Company anticipates that it will turn positive during the first half of 2002 ." With regard to the 27 Company's financial guidance, Case stated that the figures provided were "conservative." Further, 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -28- 0 0

1 Case indicated that, even though Exodus experienced annual customer churn of 6% in the first

2 quarter, and the Company's forecast assumes that it will experience churn in the second quarter

3 comparable to the first quarter, "we believe that this level of churn will not significantly hinder our

4 ability to deliver on the revenue targets." Moreover, while Case acknowledged that there are

5 uncertainties in the economic environment, he asserted that "we are opening IDC's to meet known

6 customer demands ." With regard to Exodus' loan covenants, both Hancock and Case emphasized

7 that the Company would not fall out of compliance with the covenants . According to Case : "We are

8 currently in compliance with the covenants of our bank credit facility under which we have borrowed

9 approximately $150 million and we believe we will continue to be in compliance." Further,

10 according to Hancock :

11 We anticipate that theguidance wejustgaveyou for Q2 supports the debt covenant. We believe that the guidance we give you for the full year covers the debt 12 covenants, and I can only say this five times more, we are okay on the debt covenants, Ql, Q2, Q3, Q4, assuming that our guidance is correct . 13 Additionally, during the question and answer segment of the conference call, in response to an 14 analyst's question, Hancock indicated that Exodus was actually increasing its prices despite price 15 discounting from competitors . Hancock stated : 16 In terms ofpricing, we, as you know, announced a price increase in the area of 17 our infrastructure as well as many ofour managedprofessional services ... .

18 Further, with regards to the Company's business plan, Hancock stated that "we are still confident

19 that we should be able to turn cash EPSpositive in thefirst half of, of next year."

20 70. On the evening ofApril 26, 2001, Exodus CEO Hancock was interviewed byreporter

21 Willow Bay on CNN's Moneyline, broadcast at 6 :30 p.m. EST. During the interview, Hancock

22 stated that Exodus was "seeing increased demand from enterprise customers ." She also stated :

23 "[W]e are going to close to double our revenue this year over last year. So we're still seeing .

24 growth. We're being conservative in this next quarter . . . ."

25 71 . The foregoing oral and written statements made on April 26, 2001 were false and

26 misleading when made . As set forth below in ¶¶105-129, 152-19 1, the Company's financial results

27 were false due to improper revenue recognition practices and failure to conform with GAAP .

28 Further, as set forth below in ¶1129-130, the Company's cash balances were inaccurate. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -29- 0 0

1 Additionally, as set forth below inTJ148-150, defendants were aware that the Company was not fully

2 funded to achieve its business plan. Moreover, as set forth below in ¶¶133-141, defendants were

3 well aware that the Company did not have a strong customer base as it was suffering from high rates

4 of cancellation, bankruptcy and delinquency from customers, was suffering from extraordinary rates

5 of bad debt, and was not seeing increased demand . As set forth, defendants were also aware Exodus'

6 IDCs were operating under capacity. Defendants were aware that due to the Company's poor

7 business condition, Exodus would have to repay the Company's $150 loan from Chase Manhattan

8 to prevent running afoul of its loan covenants. Defendants were aware that their forecasts were

9 overly aggressive and made without reasonable basis . Defendants also misrepresented the number

10 of customers by including customers who were not active, who had cancelled and who had no ability

11 to pay.

12 72 . On April 30, 2001, Exodus issued a press release via the Business Wire announcing

13 the departure of Case, the Company's CFO, for personal reasons . It announced that Stoltz, who had

14 previously served as Exodus' CEO, would take over the day-to-day financial management of Exodus

15 while a search was conducted for Case's replacement . Additionally, although Exodus did not

16 specifically issue an announcement, Exodus' President and Chief Operating Officer, Casey, and

17 Executive Vice President and head of marketing, Beverly Brown, also departed the Company.

18 73 . On May 1, 2001, Exodus issued a press release via the Business Wire headlined

19 "Exodus Announces Conference Call to Reaffirm Guidance and Clarify Organizational Changes ."

20 In the conference call held later that day, defendant Hancock reassured financial analysts that the

21 recent management change would benefit Exodus by giving Exodus "a solid executive team and a

22 streamlined organization." Further, defendant Stoltz reassured analysts that "Marshall [Case]'s

23 departure is in no way related to our Q1 results or guidance [for Q2 and fiscal 2001J." With

24 respect to Exodus' business condition and outlook, Hancock stated that, "[wJe believe that we have

25 a market leading position, an achievable and fully funded business plan, and solid long term

26 demand for our services." Defendant Stoltz reaffirmed the Company's guidance for second

27 quarter 2001 of revenue of approximately $360 million; gross margin of approximately 27% ;

28 EBITDA of at least $25 million; and cash net loss of $110-$115 million, or $0 .19 to $0.20 per share. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1 -266 1 -MMC -30- 0 0

1 Stoltz also reaffirmed fiscal 2001 guidance of revenues of approximate $1 .5-$1 .6 billion, "which

2 . is approximately double our prior years' total," gross margins of 31%-33% of revenue, EBITDA of

3 at least $270 million, and cash net loss of $300-$320 million. Stoltz also stated that "the company

4 anticipates that we will turn positive during the first half of 2002." Further, Stoltz stated : "[T]o be

5 honest, there are some analysts out there that think that we are very aggressive on such a positive

6 EBITDA.... And I have gone through the plan and you know I feel comfortable that those

7 numbers are achievable...."

8 74. On May 9, 2001, Exodus issued a press release via the Business Wireregarding its cost

9 cutting measures which defendants represented would help the Company achieve its financial plan .

10 According to the press release :

11 "We have been analyzing all aspects of our operations," said Dick Stoltz, Exodus' chief financial officer. "We believe we can achieve our financial plan by 12 reorganizing and strengthening our operations . These staff reductions are consistent with that goal . As a result, we expect to record a non-recurring charge of less than 13 $10 million for the current quarter. "

14 "The streamlining we're doing does not affect our ability to serve our current customers or our ability to attract and serve new customers with the high quality of 15 service and security customers have come to expect from Exodus," Stoltz said . "We continue to expand our footprint of operations. We opened Internet data centers 1 6 in Dallas and Amsterdam last month, and next week we will open an Internet data center in Paris. Our goal with these efforts is to ensure we have the right people in 17 the right places . We believe these actions will strengthen our competitive position in the marketplace. " 18 75 . The foregoing statements were false and misleading when made . As set forth below 19 in ¶¶148-150, defendants were aware that the Company was not fully funded to achieve its business 20 plan. Further, as set forth below in ¶¶131-132, defendants were aware that their forecasts wer e 21 overly aggressive and made without reasonable basis . 22 76. On May 15, 2001, Exodus filed its Form 10-Q with the SEC for the quarterly perio d 23 ended March 31, 2001, signed by defendant Stoltz . The 10-Q showed that Exodus had achieved the 24 following financial results : 25

26 Cash and cash equivalents $1 .04 billion Accounts receivable $238 million 27 Revenues $438 million 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -31- 0 0

The Form 10-Q stated, with regards to its financial statements, that :

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S- X. Accordingly, they do not contain all of the information and footnotes required by generally accounting principles for complete financial statements . In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for the fair. presentation of the Company's financial 6 position as of March 31, 2001 and December 31, 2000, and the results of its operations and cash flows for the three-month periods endedMarch 31, 2001 and 7 2002.

8 The Form 10-Q also stated, with regards to revenues, that :

9 Service revenue increased to $300 .2 million for the three-month period ended March 31, 2001 from $244.7 and $124.3 million for the three-month periods ended 10 December 31, 2000 and March 31, 2000, respectively, increases of 23% and 141%. The revenue growth reflects increases in hosting, network services and managed 11 services, as a result of increases in new customers, orders for additional services from existing customers, increased traffic as well as new revenue arising from our 12 managed service group, including storage management, security services, content distribution, managed hosting and web application management .. .. 13 Professional service revenue was $32.3 million for the three months ended 14 March 31, 2001, compared with $32 .9 million and $24.3 million for the three months ended December 31, 2000 and March 31, 2000, respectively . . . . 15 We expect our revenue to increase, as a result of expansion of our customer 16 base and increased sales to existing customers . This increase will be offset in part by customers going out of business or downsizing or terminating their Internet 17 operations due to a variety of factors including the current economic environment . 18 Other Revenu e

19 Other revenue increased to $48.4 million for the three-month period ended March 31, 2001 from $8.1 million in the same period of the prior year, an increase 20 of 496%.

2 1 The 10-Q further indicated that its IDCs were full, by stating : "We intend to continue to expand ou r 22 II network of Internet Data Centers domestically and internationally to meet the demand for our 23 services."

24 77 . The foregoing statements were false and misleading when made . As set forth below

25 in ¶¶105-129, 152-191, defendants were aware Exodus' financial results were false due to imprope r

26 revenue recognition practices . Further, as set forth below in ¶¶105-129, 152-191, contrary t o

27 defendants' representation, Exodus' financial results did not conform with GAAP. Additionally, as 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -32- 0 0

set forth below in ¶¶133-132, contrary to defendants' representations that demand was increasing ,

2 defendants were aware that demand was weak .

3 78 . By this time, the problems affecting Internet web hosters were starting to trickle int o

4 the public. Nevertheless, Exodus continued to deny that it had problems. For example, a June 18,

5 2001 Wall Street Journal article reported that even though certain analysts believe there is a glut in

6 data center space, Exodus claimed that it was insulated from the data center glut . The article stated

7 in part, as follows :

8 According to Ted Chamberlain, an analyst at Gartner, Inc ., "there's a glut of data- center space." Analyst Stephen Murphy Murphy of CIBC World Markets estimated 9 in a report in early June that only 22% of all the data center space available in North America this year will be used or sold to customers, leaving about 78% unsold . 10 Gartner predicts that demand for data-center space, also known as co-location space, will grow by 2% to 5% annually over the next four years (down from previous 11 forecasts of 25% to 35%) . PSINet and Colo.com, both of which provide Web- hosting services, have already filed for bankruptcy protection. However, Web- 12 hosting companies like Exodus argue that they're insulatedfrom data-center glut because they have diversified business beyond providing floor space, getting a 13 substantialportion of revenue from computer management services. Hancock said 65% of the company's customers buy other services from Exodus other than just 14 co-location, and that percentage is going up. In fact, Exodus opened 3 data centers in Dallas, Paris and Amsterdam in recent weeks and has raised its prices, 15 she said. However, Garner's Chamberlain says Exodus has data centers that it has essentially "mothballed" or hasn't opened, which could be considered excess 1 6 capacity. Also, according to UBS Warburg analyst John Hodulik, because Exodus sells its hosting services as a package, it might be difficult to tell if it was discounting 1 7 prices for co-location and connectivity but boosting prices for services .

1 8 79. On June 20, 2001, Exodus preannounced its second quarter 2001 results, which fel l

1 9 far short of management's guidance to analysts and the public. Exodus' press release disclosed tha t

20 it would suffer disastrous second quarter 2001 results and that it was drastically reducing it s

21 guidance for the remainder of fiscal 2001 . The press release stated:

22 Revenue growth for the quarter and year will be below the company's previous expectations. The company now expects revenues in the second quarter 23 of 2001 to be approximately $315 million compared to first quarter 2001 revenues of $348 .7 million. The revenue shortfall is due to a decrease in the rate of new 24 customer installations, an increase in the rate of cancellations, reduction of orders from existing customers, and an increase in reserves related to dot com failures. 25 The company now expects second quarter gross margins to be approximately 21 percent and EBITDA to be slightly negative compared to $5 .5 million for the first 26 quarter, excluding a restructuring charge of up to $25 million . Cash net loss for the second quarter is expected to be approximately $140 million compared to $118 .3 27 million for the first quarter. The company expects new bookings from customers to be approximately in line with last quarter's level of $200 million . 28

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1 The company expects revenuefor the full year will be approximately $1 .35 billion and expects gross margins to be approximately 23 percent. Full year 2001 2 EBITDA is expected to be approximately $80 million. Full year cash net loss is expected to be approximately $500 million . 3 "While market conditions are certainly more challenging than they were a few 4 months ago, we remain optimistic about the overall market and Exodus 'position," said Exodus Chairman and CEO Ellen Hancock. "The fundamentals underlying 5 managed hosting are solid . Enterprises continue to look at the web as a way to reduce costs, enhance communications with their customers, partners and employees 6 and as a way to enhance productivity. We are the recognized market leader in managed hosting services," she said . 7 Credit Facility 8 The company is announcing today that it has decided to repay the $150 9 million loan under its senior creditfacility. By doing so, the company will be able to operate without the restrictions imposed by the facility. With this repayment and 10 the cost containment actions the company is taking, Exodus expects that it is fully funded through the period it reaches free cash flow positive, expected for the third 11 quarter of 2002 . By eliminating the credit facility, the company is able to use it s assets with greater flexibility to obtain additional financing if it so chooses. Exodus 12 believes that if available, such asset based financing could provide in excess of $500 million of additional funding for the company. 13 Cost Reductions and Liquidity 1 4

15 The company expects to end the second quarter of2001 with approximately 16 $550 million in cash , and exit the year with approximately $200 million after repayment of the credit facility assuming no additionalfinancing. 17 80. Following Exodus' disclosure of some of the adverse conditions then affecting the 18 Company, its stock dropped almost 50% to as low as $1 .18 the next day on high volume of 19 186,361,300 shares. During the Class Period, Exodus stock traded as high as $179 per share. 20 81 . Within days thereafter, analysts quickly downgraded the stock, including Salomon 21 Smith Barney, which downgraded Exodus to "neutral" from "buy" and removed it from its "U .S. 22 recommended-for-purchase list" ; Goldman Sachs, which downgraded the stock to "market perform" 23 and taking it off Goldman's "recommended-list" ; UBS Warburg, which cut its price target to $3 per 24 share from $15; Lehman, which downgraded Exodus from "buy" to "market perform" ; and Morgan 25 Stanley Dean Witter, which downgraded the stock from "strong buy" to "neutral ." Moreover, Jeff 26 Camp, an analyst with Morgan Stanley Dean Witter, took the rare step of apologizing for not 27 downgrading Exodus earlier. According to Jeff Camp, "The retail buyers, I would say, the 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -34- Exhibit A (Part 2 of 3) 0 is

1 individual investors, you know, the people that we see every day are angry . And there is no

2 question about it . They have a right to be angry and that's where the apology came from ."

82. With respect to Exodus' bonds, S&P cut Exodus' bond rating to "B-" and it s

convertible bonds to junk status at "CCC." Similarly, Moody's downgraded Exodus' senio r

unsecured debt from B3 to Caal .

83. Further, several financial articles indicated that Wall Street had been misled by the

Company. For example, an article dated June 21, 2001 by Michael Liedtke on AP Online stated :

Shares of Exodus Communications Inc . plunged 30 percent Thursday after the Web hosting service delivered 'a rude financial surprise that amplified concerns about the once-vibrant company's ability to survive the dot-com meltdown .

10 Shares in the Santa Clara-based company fell 68 cents to close at $1 .57 Thursday on the Nasdaq Stock Market. The selloff continued an investor retreat that has left 11 Exodus' stock a fraction of its 52-week high of $69 .

12 Thursday's backlash reflects a spreading sentiment that Exodus has been misleading Wall Street about its business outlook, said analyst Frederick Moran 1 3 of Jeffries & Co. in New York.

14 "You can only pull the wool over the eyes of Wall Streeters so many times before they throw in the towel on you, "Moran said. "Investors have given upon Exodus . 15 It's obviously not funded to last beyond this year . "

16

1 7 Investors are losing their patience with Exodus because management has previously issued reassuring statements only to change its tune later, said analyst 18 James Linnehan of Thomas Weisel Partners .

19 "How much confidence can we have in them this time? They are losing their credibility with the market, "Linnehan said. "This could be a deathwatch now. " 20 Similarly, a June 21, 2001 analyst report written by Daniel J . Renouard of Robert W. Baird & Co . 21 regarding Exodus emphasized : "Management Credibility Shaky." 22 84. Even though Exodus' announcement on June 20, 2001 revealed some of the negative 23 conditions that had been impacting the Company, it did not reveal the entire fraud, causing its stock 24 price to continue trading at artificially inflated levels . Further, subsequent to the June 20, 2001 25 announcement, defendants continued to deny problems facing Exodus, and continued to make false 26 and misleading statements. 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -35 .- 0 0

1 85 . On July 6, 2001, Exodus filed a Form S-8 Registration Statement with the SEC in

2 connection with the registration of shares reserved for issuance upon exercise of stock options under

3 the Company's 1998 Equity Incentive Plan . In connection with the Registration Statement, KPMG

4 consented to the incorporation by reference of its audit report dated January 24, 2001, which was

5 false for certifying that the Company had fairly represented its financial condition .

6 86. On July 16, 2001, Exodus issued a press release announcing that William Austin was

7 named the Company's CFO, and that Richard Stoltz, the interim and previous Chief Financial Officer

8 and Chief Operating Officer, assumed the position of Senior Advisor of Strategy and Finance to the

9 CEO .

10 87 . On July 26, 2001, Exodus issued a press release announcing its second quarter 2001

11 results. The press release continued to portray Exodus as a market leader continuing to increase its

12 strength and on the clear path to profitability. According to the press release :

13 Exodus Communications, Inc. (NASDAQ: EXDS) today reported second quarter 2001 revenues of $318.7 million, above the most recent guidance. This revenue 14 compares to $177.7 million in the second quarter 2000, an increase of 79percent. EBITDA profit was $3 .2 million for the second quarter 2001, also above the most 15 recent guidance, compared to $8.1 million for the second quarter 2000, marking the sixth consecutive quarter the Company has delivered positive EBITDA results 16 (excluding the impact of SAB101) .

17 Cash net loss was $138 .5 million for the second quarter 2001, or $0 .25 per share, compared with a cash net loss of $43 .0 million, or $0 .11 per share, for the second 18 quarter 2000. Cash and cash equivalents were $616 .8 million at the end of the quarter. 19 During the second quarter, the Company recorded total charges of $318 .3 million for 20 restructuring and related activities, primarily from the disposition of certain excess administrative and non-operational facilities, and, to a less extent, staff reductions 21 and the impairment of other assets . These activities, combined with other cost reduction activities, are expected to result in reduced spending of over $250 million 22 annually.

23 Net loss for the second quarter 2001 was $583 .4 million or $1 .05 per share, compared to $51 .8 million or $0 .13 per share in the second quarter 2000 . 24 "Exodus has delivered a solid quarter in a challenging environment," said Ellen M . 25 Hancock, chairman and CEO of Exodus. "Exodus continues to attract and sign new customers and expand the services provided to existing customers . We are please d 26 to add 264 new names to our long list of customers who outsource their operations to Exodus. Although we continue to see churn, we have been replacing those 27 customers with new ones that make our customer base even stronger . The vast majority of our customer churn was the result of the general economic environment 28 and the financial pressures those customers experienced . No other company can FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -36- • •

1 provide what we do in terms of the quality and depth of service offerings and customer support. Our global network and outsourcing solutions are unsurpassed . 2 The Company's outstanding customer and partner relationships and our dedicated and skilled employees are the key to industry leadership ." 3 "In response to the current economic environment, we have implemented plans to 4 reduce our expenditures and strengthen our business," said Hancock. " We continue to target the third quarter ofnextyear to achievefree cash flow . " 5 Key milestones and metrics that the Company achieved during the quarter include : 6 • Signing over $200 million of gross new annualized recurring bookings for the 7 quarter. Assuming these bookings were installed today, the $200 million represents the recurring revenues that would result from these new contracts over 8 the next 12 months. In addition to thegross new bookings , we received orders for non-recurring revenues from equipment sales, consulting services and other 9 services.

10 • The net number of outsourcing customers increased to 4,540 at quarter end. 1 1

12 • At quarter end, enterprise customers increased to 63 percent of Exodus'total monthly recurring revenues and bookings, compared to 45 percent one year ago . This 13 achievement demonstrates the progress the Company has made in shifting its customer mix toward an enterprise customer base . 14 • The annualized recurring revenue run rate at the end of the quarter was 15 approximately $1.44 billion .

16 • Average annualized revenue per IDC customer was approximately $317,000 .

17 • In response to new outsourcing demand, the Company opened IDCs in Amsterdam, Dallas, Miami and Paris . At quarter end, total gross square footage grew 18 to approximately 5.6 million square feet in 44 IDCs.

19 • The GlobalCenter(R) acquisition is essentially complete and all significant functions and operations are now fully integrated . 20 Second Quarter Highlights 21 Operational and financial highlights for the second quarter are as follows: 22 • Total revenue mix consisted o f 48 percent from infrastructure 23 31 percent from managed and professional services 21 percent from Internet connectivity 24 ' Gross margins, excluding restructuring and asset impairment charges, were : 23 percent of revenue, or $74.7 million 25 43 percent of revenue, or $137 .8 million, excluding depreciation and amortization • Annualized churn was 9 percent at quarter end 26 • The number of EBITDA positive IDCs remained at 27 • Days sales outstanding were 72 days 27 • Capital expenditures were $188 .6 million and principally represented investments to build and expand IDC s 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -37- 2 Exodus expects to achieve third quarter 2001 results as follows : • Revenue of approximately $325 millio n 3 • Gross margins of approximately 22 percent of revenue • EBITDA of approximately $15-$20 millio n 4 • Cash net loss of approximately $145 million, or $0.26 per share • Exodus expects results for 2001 as follows : 5 • Revenues of approximately $1 .35 billion • Gross margins of approximately 23 percent of revenue 6 • EBITDA of approximately $70-$80 million • Cash net loss of approximately $515 million, or $0.93 per shar e 7 • Gross IDC square footage will be 5 .9 million after opening additional IDCs in the Santa Clara and Washington, DC areas 8 • Capital expenditures of approximately $900 million • Cash and cash equivalents exiting the year of approximately $200 millio n 9 "As businesses continue to grow and expand their e-commerce and Internet 10 initiatives, outsourcing remains a critical component of those strategies," said Hancock. "Exodus is well positioned with the capacity and the value added service 11 offerings to take advantage of this growth . Utilizing a partner like Exodus is the best way for companies to implement their mission-critical outsourcing initiatives . " 12 88 . The foregoing statements were false and misleading because, as set forth below in 13 ¶¶105-129, 152-191, Exodus' financial results were false due to improper revenue recognition 1 4 practices and failure to conform with GAAP. Further, as set forth below in ¶¶ 192, Exodus' cash 15 balances were also false. Defendants also misrepresented the number of customers by including 16 customers who were not active, who had cancelled and who had no ability to pay. 17 89. On August 2, 2001, Cnet News .com published an interview with Hancock . In the 18 interview, Hancock continued to dispel rumors of problems with Exodus : 19 Q : Why do you think Exodus stock has been popular with short sellers? 20 A: I believe we had a series of disconnects about our business with some analysts . One 21 was whether there's a glut of data centers. Absolutely not true. We opened.up four new data centers in the quarter. We expect to open a new data center on the 22 East Coast this quarter and it looks like we'll need to open another data center on the West Coast this year. So we don't believe in theglut theory. Second, the theory 23 goes, is that because of a glut, we're doing massive discounting . And we say, 'Sorry, we're not doing that.' And then there was the comment that 'They're not going to 24 have enough cash, because if they spend this much in the first half, they must be going to spend that much in the second half.' And the answer is, we're not . So we 25 did have some disconnects with the analysts, and I believe that did have an impact on how people feel about the stock . 26 90. On August 14, 2001, Exodus filed its Form 10-Q for the quarterlyperiod ending Jun e 27 30, 2001, signed by William Austin, as follows : 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -38- Cash and cash equivalents $616 million 2 Accounts receivable $272 million 3 Revenues $282 million

4 The Form 10-Q stated, with regards to its financial statements, that : 5 The accompanying unaudited condensed consolidated financial statements 6 have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of 7 Regulation S-X . Accordingly, they do not contain all of the information and footnotes required by generally accounting principles for complete financial 8 statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments , consisting 9 of normal recurring adjustments, necessary for the fair presentation of the Company's financialposition as of June 30, 2001 and the results of its operations 1 0 and cashflows for the three andsix-monthperiods endedJune 30, 2001 and 2000.

11 With regards to revenues, the Form 10-Q stated :

12 Service revenue increased 75% and 104% to $282 .5 million and $582 .7 million for the three and six-month periods ended June 30, 2001 from $161 .4 and 13 $285 .7 million for the same periods of the prior year, respectively . 14

15 Other revenue increased 122% and 246% to $36 .2 million and $84 .7 million for the three and six-month periods ended June 30, 2001 from $16.3 million and 1 6 $24.4 million in the same periods of the prior year, respectively .

17 The Form 10-Q also stated:

18 We believe our currently estimated working capital and capital expenditure requirements over the next 12 months can be met with existing cash and cash 19 equivalents, cash from sales of services to customers .and collections of existing and future accounts receivable from customers, cash from sales of investments and other 20 property, existing and future lease financings and other financing lines of credit, and other debt or equity financings . We may also seek to raise additional funds through 21 public or private debt or equity financings, strategic relationships or other arrangements. 22 In the Form 10-Q, the Company also disclosed that a member of its Board of Directors, Thadeus J . 23 Mocarski, resigned from the Board and that the Board reduced the authorized number of members 24 of the Board to nine. 25 91 . On August 21, 2001, Exodus announced via a press release that two other Boar d 26 members, Mark Dubovoy and Naomi Seligman, also resigned from the Board. 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -39- 1 92. The departure of these three Board members was discussed in an article in the Augus t

2 28, 2001 San Jose Mercury News:

3 Several venture capitalists theorized that the trio [Mocarski, Dubovoy and Seligman] hit the door in case the debt-saddled firm files for bankruptcy protection . The 4 Securities and Exchange Commission used to require board members of public companies that go bankrupt to disclose that in future regulatory filings ; those rules 5 have changed, but not all VCs I spoke to knew that .

6 None of the three ex-board members - venture capitalists Mark Dubovoy and Ted Mocarski, and e-commerce consultant Naomi Seligman - could be reached to 7 comment. But Exodus Chief Executive Ellen Hancock says the company is in no danger of filing Chapter 11 . 8 Hancock and Exodus board member Bill Krause say the defections were tied to the 9 board members' need to move on to new investments, not Exodus' financial straits . Dobovoy and Mocarski came to the company via venture investments that were 1 0 returned long ago to the limited partners in their respective firms .

11 "They have no upside, and their limited partners put pressure on them to resign and manage new investments," says one valley insider, describing how such scenarios 12 typically work .

13 Hancock also shoots down published reports that the board members had quit following a heated debate about the Company's future . "To be blunt, that's bull," she 14 says, adding a four-letter syllable to that word.

15 93 . On August 27, 2001, Information Week reported Hancock saying that "[wJe're viable

16 ... [wJe have sufficient cash," and that Exodus has sufficient cash to survive for another year, when

17 she expects it to become cash-flow positive . Likewise, the September 3, 2001 Computer Reseller

18 News article contained an interview with Hancock wherein Hancock was bullish about Exodus'

19 future, asserted that Wall Street speculation that Exodus will be declaring bankruptcy within the next

20 six months is wrong, and emphasized that Exodus will have enough money and does not need to get

2 1 additional funding until it reaches profitability within about a year .

22 94. The next day, on September 4, 2001, Exodus announced that defendant Hancoc k

23 resigned, and that William Krause was appointed as CEO and Chairman of the Board of the

24 Company.

25 95 . On September 25, 2001, the Wall Street Journal reported that people familiar with

26 the situation said that Exodus was preparing a bankruptcy-court filing, and Exodus has bee n

27 considering debtor-in-possession financing and other arrangements .

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -40- 1 96. Following this leak regarding Exodus' bankruptcy, its stock price plummeted to 17 1

2 11 cents on record volume of 193 million shares .

3 97. The next day, on September 26, 2001, Exodus issued a press release announcing that

4 it had filed for Chapter 11 bankruptcy. In the press release, new CEO Krause admitted that Exodus

5 had excess capacity : "We sacrificed profitability in exchange for growth and market share,

6 overexpanding in some areas in advance of demand, not anticipating the decline as the dot .com

7 bubble burst and the economy weakened . "

8 98. Following the announcement of Exodus' bankruptcy, Nasdaq halted Exodus' trading

9 until additional information was provided by the Company .

10 99. On October 5, 2001, when trading was allowed to resume on Exodus stock, Exodus'

11 stock price dropped further to 10 cents on high volume of 72 million shares .

12 100. As a result, plaintiffs and members of the Class who acquired their Exodus shares

13 I during the Class Period suffered damages .

14 POST CLASS PERIOD EVENTS

15 101 . On October 5, 2001, Exodus announced it had voluntarily delisted from the

16 NASDAQ and began trading on the OTC Bulletin Board .

1 7 102 . Exodus has not reorganized but has liquidated . On June 5, 2002, the United States

18 I District Court for the District of Delaware confirmed Exodus' Second Amended Joint Plan o f

19 I Reorganization. Under the Plan, all of the outstanding shares and all of the outstanding debt

20 I securities of Exodus were cancelled and ceased to be outstanding as of June 19, 2002 .

21 103 . Exodus' financial statements for fiscal 2001 were never audited because Exodu s

22 maintained, in a Form 12b-25 filing on April 2, 2002, that because it planned to liquidate, and that

23 its common stock will have no value, such information would have little to no value or relevanc e

24 to investors.

25 BASIS FOR THE ALLEGATION S

26 104. The allegations herein are based on plaintiffs' counsels' investigation, including a

27 review of publicly available documents, consisting of, inter alia, Exodus' filings with the SEC ,

28 Exodus' press releases, Exodus' conference calls, analyst repo rts on Exodus, and newspaper articles

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -41- 1 and other media coverage on Exodus and its officers . The allegations herein are also based upon

2 certain Exodus internal documents and interviews with certain former Exodus employees includin g 3 11 the following Confidential Witnesses ("CW"):

4 (a) CW1 - CW1 was the Controller for Exodus' Professional Service s

5 Organization from January 2000 through February 2002 . CW1 was responsible for the overall

6 financial accounting and reporting for the Professional Services Organization, and is knowledgeable

7 about Exodus' overall business and accounting operations because Professional Services interacted

8 daily with the sales organization and had visibility over all of Exodus' revenue sources . CW1 was 9 on distribution for all of Exodus' financial reporting, and regularly attended the Company's weekly

1 0 executive staff meeting until the end of June 2001 . These meetings were typically held on Monday

11 mornings, and were attended by defendants Hancock, Case, Dollahite, Stoltz, Mohamad, Wegner,

12 Yeack and Brown along with other officers . CW 1 obtained an undergraduate degree in accounting

13 and has passed the CPA exam.

14 (b) CW2 - CW2 worked in public relations for Exodus until he was laid off i n

1 5 April 2001 . In August 2001, CW2 was rehired by Exodus to work in Exodus' Collections Taskforce , 16 where he remained until October 2001 .

17 (c) CW3 - CW3 was the Vice President of Service Operations at Exodus from

18 the end of 1999 to the beginning of April 2001 . CW3's responsibilities included overseeing all

1 9 aspects of service operation's "Operating Measurements and Metrics" and the "War Room" (which

20 was essentially the customer complaint department) . CW3's Operating Measurements and Metrics

21 responsibilities consisted of compiling information on all customer rates of renewal, cancellations, 22 and complaints .

23 (d) CW4 - CW4 was a financial analyst for Exodus from October 1999 unti l

24 January 2002 . CW4's responsibilities included monitoring costs and revenue for individual servic e

25 centers, and to produce budget forecasts for the centers . Although CW4's coverage primarily

26 included data centers in Seattle, and occasionally for centers in the Bay Area, Irvine, Texas an d

27 Chicago, by late 2001, CW4 was involved with P&L and forecasting work for all of the North 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -42- 1 America regions. At one point, CW4 was also assigned to investigate and resolve a salesperson's

2 disputes over his commissions .

3 (e) CW5 - CW5 was the Senior Manager of Credit and Collections for Exodus

4 from June 2000 through May 2001 . CW5's responsibilities included generating bad debt reserve

5 reports and revenue reserve reports . CW5's responsibilities also included communicating with

6 collections personnel to determine whether certain debts could be collected .

7 (f) CW 6 - CW6 was an account executive for Exodus from February 2000

8 through April 2001 . CW6 was responsible for selling all of Exodus' products and services to

9 customers in the Pacific Northwest Region . CW6 followed the sales cycle from start to finish, and

10 maintained the accounts after they were landed .

11 (g) CW7 - CW7 was an account executive with GlobalCenter before it was

12 acquired by Exodus. CW7 continued with Exodus in this capacity from January 2001 through May

13 2001 . CW7 was primarily responsible for bringing in new business and upselling additional services

14 to customers. Once an account was landed, CW7 would maintain the accounts .

15 (h) CW8 - CW8 was a marketing operations manager for Exodus from December

16 2000 through August 2001 . CW8 was responsible for many support functions within the Marketing

17 Department. CW8 was also put in charge of integration of the GlobalCenter acquisition within the 18 Marketing Department .

19 (i) CW9 - CW9 was the Vice President of Facilities for Exodus from February

20 1997 through October 2001 . CW9's responsibilities included project development, including

21 acquisitions, data center builds, real estate and construction management, and mechanical and

22 electrical engineering management. CW9 supervised nationwide building development and

23 maintenance issues for Exodus . In March 2000, CW9 put together a capital plan for Exodus .

24 (j) CW10 - CW10 was a Credit & Collections Analyst for Exodus from July

25 1998 through the end of June 2001 . CW 10 was initially hired as a collector and assigned to collect

26 outstanding invoices from Exodus customers . In mid-1999, CW10 also became responsible for

27 determining the creditworthiness of customers . As a Credit & Collections Analyst, CW10's

28 responsibilities primarily involved running credit checks on prospective customers .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -43- 1 (k) CW11 - CWl1 has been a Credit & Collections Analyst for Exodus sinc e

2 August 1999. CW11 was the sole Credit & Collections Analyst assigned to the "Strategic Accounts"

3 11 group which consisted of Exodus' high profile customers until the Collections Task Force, or th e 4 11 "Customer Care Center" group, was formed in June 2001 .

5 (1) CW12 - CW12 was a collector at Exodus from the end of 1998 throug h

6 I) September 2001 . In early 2000, CW12 was promoted to Sr . Collection Specialist.

7 REASONS WHY DEFENDANTS' STATEMENTS WERE FALSE AND MISLEADING 8 A. Exodus Entered into Transactions with Non-Creditworthy Customer s 9 105 . During the Class Period, Exodus entered into numerous contracts with non- 10 creditworthy customers, and customers who could not otherwise afford Exodus' services, in order 11 to show revenue growth. According to CW1 : 12 (a) At the very beginning of January 2000, Exodus implemented a new 13 compensation plan for its sales force. CW1 had just joined the company at this time, and became 14 immediately familiar with the plan through conversations with Senior Vice President of Finance 15 Mike Healy. As a controller for Professional Services, it was necessary for CW1 to know the details 16 of all sales transactions, as well as employee compensation, because he controlled or "owned" the 17 P&L for the entire Professional Consulting Services organization . 1 8 (b) Revenue for Professional Services was historically delineated as both monthl y 19 recurring cost ("MRC") and non-recurring cost ("NRC") . Typically, in a Professional Services 20 agreement, 95% of the associated contract value (revenue) had historically been booked within one 21 quarter. The services provided by Exodus were normally architectural design and installation of 22 equipment in a "cage" which had been leased by a customer within an Exodus IDC . The cost of the 23 equipment was invoiced through the Professional Services Organization, along with the services 24 performed for installation and implementation ofweb-hosting operations . Approximately 5% of the 25 pricing and revenue associated with a Professional Services deal would be appropriately scheduled 26 and invoiced over twelve months, at which time the service agreement would come up for renewal . 27 This small portion of service revenue was primarily to pay for a monitor - an Exodus employee at 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -44- 0 •

1 the data center who monitors volumes of electronic traffic, and can inform any given customer when

2 their website is crashing.

3 (c) According to CW1, in January 2000, Exodus' sales compensation plan was

4 changed to incentivize the sales force to "dress up" NRC deals as MRC deals, allowing the customer

5 to pay for the entire installation and services over twelve months. Exodus financed the deal for

6 customers in this way, structured along with "side agreements" where the sales force was encouraged

7 to tell customers that if they decided not to continue utilizing the equipment or leased space after

8 ninety days, they could cancel and Exodus would "debook" the transaction . This practice resulted

9 in Exodus financing many deals that customers obviously would not have been able to afford and

1 0 pay for up front. CW 1 learned of such side deals through conversations with various other sales and

11 finance employees .

12 (d) Exodus urged its sales force to structure deals this way in order t o

13 accommodate the growing number of uncreditworthy or cash-poor companies, especially in the dot-

1 4 com sector, and to create the appearance of growth for Exodus . In the new sales compensation plan,

15 Exodus gave its salespersons "quota protection" for the entire value of these deals, even though the

16 customer lacked the financial resources to pay for the entire order . For example, a salesperson who

17 had a 17.5% commission up to $10 million would get a 22% commission if he exceeded $10 million .

18 It was very important for salespersons to increase their commission level . While salespersons would

19 only receive commissions for months that customers did pay, if a customer cancelled the order, the

20 salesperson still receive credit for quota purposes for the entire amount of the 12 month sales

2 1 agreement. Once a customer pulled out of the deal, Exodus' profit margin was severely affected .

22 For example, in a $1 .2 million Professional Services deal, Exodus would likely invest about one-

23 third of that or $400,000 in design work and equipment . If the customer paid for only 90-days (three

24 payments at $100,000) and then pulled out pursuant to a side deal, Exodus had over $400,000 in

25 costs (including labor) but received only $300,000 in revenue .

26 (e) The end result was that more customers were enticed to enter deals structure d

27 as MRC, especially those who would not have had the cash available or could not find a creditor t o

28 finance the expensive design work. Salespersons were credited against their quotas for the entir e

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -45- 1 amount of the transactions, but Exodus accounts receivables ("A/R") became inflated with invoices

2 that would never be paid . With the new compensation plan and directive to structure deals as MRC,

3 salespersons were at least assured of quota relief, even in the case of customers who canceled or

4 would not pay when these costs were amortized over twelve months .

5 (f) By the first or second quarter of 2000, CW1 discovered that Exodus' order

6 management system had continued to create monthly orders against Exodus' agreement with its

7 customer and to generate invoices as if the deal were proceeding per the agreements, even if the

8 customer had cancelled . In turn, Exodus recognized revenue upon invoicing procedures for the

9 Professional Services portion ofExodus agreements . However, this revenue was "completely false ."

10 (g) The same practice of false revenue recognition for non-paying or canceling

11 customers occurred with Exodus' revenue as well . Since this portion of Exodus' business accounted

12 for over 80% of gross revenues, the dollar value of inappropriately recognized lease revenue was far

13 greater than the Professional Services piece . As Exodus moved through fiscal 2000 and into fiscal

14 2001, the percentage of false revenue associated with MRC invoicing - for both Professional

15 Services and leases - ramped at an accelerated level as the primary sector of Exodus business - the

16 dot-coms - became unstable and insolvent .

17 (h) During the Class Period, CW1 raised the MRC issue with other Exodus

18 executives, including, Hancock, and "took a healthy beating" whenever he raised the issue . CW 1's

19 confrontations with the executive management team - in particular in Monday morning meetings

20 attended by all of the Individual Defendants - became so adversarial that he was dismissed from

21 attendance shortly after the close of the second quarter of 2001 . His statements to the executive

22, defendants during the first and second quarters included his concerns that Exodus continuously failed

23 to establish a reserve for customers known to be non-creditworthy with A/R aged over 60 days (to

24 as much as one year) and that, nevertheless, Exodus had continued to invoice and recognize revenue .

25 (i) CW1 also had many discussions with Mike Healy (Senior Vice President of

26 Finance) and Susan Colvin (Controller) regarding Exodus' failure to establish reserves, to debook

27 "bad" receivables, and the lack of creditworthiness for certain customers that Exodus extended credit

28 to in MRC structured deals. In most cases, customers that canceled after 90 days and before the end

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -46- 6 0

1 of the agreement period (typically 12 months), usually stopped utilizing Exodus' services and,

2 therefore, discontinued payments for all service and lease related invoices .

3 106. Another former Exodus employee, CW10, who was involved in Exodus' credit and

4 collections, also confirmed that Exodus structured NRC as MRC deals in order to accommodate non-

5 creditworthy customers . According to CW 10 :

6 (a) Exodus implemented a change in the compensation of its sales in early 2000 .

7 According to CW10, prior to fiscal year 2000, once installation was complete and installation

8 invoices were created, the Salespersons received 40% of the total calculated commissions for the

9 sale, and the remaining 60% of the commission were then paid to the salesperson on a pro rata basis

10 over the life of the agreement - usually 12 months. Prior to fiscal year 2000, commission were not

11 paid if a customer cancelled, and commission payments were reversed for invoices that were not

12 paid, or "debooked . "

13 (b) According to CW10, this change helped Exodus reach the smaller dot-com

14 companies that could not afford to be installed in an IDC . Since Exodus was now financing the

15 entire transaction by structuring both lease and installation payments over a 12-month term, the

16 creditworthiness of customers should have become more important to Exodus . Instead, most of the

17 new customers, primarily Internet companies, were not creditworthy for the types of monthly

18 payments they were required to make in connection with their purchases from Exodus, but these

19 deals were "pushed through" by senior management after rejections by the Credit & Collections and

20 Finance Departments. According to CW10, Mohamad and Hancock were regularly involved in

21 directing that these high-risk deals be made, and Senior Vice President of Finance Mike Healy was ,

22 forced to approve virtually everyone who "walked in the door . "

23 (c) In early 2000, CW 10 assisted Exodus in creating a credit analysis form, which

24 detailed a customer's financial status . Bank account information and balances were itemized, venture

25 capital firms and committed investments were referenced, as well as vendor contacts and references .

26 For Exodus to execute a sales agreement with a new customer, an authorizing signature on the

27 customer's credit analysis was required. According to CW10, typically, the dot-corns and start-ups

28 were not creditworthy, because they had limited cash, limited or no other available venture capital, FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1 -2661 -MMC -47- C E

1 no credit history or poor credit, few or no references, with products still in development. Her

2 immediate manager, Jeff Ploshay, would not sign off on these deals, and the credit reports were

3 elevated to Senior Vice President of Finance, Mike Healy . As the primary Credit & Collections 4 Analyst for Exodus, CW 10 was in regular communications with Ploshay, and sometimes Healy, over

5 the ultimate decisions of executive management regarding noncreditworthy customers . She was

6 informed that Hancock personally approved a majority of noncreditworthy customers . If approval

7 did not come from Hancock, approval would come from Mohamad, Dollahite, and sometimes Case

8 or Stoltz. According to CW 10, the highest risk customers - which could not be approved by Healy

9 because they had such poor credit and cash conditions - were routinely approved by Hancock, Case,

1 0 and/or Stolz. According to CW 10, nearly all of the dot-coms that had gone bankrupt during the

1 1 1999-2001 time frame, had been Exodus' customers .

12 (d) As of early 2000, the Credit & Collections Department prepared a "Credi t

13 Analysis form" for each prospective new customer of Exodus . The form included a Dunn &

14 Bradstreet derived credit analysis, if any . Usually the prospective customers were too new or too

15 small to be recognized by Dunn & Bradstreet. According to CW 10, a review of these forms for a

16 majority of Exodus' customers showed that Exodus was at great risk for long-term success .

17 B. Exodus' Financial Results Were False Because Exodus Continued to Record Revenue for Customers Who Had Canceled Their Order s 18 107. During the Class Period, Exodus' financial results were false because it continued t o 19 record revenues even after customers had canceled their orders . According to CW1 : 20 (a) Exodus' billing system could invoice customers "in perpetuity ." Unless 21 someone were to physically go into the system directly to perform a "debook," the system woul d 22 continue to bill for years . Even though the original agreement might specify a 12-month order, the 23 system would continue to invoice at the same monthly rate after the twelve months, unless someone 24 physically input the changes . In addition, sales contracts involved language that the agreement s 25 between Exodus and its customers would automatically renew at the end of twelve months unles s 26 customers formally notified Exodus of non-renewal . However, in practice ; customers would 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -48- 1 generally just cancel at some point without formal notification to Exodus as provided under the 2 agreements .

3 (b) Although Exodus knew that customers had cancelled and were not payin g

4 invoices, Exodus would not contact customers to verify cancellations for purposes of changing the

5 order system and discontinuing the invoice process . Typically, customers would just ignore Exodus

6 invoices after having cancelled, due to the side agreements made with Exodus . Once Exodus'

7 Collections Department got involved, the customer's A/R could be as much as 180 to 270 days owed .

8 When the customers were finally contacted by Exodus for payment, their response to Exodus, if any,

9 would simply be that they were not going to pay the bill and were told they did not have to .

10 (c) Even though Exodus' sales contracts, including the lease portion of the

1 1 agreements, looked "ironclad," beginning in early 2000, Exodus began to establish a track record o f

12 "letting companies off the hook ." This should have put into question Exodus' entire revenue stream .

13 108 . CW10, another former Exodus employee, also corroborated that Exodus continue d

14 to invoice and recognize revenue on customers who had cancelled their services :

15 (a) According to CW 10, many customers cancelled at some point during the 12- 1 6 month period of the sales agreements and were allowed to do so as a result of side agreements made

17 with Exodus customers by the Sales Department under Mohamad . CW10 learned that Sam

18 Mohamad encouraged the sales force to tell customers that Exodus would allow them to cancel

19 agreements and pull out of IDCs after 90 days, if, for whatever reason, they did not desire to continue

20 using the Exodus services throughout the life of the agreement . Upon attempting to collect on bad

21 debts, collectors heard this over and over again from Exodus' customers .

22 (b) When customers could no longer afford to meet the terms of their agreement s 23 with Exodus, many would move out of IDCs "overnight," but invoicing would continue even though

24 the customer's equipment had been pulled out and Exodus was no longer performing services .

25 According to CW 1.0, regardless of whether customers informed a sales rep or anyone else at Exodus

26 about cancellation, a large percentage of those that did cancel actually moved out of IDCs, and this

27 activity was known to Exodus management through emails between IDC management and corporate . 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC . -49- 1J

1 (c) The Solomon system continued to invoice customers that no longer utilized

2 Exodus services. These customers were no longer installed in Exodus IDCs and already owed

3 Exodus for receivables that had aged 60 - 90 days, and beyond . Collectors learned of cancellations

4 from customers, rather than Exodus' own systems, once collectors tried to collect outstanding A/ R

5 for customers that pulled out.

6 (d) As Exodus customers received invoices for deals that had been cancelled, or

7 services not performed, it would take approximately three months before collections would be i n

8 touch with customers to determine the reasons why customers were not paying . Many informed the

9 collectors that they had previously alerted the Exodus salesperson responsible for that customer of

10 elections to cancel deals, or that they were disputing invoices for certain reasons . Then the Credit

11 & Collections Department would contact the salesperson, who would admit that they had received

12 these communications from customers, but had "forgotten" to tell the Accounting Department .

13 (e) The witness believes that approximately 80% of the revenue reported b y

14 Exodus during fiscal year 2000, and through the end of the Class Period, was largely fraudulent . In

15 many cases the entire amounts of invoices recognized as revenue were not collectable, and in other

1 6 cases, only portions of the invoices were collectable or actually owed by customers .

17 109 . Similarly, CW 11 confirmed that Exodus was invoicing customers who had cancelle d

18 their services .

19 (a) CW11 recalled that the collectors at Exodus referred to themselves as bein g

20 "the last to know ." It became a common, daily occurrence for them to contact customers about old

21 A/R., and be told that the customer had cancelled months earlier. Since Exodus was understaffed on

22 collectors, it was not unusual for a customer to go from three to five months without paying without

23 being contacted by a collector. Once a customer was contacted, the customer would refer the

24 collector to the account executive, who had been informed of the pull-out . The account executives

25 many times would claim that they forgot to tell accounting .

26 (b) According to CW1 1, Exodus was a completely sales driven company.

27 Because cancellations affected revenue and commissions , Exodus' management from Mohamad to

28 the executive officers ignored it for as long as possible.

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -50- 0 0

1 (c) Based on the number of accounts in Solomon during the Class Period, and that

2 11 fact that about half of those invoiced had actually cancelled, CW 11 estimates that about 40% to 50 %

3 I of the revenue recognized during the Class Period was inappropriate. According to CW1 1, much

4 11 of the bad A/R was written off after the Company went bankrupt .

5 C. Defendants Misrepresented the Number of Exodus Customer s

6 110. Exodus also misrepresented the number of customers it had. According to CW 11 an d

7 CW12 :

8 (a) Exodus had two systems, Solomon and Siebel . In the Solomon system, each

9 customer of Exodus was assigned to the Credit and Collections Department once becoming a

1 0 customer. Solomon was highly accurate as a historical database for Exodus customers . A collector

11 was given responsibility to monitor payment history and collect against any invoices aged 60 days

12 or more. In the Siebel system, the order management system, a customer list was also maintained,

13 but the list also contained sales inputs for potential customers. Solomon reflected actual customers

14 which had signed Master Sales Agreements with Exodus . Siebel did not .

15 (b) When Hancock asserted that Exodus had over 4,500 customers, this was fals e

16 for two reasons . First, she was referring to the number of customers in the Siebel database, which

17 included potential customers identified by contacts with the sales force . On the other hand, Solomon

18 reflected an actual 3,500 or so customers. Second, of the 3,500 customers in Solomon, over 1,500

19 customers were formally cancelled by Credit & Collections after the Class Period because collectors

20 had determined that these customers had pulled out of deals and data centers from the fall of 2000

21 through the end of the Class Period . Despite these pull-outs and cancellations, Exodus had

22 continued to invoice and recognize revenue until collectors manually cancelled the accounts in the

23 Siebel and Solomon systems . Thus, contrary to the representation that Exodus had about 4500

24 customers, there were in fact only about 2000 customers .

25 C. Exodus' Revenue Was Inflated Through Barter Transactions and Other False Accountin g 26 111 . During the Class Period, there were some specific transactions that resulted in fals e 27 revenue recognition and false accounting . According to CW1, the following examples are only a 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -51- C 1 11 sample of the total transactions that resulted in significantly material amounts of revenue that shoul d 2 11 not have been recognized:

3 (a) Oracle - In approximately the fourth quarter of 1999, Exodus entered into a

4 barter transaction with Oracle. The end result, according to CW 1, was that both companies "grossed

5 up their revenue" on which there were no real sales for either party. Included in the deal was the

6 purchase by Exodus of Oracle licenses in the amount of approximately $5 million, which Exodus

7 had no need for and would never use . In exchange, the witness believes Exodus invoiced Oracle for

8 "services rendered," which were never performed, and the two companies effectively swapped

9 invoices. According to CWl, the revenue recognized from the Oracle deal had no cost associated

10 and, therefore, the total amount went directly to net income (or to offset asset loss) . CW1 recalled

11 that in approximately December 2000, newly hired Chief Operating Officer Don Casey "just lost it"

12 over what he had learned about the Oracle deal . Casey demanded that Hancock, Dollahite and Case

13 immediately debook the Oracle licenses as an asset, saying that the purpose of the Oracle transaction

1 4 was obvious and that there was never any real need for, nor usable and or sellable Oracle leases

15 purchased. According to CW 1, to make this barter transaction appear as a legitimate sale and

16 purchase, Mike Williams (Vice President of Sales), and Sam Mohamad (who had come to Exodus

17 from Oracle) were involved arranging this transaction.

18 (b) Innoventry - In approximately the first quarter of 2001, CW1 wa s

1 9 approached by an Exodus employee regarding a barter deal involving this small Silicon Valley start-

20 up worth approximately $800,000. This employee told CW1 that Innoventry had no cash and

21 appeared to be struggling, and that he did not feel comfortable signing off on the deal to finance

22 Innoventry on an MRC basis. After reviewing some data, CW1 agreed. However, CW1 was

23 informed by Bencat Bhamidipati, a Finance "business partner" for Dollahite, that "Ellen (Hancock)

24 really wanted this deal and was going to do it . She believes it is an important customer ." Although

25 CW1 informed Bhamidipati that all of Exodus' customers are important, but this customer had no

26 money, and it was clear that Exodus would never be paid, revenue was recognized for Innoventry

27 during the first and second quarters of fiscal 2001 because Mohamad, in charge of sales, pushed the

28 deal through . CW1 believes that the Innoventry deal was a barter transaction in which Exodu s

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -52- 0 0

1 purchased software licenses from Innoventry that were unneeded, and in turn, invoiced Innoventry

2 in an MRC type of transaction over the next twelve months or so for installments on this $800,000

3 transaction, and recognized revenue associated with the invoices . CW1 does not believe Innoventry

4 ever made any payments to Exodus whatsoever, nor did Exodus to Innoventry . Sometime during

5 the second half of 2001, the Innoventry deal was debooked .

6 (c) Alta Vista - The original sale for Alta Vista had been placed in approximately

7 forth quarter 1999 or first quarter 2000 . Alta Vista was a spinoff of CMGI, a technology company,

8 and was created as a Netscape-type of search engine . CMGI was Alta Vista's primary and possibly

9 sole source of funding, and by first quarter 2001, it became public that CMGI was going under

10 financially. The original deal with Alta Vista provided Exodus with $179,000 per month in

11 continuing revenue . CW 1 recalled that the deal had been renegotiated down to $149,000 per month

12 as of June 2000. However, in first quarter 2001, with the news about CMGI, Alta Vista itself

13 became insolvent and stopped making payments . CW1 believes that Alta Vista canceled its

14 agreement with Exodus pursuant to some sort of side agreement between the two companies . By

15 second quarter 2001, Alta Vista already owed Exodus several hundred thousand dollars, and some

16 of it had been aging since at least fourth quarter 2000. CW1 called the CFO of Alta Vista and

17 arranged for a meeting to discuss the deal and Alta Vista's outstanding invoices . CW1 went to Alta

18 Vista sometime during the second quarter of 2000 and met with its CFO . Alta Vista's CFO informed

19 CW1 that he had been a victim of a "bad deal ." The CFO stated that he had never approved the deal

20 on behalf of Alta Vista and, somehow, someone below him had been manipulated by an Exodus

21 salesperson and that Alta Vista had little use for Exodus . Following the meeting, Alta Vista

22 immediately restructured the deal, and within a quarter or so, "kicked Exodus out ." CW 1 stated that

23 during first and second quarters 2001, Exodus reassigned monthly revenue for invoices that would

24 never be paid, of which Exodus was aware.

25 (d) Niku - Niku and Exodus entered into a barter deal, whereby Exodus

26 purchased a software license from Niku for approximately $417,000 . In turn, Exodus invoiced Niku

27 "for services rendered" in the same amount, and Niku wrote Exodus a check for $417,000 . In fact,

28 no services had been performed . Since this transaction was done under the umbrella of Professional FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -53- 0 0

1 Services, CW1 became involved . According to CW1, the transaction occurred on approximately

2 December 27, 2000, at which time the entire dollar value, $417,000, was recorded as revenue . CW 1

3 recalls that this amount was debooked in later 2001 . He described that the company "left this credit

4 hanging out there" to avoid debooking revenue during the Class Period. CW1 had discussions with

5 Sam Mohamad regarding this transaction, and learned that Mohamad was spearheading the entire

6 barter transaction in which the two companies agreed that "we'll buy your product if you buy ours ."

7 According to CW 1, neither company ever had any intention of using the other's product . Ultimately, 8 CW 1 himself wrote off the $417,000 in revenue associated with the fictitious sale to Niku at the

9 direction of Mike Healy, the Senior Vice President of Finance . CWl recalled that Mike Healy

10 rejected the Niku deal from the beginning, but was pressured by Mohamad to ultimately give

11 approval . Additionally, the Vice President of Sales, Mike Williams was directly involved with this

12 transaction. A statement of work was actually prepared by Stu Elefant, a pre-sales director who was

13 to obtain a bonus for his team (approximately 10%) for closing this deal . The preparation of the

14 statement of work was in reality an unnecessary exercise, but only done to further create an illusion

15 that some effort had been expended . Although the $417,000 amount might be insignificant in terms

16 of the Company's gross revenues, deals like these were very important because these amounts "blow

17 straight through to net income ."

18 (e) Vulcan - Exodus entered into an agreement with a Silicon Valley customer,

19 Vulcan, in early 2000 . The salesperson handling the deal was Chuck Lambreau, and Sam Mohamad

20 was also involved . The deal was made between Lambreau and his sister, who worked at Vulcan in

21 the IT department. Vulcan, a customer as of first quarter 2000, continued to be carried as a customer

22 through the end of 2001, when the revenue associated with the deal, approximately $1 million, was

23 written off because Vulcan had never paid . According to CWl, some of the revenue recognized

24 associated with Vulcan was false because Exodus was not performing any services and because

25 Vulcan was already well in default - perhaps one or two quarters - on Exodus A/R . CW 1 attempted

26 to get in touch with responsible management at Vulcan and could not get his calls returned .

27 (f) SANrise- SANrise was a deal that resulted in Exodus' booking of $39 million

28 in revenue, which was executed in January 2001 . The deal was orchestrated by Vice President of

FIRST AMENDED`;CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -54- t •

1 Marketing Bruce Talley, Mohamad and Healy. CW1 received an email from Healy's organization

2 indicating that McCarthy's Professional Services organization would be allocated a total of $3 .6

3 million as Professional Services revenue . This amount was allocated between various regions,

4 including the Western, Eastern and Southern U .S ., EMEA and the South Pacific. CW1 responded

5 that he had no hours billed by the Professional Services organization with respect to this deal, but

6 was told that this was an accounting decision which had been made by upper management . In fact,

7 the deal was not for any leases or spaces ordered by SANrise . SANrise, a storage company, was

8 purchasing the Exodus "Data Vault" because Exodus had been operating its own storage component

9 without success . In essence, SANrise was purchasing Exodus storage-related business (customer s

10 and some hard assets) only . Exodus receivables associated with the same were not included in the

11 deal. CW1 learned that SANrise was not a cash-rich company and that in exchange for the Data

12 Vault purchase price, Exodus received approximately 20% ownership in SANrise . CW1 does not

13 believe that any dollars ever changed hands, that the 20% interest in SANrise was a stock transaction

14 in exchange for the Data Vault . According to CW1, the $39 million value of the deal (which he

15 believes to have been fictitious) should have been accounted for as an extraordinary item, or a

16 discontinued operation. Instead, Exodus recognized the amount as revenue on its P&L on an MRC

17 basis . He stated that this transaction was really an asset sale, where Exodus sold off a part of its

18 business, but the executive management team wanted to take the amount as revenue over time in

19 order to "massage the numbers ." CW 1 recalled that the SANrise deal was discussed in executive

20 management meetings, probably during first quarter 2001 . Case, Hancock, Dollahite, Williams and

21 Healy concluded that through the accounting entries described above, Exodus could make the

22 SANrise transaction appear as regular and ordinary income over time, rather than taking the related

23 charge or income below the revenue line on the P&L. CW1 believes that the revenue recognized

24 relating to the SANrise deal was ultimately debooked in fourth quarter 2001 . Somewhere around that

25 time, SANrise became non-viable, and there were stories circulating about this company joining the

26 list of technology start-up failures . The SANrise transaction was large. In an internal Exodus

27 document entitled "Exodus Operations Summary," dated January 24, 2001, under the section "North

28 America Top 10 Customers," SANrise was listed as Exodus' largest customer, accounting for 2 .8% FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -55- 1 of the Company's MCR in North America. Also, according to a SANrise press release dated June

2 26, 2001, defendant Marshall Case was hired as SANrise's CFO after his departure from Exodus . 3 112. CW 10 also confirmed that Exodus inappropriately recognized revenue on many

4 barter transactions during fiscal years 2000 and 2001 . According to CW 10, many times, collectors

5 were unaware that a barter arrangement existed, and would simply begin contacting customers

6 because of aged A/R . Once a collector became aware of, and confirmed the barter deal by speaking

7 with both the customer and the Exodus sales rep, collectors submitted emails to accounting

8 indicating that the dollar amount (value) of the barter-related invoices should be taken out of A/R .

9 However, while A/R was reduced and therefore had a positive effect on Exodus aging, revenue was

10 not debited or reduced . Therefore, Exodus continuously carried and reported revenue associated

11 with barter transactions in the full amount of invoices for which cash was never collected . 12 According to CW 10, the dollar amount (value) of revenue invoices associated with barter deals was

13 "in the millions and millions" for fiscal 2000 and fiscal 2001, including :

14 (a) Inktomi - According to CW 10, Exodus and Inktomi engaged in a practice of

15 swapping invoices for approximately $500,000 at quarter-end simply to add to each other's revenue

16 for the quarter. CW10 stated that neither invoice was ever paid and Exodus carried the Inktomi

17 receivable on A/R for as long as executive management wished, prior to issuing credits for the

18 inflated invoices . According to CW 10, at quarter-end, Stoltz (and sometimes Healy) informed her

19 of an amount that should be taken out of Inktomi's oldest receivables and accounted for as a barter .

20 According to CW 10, this is how dollar amounts or values of barter transactions were typically

21 communicated to the Collections Department, as there were no reports or forms associated with

22 identification of barter transactions at Exodus . Typically, the directive came from Ploshay for most

23 accounts, indicating an amount that had been determined at upper-management levels to be a barter .

24 (b) StorageNetworks - According to CW 10, StorageNetworks, like SANrise,

25 provided Exodus customers with data storage and backup services . As a result, much of the revenue

26 associated with StorageNetworks was actually accounted for through barter transactions . Exodus

27 invoiced StorageNetworks for services performed for Exodus customers, and StorageNetworks

28 invoiced Exodus for space and bandwidth. CW10 estimated that at least 80% of the revenue FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -56- 0

1 recognized by Exodus for invoices sent to StorageNetworks was accounted for on service swaps in

2 the same type of barter accounts performed under the Inktomi and SANrise accounts.

3 (c) StorageWay - According to CW 10, StorageWay became an Exodus customer

4 sometime in 1999. She recalled that the company had very bad credit, no money, and was approved

5 by the Exodus executives because it provided storage and backup services for Exodus customers .

6 A/R for StorageWay was largely accounted for through barter transactions, although Exodus

7 recognized revenue on invoices in the same way as it did for storage and data backup vendors -

8 SANrise and StorageNetworks .

9 D. Exodus ' Revenue Was Inflated Because It Invoiced Customers for Services Before Installation Had Been Complete d 10 113 . According to CW 10, Exodus invoiced and recognized revenue from customers even 11 before it had completed installation : 12 (a) The sales process at Exodus was that when a salesperson closes a deal, an 13 order is entered into the Exodus Order Management System (Siebel) . The order defined all hardware 14 and services to be provided to the customer, for the equipment, installation, connectivity and 15 bandwidth monitoring associated with the customer 's use of an Exodus IDC for its Internet 16 operations. The Project Management Department and Professional Services Department both 17 generated their own "installation reports ." These reports were supposed to reflect that equipment, 18 connectivity, and other initial efforts to set-up a customer in an IDC, had been performed . According 19 to CW10, the Exodus agreements provided that Exodus would begin to invoice customers for 20 monthly payments once they had been properly installed in an IDC and connected to the Internet in 21 a manner which the customer could then begin actually utilizing the Exodus web hosting capabilities . 22 (b) These installation reports, which triggered that onset of monthly invoicing and 23 revenue recognition, were false. Sam Mohamad, working with management of the Professional 24 Services and Project Management Departments, instituted a practice to generate these installation 25 reports prior to installation work ever beginning . According to CW 10, nearly all Exodus customers 26 were invoiced for installation that did not occur until approximately three months later, usually in 27 the next quarter. By the time these invoices aged, and collectors began to call customers, the first 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -57- 0 0

1 three months of invoices -which were false - had now aged some 90 days . As a result, three, four,

2 or five months after the fact, the collectors were learning from customers that actual installation dates

3 were three months beyond what was reflected on the installation reports, and that the customers did

4 not owe payment for the first three invoices (or so) because Exodus sales agreements provided for

5 payments to begin only once the installation was complete.

6 (c) According to CW10, revenue for these false invoices was recognized, and

7 once the falsitywas confirmed by responsible Exodus collectors, credits were owed to the customers.

8 However, in order for the Accounting Department to issue a credit, approval was required by upper

9 management. Collectors dealt directly with defendant Dollahite over the issuance of credits . It was

10 Dollahite who authorized whether and when to issue a credit for a disputed invoice . In most cases

11 it took at least seven months between the date of the false invoice (based on a false installation

12 report) and the date a credit would ultimately be issued . The witness recalled that sometimes credits

13 were not issued for over one year . CW 10 believes these delays in credits were a result of the

14 executive defendants' practices to manipulate revenue reporting .

15 (d) Upon discovering that these false installation reports had been responsible fo r

1 6 false invoices - which customers now disputed - collectors emailed Ploshay indicating that a credit

1 7 issuance was required. However, Ploshay would either email a response or verbally inform

18 ) collectors that he could not authorize a credit until Dollahite gave approval . Collectors then, on

19 many occasions, continuously emailed Dollahite through months or quarters, reminding him that a

20 credit was needed (including the reasons, the amount, and the customer involved) . Once Dollahite

21 gave approval, the collector made the actual accounting entries into the Exodus accounting system,

22 Solomon. According to CW 10, the entry included a credit to customer's A/R, and a debit to revenue .

23 The credit was always made against the oldest (or most aged category of) A/R for that customer .

24 According to CW10, the practice of falsifying installation reports to reflect that installations and

25 services had been performed solely in order to begin generating invoices, gave Exodus "extra

26 revenue" to work with every quarter, and credits would usually not be issued until at least the next

27 quarter, and as much as one year or more thereafter.

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -58- 1 (e) According to CW 10, the generation of false installation reports was automatic

2 as new sales agreements were executed, and all customers were subjected to false installation reports . 3 Because Exodus was so "revenue hungry," this practice enabled Exodus to begin invoicing and

4 recognizing revenue right after new sales were entered into, rather than to delay the process until

5 installation was actually completed .

6 114. CW12 also confirmed that Exodus had improperly invoiced customers prior to

7 installation:

8 (a) CW 12 stated that Exodus' invoices to customers consistently included various

9 types of overcharges. Customer disputes over those charges were almost always correct, and resulted

10 in a credit owed.

11 (b) In particular, customer that ordered new installations in IDCs were

12 consistently invoiced prior to installations having been completed, and many times prior to even

13 beginning. This meant that Exodus was able to recognized revenue for installations, which typically

14 were not completed for 2-4 months after Master Sales Agreements were executed . By the time those

15 initial invoices which falsely billed became aged 60 days, 4-6 months had elapsed . Collectors were

16 consistently informed by customers that the reason the invoices were not paid was because those

17 amounts were not owed.

18 (c) CW12 also confirmed that Exodus did not timely approve of credits . 19 According to CW12, Susan Colvin told collectors in month-end Finance/Credit and Collections

20 meetings which occurred during later 2000 and at the end of 1Q 2001, that credits were not-being

21 issued because Exodus needed the revenue for reporting its numbers . CW12 specifically recalled

22 that at the end of either 4Q 2000 or IQ 2001, Colvin stated that the Board of Directors was going

23 to meet, and would be reporting either quarterly or annual numbers . Colvin said that Exodus

24 "needed to keep the money on the books" for reporting purposes, and that was why credits were

25 being held up . According to CW12, it was typical for Colvin to advise collectors at monthly

26 meetings that management did not want to approve credits because of the adverse impact this would

27 have on financial reporting .

28 E. Other Sources and Facts Corroborate that Exodus Had Engaged in FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -59- 0 0

1 Improper Revenue Recognition Practice s

2 115. Exodus' practice of improperly recording revenue has also been confirmed by other

3 former Exodus employees.

4 116. According to CW2, who worked on the Collections Task Force set up in 2001 to

5 collect payments from customers, CW2 learned on the Task Force that a lot of the Company's

6 revenues were not real due to overbilling and shoddy revenue recognition practices . CW2 observed

7 a lot of transactions that should not have been booked as revenue, including, for example, customers

8 being charged for eight spaces even though they only had one space, Exodus recognizing revenue

9 on orders that were canceled, and Exodus billing customers on large orders even where the

10 customers had cut back on their orders. Among the debts the Collections Task Force attempted to

11 collect included American Airlines, which owed between $5 and $7 million to Exodus . From being

12 on the Collections Task Force, CW2 learned that in 2001, Exodus was trying to collect close to $500

13 million in debts from customers .

14 117 . Similarly, according to CW3, a former employee of Exodus whose responsibilities

15 included overseeing "Operating Measurements and Metrics" and the "War Room" (or the customer

16 complaint department), CW3 was informed by customers that Exodus salespeople were falsifying

17 customer orders, recognizing revenue from the orders, and then later crediting the orders . For

18 example, a salesperson would book $20,000 of Exodus' services to a customer, and then cancel the

19 order before an invoice was generated; if a customer allowed the salesperson to do this, they would

20 get a 50% price break on their order in the next quarter . This practice allowed salespeople to make

21 their quarterly goals, earn commissions or to win sales trips . Even when customers later received

22 credits for the order, no deductions would be made to the commissions paid to the Exodus

23 salespeople . According to CW3, when he became aware of this practice, he immediately notified

24 CEO Hancock. To his knowledge, none of the salespeople were fired .

25 118. Likewise, according to CW4, questionable revenue had been recognized . In January

26 2001, CW4 was assigned by her immediate manager to resolve the complaints by a salesperson,

27 Chuck Lambreau, over his commissions . Her job involved "digging down" to find out the actual

28 orders landed by Lambreau, to determine the actual invoice amount versus the agreed amounts and FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -60- 0 •

schedules, and to figure out the adjustments that should be made to his commission. According to

CW4, Lambreau was owed commissions for Professional Services sales closed in December 2000

and in January 2001, which appeared to involve "side deals" made between him and Exodus

customers. Agreements had been booked for much larger dollar amounts than the actual orders that

came in from customers, and it appeared that Lambreau orchestrated agreements to reflect one big

order when, in fact, he had agreed that customers could actually order smaller quantities of services

over time. Because Lambreau's deals accounted for approximately 40% of the total revenue for

Professional Services in the Seattle area, and he was highly protected by Mohamad, Lambreau ended

up being paid his full commission because Mohamad wanted to make sure that Exodus kept this

10 aggressive salesman .

11 119. Additionally, according to CW10, some of the charges to Exodus' customers were in

12 excess to what the customers ordered, including charging customers for installations or bandwidt h

13 that were never provided. For example, according to CW 10:

14 (a) Exodus' invoices to Inktomi included excessive bandwidth that Inktomi neve r

15 ordered. Throughout the Class Period, Exodus invoiced Inktomi approximately $200,000 per month,

16 but only about half of those charges were ever actually owed. CW 10 met with the CFO of Inktomi

17 ("Bill"), as well as her collections counterpart ("Sholeh"), on several occasions during her tenure

1 8 with Exodus. She met with them in later 2000, and then again during the first quarter of 2001, to

19 work out the complexities of what Inktomi actually owed Exodus . By the time CW 10 left Exodus

20 in late June 2001, approximately 50% of Inktomi's A/R was still the subject of outstanding credits,

21 and at least 50% of those credits should have been issued by first quarter 2001 .

22 (b) Other customers that were the subject of overcharges for bandwidth and IDC

23 space included Yahoo, Bestbuy.com, Metropolitan Life, Franklin Templeton, Akamai, United

24 HealthCare Services, Microsoft, Deutsche Bank/Alex Brown, and Freerealtime .com. With regards

25 to many of these accounts, substantial credits were owed to the customers but not authorized during

26 the Class Period.

27 120. Likewise, CW 11 corroborated the Exodus had over-billed customers :

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -61- 0

1 (a) According to CW1 1, some of the large customers he handled were on the

2 "expansion plan" with Exodus . This meant that they might lease 20,000 square feet in an IDC, but

3 initially only installed 5,000 . Yet installation reports were generated indicating full installation

4 which triggered invoicing for the entire 20,000 square feet . This became the subject of large credits .

5 (b) According to CW11,-Exodus carried a huge backlog of credits for all types

6 of over-billing and disputed charges, most ofwhich went for months and even quarters without being

7 authorized, as Ploshay waited for Healy or some other executive management to approve the credits .

8 Generally, it averaged about four months from invoice to credit for the high profile accounts. For

9 customers who were owed credits for bandwidth or data storage types of overcharges, the credit s

10 took even longer. According to CW1 1, management was not ready to give up these types of credits

11 because they were substantial - they individually amounted to hundreds of thousands of dollars

12 worth of credits for the months of over-charges .

13 121 . Similarly, CW 12 confirmed that Exodus' invoices to customers consistently included

14 various types of overcharges . These overcharges not only included charges to customers prior to

15 installation, but invoices for cages that customers did not occupy, equipment they had not leased or

16 purchased, and bandwidth charges which were inflated or erroneous . These types of issues made up

17 the large numbers of credits that collectors determined were owed to customers' accounts, and

18 revenue which was clearly not owed and not collectable. According to CW12, customers became

19 so upset that they were continuously being invoiced after having proven that they did not owe the

20 money, that they emailed Hancock directly, and even showed up at Exodus demanding to see the

21 account executives in order to put a stop to the continued charges . CW 12 was told by customers that

22 they had emailed Hancock demanding that collection activity stop . CW12 even emailed Hancock,

23 on occasion, to verify alleged prior communications between customers and Hancock over collection

24 issues; these emails would include the collection status and the customer's reference to prior

25 communications with Hancock. CW12 has "no doubts" that Hancock and other executive

26 defendants had full knowledge, and were orchestrating Exodus' practice to keep false and

27 uncollectible revenue from being written off or credited, in order to manipulate numbers in Exodus'

28 public financial reports .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-IVIMC -62- 0 0

1 122 . Other sources also substantiate that Exodus had engaged in improper revenue

2 recognition practices . Storagenetworks, Inc . filed a lawsuit against Exodus in the Court of Chancery

3 for the State of Delaware, Case No. 19127-NC, on September 25, 2001 . The lawsuit is based on

4 Exodus' failure to submit payments to Storagenetworks as the billing agent responsible for invoicing

5 and collecting payments from customers for Storagenetworks' services . Storagenetworks also

6 alleged,

7 that [Exodus] has billed Customers that were not receiving service, and has failed to pass onto Customers service credits issued by STOR . 8 In addition, Exodus has engaged in manipulative behavior in some of its past 9 remittances to STOR by, for example, post-dating checks to STOR to push them into the next quarter, so Exodus would have morefavorable quarterly accounting 10 treatment.

11 According to an Exodus report entitled Exodus Operations Summary, dated January 24, 2001, unde r

1 2 the section "North America Top 10 Customers," Storagenetworks was listed as Exodus' fifth larges t

13 customer, accounting for 1 .3% of the MCR in the North America region.

14 123 . Other lawsuits have also been filed by customers against Exodus for wrongful billing

15 and for improperly attempting to collect monies they did not owe. In a lawsuit filed by Xand

16 Corporation against Exodus in the Southern District of New York, Case No . 01 CIV 9027, on

17 October 10, 2001, Xand alleged that it was unlawfully billed and invoiced by Exodus in the amount

18 of $179,081 .66 . According to an Exodus report entitled Exodus Operations Summary, dated January

19 24, 2001, under the section "Northeast Top 10 Customers," Xand was listed as Exodus' ninth largest

20 customer, accounting for 1 .7% of the MCR in the New Jersey area .

21 124. Similarly, in a lawsuit filed by iBEAM Broadcasting Corporation against Exodus i n

22 Santa Clara Superior Court, Case No. CV800653, on August 13, 2001, over a payment dispute and

23 Exodus' blockage of access to its equipment, iBEAM alleged : "After the inception of iBEAM's

24 business relationship with Exodus, Exodus implemented a new billing system that generated

25 incorrect, duplicate or late invoices to iBEAM."

26 125 . Likewise, in a lawsuit filed by Paid For Surf Corp . against Exodus in the Supreme

27 Court of the State of New York, Case No . 2001-5342, on August 8, 2001, Paid For Surf Corp.

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -63- U 1 alleged that Exodus wrongfully refused Paid For Surf Corp . access to its equipment even though the

2 bills were owed by someone else .

3 126. Also, according to a June 4, 2001 Informationweekarticle, a dispute erupted between

4 Exodus and its customer, Ventro, when Exodus refused to allow Ventro to collect its servers fro m

5 its site, claiming that Ventro owed debt . According to a June 4, 2001 E-Week article, based on

6 information from a tipster, Ventro was about to seek a court-ordered injunction from the local

7 sheriffs department to gain access. The dispute was apparently resolved before any legal action too k

8 place.

9 F. Exodus' Days Sales Outstanding Numbers Were Artificially Low 10 127. During the Class Period, Exodus' financial reporting also consistently reflected a n 11 I artificially low days sales outstanding ("DSO") : 12 (a) According to CW 1, Exodus' policy required controllers to credit A/R and debit 13 bad debt expense as A/R aged, which preserved the appearance of revenue that was not real . These 1 4 entries created an expense under the net income line so that although expenses looked higher, 15 revenue still looked artificially better . As a result, revenue and expenses crossed recording periods . 16 (b) According to CW 1, Exodus changed this practice after filing bankruptcy, and 17 began to reserve against delinquent accounts, credit A/R and debit revenue . This change essentially 18 amounted to an admission that Exodus had employed false accounting during the Class Period . 19 (c) CW 1 recalled telling the executive team, during the first quarter of 2000, that 20 Exodus should be establishing reserves and should be debiting revenue instead of a bad debt expens e 2 1 after reporting periods where false revenue was inappropriately recognized . However, Dollahite, 22 Case and Wegner took the position that McCarthy "didn't understand this business," and that th e 23 accounting was done appropriately. 24 G. Exodus' Cash Balances Were Inflated 25 128. CW1 indicated that Exodus was never able to balance books with respect to cash . 26 According to CW1, during the fourth quarter of 2000, Exodus was $100 million off in cash balances . 27 This was the result of a practice used by Exodus at year-end to call customers and ask if customer s 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1 -266 1 -MMC -64- 4~ . 1 had mailed off checks . However, Exodus was well familiar with the practice that companies would

2 hold checks beyond year-end December 31, and not send checks until the beginning of the next year,

3 because the customer companies could then keep more cash on their own books and show better cash

4 balances. By calling customers and asking them if they had mailed a check dated against an invoice

5 dated, for example, in December, the customers would normally state that a check had, in fact, been

6 mailed. This was a "game" wherein both sides understood the rules . The Exodus finance person

7 would get information regarding the check number, amount, and would count receipt of that payment

8 as part of Exodus' year-end cash balance. In this way, receivables were lowered, DSO was

9 improved, and cash balances were artificially high for Exodus . The accounting entry performed

10 upon this fictitious confirmation of a check being sent was that cash was debited, and receivables

11 were credited. Exodus did the same thing with customers whose receivables had aged 60, 90 days

12 or more. As a result, A/R never looked as bad as it really was, and DSO was artificially low - a

13 component that was important to Wall Street's analysis of tech companies . CW1 stated that DSO

14 was "always way lower" than reflected on Exodus financial reports .

15 H. Defendants Misrepresented the Number of Exodus Customers 16 129. Exodus also misrepresentedthe number of customers it had . According to CW 11 and 17 CW12 : 18 (a) Exodus had two systems, Solomon and Siebel . In the Solomon system, each 19 customer of Exodus was assigned to the Credit and Collections Department once becoming a 20 customer. Solomon was highly accurate as a historical database for Exodus customers . A collector 2 1 was given responsibility to monitor payment history and collect against any invoices aged 60 days 22 or more. In the Siebel system, the order management system, a customer list was also maintained, 23 but the list also contained sales inputs for potential customers . Solomon reflected actual customers 24 which had signed Master Sales Agreements with Exodus . Siebel did not. 25 (b) When Hancock asserted that Exodus had over 4,500 customers, this was fals e 26 for two reasons . First, she was referring to the number of customers in the Siebel database, which 27 included potential customers identified by contacts with the sales force . On the other hand, Solomon 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -65- 0 0

1 reflected an actual 3,500 or so customers . Second, of the 3,500 customers in Solomon, over 1,50 0

2 customers were removed from the database by Credit & Collections after the Class Period because

3 collectors had determined that these customers had pulled out of deals and data centers from the fal l

4 of 2000 through the end of the Class Period. Despite these pull-outs and cancellations, Exodus had

5 continued to invoice and recognize revenue until collectors manually cancelled the accounts in the

6 Siebel and Solomon systems . Thus, contrary to the representation that Exodus had about 4,500

7 customers, there were in fact only about 2000 customers.

8 130. Likewise, CW12 corroborated that defendants had overstated the number o f

9 customers Exodus had :

10 (a) According to CW12, even though defendants made public statements that

11 Exodus had 4500 or more customers, the Solomon system reflected only about 3500 customers .

12 Further, of the 3500 customers shown as "active" in the Solomon database, at least 1000 of those

13 should have been considered "cancelled," as many of these had in fact cancelled at least several

1 4 months earlier.

15 (b) Based on her knowledge that approximately 1000 of the customers listed as

16 active in Solomon were actually inactive and cancelled, CW 12 estimates that between 25% and 35%

17 of the revenue recognized by Exodus during the first half of 2001 should not have been cancelled .

1 8 In addition, another substantial amount of revenue was recognized as a result of false charges and

19 I overcharges in invoices sent to customers, which was also not owed and not collectable . CW12

20 I estimates this amount to be another 10% to 20% of reported revenue .

2 1 1. Defendants' Forecasts for Exodus Were Made Without Reasonable Basis 22 131 . During the Class Period, Exodus' forecasts were also made without reasonable basis . 23 According to CW1 : 24 (a) On approximately the 20th of every month, a Company-wide profit and los s 25 statement (P&L) was distributed to defendants Hancock, Stoltz, Dollahite, Case (until he left in April 26 2001, and then Mike Perry), as well as Williams, Healy, and other Vice Presidents and other 27 management. This "financial statement summary" was a package covering eleven months prior to 28 I

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -66- 0

1 the reporting month, the reporting month itself and twelve months looking forward . The P&L served

2 both as a financial statement based on actuals (or at least accounting as performed) and as a forecast

3 for the following year.

4 (b) Exodus' forecasting for sales was never reliable . There was just no scientific

5 method or logical procedure used . Instead, the Exodus finance and sales teams assumed forecast

6 numbers that Hancock gave to the Street, which were always completely unrealistic as far as the

7 actual outlook input by the organizations working with customers . The forecast portion of the P&L

8 included a tool - a spreadsheet - that identified potential sales in the Company's pipeline . The

9 spreadsheet included the potential customer name, potential dollar value of the deal and various

10 percentages applied to the probability that the deal would close . For example, 0-10% would involve

11 a deal where Exodus had not yet even spoken to a customer. Where negotiations had begun, and the

12 salesperson thought there was a good possibility that the customer would sign, 25% was assigned .

13 Basically, salespersons would assign percentages by instinct . In addition, 100% of anticipated

14 revenue was assigned for deals that had been executed and where Exodus was beginning work .

15 These percentages were then applied to the total potential value of each deal and added to indicate

16 Exodus' current projection for revenue in the next quarter . Total value of all deal was also summed

17 to indicate a potential for Exodus revenue in the next quarter . For more than one quarter out, if

18 plotted and graphed, the projection looked like a heart monitor sign wave .

19 (c) CW1 engaged in heated discussions during Monday morning executive

20 meetings with the defendants involving forecasts . The trends in forecasts prepared from inputs by

21 sales and finance organizations showed downward trends from at least June of 2000 through the

22 Company's bankruptcy and continuing in 2001 . The forecasted revenue included monthly recurring

23 revenue which the responsible organizations knew to be false or misleading, because associated

24 customers had either gone bankrupt, canceled or demonstrated a growing history of non-payment .

25 Yet, Hancock consistently represented large growth in revenue to the Street for the different quarters

26 and years that CW1 was with the Company .

27 (d) In the management meetings, CW1 presented projections for revenue from

28 approximately June 2000 through the end of 2001 . For example, according to accurate projections, FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1 -266 1 -MMC -67- 0

1 Professional Services might do $32 million in a quarter . In response, usually Healy, Dollahite or

2 Hancock would state that this was not good enough . Then, Hancock would make statements to the

3 Street indicating a substantially higher number, like $37 million . This, as CW1 states, was "how

4 forecasting at Exodus went."

5 (e) CW1 and other finance personnel called customers daily, called salespeople

6 in the field, and tried to find out how reliable forecast deals were. He believes that the actual

7 numbers provided to the executives were highly accurate . However, the numbers provided to the

8 Street were much higher than Exodus' internally projected numbers .

9 (f) In the executive meetings, "allocation" was described as the method bywhich

10 the gross revenue forecast that Hancock had given to the Street, would be allocated to the various

11 revenue generating organizations . Because CW1 insisted that the internal forecasts were accurate

12 and based on accurate information, and he did not care what he was being told to forecast by upper

13 management, these arguments resulted in CW1 being banned from executive Monday, morning

14 meetings at the end of June, right after the close of second quarter 2001 .

15 (g) CW 1 stated that the MRC sales - which Exodus began pushing in late 1999

16 and early 2000 - were all written in agreements covering or encompassing a 12-month span .

17 Therefore, the actual projections developed internally showed a large drop in business, at least by

18 first quarter 2001 . There was an MRC spreadsheet showing the specific points in time where large

19 groups of deals would fall off, unless customers renewed . As Exodus progressed through fiscal year

20 2000, it became even more clear that customers would not renew, because the rate of cancellations

21 early in the 12-month agreement was accelerating . MRC related revenue continued to be invoiced

22 and recognized after the 12-month agreements lapsed, because nobody was assigned to go into the

23 order management system and manually cancel the invoicing schedule. If a deal were not debooked

24 manually, invoicing would continue in perpetuity.

25 132 . The fact that Exodus' public forecasts were made without reasonable basis is also

26 corroborated by Exodus internal emails . For example, according to an email dated February 13,

27 2001 from Rowena Ironside to Bill Yeack, which copied Don Casey, Ted Hull and Sheryl Pearson,

28 the message states: "Bill - I am very concerned that the UK ProServe Target number for Q1 FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -68- 0 0

1 somehow got from a plan of $2 .9m and a January 25 flash of $2 .5m to a TARGET of $4.1m. Seems

2 that people think you get the credit for agreeing to this - but I know that you know that you cant [sic]

3 add 41 % to plan and 64 % to flash 5 weeks into a quarter in our business and have a hope in hell

4 of making it."

5 J. Exodus Was Suffering from High Rates of Customer Bankruptcies, Customer Delinquencies, Customer Cancellations and Lack of Demand 6 133 . According to CW 1, defendants knew about increased aging ofreceivables and failures 7 of dot-com customers beginning in early 2000 . The trend was clear, according to CW1, who learned 8 of the risk for this entire sector upon joining Exodus in January 2000 . He inherited the P&L for the 9 Professional Services organization and noted immediately within the first quarter of 2000 that 10 expenses were on the increase . When he "drilled down" to identify these expenses, he noticed that 11 the increases were due to the issuance of credits relating to bad debt for customers who had not paid 12 for three to six months or longer. The dot-com problem began much sooner than the problem 13 became known to the public, that even upon the acquisition of Cohesive in 1999, Exodus became 14 aware that it had acquired a substantial amount of bad debt comprising Cohesive's receivables . Bad 15 A/R made for a large portion of Cohesive revenue that had been of primary importance to Exodus 16 for the acquisition to show growth and revenue in the Exodus pro forma P&L . 17 134 . By late 2000 and early 2001, the problems with failing dot-coms and bad debts were 18 dramatically impacting Exodus. Nevertheless, defendants continued to portray Exodus in a highly 19 positive light, even as concrete facts indicated that Exodus was suffering from record rates of 20 customer bankruptcies, customer delinquencies, customer cancellations and weak demand . 21 135 . According to CW5, the former Senior Manager of Credit and Collection at Exodus, 22 Exodus significantly downplayed the impact of the dot-com slowdown on its business . Everymonth, 23 and a once a quarter, CW5 would go through each customer account to determine whether there was 24 collectible revenue. It was her responsibility to generate bad debt reserve reports and revenue 25 reserve reports on a monthly basis, which were typically provided to management by the sixth day 26 of the following month. These reserve reports, which included figures as well as charts, were 27 prepared for the executive meetings . According to CW5, in first and second quarters 2001, there 28 FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -69- Exhibit A (Part 3 of 3) t •

1 were a lot of customer disputes and delinquencies . She was continuously getting calls to dispute

2 charges. The last reserve report she prepared was for the March 2001 close . Hancock received this

3 report by hand delivery in early April, along with other members of upper management including

4 Wegner, Dollahite and Case . The reserve report showed that 40% ofthe overall accounts receivable

5 was not collectible. After Hancock reviewed the report, Hancock insisted the report had to be

6I1 wrong, that the number was too high and had to be changed . Hancock told CW5's supervisor, Susan

7 Colvin (the Controller), to change the number . The number was later sent out to the people involved

8 in sales to challenge - but no one challenged the figure.

9 136. Similarly, according CW4, a former Exodus financial analyst assigned to Exodus '

1 0 Professional Services segment, the P&Ls for data centers within her responsibility reflected a

11 significant drop in revenue in late March and early April 2001 . According to CW4, other employees

12 told her in conversations and through emails during February and March 2001 that dot-com

13 customers were filing for bankruptcy in large numbers, that these and other customers were

14 canceling orders, not making payments to Exodus, and that Exodus' revenues were "way down ."

15 Even though revenue was in decline, because some of the dot-com bankruptcy scenarios required

16 Exodus to continue providing services for periods of time without being paid, the P&Ls during the

17 Class Period generally reflected that costs remained the same . Furthermore, despite CEO Hancock's

18 very positive statements concerning Exodus' prospects and forecasts, and positive statements about

19 the Company's transition to new enterprise customers, in both the forecast and P&Ls she reviewed

20 for her data centers during first and second quarters 2001, CW2 did not see this influx .of new

2 1 customers or replacement revenue for dot-corns that had gone out of business . CW2 worked on a

22 "Top Ten Customer" list for the Seattle area, which was submitted to corporate finance along with

23 the P&Ls, and recalled that during second quarter 2001, some of Exodus' "biggest customers"

24 dropped off, including Boeing . At least in her region of the Pacific Northwest, it appeared that

25 Exodus was actually losing some large enterprise customers .

26 137. Likewise, according to CW3, whose responsibility was to compile information o n

27 Exodus' customer base, in first quarter 2001, Exodus' customers were cancelling orders and/or wer e

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -70- 0 0

1 not renewing orders, and dot-com revenue was not coming in because companies were going out o f

2 business or were delinquent in their payments. In first quarter 2001, he saw high customer chum .

3 138 . Exodus sales executives also saw weakness in sales . According to CW6, a former

4 Exodus account executive, he noticed a decline in cancellations at the end of 2000, particularly in

5 the dot-com arena. He also stated that he was having extreme difficulty bringing in new customers,

6 and that he was producing low numbers and was consistently not making his goal . He also estimated

7 that probably less than 10% of the sales force was at their plan or goal by the time he left in April

8 2001 .

9 139. According to CW7, another former Exodus account executive who received client

10 base listings, which he believed were updated weekly, by the time he left Exodus in May 2001, these

11 client base listings had become noticeably shorter .

12 140. CW 10 also observed high rates of cancellations . According to CW 10, she saw Chum

13 Analysis Reports regularly, and saw that the numbers of cancelling customers steadily climbed

1 4 throughout 2000 and through the Class Period, especially as the dot-com segment went bust .

15 However, CW 10 cautioned that the Chum Analysis Report was not accurate with respect to the dates

16 that customers were shown to have cancelled because management would not formally cancel

17 customers within the quarter of cancellations. Instead, cancelled customers were not reflected in the

1 8 Chum Report until the beginning of the following quarter in order to make the chum look lower than

19 it really was. According to CW10, after the GlobalCenter acquisition closed in January 2001,

20 Exodus' business condition got even worse . There were far less new orders, despite the fact that

21 Hancock was touting Exodus' penetration into the enterprise market . Even though several new and

22 large customers came on board during the first and second quarters of 2001, it was not nearly enough

23 to counter the excessive cancellations and increases in bad debt that she observed in the Collection s

24 Department . Further, false billings were getting worse as more and more customers complaine d

25 about items in invoices that were never ordered or provided .

26 141 . Statements made by defendants after the Class Period also indicate that defendant s

27 were aware of Exodus' poor business conditions during the Class Period, as follows :

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -71- 1 (a) In Exodus' Bankruptcy Disclosure Statement signed by defendant Wegner,

2 filed with the Bankruptcy Court in the District of Delaware on March 25, 2002, Exodus

3 acknowledged it was aware of the impact of an economic slowdown by at least late 2000. Exodus

4 admitted : "Beginning in late 2000 and early 2001, economic conditions began to deteriorate,

5 particularly for emerging Internet "dot.coms, " ,and during 2001 many of Exodus 's "dot.com"

6 clients failed. Additionally, a substantial number of Exodus's traditional enterprise clients

7 delayed - and in some cases cancelled -purchase decisions."

8 (b) Further, in an interview by Jennifer Mears of Network World, published by

9 Network World Fusion on October 1, 2001, William Krause (who replaced Hancock as CEO o n

1 0 September 4, 2001), highlighted that Exodus was having problems with non-paying customers :

11 Jennifer Mears : Obviously keeping customers is a big concern. What are you expecting in terms of customer losses, and what is the percentage of Exodus 12 customers who have some sort of penalty-free exit clause ?

13 William Krause : I have no idea, No. 1, and No. 2, I wouldn't disclose it . .. . But let me also answer your question with , there are some customers that we've 14 acquired that aren't customers. And what I mean by that is, in my definition of a customer you have to meet three requirements. One is that you have to have a 1 5 need, two is that it's something Exodus can fulfill, so that No. 3, you'll pay us for it. Unfortunately, in this emphasis on revenue growth at any cost, we've taken on 16 some obligationsforpeople who aren't customers. And I'd just as soon have those people burdening someone else 's balance sheet. And so we are taking actions, 17 aggressive and swift, to ask these organizations to get their servicesfrom someone else. Let me also be clear, we're not being arrogant about it . We're not being nasty 18 about it. We've giving them time to make a transition, but we're also being very firm that if you can't pay your bills, we can't afford to have you burdening the balance 19 sheet. If there's any decline in our customer base, that's were 90% of it will come from. 20 (c) In a September 28, 2001 article by Evan Koblentz in eWeek, Krause again 21 acknowledged the degree to which Exodus was affected by customers who failed to pay : 22 "We have a lot of customers who don 't qualify to be customers," he said. "We 23 shouldn't have had them as customers in the first place, [although] virtually 90 percent of that [was] self-induced." Exodus will give notice to such customers "to 24 go be a burden to someone else's balance sheet . If you can't pay your bills, please go away. Quickly," Krause said . 25 K. Exodus' Internet Data Centers Had Excess Capacit y 26

27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -72- 0 0

1 142. During the Class Period, Exodus' IDCs were operating under capacity . According

2 to CW1, Exodus' statements about customer demand and utilization of space in its IDCs was

3 misleading at best, for the following reasons :

4 (a) There was no one "clean report" that identified utilization of floor space, but

5 rather breakouts on the IDC P&Ls only represented "revenue per square foot," or "revenue per

6 installed square foot." Despite the Company's statements to the Street that IDCs were full or were

7 expected to be full by certain dates, in reality, none were ever filled up . Customers who had signed

8 up for space would actually debook, or decide to move to a different IDC, and there were always

9 great amounts of unused "raised floor." CW1 recalled an Atlanta IDC having 300,000 square feet

10 of raised floor, where a great amount of this capacity was unused . He also recalled 500,000 plus

11 square feet in the Seattle data center (DC3) that was in a new facility which was not used . According

12 to CW1, he had visited both Atlanta and Seattle and the interior of these data centers was so large

13 one "could land a space shuttle ." Both of these facilities were discharged in bankruptcy and sold off.

14 (b) There were various ad hoc reports, prepared by different financial analysts to

15 show revenue per square foot and install square foot, and these reports were 'distributed to the

16 executive management team . These reports clearly identified the fact that Exodus was sitting on

17 huge amounts of empty space.

18 (c) For example, Seattle's only customer for its large new data center was

19 Microsoft. According to CW1, once Exodus executives looked at a P&L for the IDC, reflecting

20 something like $2 million per month in revenue for an IDC known to have 500,000 square, feet of

21 raised floor, it should only have flagged the need for Exodus to sell the asset .

22 (d) According to CW1, Exodus executives desperately wanted to issue new

23 releases about the first customer in a new IDC. Once a customer moved into a new IDC, Exodus

24 made statements to the effect that the IDCs were filling up . According to CW 1, "It just wasn't true ."

25 143. Whether Exodus' IDCs were full was readily observable, and even Exodus customers

26 noticed a difference . According to an Eweek article dated May 7, 2001, Exodus customers like Marc

27 Vigod, the president of VLM, Inc ., noticed a decline in the Company's business ; the article quoted

28 Vigod as saying that when he went to Exodus' IDC to remove his equipment around late April/early FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -73- 0 0

1 May 2001, "I was surprised to see half the data center empty" ; also, according to Vigod, while

2 removing VLM's equipment, an Exodus security guard remarked to him that more customers were

3 seen leaving than entering lately.

4 144. Statements made by Exodus' executives just before and after the Company filed for

5 bankruptcy also indicate that defendants were aware of the over-capacity of the IDCs :

6 (a) In Exodus' Motion Authorizing Sale of Substantially All of the Debtor's

7 Business Assets to Digital Island, filed with the Bankruptcy Court for the District of Delaware on

8 November 30, 2001, Exodus admits that some of its IDCs were vacant and/or were not full . The

9 filed document states : "Since the filing of these chapter 11 cases, the Debtors have taken a number

10 of actions to adjust and improve their business and growth strategies in light of changing economic

11 circumstances, including disposing of several nonoperating, redundant or otherwise noncore assets,

12 including vacant IDCs and office space in the United States and abroad . The Debtors have also

13 curtailed their aggressive growth strategies and, instead, havefocused on consolidating customers

14 in strategically located sites to increase utilization ofIDCs, reduce overhead expenses and provide

15 a more efficient platform to service customers . "

16 (b) In an interview with Jennifer Mears ofNetwork World, published by Network

17 World Fusion on October 1, 2001, Krause indicated that Exodus' IDCs were not full, as follows :

18 Jennifer Mears : As for the data centers, you're closing 10 that were unde r construction, but some analysts say more consolidation will be necessary . Will 19 operational data centers be closed?

20 William Krause : We have nothing to report there . Obviously, we evaluate our business just like everyone else does . We are managing for profitability . In 21 doing so we're going to look at data centers in terms of, are they providing uniqu e value to our customers, and if so, then we ought to be able to charge for that value 22 a price that is high enough to cover our costs and allow us to make money . Where we have four data centers, such as in the Washington, D .C., area, and we've got 23 customers in all four but all are operating under capacity , if customers didn't care about being moved to one of the other data centers that would be a smart move for 24 our customers and for us. So those are the kinds of things we'd evaluate, but we've not made any of those decisions yet . 25 (c) Hancock acknowledged the overcapacity of Exodus' IDCs in an interview with 26 The Industry Standard's Alexei Oreskovic . The interview, published on August 22, 2001, is as 27 follows: 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -74- 4,0 0

1 The Industry Standard: Exodus has said it doesn't necessarily agree with analysts' reports of overcapacity in the hosting sector, yet many ofyour data centers 2 are at only 50 percent capacity. That sounds like overcapacity.

3 Hancock: 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 the country, or you 4 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 5 in Amsterdam or Germany. Last quarter, we opened up four new data centers : one in Amsterdam, one in Paris, one in Dallas and one in Miami . So with all this 6 discussion of glut, we're opening up data centers .

7 (d) According to another article by Jennifer Mears of Network World Fusion ,

8 published on September 26, 2001 concerning Exodus' Chapter 11 filing, Exodus' IDCs were

9 operating under-capacity:

10 Exodus says 27 of its 44 data centers have positive earnings . But analysts note that many of the firm's centers are running at capacity levels as low as 10% . 11 "You can't afford to support the cost of a data center when you're only making revenue on 10% of the space," says Andrew Schroepfer, president of Tier 1 Research . 1 2 (e) Sam Mohamad, Exodus' President of Sales, Marketing and Professiona l 13 Services, later acknowledged in an August 13, 2001 Tele.com article that Exodus was opening IDC s 14 before properly ascertaining that demand was sufficient . The article, which discusses data cente r 15 glut, states: 16 [M]ost hosting providers are targeting established enterprises instead of dot- 1 7 coms and moving to high revenue managed hosting services . The change may be sound, but the switch means that sales take longer and involve more senior personnel, 1 8 says Sam Mohamad, Exodus president of sales, marketing and professional services . It also means that hosting companies don't build on speculation . Exodus now opens 1 9 a sales office before finding a data center location to see if demand is sufficient- an approach that Genuity also supports . "We used to stop at the market analysis 20 phase," Mohamad says .

21 (f) Exodus' November 14, 2001 Form 10-Q filing, made after the Company went

22 into bankruptcy, indicated that, during the third quarter ending September 30, 2001, the Compan y

23 recorded an impairment charge of $746 .6 million for certain IDC property and equipment and

24 construction in progress. This is also an indicator that Exodus' IDCs were not fully utilized .

25 (g) Furthermore, in an October 25, 2001 press release, William Krause also

26 acknowledged, "In assessing our international operations, cost structure and potential for profitable

27 growth, it became clear that we were over invested in non-operational or under-utilizedfacilities

28 in certain markets."

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -75- •

1 L. The Acquisition of GlobalCenter Did Not Enhance Exodus ' Business

2 145 . The defendants' statement that the GlobalCenter acquisition would "enhance" Exodus'

3 global IDC infrastructure was false and misleading when made.

4 146 . According to CW8, whose responsibilities included integrating the GlobalCente r

5 acquisition within the Marketing Department, based on her conversations with the Vice Presiden t

6 of International Operations who worked on the due diligence, the witness learned that the due

7 diligence team led by Vice President of Business Development had strongly recommended against

8 the acquisition of GlobalCenter. The team had examined other potential competitors to acquire and

9 had recommended a different competitor. than GlobalCenter. Exodus' Board of Directors, who

10 received these reports from the due diligence team, was against the acquisition, concluding that it

11 would be too expensive and that the business model was "not a good fit" for Exodus . Nevertheless,

1 2 Exodus' CEO, Hancock, wanted GlobalCenter for its two IDCs in Manhattan, one on 9th Avenu e

13 and another on 11th Avenue, which were considered "prime real estate ." However, along with these

14 two stellar Manhattan locations, came other GlobalCenter facilities, some of which were largel y

15 empty. CW8 learned that the Data Centers in Tokyo, Sydney, another in London and pending

1 6 openings in Paris and Munich all experienced substantial shortage in demand . Shortly after the clos e

17 of the acquisition, Exodus decided to cancel the opening of centers in Munich and Paris - neithe r 18 of which had actually been opened by GlobalCenter.

19 147. Exodus later acknowledged, in its Form 10-Q dated November 14, 2001 for th e

20 quarterly period ended September 30, 2001, filed after the Company's bankruptcy, GlobalCenter's

21 IDCs were operating under capacity . According to the Form 10-Q, "IDC utilization rates declined

22 recently as a result of the slowdown in the number of new customers, the elimination of the

23 Company's financially unstable customers and the Company' s acquisition of GlobalCenterHolding

24 Co., Inc., in January 2001 ."

25 M. Exodus Could Not Achieve Its Business Plan

26 148 . Defendants' representations that Exodus "has a clear path to profitability," that it

27 would "turn cash EPS positive during the first half of 2002," and that it has a "fully funded busines s 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -76- 4~ 0

1 11 plan" were false and misleading because defendants were aware that Exodus was woefully short of

2 11 funds required to achieve its business plan.

3 149. According to CW9, a former Exodus employee responsible for product development ,

4 in March 2000, she had been asked to put together a capital plan for the rest of the year . By April

5 2000, she turned in a plan reflecting the need for $3 .2 billion to accomplish the goals set forth by the

6 executive staff. The executives balked at these numbers because, at the time, they only had $750

7 million to work with. Her plan was dismissed, and Exodus continued building additional centers

8 out, knowing they didn't have the capital to cover the expense of these expansions . In August 2000,

9 Jim Stoddard and an employee in the Finance Division also submitted a capital plan. The second

10 capital plan also reflected the need for $3 .2 billion. Thus, by at least August 2000, defendants were

1 1 aware they did not have sufficient capital to support Exodus' expansion and to accomplish its

12 business plan.

13 150. Defendants were also aware that Exodus was not fully funded to achieve its busines s

14 plan because it was quickly burning through cash and its business condition was rapidly

15 deteriorating. By March 2001, Exodus was paying $75 million in quarterly interest on its $3 billion

1 6 debt, was continuing to spend to execute its merger and restructuring plans, was continuing to build

17 IDCs, and its fixed cost infrastructure and capital spending were much too high in the face of the

18 dramatic decline in industry growth . The Company used over $450 million in cash and cash

19 equivalents in its first quarter 2001, and even with $1 billion in cash and reductions in capital

20 expenditure, the Company would not have had sufficient funding until it turned cash EPS positive

21 in the first half of 2002 because the Company was having difficulty turning its sales to cash, was

22 suffering net operating losses, and its gross profit margin was falling . Indeed, defendants were aware

23 that the economic conditions were so bleak that many Web hosting companies like itself were

24 seeking strategic alternatives, including : PSINet Inc ., which hired financial advisors in November

25 2000 to seek strategic alternatives due to declining demand and poor business conditions ; Digital

26 Island, which hired a financial advisor in August 2000 to assist it in being acquired due to its weak

27 sales and lack of profits being generated from existing customers ; and NaviSite, which laid off 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -77- 0 0

I employees and closed several sales offices. Further, several had filed for bankruptcy. Exodus also

later followed the same bankruptcy route .

N. Defendants Were Aware that Exodus Would Violate Its Loan Covenant

151 . Defendants' statement that Exodus "will continue to be in compliance with th e

covenants of [its] bank credit facility" was false and misleading . Defendants were aware that th e 6 Company would not achieve its second quarter 2001 guidance because of the poor busines s 7 conditions then negatively impacting Exodus and because defendants were aware their forecasts were 8 overly aggressive . Consequently, defendants knew that in order to prevent falling out of compliance 9 with loan covenants with Chase Manhattan Bank by falling-short of the EBITDA of $35 million tha t 10 it was required to achieve in second quarter 2001, Exodus was forced to pay back the $150 million 11 it had borrowed, further draining much needed cash . 12 0. Exodus' Financial Statements Violated GAAP Exodus' 13 False Financial Reporting During the Class Perio d

14 152. In order to inflate the pri ce of Exodus' securities, defendants caused the Company t o

15 falsely report its financial results included in press releases and SEC filings during the Class Period .

16 Defendants caused the Company to falsely report its financial results in violation of GAAP through:

1 7 i) improper revenue recognition ; ii) overstating accounts receivable ; and iii) falsely recording cash

18 receipts.

19 153 . During 2000, as the Internet technology industry began to crumble, Exodus wa s

20 desperate to report continued revenue growth and devised several schemes to fraudulently recognize

21 revenue. The Company's improper revenue recognition revolved around the control the executive

22 management team had in entering into and approving initial deals with customers and approving

23 changes to be made to existing customer invoicing . This control enabled defendants to : i) invoice

24 and record revenue prior to hardware being installed and prior to Internet connectivity ; ii) continue

25 invoicing and recognizing revenue after a contract had been terminated either through customer

26 cancellation or non-payment by the customer ; iii) encourage sales personnel to enter into contracts

27 that contained side agreements which allowed customers to "back out" of a deal with no penalties ;

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -78- 0 0

1 and iv) continually override credit reviews on prospective customers and thus enter into contracts

2 where collection was not reasonably assured.

3 154. Further, defendants also entered into or approved bogus barter transactions as a means,

4 to boost revenues. The barter transactions were entered into for the sole purpose of increasing

5 revenue. In most circumstances, Exodus either had no intention or need to utilize the bartered asset

6 received ; or no assets or services were exchanged - both parties simply agreed to exchange invoices

7 and record bogus revenue.

8 155. As a result of these improper revenue recognition schemes, by the end of 2000

9 defendants were faced with another issue to deal with - growing accounts receivable that were not

10 collectible. In an attempt to hide any "red flags" that an increasing accounts receivable balance

11 would raise, defendants entered into another fraudulent accounting practice - recording fictitious

12 cash receipts.

13 156. GAAP are those principles recognized by the accounting profession as the

14 conventions, rules and procedures necessary to define accepted accounting practice at a particular

15 time. SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with

16 the SEC which are not prepared in compliance with GAAP are presumed to be misleading and

17 inaccurate, despite footnote or other disclosure . Regulation S-X requires that interim financial

18 statements must also comply with GAAP, with the exception that interim financial statements need

19 not include disclosures which would be duplicative of disclosures accompanying annual financial

20 statements. 17 C.F.R. §210.10-01(a).

21 P. Exodus' Improper Revenue Recognitio n

22 157. GAAP, as described by FASB Statement of Concepts No. 5 ("FASCON No. 5"),

23 provides the basic requirements for revenue to be recognizable : (1) revenue must have been earned ;'

24 and (2) revenue must be realizable (collectible). See FASCON No. 5, ¶83 .

25

26

27 ' FASCON No. 5 states, "revenues are considered to have been earned when the entity ha s substantially accomplished what it must do to be entitled to the benefits represented by the 28 revenues ." See FASCON No. 5, ¶83 (b) . FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -79- i~ •

1 158 . Further, the SEC sets forth the following criteria for revenue to be recognized, all o f

2 which must be met :

3 (a) Persuasive evidence of an arrangement exists;

4 (b) Delivery has occurred or services have been rendered;

5 (c) The seller's price to the buyer is fixed or determinable ; and

6 (d) Collectibility is reasonably assured.

7 See SEC Staff Accounting Bulletin No . 101 - Revenue Recognition in Financial Statements ("SAB

8 101 "). SAB 101 further defines delivery as follows:

9 Delivery generally is not considered to have occurred unless the product has been delivered to the customer's place of business or another site specified by the 10 customer.

1 1

12 After delivery of a product or performance of a service, if uncertainty exists about customer acceptance, revenue should not be recognized until acceptance occurs. 13 Customer acceptance provisions may be included in a contract, among other reasons, to enforce a customer's rights to (1) test the delivered product, (2) require the seller 14 to perform additional services subsequent to delivery of an initial product or performance of an initial service (e.g., a seller is required to install or activate 15 delivered equipment), or (3) identify other work necessary to be done before accepting the product . . . . when such contractual customer acceptance provisions exist, 16 the staff generally believes that the seller should not recognize revenue until customer acceptance occurs.... 17 159. Exodus recognized revenue in violation of GAAP and SEC rules because it : 18 (a) recorded revenue prior to rendering services ; 19 (b) recorded revenue on cancelled or non-renewed contracts ; 20 (c) recorded revenue from transactions in which collectibility was not probable ; 2 1 and 22 (d) recorded revenue and assets in conjunction with bogus barter transactions an d 23 failed to disclose such transactions. 24 160. Absent Exodus' improper revenue recognition, it would have reported materially les s 25 revenue during the Class Period. 26 Q. Exodus Recorded Revenue Prior to Installation and Activation 27 of Services and Continued Recording Revenue on Cancelled and Terminated Contract s 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -80- f 0

161 . It was common practice for Exodus to record revenue on contracts prior to prope r

installation and Inte rnet connectivity. Throughout the Class Pe riod Exodus also continued to record

revenue on contracts that had been cancelled or terminated . These transactions were in violation of

GAAP and SEC rules as delivery had not occurred, persuasive evidence of an arrangement did not

5 exist, and collectibility was not reasonably assured.

6 162. CW 1 described Exodus' practice of recording revenue on cancelled or terminate d

7 contracts and provided the following summary . Beginning in early 2000, in order to create the

8 appearance of continued revenue growth and to accommodate the growing number of customers that

9 did not have the ability to pay a "lump sum" of cash for services, Exodus encouraged its sales force

10 to enter into side agreements and to structure agreements as "Monthly Recurring Cost" ("MRC")

1 1 deals .' Although an MRC deal typically covered a 12 month period, Exodus' sales personnel were

1 2 encouraged to tell customers that if they decided to discontinue service after 90 days, Exodus would

1 3 not pursue the breach of contract . This practice is important for the following reasons : (1)

14 essentially Exodus was financing deals for its customers that otherwise did not have the ability to

15 pay; and (2) Exodus' order management system, which invoiced over 4,000 customers, was set up

16 to invoice customers "in perpetuity" on MRC contracts. Hundreds of customers that had canceled

17 their contracts or never approved a deal continued to get invoices until Exodus' senior management

18 gave approval to cancel the invoicing.' As a result, revenue continued to be inappropriately recorded

19 for contracts that defendants knew were cancelled, severely delinquent, or otherwise disputed .

20 Recognizing revenue on deals that clearly do not exist is improper under GAAP .

21 163. CW 10 disclosed that Exodus routinely invoiced and prematurely recognized revenu e

22 on deals where completion or start-up of services had not yet occurred . This was done in order to

23 record revenue before the end of a quarter . Further, many of these "pre-invoiced" installations wer e

24 2 Revenue was delineated as MRC and Non-Recurring Cost ("NRC") . An MRC deal typically 25 covered a 12 month period while an NRC deal covered the initial costs of installation and implementation . Structuring a deal as an MRC provided the customer with a longer period of time 26 to pay for the services. As a result, many customers that did not have the capital readily available for a lump sum payment entered into deals structured as MRC deals . 27 3 Several CWs confirmed that revenue was recorded at the time invoices were generated from 28 the billing system. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -81- 1P 0

1 never performed or the invoices included work beyond what was ultimately installed . The following

2 paragraphs summarize CW10's understanding of Exodus' fraudulent sales practice .

3 164. As a salesperson closed a deal, an order was entered into the Exodus Order

4 Management System (Siebel) . The order defined all hardware and services to be provided to the

5 customer. This included the equipment, installation, connectivity and bandwidth monitoring

6 associated with the customer's use of an Exodus IDC for its Internet operations . The Exodus

7 agreements provided that Exodus would begin monthly invoicing once hardware was properly

8 installed in an IDC and connection to the Internet had occurred . In other words, monthly invoicing

9 should not have begun until the customer could actually utilize the Exodus Web hosting capabilities.

10 165 . The Project Management and Professional Services Departments both generated

11 "installation reports ." The purpose of the installation reports was to indicate that all services related

12 to equipment installation connectivity, and any other initial set-up activities had been performed .

13 CW 10 estimated that these installation reports, which triggered the onset of monthly invoicing and

14 revenue recognition, were prematurely prepared or otherwise false in almost all instances because

15 defendant Mohamad orchestrated a standard practice to generate these installation reports prior to

16 installation work ever beginning . Nearly all Exodus customers were invoiced prematurely for

17 installations that did not occur until approximately three months later, typically the next quarter.

18 By the time Exodus collectors would contact customers at least three months of false invoices had

19 been generated, and therefore three months of revenue had been improperly recognized ;

20 166. The practice of falsifying the installation reports gave Exodus "extra revenue" to work

21 with every quarter. CW10 stated that the generation of false installation reports was as new sales

22 agreements were executed, and as a result, all new customers throughout the Class Period were

23 subject to false installation reports and consequently false revenue recognition .

24 167. Further; CW 10 stated that defendant Mohamad encouraged the Exodus sales force

25 to tell customers that Exodus would allow them to cancel agreements and back out of IDC

26 agreements after 90 days, even though the agreements were typically for a twelve month period . CW

27 10 stated that customers repeatedly told this to Exodus collectors when contacted about past due or

28 disputed balances .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -82- 0 •

1 168. Defendants' scheme of fraudulent revenue recognition continued even after collection

2 efforts confirmed that customers had been fraudulently invoiced and were therefore owed credits,

3 which when issued would result in a reduction of revenue and/or net income . Before a credit could

4 be issued, approval was required by upper management, specifically defendant Dollahite . CW 10

5 stated that in most cases it took at least seven months, and in some cases more than a year from the

6 date a false invoice was generated to the date a credit was ultimately issued .

7 169. CW12 confirmed defendant's practice of delaying the issuance of credit memos .

8 170 . CW 12 specifically recalls at least two meetings that Colvin held with collector during

9 each of the first and second quarters of 2001, one of which occurred within a week of each quarter

10 close. In these meetings Colvin explained to the collectors that no credits were to be issued because 11 sales were not doing well and Exodus needed to keep these transactions on the books in order to

12 report the quarter .

13 171 . CW 10 specifically identified and described the following customer accounts as

14 having false and/or premature revenue recognition :

15 (a) Lycos, Inc. - Lycos, Inc. consistently generated approximately $2 million per

16 month in revenue throughout the Class Period. There were always credits owed to Lycos due to the

17 fraudulent overbilling of the account . Further, installation charges were prematurely invoiced at least

18 three months prior to the actual installation . CW10 estimates that at least 25%-50% of the Lycos

19 accounts receivable during the Class Period was the result of fraudulent overbillings and known

20 credits due to Lycos that had not been approved by defendant Dollahite or other executive

21 management.

22 (b) Yahoo.com - Yahoo was the subject of substantial false billings, including

23 premature invoicing for installation . The fraudulent billings also related to invoicing for excessive

24 bandwidth and space that was not ordered or used . Substantial credits were owed to Yahoo during

25 the Class Period.

26 (c) Merrill Lynch - The Merrill Lynch deal called for payment of $2 million per

27 quarter. CW10 recalled that "right off the bat," Merrill Lynch was invoiced for approximately

28 $800,000 through the false installation sheet/premature invoicing scheme described above . Due to FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -83- 0 #

1 the fraudulent invoices, by the end of the first quarter 2001, over $1 million in credits were owed to

2 Merrill Lynch. These credits were not approved or issued until at least second quarter 2001 .

3 (d) CNA Insurance - CNA was invoiced through the false installation

4 sheet/premature invoicing scheme and was also the subject of excessive charges for bandwidth and

5 IDC space. The fraudulent overcharges continued to occur throughout the Class Period .

6 (e) BestBuy.com- BestBuy.com was prematurely invoiced prior to installation.

7 CW10 further recalls that "bandwidth was a mess" with this customer, as Exodus continuously

8 invoiced BestBuy.com for amounts far in excess of bandwidth utilized . Large credits were owed to

9 the BestBuy.com account throughout the Class Period, but authorization by defendant Dollahite or

10 other executives did not occur until several quarters later.

11 (f) Metropolitan Life - False installation invoices were generated prematurely

12 and recognized as revenue in first quarter 2001 on this account . CW10 further recalled issues

13 between Exodus and MetLife over bandwidth and IDC space charges . A substantial portion of the

14 MetLife accounts receivable balance throughout the Class Period was ultimately reversed by issuing

15 credit to the customer. The credits were not issued until at least third quarter 2001 .

16 (g) Franklin Templeton - This account was a "big mess" beginning when it first

17 became a customer in 2000 . This account was also subject to premature installation invoices .

18 Additionally, Franklin Templeton was over-billed for IDC space and excessive professional services,

19 as well as for services never performed. CW 10 estimated that at least 50% of the revenue recognized

20 and accounts receivable associated with the Franklin Templeton account were false and subject to

21 credits.

22 (h) Advertising .com - Installation invoices were generated prematurely on this

23 account. Also this high credit risk customer was approved by Hancock . See ¶1177-178 for further

24 discussion regarding customers that presented a high credit risk .

25 (i) Akamai - Exodus generated invoices for excessive bandwidth on this account

26 and CW 10 recalled that substantial credits were owed to this customer throughout the Class Period .

27 (j) United HealthCare Services - Although this was a creditworthy and good

28 customer, Exodus fraudulently over-billed this account . CW 10 estimates that by the end of second

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -84- F-]

1 quarter 2001 as much as 50% of the accounts receivable associated with this account related to

2 fraudulent invoices.

3 (k) Microsoft - There were heated disputes regarding Exodus' invoices to

4 Microsoft. A portion of the problems were due to excessive charges for space and bandwidth . These

5 problems were ongoing during the Class Period, and credits were issued in later 2001 .

6 (1) Inktomi - Exodus and Inktomi announced Exodus' plan to deploy Inktomi's

7 technology in its IIDCs in December 1998 . According to CW10, Inktomi also became a customer

8 of Exodus in early 1999, at which time Exodus prematurely invoiced Inktomi for installation . The

9 fraudulent invoicing on the Inktomi account continued throughout the Class Period . CW 10 recalled

10 that throughout the Class Period Exodus invoiced Inktomi for approximately $200,000 per month ,

11 but only 50% of the charges were real . Further, at quarter ends Exodus and Inktomi would swa p

1 2 invoices totaling approximately $500,000 - for no other reason than to fictitiously gross-up revenue .

13 172. Plaintiffs have obtained Exodus' internal "Top 30 as of 2/21/01" report from one o f

14 the Confidential Witnesses. The report identifies the then current list of the 30 Exodus customer s

15 I with the highest accounts receivable balances. Further, the report contains "Comments re : Status. " 1 6 These comments document the status of collection and/or other pertinent comments . The following

17 accounts appear on the "Top 30 as of 2/21/01" report and confirm the information received fro m

18 CW 10 as documented above :

19 (a) Advertising.com : Advertising.com appeared on the report with an

20 outstanding accounts receivable balance of $1,536,897.77. The comments stated, "Disputes over

21 SNI, bandwidth, billing where space was never in use . "

22 (b) CNA Insurance: CNA Insurance appeared on the report with an outstanding

23 accounts receivable balance of $2,646,495 .92. The comments stated, "Most of the invoices are in

24 dispute per A/P."

25

26

27

28 I

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -85- 0 #

1 (c) Franklin Templeton Companies : Franklin Templeton Companies appeared

2 on the report with an outstanding accounts receivable balance of $1,646,174.44. The comment s

3 stated, "Contract confusion concerning new or old contract with debooking issues."'

4 173 . Suzanne Colvin, Controller, specifically expressed concern over the past due Frankli n

5 Templeton account in an email dated February 22, 2001 . The email stated:

6 I am frightened to see Franklin Templeton back on this report - - and to notice the comment that is listed . Given the MASSIVE challenges we encountered last time 7 with this account and how hard it was to sort out the billing issues, should you step in right away? 8 174. CW2 and CW5 also confirmed that invoicing and revenue recognition continued after 9 a contract was cancelled . CW2 was part of the Collections Task Force, internally referred to as the 10 Customer Care Center or "CCC ." The CCC was established during first quarter 22001 to work 11 customers with past due balances to determine if 1) past due charges were legitimate ; and 2) if 1 2 charges were legitimate, to arrive at mutually agreeable payment terms . Through CW2's work on 13 the CCC it was apparent that revenues recorded during the Class Period were not "real ." 14 175. CW3 also confirmed that in first quarter 2001 Exodus would book a service, record 15 revenue, and then ultimately "debook" the transaction by issuing credit memos to customers i n 16 subsequent quarters. 17 176. Further, CW11 stated that by the fall of 2001, approximately 1,500 active customer 1 8 accounts were formally cancelled by the Credit and Collections department because CCC collectors 19 had determined that these customers had previously cancelled. Some cancellations had occurred as 20 early as the fall of 2000 . CW11 stated that approximately 40-50 % of revenue was recognized 21 inappropriately during the first 6 months of 2001 . Taking into account the $96 million bad debt 22 reserve that Exodus reported at 6/30/01, this would equate to at least $171 million of fraudulent 23 revenue recognized during the first six months of 2001 . This fraudulent revenue represents 14% of 24 the reported net loss for the 6 months ended 6/30/01 . 25 177. CW12 confirmed the false installation practices as well as the continued invoicin g 26

27 4 According to CWl, Exodus employees used the term "debook" to refer to credit memos 28 issued or reserves established for revenue that had been inapprop riately recorded in a prior period. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-O1-2661-MMC -86- 1' •

1 and revenue recognition on cancelled contracts. CW12 further confirmed that at least 1,000 of th e

2 customers being invoiced during the first 6 months of 2001 had previously cancelled and man y

3 others were owed credits that were pending approval .

4 178. Also, in an effort to hide this fraudulent revenue, Exodus employed a scheme t o

5 fictitiously record cash receipts so that it appeared as though customers were paying the invoices .

6 See ¶192 .

7 R. Exodus Recorded Revenue on Contracts Where Collectibility Was Not Reasonably Assured and Failed to Establish Adequate 8 Reserves

9 179. It was common practice for Exodus to enter into contracts with customers that had

10 limited capital resources, many of which were Internet companies on the verge of bankruptcy .

11 Despite this known inability to pay, defendants Hancock, Mohamad, Dollahite, Case and Stoltz

12 frequently approved deals with these customers in order to continue to report revenue growth

13 throughout the Class Period . These transactions were in violation of GAAP and SEC rules as the

14 collectibility was notreasonably assured. Recording revenues on transactions in which collectibility

15 was an issue contributed to Exodus' deteriorating accounts receivable throughout the Class Period .

1 6 180. CW 10 stated thatprior to executing an agreement with a new customer, authorization

17 had to be received.' CW10 stated that Jeff Ploshay, had the authority to approve deals with

18 customers that did not present a credit risk . However, many of the Internet and start-up customers

19 were a high credit risk and required "upper management" authorization. Many of these companies

20 had : limited cash; limited access to additional cash ; limited, or poor credit history; limited number

21 of references and products still in development . Despite these known risks, defendant's Hancock,

22 Mohamad, Dollahite, Case and Stoltz authorized sales agreements with risky Internet and start-up

23 companies. CW10 discussed the following examples of high risk contracts that required and

24 received "upper management" approval :

25 CW10 stated that beginning in early 2000, a credit analysis form was created to formalize 26 and document a customer's financial status. The form contained a customer's bank account information and balances, venture capital firms and committed investments , as well as vendor 27 references. An authorizing signature was required on the credit analysis form before a deal could be entered into. 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1-266 1 -MMC -87- qo 0

1 (a) Advertising.com -Advertising . com was a typical dot-com customer that had

2 poor credit and insufficient funds. This contract was approved by defendant Hancock.

3 Advertising.com was also the subject of premature installation invoices .

4 (b) Freerealtime.com - Freerealtime .com became a customer of Exodus during

5 2000. CW10 performed the credit analysis and informed Ploshay that this company was a huge

6 credit risk. The deal was "pushed through" by Hancock or other executives, and always presented

7 a "hard collection." Further, Freerealtime also disputed invoices because it had been overcharged

8 for bandwidth and prematurely charged for installation.

9 (c) Business.com - CW10 described Business .com as "the typical dot-com

10 customer" in that it was an uncreditworthy customer which executive management approved and

11 ultimately resulted in delayed or no payments . Further, Business .com was the subject of premature

12 installation invoicing.

13 181 . Additional examples of high risk customers approved by Hancock or Stoltz during

14 2000 are Buy.com and Beyond.com.

15 182. CW5 also disclosed that although Exodus had procedures for determining the

16 creditworthiness of potential customers, defendant Hancock would frequently approve non-

17 creditworthy customers in order to record revenues.

18 183 . As an example, CW5 described one particular instance when services were shut down

19 on a customer that owed approximately $700,000 . Despite the delinquency and known inability to

20 pay, defendants Hancock and Case ordered the customers' services to be "brought back up"

21 immediately. Services were returned, monthly billing continued and collection was not made .

22 184. Notwithstanding the fact that Exodus recognized revenue in violation of GAAP by :

23 (a) recording revenue prior to rendering services ; (b) recording revenue on cancelled or non-renewed

24 contracts ; and (c) recording revenue on transactions in which collectibility was not probable, Exodus

25 also violated GAAP by failing to establish sufficient reserves for its deteriorating accounts

26 receivable. GAAP as set forth in FASB Statement of Financial Accounting Standards (SFAS) No .

27 5, Accounting for Contingencies, sets forth that an estimated loss shall be accrued by a charge to

28 income if it is probable that an asset had been impaired and the amount can be reasonably estimated. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-0 1 -2661 -MMC _88- 1 See SFAS No. 5 ¶8 . Further, collectibility of receivables is specifically listed as an example of a loss

2 contingency. See SFAS No. 5 ¶4.

3 185 . CW5 was responsible for generating bad debt reserve and revenue reserve reports .

4 These reports were generated on a monthly basis and distributed by the 6th day of the following

5 month. CW5 stated the March 2001 report reflected 40% of the overall accounts receivable as being

6 uncollectible. This report was distributed to defendants Hancock, Case and Dollahite in early April,

7 well before defendants filed the Company's first quarter 2001 Form 10-Q and within weeks of

8 defendants filing the Company's 2000 Form 10-K . However, no additional reserves were established

9 and no disclosures were made regarding the deteriorating accounts receivable balance in either of

10 these SEC filings .

11 186. Exodus reported an accounts receivable reserve of $23 .8 million or 12% of its gross

12 accounts receivable balance as of 12/31/00 and $95 .5 million or 26% of its gross accounts receivable

13 balance as of 6/30/01 . A 40% accounts receivable reserve would have required an additional charge

14 of $56 million or 22% of the Company's reported net loss for the year-ended 12/31/00, or a an

15 additional charge of $52 million as of 6/30/01 .

16 S. Exodus' Barter Transaction s

17 187. Another scheme devised by defendants was to improperly gross up revenues based

18 on fictitious or over valued barter transactions .

19 188. GAAP, as set forth by APB 29, Accounting forNonmonetary Transactions, concludes

20 that, in general, accounting for nonmonetary transactions should be based on the fair values of the

21 assets (or services) involved . See APB 29, ¶18 . Further, APB 29 states "an enterprise that engages

22 in one or more non-monetary transactions during a period should disclose in financial statements for

23 the period the nature of the transactions, the basis of accounting for the assets transferred, and gains

24 or losses recognized on transfers." See APB No. 29, ¶28.

25 189. Further, SEC Regulation S-K §229 .303, requires management to describe any known

26 trends or uncertainties that have had or that the registrant reasonably expects will have a material

27 favorable or unfavorable impact on net sales or revenues or income from continuing operations .

28 Failure to disclose non-monetary transactions violates this SEC regulation .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -89- t 0

1 190. The AICPA in its guidance to auditors has identified barter transactions as a highly

2 suspicious transaction . AICPA Practice Alert No . 95-1, Revenue Recognition Issues, discusses the

3 possibility that client personnel may knowingly participate and assist in schemes designed to

4 overstate revenue and conditions that can be indicative of improper and unusual revenue practices .

5 AICPA Practice Alert No. 95-1 specifically lists barter transactions as an example of improper and

6 unusual revenue transactions.'

7 191 . Exodus entered into barter transactions for the sole purpose of grossing up revenue 8 as the Company did not need and never intended to utilize software and other assets received as a

9 result of these exchanges . These transactions violated GAAP and SEC rules as they were not based

10 on fair values of assets or services exchanged and Exodus failed to disclose the existence of such

11 transactions. Following are examples of this practice : 12 (a) CW1 stated that during the first quarter of 2001, Exodus entered into a barter

13 transaction with a small Silicon Valley start-up, Innoventry. CW1 recalled that in return for an

14 $800,000 MRC type transaction, Exodus "purchased" unneeded software licenses from Innoventry .

15 This transaction was "debooked" in the second half of 2001 .

16 (b) CW1 also described a barter transaction with a company named Niku . In this

17 transaction the two companies agreed to write checks for approximately $417,000 . Although Exodus

18 invoiced Niku for "services rendered" during 4Q00, no services were ever performed. Further, the

19 software licenses Niku was to provide Exodus related to a time management system . Exodus was

20 in the process of implementing a different time management system and had no intention of utilizing

21 the Niku license . This fictitious transaction was "debooked" in the second half of 2001 . 22 (c) CW1 further explained that the fictitious barter transactions were extremely

23 important to Exodus as there were no costs associated with these fictitious sales and the amounts

24 "blow straight through to net income."

25

26 6 Additionally, AICPA Practice Alert No . 98-3, Revenue Recognition Issues, was issued i n 27 November 1998 to remind auditors of certain factors or conditions that can be indicative of increased audit risk of improper, aggressive or unusual revenue recognition practices . Once again, this alert 28 specifically lists barter transactions as an issue requiring special consideration. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC _90- 0 0

1 (d) Contrary to GAAP and SEC rules, Exodus improperly recognized revenue

2 during the Class Period in conjunction with barter transactions and failed to disclose such

3 transactions.

4 EXODUS' FRAUDULENT CASH ACCOUNTIN G

5 192. As a result of its improper revenue recognition practices, Exodus' accounts receivable

6 balances deteriorated throughout the Class Period . In an attempt to conceal its fraudulent revenue

7 recognition practices, Exodus recorded fictitious cash receipts to give the appearance that its

8 accounts receivables were being paid . As described by CW 1, this fraudulent practice was initiated

9 at the direction of Suzanne Colvin, Controller, and consisted of contacting customers, including

10 those with balances greater than 60 or 90 days past due, and inquiring if or when a check would be

11 sent. Upon confirmation that "a check was in the mail," Exodus would record a fictitious entry to

12 increase its cash and decrease its accounts receivable . Exodus' reporting of a fictitious cash balance

13 is a violation of one of the most basic concepts of GAAP - Representational Faithfulness.' See

14 FASCON No. 2, ¶¶63-71 . Further, in addition to the misstatement of Exodus' financial statements, 15 the recording of fictitious cash receipts also caused Exodus' calculated DSO to be artificially low .

16 DSO indicates how quickly a company will collect cash from its sales activity and it is an important

17 metric that Wall Street analysts frequently analyze when reporting on a company .

18 Fundamental GAAP Violations

19 193. Due to the accounting improprieties discussed above, the Company presented its 20 financial statements in a manner which violated GAAP, including the following fundamental

21 accounting principles: 22 (a) The principle that interim financial reporting should be based upon the same

23 accounting principles and practices used to prepare annual financial statements was violated (APB

24 No. 28, ¶10);

25

26

27 7 FASCON No . 2 defines Representational Faithfulness as follows : "Correspondence or agreement between a measure or description and the phenomenon that it purports to represent 28 (sometimes called validity) ." See FASCON No. 2 Glossary of Terms. FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC - 91 - 0 0

1 (b) The principle that financial reporting should provide information that is useful

2 to present and potential investors and creditors and other users in making rational investment, credit

3 and similar decisions was violated (FASCON No. 1, ¶34) ; 4 (c) The principle that financial reporting should provide information about the

5 economic resources of an enterprise, the claims to those resources, and effects of transactions, events

6 and circumstances that change resources and claims to those resources was violated (FASCON No.

7 1, ¶40) ; 8 (d) The principle that financial reporting should provide information about how

9 management of an enterprise has discharged its stewardship responsibility to owners (stockholders)

10 for the use of enterprise resources entrusted to it was violated . To the extent that management offers

11 securities of the enterprise to the public, it voluntarily accepts wider responsibilities for

12 accountability to prospective investors and to the public in general (FASCON No . 1, ¶50) ;

13 (e) The principle that financial reporting should provide information about an

14 enterprise's financial performance during a period was violated. Investors and creditors often use

15 information about the past to help in assessing the prospects of an enterprise . Thus, although

16 investment and credit decisions reflect investors' expectations about future enterprise performance,

17 those expectations are commonly based at least partly on evaluations of past enterprise performance

18 (FASCON No . 1, ¶42); 19 (f) The principle that financial reporting should be reliable in that it represents

20 what it purports to represent was violated . That information should be reliable as well as relevant

21 is a notion that is central to accounting (FASCON No . 2, ¶¶58-59) ;

22 (g) The principle of completeness, which means that nothing is left out of the

23 information that may be necessary to insure that it validly represents underlying events and

24 conditions was violated (FASCON No . 2, ¶79); and 25 (h) The principle that conservatism be used as a prudent reaction to uncertainty

26 to try to ensure that uncertainties and risks inherent in business situations are adequately considered

27 was violated . The best way to avoid injury to investors is to try to ensure that what is reported

28 represents what it purports to represent (FASCON No . 2, ¶¶95, 97) .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -92- r •

194. Further, the undisclosed adverse information concealed by defendants during th e

relevant period is the type of information which, because of SEC regulations, regulations of the

national stock exchanges and customary business practice, is expected by investors and securities

analysts to be disclosed and is known by corporate officials and their legal and financial advisors to

be the type of information which is expected to be and must be disclosed .

SCIENTER

195. The combination of defendants' knowledge or deliberate recklessness, along wit h

I motive for committing the fraud, establishes scienter, as follows :

Knowledge

10 196. As set forth above, defendants had full knowledge of the improper revenu e

11 recognition practices and the poor business condition of Exodus . Among other things, by

12 participating in Monday morning executive meetings where the MRC issues, reserve issues and

13 forecasting issues were brought up, defendants obtained knowledge of such issues . Defendants

14 Hancock, Case and Dollahite also had direct knowledge of barter transactions, including thos e

15 I involving Oracle, Innoventry and SANrise . Defendants also received various reports, such as

16 Exodus' P&L statements and reserve reports, that disclosed the Company's true financial condition s

17 to which they were aware . Furthermore, Hancock was fully aware that Exodus was improperly

18 recording revenue that had been canceled, because she was directly informed of such . Defendants

19 were also aware that Exodus did not have sufficient funds to make its business plan because the

20 I capital plan showed that Exodus needed much more cash than it had to accomplish its plan .

21 Motive

22 197 . Desire to Profit from Insider Trading - During the Class Period, almost all of the

23 defendants engaged in insider trading, selling 1 .4 million shares of Exodus stock for proceeds of over

24 $72.5 million. These trades were made prior to the adverse disclosure by Exodus while the

25 defendants were making positive statements about the Company . The following are the insider sales :

26 NAME DATE SHARES PRICE PROCEED S 27

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-O1-2661-MMC -93- M •

1 Hancock, Ellen May 31, 2000 20,000 $72.87 $1,457,400 2 (CEO and Chairman) 3 Aug 30, 2000 66,638 $65.38 $4,356,792 4 May 1, 2001 81,695 $9.83 $ 803,06 1

5 May 2, 2001 145,580 $9.83 $1,431,05 1

6 May 4, 2001 57,758 $9.83 $ 667,76 1 Sub-total 371,671 $8.72 million 7 Case, Marshall Aug 31, 2000 200,000 $65.11-$66.31 $13.15 million 8 (CFO and EVP of Finance) 9 Sub-total 200,000 $13.15 million 10 Wegner, Adam W. April 26, 2000 10,000 $80.01 $ 800,100 (EVP of Legal 11 & Corp. Affairs) 12 Apri l 28, 2000 34,800 $85.00 $2,958,000 13 Aug 31, 2000 114,996 $65.00-$66.00 $7.58 million

14

15 May 2, 2001 29,834 $10.50 $ 313,25 7

16 May 2, 2001 30,000 $10.00 $ 300,000 sub-total 219,630 $11.95 million 17 Dollahite, Herbert May 30, 2001 96,800 $7.88 $762,784.00 18 (EVP of Custome r Service, Support & 19 Quality)

20 sub-total 96,800 $762,784.00 Mohamad, Sam 21 April 25, 2000 5,000 $77.89 $ 348,45 0 (EVP of Worldwide 22 Sales) April 27, 2000 10,000 $73 .75 $ 737,500 23 April 28, 2000 10,000 $85.97 $ 859,700 24 May 4, 2000 10,000 $87.70 $ 877,000 25 May 5, 2000 10,000 $84.28 $ 842,800 26 May 9, 2000 10,000 $79.37 $ 793,700 27 Aug 31, 2000 192,971 $64.83-$66.50 $12.68 million

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-O1-2661-MMC - 94 - 1 •

1 sub-total 247,971 $17.14 million 2 Yeack, William R. Aug 31, 2000 117,600 $64.91 $7.63 million (EVP of Managed 3 Professional Services) 4 sub-total 117,600 $7.63 million 5 Brown, Beverly Aug 31, 2000 201,360 $64.75-$65 .88 $13.15 million 6 (EVP of Marketing) sub-total 201 ,360 $13.15 million 7 TOTAL 1,455,032 $72.5 million 8

9 198. These trades were suspicious in timing and amount. Defendants Hancock and 10 Wegner's first sales of Exodus stock occurred just after the start of the Class Period (even though 11 Hancock had been employed by Exodus since July 1998 and Wegner since October 1998), and the y 12 sold large amounts of Exodus stock just before some of the highly negative information wa s 13 disclosed to the market on June 20, 2001 . Similarly, Dollahite", who had been employed by Exodu s 14 since June 1998, made his first and only sale of Exodus stock just before this date . Further, when

15 CFO Case sold his shares on August 31, 2000, he sold 100% of his holdings of Exodus stock. 16 199 . In particular, Hancock's trades were so unusual that a July 9, 2001 article in Barron's 17 entitled "Shareholders Are Exiting Exodus, Including CEO Hancock," commented on the massiv e 1 8 insider sales by defendant Hancock at a suspicious time . The article stated:

19 But what is a tad surprising, if not entirely disappointing, is that among the throngs of disenchanted stockholders running scared from the company's shares has been 20 Exodus chief executive, Ellen Hancock . As the sawgoes, actions speak louder than words, and Hancock has been dumping her holdings with the alacrity of a panicky 21 momentum trader . 22 According to Thompson/First Call, Hancock sold or registered to sell more than 685,000 shares during the first half of May. (Some shares were held indirectly by a 23 family member or trust) . First Call estimates the potential proceeds of the unloading .7 million. Some 285,000 shares were sold at 9 .83 . The trampled issues 24 around $6 closed Friday under 2. A skipper is entitled to lighten her load when the vessel is sinking. But Hancock deep-sixed a large chunk of her holdings just weeks before 25 the rest ofus would learn that the company's second quarter was a shipwreck . 26 200. Desire to Obtain Financing - Another reason why defendants were motivated to 27 artificially inflate the stock price of the Company was in order to obtain a high credit rating an d 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -95- 1 1

1 much needed financing. From the Company's inception, Exodus has financed its operations

2 primarily through sales of stock, various debt and note offerings and working capital lines of credit .

3 In order to continue to obtain such financing at favorable terms, defendants were motivated to falsify

4 its financial performance, to make highly positive statements about the Company, and to artificially

5 inflate its stock price. During the Class Period, defendants were able to complete a private offering,

6 a secondary public offering and a public notes offering for proceeds of almost $2 billion. Disclosure

7 of the Company's true facts would have greatly hindered the Company's ability to obtain financing,

8 the life-blood of the Company. Desire to Continue the Appearance of Growth - From Exodus'

9 inception as a public company, Exodus was billed as a fast growth Company, and its high stock price

10 was dependent upon its phenomenal growth rate . During the Class Period, defendants engaged in

11 a growth by acquisition strategy in order to sustain this growth rate and in order to meet Wall Street

12 expectations. The failure to grow and to meet expectations would have jeopardized the funding

13 much needed by the Company to continue its business, and would have hindered the Company's

14 ability to attract and keep employees, whose compensation was linked in part to Exodus' stock price .

15 Further, by continuing the appearance of growth, defendants were able to continue to enjoy their

16 executive positions, high compensations, and prestige . Desire to Prevent Bankruptcy - Because

17 unless Exodus was able to show growth and strength, it would have difficulty obtaining funding, in

18 order to prevent Exodus from filing bankruptcy much sooner, defendants were motivated to engage

19 in the fraud . Bankruptcy meant that defendants were likely to lose their positions, high

20 compensations, and prestige . Further, Exodus' bankruptcy would have also affected their reputations

21 and prospects for future positions with other companies .

22 PLAINTIFFS' CLASS ACTION ALLEGATION S

23 201 . Plaintiffs bring this action as a class action pursuant to Rule 23(a) and (b)(3) of the

24 Federal Rules of Civil Procedure on behalf of a class consisting of all persons and entities who

25 purchased or otherwise acquired Exodus securities from April 20, 2000 through and including

26 September 25, 2001, inclusive, and who were damaged thereby . Excluded from the Class are

27 defendants, officers and directors of the Company, members of their immediate families, and their

28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -96- i •

1 legal representatives, heirs, successors or assigns and any entity in which defendants have or had a

2 controlling interest .

3 202. During the Class Period, Exodus securities were traded on an efficient and developed

4 securities market. Thousands of brokers nationwide have access to trading information about

5 Exodus through the system . Within minutes of any transaction taking place, this system displays the

6 most recent trades and prices.

7 203 . The members of the class are so numerous that joinder of all members is

8 impracticable. While the exact number of class members is unknown to plaintiffs at this time and

9 can only be ascertained through appropriate discovery, plaintiffs believe that there are thousands of

10 members of the class . During the Class Period, Exodus had over 550 million shares of common

11 stock outstanding and actively traded on the NASDAQ National Market, an efficient market, under

12 the ticker symbol "EXDS . "

13 204. Plaintiffs' claims are typical of the claims of the members of the class as all members

14 of the class are similarly affected by defendants' wrongful conduct in violation of federal law that

15 is complained of herein.

16 205 . Plaintiffs will fairly and adequately protect the interests of the members of the class

17 and have retained counsel competent and experienced in class and securities litigation. Plaintiffs

18 have no interests that are adverse or antagonistic to those of the class .

19 206. A class action is superior to other available methods for the fair and efficient

20 adjudication of this controversy. Because the damages suffered by many individual class members

21 maybe relatively small, the expense and burden of individual litigation make it virtually impossible

22 for the class members to individually seek redress for the wrongful conduct alleged herein .

23 207. Common questions of law and fact exist as to all members of the class and

24 predominate over any questions affecting solely individual members of the class . Among the

25 questions of law and fact common to the class are :

26 (a) whether the federal securities laws were violated by defendants' acts as alleged herein ;

27 (b) whether defendants participated in and pursued the common course of conduct

28 complained of herein;

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC -97- y 0

1 (c) whether documents, press releases and other statements disseminated to the investing

2 public during the Class Period misrepresented the business condition of Exodus ;

3 (d) whether defendants failed to correct prior statements when subsequent events

4 rendered those prior statements untrue or inaccurate ;

5 (e) whether defendants acted willfully or recklessly in misrepresenting and/or omitting

6 to state material facts;

7 (f) whether the market price of Exodus' securities during the Class Period was artificially

8 inflated due to the misrepresentations and/or non-disclosures complained of herein ; and

9 (g) whether the members of the class have sustained damages, and, if so, what is the

10 proper measure thereof.

11 208. Plaintiffs will rely, in part, upon the presumption of reliance established by the

12 fraud-on-the-market doctrine in that:

13 (a) defendants made public misrepresentations or omitted material facts during the Class

14 Period, as alleged herein;

15 (b) the misrepresentations and/or omissions were material ;

16 (c) Exodus' securities were traded in an efficient market ;

17 (d) the misrepresentations and/or omissions alleged tended to induce reasonable investors

18 to misjudge the value of Exodus shares; and

19 (e) plaintiffs and members of the class acquired their securities between the time

20 defendants made the misrepresentations and/or omissions and the time the truth was revealed,

21 without knowledge of the falsity of the misrepresentations .

22 COUNT I (Violations of Section 10(b) of the Exchange Act 23 and Rule 10-5 Promulgated Thereunder )

24 209 . Plaintiffs incorporate by reference the above paragraphs as if set forth fully herein .

25 210 . During the Class Period, the defendants, and each of them, carried out a plan, scheme

26 and course of conduct which was intended to and, throughout the Class Period, did : (i) deceive the

27 investing public, including plaintiffs and the other class members, as alleged herein ; (ii) artificially

28 inflate and maintain the market price of Exodus ; and (iii) cause plaintiffs and other members of the FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC _98- 0 0

1 class to purchase Exodus securities at inflated prices. In furtherance of this unlawful scheme, plan

2 and course of conduct, defendants, and each of them, took the actions set forth herein .

3 211 . Defendants (a) employed devices, schemes, and artifices to defraud ; (b) made untrue

4 statements of material fact and/or omitted to state material facts necessary to make the statements

5 not misleading; and (c) engaged in acts, practices, and a course ofbusiness which operated as a fraud

6 and deceit upon the purchasers of the Company's securities in an effort to maintain artificially high

7 market prices for Exodus securities in violation of § 10(b) of the Exchange Act and Rule I Ob-5 .

8 212 . The statements made by defendants during the Class Period were materially false and

9 misleading because at the time they were made, the Company and persons acting as corporate

10 officers knew or were consciously reckless in failing to disclose the matters set forth herein.

11 213 . In ignorance of the artificially high market prices of Exodus' publicly traded

12 securities, and relying directly on defendants or indirectly on the false and misleading statements

13 made by defendants, upon the integrity of the market in which the securities trade, on the integrity

14 of the regulatory process and the truth of representations made to appropriate agencies throughout

15 the Class Period and/or on the absence of material adverse information that was known to defendants

16 but not disclosed in public statements by defendants during the Class Period, plaintiffs and the other

17 members of the class acquired Exodus securities during the Class Period at artificially high prices

18 and were damaged thereby.

19 214. Had plaintiffs and the other members of the class and the marketplace known of the

20 true financial condition and business prospects of Exodus which were not disclosed by defendants,

21 plaintiffs and other members of the class would not have purchased or otherwise acquired their

22 Exodus securities during the Class Period, or would have not done so at the artificially inflated prices

23 which they paid . Hence, plaintiffs and the class were damaged by defendants' violations of § 10(b)

24 and Rule l Ob-5.

25 COUNT II (Violation of §20(a) of the Exchange Act 26 Against the Individual Defendants)

27 215 . Plaintiffs incorporate by reference the above paragraphs as if set forth fully herein .

28 This Count is asserted against the Individual Defendants .

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS- C-0 1 -266 1 -MMC -99- 1 216. The Individual Defendants acted as controlling persons of Exodus within the meaning

2 of §20(a) of the Exchange Act as alleged herein. By reasons of their executive and managerial

3 positions with Exodus, the Individual Defendants had the power and authority to cause the Company

4 to engage in the wrongful conduct complained of herein .

5 217. By reasons of the aforementioned wrongful conduct, the Individual Defendants are

6 liable pursuant to §20(a) of the Exchange Act . As a direct and proximate result of their wrongful

7 conduct, plaintiffs and the other members of the class suffered damages in connection with

8 purchasing the Company's securities during the Class Period.

9 COUNT III (Violation of Sections 11 and 15 of the Securities 10 Act Against Hancock, Goldman, Merrill Lynch, Morgan Stanley and J . P. Morgan)

11 218 . Plaintiffs assert claims for violations of § 11 of the Securities Act, 15 U.S .C. §77k,

12 against defendants Hancock, Goldman, Merrill Lynch, Morgan Stanley and J . P. Morgan on behalf

13 of investors who purchased securities pursuant to a registration statement filed with the SEC during

14 the Class Period, including but not limited to the February 6, 2001 stock and note offering . A Claim

15 is also asserted against defendant Hancock for violation of § 15 ofthe Securities Act, 15 U .S .C . §77o,

16 by virtue of her direct and indirect control and domination of Exodus .

17 219. Exodus issued the securities registered by the Registration Statement . The defendants

18 named in this Claim either signed the Registration Statement or were a director of the issuer at the

19 time of the filing of the Registration Statement .

20

21 PRAYER

22 WHEREFORE, plaintiffs pray for relief and judgment, as follows :

23 1 . Determining that this action is a proper class action, certifying plaintiffs as class

24 representatives under Rule 23 of the Federal Rules of Civil Procedure and plaintiffs' counsel as class

25 counsel;

26 2. Awarding compensatory damages in favor of plaintiffs and the other class members

27 against all defendants, jointly and severally, for all damages sustained as a result of defendants'

28 wrongdoing, in an amount to be proven at trial, including interest thereon ;

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC - 100 - f

1 3 . Awarding plaintiffs and the class their reasonable costs and expenses incurred in this

2 action, including counsel fees and expe rt fees; and

3 4. Such other and further relief as the Court may deem just and proper.

4

5 JURY DEMAND

6 Plaintiffs hereby demand a trial by jury.

7 DATED : July 11 , 2002 MILBERG WEISS BERSHAD 8 HYNES & LERACH LLP REED R. KATHREIN 9 JOHN K. G T EX KANO S SAMS II 1 0 11 '`3`~ ~,~ •~ ~,~

12 JOHN K. GRA~T

13 100 Pinr et , Suite 2600 San Francisco, CA 94111 14 Telephone : 415/288-4545 415/288-4534 (fax)

15 MILBERG WEISS BERSHAD 16 HYNES & LERACH LLP WILLIAM S. LERACH 17 401 B Street, Suite 1700 San Diego, CA 9210 1 18 Telephone : 619/231-1058 619/231-7423 (fax)

19 WEISS & YOURMAN 20 JOSEPH H . WEISS 551 Fifth Avenue, Suite 1600 21 New York, NY 10176 Telephone : 212/682-3025 22 212/682-3010 (fax)

23 WEISS & YOURMAN KEVIN J. YOURMAN 24 ELIZABETH P. LIN 10940 Wilshire Blvd., 24th Floor 25 Los Angeles , CA 90024 Telephone : 310/208-2800 26 310/209-2348 (fax )

27 Co-Lead Counsel for Plaintiffs

G :\CAS E S\E xo d us \ CXS 8023 6 . cpt 28

FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIO N OF THE FEDERAL SECURITIES LAWS - C-01-2661 -MMC - 101 - 1 DECLARATION OF SERVICE BY FACSIMILE . PURSUANT TO NORTHERN DISTRICT LOCAL RULE 23-2(c)(2 ) 2

3 I, the undersigned, declare : 4 1 . That declarant is and was, at all times herein mentioned, a citizen of the United States 5 and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interest 6 in the within action; that declarant's business address is 100 Pine Street, 26th Floor, San Francisco, 7 California 94111 . 8 2 . That on July 11, 2002, declarant served by facsimile the FIRST AMENDED 9 CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL 10 SECURITIES LAWS to the parties listed on the attached Service List and this document was 11 forwarded to the following designated Internet site at : 12 http://securities.milberg.com 13 3 . That there is a regular communication by facsimile between the place of origin and 14 the places so addressed . 15 I declare under penalty of perjury that the foregoing is true and correct . Executed this 11th 16 day of July, 2002, at San Francisco, California. A, I 17

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FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS- C-01-2661-MMC C` • a

EXODUS (LEAD ) Service List - 07/11/02 Page 1

COUNSEL FOR PLAINTIFF(S )

Kevin J . Yourman Reed R . Kathrein Elizabeth P . Lin John E . Grant WEISS & YOURMAN* * Ex Kano S . Sams I I 10940 Wilshire Blvd ., 24th Floor MILBERG WEISS BERSHAD HYNES & Los Angeles, CA 90024 LERACH LL P 310/208-280 0 100 Pine Street, Suite 2600 310/209-2348 (fax ) San Francisco, CA 94111 415/288-4545 415/288-4534 (fax )

William S . Lerach Joseph H . Weiss MILBERG WEISS BERSHAD HYNES & WEISS & YOURMAN* * LERACH LLP * 551 Fifth Avenue, Suite 1600 401 B Street, Suite 1700 New York, NY 10176 San Diego, CA 92101-5050 212/682-302 5 619/231-105 8 212/682-3010 (fax ) 619/231-7423 (fax )

COUNSEL FOR DEFENDANTS

Elizabeth E . Karne s BROBECK, PHLEGER & HARRISON LLP*** 2000 University Avenue Palo Alto, CA 94303 650/331-8000 650/331-8100 (fax)

*Denotes Service Via U .S . Mail on July 11, 2002 **Denotes service Via Federal Express on July 11, 200 2 ***Denotes Service via Hand Delivery on July 11, 2002 Exhibit B h

1 JONATHAN C . DICKEY, SBN 088226 PAUL J. COLLINS, SBN 187709 2 JOHN D. van LOBEN SELS, SBN 201354 GIBSON, DUNN & CRUTCHER LLP 3 1530 Page Mill Road Palo Alto, California 94304 4 Telephone : (650) 849-5300 Facsimile : (650) 849-5333 5 Attorneys for Defendants GOLDMAN, SACHS & 6 CO ., MERRILL LYNCH & CO ., MORGAN STANLEY DEAN WITTER, and J .P. MORGAN 7 8

9 UNITED STATES DISTRICT COURT

10 FOR THE NORTHERN DISTRICT OF CALIFORNIA

11 SAN FRANCISCO DIVISIO N 12 13 In re EXODUS COMMUNICATIONS, INC . Master File No . C-01-2661-MMC 14 SECURITIES LITIGATION CLASS ACTION 15 NOTICE OF MOTION AND MOTION This Document Relates to: 16 OF UNDERWRITER DEFENDANTS ALL ACTIONS . GOLDMAN, SACHS & CO., MERRILL 17 LYNCH & CO ., MORGAN STANLEY 18 DEAN WITTER, AND J.P. MORGAN TO DISMISS THE FIRST AMENDED 19 CONSOLIDATED COMPLAINT ; AND MEMORANDUM OF POINTS AND 20 AUTHORITIES 21 22 23 24 25

26 27 28

Gibson, Dunn & I) CrutcherLLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE NO . C-O1-2661-MMC 1 TABLE OF CONTENT S 2 Page 3 NOTICE OF MOTION AND MOTION ...... 1 4 1. INTRODUCTION ...... 2 5 II. BACKGROUND AND PROCEDURAL HISTORY ...... 5 6 III. ARGUMENT ...... 8 7 A. The Standard For This Motion ...... 8 8 B. The FAC Should Be Dismissed Against The Underwriters For 9 The Reasons Set Forth In The D&O Defendants' Memorandu m Of Points And Authorities ...... 9 10 C. Plaintiffs' Claims Are Barred By The Statute of Limitations ...... 9 11 D. Plaintiffs' Section 10(b) And Rule I Ob-5 Claims Against The 12 Underwriters Should Be Dismissed...... 1 3

13 1 . No Underwriter Is Alleged To Have Made Any False O r Misleading Statement ...... 1 3 14 2 . Plaintiffs Fail To Allege Facts That, If True, Would 15 Demonstrate That The Underwriters Made Any Forward-Looking Statement With Actual Knowledge Of 16 Falsity...... 1 8

17 3 . Plaintiffs Fail To Allege Facts That, If True, Woul d Demonstrate That Any Of The Underwriters Acted With 18 At Least "Deliberate Recklessness." ...... 20

19 E. Plaintiffs' Section 11 Claim Should Be Dismissed ...... 22

20 1 . Plaintiffs Lack Standing To Assert A Section 11 Claim...... 23

21 a) Plaintiffs' Attempt To Usurp The Court' s Authority By Appointing Themselves To Th e 22 Lead Plaintiff Group Should Be Rejected ...... 23

23 b) Plaintiffs Fail To Allege Facts Sufficient To Demonstrate That Any Plaintiff Has Standing To 24 Assert Section 11 Claims Based On The February 6, 2001 Secondary Stock Offering ...... 25 25 2. Plaintiffs Fail To Plead Fraud With The Specificity 26 Required Under The PSLRA And Rule 9(b) Of Th e Federal Rules Of Civil Procedure...... 27 27 IV . CONCLUSION ...... :...... 30 28

Gibson, Dunn & Crutcher LLP 1 1 UNDERWRITER DEFENDANTS' MOTION TO DISMISS , CASE No . C-0 1-266 1 -MMC 0 0

1 TABLE OF AUTHORITIES

2 Pa e s

3 CASES 4 Abbey v. Computer Memories, Inc. , 5 634 F. Supp. 870 (N.D . Cal. 1986) ...... 25, 26 6 ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336 (5th Cir. 2002)...... 14 7 Abrams v. Baker Hughes, Inc. , 8 292 F. 3d 424 (5th Cir. 2002)...... 21 9 Barnes v. Osofsky, . . .. 10 373 F.2d 269 (2d Cir. 1967)...... 25 11 Berry v. Valence Technology, Inc . , 175 F .3d 699 (9th Cir. 1999)...... 10, 12 12 Branch v. Tunnell, 13 14 F.3d 449 (9th Cir. 1994)...... 9

14 Briskin v. Ernst & Ernst, ...... 10 15 589 F .2d 1363 (9th Cir. 1978) ...... 16 Brumbaugh v. Princeton Partners, 985 F.2d 157 (4th Cir. 1993)...... 11 17 California Pub . Employees' Ret. Sys. v. Chubb Corp. , 18 127 F. Supp . 2d 572 (D.N.J. 2001) ...... 24

19 Caprin v. Simon Transportation Services, . 2d 1251 (D. Utah 2000) ...... 1 2 20 112 F . Supp 21 CSIInv. Partners II, L .P. v. Cendant Corp. , 180 F. Supp. 2d 444 (S.D.N.Y. 2001) ...... 1 1 22 De la Fuente v. DCI Telecomms., Inc. , 23 206 F.R.D . 369 (S.D.N.Y. 2002) ...... 10

24 Dodds v. Cigna Sec., Inc. , 12 F.3d 346 (2d Cir. 1993)...... 10 25 . 3Com Corp., 26 Gaylinn v 185 F. Supp. 2d 1054 (N .D. Cal. 2000) ...... 13 27 Gompper v. VISX, Inc., 28 298 F.3d 893 (9th Cir. 2002)...... 9, 20

Gibson , Dunn & (I "' Crutcher LLP 111 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 0 TABLE OF AUTHORITIE S [Continued] 1 Pa e s 2 3 Gray v. First Winthrop Corp. , 82 F.3d 877 (9th Cir. 1996) ...... 1 0 4 Great Rivers Coop. v. Farmland Indus., Inc. , 5 120 F .3d 893 (8th Cir. 1997) ...... 10,1 1

6 Greebel v. FTP Software, Inc. , 1st Cir 1999) ...... 1 5 7 194 F 3d 185 ( 8 Guenther v. Cooper Life Sciences, Inc. , 759 F. Supp. 1437 (N.D. Cal. 1990) ...... 25, 26 9 Harris v. Ivax Corp. , 10 182 F.3d 799 (1 lth Cir. 1999)...... 1 8

11 Helwig v. Vencor, Inc. , 251 F.3d 540 (6th Cir. 2001)...... 18 12 13 Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076 (9th Cir. 1999)...... 25 14 In re Commtouch Software Ltd. Sec. Litig., 15 2002 U.S . Dist. LEXIS 13742 (N .D . Cal. July 24, 2002) ...... 1 2

16 In re Convergent Technologies Sec. Litig. , 948 F.2d 507 (9th Cir. 1991)...... 14 17 In re FVC.com Sec. Litig. , 18 136 F. Supp. 2d 1031 (N.D. Cal. 2000) 19 aff'd, 32 Fed. Appx. 338 (9th Cir . 2002) ...... 22 20 In re GlenFed, Inc. Sec. Litig. , 42 F.3d 1541 (9th Cir. 1994)...... 28, 29, 30 21 In re Harmonic Inc. Sec. Litig. , 22 163 F. Supp. 2d 1079 (N.D. Cal. 2001) ...... 27 23 In re IasiaWorks, Inc. Sec. Litig. , 24 2002 WL 1034041 (N.D. Cal. May 15, 2002) ...... 27 25 In re K-Tel Int'l, Inc. Sec. Litig. , 300 F.3d 881 (8th Cir. 2002)...... 1 6 26 In re Lucent Techs., Inc. Sec. Litig. , 27 194 F.R.D . 137 (D.N.J. 2000) ...... 24 28

Gibson , Dunn & II Crutcher LLP iv UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-0 1 -266 1 -MMC I TABLE OF AUTHORITIE S [Continued] 1 Pa e s 2 3 In re NorthPoint Communications Group, Inc. Sec. Litig. , 184 F. Supp. 2d 991 (N.D. Cal. 2001) ...... 2 1 4 In re NorthPoint Communications Group, Inc. Sec. Litig. , 5 2002 WL 1775268 (N .D . Cal . May 28, 2002) ...... 15, 17

6 In re Pacific Gateway Exch . Inc. Sec. Litig., 2002 WL 851066 (N .D. Cal. Apr. 30, 2002) ...... 18, 1 9 7 . Litig., 8 In re Pacific Gateway Exch ., Inc. Sec 169 F . Supp. 2d 1160 (N.D. Cal. 2001) ...... 20 9 In re Silicon Graphics, Inc . Sec. Litig. , 10 183 F.3d 970 (9th Cir . 1999)...... 20, 21, 22

11 In re Software Toolworks, Inc . Sec. Litig., 50 F.3d 615 (9th Cir . 1994)...... 2 1 12 13 In re Splash Tech. Holdings, Inc. Sec. Litig. , 2000 WL 1727405 (N .D. Cal. Sept. 29, 2000) ...... 10, 1 9 14 In re Splash Tech. Holdings, Inc. Sec. Litig., 15 160 F. Supp. 2d 1059 (N .D. Cal. 2001) ...... 1 8

16 In re Stac Elecs. Sec. Litig. , 89 F.3d 1399 (9th Cir . 1996)...... 9, 19, 27 17 In re Stratosphere Corp ., Inc. Sec. Litig., 18 1 F. Supp. 2d 1096 (D . Nev. 1998) ...... 22 19 In re Syntex Corp . Sec. Litig., 20 855 F. Supp. 1086 (N.D . Cal. 1994) ...... 1 0

21 In re USEC Sec . Litig., 190 F. Supp. 2d 808 (D. Md. 2002) ...... 1 1 22 In re Vantive Corp. Sec. Litig., 23 283 F.3d 1079 (9th Cir . 2002)...... 1 8 24 In re Worlds of Wonder Sec. Litig. , 25 35 F.3d 1407 (9th Cir . 1994)...... 2 1

26 Jenkins v. McKeithen, 395 U.S . 411 (1969) ...... 9 27 28

Gibson, Dunn & Crutcher LLP V UNDERWRITER DEFENDANTS ' MOTION TO DISMISS, CASE No . C-0 1 -266 1 -MMC I TABLE OF AUTHORITIE S [Continued] 1 Pa &e s 2 3 Kane v. Madge Networks N. V., 2000 WL 33208116 (N .D. Cal. May 26, 2000) 4 aff'd, 32 Fed. Appx. 905 (9th Cir. 2002) ...... 15

5 Kramas v. Sec. Gas & Oil, Inc . , 672 F.2d 766 (9th Cir. 1982)...... 10 6 Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 7 501 U.S . 350 (1991) ...... 911 0 8 Lilley v. Charren, 9 936 F. Supp. 708 (N.D. Cal. 1996) ...... 25,26

10 Lipton v. Pathogenesis Corp. , 284 F.3d 1027 (9th Cir. 2002)...... 2 1 11 McFarland v. Memorex Corp., 12 493 F. Supp. 631 (N.D. Cal . 1980) ...... 25, 26 13 Neitzke v. Williams, 14 490 U.S. 319 (1989) ...... 9

15 Novak v. Kasaks, 216 F.3d 300 (2d Cir . 2000)...... 14 16 Parrino v. FHP, Inc., 17 146 F.3d 699 (9th Cir. 1998)...... 5 18 Ravens v. Iftikar, 19 174 F.R.D. 651 (N.D . Cal. 1997) ...... 24 20 Ronconi v. Larkin, 253 F.3d 423 (9th Cir . 2001)...... 16, 19 21 SEC v. Seabord Corp., 22 677 F.2d 1301 (9th Cir. 1982)...... 10 23 Sterlin v. Biomune Sys., Inc, ...... 1 24 154 F.3d 1191 (10th Cir. 1998) ...... 10,1 25 Stull v. Bayard, 561 F.2d 429 (2d Cir . 1977) ...... 12 26 Volk v. D.A. Davidson & Co., 27 816 F.2d 1406 (9th Cir . 1987)...... 12 28

Gibson, Dunn & Crutcher LLP Vi UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-0 1 -2661 -MMC 0 0 TABLE OF AUTHORITIE S [Continued] 1 Page(s) 2 3 Wenderhold v. Cylink Corp. , 188 F.R.D. 577 (N.D. Cal. 1999) ...... 24 4 Yourish v. California Amplifier, 5 191 F.3d 983 (9th Cir. 1999)...... 17, 28, 30

6 STATUTES 7 15 U.S .C . § 77m ...... 9 8 15 U.S .C. § 77z-1(a)(2)(A) ...... 23 9 15 U.S .C. § 77z-1(a)(3)(A) ...... 23 10 15 U .S.C. § 77z-1(a)(3)(B)(i)...... 24 11 15 U.S.C . § 77z-2(c)(1) ...... 19 12 15 U.S .C . § 77z-2(c)(1)(B) ...... 28 13 15 U.S .C. § 78u-4(b)(1) ...... 13 14 ...... 20 15 15 U.S.C. § 78u-4(b)(2) ...... 16 15 U.S.C. § 78u-5(c)(1)(B)(i)-(ii) ...... 18 17 Fed. R. Civ . P . 12(b)(6) ...... 1, 8, 19

18 Fed. R. Civ . P . 9(b) ...... 1,4,8

19 Private Securities Litigation Reform Act of 1995 ...... 1

20 Securities Act of 193. 3 ...... 1

21 Securities Exchange Act of 1934 ...... passim 22 OTHER AUTHORITIE S 23 Paul C. Curnin & Christine M . Ford, The Critical Issue of Standing under Section 11 of the Securities 24 Act of 1933, VI Fordharn J. Corp. & Fin. L. 155, 157 (2001 ) ...... 25 25

26 27 28

Gibson , Dunn & II Crutcher LLP vii UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-0 1 -266 1 -MMC 0

1 NOTICE OF MOTION AND MOTION

2 TO PLAINTIFFS AND THEIR ATTORNEYS OF RECORD :

3 NOTICE IS HEREBY GIVEN that, on January 10, 2003, at 9 :00 a.m., or as soon thereafter

4 as the matter may be heard, in the courtroom of the Honorable Maxine Chesney of the above-entitled

5 Court, located at 450 Golden Gate Avenue, San Francisco, California, defendants Goldman, Sachs &

6 Co ., Merrill Lynch & Co ., Morgan Stanley Dean Witter, and J .P. Morgan (collectively, th e

7 "Underwriters") shall and hereby do move the Court for an order dismissing without leave to amend

8 plaintiffs' First Amended Consolidated Complaint For Violation Of The Federal Securities Law s

9 ("FAC").

10 This motion to dismiss is brought pursuant to the Private Securities Litigation Reform Act of

11 1995, and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure on the grounds that

12 plaintiffs failed to plead fraud with particularity and failed to state a claim upon which relief may be

13 granted. The Underwriters also move to dismiss the FAC on the grounds that the causes of action set

14 forth in the FAC were not first asserted within the applicable statute of limitations period and, in

1.5 addition, none of the plaintiffs has standing to assert a claim under Section 11 of the Securities Act of

16 1933. This motion will be based on this Notice of Motion and Motion, the attached Memorandum of

17 Points and Authorities, the accompanying Request to take Judicial Notice, and Declaration of

18 Jonathan C. Dickey, all of the records and files in this action, and such additional matters of which

19 the Court may take judicial notice or come before the Court at the hearing on this matter .

20 ISSUES TO BE DECIDED

21 1 . Did the plaintiffs bring their claims against the Underwriters more than one year after

22 having been put on inquiry notice as to the existence of potential claims?

23 2. Have the plaintiffs sufficiently alleged a claim under Section 10(b) of the Securitie s

24 Exchange Act of 1934 and SEC Rule l Ob-5 against the Underwriters ?

25 3. Do any of the lead plaintiffs have standing to assert a claim under Section 11 of th e

26 Securities Act of 1933?

27 4. Have the plaintiffs sufficiently alleged a claim under Section 11 of the Securities Act

28 of 1933?

Gibson, Dunn & Crutcher LLP 1 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0

MEMORANDUM OF POINTS AND AUTHORITIE S

2 I. INTRODUCTION 3 In their motion to dismiss, the former officers and directors (the "D&O Defendants") o f 4 Exodus Communications, Inc . ("Exodus" or the "Company") explain why the First Amended 5 Complaint ("FAC") should be dismissed in its entirety against all defendants . The Underwriters join 6 the D&O Defendants' motion, and submit this separate memorandum setting forth a number of

7 independent reasons why the FAC should be dismissed as to the Underwriters .

8 This is plaintiffs' fourth complaint in this action. The first was filed on July 12, 200 1

9 following the issuance of a press release by Exodus Communications, Inc . ("Exodus") on June 20,

10 2001 in which Exodus announced that its second quarter 2001 financial results would miss investors'

11 expectations due to a number of factors and problems with Exodus' business that, according to

12 plaintiffs, existed as far back as April 2000 . Plaintiffs filed a consolidated complaint in December

13 2001, followed by a "corrected" complaint in April 2002 - and this Court dismissed that complaint

14 on the grounds that it failed to state a claim against Exodus' former officers and directors (the "D&O

15 Defendants") . Over one year after plaintiffs first discovered the "fraud" of which they now complain,

16 and after their fraud claims against the D&O Defendants already had been dismissed once, plaintiffs

17 assert for the first time new claims against new defendants - the Underwriters .

18 Plaintiffs' new claims against the Underwriters are predicated upon two public offerings, both

19 of which occurred on February 6, 2001 - a secondary offering of Exodus common stock and an

20 offering of 5.25% convertible subordinated notes.1 The offering documents are replete with

21 warnings, including that the offerings "involve[] a high degree of risk," that Exodus had a "short

22 operating history" marked by "significant fluctuations," which made evaluation of its business

23 operations and prospectus "difficult," that the Company was plagued with "continuing losses," that

24 management believed that Exodus would "continue to experience net losses on a quarterly and annual

25 basis for the foreseeable future," and that Exodus was pursuing a business strategy of "rapi d 26 Because the February 6, 2001 Prospectus ("Prospectus") relating to the secondary stock offering 27 is substantially identical to the February 6, 2001 offering materials relating to the 5 .25% convertible subordinated notes, the Underwriters refer in this memorandum to both documents, 28 but cite only to the Prospectus .

Gibson, Dunn & Crutcher LLP 2 UNDERWRITER DEFENDANTS' MOTION TO DISMISS , CASE No. C-0 1 -2661 -MMC 0

1 expansion" that was expected to "produce[ ] a significant strain on our businesses ." Nonetheless,

2 plaintiffs pronounce themselves "shocked" that, faced with a worsening high technology economic

3 climate in 2001, Exodus ultimately was forced into bankruptcy . Having failed to plead fraud claims

4 adequately against the D&O Defendants, and despite having taken well over one year to "investigate"

5 their purported claims against the Underwriters, the FAC sets forth only haphazard fraud allegations

6 against the Underwriters. These "new" claims are little more than an afterthought of plaintiffs i n

7 search of deep pockets, and are subject to dismissal for the following reasons:

8 First, as is evident on the face of the FAC, plaintiffs were on notice of their purported claims

9 against the Underwriters over one year prior to filing their claims against the Underwriters and after

10 the one-year statute of limitations had run. Plaintiffs allege that the Underwriters are liable for ,

11 among other things, certain allegedly false or misleading statements appearing in the Prospectus

12 published by Exodus on February 6, 2001 . More specifically, plaintiffs allege that the February 6,

13 2001 Prospectus was part of a broader scheme to defraud Exodus' investors beginning on April 20,

14 2000 and that defendants' "egregious accounting fraud" began to unravel when, on June 20, 2001,

15 Exodus "disclosed that it would suffer disastrous second quarter 2001 results and that it wa s

16 drastically reducing its guidance for the remainder of fiscal 2001 ." FAC ¶J 1, 79. Plaintiffs further

17 allege that the June 20, 2001 announcement precipitated an "almost 50%" drop in the market price of

18 Exodus common stock . FAC ¶ 80. Despite this clear and obvious "storm warning" - which was

19 sufficient for them to bring their original lawsuit - plaintiffs ignored their purported claims against

20 the Underwriters for over one year, electing to pursue these defendants only after first suing the D&O

21 Defendants - and losing the D&O Defendants' motion to dismiss . Thus, plaintiffs' claims against

22 the Underwriters, asserted for the first time in the July 11, 2002 FAC, are time-barred .

23 Second, plaintiffs' allegations against the Underwriters are insufficient as a matter of law .

24 Plaintiffs' 101-page, 219-paragraph FAC repeatedly accuses all defendants of engaging in a

25 "scheme" to defraud Exodus' investors, but does not describe in any respect the Underwriters '

26 supposed role in that "scheme" at any point during the 17-month-long purported class period, other

27 than reciting that they acted as underwriters in the February 6, 2001 offerings . Although plaintiffs do

28 conclusorily allege that four statements from the February 6, 2001 Prospectus were false or

Gibson, Dunn & Crutcher LLP 3 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No. C-0 1 -266 1 -MMC 0

1 misleading, plaintiffs nowhere attempt to plead basic facts that would demonstrate why any of th e

2 allegedly false or misleading statements in the February 6, 2001 Prospectus was false when made, let

3 alone materially so . Thus, for example, plaintiffs describe alleged violations of generally accepte d 4 accounting principles ("GAAP") - and describe certain transactions they allege to have been the

5 subject of accounting improprieties - but do not describe how those alleged transactions (most of

6 which are alleged to have occurred after the February 6, 2001 offerings) rendered the statement s

7 made in the Prospectus false or misleading .

8 Third, plaintiffs nominally include the Underwriters as defendants in their fraud claims under

9 Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and SEC Rule lOb-5, and

10 devote 64 of 219 paragraphs to allegations as to how the "defendants" - presumably including the

11 Underwriters - supposedly knew Exodus' public statements were false or misleading when made .

12 None of those 64 paragraphs mentions any of the Underwriters, let alone identifies any basis for the

13 Court to conclude that any of the Underwriters acted with at least "deliberate recklessness," as is

14 required to state a securities fraud claim in the Ninth Circuit.

1.5 Fourth, none of the individuals certified by the Court as "lead plaintiffs" in this case is alleged 16 to have purchased any of the securities in the February 6, 2001 offerings . Thus, none has standing to

17 assert a claim under Section 11 of the Securities Act of 1933 ("Securities Act") . Recognizing this,

18 plaintiffs attempt to circumvent the clear requirements of the PSLRA and usurp the statutory

19 authority of this Court by, in effect, quietly appointing two, new members of the lead plaintiff group,

20 ignoring the PSLRA "lead plaintiff' provisions . Even so, neither of the new plaintiffs introduced in

21 the FAC is alleged to have purchased in the February 6, 2001 public offerings and plaintiffs do not

22 allege facts sufficient for the Court to conclude that new plaintiff Thomas Welsh purchased shares

23 traceable to an Exodus registration statement.

24 Finally, even if the Court were to conclude that the new "self-appointed" plaintiffs hav e

25 standing to assert a Section 11 claim against the Underwriters, the allegations in the FAC fail to state

26 a claim because plaintiffs do not plead facts that, if true, would meet even the most basic pleading

27 requirements for fraud claims under Fed. R. Civ. P. 9(b) or the PSLRA. For all of these reasons,

28 plaintiffs' claims against the Underwriters must be dismissed .

Gibson, Dunn & Crutcher LLP 't UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 I

1 II. BACKGROUND AND PROCEDURAL HISTORY 2 Beginning in 1995 and throughout the purported class period, Exodus owned and operated 3 internet data centers ("IDCs"), providing its customers with facilities, servers and broadband 4 connectivity services needed to run their internet operations. FAC ¶ 25 .2 Exodus went public in 5 March 1998 . Id., ¶ 26. Although Exodus traded as high as $141 .625 per share in early April 2000, 6 its stock was trading at $20 per share at the end of 2000 . See Underwriters' Request to take Judicial 7 Notice ("RJN"), Ex . A at 1-6. On January 10, 2001, Exodus acquired GlobalCenter - another 8 provider of web hosting services. FAC ¶ 53 . 9 On February 6, 2001, Exodus issued 13 million shares of common stock in a secondary public 10 offering, raising approximately $229 million . Id., ¶ 58. On that same date, Exodus also raised 11 $500 million in an offering of 5 .25% convertible subordinated notes . Id., ¶ 59. Goldman, Sachs & 12 Co., Merrill Lynch & Co ., Morgan Stanley Dean Witter, and J .P. Morgan served as the lead 13 underwriters for both transactions . Id., ¶¶ 21-24. At the time of the February 6, 2001 offerings, 14 Exodus reported operating losses of $24.7 million in 1997, $57 .5 million in 1998, $97 .2 million in 1.5 1999, and $91 .5 million for the first nine months of 2000 . See RJN, Ex. B at 7. In addition, Exodus 16 reported negative cash flows (before financing activities) of $39.3 million in 1997, $140 million in 17 1998, $437.3 million in 1999, and over $1 billion for the first nine months of 2000 . Id. at 8. 18 Although plaintiffs contend that Exodus' February 6, 2001 Prospectus was misleadingly 19 positive about its business and financial condition, the Prospectus contained 12 pages of detailed risk 20 factors associated with an investment in Exodus securities, including, in the first sentence, a warning 21 that "[T]his offering involves a high degree of risk " Id. at 10. The Prospectus also warned that 22 Exodus ' "short operating history, evolving business, and continuing losses make an investment in 23 [Exodus'] securities difficult to evaluate." Id. at 11 . Exodus further warned investors that: 24

25 2 The facts set forth herein are derived from the FAC, documents relied upon but not attached to the FAC, and judicially noticeable sources - all of which may be considered by this Court in 26 addressing the Underwriters' motion to dismiss . See, e.g., Parrino v. FHP, Inc., 146 F.3d 699, 705-06 (9th Cir . 1998). Although facts derived from the FAC are assumed to be true under Rule 27 12(b)(6) solely for purposes of this motion to dismiss, even Rule 12(b)(6) does not require this Court to assume the truth of unwarranted or illogical inferences, or of only those inferences 28 favorable to the plaintiffs . Gompper v. VISX, Inc., 298 F .3d 893, 896-97 (9th Cir. 2002).

Gibson, Dunn & Crutcher LLP 5 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No. C-0 1 -266 1 -MMC 0 0

1 limited operating history and the pace of the change in our business makes evaluating business operations and our prospects difficult. We have incurred operating losses 2 each fiscal quarter and year since 1995 . Our accumulated deficit was approximately $484.5 million at December 31, 2000 . We anticipate making continuing investments 3 in new Internet Data Centers and network infrastructure, product development, sales and marketing programs and personnel . We believe that we will continue to 4 experience net losses on a quarterly and annual basis for the foreseeable future. . . . Although we have experienced significant growth in revenue in recent periods, this 5 growth rate is not necessarily indicative of future or other operating results. It is possible that we may never achieve profitability on a quarterly or an annual basis . 6 Id. (emphasis added). The risk disclosures continued : "operating results have fluctuated widely and 7 we expect this to continue," due to, among other things, fluctuations in "demand for and market

8 acceptance of our services," "customer retention and satisfaction," "capacity utilization of our 9 Internet Data Centers," and "the provision of customer discounts and credits ." Id. 10 Moreover, Exodus specifically warned investors that "rapid expansion produces significant 11 strain on our business and requires [it] to expend substantial resources" (id. at 13), and that "[s]ome 12 of our customers are emerging Internet-based businesses that may not pay us for services on a timely 13 basis and may not succeed over the long term . Approximately 43% of our monthly recurring revenue 14 during the fourth quarter 2000 was derived from customers that are emerging Internet-based 1.5 businesses . . . . The unproven business models of some of these customers and an uncertain 16 economic climate make their continued financial viability uncertain." Id. at 15 . Exodus further 17 warned that its dependence on risky internet businesses rendered it particularly "vulnerab[le] to 18 general adverse economic and industry conditions" (id. at 14), in part because its "substantial 19 leverage and debt service obligations adversely affect our cash flow" and, consequently, "[t]here is 20 the possibility that we may be unable to generate cash sufficient to pay the principal of, interest on 21 and other amounts due in respect of certain of our debt securities when due ." Id. at 54. 22 In 2001, as economic conditions worsened - particularly in the high tech industries that 23 Exodus said accounted for 43% of its monthly recurring revenue - Exodus encountered increasing 24 financial difficulties. On June 20, 2001, Exodus pre-announced its second quarter financial results, 25 which plaintiffs describe as "disastrous ." FAC ¶ 79. Plaintiffs acknowledge that, "within days" 26 following this announcement, "analysts" - including analysts employed by the Underwriters - 27 "quickly downgraded the stock ." Id., ¶ 81 . Indeed, plaintiffs specifically allege that "Jeff Camp, an 28 analyst with [defendant] Morgan Stanley Dean Wi tter, took the rare step of apologizing for not

Gibson, Dunn & CrutcherLLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-O1-2661-MMC 0 0

1 downgrading the stock earlier." Id. Plaintiffs then quote extensively from an interview Mr. Camp

2 gave on CNN's Moneyline program, in which Mr. Camp stated , "The retail buyers , I would say, the

3 individual investors, you know, the people we see every day are angry. And there is no question

4 about it. They have a right to be angry and that' s where the apology came from." Id. (emphases and 5 boldface removed).3 Plaintiffs further allege that several news articles extensively discussed the 6 problems Exodus was having, including a June 21 , 2001 article from AP Online, in which the author 7 quoted a Wall Street investment banker, Frederick Moran, as stating that "Thursday's backlash 8 reflects a spreading sentiment that Exodus has been misleading Wall Street about its business

9 outlook" and "`You can only pull the wool over the eyes of Wall Streeters so many times before they

10 throw in the towel on you,' Moran said. `Investors have given up on Exodus . It's obviously not

11 funded to last beyond this year."' Id., ¶ 83 . As a result, plaintiffs allege that analysts "quickly"

12 downgraded Exodus' stock (id., ¶ 81), rating agencies downgraded its bond ratings (id., ¶ 82), and 13 Wall Street placed Exodus on a "death watch ." Id., ¶ 83 . 14 On July 12, 2001, the first of many securities class action lawsuits was filed against Exodu s

15 and the D&O Defendants. Among other things, plaintiffs alleged in their original complaint, after an 16 "investigation conducted by counsel" (see RJN, Ex. D at 2), that Exodus and the D&O Defendants 17 "knew" that Exodus' business and financial condition were deteriorating at least as far back as the 18 "second half of year 2000" and that Exodus would not be able "to recover in 2001 ." Id., ¶ 25 . 19 Plaintiffs further alleged that Exodus and the D&O Defendants "knew" by March 2001 that Exodus' 20 "revenue would not continue to be strong and financial results would be adversely affected" as 21 defection by customers reached record levels, customer cancellations increased, customer failures 22 increased, and orders decreased, and, as a consequence, that Exodus' share price would be

23 "devastate[d] ." Id., ¶J 25, 27, 32 . In a follow-on complaint filed on July 18, 2001, plaintiffs also

24 alleged that Exodus' positive statements concerning its January 10, 2001 acquisition of GlobalCenter 25 were false and misleading because, among other things, "spending by dot com and old economy

26 27

28 11 3 A full transcript of the Moneyline interview is attached as Exhibit C to the RJN.

Gibson , Dunn & (~ 7 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0

1 customers alike was rapidly decreasing," "capacity was 50% above demand," and "prices had

2 declined sharply." RJN, Ex. E, ¶¶ 28, 32.

3 On September 26, 2001, Exodus entered into bankruptcy proceedings . FAC ¶ 97 . Thereafter,

4 on October 29, 2001, the Court consolidated all the related class actions, and appointed Michae l

5 Klein, Tresi Trucking, Inc . and William Freedman to serve as lead plaintiffs - none of whom is

6 alleged to have purchased Exodus securities traceable to a registration statement . See FAC ¶ 9.

7 Plaintiffs filed their Consolidated Class Action Complaint for Violation of the Federal Securities

8 Laws ("Consolidated Complaint") on December 13, 2001 . In that complaint, plaintiffs repeated their

9 prior allegations and also alleged that Exodus' positive statements concerning its January 10, 2001

10 acquisition of G1obalCenter were false and misleading because, among other things, many o f

11 GlobalCenter's IDC's were "practically empty" and because GlobalCenter, like Exodus, had

12 historically incurred significant losses . RJN, Ex . F, ¶¶ 26, 27. Defendants moved to dismiss

13 plaintiffs' Consolidated Complaint on February 14, 2002 . Plaintiffs filed a "Corrected" Consolidated

14 Class Action for Violation of the Federal Securities Laws ("Corrected Complaint") on April 17 ,

15 2002. Despite plaintiffs' broad allegations in that complaint concerning false and misleading

16 statements by Exodus going back to the period before the February 6, 2001 offerings, plaintiffs

17 asserted no claim against the Underwriters, and did not include a Section 11 claim against anyone for

18 alleged false or misleading statements in the Prospectus against anyone. Id. On May 28, 2002, the

19 Court granted defendants' motion and dismissed plaintiffs' claims in their entirety .

20 Finally, on July 11, 2002 - over a year after first instituting this action - plaintiffs filed the

21 FAC, adding Section 11 claims for the first time and for the first time asserting claims against the

22 Underwriters based on precisely the same substantive factual allegations as were asserted in prior

23 pleadings . The Underwriters now move to dismiss the FAC pursuant to the PSLRA and Fed . R. Civ.

24 P . 9(b) and 12(b)(6).

25 III. ARGUMENT

26 A. The Standard For This Motion. 27 "Rule 12(b)(6) authorizes a court to dismiss a claim on the basis of a dispositive issue of

28 law. . . . This procedure, operating on the assumption that the factual allegations in a complaint are

Gibson . Dunn & Crutcher LLP 8 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0

1 true, streamlines litigation by dispensing with needless discovery and factfinding ." Neitzke v.

2 Williams, 490 U.S. 319, 326-27 (1989) (citation omitted) . For purposes of this motion, the Court

3 must accept as true only properly pleaded allegations of material facts . See Jenkins v. McKeithen,

4 395 U.S. 411, 421 (1969) . Mere "conclusory allegations of law and unwarranted inferences ar e 5 insufficient to defeat a motion to dismiss for failure to state a claim." In re Stac Elecs. Sec. Litig., 89

6 F.3d 1399, 1403 (9th Cir. 1996) (citation omitted). Moreover, in evaluating the sufficiency o f

7 inferences derived from pleaded facts, the Court is required to consider all reasonable inferences -

8 not just those advocated by plaintiffs . VISX, 298 F.3d at 896-97 . The Court is also entitled t o

9 consider "documents whose contents are alleged in [the] complaint and whose authenticity no party

10 questions," such as public disclosure documents at issue in this case. Branch v. Tunnell, 14 F.3d 449,

11 454 (9th Cir. 1994).

12 B. The FAC Should Be Dismissed Against The Underwriters For The Reasons Set Forth In The D&O Defendants' Memorandum Of Points And Authorities . 13 The D&O Defendants set forth persuasive reasons for dismissing the FAC in its entirety. As 14 each of those arguments applies with even greater force to the Underwriters, the Underwriters join in 1.5 the D&O Defendants' arguments. 1 6 C. Plaintiffs' Claims Are Barred By The Statute of Limitations . 17 Section 13 of the Securities Act (15 U .S .C . § 77m) provides that "[n]o action shall be 18 maintained to enforce any liability created under section 11 . . . unless brought within one year after 19 the discovery of the untrue statement or omission, or after such discovery should have been made by 20 the exercise of reasonable diligence ." In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 21 501 U.S. 350, 364 & n .9 (1991), the Supreme Court held that claims brought pursuant to Section 22 10(b) and SEC Rule I Ob-5 also "must be commenced within one year after the discovery of the facts 23 constituting the violation." The statute of limitations "is triggered `when the plaintiff has actual 24 knowledge of the fraud or knowledge of facts sufficient to put a reasonable person on notice ."' In re 25 26 27 28

Gibson , Dunn & n Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-O1-2661-MMC 0

Syntex Corp. Sec. Litig., 855 F. Supp. 1086, 1099 (N.D. Cal. 1994) (emphasis added), aff'd, 95 F.3 d

2 922 (9th Cir. 1996).4 3 Inquiry notice exists when "a reasonable investor, in the exercise of reasonable diligence,

4 `should have discovered the facts underlying the alleged fraud ."' In re Splash Tech. Holdings, Inc.

5 Sec. Litig., 2000 WL 1727405, *17 (N .D . Cal. Sept. 29, 2000) (quoting Valence, 175 F.3d at 704);

6 see also SEC v. Seabord Corp., 677 F.2d 1301, 1309 (9th Cir. 1982) (holding that statute of 7 limitations for securities fraud "commences when the plaintiff discovered or could have discovered 8 the fraud with the exercise of reasonable diligence") (internal citation omitted) . These facts, 9 frequently referred to as "storm warnings," "alert a reasonable investor of the probability of fraud ."

10 Splash Tech., 2000 WL 1727405, at * 17; see also Great Rivers Coop . v. Farmland Indus., Inc., 120

11 F.3d 893, 896 (8th Cir. 1997) (discussing storm warnings) ; Gray v. First Winthrop Corp., 82 F.3d

12 877, 881 (9th Cir . 1996) ("[I]f a prudent person would have become suspicious from the knowledge 13 obtained through the initial prudent inquiry and would have investigated further, a plaintiff will be 14 deemed to have knowledge of facts which would have been disclosed in a more extensive

15 investigation.") (quoting Briskin v. Ernst & Ernst, 589 F.2d 1363, 1367 (9th Cir. 1978)). It is well 16 established, moreover, that the standard for inquiry notice is an objective one . See, e.g., Valence, 175

17 F.3d at 704; Kramas v. Sec. Gas & Oil, Inc., 672 F .2d 766, 770 (9th Cir. 1982); Splash Tech., 2000

18 WL 1727405, at * 17. Accordingly, courts frequently have held claims to be barred by the statute of 19 limitations at the motion to dismiss stage .5 20 21 The Ninth Circuit has not ruled on whether inquiry notice is sufficient to commence running of 22 the statute of limitations for claims brought under Section 10(b) and Rule I Ob-5 . See Berry v. Valence Tech., Inc., 175 F.3d 699, 703-04 (9th Cir. 1999). However, as discussed in Valence, 23 "every circuit to have addressed the issue since Lampfhas held that inquiry notice is th e appropriate standard ." Id. at 704 (citing, e.g., Sterlin v. Biomune Sys., Inc. 154 F.3d 1191, 1201 24 (10th Cir. 1998)) . See, e.g., In re Syntex Corp . Sec. Litig., 855 F. Supp . at 1099 (granting motion to dismiss and 25 holding that plaintiffs' possession of SEC Form 4 reports disclosing information sufficient to put them on inquiry notice) ; Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir . 1993) (affirming 26 motion to dismiss, and holding that the question of inquiry notice may be resolved against a plaintiff as a matter of law) ; De la Fuente v. DCI Telecomms., Inc., 206 F.R.D. 369, 381 27 (S.D.N.Y. 2002) (granting defendants' motion to dismiss when "all of the disclosures . . . are contained in public records that were filed on easily verifiable dates more than one year prior to 28 the commencement of this action").

Gibson, Dunn & 10 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0

For the statute of limitations to be triggered, plaintiffs need not have all the facts necessary t o

2 establish that a statement was untrue . See, e.g., Brumbaugh v. Princeton Partners, 985 F.2d 157, 162

3 (4th Cir. 1993) (holding that "inquiry notice is triggered by evidence of the possibility of fraud, not

4 by complete exposure of the alleged scam") (citation omitted) ; In re USEC Sec . Litig., 190

5 F. Supp. 2d 808, 817 (D. Md. 2002) (holding that "notice is triggered by evidence of the `possibility'

6 of untrue statements or omissions, and not by complete exposure of the wrongful conduct") (citation

7 omitted). Indeed, courts have held that when "storm clouds" have gathered, self-serving statements

8 by the issuer reassuring investors are insufficient to relieve investors of their obligation to conduct a

9 reasonable inquiry as to the possible existence of claims.6

10 Notably, this case does not depend on inquiry notice or storm warnings . Here, plaintiffs

11 brought the original action on July 12, 2001 based on allegations that on June 20, 2001, Exodus

12 "shocked the market" by revealing, "contrary to [Exodus'] prior statements . . . . that revenue would

13 be significantly below expectations (and actually decline sequentially) ." See RJN Ex. D at 3.

14 According to plaintiffs, these disclosures more than a year before the Underwriters were added as

15 defendants caused Exodus' stock to "decline almost 50%" in one day. FAC ¶ 80 . Plaintiffs further

16 allege that Exodus' June 20, 2001 "admissions" were followed by a number of analyst reports

17 indicating that analysts, too, believed they had been deceived by Exodus. See supra at 6-7; RJN

18 Ex. D at 4. For the convenience of the Court, a timeline reflecting these events is provided as a n

19 appendix.

20 Exodus' June 20, 2001 press release, which plaintiffs themselves contend exposed "true "

21 information previously concealed by Exodus, together with the related analyst reports and news

22 articles, by their own admission put plaintiffs on actual notice of their alleged claims, at latest, o n

23 June 21, 2001 (the date of the analyst reports and news articles) . See In re Commtouch Software Ltd.

24 See, e.g., Sterlin, 154 F.3d at 1204 (holding that "dear shareholder" letters from a company's 25 chairman and CEO refuting the claims in an unfavorable magazine article did not relieve plaintiff of his duty to investigate); see also Great Rivers Coop ., 120 F.3d at 898 (holding that defendant's 26 "self-serving statements about the invalidity of [a class action] suit do not . . . negate the other pertinent information presented in" an unfavorable magazine article) ; CSI Inv. Partners II, L.P. v. 27 Cendant Corp., 180 F. Supp. 2d 444, 457 n.14 (S.D.N.Y. 2001) (holding that "once a plaintiff is on inquiry notice, misleading statements or reassurances by the defendant do not relieve him of 28 his duty to undertake reasonable inquiry") (citation omitted) .

Gibson, Dunn & Crutcher LLP 1 1 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 0

Sec. Litig., 2002 U.S. Dist. LEXIS 13742, at * 16 ("Because these announcements were by all

2 accounts issued to the public . . . knowledge of their contents (though not necessarily their alleged 3 fraudulence) can be imputed to plaintiff as of their release date") (emphasis added) (citation

4 omitted). A fortiori, plaintiffs were on inquiry notice by June 21, 2001 as well .? Because plaintiffs 5 did not assert claims against the Underwriters until July 11, 2002, they filed over one year after they 6 had actual notice, or at least had been put on inquiry notice, and their claims are time-barred. 8

7 Other courts have dismissed securities claims based on remarkably similar facts . In Caprin v. 8 Simon Transportation Services, 112 F. Supp. 2d 1251, 1253-54 (D . Utah 2000), for example, the 9 issuer, a trucking company, completed a secondary public offering and, as here, warned in its offering

10 materials of numerous risks associated with its business . Over one year later, the issuer announced a 11 large quarterly loss based on a revenue shortfall and increased compensation and accident expenses,

12 causing its stock price to fall by approximately 40% . Id. at 1254. Although a lawsuit was filed 13 almost immediately, an amended class action complaint alleging violations of Section 11 was not 14 filed until more than a year after the quarterly losses were revealed. The court dismissed the Section 15 11 claims, holding that plaintiffs were on inquiry notice at the time of the quarterly loss and that a 16 reasonable investigation would have uncovered the relevant facts concerning the alleged Section 11

17 violations. Id. Plaintiffs' claims in this case are no different - the June 20, 2001 press release 18 concerning Exodus' second quarter shortfall put plaintiffs on notice that the February 6, 2001 19 Prospectus was potentially actionable . Thus, plaintiffs in this case cannot credibly claim that the y 20 21 Plaintiffs' claim that the market value of Exodus' stock fell 50% in one day is evidence that the market was alerted to the significance of this disclosure to Exodus' business . Given this, 22 plaintiffs "should have brought their action once they discovered or should have discovered the facts constituting their claim ." Volk v. D.A. Davidson & Co., 816 F.2d 1406, 1413 (9th Cir. 1987) 23 (quoting Stull v. Bayard, 561 F.2d 429, 433 n.4 (2d Cir. 1977). Plaintiffs attempt to plead around the statute of limitations in paragraph 84 of the FAC, in which 24 they allege that "[e]ven though Exodus' announcement on June 20, 2001 revealed some of the negative conditions that had been impacting the Company, it did not reveal the entire fraud ." 25 FAC ¶ 84. Whether the press release "reveal[ed] the entire fraud" is irrelevant . A storm warning need only "raise sufficient suspicion of fraud to cause a reasonable investor to investigate the 26 matter further." Valence, 175 F.3d at 704. Here, it is the June 20, 2001 press release, combined with the various articles, analyst reports, and television interviews quoted in the FAC, that 27 constituted the "storm warnings" that put plaintiffs on notice of their claims and that enabled plaintiffs to assert the fraud claims set forth in their original complaint based on the same 28 allegations.

Gibson, Dunn 8 Crutcher LLP 12 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC I lacked notice of their claims or that the storm warnings were too remote . Based on the substantively

2 identical allegations underlying their claims against the Underwriters, plaintiffs brought their original

3 complaint more than a year before adding the Underwriters as an afterthought . It is too late for them

4 to drag the Underwriters into this action .

5 D. Plaintiffs' Section 10 (b) And Rule 10b-5 Claims Against The Underwriters Should Be Dismissed. 6 1. No Underwriter Is Alleged To Have Made Any False Or Misleading 7 Statement. 8 Under the PSLRA, plaintiffs alleging violations of Section 10(b) must "specify each statement

9 alleged to be misleading, the reason or reasons why the statement is misleading, and, if an allegation

10 regarding the statement or admission is made on information and belief, the complaint [must] stat e

11 with particularity all facts on which that belief is formed ." 15 U.S.C. § 78u-4(b)(1) . The FAC must

12 be dismissed for the simple and fundamental reason that plaintiffs fail to identify any false o r

13 misleading statement made by any of the Underwriters, much less plead facts sufficient to meet the

14 other requirements of the PSLRA pleading standard. Indeed, plaintiffs' 101-page, 219-paragraph

15 complaint identifies no statement - false, misleading or otherwise - made by any of th e

16 Underwriters at any time during the purported class period . Plaintiffs, for example, do not allege that

17 any Underwriters is responsible for statements appearing in any of Exodus' quarterly or annual

18 reports, Form 8-K filings, proxy statements, or press releases . See, e.g., Gaylinn v . 3Com Corp., 185

19 F. Supp. 2d 1054, 1064 (N.D . Cal. 2000) (dismissing securities fraud claims against non-speaking

20 defendants).

21 Instead, the only possible statements that can be legally attributed to the Underwriters are

22 statements appearing in the February 6, 2001 Prospectus, which is barely discussed in the FAC .

23 Where the February 6, 2001 Prospectus is discussed (see FAC ¶¶ 58-60), plaintiffs identify only four

24 allegedly false or misleading statements that are buried among the 12 full pages of detailed risk

25 factors associated with an investment in Exodus securities - including, for example, the conspicuous

26 disclosure that the offerings "involve[] a high degree of risk ." Plaintiffs, however, have not pled facts

27 sufficient to demonstrate that any of those four statements was actually false when made .

28

Gibson , Dunn & Crutcher LLP 1 3 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 9

1 Statement Concerning GlobalCenter . Plaintiffs contend that the statement that

2 management's "belie[f] that the acquisition [of Global Center] enhances our global Internet Dat a

3 Center infrastructure, strengthens our network, our customer support, sales and professional services

4 organizations, and expands our customer base" is false . FAC ¶ 58. Plaintiffs, however, identify

5 nothing false about this statement . Plaintiffs do not allege that management did not hold that belief,

6 that the acquisition of GlobalCenter's facilities did not strengthen the Company's infrastructure and

7 network; that GlobalCenter's customer support, sales and professional services organization ; or that

8 the acquisition of GlobalCenter's customer base did not actually expand Exodus' customer base . To

9 the contrary, plaintiffs contend only that (1) Exodus' due diligence team allegedly favored th e

10 acquisition of another company over GlobalCenter (FAC ¶ 146) ; (2) the Board of Directors opposed

11 the acquisition (a fact belied by the Board's approval of that acquisition) (id.); (3) certain of

12 GlobalCenter's data centers "experienced a substantial shortage of demand" (id.) ; and (4) Exodus

13 acknowledged in November 2001 that the GlobalCenter acquisition contributed to a decline in

14 Exodus' "IDC utilization rates." Id., ¶ 147. Even if any or all of the problems with the GlobalCenter

15 acquisition must be considered true for purposes of this motion to dismiss, nothing about the m 16 renders management's statements of belief in the Prospectus untrue or misleading. See, e.g., In re

17 Convergent Techs. Sec. Litig., 948 F.2d 507, 512 (9th Cir. 1991) ("Liability depend[s] on the

18 plaintiffs' success in demonstrating that one of the statements made by the company was actually

19 false or misleading") .

20 Moreover, even if a statement of management's belief could form the basis of a Section 10(b)

21 claim against the Underwriters, this Court need not accept as true any of the reasons plaintiffs cite as

22 the basis for the GlobalCenter statement's alleged falsity, because plaintiffs rely exclusively on an

23 unidentified former Exodus marketing employee ("Confidential Witness 8") who has no connection

24 to or personal knowledge of any of the matters alleged . See FAC ¶¶ 145-147 ; Novak v. Kasaks, 216

25 F.3d 300, 313-14 (2d Cir . 2000) (holding that when plaintiffs attempt to rely on confidentia l

26 witnesses, the allegations must demonstrate with particularity that the witness would have a

27 foundation for the facts and statements attributed to him) ; accord ABC Arbitrage Plaintiffs Group v.

28 Tchuruk, 291 F.3d 336, 352 (5th Cir. 2002) (same); In re NorthPoint Communications Group, Inc .

Gibson, Dunn & Crutcher LLP 14 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-0 1-266 1 -MMC Sec. Litig., 2002 WL 1775268, *5 (N .D . Cal. May 28, 2002) (when a complaint incorporate s

2 allegations attributed to a confidential witness, these allegations "must be accompanied by enoug h

3 particularized detail to support a reasonable conviction in the informant's basis of knowledge" )

4 Statement Concerning Exodus' 2000 Revenue. Plaintiffs next contend that Exodus '

5 statement that it had achieved "revenues of $280 .4 million for the quarter ended December 31, 2000,

6 and $818 .4 million for fiscal year 2000" was false or misleading in light of the various accounting

7 improprieties alleged throughout the FAC. FAC ¶ 58 . Those financial results, of course, are the

8 same as those reported in Exodus' March 30, 2001 Form 10-K Report, which were audited and

9 certified as materially accurate by KPMG, and which have never been restated, despite plaintiffs'

10 allegations of pervasive and "egregious accounting fraud ." Moreover, for the reasons discussed at

11 length in the D&O Defendants' brief, plaintiffs do not even plead minimal facts that, if true, would

12 demonstrate that any portion of Exodus' revenue was recognized in contravention of GAAP .

13 Equally significant is the fact that nowhere in the FAC do plaintiffs identify any amount by

14 which they contend Exodus' financial statements to have been overstated at any particular point-in-

15 time . In Greebel v. FTP Software, Inc., 194 F.3d 185, 204 (1st Cir. 1999), the First Circuit identified

16 a non-exclusive list of particular allegations that plaintiffs must provide when alleging irregularities

17 in revenue recognition. The first item on that list is "such basic details as the approximate amount by

18 which revenue and earnings were overstated." Id. (emphasis added); see also Kane v. Madge

19 Networks N. V., 2000 WL 33208116, at *6-8 (N.D. Cal . May 26, 2000) (holding that to plead falsity

20 with particularity, plaintiffs were required to plead a time-frame and dollar amount associated with

21 allegedly "inconsistent contemporaneous statements or information") aff'd 32 Fed. Appx. 905 (9th

22 Cir. 2002). This "basic detail" is particularly important with respect to plaintiffs' claims against the

23 Underwriters given that (a) the only statements the Underwriters could be held legally responsible

24 based on the bare allegations against them in the FAC are those from the February 6, 2001

25 Prospectus, and (b) most of the accounting issues plaintiffs identify, even assuming arguendo that

26 they constitute violations of GAAP, are alleged to have occurred after February 6, 2001 .9

27 9 For example, plaintiffs identify nine "barter transactions" that they allege violated GAAP . See 28 FAC ¶¶ 111-112. Even assuming that revenue recognition on barter transactions is a per se [Footnote continued on next page]

Gibson, Dunn & II Crutcher LLP 15 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No. C-0 1-266 1 -MMC 1 Statement Concerning Demand For Exodus' Services . Plaintiffs also allege that the

2 Prospectus falsely stated that "[Exodus has] established a diverse base of customers and continues to

3 focus on supporting the strong demand from the enterprise market." FAC ¶ 58 . Once again, .

4 however, plaintiffs do not plead facts that, if true, would demonstrate this statement to have bee n

5 false when made. Plaintiffs do not suggest that Exodus did not have a "diverse base of customers,"

6 nor that the Company's strategy was not "focus[ed] on supporting . . . the enterprise market."

7 Plaintiffs' only quarrel with this statement appears to be that demand in the enterprise market was not

8 "strong" or was not "strong" in certain locations . See id., ¶¶ 142-144. Indeed, plaintiffs cite a litany

9 of press reports and confidential witness statements, all of which on their face address a time perio d

10 after the February 6, 2001 offerings. Thus, even if plaintiffs' allegations as to overcapacity in terms

11 of storage space in certain locations somehow translate into demand in the "enterprise market" as a 12 whole that was not "strong" in the aggregate after February 6, 2001, those allegations are patently

13 insufficient to allege falsity of Exodus' statements concerning the aggregate level of enterprise

14 market demand as of or prior to February 6, 2001 . Indeed, even if there were some degree o f

15 overcapacity in some of Exodus' IDCs, that simple fact alone is not sufficient to allege falsity . See,

16 e.g., Ronconi v. Larkin, 253 F.3d 423, 430 (9th Cir. 2001) (affirming dismissal of securities fraud

1 7 18 [Footnote continued from previous page ] 19 violation of GAAP (and it is not), the FAC does not plead facts from which this Court could conclude that the financial statements included in Exodus' February 6, 2001 Prospectus were 20 materially inaccurate as a result of revenue recognized on any of those eight transactions . Revenue from one of the eight transactions was alleged to have been debooked before year-end 21 2000 (id., ¶ 111(a)), three are alleged to have occurred sometime in the first quarter of 2001 (and, therefore, were not implicated in the 2000 financial statements published in the Prospectus) (id., 22 ¶¶ 111(b), (c), (f)), and plaintiffs plead no time-period or dollar value with respect to three more (id., ¶¶ 112(a), (b), (c)) . Of the two remaining transactions, one is alleged to have accounted for 23 only $417,000 of Exodus' $280 .4 million fourth quarter 2000 revenue (id., ¶ 111(d)), and the other $1 million over eight quarters (id., ¶ 111(e)) (when Exodus recognized nearly $2 billion in 24 revenue). The FAC is replete with allegations that Exodus violated GAAP, but nowhere do plaintiffs state any amount by which any particular revenue or earnings figures were overstated a t 25 any particular time . Absent pleading of such basic facts, it is impossible to determine whether the financial statements included in the February 6, 2001 Prospectus were inaccurate, let alon e 26 materially inaccurate. See, e.g., In re K-Tel Int'l, Inc . Sec. Litig., 300 F .3d 881, 893 (8th Cir. 2002) (affirming dismissal of claims alleging violations of GAAP - even where plaintiff s 27 identified specific amounts associated with each alleged violation - on grounds that plaintiffs nevertheless "fail[ed] to specify any contracts or circumstances that K-Tel knew at the time of the 28 March 10-Q or the June 10-K would result in specified losses") .

Gibson, Dunn & 1 6 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 1 claims and holding that "[p]roblems and difficulties are the daily work of business people . That they

2 exist does not make a lie out of the alleged false statements .") .

3 Statement Concerning the Number of Exodus Clients. Plaintiffs contend that Exodus '

4 statement in the Prospectus that it has 4,500 customers as of February 6, 2001 (FAC ¶ 58) is false

5 because Exodus included in that number (1) potential customers for which no orders had yet been

6 received, and (2) customers who had cancelled their contracts. Id., ¶ 129(b). Plaintiffs contend that

7 the true number of Exodus customers was only "about 2000 ." Id. However, plaintiffs make no effort

8 to differentiate between the allegedly "true" number of Exodus customers as of the date of the

9 Prospectus and the number of customers at any time thereafter . Given the worsening state of the

10 technology economy throughout 2001 - which plaintiffs concede hit internet services companies

11 such as Exodus particularly hard (see id., ¶ 78) - there is no reason this Court must infer that the

12 number of customers Exodus had as of the date of its bankruptcy on September 26, 2001 was the

13 same as the number of customers it serviced as of February 6, 2001 . See, e.g., Yourish v. California

14 Amplifier, 191 F.3d 983, 997 (9th Cir. 1999) (rejecting "temporal proximity" as a basis, withou t

1 .5 more, to infer fraud). If anything, the inference this Court should draw from plaintiffs' allegations is 16 that Exodus' customer base deteriorated along with the internet economy throughout 2001 .

17 Even if the FAC could be read to allege that Exodus had only 2000 customers as of February

18 6, 2001, the FAC provides no reason for this Court to infer that the combined Exodus-GlobalCenter

19 entity had only 2000 customers. Plaintiffs' "number of customers" allegations are predicated entirely

20 on information obtained from "Confidential Witnesses" 11 and 12 . According to the FAC, "CW 11

21 was a "Credit & Collections Analyst for Exodus" and "CW12" was "Sr . Collections Specialist" at

22 Exodus. FAC ¶¶ 104(k), (1). Neither witness purports to have any basis of knowledge as to th e

23 number of customers Exodus acquired when it acquired GlobalCenter four weeks prior to th e

24 offerings on January 10, 2001 . See NorthPoint, 2002 WL 1775268 at *6 (holding that "where the 25 nexus between a witnesses' duties and his or her allegations is less evident, the absence of specific

26 detail going to a basis of knowledge is more troublesome - and saps the allegations of their

27 strength") . Indeed, even if the Court assumes that Exodus had only 2000 customers at the time of the

28

Gibson, Dunn & 17 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-O1-2661-MMC I

1 GlobalCenter acquisition, the only reasonable inference to be drawn from the facts alleged in the

2 FAC is that the GlobalCenter acquisition added a large number of customers to Exodus' business .

3 2. Plaintiffs Fail To Allege Facts That, If True, Would Demonstrate Tha t The Underwriters Made Any Forward-Looking Statement With Actual 4 Knowledge Of Falsity . 5 Under the PSLRA, to be liable for making a fraudulent "forward-looking statement," a

6 plaintiff must plead and prove facts demonstrating that the defendant made the forward-lookin g

7 statement with "actual knowledge" that the statement was false or misleading at the time it was made .

8 15 U.S.C. § 78u-5(c)(1)(B)(i)-(ii) ; see In re Vantive Corp . Sec. Litig., 283 F.3d 1079, 1085 (9th Cir.

9 2002). One of the four statements from the February 6, 2001 Prospectus - the statement tha t 10 Exodus' management "believ[ed] that the acquisition [of Global Center] enhances our global Internet

11 Data Center infrastructure, strengthens our network, our customer support, sales and professiona l

12 services organizations, and expands our customer base" - is a forward-looking statement that is

13 subject to the PSLRA's safe harbor for disclosure of forward-looking information .

14 Courts have held that a present-tense statement may qualify as a forward-looking statement

15 "as long as the truth or falsity of the statement cannot be discerned until some point in time after the

16 statement is made ." In re Splash Tech. Holdings, Inc. Sec. Litig., 160 F. Supp. 2d 1059, 1067 (N.D.

17 Cal. 2001); see also Harris v. Ivax Corp., 182 F.3d 799, 805 (11th Cir. 1999) (holding a present-tense 18 statement to be a forward-looking statement and stating "a statement about the state of a compan y

19 whose truth or falsity is discernible only after it is made necessarily refers only to futur e

20 performance"); In re Pacific Gateway Exch . Inc. Sec. Litig., 2002 WL 851066, at * 12 (N .D. Cal. Apr. 21 30, 2002) (finding statement of management's "belief' to be forward-looking for purposes of PSLRA

22 safe harbor). A corporate officer's statements about the positive effects of a merger have been 23 consistently treated as forward-looking statements, and the fact that "a pessimistic argument could

24 have been made against the merger . . . does not raise a strong inference that defendants actually

25 knew their forward-looking statements to investors were false or misleading when made . Ronconi,

26 253 F.3d at 430 ; see also Helwig v. Vencor, Inc ., 251 F.3d 540, 656 (6th Cir. 2001) (dismissing claim 27 for securities fraud in connection with defendants' acquisition because the court "doubt[ed] that

28

Gibson, Dunn & Crutcher LLP 1 8 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No. C-0 1 -266 1 -MMC 1 defendants would have completed the merger knowing that the deal would not `be accretive to

2 earnings"'), cert. denied, 122 S . Ct. 2616 (2002).

3 In Ronconi, the Ninth Circuit affirmed the dismissal of secu rities fraud claims under

4 remarkably similar circumst ances. Plaintiffs in that case alleged that defendants misled investors by

5 giving a false impression that the merger was going well when , in fact, the company w as

6 experiencing numerous problems . 253 F.3d at 428. The trial court dismissed plaintiffs' claims

7 pursuant to defendants' Rule 12(b)(6) motion, and the Ninth Circuit affirmed that dismissal ,

8 explaining that plaintiffs alleged no facts "that would support an inference that the company's more

9 optimistic predictions were known to be false or misleading at the time by the people who made

10 them." Id. at 430. The same is true here. Plaintiffs allege no facts from which the Court could infer

11 that management - let alone the Underwriters - actually knew on February 6, 2001 that the

12 predictive statement as to future advantages to be achieved from the just-announced GlobalCenter

13 acquisition would not materialize. See Vantive, 283 F.3d at 1092 (finding pleading to be deficient

14 when "[t]here are no facts alleged to show that the defendants knew their forecasts were false when

1.5 made"); see also Splash Tech., 160 F. Supp. 2d at 1070 (rejecting as deficient plaintiffs' allegations

16 that defendants (1) "were `hands on' managers," (2) "closely monitored the businesses of their key

17 customers," (3) "knew about the adverse information from internal reports and conversations with

18 other unidentified officers and employees," (4) received "forecasts concerning . . . projected

19 demand," and (5) were aware of adverse statements in analyst repo rts) .10

20

21

22 10 The PSLRA also provides that forward-looking statements accompanied by meaningful cautionary language are not actionable . See 15 U.S .C . § 77z-2(c)(1) . The forward-looking 23 statement regarding the effects on Exodus ' business of the GlobalCenter acquisition is protected by the "bespeaks caution" prong of the safe harbor because, as noted above, Exodus' February 6, 24 2001 Prospectus was replete with cautionary language - including language specific as to risks associated with the GlobalCenter acquisition. See In re Stac Elecs. Sec. Litig., 89 F.3d at 1408 25 ("a court can rule as a matter of law that defendants' forward-looking representations contain enough cautionary language or risk discloser to protect the defendant against claims of securities 26 fraud") (citation omi tted); Pacific Gateway Exch., 2002 WL 851066, at *I I (dismissing Section 10(b) claims based on forward-looking statements of management ' s "belief' as to issuer' s future 27 prospects, explaining that "[t]he disclosures in the 10 -K would have alerted a reasonable investor that [the issuer' s] future prospects were uncertain, and that buying shares of [its] stock was 28 therefore speculative , at best") .

Gibson, Dunn & Crutcher LLP 19 UNDERWRITER DEFENDANTS' MOTION TO DISMISS ,. CASE No. C-0 1 -266 1 -MMC 1 3 . Plaintiffs Fail To Allege Facts That, If True, Would Demonstrate That Any Of The Underwriters Acted With At Least "Deliberate Recklessness ." 2 Even if this Court could infer from facts alleged in the FAC that the Underwriters were 3 responsible for making a false or misleading statement, plaintiffs still must plead facts "giving rise to 4 a strong inference that [each] defendant acted with the required state of mind ." 15 U.S.C. § 78u- 5 4(b)(2). As recognized In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 979 (9th Cir. 1999), the 6 PSLRA requires plaintiffs to plead "in great detail" that each defendant participated in making false 7 or misleading statements of present or historical fact with at least a high "degree of recklessness that 8 strongly suggests actual intent ." Moreover, "[w]hen determining whether plaintiffs have shown a 9 strong inference of scienter, the Court must consider all reasonable inferences to be drawn from the 10 allegations, including allegations unfavorable to plaintiffs." VISX, 298 F.3d at 897 (emphases 11 added). Finally, it is well-established that plaintiffs must allege such facts as to each defendant. See, 12 e.g., In re Pacific Gateway Exch ., Inc. Sec. Litig., 169 F. Supp. 2d 1160, 1167 (N.D. Cal. 2001). 13 The allegations set forth in the FAC do not meet the Silicon Graphics standard as to the 14 Underwriters . Far from pleading particularized facts specific to the Underwriters and their state of 15 mind, the FAC does not mention the Underwriters (either collectively or individually) except in those 16 paragraphs under the heading "The Parties" (FAC ¶IJ 21-24) and in the paragraph generically alleging 17 the Underwriters' liability under Section 11 . FAC ¶ 218 . Thus, plaintiffs allege no source of the 18 Underwriters' alleged knowledge of any alleged adverse facts, let alone any facts in existence at the 19 time of the February 6, 2001 offerings . Moreover, plaintiffs' scienter allegations against the . 20 Underwriters do not even make sense, given the allegation elsewhere in the FAC (¶J 81, 83) that an 21 analyst employed by one of the Underwriters actually disclosed the possibility fraud, and publicly 22 criticized Exodus, immediately following Exodus' June 20, 2001 earnings announcement . This 23 complete failure to allege facts supporting an inference of conduct amounting to at least deliberate 24 recklessness requires dismissal of plaintiffs' Section 10(b)/Rule l Ob-5 claims . 25 Given that the Underwriters' only participation in the alleged fraudulent scheme was as 26 underwriters for the February 6, 2001 offerings, the Underwriters can only speculate that plaintiffs 27 believe that the customary fees the Underwriters earned for their services gives rise to some inference 28 of fraudulent intent . If this is plaintiffs' theory, it is inadequate as a matter of law for a variety o f

Gibson, Dunn & 20 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 0

1 reasons. First, allegations that a defendant had a "motive and opportunity" to commit fraud are no t

2 sufficient to plead the "deliberate recklessness" required under the PSLRA and Silicon Graphics. See

3 Silicon Graphics, 183 F.3d at 979. Likewise, generic "they did it for the fees" allegations wer e

4 insufficient under the pre-PSLRA pleading standards and certainly are not sufficient to plead the

5 required "strong inference" of "deliberate recklessness." See, e.g., In re Worlds of Wonder Sec.

6 Litig., 35 F.3d 1407, 1427 n.7 (9th Cir. 1994) (affirming dismissal of fraud claims against auditors

7 alleged to have participated in fraudulent scheme out of desire to earn professional fees) .

8 Similarly, if it is plaintiffs' theory that the Underwriters must have had knowledge of alleged

9 GAAP violations as the result of the performance of their Section 11 "due diligence" duties prior to

10 the February 6, 2001 offerings, that allegation also would fail as a matter of law . Allegations of

11 GAAP violations, without more, were not sufficient to plead fraud prior to the PSLRA (see, e.g., In

12 re Software Toolworks, Inc. Sec. Litig., 50 F.3d 615, 627 (9th Cir. 1994)), and such allegation s

13 certainly are not sufficient now. Even a restatement of prior-period financial statements (that is, an

14 admission that the financial statements were not prepared in compliance with GAAP) has been held

15 an insufficient basis to infer scienter . See Abrams v. Baker Hughes, Inc ., 292 F.3d 424, 430 (5th Cir. 16 2002) ("the mere publication of inaccurate accounting figures or failure to follow GAAP, without

17 more, does not establish scienter"); In re NorthPoint Comm. Group, Inc. Sec. Litig., 184 F. Supp . 2d

18 991, 1003 (N.D. Cal. 2001) ("while the size of the `restatement' was indeed large, . . . that alone does

19 not raise a strong inference that the October 26 revenue allowance was set too low with deliberat e

20 recklessness"). 21 Finally, if plaintiffs' theory is that the Underwriters must have known some or all of the

22 adverse facts alleged in the FAC simply because the Underwriters had "access" to that information in

23 performing their Section 11 due diligence duties, that theory also has been rejected as insufficient to

24 plead scienter. Numerous courts have rejected substantially identical allegations . In Lipton v.

25 Pathogenesis Corp., 284 F.3d 1027, 1036 (9th Cir. 2002), for example, the Ninth Circuit rejected the

26 plaintiffs' attempt to "assert in conclusory terms that the defendants had access to internal dat a

27 demonstrating a decline in sales ." According to the court, the plaintiffs failed to "identify an y

28 internal reports of `sales data,' much less plead, in any detail, the contents of any such report or th e

Gibson, Dunn & Crutcher LLP 21 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC r: E

1 purported data ." Id. Without this information, the court held, there was no basis for determining

2 whether the defendants had knowledge "`that would cause their optimistic representations to be

3 consciously misleading ."' Id. (quoting Silicon Graphics, 183 F.3d at 985). Indeed, courts recognize

4 that plaintiffs in every securities fraud case could allege that an underwriter of an offering, an auditor, 5 or an inside executive had "access" to internal information, and that to accept such allegations would 6 eviscerate the requirement to plead specific facts giving rise to a strong inference of scienter . Cf. In

7 re Stratosphere Corp., Inc. Sec. Litig., 1 F. Supp . 2d 1096, 1121-22 (D. Nev. 1998) (to accept

8 "access" allegations "would be to read the particularity requirement out of the PSLRA for 9 underwriter defendants, as virtually all underwriters of securities have the type of `close connection'

10 with a corporate defendant that Plaintiffs generally allege"); In re FVC.com Sec. Litig., 13 6

11 F. Supp. 2d 1031, 1037 (N.D. Cal. 2000) ("the lack of any specifics creates an inference that no . . . 12 communications occurred" and, therefore, "the only reasonable inference to be drawn from the 13 Complaint is that plaintiffs have no factual basis for alleging that such communications took place") . 14 The simple fact is that plaintiffs in this case recklessly accused the Underwriters of fraud, bu t 15 fail even to attempt to plead the basic elements of that fraud. Plaintiffs plead no specific 16 contemporaneous documents, reports, conversations, observations, or other information or data in the 17 Underwriters' possession of the sort that is typically cited in support of fraud allegations . Indeed,

18 plaintiffs here do not plead any specific theory of "deliberate recklessness" as to the Underwriters . 19 Under these circumstances, plaintiffs' fraud claims against the Underwriters should be dismissed .

20 E. Plaintiffs' Section 11 Claim Should Be Dismissed. 21 As discussed above, plaintiffs' Section 11 claim against the Underwriters should be dismisse d

22 because all of plaintiffs' claims against the Underwriters are barred by the statute of limitations . In

23 addition, plaintiffs' Section 11 claim is subject to dismissal because plaintiffs lack standing to asse rt

24 the claim and because, as with plaintiffs ' Section 10 (b) and Rule IOb-5 claims, plaintiffs failed to

25 satisfy the pleading requirements of the PSLRA and Rule 9(b) .

26 27 28

Gibson, Dunn & II Crutcher LLP 22 UNDERWRITER DEFENDANTS' MOTION TO DISMISS , CASE No. C-O1-2661-MMC v 0

1 1. Plaintiffs Lack Standing To Assert A Section 11 Claim. 2 a) Plaintiffs ' Attempt To Usurp The Court's Authority By Appointing Themselves To The Lead Plaintiff Group Should Be Rejected. 3 Without notice to or approval by this Court, plaintiffs' counsel attempts to introduce two ne w 4 plaintiffs to this litigation - Thomas Welsh, who is alleged to have "purchased Exodus shares during 5 the Class Period traceable to Exodus' February 6, 2001 . . . secondary offering," and Martin Fox, who 6 is alleged to have "purchased notes during the Class Period issued in connection with Exodus ' 7 February 6, 2001 notes offering" (FAC ¶ 9) - for the sole purpose of asserting new claims against 8 the newly added Underwriter defendants . Neither of these new plaintiffs, however, complied with 9 the PSLRA's certification, publication, or lead plaintiff appointment requirements . Plaintiffs' brazen 10 attempt to appoint themselves lead plaintiffs is an unprecedented encroachment on this Court's 11 authority and duty under the PSLRA to manage securities litigations . 12 First, Section 27(a)(2)(A) of the Securities Act, 15 U .S.C. § 77z-1(a)(2)(A), requires "[e]ach 13 plaintiff seeking to serve as a representative party on behalf of a class [to] provide a sworn 14 certification; which shall be signed by such plaintiff and filed with the complaint," that, among other 1.5 things, "states that the plaintiff has reviewed the complaint and authorized its filing," "states that the 16 plaintiff did not purchase the security that is the subject of the complaint at the direction of the 17 plaintiff's counsel or in order to participate in any private action," and "sets forth all of the 18 transactions of the plaintiff in the security that is the subject of the complaint during the class period 19 specified in the complaint ." No such certifications were served on the Underwriters in this case and, 20 to the Underwriters' knowledge, none were filed with the Court at the time of the filing of the FAC 21 - despite the fact that plaintiffs Welsh and Martin are newly added plaintiffs asserting newly added 22 claims against newly added defendants . 23 Second, Section 27(a)(3)(A) ofthe Securities Act, 15 U .S.C. § 77z-1(a)(3)(A), requires "the 24 plaintiff or plaintiffs [to] cause to be published, in a widely circulated national business-oriented 25 publication or wire service, a notice advising members of the purported class" of, among other things, 26 "the pendency of the action, the claims asserted therein, . . . the purported class period," and "that, not 27 later than 60 days after the date on which the notice is published, any member of the purported class 28 may move the court to serve as lead plaintiff of the purported class ." Plaintiffs here published n o

Gibson, Dunn & Crutcher LLP 23 UNDERWRITER DEFENDANTS' MOTION TO Dismiss, CASE No . C-01-2661-MMC M

such notice and made no lead plaintiff motion with respect to their newly added Section 11 claims .

2 The only notice that has been published to date - and the only lead plaintiff motion filed and

3 considered by this Court - related to a shorter purported class period and did not relate to Section 11

4 claims. See RJN, Exs. G & H.

5 Finally, Section 27 (a)(3)(B)(i), 15 U.S .C. § 77z-1(a)(3)(B)(i), states that "[n]ot later than 90 6 days after the date on which a notice is published . . ., the court shall consider any motion made by a

7 purported class member in response to the notice . . . and shall appoint as lead plaintiff the member of 8 members of the purported plaintiff class that the court determines to the most capable of adequately

9 representing the interests of class members." Once again, plaintiffs ignored this statutory 10 requirement, never sought appointment by the Court to serve as lead plaintiffs, and are attempting to 11 usurp this Court's statutory authority under the PSLRA .

12 Plaintiffs' actions here not only are unprecedented, they fly in the face of the decisions o f 13 numerous courts that have denied motions to appoint lead counsel for failure to satisfy the statute's

14 simple notice requirements . )1 Thus, even if the Court were to treat plaintiffs' FAC as the functional 1.5 equivalent of a motion for appointment as lead plaintiffs, the plain language of the PSLRA and the

16 case law require denial of that motion. Because none of the three plaintiffs appointed by the Court o n

17 October 29, 2001 to serve as lead plaintiffs in this case - Michael Klein, Tresi Trucking, Inc. and

18 William H. Freedman - is alleged to have purchased Exodus securities in the February 6, 200 1

19 offerings (see FAC ¶ 9), and because new plaintiffs Welsh and Fox are not proper plaintiffs in thi s 20 21

22 11 See, e.g., California Pub . Employees'Ret. Sys. v. Chubb Corp., 127 F. Supp. 2d 572, 580-81 (D.N.J. 2001) (denying motion to appoint lead plaintiff that failed to disclose its potential lack of 23 standing with respect to Section 11 and 14(a) claims, representing two of the complaint's three causes of action) ; In re Lucent Techs., Inc. Sec. Litig., 194 F.R.D. 137, 148 (D .N.J. 2000) 24 (denying motion to appoint lead plaintiff based on their failure to explain the subject matter of the class action, and noting that "[a]ny interested class member could not help but have a series of 25 questions upon reading such a vague, inadequate document") ; Wenderhold v. Cylink Corp., 188 F.R.D. 577, 580-81 (N .D. Cal. 1999) (denying motions to appoint based on failures to describe 26 the nature of the claims asserted, the alleged misstatements or omissions, and the class period) ; Ravens v. Iftikar, 174 F.R.D . 651, 655 (N .D . Cal. 1997) (denying motion to appoint lead plaintiff 27 based on its failure to allege true value of stock throughout the class period, discuss potential conflicts among class members over valuation, and inform putative class members of likely 28 disputes over class definition) .

Gibson, Dunn & Crutcher LLP 24 UNDERWRITER DEFENDANTS' MOTION TO DISMISS,,CASE No . C-O1-2661-MMC 1 action, there is no lead plaintiff with standing to assert Section 11 claims against the Underwriters

2 and those claims should be dismissed .

3 b) Plaintiffs Fail To Allege Facts Sufficient To Demonstrate That Any Plaintiff Has Standing To Assert Section 11 Claims Based On The 4 February 6, 2001 Secondary Stock Offering . 5 Neither new plaintiff Welsh nor new plaintiff Fox is alleged to have purchased any Exodus

6 security in the February 6, 2001 offerings and, therefore, neither should be permitted to sue under

7 Section 11 . Moreover, plaintiffs' patently conclusory allegation that plaintiff Welsh purchase d

8 Exodus shares sometime "during the class period" and that his shares is "traceable" to the February 6,

9 2001 offering (FAC ¶ 9) are insufficient to plead Welsh's standing to assert a Section 11 claim . It is

10 well-established that only persons who purchased stock in a public offering have standing to asser t

11 claims under Section 11 based on allegedly false or misleading offering materials . See, e.g., Barnes

12 v. Osofsky, 373 F.2d 269, 273 (2d Cir. 1967) (holding Section 11 claims are limited to purchasers of

13 securities that are the direct subject of a registration statement) . Accordingly, numerous courts have

14 held that only persons who actually purchased securities in the distribution process or who ca n

15 "trace" their shares to the distribution process have standing to assert a claim under Section 11 .12

16 In Abbey v. Computer Memories, Inc., 634 F. Supp. 870 (N.D . Cal. 1986) Judge Lynch

17 explained that "Section I 1 simply was not intended to provide a remedy to every person who might

18 have been harmed by a defective registration statement" and, therefore, "a plaintiff who can only

19 show that his or her shares might have been issued in the relevant offering should not be given the

20 benefit of section I I's conclusive presumption of reliance ." Id. at 875. Judge Lynch explained that

21 such purchasers instead "should be treated the same as individuals whose shares clearly were not

22 issued in the offering ." Id. "The `direct tracing' requirement simply precludes a shareholder from

23 taking advantage of Section I I's relaxed liability requirements when the shareholder's connection to

24 12 See, e.g., Hertzberg v. Dignity Partners, Inc., 191 F .3d 1076, 1080-81 (9th Cir. 1999) (holding 25 that Section 11 claims are limited only to persons who "must have purchased a security under that, rather than some other, registration statement"); Lilley v. Charren, 936 F. Supp. 708, 718 26 (N.D. Cal. 1996); Guenther v. Cooper Life Sciences, Inc., 759 F. Supp. 1437, 1439 (N.D. Cal. 1990) ; McFarland v. Memorex Corp., 493 F. Supp. 631, 642 (N.D . Cal. 1980); Abbey v. 27 Computer Memories, Inc., 634 F . Supp. 870, 875 (N .D. Cal. 1986); see generally Paul C. Curnin & Christine M . Ford, The Critical Issue of Standing under Section 11 of the Securities Act of 28 1933, VI Fordham J . Corp. & Fin. L. 155, 157 (2001) .

Gibson , Dunn & 25 Crutcher LLP UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0

the relevant offering is so attenuated that he or she cannot directly trace his or her shares to the

2 offering." [cite] Accordingly, "[r]elaxing the tracing requirement such that a plaintiff may fulfill it by 3 showing even high probability that some of his shares were from the relevant offering would be 4 inconsistent with the narrow scope of potential liability envisioned by section 11 ." Id.13 Numerous 5 courts have applied the tracing requirement to dismiss Section 11 claims at the pleading stage where 6 plaintiffs fail to plead facts that, if true, would demonstrate that they actually purchased in a public 7 offering or have some particularized basis for pleading an ability to "trace" shares purchased in the

8 secondary securities markets to a public offering . Moreover, in addressing the tracing requirement,

9 other courts have routinely dismissed complaints that inadequately allege that shares were purchased

10 pursuant to a particular registration statement . See Lilley, 936 F. Supp. at 718 (requiring that

11 plaintiffs "allege the dates and establish that they purchased stock pursuant to the offering") ;

12 Guenther, 759 F. Supp. at 1439; McFarland, 493 F. Supp. at 642. 13 To survive a motion to dismiss, plaintiffs must allege some factual basis for their conclusor y 14 allegation that the shares Welsh purchased "during the class period" were actually issued in the

15 February 6, 2001 secondary offering of 13 million shares (approximately 2 .4% of the Exodus stock 16 outstanding after the February 6 offering), rather than - as is overwhelmingly more likely - from

17 the pool of537 million shares in the market prior to February 6, 2001 . See RJN, Ex. B at 3 ; Lilley,

18 936 F. Supp. at 715-16 (granting defendants' motion to dismiss plaintiffs' Section 11 claim and 19 holding, "given the fact that the market eventually contained shares that were not issued pursuant to

20 the [Prospectus], it does appear that plaintiffs must amend their pleadings to allege the specific dates

21 and facts that establish the representative plaintiffs' standing for a section 11 claim") . 22 23 24 25 13 In Abbey, the court rejected the plaintiff's argument that he should be permitted to maintain his 26 Section 11 claim because of the statistical probability that his stock contained at least some of the newly issued shares. After detailing the complex path publicly-traded shares can take from issuer 27 to end purchaser, the court determined that plaintiff could not hope to demonstrate that the shares he purchased actually were issued in the defendant's secondary public offering . 634 F. Supp. at 28 872-73.

Gibson , Dunn & I I Crutcher LLP 26 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-0 1 -266 1 -MMC Is

1 2. Plaintiffs Fail To Plead Fraud With The Specificity Required Under The PSLRA And Rule 9(b) Of The Federal Rules Of Civil Procedure. 2 Just as plaintiffs failed adequately to state a claim under Section 10(b) because they failed t o 3 plead the claim with particularity, plaintiffs also fail to state a claim against the Underwriters under 4 Section 11 . The same policy considerations that motivated the enactment of the PSLRA - namely, 5 preventing baseless "strike suits" filed at a high reputational and monetary cost primarily to "deep 6 pocket" defendants - also apply to Section 11 claims that are based on allegations of fraud . 7 Consequently, courts in the Ninth Circuit and elsewhere have made it clear that the pleading 8 requirements of Rule 9(b) apply to Section 11 claims that "sound in fraud ." See, e.g., In re Stac 9 Elecs. Sec. Litig., 89 F.3d at 1404-05 . ("We now clarify that the particularity requirements of Rule 10 9(b) apply to claims brought under Section 11 when, as here, they are grounded in fraud" and 11 "nominal efforts" to say that Section 11 claim sounds in negligence rather than fraud was 12 "unconvincing where the gravamen of the complaint is plainly fraud and no effort is made to show 13 any other basis for the claims levied at the Prospectus") ; In re Harmonic Inc. Sec. Litig., 163 14 F . Supp. 2d 1079, 1088 (N.D. Cal. 2001) (inquiring into the "essence of [plaintiffs'] claims . . . that 15 defendants deliberately - not negligently or accidentally - withheld unfavorable information") ; In 16 re IasiaWorks, Inc. Sec. Litig., 2002 WL 1034041, at *5 (N.D. Cal. May 15, 2002) (holding that 17 allegations that defendants deliberately concealed the size of internet data centers and intention to 18 seek additional funding sounded clearly in fraud) . 19 Here, the gravamen of the FAC is fraud and, accordingly, plaintiffs' allegations must meet the 20 heightened pleading requirement set forth in Fed . R. Civ. P. 9(b). Plaintiffs allege that each of "the 21 defendants identified herein participated in an egregious accounting fraud designed to deceive 22 investors of Exodus" (FAC ¶ 1), "falsitlied] Exodus' financial results" (id.), "embarked on a scheme 23 to defraud" (id., ¶ 27), acted with "knowledge or deliberate recklessness" (id., ¶ 195), made 24 numerous statements to the public at a time when they allegedly were "aware" of certain adverse 25 facts (id., ¶¶ 30, 35, 39, 45, 57, 60, 66, 71, 75, 77), "had full knowledge of the improper revenue 26 recognition practices and the poor business condition of Exodus" through receipt of various 27 unspecified period reports (id., ¶ 196), and generally "carried out a plan, scheme and course of 28

Gibson, Dunn & Crutcher LLP 27 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No. C-0 1-2661 -MMC 1 conduct which w as intended to . . . deceive the investing public ." Id., ¶ 210. These allegations

2 permeate the entire FAC and are allegations inherently sounding in fraud, not negligence .

3 Rule 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting

4 fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b) for a complaint to allege

5 fraud with the requisite particularity under Rule 9(b), "a plaintiff must set forth more than the neutral

6 facts necessary to identify the transaction," such as the "time, place, and content of an' alleged

7 misrepresentation." In re GlenFed, Inc . Sec. Litig., 42 F .3d 1541, 1547-48 (9th Cir. 1994) (en banc).

8 "A plaintiff must set forth, as part of the circumstances constituting fraud, an explanation as to why

9 the disputed statement was untrue or misleading when made." Id. at 1549. In short, "Rule 9(b)

10 requires particularity as to the circumstances of the fraud - this requires pleading facts that by any

11 definition are `evidentiary' : time, place, persons, statements made, explanation of why or how such

12 statements are false or misleading ." Id. at 1547-48 n.7 . Courts in this circuit have held that the

13 falsity requirement can be satisfied "`by pointing to inconsistent contemporaneous statements or

14 information (such as internal reports) which were made by or available to the defendants."'

15 California Amplifier, 191 F.3d at 993 (quoting GlenFed, 42 F.3d at 1549). Moreover, as with claims

16 asserted under Section 10(b) and Rule I Ob-5, the PSLRA requires plaintiffs to plead that any

17 allegedly false or misleading forward looking statement was made with "actual knowledge" that the

18 statement was false . 15 U.S.C. § 77z-2(c)(1)(B).

19 Under these standards, plaintiffs' Section 11 claims fail for the same reasons discussed above

20 with respect to plaintiffs' Section 10(b) and Rule IOb-5 claims. That is, the FAC contains page-after-

21 page of ramble and innuendo about specific customers and Exodus' revenue recognition practices,

22 but contains no specific facts that if, true, would demonstrate that any statement appearing in the

23 February 6, 2001 Prospectus was false when made . Nor do plaintiffs attempt to identify any source

24 of information available to the Underwriters in the period prior to the February 6, 2001 offerings that

25 supposedly contradicted the public statements Exodus made in the Prospectus concerning

26 management's beliefs as to benefits associated with the GlobalCenter acquisition, demand from

27 enterprise customers, Exodus' fiscal year 2000 revenues, or the number of Exodus customers .

28 Instead, plaintiffs make only conclusory assertions that management did not actually believe that th e

Gibson, Dunn & p Crutcher LLP 2 8 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-O1-2661-MMC E

1 GlobalCenter acquisition would have the stated benefits (without specifying any reasons specific to

2 the challenged statement), that demand for Exodus' services and products was declining (by an 3 unknown amount at undifferentiated points in time and with unspecified impact on Exodus' financial 4 results), that Exodus' statement as to fiscal year 2000 revenue was based on revenue recognized in

5 violation of GAAP (with an unknown quantitative impact on the revenue figures actually identified in 6 the Prospectus), and that Exodus over-counted customers (again, by an unknown amount as of

7 February 6, 2001) . Such conclusory allegations - even if contained in 101-page complaint - are 8 not sufficient to withstand a motion to dismiss based on Rule 9(b) .

9 The Ninth Circuit and other courts have repeatedly addressed the issue of what plaintiffs must

10 plead with respect to "inconsistent contemporaneous statements or information (such as internal

11 reports) which were made by or available to the defendants" - and those precedents demonstrate

12 why plaintiffs' allegations are insufficient as a matter of law . In GlenFed, the Ninth Circuit

13 dismissed a complaint, in part, because plaintiffs alleged that GlenFed failed to disclose that the level

14 of foreclosures and defaults was increasing. GlenFed, 42 F.3d at 1552. The Ninth Circuit dismissed

15 claims based on that alleged omission because the complaint did not allege "what information within

16 GlenFed revealed that foreclosures and defaults were increasing . . . ." Id. As in GlenFed, plaintiffs

17 here generally allege that demand for Exodus' services was decreasing, but fail to allege any specific

18 basis upon which the Underwriters would have known that or even any specific information that

19 indicates that demand was decreasing at the time of the February 6, 2001 offerings .

20 In contrast, the court in GlenFed denied defendants' motion to dismiss claims assertin g

21 violations of GAAP arising from GlenFed's allegedly inadequate internal accounting controls and

22 inadequate loan loss reserves. With respect to those allegations, the plaintiffs alleged that the

23 defendants knew of specific deficiencies in GlenFed's internal controls and inadequate loss reserves

24 because defendants received specific reports from GlenFed's internal audit department and a specific

25 proposal submitted by an accounting firm . See id. at 1550. The FAC here provides none of this level

26 of detail. There are no allegations that KPMG identified any revenue recognition violations in any of

27 its reviews of Exodus' quarterly financial statements in 2000 or in its audit of Exodus' year-end

28 financial statements. Nor is there any allegation that any internal audit personnel identified an y

Gibson, Dunn & Crutcher LLP 2 9 UNDERWRITER DEFENDANTS' MOTION TO DISMISS, CASE No . C-01-2661-MMC 0 0

1 policy, procedure, or specific transaction that was not appropriately accounted for at any time, let

2 alone prior to the February 6, 2001 offerings . Indeed, by relying almost exclusively on information 3 purportedly obtained from a number of "confidential witnesses," rather than on the type of

4 documentary foundation contemplated in GlenFed and California Amplifier, plaintiffs evidently hope

5 to avoid the pleading requirements associated with "internal report" allegations, such as the date,

6 author, recipients, and content of such reports . See Silicon Graphics, 183 F.3d at 985 .

7 IV. CONCLUSIO N 8 For all the foregoing reasons, defendants Goldman, Sachs & Co ., Merrill Lynch & Co .,

9 Morgan Stanley Dean Witter, and J .P . Morgan respectfully request that this Court enter an order

10 dismissing plaintiffs' First Amended Consolidated Class Action Complaint without leave to amend .

11 DATED: October 23, 2002 GIBSON, DUNN & CRT;TCHER LLP 12 c

13 By: Jonathan C . Dickey v 14 rneys for Defendants GOLDMAN, SACHS & CO ., 15 MERRILL LYNCH & CO., MORGAN STANLEY DEAN WITTER, and J .P. MORGAN 16 45042049_I .DOC 17 18 19 20 21 22 23 24 25

26 27 28

Gibson , Dunn & CrutcherLLP 30 UNDERWRITER DEFENDANTS' MOTION TO DISMISS , CASE No . C-0 1 -266 1-MMC Appendix A Exodus acquires GlobalCenter . o 0

N Exodus issues Prospectuses for its offering of 13,000,000 shares of common stock and $500 million in 5 1/4% convertible subordinated notes . The Underwriters serve as lead underwriters for both offerings . o

rn O O O Exodus issues its press release announcing that its second quarter 2001 financial results would miss analyst expectations . Jeffrey Camp MoneyLine interview . Several other financial press stories report problems at Exodus . o

Plaintiffs file first complaint against Exodus and several officers and directors alleging violations of Section 10(b) of the Exchange Act . N Plaintiffs' lead counsel, Milberg Weiss, files the first of its complaints against Exodus and several officers -4 0

and directors alleging violations of Section 10(b) of the Exchange Act . OD 0

Exodus files for bankruptcy protection . rn

Plaintiffs file a consolidated complaint . It contains no claims under Section 11 N of the 1933 Securities Act, and does not name or mention the Underwriters . 0

In response to defendants' motion to dismiss, plaintiffs file a "corrected" consolidated complaint . Again, the "corrected" i complaint does not include a Section 11 claim, and does not name or mention the Underwriters .

The court grants defendants' motion to dismiss in all respects . o 0 N

I v Plaintiffs file the First Amended Consolidated Complaint, naming the Underwriter s as defendants for the first time, and for the first time allege claims under Section 11 .

a Exhibit C v

1 MILBERG WEISS BERSHAD HYNES & LERACH LLP 2 REED R. KATHREIN (139304) JOHN K. GRANT (169813 ) 3 EX KANO S . SAMS II (192936) 100 Pine Street, Suite 260 0 4 San Francisco, CA 94111 Telephone: 415/288-4545 5 415/288-4534 (fax ) -and- 6 WILLIAM S . LERACH (68581) 401 B Street, Suite 170 0 7 San Diego, CA 92101 Telephone: 619/231-1058 8 619/231-7423 (fax)

9 WEISS & YOURMAN JOSEPH H. WEISS 10 551 Fifth Avenue, Suite 1600 New York, NY 10176 11 Telephone: 212/682-3025 212/682-3010 (fax ) 12 and - KEVIN- J. YOURMAN (147159) 13 ELIZABETH P. LIN (174663) 10940 Wilshire Blvd., 24th Floor 14 Los Angeles, CA 90024 Telephone: 310/208-2800 15 310/209-2348 (fax )

16 Co-Lead Counsel for Plaintiffs

17 UNITED STATES DISTRICT COURT 18 NORTHERN DISTRICT OF CALIFORNIA 19

20 In re EXODUS COMMUNICATIONS, INC Master File No. C-01-2661-MMC SECURITIES LITIGATION 21 CLASS ACTION

22 This Document Relates To: PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' 23 ALL ACTIONS . MOTION TO DISMIS S

24 DATE: January 31, 2003 TIME: 9:00 a.m. 25 COURTROOM: Honorable Maxine M. Chesney 26

27

28 I Y 9 is

1 TABLE OF CONTENTS

2 Page 3

4 1. INTRODUCTION ...... 1

5 II. PROCEDURAL BACKGROUND AND SUMMARY OF FACTS ...... 3

6 M. STANDARDS ON A MOTION TO DISMISS ...... 6

7 IV. ARGUMENT ...... 7

8 A. Plaintiffs' Claims Are Not Barred by the Statute of Limitations ...... 7

9 B. Plaintiffs Have Adequately Alleged the Section 11 Claim ...... 1 3

10 1 . Plaintiffs Have Not Attempted to Appoint Additional Lead Plaintiffs ...... 1 3 11 2. Plaintiffs Have Standing to Assert the Section 11 Claim ...... 1 5 12 3. Rule 9(b) Is Inapplicable to the Section 11 Claim ...... 1 6 13 C. The Underwriter Defendants May Be Held Liable for Section 10(b) an d 14 Rule lOb-5 Violations ...... 20

15 1 . The FAC Adequately Alleges the Reasons Why Statement s Contained in the Offering Documents Were False and Misleading 16 When Made ...... 2 1

17 a. Statement Concerning GlobalCenter ...... 2 1

18 b. The Financial Statements ...... 22

19 c. Statements Concerning Demand ...... 24

20 d. Statements Concerning Number of Customers ...... 24

21 e. Statements Concerning Certain Exodus Customers ...... 25

22 2. The GlobalCenter Statement Was Not Forward-Looking ...... 25

23 3. The FAC Adequately Alleges Scienter ...... 27

24 V. CONCLUSION ...... 28

25

26

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PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - i - I Y 0 0

1 TABLE OF AUTHORITIE S

2 CASES Page 3 Aldridge v. A. T. Cross Corp . , 4 284 F.3d 72 (1st Cir. 2002) ...... 22, 23, 25

5 Antell v. Arthur Andersen LLP, No. 97 C 3456, 1998 U.S. Dist. LEXIS 7183 (N.D . Ill. May 4,1998) ...... 1 0 6 Backhaus v. Streamedia Communications, Inc . , 7 [2002 Transfer Binder], Fed . Sec. L. Rep. (CCH) ¶91,964 (S .D.N.Y. 2002) ...... 8

8 Berry v. Valence Tech., Inc. , 175 F.3d 699 (9th Cir. 1999) ...... 7, 8, 9 9 Caprin v. Simon Transportation Services, Inc. , 10 112 F. Supp. 2d 1251 (D. Utah 2000) ...... 10,1 1

11 Carley Capital Group v. Deloitte & Touche, LLP. , 27 F. Supp. 2d 1324 (N .D . Ga. 1998) ...... 7 12 Chill v. GE, 13 101 F.3d 263 (2d Cir . 1996) ...... 27

14 Chris-Craft Indus. v. Piper Aircraft Corp., 480 F.2d 341 (2d Cir . 1973) ...... 1, 27 15 Conley v. Gibson , 16 355 U.S. 41 (1957) ...... 6

17 Eichenholtz v. Brennan, 52 F.3d 478 (3d Cir. 1995) ...... 1, 16 18 Ernst & Ernst v. Hochfelder, 19 425 U.S. 185 (1976) ...... 2

20 Freeland v. Iridium World Communications, Ltd., et al. , No . 99-1002 slip op. (D .D.C. Mar. 15 . 2001) ...... 1 6 21 Fujisawa Pharm. Co. v. Kapoor, 22 115 F.3d 1332 (7th Cir. 1997) ...... 11,1 2

23 Gray v. First Winthrop Corp . , 82 F.3d 877 (9th Cir. 1996) ...... 26 24 Gross v. Medaphis Corp. , 25 977 F. Supp. 1463 (N.D. Ga. 1997) ...... 26

26 Harden v. Raffensperger, Hughes & Co. , 65 F.3d 1392 (7th Cir. 1995) ...... 1 27 Heliotrope Gen . Inc. v. Ford Motor Co . , 28 189 F.3d 971 (9th Cir. 1999) ...... 6, 25

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS - C-01-2661-MMC - ii - 1 Page

2 Herman & MacLean v. Huddleston, 459 U.S . 375 (1983) ...... 2, 16, 17, 26 3 Hertzberg v. Dignity Partners, Inc. , 4 191 F.3d 1076 (9th Cir . 1999) ...... 1 5

5 Huddleston v. Herman & MacLean, 640 F.2d 534 (5th Cir . 1981) ...... 26 6 In re 2TheMart .com Sec. Litig., 7 114 F. Supp. 2d 955 (C.D. Cal. 2000) ...... 7

8 In re AES Corp . Sec. Litig. , 825 F. Supp. 578 (S .D.N.Y. 1993) ...... 1 6 9 In re Ames Department Stores, Inc. Note Litig. , 10 991 F.2d 968 (2d Cir. 1993) ...... 1 0

11 In re Apple Computer Sec. Litig. , 886 F .2d 1109 (9th Cir . 1989) ...... 21 12 In re Cabletron Systems , 13 No . 01-1965, 2002 U.S. App. LEXIS 23372 (1st Cir . Nov. 12, 2002) ...... 22, 23

14 In re Cavanaugh, 306 F .3d 726 (9th Cir . 2002) ...... 1 3 15 In re Chambers Dev. Sec. Litig. , 16 848 F . Supp. 602 (W.D. Pa. 1994) ...... 1 5

17 In re Consumers Power Co. Sec. Litig. , 105 F.R.D. 583 (E.D. Mich. 1985) ...... 1 9 18 In re GlenFed, Inc. Sec. Litig., 19 42 F.3d 1541 (9th Cir. 1994) ...... 20

20 In re Independent Energy Holdings PLC, Sec. Litig. , [2002 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶91,920 21 (S.D.N.Y. 2002) ...... 14, 1 5

22 In re MTC Elec. Techs. Shareholder Litig. , 993 F. Supp. 160 (E.D.N.Y. 1997) ...... 20, 27 23 In re MobileMedia Sec . Litig. , 24 28 F. Supp. 2d 901 (D.N.J. 1998) ...... 26

25 In re NationsMart Corp . Sec. Litig. , 130 F.3d 309 (8th Cir. 1997) ...... 1 8 26 In re Nuko Information Systems Sec. Litig. , 27 199 F.R.D . 338 (N.D . Cal. 2000) ...... 27

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMIS S C-01-2661-MMC - iii - 1 Page

2 In re Southern Pacific Funding Corp . Sec. Litig. , 83 F . Supp. 2d 1172 (D. Or. 1999) ...... 1 9 3 In re Splash Tech. Holdings Sec. Litig. , 4 [2000-2001 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶91,249 (N .D . Cal. 2000) . . . 9

5 In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996) ...... 18, 20 6 In re Sterling Foster & Co. Sec. Litig. , 7 222 F. Supp. 2d 216 (E.D.N.Y. 2002) ...... 15

8 In re Valence Tech . Sec. Litig., [ 1995 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶98,793 (N .D . Cal. 1995) . . . . . 1 8 9 In re ValueJet, Inc., Sec. Litig. , 10 984 F. Supp. 1472 (N.D . Ga. 1997) ...... 26

11 Kaplan v. Rose, 49 F .3d 1363 (9th Cir. 1994) ...... 2, 1 6 12 Kensington Capital Management v . Oakley, Inc., 13 [ 1999 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶90,41 1 (C.D . Cal. 1999) ...... 19 14 Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 15 501 U.S. 350 (1991) ...... 7

16 Law v. Medco Research , 113 F.3d 781 (7th Cir. 1997) ...... 11,12 17 Lilley v. Charren, 18 936 F. Supp. 708 (N.D. Cal. 1996) ...... 7, 8

19 Lister v. Oakley, Inc., [ 1999 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶90,410 (C .D. Cal. 1999) . . . . . 26 20 Rothman v. Gregor, 21 220 F.3d 81 (2d Cir. 2000) ...... 8, 1 0

22 Schlagel v. Learning Tree Intl, [1998 Transfer Binder] Fed . Sec. L. Rep. (CCH) ¶90,403, at 91,81 3 23 (C .D. Cal. 1998) ...... 7

24 Voit v. Wonderware Corp. , 977 F. Supp. 363 (E.D. Pa. 1997) ...... 26 25 Warshaw v. Xoma Corp., 26 74 F.3d 955 (9th Cir. 1996) ...... 1 9 27

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - iv - T 0 S

1 Page

2 STATUTES, RULES AND REGULATION S

3 15 U.S.C. §77k ...... passim. 4 §77k(a) ...... 3, 15, 1 6 §77k(b) ...... 2 5 §77m ...... 2, 7 §78i(e) ...... 2, 7 6 §78j ...... passim. §78j(b) ...... passim. 7 §78u-4(a)(2) ...... 14 §78u-4(a)(3)(A)(i) ...... 14 8 §78u-4(a)(3)(B)(iii)(I) ...... 14 §78u-4(a)(3)(B)(iii)(II) ...... 1 3 9 §78u-4(b)(2) ...... 20 §78u-5(c)(1) ...... 25, 26 10 17 C.F.R. 11 §240.1 Ob-5 ...... passim.

12 Federal Rules of Civil Procedur e Rule 8(e)(2) ...... 1 7 13 Rule 9(b) ...... passim. Rule 11 1 1 14 Rule 12(b)(6) ...... 7, 1 3 Rule 23 ...... 1 5 15 SECONDARY AUTHORITIES 16 The Sarbanes-Oxley Act of 2002 , 17 P. L. 107-204 §804, 116 Stat. 745 (2002) ...... 1 2

18 Capitol Hill Hearing : Conference Report on Corporate Responsibility Legislation, Federal News Service (July 24, 2002) ...... 1 2 19 Capitol Hill Hearing Testimony : Accounting Industry Oversight Board, 20 107th Cong., 2d Sess. (April 9, 2002) ...... 12

2 1

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PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS - C-01-2661-MMC - v - -1 r 0 0

1 ISSUES TO BE DECIDED

2 1 . Whether plaintiffs' claims are barred by the statute of limitations .

3 2. Whether plaintiffs have sufficiently alleged § 10(b) and Rule 1 Ob-5 claims against

4 Underwriter Defendants.

5 3. Whether plaintiffs have standing to assert a § 11 claim .

6 4. Whether plaintiffs' § 11 claim, which is not grounded in fraud, is subject to the fraud

7 pleading standards of Rule 9(b), and if so, whether plaintiffs' claims are pled with the requisite

8 particularity.

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PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - vi - 0

1 MEMORANDUM OF POINTS AND AUTHORITIE S

2 Plaintiffs respectfully submit this opposition to the motion to dismiss filed by defendants

3 Goldman, Sachs & Co ., Merrill Lynch & Co ., Morgan Stanley Dean Witter, and J.P . Morgan

4 ("Underwriter Defendants") . In addition to the points and authorities set forth below, the points and

5 authorities in plaintiffs' memorandum in opposition to the Individual Defendants' motion to dismiss

6 are also incorporated herein by reference, as the Underwriter Defendants and Individual Defendants

7 raise many of the same arguments.

8 I. INTRODUCTIO N

9 The Securities Act of 1933 (the "1933 Act"), along with the Securities Exchange Act of 1934

10 (the "1934 Act"), embrace ""'a fundamental purpose . . . to substitute a philosophy of full disclosure

11 for the philosophy of caveat emptor.""' Harden v. Raffensperger, Hughes & Co ., 65 F.3d 1392,1399

12 (7th Cir. 1995) (citing Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164,171 (1994)).

13 Section 11 of the 1933 Act creates an express cause of action against a series of individuals,

14 including underwriters, for material misstatements in or omissions of material fact from a

15 registration statement . Harden, 65 F.3d at 1403-04 (citing 15 U .S .C. §77k(a)) . Section 10(b) of the

16 1934 Act makes it unlawful for "any person" to use or employ any manipulative or deceptive device

17 or contrivance in connection with the purchase or sale of any security . 15 U.S.C. §78j(b); 17 C.F.R.

18 §240.10b-5.

19 Securities underwriters play a vital role in protecting investors and ensuring that public

20 companies comply with their obligations to provide full and fair disclosure to the investing public.

21 As at least one court has recognized, "[n]o greater reliance in our self-regulatory system is placed

22 on any single participant in the issuance of securities than upon the underwriter ." Chris-Craft Indus.

23 v. Piper Aircraft Corp ., 480 F.2d 341, 370 (2d Cir. 1973). "And Congress intended to impose a'high

24 degree of trusteeship' on underwriters ." Eichenholtz v. Brennan, 52 F .3d 478, 485 (3d Cir . 1995)

25 (citation omitted) .

26 The First Amended Consolidated Class Action Complaint ("FAC") in this case alleges that

27 Underwriter Defendants were derelict in their duties . The Underwriter Defendants were the

28 underwriters in selling over 13 million shares of Exodus Communications, Inc .'s ("Exodus" or the PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - 1 - S

1 "Company") common stock for proceeds of about $230 million pursuant to a false and misleading

2 registration statement and prospectus in a secondary public offering on February 6, 2001 . The

3 Underwriter Defendants were also the underwriters in selling $500 million of Exodus' 5-1/4%

4 convertible subordinated notes pursuant to a false and misleading registration statement and

5 prospectus on February 6, 2001 . These offerings raised approximately $730 million for Exodus, and

6 the Underwriter Defendants earned underwriting fees of $24 .5 million in connection with these

7 offerings. Four short months after these public offerings, Exodus disclosed that its 2Q01 results

8 would fall short of management's guidance to analysts and the public . Three months thereafter,

9 Exodus filed for bankruptcy .

10 The Underwriter Defendants here are subject to liability under § 11 of the 1933 Act . Section

11 11 is non fraud liability under which the Underwriter Defendants are primafacie liable and can

12 avoid liability only by bearing their burden of proofthat they exercised due diligence . Plaintiffs

13 need not allege that defendants had actual knowledge of, or even should have known of, the false

14 and misleading statements. See 15 U.S.C . §77k(b); Ernst & Ernst v. Hochfelder, 425 U.S . 185, 200

15 (1976) (underlying Congressional policy was to create express liability regardless of fault) ; Kaplan

16 v. Rose, 49 F .3d 1363, 1371 (9th Cir. 1994) (under §11, "defendants will be liable for innocent or

17 negligent material misstatements") . Plaintiffs need only allege false and misleading statements

18 existed and were material . Id. As demonstrated below, because plaintiffs have adequately alleged

19 § 11 liability against the Underwriter Defendants, this claim against them should not be dismissed .

20 The Underwriter Defendants are likewise subject to liability under § 10 and Rule 1 Ob-5 of the

21 1934 Act. The false statements in a registration statement can create liability not only under § 11 of

22 the 1933 Act, but under § 10(b) of the 1934 Act and Rule lOb-5 promulgated thereunder . Herman

23 & MacLean v. Huddleston, 459 U.S. 375, 387 (1983) . Because plaintiffs have adequately alleged

24 the § 10(b) claim against the Underwriter Defendants pursuant to the requirements of the Private

25 Securities Litigation Reform Act ("PSLRA"), this claim should also not be dismissed.

26 Further, plaintiffs' claims against the Underwriter Defendants are not barred by the statute

27 of limitations, as plaintiffs' §11 and § 10(b) claims were properly brought within one year of

28 discovery of the facts constituting the violation . 15 U.S.C. §77m; 15 U.S .C. §78i(e). Moreover, PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -2- 1 plaintiffs have standing to bring the claims because they bought securities pursuant or traceable to

2 the offerings, and have so alleged . 15 U.S .C. §77k(a). Accordingly, the Underwriter Defendants'

3 motion to dismiss should be denied .

4 II. PROCEDURAL BACKGROUND AND SUMMARY OF FACT S

5 This is a securities class action alleging violation of the federal securities laws brought on

6 behalf of those who purchased or acquired Exodus securities between April 20, 2000 and September

7 25, 2001 (the "Class Period"). ¶¶1, 201 . 1

8 The original complaint in this case, filed on July 12, 2001, had a shorter class period and was

9 brought on behalf of all purchasers of Exodus securities between March 30, 2001 and June 20, 2001 .

10 The original complaint, and other similar complaints, were filed shortly after Exodus, on June 20,

11 2001, revealed that its 2Q01 results would fall short of management's guidance to analysts and the

12 public, and that demand for the Company's services was weaker in that quarter than defendants had

13 previously represented. The original complaint, and related complaints, alleged that the statements

14 made by defendants during 2Q01 concerning Exodus' business strength were false and misleading .

15 Shortly thereafter, the Court consolidated the related complaints brought in various cases,

16 and appointed lead plaintiffs and lead counsel in the consolidated case . A consolidated complaint

17 was subsequently filed on December 13, 2001 .2 The consolidated complaint alleged that defendants,

18 during the period March 30, 2001 through June 20, 2001, made false and misleading statements . It

19 alleged that, contrary to defendants' representations about Exodus' business conditions in 2Q01,

20 Exodus was not seeing growth, was experiencing decreased demand, and that defendants were aware

21 Exodus would not meet 2Q01 guidance . On May 28, 2001, after considering the parties' memoranda

22 in connection with defendants' motion to dismiss, the Court dismissed the consolidated complaint

23 with leave to amend.

24 On July 1, 2002, following further investigation and additional interviews with numerous

25 former Exodus employees, plaintiffs filed the FAC. The information provided by new sources

26 27 All' paragraph references ("¶") are to the FAC, unless otherwise indicated .

2 A corrected consolidated class action complaint was filed with the Court on April 5, 2002, 28 to correct an error in the class definition in the consolidated complaint . PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - 3 - 0

1 between the time of the filing of the consolidated complaint and the FAC indicated for the first time

2 that Exodus' financial results, from as far back as April 20, 2000, were false and misleading, and

3 violated Generally Accepted Accounting Principles ("GAAP") . Information from certain new

4 sources also indicated that defendants were aware Exodus' acquisition of GlobalCenter Holding Co .

5 ("GlobalCenter") would not enhance the Company, that the number of Exodus customers being

6 touted by defendants was false, and that demand for Exodus' services had diminished prior to 2Q01 .

7 Based on information obtained from these new sources, plaintiffs extended the Class Period to

8 between April 20, 2000 and September 25, 2001 . Furthermore, based on the new facts obtained,

9 plaintiffs' counsel were put on notice for the first time that the registration statements and

1 0 prospectuses issued in connection with Exodus' February 6, 2001 stock and note offerings were false

1 1 and misleading. Accordingly, § 11 and § 10(b) claims were made against the Underwriter Defendants

12 in the FAC in connection with material misrepresentations and omissions contained in Exodus'

13 February 6, 2001 registration statements and prospectuses .

14 The FAC alleges that the February 6, 2001 offering documents were false and misleading for

15 representing that Exodus had achieved revenues of $280 .4 million for 4Q00, and $818.4 million for

16 FY00 . ¶¶58, 59. As alleged in detail throughout the FAC, these financial results were false and

17 misleading because Exodus had engaged in wrongful revenue recognition and accounting practices

1 8 in violation of GAAP, which served to artificially inflate Exodus' financial figures . The FAC alleges

19 that Exodus' financial results throughout the Class Period were inflated because, inter alia, the

20 Company was recording revenue in connection with non-creditworthy customers, ¶¶105-106, 179-

21 186, was recognizing revenue for customers who had canceled their orders, ¶11107-109, 161-178, was

22 recognizing revenue in connection with barter transactions, ¶¶111-112, 187-191, and was

23 recognizing revenue from customers even before they had been installed in an Internet Data Cente r

24 ("ID C") (¶¶113-114, 161-178).

25 The FAC also alleges that the offering documents were false and misleading for representin g

26 that Exodus had 4,500 customers under contract that it was serving. ¶¶58, 59. Contrary to

27 representations, the 4,500 number includedpotential customers identified by contacts with the sales

28 force, which were contained in Exodus' Siebel database . ¶129. However, Exodus' Solomon

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -4- S

1 database, which reflected the actual number of customers, showed that Exodus had only about 3,500

2 actual customers and, of those customers, over 1,000 were not active and had canceled. ¶1129-130.

3 The FAC further alleges that Exodus' February 6, 2001 registration statements and

4 prospectuses were false and misleading for emphasizing that Exodus had prominent customers, such

5 as iBeam Broadcasting Corporation ("iBeam"), Inktomi and Storagenetworks, without disclosing that

6 there were serious revenue recognition issues with these customers. ¶¶58, 59. Indeed, in a lawsuit

7 filed against Exodus by Storagenetworks (Exodus' fifth largest customer in North America),

8 Storagenetworks alleged that Exodus "has billed Customers that were not receiving service," "has

9 failed to pass onto Customers service credits issued by STOR," and "has engaged in manipulative

10 behavior in some of its past remittances to STOR by, for example, post-dating checks to STOR to

11 push them into the next quarter, so Exodus would have more favorable quarterly accounting

12 treatment." ¶122. Likewise, Exodus' customer, iBeam, in its lawsuit against Exodus, alleged that

13 Exodus' billing system "generated incorrect, duplicate or late invoices to iBeam ." ¶124.

14 Furthermore, according to a former Exodus employee, even though Exodus invoiced Inktomi

15 approximately $200,000 per month, only 50% of the charges were real ; and at quarter ends, Exodus

16 and Inktomi would swap invoices totaling $500,000 for no other reason than to fictitiously inflate

17 revenue . ¶171 .

18 The FAC also alleges that the offering documents were false and misleading for representing

19 that Exodus was "experiencing strong demand from the enterprise market" when, in actuality,

20 Exodus was not experiencing strong demand from the enterprise market. ¶¶58, 59. Indeed, the

21 Disclosure Statement filed by Exodus in bankruptcy court later admitted that one of the reasons for

22 Exodus' demise was because economic conditions had deteriorated by late 2000, and a substantial

23 number of Exodus' traditional enterprise clients had delayed or cancelled purchases . ¶141 . Also,

24 several former Exodus employees observed that by late 2000 and early 2001, Exodus' business was

25 suffering, and its business was not being supported through demand from enterprise customers .

26 ¶¶133-140 .

27 The FAC further alleges that the offering documents were false and misleading for

28 representing that Exodus' acquisition of GlobalCenter would enhance the Company . ¶158, 59. PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -5- 0 0

1 Defendants' representations about GlobalCenter were belied by certain undisclosed facts .

2 Unbeknownst to the public, Exodus' due diligence team, led by its Vice President of Business

3 Development, had strongly recommended against the acquisition of GlobalCenter . ¶146 . Exodus'

4 Board of Directors received reports from the due diligence team and was against the acquisition,

5 concluding that it would be too expensive and that the business model was "not a good fit for

6 Exodus." ¶146. Nevertheless, Exodus' CEO, Ellen Hancock, wanted GlobalCenter for its two IDCs

7 in Manhattan (one on 9th Avenue and another on 11th Avenue), which were considered "prime real

8 estate," but along with these two stellar Manhattan locations, came other GlobalCenter facilities,

9 some of which were largely empty. ¶146. The data centers in Tokyo, Sydney, and London and

10 pending openings in Paris and Munich all experienced substantial shortage in demand . ¶146. In

11 fact, shortly after the close of the GlobalCenter acquisition, Exodus decided to cancel the opening

12 of the Paris and Munich centers . ¶146.

13 Exodus' June 20, 2001 announcement, which revealed that Exodus' 2Q01 results would fall

14 short of management's guidance to analysts and the public, did not put plaintiffs on either actual or

15 inquiry notice of any of the foregoing. Nothing in Exodus' public disclosures indicated that certain

16 statements contained in Exodus' February 6, 2001 registration statements and prospectuses were false

17 and misleading. Nothing indicated that Exodus' publicly announced financial results during the

18 Class Period were false and misleading. Nothing indicated that the number of customers Exodus had

19 was actually substantially less than the number defendants had publicized . Nothing indicated that

20 Exodus had engaged in accounting shenanigans . And nothing indicated that Exodus' due diligence

21 team had recommended against the acquisition of GlobalCenter .

22 III. STANDARDS ON A MOTION TO DISMIS S

23 As the Court is already well aware, a complaint cannot be dismissed for failure to state a

24 claim "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his

25 claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957). The Court

26 may not test the evidence at this stage, but must accept the complaint's allegations as true and

27 construe them in the light most favorable to the plaintiffs . Heliotrope Gen . Inc. v. Ford Motor Co.,

28 189 F.3d 971, 978-79 (9th Cir . 1999). The issue is not whether the plaintiffs will ultimately prevail, PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -6- 0 [1

1 but whether the plaintiffs are entitled to offer evidence to support their claim. In re 2TheMart.com

2 Sec. Litig., 114 F. Supp . 2d 955, 959 (C.D. Cal. 2000). It is only under extraordinary circumstances

3 that dismissal is proper under Rule 12(b)(6) . Schlagel v. Learning Tree Intl, [ 1998 Transfer Binder]

4 Fed. Sec. L. Rep. (CCH) ¶90,403, at 91,813 (C.D . Cal . 1998) (citing United States v . Redwood City,

5 640 F.2d 963, 966 (9th Cir. 1981)).

6 IV. ARGUMENT

7 A. Plaintiffs' Claims Are Not Barred by the Statute of Limitation s 8 The statute of limitations governing §11 of the 1933 Act requires a plaintiff to file a

9 complaint within three years of offer or sale of a security or within one year of actual notice or

10 inquiry notice of an untrue of misleading statement . 15 U.S.C . §77m. The statute of limitations

11 governing § 10(b) of the 1934 Act and Rule I Ob-5 requires a complaint to be filed within one year

12 after the discovery of facts constituting the violation and within three years after such violation . 15

13 U.S .C. §78i(e); Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S . 350, 364 (1991) . 14 The Ninth Circuit has not yet determined whether the statute of limitations for § 10(b) and Rule 1 Ob-

15 5 requires actual discovery or inquiry notice . Berry v. Valence Tech ., Inc., 175 F.3d 699, 704 (9th

16 Cir. 1999) ("In this case, we need not decide whether actual discovery or inquiry notice applies . . . ."). 17 The Underwriter Defendants here argue that plaintiffs' claims are barred by the statute of

18 limitations . They argue that by at least June 21, 2001 - when Exodus' June 20 press release 19 disclosed that the Company would not meet its guidance for 2Q01, and negative analyst reports and

20 news articles were published on June 21 - that plaintiffs had actual notice and inquiry notice that

21 served to trigger the statute of limitations . The Underwriter Defendants are wrong .

22 As an initial matter, defendants bear the burdens of production and persuasion as to a statute

23 of limitations defense . Carley Capital Group v. Deloitte & Touche, L.L.P., 27 F. Supp. 2d 1324,

24 1341 (N.D. Ga. 1998) (citing Smith v. Duff & Phelps, Inc., 5 F.3d 488, 492 n.9 (l lth Cir. 1993)).

25 "It may be decided as a matter of law when the plaintiff discovered the alleged wrongdoing only

26 when uncontroverted evidence irrefutably demonstrates that plaintiff discovered or should have

27 discovered the fraudulent conduct." Lilley v. Charren, 936 F. Supp. 708, 714-15 (N .D. Cal. 1996)

28 (emphasis added) (citing Mosesian v. Peat, Marwick, Mitchell & Co ., 727 F.2d 873, 877 (9th Cir. PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -7- S 0

1 1984)) . "Otherwise, when a plaintiff discovered or should have discovered the fraud is a question

2 of fact." Lilley, 936 F. Supp . at 714 . 3 Even assuming that inquiry notice commences the statute of limitations for both the § 11 and

4 § 10(b) claims in this case, the date of "discovery" that commences the statute of limitations in a case

5 where a plaintiff has received inquiry notice is not the date that the duty of inquiry arises . Rather,

6 "'[a] plaintiff in a federal securities case will be deemed to have discovered fraud for the purposes 7 of triggering the statute of limitations when a reasonable investor of ordinary intelligence would have

8 discovered the existence of the fraud."' Rothman v. Gregor, 220 F.3d 81, 97 (2d Cir. 2000) (citing

9 Dodds v. Cigna Sec., 12 F.3d 346, 353 (2d Cir . 1993)) . "Misleading statements in the Prospectus

10 or other public statements, without an event that would reveal the misleading nature of the

11 statements, are not enough to put investors on inquiry notice ." Backhaus v. Streamedia

12 Communications, Inc ., [2002 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶91,964, at 90,587

13 (S .D .N.Y. 2002) (emphasis added) .

14 The most recent Ninth Circuit decision dealing with the statute of limitations in a securities

15 class action is Valence, 175 F.3d 699. In Valence, the Ninth Circuit reversed the district court's

16 granting of summary judgment for defendants on the statute of limitations issue where defendants

17 had argued that a Forbes publication, which raised questions about the viability of Valence's product,

18 was sufficient to trigger the statute of limitations . In finding that the Forbes article did not trigger

19 the statute of limitations under either the actual discovery or inquiry notice standard, the Ninth

20 Circuit noted that "[w]hile an investor need not have full knowledge of fraud in order reasonably to

21 be expected in investigate worrisome allegations concerning his investments, he will not be

22 presumed to have done so unless the allegations are sufficient to 'excite inquiry into the possibility

23 of fraudulent conduct." Valence, 175 F.3d at 704 (citing Sterlin v. Biomune Sys., Inc., 154 F .3d

24 1191, 1203 (10th Cir . 1998)). According to Valence, even under the inquiry notice standard, "there

25 must be some reasonable nexus between the allegations made in the article and the nature of the

26 action subsequently brought ." Valence, 175 F.3d at 705 . Further, if the inquiry notice standard

27 applied, the Court would have to resolve (1) whether the event or publication raised sufficient

28 suspicion of fraud to cause a reasonable investor to investigate the matter further and (2) when a

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -8- 0

1 reasonably diligent investor should have discovered the facts underlying the alleged fraudulent

2 activity. Id.

3 The standard set forth in Valence was applied in In re Splash Tech. Holdings Sec. Litig.,

4 [2000-2001 Transfer Binder] Fed . Sec. L. Rep. (CCH) ¶91,249, at 95,354-55 (N .D. Cal. 2000).

5 There, the district court held that plaintiffs' claims were not barred by the statute of limitations

6 because even though "storm clouds" - the company's announcement of problems combined with a

7 21 % decline in Splash's stock - invoked a duty to inquire (the first prong in the test set forth in

8 Valence), they did not commence the running of the statute of limitations because the analysis does

9 not end with that finding . Splash, ¶91,249, at 95,355 . Rather, the analysis ends with an assessment

10 of when a reasonable investor should have discovered the facts underlying the alleged fraudulent

11 activity (the second prong of the Valence test). Id.

12 In the case at bar, the statute of limitations did not begin to run on June 21, 2001 because

13 there were no public events or announcements that put investors on inquiry notice of the false and

14 misleading statements contained in Exodus' February 6, 2001 registration statements and

15 prospectuses . The June 20, 2001 Exodus announcement and the June 21, 2001 analyst reports and

16 news articles, concerned the fact that Exodus would miss its 2Q01 guidance . These announcements

17 and articles put plaintiffs on inquiry notice that Exodus' business was not as rosy as defendants had

18 portrayed in 2Q01, and plaintiffs' original complaints and consolidated complaint were timely filed

19 to address those issues . However, the events of June 20 and June 21 did not put plaintiffs on inquiry

20 notice that Exodus had engaged in financial shenanigans, that Exodus' published financial statements

21 were false and misleading, that Exodus' officers/directors did not truly believe the GlobalCenter

22 acquisition would enhance the Company, or that the number of customers defendants represented

23 Exodus had was inaccurate . These undisclosed facts were never made public, and could not have

24 been discovered by plaintiffs through the exercise of reasonable diligence - particularly since

25 plaintiffs were prohibited from conducting discovery pursuant to the discovery stay of the PSLRA,

26 and the defendants who were in control of the documents were concealing the true facts . It took

27 months of investigation and interviewing internal sources for plaintiffs to discover these new facts

28 and to determine that additional statements (those statements contained in Exodus' February 6, 2001

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -9- 0 0

1 offering documents), which were not included in the original complaints and the consolidated

2 complaint, had been false for which Underwriter Defendants may be held liable . Under these

3 circumstances, plaintiffs' claims are not barred by the statute of limitations .

4 There was nothing in the June 20, 2001 Exodus announcement and the June 21, 2001 analyst

5 reports and news articles that would suggest to plaintiffs that certain of the statements contained in

6 Exodus' February 6, 2001 offering documents were false and misleading, and that the Underwriter

7 Defendants may therefore be implicated. The information available to plaintiffs at the time of filing

8 their original complaints and their consolidated complaint did not suggest the Underwriter

9 Defendants' potential liability . Indeed, in Rothman, 220 F.3d at 96-98, the appellate court reversed

10 the district court's finding that claims against auditor Arthur Andersen LLP ("Andersen") were time

11 barred, where plaintiffs' amended complaint added Andersen as a new defendant more than a year

12 after the filing of the original complaint . The appellate court held that the facts alleged in the

13 original complaint could not have constituted actual notice of Andersen's fraud because key

14 information was missing, and remanded the issue to the district court for fact finding of when

15 plaintiffs, in the exercise of reasonable diligence, should have discovered facts underlying their fraud

16 claim against Andersen . Likewise, in Antell v. Arthur Andersen LLP, No. 97 C 3456, 1998 U .S .

17 Dist. LEXIS 7183 (N .D . Ill. May 4,1998), the court denied an accounting firm's motion to dismiss

18 on statute of limitations grounds because it found that plaintiffs should not be charged with inquiry

19 notice until they knew or should have known that the defendant acted with scienter . Similarly, in

20 In re Ames Department Stores, Inc. Note Litig., 991 F.2d 968 (2d Cir . 1993), the appellate court

21 found that the publication of negative news articles and analysts' reports, a decline in the stock price,

22 the announcement by the defendant that it expected to post a year-end loss, and the filing of a fraud

23 complaint by holders of common stock in the company, did not trigger the statute of limitations

24 because the class action by common stockholders did not put plaintiff bondholders on notice of their

25 own fraud claims, and the factual claims made in the bondholders' complaint were more complex

26 than those made in the initial stockholders' complaint.

27 The case cited by the Underwriter Defendants, Caprin v. Simon Transportation Services, Inc.,

28 112 F . Supp . 2d 1251 (D . Utah 2000), is inapposite. Caprin apparently involved a second amended

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC _10- 0 0

1 complaint that was substantially similar to the first amended complaint, where the core allegations

2 regarding accident reserves appear to have been publicly disclosed, and reasonable investigation

3 would have uncovered the 1933 Act claims . 112 F. Supp. 2d at 1256. Here, in contrast, plaintiffs

4 were not on notice of the types of fraud involved in this case until an extensive informal

5 investigation, conducted without the advantages of formal discovery, disclosed them . There was no

6 way that plaintiffs would have discovered the new facts alleged in the FAC based on the public

7 information available .

8 Furthermore, various courts have cautioned that, in analyzing the statute of limitations issue,

9 the inquiry notice doctrine should not be applied too broadly . In Law v. Medco Research, 113 F.3d

10 781 (7th Cir. 1997), the court, in an opinion written by the highly respected Judge Richard Posner,

11 held that the statute of limitations did not begin to run, even if there were grounds for suspicion,

12 where the plaintiff did not have sufficient access to the information necessary to state a cause of

13 action for securities fraud . Id. at 786. The court warned that too much emphasis on the statute can

14 precipitate premature and groundless suits, as plaintiffs rush to beat the deadline without being able

1 5 to obtain good evidence of fraud, and noted that the three-year statute of repose gives defendants a

16 definite limit beyond which they needn't fear being sued . Id. Similarly, in Fujisawa Pharm. Co. v.

17 Kapoor,115 F.3d 1332 (7th Cir . 1997), the court cautioned that inquiry notice must not be construed

18 too broadly such that the statute of limitations starts running too soon for the victim of the securities

19 fraud to be able to bring suit within a year. Id. at 1335 . The court explained that "the facts

20 constituting such notice must be sufficiently probative of fraud - sufficiently advanced beyond

21 the stage of a mere suspicion, sufficiently confirmed or substantiated - not only to incite the

22 victim to investigate but also to enable him to tie up any loose ends and complete the investigation

23 in time to file a timely suit." Id. (emphasis added). The court noted that Rule 9(b) requires that

24 fraud be pled with particularity, and that Rule 11 provides sanctions for making allegations without

25 evidentiary support. Id. Therefore, inquiry notice requires that the suspicious circumstances place

26 the potential plaintiff in possession of, or with ready access to, the essential facts that he needs in

27 order to be able to sue. Id. at 1337.

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -11- ! r

1 The well-reasoned opinions in Law and Fujisawa Pharm. are particularly applicable to this

2 case. While Exodus' June 20, 2001 announcement puts plaintiffs on notice of defendants' fraudulent

3 misrepresentations about Exodus' business conditions and prospects in 2Q01, they did not put

4 plaintiffs on notice that other statements made prior to 2Q01 - including financial statements,

5 statements about Exodus' GlobalCenter acquisition, and statements about the number of customers

6 Exodus had - may have also been false and misleading . Plaintiffs were stayed from conducting

7 discovery and were severely limited in their ability to conduct a thorough investigation, and could

8 not have discovered these additional misrepresentations and omissions through reasonable exercise

9 of due diligence . As a practical matter, "many large frauds unfold gradually : the first hints may be

10 troubling, but do not clearly indicate either the nature or extent of the wrongdoing. The realization

11 that a lawsuit is necessary and appropriate does not come immediately." See Capitol Hill Hearing

12 Testimony: Accounting Industry Oversight Board, 107th Cong., 2d Sess. (April 9, 2002) (testimony

13 of Prof. Donald C. Langevoort, Georgetown University Law Center Before the Committee on

14 Financial Services).

15 In fact, recognizing the problem with the one-year statute of limitations, Congress recently

16 extended the limitations period . The Sarbanes-Oxley Act of 2002, P . L. 107-204 §804,116 Stat. 745

17 (2002), enacted on July 30, 2002, extends the statute of limitations for "a private right of action that

18 involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory

19 requirement concerning the securities laws" to two years after the discovery of the facts constituting

20 the violation, or five years after such violation. The Sarbanes-Oxley Act was enacted because public

21 companies like Enron Corp . ("Enron") and WorldCom, Inc . ("WorldCom") had been able to

22 successfully conceal their fraud from investors. As a result, "our capital markets, the most respected

23 in the world, have suffered a series of blows, mostly self-inflicted, which have led to the loss of

24 literally trillions of investor dollars ." Capitol Hill Hearing: Conference Report on Corporate

25 Responsibility Legislation, Federal News Service (July 24, 2002) (statement of Representative

26 Michael Oxley, Chairman, House Financial Services Committee) . Here, defendants pulled the wool

27 over Exodus investors' eyes, and concealed information that would not have been discovered except

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -12- 0 r

1 through an extraordinary investigation . Defendants should not be rewarded for successfully

2 concealing the fraud .

3 B. Plaintiffs Have Adequately Alleged the Section 11 Claim

4 1. Plaintiffs Have Not Attempted to Appoint Additional Lead Plaintiffs 5 The Underwriter Defendants, in an attempt to dismiss the § 11 claims against them, argue that 6 plaintiffs' counsel have inappropriately appointed Martin Fox and Thomas Welch as lead plaintiffs 7 without authorization by the Court . This argument is without merit . 8 Importantly, the FAC neither designates nor identifies Fox and Welch as "lead plaintiffs ." 9 Fox and Welch are simply "plaintiffs" who, respectively, purchased notes issued in connection with 10 Exodus' February 6, 2001 notes offering, and purchased shares traceable to Exodus' February 6, 2001 11 secondary offering . No statute or rule prohibits them from being named as such in the FAC . Even 12 assuming that including Fox and Welch as additional plaintiffs in the FAC somehow makes them 13 "lead plaintiffs," this is not an issue the Underwriter Defendants can raise, since issues concerning 14 the designation of lead plaintiffs is an issue that can only be raised by another plaintiff . See 15 15 U.S.C. § 78u-4(a)(3)(B)(iii)(II). Furthermore, whether Fox and Welch are or are not lead plaintiffs 16 has no bearing on this motion to dismiss. A motion to dismiss is designed to test the adequacy of 17 the pleading . See Fed. R. Civ. P. 12(b)(6). It has nothing to do with designation of the lead plaintiff 18 pursuant to the PSLRA, which was designed to take place at the very early stages of the litigation 19 in order to "'increas[e] the likelihood that parties with significant holdings in issuers, whose interests 20 are more strongly aligned with the class of shareholders, will participate in the litigation and exercise 21 control over the selection and actions of plaintiffs counsel ."' In re Cavanaugh, 306 F.3d 726, 737 22 (9th Cir. 2002) (citing Conf. Rep. 32). 23 Here, the Court has already appointed Michael Klein, Teresi Trucking, Inc., and William H. 24 Friedman as lead plaintiffs to monitor the case . See Order Granting Motion to Appoint Michael 25 Klein, Teresi Trucking, Inc., and William H. Friedman as Lead Plaintiff Pursuant to Section 26 21(D)(a)(3)(B) of the Securities Exchange Act of 1934 and Approving Lead Plaintiffs Choice of 27 Counsel, entered on October 29, 2001 . Appointment of these persons as lead plaintiffs resulted from 28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - 13 - s E

1 the fact that the lead plaintiff procedures set forth in the PSLRA were properly followed, including

2 the timely publication of a notice informing the public that a class action was being brought on

3 behalf of those who purchased Exodus' securities . See Notice of Publication, filed on July 30, 2001 .

4 Based on the procedure set forth in the PSLRA, there are now lead plaintiffs to oversee the case .

5 The appointment of lead plaintiffs in this case by the Court, however, does not preclude

6 additional plaintiffs from coming forward . Fox and Welch are merely additional plaintiffs who have

7 come forward to assert new claims against new defendants . This does not make them the lead

8 plaintiffs, or change the fact that the Court has already appointed certain persons as lead plaintiffs

9 to monitor this action . Moreover, no additional notices pursuant to the lead plaintiff provision of

1 0 the PSLRA need be published, because the PSLRA does not require the publication of additional

1 1 notices after an initial notice of the class action has already been published . See 15 U.S .C. §78u-

12 4(a)(3)(A)(i) . Further, Fox and Welch are not required to file plaintiff ce rtifications, since the

13 PSLRA does not so require the filing of plaintiff ce rtifications with an amended complaint . See 15

14 U.S .C. §78u-4(a)(2).3

15 Fox and Welch need not be designated lead plaintiffs in order to be named as additiona l

16 plaintiffs or to serve as class representatives . The criteria set forth in the PSLRA for the selection

17 of lead plaintiff is largely predicated upon determining who, among those moving to serve as lead

18 plaintiff, has the greatest financial interest in the case . 15 U.S.C. §78u-4(a)(3)(B)(iii)(I) . Indeed, it

1 9 would be anomalous for a court to select a lead plaintiff, based on the financial interest criteria set

20 forth in the PSLRA, only to have the class action derailed because of the selected lead plaintiffs

21 inability to represent all members of the class . That is why it is perfectly appropriate, as here, for

22 lead plaintiffs to include additional non-lead plaintiffs in order to ensure that all members of the class

23 will be represented . For example, in In re Independent Energy Holdings PLC, Sec . Litig., [2002

24 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶91,920 (S .D.N.Y. 2002), the designated lead plaintiffs

25 requested that a non-lead plaintiff be certified as the class representative for the § 11 claim . In

26

27 3 Nevertheless, if the Court requests, plaintiffs will submit Fox's and Welch's plaintiff 28 certifications. PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -14- 1 certifying the non-lead plaintiff as a class representative, the court recognized the distinction between

2 the functions of a lead plaintiff and the class representative :

3 A lead plaintiff is not synonymous with a class representative, and in the ordinary course of litigation the class representative will not appear on the scene until long 4 after the lead plaintiff. No lead plaintiff is compelled to serve as a clas s representative. While the PSLRA defines the qualifications and selection process for 5 lead plaintiff, the class representative is selected not pursuant to the PSLRA, but pursuant to Rule 23 . 6 Independent Energy, ¶91,920, at 90,249 (citing In re Oxford Health Plans, Inc. Sec. Litig., 199 7 F.R.D. 119, 125 (S .D.N.Y. 2001)). The PSLRA does not require that only appointed lead plaintiffs 8 serve as class representatives, or vice versa . Fox and Welch may be class representatives without 9 being appointed lead plaintiffs. 10 2. Plaintiffs Have Standing to Assert the Section 11 Claim 11 Section 11 provides that where a material fact is misstated or omitted from a registration 12 statement, "any person acquiring such security" may bring an action for losses caused by the 13 misstatement or omission . 15 U.S.C. § 77k(a). Standing to sue under §11 is not only limited to 14 those who bought on the offering, but extends to aftermarket purchasers as well . Hertzberg v. 15 Dignity Partners, Inc., 191 F .3d 1076 (9th Cir. 1999). 16 Fox and Welch have standing to assert the § 11 claim here . The FAC alleges that plaintiff 17 Fox purchased notes issued in connection with Exodus' February 6, 2001 note offering, and alleges 18 that plaintiff Welch purchased Exodus shares traceable to Exodus' February 6, 2001 secondary public 19 offering. ¶9. The standing requirement is satisfied because plaintiffs have alleged that their 20 securities were purchased in the public offerings or were traceable to the public offerings at issue. 21 15 U.S.C. § 77k(a). These allegations are sufficient at this stage of the litigation . 22 In In re Chambers Dev. Sec. Litig., 848 F. Supp. 602, 624 (W .D. Pa. 1994), the court denied 23 a motion to dismiss, holding that "[p]laintiffs are not required, at this stage, to trace each of their 24 Chambers securities purchases to the Registration Statements, but they are required to allege that 25 they purchased pursuant to the public offerings or that their securities are traceable to those offerings 26 Similarly, in In re Sterling Foster & Co. Sec. Litig., 222 F. Supp. 2d 216, 247-48 (E .D .N.Y. 27 2002), the court rejected defendants' arguments that plaintiffs could not trace their shares back to the 28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - 15 - 0 0

1 secondary offering because this issue pertains to the merits of the § 11 claim rather than to standing,

2 and cannot be resolved at the pleading stage of the litigation . Likewise, in In re AES Corp. Sec.

3 Litig., 825 F. Supp. 578, 592 (S.D .N.Y. 1993), the court held that "[s]ince plaintiffs have alleged that

4 their securities were purchased in AES's public offerings or were traceable to the public offerings

5 at issue, they have standing to bring these claims under sections 11 and 12(2) ." Because plaintiffs

6 are entitled to trace their shares back to the offering, but need not do so at this stage of the litigation,

7 the Underwriter Defendants' motion to dismiss the § 11 claim must be denied.

8 Furthermore, even without Fox and Welch, the lead plaintiffs who were appointed by the

9 Court are able to represent securities purchasers in the § 11 claim. Here, defendants'

10 misrepresentations and omissions harmed those who purchased Exodus' common stock in the

11 aftermarket as well as those who purchased Exodus' securities pursuant to its registration statements

12 and prospectuses by artificially inflating the prices of all of these securities . Lead plaintiffs have

13 standing to assert claims on behalf of all securities purchasers because they all have an interest in

14 proving that defendants issued false and misleading statements. Their interests are clearly aligned.

15 See, e.g., Freeland v . Iridium World Communications, Ltd., et al., No. 99-1002, slip op . at 3 (D.D .C .

16 Mar. 15. 2001) (declining to appoint separate lead plaintiffs for note and stock purchasers because

17 "the interests of purchasers of both common stock and notes are directly aligned as to the remaining

18 defendants because the seminal issue to be proven- whether these defendants disseminated false and

19 misleading information about Iridium's product- is common to all purchasers of Iridium securities")

20 (attached as Exhibit A to the Declaration of John K . Grant, filed herewith.).

21 3. Rule 9(b) Is Inapplicable to the Section 11 Claim

22 Plaintiffs' § 11 claim has been adequately pled. "Civil liability under Section 11 [of the 1933

23 Act] was designed . . . to promote enforcement of the Act and to deter negligence by providing a

24 penalty for those who fail in their duties ." Eichenholtz, 52 F.3d at 485 . Section 11 imposes liability

25 on underwriters and others "[i]n case any part of [a] ... registration statement ... contain[s] an untrue

26 statement of a material fact or omit[s] to state a material fact required to be stated therein or

27 necessary to make the statements therein not misleading ." 15 U.S .C. §77k(a) . To plead a prima

28 facie § 11 claim, plaintiffs only need allege "a material misstatement or omission in a registration PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -16- C C

1 statement ." Herman & MacLean, 459 U.S. at 382; Kaplan, 49 F.3d at 1371 . Section 11 imposes

2 strict liability, such that defendants are liable for innocent or negligent material misstatements or

3 omissions. Id. Furthermore, scienter, reliance and causation are not elements of a § 11 claim . Id.

4 Because of the lenient pleading requirements for a § 11 claim, the Underwriter Defendants'

5 attempt to evade liability by arguing that the heightened pleading requirements of Rule 9(b) apply

6 to the § 11 claim, and that the § 11 claim "sounds in fraud" because a § 10(b) claim is also alleged in

7 the FAC. However, Rule 9(b) does not apply to the § 11 claim here .

8 In Herman & MacLean, 459 U.S. 375, the Supreme Court held that the availability of an

9 express remedy under the 1933 Act (§11) against one who includes a falsehood or misleading

10 information in his registration statement does not preclude a defrauded purchaser of stock from

11 maintaining an action under the 1934 Act (§ 10(b)) . In reaching this decision, the Supreme Court

12 examined legislative history, and concluded that Congress intended for cumulative remedies under

13 the 1933 Act and the 1934 Act in order to afford broad protection to investors, as "[i]t would be

14 anomalous indeed if the special protection afforded to purchasers in a registered offering by the 1933

15 Act were deemed to deprive such purchasers of the protections against manipulation and deception

16 that § 10(b) makes available to all persons who deal in securities ." Herman & MacLean, 459 U.S.

17 at 383. Accordingly, because these remedies were intended to be cumulative, it would be

18 nonsensical to transform the lenient pleading requirements for the § 11 claim into one requiring more

19 stringent pleading simply because a § 10(b) claim is also alleged in the same complaint .

20 The foregoing interpretation also comports with Fed . R. Civ. P . 8(e)(2), which permits

21 pleading of alternative claims . Under Rule 8(e)(2), plaintiffs may pursue both non-fraud and fraud

22 claims in a single action without converting the entire action into a fraud claim .' Indeed, in In re

23 24 4 Rule 8(e)(2) states:

A party may set forth two or more statements of a claim or 25 defense alternately or hypothetically, either in one count or defense or in separate counts or defenses . When two or more statements are 26 made in the alternative and one of them if made independently would be sufficient, the pleading is not made insufficient by the 27 insufficiency of one or more of the alternative statements. A party may also state as many separate claims or defenses as theparty has 28 regardless of consistency and whether based on legal, equitable, or PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC - 17 - 9 C

1 NationsMart Corp. Sec. Litig.,130 F.3d 309, 316 (8th Cir .1997), the appellate court, in finding that

2 the § 11 allegation was sufficiently pled, stated

3 even if the plaintiffs were alleging fraudulent conduct under §11, as the defendants argue in their brief, any such allegation would be mere surplusage . 4 The only consequence of a holding that Rule 9(b) is violated with respect to a § 1 1 claim would be that any allegations of fraud would be stripped from the claim . The 5 allegations of innocent or negligent misrepresentation, which are at the heart of a § 11 claim, would survive . The plaintiffs' case should not have been dismissed becaus e 6 they alleged more than was necessary to recover under §11 of the Securities Act.

7 Id. at 315 (emphasis added) . See also In re Valence Tech . Sec. Litig., [1995 Transfer Binder] Fed.

8 Sec. L. Rep. (CCH) ¶98,793, at 92,798 (N .D. Cal. 1995) (with respect to § 11, "plaintiffs do satisfy

9 Rule 8(a)(2) which provides that a pleading which sets forth a claim for relief shall contain'a short

10 and plain statement of the claim showing that the pleader is entitled to relief") (citation omitted) .

11 The Congressional intent not to heighten the pleading requirements to § 11 claims was

12 reaffirmed when Congress, in 1995, enacted sweeping reforms to securities laws with the PSLRA .

13 In the PSLRA, Congress chose not to change the pleading requirements for § 11 of the 1933 Act .

14 Congress, which was presumably aware of the lenient pleading standards for § 11 under the 1933 Act,

15 did not create any "particularity provision" for pleading 1933 Act claims and chose not to heighten

16 these pleading standards, as it did with the 1934 Act claims .

17 The Underwriter Defendants' reliance on In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir .

18 1996), is misplaced. Stac was a pre-PSLRA case, and did not deal with the fact that the PSLRA

19 applied heightened pleading requirements to only 1934 Act claims (§ 10(b) claims), not to 1933 Act

20 claims (§11 claims). As stated above, if Congress, in enacting the PSLRA, intended heightened

21 pleading requirements to apply to 1933 Act claims, it would have included such a provision in the

22 PSLRA. Since Congress chose not to do so, this demonstrates that Congress did not intend for such

23 requirements to be applied to 1933 Act claims . Furthermore, Stac is distinguishable because in Stac,

24 the underwriters, who were also named defendants, were alleged to have disseminated, apart from

25 the prospectus, false and misleading information about the company through "roadshow"

26

27 maritime grounds....

28 (Emphasis added .) PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -18- 0

1 presentations, analyst reports and other documents . 89 F.3d at 1402. In contrast, here, plaintiffs did

2 not allege that the Underwriter Defendants made any false statements aside from those contained in

3 the registration statements and prospectuses from which the § 11 claim is derived . See ¶¶21-24.

4 Indeed, in the Underwriter Defendants' motion to dismiss, the Underwriter Defendants themselves

5 recognized that the FAC "does not describe in any respect the Underwriters' supposed role in [the]

6 'scheme' at any point during the 17-month-long purported class period, other than reciting that they

7 acted as underwriters in the February 6, 2001 offerings ." Notice of Motion and Motion of

8 Underwriter Defendants Goldman, Sachs & Co ., Merrill Lynch & Co ., Morgan StanleyDean Witter,

9 and J.P. Morgan to Dismiss the First Amended Consolidated Complaint ; and Memorandum of Points

10 and Authorities at 3 . That is precisely why Rule 9(b) does not apply.

11 The thrust of plaintiffs' § 11 claim is that the registration statements contained untrue

12 statements of material fact and omitted to state other facts necessary to make the statements made

13 not misleading . See ¶¶58-60. Plaintiffs have separated their § 10(b) and the § 11 counts, and the

14 fraud allegations only appear in the § 10(b) count but not the § 11 count . See ¶11209-219. In

15 Kensington Capital Management v. Oakley, Inc., [1999 Transfer Binder] Fed. Sec. L. Rep. (CCH)

16 ¶90,411 (C .D. Cal. 1999), the court rejected underwriters' argument that plaintiffs' §11 claim was 17 grounded in fraud because the complaint did not allege that the statements contained in the offering

18 were made fraudulently or with intent to deceive. Similarly, inIn re Southern Pacific Funding Corp.

19 Sec. Litig., 83 F. Supp. 2d 1172, 1176 (D. Or. 1999), the court rejected the argument that the §11 20 claim was subject to Rule 9(b) where the complaint "fairly alleged a claim that defendants included

21 false information in the [registration statement]." Furthermore, in In re Consumers Power Co . Sec.

22 Litig., 105 F.R.D. 583 (E.D . Mich. 1985), the court refused to apply Rule 9(b) pleading standards

23 to the § 11 claim where the plaintiffs had separated their claims into distinct counts at the end of the

24 complaint.

25 Even if Rule 9(b) did apply here, plaintiffs' claims are more than adequate . In a securities

26 class action, a pleading is sufficient under Rule 9(b) "'if it identifies the circumstances of the alleged

27 fraud so that defendants can prepare an adequate answer ."' Warshaw v. Xoma Corp., 74 F.3d 955,

28 960 (9th Cir. 1996) (citing Kaplan, 49 F.3d at 1370). Moreover, "the scienter requirement of Rule PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -19- a

1 9(b) does not apply to Section 11 claims, as such claims may be based on negligent or innocent

2 misstatements or omissions."' Stac, 89 F.3d at 1405 n.3 . Here, the FAC has identified the time,

3 place and nature of what was false or concealed, and has explained the reasons why they are false

4 and misleading. See In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548 (9th Cir . 1994).

5 Accordingly, the Rule 9(b) requirement is satisfied .

6 C. The Underwriter Defendants May Be Held Liable for Section 10(b) and Rule 10b-5 Violation s 7 In addition to being held liable for violations under § 11 of the 1933 Act, the Underwriter 8 Defendants may also be held liable for § 10(b) and Rule I Ob-5 violations . Section 10(b) makes it 9 unlawful for "any person" to use or employ any manipulative or deceptive device or contrivance in 10 connection with the purchase or sale of any security. 17 C .F.R. §240.1Ob-5 . Underwriters are 11 included among the persons who may be held liable as long as they either (i) employed any device, 12 scheme or artifice to defraud; (ii) made any untrue statement of material fact or omitted to state a 13 material fact necessary in order to make the statements made not misleading ; or (iii) engaged in any 14 fraud or deceit. Id. "An underwriter by participating in an offering constructively represents that 15 statements made in the registration materials are complete and accurate . . . . The representations in the 16 registration statements are those of the underwriter as much as they are those of the issuer ." In re 17 MTC Elec. Techs. Shareholder Litig., 993 F. Supp. 160, 162 (E.D.N.Y. 1997) (citing Chris-Craft, 18 480 F.2d at 370) . The underwriter's role in a public offering supports primary liability under § 10(b) . 19 MTC Elec., 993 F. Supp. at 162. 20 The Underwriter Defendants, however, argue that plaintiffs have not adequately pled the 21 § 10(b) and Rule 1 Ob-5 claims against them . First, they argue that plaintiffs have not adequately 22 demonstrated why the statements contained in the offering documents were false and misleading 23 when made. Second, they argue that plaintiffs have not adequately alleged the Underwriter 24 Defendants' knowledge with respect to a particular forward-looking statement . Third, they argue 25

26

27 5 According to the PSLRA, scienter need be alleged only for claims in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind. 15 28 U.S.C. §78u-4(b)(2) . PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -20- 0

1 plaintiffs have not alleged facts demonstrating the Underwriter Defendants acted with "deliberate

2 recklessness." Plaintiffs disagree with all of these contentions .

3 1 . The FAC Adequately Alleges the Reasons Why Statements Contained in the Offering Documents Were False and 4 Misleading When Made

5 a. Statement Concerning GlobalCente r

6 Plaintiffs have adequately alleged that defendants' statement in the February 6, 2001

7 registration statements and prospectuses that "[w]e believe that the acquisition [of GlobalCenter]

8 enhances our global Internet Data Center infrastructure, strengthens our network, our customer

9 support, sales and professional services organizations, and expands our customer base" - was false

10 and misleading when made . Plaintiffs have alleged sufficient facts indicating that defendants did 11 not truly believe the statement they made, and that this statement was false and misleading for failing

12 to disclose that Exodus' internal due diligence team had strongly recommended against the

13 acquisition of G1obalCenter; that Exodus' Board of Directors was against the acquisition (concluding 14 it would be too expensive and that the business model was "not a good fit" for Exodus) ; that

15 GlobalCenter's data centers in Tokyo, Sydney, and London and pending openings in Paris and

16 Munich all experienced substantial shortage in demand ; and that the GlobalCenter acquisition was

17 nevertheless pushed through by CEO Hancock because she wanted GlobalCenter for its two IDCs

18 in Manhattan which were considered "prime real estate ." ¶146. These undisclosed public facts, as

19 set forth in the FAC, adequately explain why defendants' positive statement about the GlobalCenter

20 acquisition was false and misleading when made . See In re Apple Computer Sec. Litig., 886 F.2d

21 1109, 1113 (9th Cir. 1989) (a statement is actionable if (1) the statement is not genuinely believed,

22 (2) there is no reasonable basis for the belief, or (3) the speaker is aware of any undisclosed facts

23 tending to seriously undermine the accuracy of the statement) .

24 Plaintiffs have also sufficiently provided a basis for their beliefs about the GlobalCenter

25 acquisition. Contrary to defendants' contention that information obtained about GlobalCenter from

26 Confidential Witness No . 8 ("CW8") is unreliable, the facts are to the contrary . CW8 had reason to

27 inquire about the GlobalCenter acquisition in the course of her employment because CW8 was in

28 charge of integrating the GlobalCenter acquisition within the Marketing Department . ¶104(i). CW8 PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -21- 1 specifies that by speaking to the Vice President of International Operations who worked on the due

2 diligence of GlobalCenter, she learned the circumstances surrounding the acquisition . ¶146 . CW8

3 has provided the titles of Exodus employees involved in conducting the due diligence on

4 GlobalCenter, identified which specific GlobalCenter data centers were suffering from a shortage

5 in demand, and described with particularity the reasons why Hancock wanted to acquire

6 GlobalCenter . The details of CW8's information, combined with the fact that another witness saw

7 the decline of Exodus accelerate immediately after the GlobalCenter acquisition, ¶140, and that the

8 Company's own Form 10-Q later acknowledged the decline of Exodus' IDC utilization rates was due

9 in part to the acquisition of GlobalCenter, ¶147, further serve to confirm the information provided

10 by CW8 . See In re Cabletron Systems, No . 01-1965, 2002 U.S. App. LEXIS 23372, at *34 (1st Cir.

11 Nov. 12, 2002) (finding information provided by confidential sources sufficient where the

12 information provided not conclusory allegations of fraud, but specific details) .

13 b. The Financial Statements

14 Defendants contend that Exodus' financial results could not have been false and misleading

15 because they were audited by KPMG LLP ("KPMG") . As the public has seen through the financial

16 fiascos of Enron (restating financial statements for 1997 through the first two quarters of 2001,

17 reducing shareholders' equity by $1 .2 billion), WorldCom (restating approximately $9 billion in

18 revenue affecting financial results from at least early 1999 through the first quarter of 2002), and

19 Adelphia Communications (restating financial results for 1999 through 2001, reducing shareholders'

20 equity by $3 .5 billion), outside auditors' certifications of financial results are no guarantee of the

21 accuracy of a company's financial results. Here, just because KPMG certified Exodus' financial

22 results for fiscal 2001, it does not mean there were no accounting shenanigans that served to

23 artificially boost Exodus' financial results. Furthermore, KPMG did not audit or certify Exodus'

24 financial results for fiscal 2002 because the Company filed for bankruptcy prior to year-end .

25 In Aldridge v . A.T. Cross Corp ., 284 F.3d 72 (1st Cir. 2002), the appellate court recognized

26 that accounting fraud can occur even though the company did not restate any of its financials .

27 According to the appellate court:

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-O1-2661-MMC -22- F 0 0

1 The company argues that because it has never restated any of its financials or otherwise indicated any error in the 1998 financial statements, and because it s 2 financial statements were audited by an independent accounting firm, no inference of accounting error, and so no inference of scienter, can be drawn . We disagree. Had 3 the 1998 financials been restated, that might well have been useful to Aldridge . However, the fact that the financial statements for the year in question were not 4 restated does not end Aldridge's case when he has otherwise met the pleading requirements of the PSLRA. To hold otherwise would shift to accountants the 5 responsibility that belongs to the courts . It would allow officers and directors of corporations to exercise an unwarranted degree of control over whether they are sued, 6 because they must agree to a restatement of the financial statements .

7 Id. at 83. Similarly, here, KPMG's certification of Exodus' fiscal 2001 financial results, and the lack

8 of restatements, prove nothing.

9 The Underwriter Defendants also argue that the FAC has not been adequately pled because

10 plaintiffs have not identified the amounts by which Exodus' financial statements have been

11 overstated. Nonsense. The FAC, in fact, does provide such figures . Taking into account

12 information provided by witnesses and documents indicating that Exodus was recording revenue

13 prior to installation and was recording revenue on canceled and terminated contracts, and that

14 Exodus reported $96 million in bad debt reserved as of June 30,200 1, plaintiffs allege that there was

15 at least $171 million of fraudulent revenue recognized during the first six months of 2001 . ¶¶161-

16 178. Plaintiffs also allege that, based on information that Exodus was recording revenue on contracts

17 where collectibility was not reasonably assured, and an internal March 2001 reserve report that

18 reflected 40% of the overall accounts receivable as uncollectible, the Company should have taken

19 an additional charge of $56 million for the year ended December 31, 2000, or an additional charge

20 of $52 million as of June 30, 2001 . ¶¶179-186 . The FAC further alleges other improper accounting

21 practices at Exodus with particularity, including barter transactions and the recording of fictitious

22 cash receipts throughout the Class Period . ¶¶187-192 . Even if the FAC had failed to identify

23 specific figures regarding the amount that was misstated, the FAC is sufficient as long as it

24 adequately alleges improper accounting practices that served to artificially inflate Exodus' financial

25 results . See Aldridge, 284 F.3d 72 (holding that district court erred when it dismissed the action in

26 part due to the complaint's failure to identify specific figures regarding which transactions were

27 misstated and by what amounts) ; Cabletron, 2002 U.S . App. LEXIS 23372, at *16 (allegations

28 sufficient even absent the identification of specific figures because "[i]t is not difficult to conclude PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -23- 1 that such [improper revenue recognition] practices, if they went on, certainly add up to fraudulent

2 and material misstatement") .

3 c. Statements Concerning Deman d

4 Plaintiffs have provided sufficient facts to demonstrate that the statement in the February 6,

5 2001 offering documents that Exodus had "strong demand from the enterprise market" was false and

6 misleading when made. Plaintiffs have provided numerous facts indicating that Exodus was not 7 enjoying strong demand at the time of the statement, including information from several different

8 sources who observed that, by late 2000 and early 2001, Exodus was experiencing weakness in sales,

9 cancellations, and a drop in demand . ¶¶133-140. Furthermore, Exodus' own bankruptcy disclosure

10 statement later acknowledged that "[b]eginning in late 2000 and early 2001 . . . a substantial number

11 of Exodus' traditional enterprise clients delayed - and in some cases canceled -purchase decisions ."

12 ¶141 . Thus, the facts show that, contrary to defendants' representations, Exodus was not enjoying 13 "strong demand from the enterprise market" as of February 6, 2001 .

14 d. Statements Concerning Number of Customers 15 Plaintiffs allege that the representations in the offering documents that Exodus had 4,500

16 customers were false, and have specified with particularity the reasons why . ¶60. As alleged in the

17 FAC, Exodus had two systems, Solomon and Siebel . Exodus' Solomon database reflected actual

18 customers who had signed Master Sales Agreements with Exodus . However, Exodus' Siebel

19 database included potential customers identified by contacts with the sales force . When defendants 20 publicly represented that Exodus had 4,500 customers, this was false because this number reflected

21 the number of customers in the Siebel database . The Solomon database - containing the actual

22 number of customers who had signed agreements with Exodus - only reflected about 3,500

23 customers. Furthermore, according to two separate witnesses, at least 1,000 of the 3,500 customers

24 had been inactive or had canceled, leaving approximately 2000 customers . ¶¶129-130 . The falsity

25 of the customer count is corroborated by the fact that Exodus removed some 1,500 customers from

26 its customer database shortly after the Class Period, ¶176, and by Krause's admission that Exodus'

27 bankruptcy was caused, in large part, by "a lot of customers" who were not paying their bills .

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -24- 1 Faced with this straight-forward allegation identifying a clearly false and misleading

2 statement made by defendants, defendants argue facts that are not pled in the FAC . Defendants

3 speculate that the acquisition of GlobalCenter may have added to the number of customers, and that

4 plaintiffs were possibly using the number of customers Exodus had as of the date of its bankruptcy

5 on September 26, 2001 instead of what it really had on the date of the offering documents on

6 February 6, 2001 - even though the FAC alleges no such thing . The inferences defendants attempt

7 to have this Court draw are unreasonable . On a motion to dismiss, the Court is required to take the

8 allegations in the FAC as true, and construe them in the light most favorable to plaintiffs .

9 Heliotrope, 189 F.3d at 978-79. See also Aldridge, 284 F.3d at 78-80 (reversing district court's 10 dismissal of the claims where the district court failed to draw all reasonable inferences in plaintiffs'

11 favor) .

12 e. Statements Concerning Certain Exodus Customer s 13 The Underwriter Defendants do not even address the allegation that the offering documents

14 were also false and misleading because, while they identified customers like iBeam, Inktomi and

15 Storagenetworks as some of Exodus' prominent customers, they failed to disclose that there were

16 serious revenue recognition issues associated with those customers . ¶158, 59. In failing to address

17 this allegation, the Underwriter Defendants have effectively conceded this allegation .

18 2. The GlobalCenter Statement Was Not Forward -Looking

19 The Underwriter Defendants contend the statement that "We believe that the acquisition [of

20 Global Center] enhances our global Internet Data Center infrastructure, strengthens our network, our

21 customer support, sales and professional services organizations, and expands our customer base" -

22 is a forward-looking statement subject to the PSLRA's safe harbor protection . The Underwriter

23 Defendants are wrong .

24 In order to invoke the safe harbor provision of the PSLRA, the statement at issue must be :

25 (i) forward-looking ; (ii) identified as such; and (iii) accompanied by meaningful cautionary

26 statements identifying important factors that could cause actual results to differ materially from those

27 in the forward-looking statements . 15 U.S.C. §78u-5(c)(1) . The statement concerning GlobalCenter

28 does not satisfy any of the foregoing criteria.

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -25- 0 0 0

1 First, the safe harbor provision does not apply because the statement about GlobalCenter

2 consists of only verbs in the present tense ("believe," "enhances," "strengthens," "expands"), and is

3 not at all reflective of the future. Allegations based on omissions of existing facts or circumstances

4 do not constitute forward-looking statements protected by the safe harbor provision of the PSLRA .

5 Lister v. Oakley, Inc., [1999 Transfer Binder] Fed . Sec. L. Rep. (CCH) ¶90,410, at 91,851 (C.D. Cal.

6 1999); Gross v. Medaphis Corp., 977 F. Supp. 1463,1473 (N.D. Ga. 1997); In re Valuedet, Inc., Sec.

7 Litig., 984 F. Supp . 1472, 1479 (N.D. Ga. 1997) (refusing to apply safe harbor because plaintiffs

8 alleged failure to disclose existing facts); Voit v. Wonderware Corp., 977 F. Supp. 363, 371 (E.D.

9 Pa. 1997) . In In re MobileMedia Sec. Litig., 28 F. Supp. 2d 901 (D.N.J. 1998), the court held that

10 a statement similar to the one at issue here was not forward-looking. There, the court found that

11 management's statement that "[corporation] believes [a communications company] acquisition will

12 enhance its competitive position" - which was alleged by plaintiffs to be misleading on the basis of

13 omissions of fact known to corporation at the time the statement was made - was not a forward-

14 looking statement and was actionable. Id. at 930.

15 Second, safe harbor does not apply because the GlobalCenter statement was not identified

16 as forward-looking when it was made, a mandatory requirement of the PSLRA . 15 U.S.C. §78u-

17 5(c)(1). This failure is fatal to the Underwriter Defendants' claim for protection under the safe

18 harbor.

19 Third, there was no "meaningful" cautionary language sufficient to trigger the PSLRA's safe

20 harbor protections. 15 U.S.C. §78u-5(c)(1) . "Boilerplate" warnings are insufficient to merit safe

21 harbor protection because such warnings fail to identify particular risks with sufficient specificity

22 to protect the common investor. See Gray v. First Winthrop Corp ., 82 F.3d 877, 884 n.9 (9th Cir.

23 1996) (finding the warning that "[n]o assurance can be given that the forecasted results will be

24 achieved" was too generalized) . Further, "[t]o warn that the untoward may occur when the event is

25 contingent is prudent ; to caution that it is only possible for the unfavorable events to happen when

26 they have already occurred is deceit ." Huddleston v. Herman & MacLean, 640 F.2d 534, 544 (5th

27 Cir. 1981), affd in relevant part, 459 U.S . 375 (1983) (quoted with approval in In re Convergent

28 Techs. Sec. Litig., 948 F.2d 507, 515 (9th Cir. 1991)).

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -26- S •

1 Because the statement about GlobalCenter is not a forward-looking statement, and does not

2 fit under the criteria for safe harbor protection, plaintiffs need not prove actual knowledge wit h

3 I respect to this statement . 4 3. The FAC Adequately Alleges Scienter

5 Although plaintiffs' claim under § 11 does not require proof of scienter, the claim for violation

6 of § 10(b) does. The Underwriter Defendants here have acted with scienter. As underwriters for

7 Exodus' secondary public offering and notes offering on February 6, 2001, defendants are charge d

8 with knowledge of the truthfulness of the statements contained in the offering documents . MTC

9 Elec., 993 F. Supp . at 162. As one court recognized, "[n]o greater reliance in our self-regulatory

10 I system is placed on any single participant in the issuance of securities than upon the underwriter."

11 Chris-Craft, 480 F.2d at 370.

12 The Underwriter Defendants, in connection with the offerings, were required to conduct du e

13 diligence into the Company's business and financial conditions . However, the Underwriter

14 Defendants abdicated their duties as watchdog for investors by failing to adequately ascertain

15 whether the statements contained in the registration statements and prospectuses were accurate .

1 6 Many of the true facts underlying the misrepresentations and omissions would have been reveale d

17 through a cursory due diligence . "'An egregious refusal to see the obvious, or to investigate the

18 doubtful, may in some cases give rise to an inference of ... recklessness ."' Chill v. GE, 101 F.3d 263 ,

19 269 (2d Cir. 1996) (citation omitted) . Moreover, "'motive and opportunity coupled with highly

20 material misrepresentations or omissions may well satisfy the [PSLRA's requirement for pleadin g

21 scienter] ."' In re Nuko Information Systems Sec. Litig., 199 F.R.D . 338, 342 (N.D. Cal. 2000) (citing

22 Southern Pacific Funding, 83 F. Supp. 2d at 1177-78) . Where, as here, the Underwriter Defendant s

23 closed their eyes to misrepresentations, and were motivated to conceal true facts in order to obtai n

24 large underwriting fees of approximately $20 .4 million in Exodus' stock and notes offerings, sciente r

25 is established.

26

27

28

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -27- 11 i

1 V. CONCLUSIO N

2 For all of the foregoing reasons, plaintiffs respectfully request that the Underwriter

3 Defendants' motion to dismiss be denied .

4 DATED : December 18, 2002 Respectfully submitted, 5 MILBERG WEISS BERSHAD HYNES & LERACH LLP 6 REED R. KATHREIN JOHN K. G T 7 EX KANO' . SAMS II 8

9 K. 10 100 Pine-Street-;Suite 2600 11 San Francisco, CA 94111 Telephone: 415/288-4545 12 415/288-4534 (fax) 13 MILBERG WEISS BERSHAD HYNES & LERACH LLP 14 WILLIAM S. LERACH 401 B Street, Suite 1700 15 San Diego, CA 92101 Telephone: 619/231-1058 16 619/231-7423 (fax)

17 WEISS & YOURMAN JOSEPH H. WEISS 18 551 Fifth Avenue, Suite 1600 New York, NY 10176 19 Telephone: 212/682-3025 20 212/682-3010 (fax )

21 WEISS & YOURMAN KEVIN J. YOURMAN ELIZABETH P. LIN 22 10940 Wilshire Blvd., 24th Floor Los Angeles, CA 90024 23 Telephone: 310/208-2800 24 310/209-2348 (fax) Co-Lead Counsel for Plaintiffs 25

26

27

28 G:\Cases-SF\Exodus\CXS80366.brf

PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC -28- 1 DECLARATION OF SERVICE BY FACSIMILE PURSUANT TO NORTHERN DISTRICT LOCAL RULE 23-2(c)(2) 2

3 I, the undersigned, declare : 4 1 . That declarant is and was, at all times herein mentioned, a citizen of the United States 5 and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interest 6 in the within action ; that declarant's business address is 100 Pine Street, 26th Floor, San Francisco, 7 California 94111 . 8 2 . That on December 18, 2002, declarant served by facsimile the PLAINTIFFS' 9 OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS to the parties listed 10 on the attached Service List and this document was forwarded to the following designated Internet 11 site at: 12 http://securities .milberg.com 13 3 . That there is a regular communication by facsimile between the place of origin and 14 the places so addressed . 15 I declare under penalty of perjury that the foregoing is true and correct . Executed this 18th 16 day of December, 2002, at San Francisco, California . 1 7

18

19 Cynthia Sheppard

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PLAINTIFFS' OPPOSITION TO UNDERWRITER DEFENDANTS' MOTION TO DISMISS- C-01-2661-MMC • s

EXODUS (LEAD ) Service List - 12/18/02 Page 1

COUNSEL FOR PLAINTIFF(S )

* Kevin J . Yourman Reed R . Kathrein Elizabeth P . Lin John E . Grant WEISS & YOURMAN Ex Kano S . Sams I I 10940 Wilshire Blvd ., 24th Floor MILBERG WEISS BERSHAD HYNES & Los Angeles, CA 90024 LERACH LL P 310/208-280 0 100 Pine Street, Suite 2600 310/209-2348 (fax) San Francisco, CA 94111-5238 415/288-454 5 415/288-4534 (fax )

William S . Lerach * Joseph H . Weiss MILBERG WEISS BERSHAD HYNES & WEISS & YOURMAN LERACH LL P 551 Fifth Avenue, Suite 1600 401 B Street, Suite 1700 New York, NY 10176 San Diego, CA 92101-5050 212/682-302 5 619/231-105 8 212/682-3010 (fax ) 619/231-7423 (fax )

COUNSEL FOR DEFENDANTS

Elizabeth E . Karne s BROBECK, PHLEGER & HARRISON LLP 2000 University Avenue Palo Alto, CA 94303 650/331-8000 650/331-8100 (fax)

*Denotes service via U .S . mail on December 18, 2002 . Exhibit D (Part 1 of 2) is 10 FILE D 1 AUG 1 9 2003

2 RICHARD W. W1EKING CLERK U .S. DISTR=CT COURT, 3 NORTHERN DISTRICT OF CALIFORNIA

4

5 IN THE UNITED STATES DISTRICT COURT 6 FOR THE NORTHERN DISTRICT OF CALIFORNIA 7

8 Master File No . C 01-2661 MM C 9 In re EXODUS COMMUNICATIONS, INC. ORDER GRANTING UNDERWRITER SECURITIES LITIGATION DEFENDANTS' MOTION TO DISMIS S 10 WITH LEAVE TO AMEND; GRANTING 11 INDIVIDUAL DEFENDANTS' MOTION TO DISMISS WITH LEAVE TO AMEN D 12 This Document Relates To : ALL ACTIONS (Docket Nos. 70 and 74) 13

0 14 U ♦1~1 A 15 Before the Court is (1) the motion to dismiss filed October 23, 2002 , by defendants a~ E 16 Goldman, Sachs & Co., Merrill Lynch & Co ., Morgan Stanley Dean Witter, and J .P. Morgan z 1 7 ("Underwriter Defendants") and (2) the motion to dismiss filed October 23, 2002, by 0 w defendants Ellen M. Hancock, R . Marshall Case, Dick Stoltz, Herbert A . Dollahite, Adam C 18 19 W. Wegner, Sam S. Mohamad, William Yeack and Beverly Brown, all former officers of

20 Exodus Communications, Inc . ("Individual Defendants"),' by which motions the Underwriter

21 and Individual Defendants seek to dismiss plaintiffs' First Amended Consolidated Class

22 Action Complaint ("First Amended Complaint" or "FAC") pursuant to Rule 9(b) and Rule

23 12(b)(6) of the Federal Rules of Civil Procedure and the Private Securities Litigation

24

25 'The positions held by the Individual Defendants are as follows : (1) Ellen M . 26 Hancock, CEO and Chairman of the Board ; (2) R . Marshall Case, Executive Vice President of Finance and CFO (through May, 2001); (3) Sam S . Mohamad, President of Worldwide ; (5) Herbert A. Dollahite, 27 Sales; (4) Dick Stolz, temporary CFO (effective May, 2001) Executive Vice President of Customer Services and Support and Quality ; (6) Adam W . Wegner, Senior Vice President of Legal and Corporate Affairs ; (7) Beverly Brown, 28 Executive Vice President and CMO ; (8) William Yeack, Executive Vice President of Managed and Professional Services . • i

Reform Act of 1995 ("PSLRA"). The matter came on regularly for hearing on January 31, 2003. Reed R. Kathrein, John K . Grant, and Ex Kano S . Sams 11 of Milberg Weiss Bershad Hynes & Lerach LLP and Elizabeth P. Lin of Weiss & Yourman appeared on behalf of plaintiffs. Jonathan C . Dickey of Gisbon, Dunn & Crutcher LLP appeared on behalf of the Underwriter Defendants . David M. Furbush and Elizabeth E . Karnes of Brobeck, Phleger & Harrison LLP appeared on behalf of the Individual Defendants . Having considered the papers submitted in support of and in opposition to th e motion, and the arguments of counsel, the Court rules as follows . I. BACKGROUN D

10 The instant action is a purported class action brought on behalf of those individual s

11 and entities who purchased Exodus Communications, Inc . ("Exodus") securities betwee n

12 April 20, 2000 and September 25, 2001, inclusive (the "class period"). (See FAC ¶ 1 .)

13 Exodus "owned and operated Internet Data Centers ("IDCs"), which provide d

14 physical space for Exodus' clients to place their servers, along with broadband connectivity

15 and other services needed to run and operate their Internet operations ." (See FAC ¶ 25 .)

16 On June 20, 2001, Exodus announced that its results for the second quarter 2001 and for

17 the fiscal year would be below prior expectations,2 whereupon Exodus' stock fell almost

18 50%. (See FAC 1179-80 .) On July 12, 2001, the first of many complaints against Exodus 19 was filed in federal court . On September 25, 2001, the last day of the class period, the 20 Wall Street Journal published an article stating that Exodus' bankruptcy was forthcoming,

21 whereupon Exodus' stock, which had traded as high as $179 per share during the class

22 period, fell to $0.17 per share. (See FAC ¶ 3.) On September 26, 2001, Exodus filed for

23 bankruptcy. (See id . )

24 On December 13, 2001, plaintiffs filed a Consolidated Class Action Complain t

25 ("CCAC"), alleging claims under §§ 10(b) and 20(a) of the Securities and Exchange Act o f 26 1934 . By order filed May 28, 2002, the Court granted the defendants' motion to dismis s

27 2Exodus' fiscal year ends on December 31 . Consequently, its first quarter ends on 28 March 31 and its second quarter ends on June 30 .

2 2 s

1 the CCAC, finding plaintiffs had failed to adequately plead that any of the allege d 2 statements were false or misleading, and that plaintiffs had failed to plead facts sufficient 3 to raise an inference that defendants had made the alleged false or misleading statements 4 with the requisite state of mind . Plaintiffs were afforded leave to amend . 5 On July 11, 2002, plaintiffs filed the FAC . The FAC, 101 pages in length, amends 6 the 37-page CCAC in six significant respects . First, the FAC increases the class period 7 from 11 weeks (March 30, 2001 to June 20, 2001) to 73 weeks (April 20, 2000 t o 8 September 25, 2001). (See CCAC 11 ; FAC ¶ 1 .) Second, the FAC adds two new

9 plaintiffs: Thomas Welch, alleged to have "purchased Exodus shares during the Class 10 Period traceable to Exodus' February 6, 2001 Registration and Prospectus for it s 11 secondary (stock) offering," and Martin Fox, alleged to have "purchased notes during the 12 Class Period issued in connection with Exodus' February 6, 2001 note offering ." (See FAC 13 ¶ 9.) Third, the FAC adds seven new defendants, three of whom are former officers of 14 Exodus, specifically, Sam Mohamad, Beverly Brown and William Yeack, and four of whom 15 are the underwriters of the February 2001 secondary stock and note offerings ("February 16 Offerings"), specifically, Goldman, Sachs & Co ., Merrill Lynch & Co ., Morgan Stanley Dean 17 Witter, and J .P . Morgan . Fourth, the FAC includes numerous additional statements, made 18 throughout the expanded class period, and allegedly false when made . Fifth, the FAC 19 adds numerous new factual allegations purporting to show such falsity . Sixth, the FAC 20 raises a new claim under §§ 11 and 15 of the Securities Act of 1933 ("Securities Act"), 15

21 U .S.C. §§ 77k, 77o, against former Exodus CEO Hancock and asserts new claims against 22 the Underwriter Defendants under : (1) §10(b) of the Securities and Exchange Act of 1934 23 ("Exchange Act"), 15 U .S.C. § 78j(b), and Rule 10b-5 of the Securities and Exchang e 24 Commission ("SEC"), 17 C.F.R. § 240.1 Ob-5, promulgated thereunder, and (2) §11 of the 25 Securities Act, all of which claims are based on allegedly false statements made in the 26

27

28

3 1 Registration Statements and Prospectuses (collectively "Registration Statements")3 issue d

2 in connection with the February Offerings .

3 II. LEGAL STANDAR D

4 A. Rule 12(b)(6)

5 Under Rule 12(b)(6), a complaint should not be dismissed unless a plaintiff can

6 prove "no set of facts in support of his claim that would entitle him to relief." See Parks

7 Sch. of Bus., Inc. v. Symington , 51 F . 3d 1480, 1484 (9th Cir. 1995). In ruling on a motion

8 to dismiss, the court must accept a plaintiff's factual allegations as true and construe them

9 in the light most favorable to plaintiff . See Gompper v. VISX, Inc. , 298 F.3d 893, 895 (91h

10 Cir. 2002). "[C]onclusory allegations of law and unwarranted inferences are insufficient to

11 defeat a motion to dismiss for failure to state a claim ." Epstein v. Washington Energy Co. ,

12 83 F. 3d 1136, 1139 (9th Cir. 1996). 13 B . Section 10(b) and the PSLRA

14 Section 10(b) of the Exchange Act states that "[i]t shall be unlawful for any person . .

15 . [t]o use or employ, in connection with the purchase or sale of any security . . . any

16 manipulative or deceptive device or contrivance in contravention of such rules and 17 regulations as the Commission may prescribe ." See 15 U.S .C . § 78j(b). A plaintiff bringing

18 a claim for securities fraud must show: (1) a false and misleading statement or omission of

19 material fact; (2) scienter; (3) reliance; and (4) damages . See Paracor Fin ., Inc. v. General 20 Electric Capital Corp., 96 F. 3d 1151, 1157 (91h Cir . 1996). False statements in a

21 registration statement are actionable under §10(b) as well as under §11 . See Herman &

22 Maclean v. Huddleston , 459 U .S. 375. 387 (1983) ("We hold that the availability of an 23 express remedy under Section 11 of the 1933 Act does not preclude defrauded purchasers 24 of registered securities from maintaining an action under Section 10(b) of the 1934 Act .")

25 A plaintiff alleging a cause of action for securities fraud is subject to "heightene d

26 3The FAC states that "[m]uch of the language in the Registration Statement and 27 Prospectus for the note offering was similar to that contained in the Prospectus for Exodus' secondary public offering ." (See FAC ¶ 59.) In their papers, the parties do not differentiate 28 between the two Registration Statements and Prospectuses .

4 E

1 pleading" standards as set forth in the PSLRA . See In re Silicon Graphics Inc . Sec. Litig. ,

2 183 F. 3d 970, 974 (9th Cir. 1999). Under the PSLRA, a plaintiff in a private securities

3 fraud action alleging material misstatements or omissions must "specify each statement

4 alleged to have been misleading ; the reason or reasons why the statement is misleading ;

5 and if an allegation regarding the statement or omission is made on information and belief,

6 the complaint shall state with particularity all facts on which that belief is formed ." See 15

7 U .S.C. § 78u-4(b)(1).

8 The PSLRA also provides that "the complaint shall, with respect to each such act o r

9 omission alleged to violate this chapter [the Securities Exchange Act of 1934], state with

10 particularity facts giving rise to a strong inference that the defendant acted with the

11 required state of mind ." See 15 U.S .C. § 78u-4(b)(2) . In this circuit, as a general matter, 12 the required state of mind is "deliberate or conscious recklessness" that the statement in

13 question was false or misleading . See No. 84 Employer-Teamster Joint Council Pension

14 Trust Fund v . America West Holding Corp . , 320 F. 3d 920, 931 (9th Cir. 2003) (quoting

15 Silicon Graphics , 183 F. 3d at 979 .) If the challenged statement in question is forward- 16 looking, however, the requisite state of mind is "actual knowledge ." See id . (quoting 15

17 U .S .C. § 78u-5(c)(1)). In determining whether plaintiffs' allegations are sufficient to raise a 18 strong inference of scienter, a court must consider (1) "the total of plaintiffs' allegations,"

19 even though some allegations may be individually lacking, and (2) "all reasonable

20 inferences capable of being drawn from the allegations, including inferences unfavorable to

21 the plaintiffs." See America West, 320 F. 3d 920, 938 (91h Cir. 2003) (internal quotations 22 omitted . )

23 Because "falsity and scienter in private securities fraud cases are generally strongl y

24 inferred from the same set of facts," the Ninth Circuit has incorporated the falsity and 25 scienter requirements "into a single inquiry ." See Ronconi v. Larkin, 253 F. 3d 423, 429

26 (9th Cir. 2001); see also America West, 320 F. 3d at 932 (noting the court "generally 27 examines the falsity and scienter requirements at the same time .") In conducting this

28 inquiry, a court is to determine whether "particular facts in the complaint, taken as a whole ,

5 ~ raise a strong inference that defendants intentionally or with deliberate recklessness mad e

2 false or misleading statements to investors ." See Ronconi v. Larkin, 253 F . 3d at 429.

3 I C. Section 11 of the Securities Act

4 "Under § 11 of the Securities Act of 1933 . . . any signer of [a] registratio n

5 statement, any partner or director of the issuer, any professional involved in preparing or

6 certifying the statement, and any underwriter of a registration statement may be liable '[i]n

7 case any part of the registration statement, when such part became effective, contained an

8 untrue statement of a material fact or omitted to state a material fact required to be stated

9 therein or necessary to make the statements therein not misleading . . .. "' Kaplan v. Rose ,

10 49 F. 3d 1363, 1371 (9th Cir. 1994) (quoting 15 U .S.C . §77k). "The plaintiff in a § 11 claim

11 must demonstrate (1) that the registration statement contained an omission or

12 misrepresentation, and (2) that the omission or misrepresentation was material, that is, it

13 would have misled a reasonable investor about the nature of his or her investment." See

14 Id . (citations omitted); see also Herman & MacLean v. Huddleston , 459 U.S . 375, 382

15 (1983) ("If a plaintiff purchased a security issued pursuant to a registration statement, he

16 need only show a material misstatement or omission to establish his prima facie case .")

17 Significantly, scienter is not a requirement for liability under §11, and "defendants will be

18 liable for innocent or negligent material misstatements or omissions ." See Kaplan v. Rose ,

19 49 F . 3d at 1371 (citing Herman & MacLean v . Huddleston, 459 U .S . at 382). Defendants

20 other than the issuer can establish a "due diligence" defense if they show that after

21 reasonable investigation they had reasonable ground to believe, and did believe, that, at

22 the time the registration statement became effective, the statements were true and there

23 was no material omission . See id . ; 15 U .S.C. § 77k(b)(3)(A).

24 III. DISCUSSION : UNDERWRITER'S MOTION TO DISMIS S

25 As noted, the FAC alleges causes of action against the Underwriter Defendants for

26 I violation of § 10(b) of the Exchange Act and SEC Rule 10(b)(5), and violation of §11 of the

27 Securities Act. Plaintiffs allege that the Underwriter Defendants are liable because th e 28 Registration Statements issued in connection with the February Offerings contained th e

6 i 0

1 following false and misleading statements : (1) "We believe that the acquisition [of

2 GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our

3 network, our customer support, sales and professional services organizations, and

4 expands our customer base"; (2) Exodus achieved revenues of $280 .4 million for the

5 quarter ended December 31, 2000, and $818 .4 million for fiscal year 2000 ; (3) "[Exodus

6 has] established a diverse base of customers and continues to focus on supporting the

7 strong demand from the enterprise market" ; (4) iBeam Broadcasting Corporation, Inktomi

8 and StorageNetworks were among Exodus' representative customers ; and (5) Exodus had

9 4500 customers under contract that it was serving . (See FAC ¶ 58.)4

10 In their Motion to Dismiss, the Underwriter Defendants raise four principa l 11 arguments: (1) both of plaintiffs' causes of action are barred by the applicable one-year

12 statute of limitations ; (2) plaintiffs have not adequately alleged a §10(b) claim because 13 plaintiffs have failed to establish falsity and scienter under the PSLRA ; (3) plaintiffs lack

14 standing to assert a §11 claim; and (4) plaintiffs have failed to adequately allege a §11 15 claim because plaintiffs have failed to state facts with the particularity required by Rule 9(b)

16 of the Federal Rules of Civil Procedure . 17 A. Statute of Limitations : Section 10 (b) and Section 11 Claims

18 The statute of limitations governing §11 claims requires that a complaint b e

19 commenced within one year of "actual discovery" or "inquiry notice" of an untrue or

20 misleading statement. See 15 U.S .C. §77m ("[n]o action shall be maintained to enforce 21 any liability created under [§11] . . . unless brought within one year after the discovery of

22 the untrue statement or omission, or after such discovery should have been made by the 23 exercise of reasonable diligence ."); see also Berry v . Valence, 175 F.3d 699, 703-04 (9`n 24 Cir. 1999) (discussing "actual discovery" and "inquiry notice" standards .) The statute of

25 limitations governing §10(b) claims requires that a complaint "be commenced within one

26 year of the discovery of the facts constituting the violation ." See Lampf v . Gilbertson , 501

27

28 4Except as indicated, plaintiffs do not purport to quote these statements directly .

7 1 U .S. 35, 364 (1991). Lampf did not further define "discovery," and the Ninth Circuit has not

2 decided whether inquiry notice, as well as actual discovery, will suffice to start the running

3 of the limitations period for §10(b) claims . See Valence , 175 F. 3d at 704 (finding it

4 unnecessary to reach issue on facts presented .) In Valence, however, the court did note 5 that all seven of the circuit courts to have addressed the issue had ruled that inquiry notice

6 is sufficient to start the running of the limitations period for §10(b) claims, and, while

7 expressing some doubt as to those courts' interpretation of Lampf, further stated : "If we

8 were to adopt inquiry notice, we would agree with the Tenth Circuit's formulation of that

9 standard ." See Valence , 175 F. 3d at 704 . The court went on to analyze the issue under 10 the Tenth Circuit's formulation of the inquiry notice standard as set forth in Sterlin v.

11 Biomune Systems, 154 F. 3d 1191, 1201 (10`h Cir . 1998).5 See Valence, 175 F. 3d at 704 .

12 Given the discussion in Lampf, and the uniformity of opinion in the other circuits that have

13 directly addressed the question, the Court holds that a plaintiff seeking to assert a claim

14 under either §10(b) or §11 must bring such claims within one year of either actual

15 discovery or inquiry notice, and, as to the latter, the Court will apply the Tenth Circuit's

16 formulation . 17 For purposes of the statute of limitations, the question of when a reasonably diligen t

18 investor did discover or should have discovered the alleged wrongdoing is a question of

19 fact, rarely to be decided as a ma tter of law. See Mosesian v. Peat Marwick, 727 F . 2d

20 873, 877 (9th Cir. 1984) ("The question of when [alleged wrongdoing] was or should have

21 been discovered is a question of fact . It may be decided as a ma tter of law only when

22 uncontroverted evidence irrefutably demonstrates plaintiff discovered or should have

23 discovered the fraudulent conduct.") (internal citations and quotation omitted).

24 Nevertheless , "a plaintiff must affirmatively plead sufficient facts in his complaint to

25 5Under that standard, a court must ask (1) whether the event/publication "raise[s] 26 sufficient suspicion of fraud to cause a reasonable investor to investigate the matter further," and (2) when "a reasonably diligent investor [should] have discovered the facts 27 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 28 statute of limitations began to run ." Id .

8 . .

demonstrate conformity with the statute of limitations ."6 See Toombs v . Leone, 777 F . 2d

2 465, 468 (9`h Cir. 1985) (citing Ingenito v. Bermec Corp . , 441 F. Supp 525, 553 (S .D.N.Y. 3 1977), Kroungold v. Triester, 407 F. Supp 414, 419 (E.D . Pa. 1975).'

4 Here, the Underwriter Defendants argue that plaintiffs' pre-consolidation complaint s

5 show that, as of June 20, 2001, the day Exodus announced that its second quarter results

6 and expected revenue for the fiscal year 2001 would be below prior expectations, plaintiffs

7 had both actual and inquiry notice as to any false or misleading statements contained in

8 the February Registration Statements . Consequently, defendants argue, plaintiffs' claims

9 against the Underwriter Defendants, first raised in the July 11, 2002 FAC, are time-barred .

10 In response, plaintiffs argue that although the June 20 announcement put them on inquiry

11 notice that the statements regarding Exodus' second quarter, i .e., statements made by the

12 Individual Defendants on or after March 31, 2003, may have been false, the

13 announcement did not serve to put plaintiffs on actual or inquiry notice as to the falsity of

14 any statements made prior to March 31, 2001 . Plaintiffs assert that they became aware of

15 the falsity of certain statements made before March 31, 2001, including the allegedly false

16 statements made in the February 2001 Registration Statements, only after "months of 17 investigation and interviewing internal sources ." (See Opp. at 9. )

18

19

20 6On February 12, 2003, the Underwriter Defendants filed a "Miscellaneous Administrative Request for Leave to Submit Additional Authority," wherein the Underwriter 21 Defendants submit additional authority bearing on the question of which party has the burden of demonstrating conformity, or lack thereof, with the statute of limitations . On 22 February 18, 2003, plaintiffs filed opposition, wherein they object to the Underwriter Defendants' submission of additional evidence, and in the alternative, request that the 23 Court consider plaintiffs' additional authority. As the Court finds that the parties' additional briefing is of value, the Court hereby GRANTS the Underwriter Defendants' and the 24 plaintiffs' requests to submit the additional briefing .

25 'Although Toombs addressed claims under §12 of the Securities Act, the holding is of equal force here . The two district court cases cited in Toombs in support of the pleading 26 requirement addressed claims under both §11 and §12 of the Act, and applied the requirement equally to each. See Ingenito , 441 F . Supp. at 553 ; Kroungold , 407 F . Supp 27 at 419. Although plaintiffs argue against imposition of the requirement, plaintiffs do not distinguish between §11 and §10(b) for that purpose, and the court likewise sees no 28 reason to do so.

9 9 #

1 1 . Actual Discovery

2 The Underwriter Defendants make two arguments in support of their assertion tha t

3 plaintiffs had actual knowledge of the alleged falsity of statements in question more than a

4 year before the filing of the FAC . Both arguments fail.

5 First, the Underwriter Defendants assert that plaintiffs' actual discovery is evidence d

6 by a pre-consolidation complaint filed July 12, 2001, in which the following allegations, all

7 based on press releases and analysts statements available to the public, were made :

8 (1) Exodus' June 20 announcement "shocked the market," by revealing that "contrary to

9 [Exodus'] prior statements . . . revenue would be significantly below expectations (and

10 actually decline sequentially)," (2) the announcement caused Exodus' stock "to fall over

11 30%," and (3) analyst reports published the next day stated that there was a "spreading

12 sentiment that Exodus had been misleading Wall Street about its business outlook ." (See

13 Underwriter Defendants' Req . Jud . Not. Ex. D at 2, 3.)8 For purposes of actual discovery,

14 the Court need not determine the exact date on which plaintiffs "actually knew of facts

15 sufficient to make out a claim for fraud," but rather can "impute knowledge of public

16 information without inquiring into when, or whether, individual shareholders actually knew

17 of the information in question ." See Valence, 175 F.3d at 703 n .4. Contrary to defendants'

18 argument, however, the above-referenced allegations do not demonstrate that plaintiffs

19 had actually discovered that any statements made prior to the beginning of the second

20 quarter were false or misleading . As noted, the June 20 announcement concerned

21 Exodus' second quarter results . Consequently, as plaintiffs argue, the allegations reveal

22 no more than plaintiffs' knowledge about revenue statements made in the second quarter .

23 Second, the Underwriter Defendants argue that plaintiffs had actually discovere d

24 their claims against the Underwriter Defendants prior to July 12, 2001 because the July 12,

25 2001 complaint contained allegations "which form the heart of plaintiffs' new claims agains t

26

27 $The Court hereby GRANTS the Underwriter Defendants ' Request for Judicial 28 Notice, filed October 23, 2002, which contains the July 12, 2001 complaint.

10 9 E

1 the Underwriters ." (See Reply at 6.) Specifically, the Underwriter Defendants argue tha t

2 plaintiffs' July 12, 2001 complaint:

3 had expressly alleged that Exodus and the [Individual] Defendants `knew' that Exodus' business and financial condition were deteriorating at least 4 as far back as the second half of the year 2000, that Exodus would not be able to recover in 2001, and that Exodus' positive statements concerning 5 its January 10, 2001 acquisition of GlobalCenter were false an d misleading because, among other things, `spending by dot com and old 6 economy customers alike was rapidly decreasing', `capacity was 50% above demand,' and `prices had declined sharply.' 7 (See Reply at 5-6.) 8 The Underwriter Defendants mischaracterize the July 12 complaint . That complaint 9 did not state that Exodus' business was deteriorating as far back as 2000 or that Exodus 10 would not be able to recover in 2001, but rather that Exodus' customers were having those 11 difficulties . (See Underwriter Req . Jud. Not., Ex. D at 6 ("Due to continued deterioration in 12 the financial condition of many of Exodus' customers during the second half of year 2000 13 and their inability to recover in 2001, defendant knew that Exodus' revenue would not 14 continue to be strong and financial results would be adversely affected .")) Moreover, 15 although the acquisition of GlobalCenter was mentioned in another pre-consolidation 16 complaint, filed July 16, 2001, plaintiffs, contrary to the Underwriter Defendants' assertions, 17 did not allege that the statement respecting GlobalCenter was false, but rather that other 18 statements concerning future revenues were false . (See id, Ex. E at 6, 8.) 19 2. Inquiry Notice 20 As the Underwriter Defendants have failed to establish that plaintiffs had actuall y 21 discovered their claims against the Underwriter Defendants prior to July 12, 2001, plaintiffs' 22 claims against the Underwriter Defendants are not, by reason of their prior pleadings, 23 barred by the statute of limitations . As the Underwriter Defendants further argue, however, 24 plaintiffs have failed to plead in their FAC facts sufficient to demonstrate conformity with 25 the statute of limitations . See Toombs, 777 F . 2d at 468 ("[A] plaintiff must affirmatively 26 plead sufficient facts in his complaint to demonstrate conformity with the statute of 27 limitations.") 28

11 i S

1 As noted, inquiry notice is established where a publication or other event "raise[s]

2 sufficient suspicion of fraud to cause a reasonable investor to investigate the matte r

3 further", and at the time that "a reasonably diligent investor [should] have discovered th e

4 facts underlying the alleged fraudulent activity." See Valence , 175 F.3d at 704.

5 Here, plaintiffs make no argument, and thus appear to concede, that Exodus '

6 June 20, 2001 announcement, coupled with the subsequent stock price drop and analyst

7 statements, were enough to raise a sufficient suspicion that defendants had engaged in

8 fraudulent activity prior to March 31, 2001, so as to cause a reasonable investor t o

9 investigate the matter further. Indeed, plaintiffs argue that they in fact began such an

10 investigation . (See Opp. at 9.) In their FAC, however, plaintiffs include no allegations from

11 which one can determine at what point a reasonably diligent investor should have

12 discovered the relevant facts underlying plaintiffs claims against the Underwriter

13 Defendants. Although plaintiffs, in their opposition, assert that they were only able to

14 ascertain their claims against the Underwriter Defendants after "months of investigation

15 and interviewing internal sources," ( see id.), plaintiffs fail to point to any facts in the FAC

16 that set forth in any respect the nature and scope of that investigation . See Kroungold , 407

17 F. Supp. at 419 ("A proper complaint should include : (1) allegations as to the time and

18 circumstances of discovery of the alleged fraud ; (2) allegations as to why the alleged fraud

19 was not discovered sooner ; and (3) allegations as to what diligence the plaintiff used in 20 making such discovery.")

21 As a consequence , the FAC, to the extent it includes claims against the Underwrite r

22 Defendants, is subject to dismissal . Plaintiffs will be afforded leave to amend to plead

23 conformity with the statute of limitations .

24 B . Section 10(b) Claim : Sufficiency of Pleadin g

25 The Underwriter Defendants contend that plaintiffs have not adequately pleaded a

26 § 10(b) claim as to any of the allegedly false statements made in the Registratio n

27 Statements because plaintiffs have failed to establish falsity and scienter with th e

28 particularity required by the PSLRA.

12 0

As noted, plaintiffs allege that five statements in the Registration Statements wer e

2 false or misleading when made : (1) "We believe that the acquisition [of GlobalCenter]

3 enhances our global Internet Data Center infrastructure, strengthens our network, our

4 customer support, sales and professional services organizations, and expands our

5 customer base" ; (2) Exodus achieved revenues of $280 .4 million for the quarter ended

6 December 31, 2000, and $818 .4 million for fiscal year 2000 ; (3) "[Exodus has] established

7 a diverse base of customers and continues to focus on supporting the strong demand from

8 the enterprise market"; (4) iBeam Broadcasting Corporation, lnktomi and Storagenetworks

9 were among Exodus' representative customers; and (5) Exodus had 4500 customers

10 under contract that it was serving . (See FAC ¶ 58 .) Plaintiffs' allegations in the FAC are

11 insufficient under the PSLRA to raise a strong inference that the Underwriter Defendants

12 intentionally or with deliberate recklessness made false or misleading statements to

13 investors .

14 First, and most notably, even assuming the statements in the Registratio n

15 Statements were false or misleading, plaintiffs fail to offer any facts sufficient to

1 16 demonstrate that the Underwriter Defendants acted with the requisite state of mind in

17 making the statements .9 In their opposition, plaintiffs state, in conclusory fashion, that the

18 Underwriter Defendants "closed their eyes to misrepresentations, and were motivated to

19 conceal true facts in order to contain large underwriting fees ." (See Opp. at 27 .) Plaintiffs

20 9The parties dispute whether one of the four statements in question, specifically, the 21 statement "[w]e believe that the acquisition [of GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our network, our customer support, sales an d 22 professional services organizations, and expands our customer base," is a "forward-looking statement." See America West, 320 F. 3d at 936. ("A `forward-looking statement' is any 23 statement regarding (1) financial projections, (2) plans and objectives of management for future operations, (3) future economic performance, or (4) the assumptions `underlying or 24 related to' any of these issues.") As the statement in question concerns the immediate effect of the acquisition rather than a projection as to a future effect, it is not forward- 25 looking. See id. at 937 (finding the statements "the settlement agreement's provisions will not have a material adverse effect on the Company's operations" and "we are not 26 anticipating any major increase in maintenance costs or the costs of oversights going forward" were not forward-looking because each was "a description of the present effects" 27 of a settlement agreement.) Accordingly, the requisite state of mind as to all of the statements challenged in the Registration Statements is deliberate or conscious 28 recklessness . See id.

13 1 overlook their failure to allege in the FAC any facts whatsoever, let alone with the requisite 2 particularity, in support of this assertion. In the absence of such facts, plaintiffs fail to plead 3 with the requisite specificity that defendants knew the statements in question were false or 4 misleading . See Epstein v . Washington Energy Co . , 83 F . 3d 1136, 1139 (9th Cir. 1996) 5 ("[C]onclusory allegations of law and unwarranted inferences are insufficient to defeat a 6 motion to dismiss for failure to state a claim .") 7 Plaintiffs argue that an underwriter is charged with knowledge of the truthfulness of 8 statements contained in a registration statement sufficient to satisfy the sciente r

9 requirement . The case cited by plaintiffs in support of this proposition, however, only holds 10 that an underwriter is deemed to have made the statements in a registration statement, a

11 point defendants here do not contest . See In re MTC Elec. Tech . Shareholder Litig., 993 12 F. Supp. 160, 162 (E.D.N .Y. 1997). Plaintiffs further argue that scienter, for purposes of a 13 §10(b) claim, may be established by showing an underwriter's failure to properly conduct 14 due diligence . Plaintiffs allege that the Underwriter Defendants "abdicated their [du e 15 diligence] duties as watchdog for investors by failing to adequately ascertain whether the 16 statements contained in the registration statements and prospectuses were accurate," and 17 that "[m]any of the true facts underlying the misrepresentations and omissions would have 18 been revealed though a cursory due diligence ." (See Opp. at 27.) To the extent plaintiffs 19 are contending that simple negligence on an underwriter's part is sufficient to give rise to 20 the requisite strong inference of scienter for a §10(b) claim, the case on which plaintiffs rely

21 is distinguishable. See Chill v. GE , 101 F. 3d 263, 269 (2d Cir. 1996) (noting "[a] n 22 egregious refusal to see the obvious, or to investigate the doubtful, may in some case s 23 give rise to an inference of . . . recklessness") (emphasis added) . In addition, to the extent 24 scienter may be established as to an underwriter by "an egregious refusal" to conduct due 25 diligence, see Chill , 101 F. 3d at 269, plaintiffs fail to allege any facts to suggest that the 26 Underwriter Defendants actually failed to conduct a proper investigation . 27 Accordingly, plaintiffs' §10(b) claim is subject to dismissal for failure to adequately

28 allege scienter. Moreover, as set forth below, plaintiffs' allegations are also insufficient to

14 0 0

establish that any the four statements in question were actually false or misleading whe n

2 made .

3 1 . Statement Regarding Exodus' January 2001 Acquisition of GlobalCente r

4 Plaintiffs allege that the statement "[w]e believe that the acquisition [of

5 GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our

6 network, our customer support, sales and professional services organizations, and

7 expands our customer base," ( see FAC ¶58), was false or misleading when made, based

8 on information obtained from "Confidential Witness 8" ("CW8"), a "marketing operations

9 manager for Exodus" who was "put in charge of integration of the GlobalCenter acquisition

10 within the Marketing Department ." (See FAC ¶ 101(h)) Specifically, plaintiffs rely on the

11 following information received from CW8 : (1) Exodus' internal "due diligence team" had

12 strongly recommended against the acquisition of GlobalCenter ; (2) Exodus' Board of

13 Directors was against the acquisition, concluding it would be too expensive and that the

14 business model was `not a good fit' for Exodus ;` (3) GlobalCenter's data centers in Tokyo,

15 Sydney and London and pending openings in Paris and Munich all experienced substantial

16 shortage in demand ; and (4) the acquisition was nevertheless pushed through by CEO

17 Hancock because she wanted GlobalCenter for its two IDCs in Manhattan, considered

18 prime real estate . (See FAC ¶146; see also Opp. at 21 .)

19 As defendants argue, the above allegations fail to demonstrate falsity because ,

20 even if all such allegations are taken to be true, "nothing about them render s

21 management's statements of belief in the Prospectus untrue or misleading ." (See Mot. at

22

23

24 "Although, for purposes of a motion to dismiss, a Court ordinarily will deem well- pleaded facts to be true, a court may take judicial notice of matters of public record outside 25 the pleadings, which may serve to contradict a plaintiffs factual allegations . See , e..., MGIC Indemnity Corp . v. Weisman , 803 F.2d 500, 504 (9th Cir.1986). Here, there is 26 uncontradicted evidence, of which the Court can take judicial notice, that Exodus' Board of Directors voted unanimously in favor of the acquisition . (See Individual Defendants Req . 27 Jud. Not. Ex. 13, Schedule 14A Proxy Statement filed December 7, 2000 .) Accordingly, plaintiffs objection to the Individual Defendants' Request for Judicial Notice fails, and the 28 Court GRANTS the Individual Defendants' Request for Judicial Notice .

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14)." Plaintiffs' allegations do not address whether anyone in Exodus' "management" 2 believed anything contrary to the reported belief regarding the GlobalCenter acquisition .

3 Moreover, the fact that the due diligence team, or even the Board of Directors,12 may have

4 had concerns about the acquisition, the fact that some of the GlobalCenter data centers

5 experienced a "substantial shortage" in demand, or that Hancock wanted GlobalCenter

6 because of its prime real estate, does not demonstrate that the GlobalCenter acquisition

7 did not enhance Exodus' infrastructure, did not strengthen Exodus' network, customer

8 support, sales and professional services organizations, or did not expand Exodus'

9 customer base . Nor, by extension, do these facts show that Exodus' management did not

10 in fact "believe" that the acquisition would lead to the results indicated in the statement .

11 Accordingly, plaintiffs have failed to show that the GlobalCenter statement was fals e

12 or misleading when made .

13 2. Statements Regarding Revenu e 14 Plaintiffs allege that the statements that Exodus had revenues of $280 .4 million for

15 the fourth quarter 2000 and $818 .4 million for fiscal year 2000 were false because Exodus

16 had engaged in four types of accounting improprieties : (1) recording revenue prior to

17 rendering services ; (2) recording revenue on cancelled or non-renewed contracts ; 18 (3) recording revenue from transactions in which collectability was not probable ; and

19

20

21 "Defendants also argue that this Court need not accept as true any of the allegations because plaintiffs' source of information, CW8, "has no connection to or 22 personal knowledge of any of the matters alleged ." (See Mot. at 14.) The Court finds that CW8, who was in charge of integrating the GlobalCenter acquisition into the Marketing 23 Department, has been described with sufficient particularity to demonstrate that CW8 possessed the information alleged. See ABC Arbitrage v. Tchuruk , 291 F . 3d 336, 352 (5`n 24 Cir. 2001) (noting that an informant must be described "with sufficient particularity to support the probability that the person in the position occupied by the source would 25 possess the information alleged) ; In re Secure Computing Corp. Sec. Litig., 120 F. Supp. 2d 810, 817 (N.D. Cal. 2000) ("[I]f Plaintiffs make an allegation that is based on a 26 statement from a witness, they must reveal all facts about that witness that were material to the formation of their belief that the witness' statement is accurate .") 27 12As noted, there are judicially-noticeable facts directly contradicting plaintiffs 28 allegation that the Board of Directors disfavored the acquisition.

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1 (4) recording revenue and assets in conjunction with "bogus" barter transactions and failin g . 2 to disclose such transactions. (See FAC ¶159.) 3 In In re Vantive Corp. Sec. Litig., 283 F. 3d 1079, 1091 (9th Cir. 1999), the Ninth

4 Circuit dismissed a complaint alleging accounting improprieties where the plaintiffs had

5 failed to sufficiently allege "the amounts by which revenues were allegedly overstated ." See

6 id . (citing Greebel v. FTP Software, Inc., 194 F .3d 185, 204 (1st Cir. 1999) ("The

7 allegations in the complaint do not include such basic details as the approximate amount

8 by which revenues and earnings were overstated .") Here, as defendants observe ,

9 plaintiffs, with one exception, are unable to point to any specific allegations respecting the

10 amount by which the revenues reported in the Registration Statements were misstated .1 3

11 Although plaintiffs allege, based on an accounts receivable report issued in March 2001,

12 that Exodus should have taken a bad-debt charge of $56 million for the year ended

13 December 31, 2000, or an additional [bad-debt] charge of $52 million as of June 30, 2001,

14 (see FAC ¶¶179-186 ; see also Opp. at 23), plaintiffs plead no facts to indicate that the

15 information in the March report was known as of the February Offerings, or that such

16 information was with respect to Exodus' bad debt for the year ended December 31, 2000 .

17 Indeed, plaintiffs themselves allege that the "bad debt charge" could have been taken

18 either prior to or after the February 2001 offering . (See FAC ¶ 186.)

19 Although plaintiffs also argue that the FAC "alleges other improper accountin g

20 practices at Exodus with particularity, including barter transactions and the recording of

21 fictitious cash receipts throughout the Class Period, (see Opp. at 23), in the paragraphs to

22 which plaintiffs cite, only one specific barter transaction is identified as having been

23 conducted in the relevant time period, specifically, fiscal year 2000, and, in any event, that

24 allegation is insufficient . Plaintiffs allege that Exodus, "on approximately December 27 ,

25

26 13Plaintiffs allege that "there was at least $171 million of fraudulent revenue recognized during the first six months of 2001 ." (See Opp. at 23, citing to FAC ¶J 161- 27 178.) This allegation, however, does not refer to the revenue statements made in the Registration Statements, which concerned revenues for fourth quarter 2000 and fiscal year 28 2000, but rather to a later time period .

17 1 2000," engaged in, and recognized revenue from, a barter transaction with a company,

2 "Niku," by which transaction "the two companies agreed to write checks for approximately

3 $417,000 ." (See FAC ¶¶ 111(d), 191(b) .) Plaintiffs further allege that "Exodus invoiced 4 Niku for `services rendered' during 4Q00," that "no services were ever performed," and that

5 the transaction was "debooked" in the second half of 2001 . (See FAC ¶111(d).) Plaintiffs

6 acknowledge, however, the relatively small size of the transaction . See id . ("Although the

7 $417,000 amount might be insignificant in terms of the Company's gross revenue, deal s

8 like these were very important because these amounts `blow straight through to income ."')

9 In light of Exodus' reported revenues of $280 .4 million for the fourth quarter 2000 and

10 $818 .4 million for fiscal year 2000, it is unlikely that a transaction in the amount of

11 $417,000, representing approximately 0.15% of the fourth quarter revenues and

12 approximately 0.05% of fiscal year 2000 revenues, would be considered important to a

13 shareholder in deciding whether to invest, and, consequently, the alleged false statements

14 concerning that transaction would not, without more, be material . See Basic Inc. v.

15 Levinson , 485 US 224, 230-31 (1988) (holding a false statement or omission is deemed

16 material if disclosure would alter the total mix of facts available to an investor and "if there

17 is a substantial likelihood that a reasonable shareholder would consider it important" to the

18 investment decision. )

19 In sum , the FAC does not contain specific factual allegations regarding materia l

20 accounting improprieties that affected the revenue statements contained in th e

21 Registration Statements . Accordingly, plaintiffs have failed to show that the revenu e

22 statement was false or misleading when made.

23 3 . Statement Regarding Demand for Service s 24 Plaintiffs claim that the statement that Exodus "continues to focus on supporting th e

25 I strong demand from the enterprise market"14 was false or misleading when made because :

26 (1) according to certain specified former Exodus employees, by late 2000 and early 2001 ,

27 14At the hearing, plaintiffs clarified that the term "enterprise market" refers to 28 customers other than "dot com" customers .

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Exodus was experiencing weakness in sales, cancellations and a drop in demand, ( see

2 FAC 11 133-140; see also Opp. at 24), and (2) Exodus' own bankruptcy disclosure

3 statement later acknowledged that "[b]eginning in late 2000 and early 2001 . . . a

4 substantial number of Exodus' traditional enterprise clients delayed-and in some cases

5 canceled - purchase decisions ." (See FAC ¶ 141 .)

6 In support of the proposition that Exodus was in fact not seeing strong demand fro m

7 the enterprise market, plaintiffs refer generally to paragraphs 133-140 of the FAC, (see

8 Opp . at 24), wherein plaintiffs allege that: (1) according to CW 1, the former Controller for 9 Exodus' Professional Services Organization, ( see FAC ¶ 104(a)), "defendants knew about

10 increased aging of receivables and failures of dot-com customers beginning in early 2000"

11 (see FAC ¶ 133) ; (2) "by late 2000 and early 2001, the problems with failing dot-corns and

12 bad debt were dramatically impacting Exodus" ( see FAC ¶134); (3) according to CW5, a

13 former senior manager of credit and collections, "in first and second quarters 2001, there

14 were a lot of customer disputes and delinquencies" (see FAC ¶135); (4) "during first and

15 second quarters 2001," CW2, a former Exodus financial analyst assigned to Exodus'

16 Professional Services segment, "did not see [an] influx of new customers or replacement

17 revenue for dot-corns that had gone out of business" ( see FAC ¶ 136); (5) according to

18 CW3, a former employee who compiled information on Exodus' customer base, in Exodus'

19 "first quarter 2001, Exodus' customers were canceling orders and/or not renewing orders,"

20 and there was "high customer churn," (see FAC ¶137); (6) CW6, a former account

21 executive, "noticed a decline in cancellations at the end of 2000, particularly in the dot-corn

22 arena," (see FAC ¶138); and (7) CW10, a former credit & collections analyst, (see FAC ¶

23 104(j)), "saw that the number of canceling customers steadily climbed throughout 2000"

24 (see FAC ¶ 140).15 Although numerous, the allegations in these paragraphs fail to alleg e

25 15The paragraphs in question also contain additional allegations that refer to time 26 periods subsequent to the February Offerings . As such allegations are not relevant to a determination of whether the statements made in the Registration Statements were false 27 when made, they are not included in the instant discussion . Moreover, several of the allegations quoted above only relate to the relevant time period to the extent that the "first 28 quarter" 2001 involves one relevant month, specifically, January .

19 S

falsity with the particularity required by the PSLRA . Plaintiffs fail to allege any facts as to particular cancellations, how any such cancellations related to Exodus' overall business, or whether such cancellations were in the enterprise market . Without such specific facts, these allegations are insufficient to demonstrate that Exodus, by the time of the February Offerings, was not seeing strong demand in the enterprise market . Exodus' later bankruptcy disclosure statement likewise fails to indicate that Exodus , at the time of the February Offerings, was not seeing strong demand . The bankruptcy statement does not provide with particularity the number of "traditional enterprise clients"

9 that were delaying or, "in some cases," canceling their purchases, and how any such

10 delays or cancellations affected Exodus' overall enterprise market business . Further, it is

11 unclear what any such "delayed" purchase decisions actually entailed, e .g ., whether there

12 was an earlier agreed upon delivery date, whether there was some other basis for

13 anticipating an earlier delivery date, and the length of time during which any such orders

14 were delayed .

15 Accordingly, plaintiffs have failed to show that the statement regarding demand wa s 16 false or misleading when made .

17 4. Statement Regarding Exodus' Representative Customer s

18 Plaintiffs allege that the Registration Statements were false and misleading because

19 "[a]mong the representative customers Exodus identified in the [Registration Statements]

20 were iBeam Broadcasting Corporation, Inktomi and Storage Networks," ( see FAC 158),

21 even though "defendants were aware that there were revenue recognition issues with

22 respect to some of Exodus' `representative customers"' ( see FAC ¶ 60).

23 As an initial matter, the Court notes that plaintiffs fail to allege , in the above-

24 I paragraphs, that there were revenue recognition issues associated with the

25 three named "representative customers, or what such issues were ."16 Moreover, to the

26 extent plaintiffs, in other paragraphs in the FAC, allege that revenue recognition issues

27 16Nor do plaintiffs, in their Opposition, direct the Court to the paragraphs in the FAC 28 in which plaintiffs set forth the revenue problems with these three customers .

20 • •

1 existed with respect to these customers, plaintiffs either fail to allege with any particularity 2 those "revenue recognition issues" or fail to show that the revenue recognition issues were 3 manifest at the time of the February offerings . 4 With respect to iBeam Broadcasting Corporation, plaintiffs allege that iBeam, in a 5 lawsuit filed against Exodus on August 13, 2001, claimed that "[a]fter the inception o f 6 iBeam's business relationship with Exodus, Exodus implemented a new billing system that

7 generated incorrect, duplicate or late invoices to iBeam ." (See FAC ¶ 124.) No facts are 8 alleged, however, indicating the amount of revenue improperly calculated with respect to 9 iBeam, or that Exodus engaged in any revenue recognition improprieties prior to the filing 10 of the Registration Statements. 11 With respect to Inktomi, although plaintiffs adequately allege a number of specific 12 facts concerning the transaction, including that Exodus and Inktomi "engaged in a practice 13 of swapping invoices for approximately $500,000 at quarter-end simply to add to each 14 other's revenue for the quarter," that "neither invoice was ever paid," and that defendant 15 Stolz would instruct CW10, at quarter-end, as to the "amount that should be taken out of 16 Inktomi's oldest receivable and accounted for as barter," plaintiffs fail to allege wit h 17 specificity the dates of the improper invoice swapping, or whether any such "swap " 18 occurred prior to the dates of the Registration Statements, or, for that matter, within the

19 class period. (See FAC 111 2(a).) 20 Finally, with respect to Storage Networks, plaintiffs allege that according to CW10,

21 "much of the revenue associated with StorageNetworks was actually accounted for through 22 barter transactions" and that "CW10 estimated at least 80% of the revenue recognized by 23 Exodus for invoices sent to Storagenetworks was accounted for on service swap," but fail 24 to allege the dates of any improper invoice "swap" or the amount of revenue improperl y

25 calculated. (See FAC ¶ 112(b).) 26 Consequently, plaintiffs fail to establish that the statement respecting Exodus' 27 representative customers was false or misleading when made.

28

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1 5. Statement Regarding Number of Exodus Customers 2 Plaintiffs allege the statement that "[f]ollowing our acquisition of GlobalCenter, w e

3 serve approximately 4,500 customers," (see FAC ¶ 58, Underwriter Defs . Req . Jud. Not. 4 Ex. B), was false or misleading when made because Exodus' internal computer tracking 5 system showed that Exodus actually had fewer customers . Specifically, plaintiffs allege

6 that according to CW 11, a credit and collections analyst for Exodus, and CW 12, a senior

7 collections specialist at Exodus, Exodus had two systems for tracking customers ,

8 "Solomon" and "Siebel ." (See FAC ¶¶ 104(k), 129.) According to these sources, the

9 Solomon system reflected actual Exodus customers, who had signed Master Sales

10 Agreements, while the Siebel system reflected both actual and potential customers. (See

11 FAC ¶129.) These sources, according to plaintiffs, have stated that the number of

12 customers in the Solomon database was actually 3500, and that the assertion that Exodus

13 had 4500 customers was based on the Siebel database numbers . (See FAC ¶129 .)

14 Plaintiffs further allege that even the 3500 number was too high, as subsequent to the 15 Class Period, over 1500 customers were pulled out of the database after Exodus' Credit

16 and Collections department "determined that these customers had pulled out of deals and

17 data centers from the fall of 2000 through the end of the Class Period." (See FAC ¶129.)"

18 Plaintiffs' allegations are insufficient for several reasons . First, plaintiffs fail to

19 provide facts about their sources sufficient to indicate that the sources had personal 20 knowledge of the information conveyed to plaintiffs . See In re Secure Computing Corp.

21 Sec. Litig. , 120 F. Supp. 2d 810, 817 (N .D . Cal . 2000) ("[I]f Plaintiffs make an allegation 22 that is based on a statement from a witness, they must reveal all facts about that witness

23 that were material to the formation of their belief that the witness' statement is accurate.")

24 Although plaintiffs allege that "a collector was given responsibility to monitor payment

25 history and collect against any invoices aged 60 days or more," and that "in the Solomo n

26 17In the FAC plaintiffs do not state when the 1500 customers were removed . In their 27 Opposition, however, plaintiffs state "some 1,500 inactive customers were deleted shortly after the Class Period," (see Opp. at 11-12), which indicates these customers were 28 removed after September 25, 2001 .

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system, each customer of Exodus was assigned to the Credit and Collections Department

once becoming a customer," ( see FAC ¶ 129), it is unclear to what extent the sources had access to the Solomon database, including the total number of customers therein, and whether they had access to the Siebel database at all . Second, although plaintiffs allege that "Solomon was highly accurate as a historical database for Exodus customers," plaintiffs fail to allege the date on which the Solomon database purportedly reflected only 3500 customers, let alone how their sources acquired such information, and whether that

8 number included any of the customers Exodus had signed subsequent to its acquisition of

9 GlobalCenter in January 2001 . (See Mot. at 17; Reply at 12-13.)

10 Similarly, plaintiffs' allegation that 1500 customers were removed from the Solomo n

11 database at some point after the class period is insufficient to demonstrate the statement

12 that Exodus had 4500 customers, made at least seven and a half months earlier, was false

13 when made . See In reVantive, 110 F. Supp 2d 1209, 1217 n.14 (N.D . Cal. 2000)

14 ("[E]vents occurring after the alleged class period do not show that the representations

15 made during the class period were false when made, plaintiffs must point to particular

16 contemporaneous facts that establish the falsity of the statement at the time it was made .")

17 Accordingly, plaintiffs have failed to show that the statements regarding the numbe r

18 I of Exodus' customers were false or misleading when made .

19 C. Section 11 Claim : Standing and Sufficiency of Pleading

20 1 . Plaintiffs' Standing to Bring a §11 claim

21 Defendants make two arguments as to why plaintiffs lack standing to raise a §1 1

22 claim. First, defendants argue that plaintiffs are a ttempting to "usurp the Court's authority"

23 by introducing two new plaintiffs , Welsh and Fox, as "lead plaintiffs " without going through

24 the procedures for ce rtification, publication and appointment of lead plaintiff as prescribed

25 by the PSLRA. Second, defendants argue that plaintiffs Welsh and Fox are unable to 26 `trace" their securities to the Februa ry Offerings, as required for standing .

27

28

23 C

1 a. Requirements for Certification, Publication, and Appointment of Lead Plaintiff 2 The PSLRA sets forth certain requirements as to certification of potential lea d 3 plaintiffs, publication of the filing of a securities class action, and appointment of a lead 4 plaintiff. See 15 USC §78u-4(a)(3)(A) . Because new plaintiffs and purported class 5 representatives Welsh and Fox have not complied with the certification and publication 6 requirements of the PSLRA and have not been appointed lead plaintiffs in this action, and 7 because no lead plaintiff is alleged to have purchased securities in the February Offerings, 8 the Underwriter Defendants argue that no plaintiff has standing to assert a claim against 9 the Underwriter Defendants. 10 As plaintiffs note, however, under the PSLRA only another plaintiff is entitled t o 11 rebut a purported lead plaintiffs certification, see 15 U .S .C . §78u-4(a)(3)(B)(iii)(l1), and the 12 Underwriter Defendants cite no authority suggesting a defendant may use the lead plaintiff 13 requirements to defeat a complaint . Accordingly, the Underwriter Defendants' argument 14 fails on this ground alone. 15 Moreover, although the PSLRA requires that a notice be published within 20 days of 16 the filing of a purported private class action securities complaint and provides for the 17 appointment of lead plaintiffs, that section does not require publication of additional notices 18 upon the addition of "class representatives ." See 15 U .S.C. § 78u-4(a)(3)(A) ; see also 19 Fed. R. Civ. P. 23 (setting forth the requirements for class representatives and certification 20 of class actions) . Nor does the PSLRA mandate that only a lead plaintiff may be a class 21 representative, or vice versa . See 15 USC §78u-4(a)(3)(A) ; In Re Independent Energy , 22 210 F.R.D . 476, 485 (S .D .N .Y. 2002) ( "A lead plaintiff is not synonymous with a class 23 representative, and in the ordinary course of litigation the class representative will not 24 appear on the scene until long after the lead plaintiff. No lead plaintiff is compelled to serve 25 as a class representative. While the PSLRA defines the qualifications and selection 26 process for lead plaintiff, the class representative is selected not pursuant to the PSLRA, 27 but pursuant to Rule 23.") 28

24 S

1 The Underwriter Defendants' reliance on In re Cavanaugh , 306 F 3d 726 (9`h Cir.

2 2002), for a contrary proposition is misplaced . In Cavanaugh, the court articulated a three-

3 step process for selecting a lead plaintiff, the third step of which allows other plaintiffs "an

4 opportunity to rebut the presumptive lead plaintiffs showing that it satisfies Rule 23's

5 typicality and adequacy requirements ." See In re Cavanaugh , 306 F 3d at 721 .

6 Cavanaugh, however, only addressed the procedure for the initial appointment of a lead

7 plaintiff; it did not purport to address a situation where claims are added after the

8 appointment of a lead plaintiff. See id. at 729-30. The Underwriter Defendants argue,

9 nonetheless, that Cavanaugh mandates that only lead plaintiffs serve as class

10 representative, because allowing "new plaintiffs to assert new claims against new

11 defendants only after the lead plaintiff process [is] completed . . . deprive[s] other potential

12 shareholders and bondholders of their legal rights under the PSLRA to seek lead plaintiff

13 status with respect to potential Section 11 claims," and because by seeking to add new

14 class representatives, "plaintiffs tacitly concede that the lead plaintiffs cannot meet the

15 Rule 23 requirements and that they purport to assign away their lead plaintiff

16 responsibilities to others ." (See Reply at 17-18 .) Defendants in essence ask this Court to

17 rule that whenever new claims are sought to be raised during the course of a securities

18 action, no matter how late in the proceeding, a court must conduct a new lead plaintiff

19 proceeding. In the absence of authority mandating such procedure, the Court declines to

20 do so.

21 Finally, §15 U.S .C. §78u-4(a)(2) requires that "each plaintiff seeking to serve as a

22 representative party on behalf of a class shall provide a sworn certificate" setting forth

23 certain information regarding the purchase of securities . Although plaintiffs argue that Fox

24 and Welch are not required to file such certificates because "the PSLRA does not so

25 require the filing of plaintiff certifications with an amended complaint," ( see Opp. at 14),

26 §15 U .S.C. §78u-4(a)(2) clearly applies to any plaintiff seeking to serve "as a

27 representative party ." Moreover, plaintiffs do not object to submitting such filings . (See

28

25 • C

Ill Opp . at 14 n.3 .) Accordingly, plaintiffs will be directed to file such certifications within th e 2 period afforded below for filing an amended complaint .

3 b. Traceability of the Securities to the February Offering s

4 To have standing to assert a claim under §11, "plaintiffs must establish that the y

5 purchased shares either (1) directly in the public offering for which the misleading

6 registration statement was filed or (2) traceable to that public offering ." See Guenther v .

7 Cooper Life Sciences , 759 F . Supp 1437, 1439 (N .D . Cal .1990); see also Hertzberg v .

8 Dignity Partners, 191 F . 3d 1076, 1080-81 (9th Cir . 1999) (holding that to assert a § 11

9 claim, a plaintiff "must have purchased a security under that, rather than some other,

10 registration statement.")

11 Here, the FAC alleges that Fox "purchased notes during the Class Period issued i n

12 connection with Exodus' February 6, 2001 note offering," and that Welsh "purchased

13 Exodus shares during the Class Period traceable to Exodus' February 6, 2001 Registration

14 Statement and Prospectus for its secondary offering ." (See FAC ¶ 9 .) The Underwriter

15 Defendants do not argue that the notes purchased by Fox are not traceable to the

16 February offering. The only question raised by the Underwriter Defendants is whether the

17 mere allegation in the FAC that Welsh's shares are "traceable" to the February offering is,

18 without more, sufficient.

19 In Shapiro v. UJB Financial Corp . , 964 F . 2d 272, 285-86 (3`d Cir . 1992), the Third

20 Circuit held sufficient an allegation in a complaint that the shares in question were

21 purchased "pursuant to" a registration statement . The court noted that "[b]efore discovery

22 takes place . . . it is impossible for plaintiffs to know whether their shares were newly

23 issued" pursuant to the subject registration statement, and concluded, "Because we cannot

24 say that plaintiffs can prove no set of facts that would entitle them to relief, the §11 claim

25 cannot be dismissed at this time." See id . In addition, plaintiffs cite to several district court

26 decisions outside of this circuit for the proposition that at this stage of litigation, a plaintiff

27 only need allege, in conclusory language, that the relevant securities are traceable to the

28 registration statement in question . See In re Chambers Development Securities Litigation ,

26 • !

848 F. Supp . 602, 624 (W.D. Pa . 1994) (denying motion to dismiss and stating that "[p]laintiffs are not required, at this stage, to trace each of their . . . securities purchases to the Registration Statements, but they are required to allege that they purchased pursuant to the public offerings or that their securities are traceable to those offerings .") ; see also In re Sterling Foster & Co . Sec. Litig., 222 F.Supp. 2d 216, 247-48 (E .D.N .Y. 2002); In re AES Corp. Sec. Litig . , 825 F .Supp. 578, 592 (S .D .N .Y. 1993). The Underwriter Defendants claim that "numerous courts have applied the tracin g requirement to dismiss Section 11 claims at the pleading stage where plaintiffs fail to plead facts that, if true, would demonstrate that they actually purchased in a public offering or

10 have some particularized basis for pleading an ability to "trace" shares purchased in the

11 secondary securities markets to a public offering," ( see Mot. at 26), and that "in addressing

12 the tracing requirement, other courts have routinely dismissed complaints that inadequately

13 allege that shares were purchased pursuant to a particular registration statement ." See id.

14 In support of these assertions, however, the Underwriter Defendants cite to only three

15 district court decisions, only one of which, Lilley v. Charren, 936 F.Supp. 708, 718 (N .D.

16 Cal . 1996), is directly in point. See id . (dismissing § 11 claim with leave to amend to

17 "allege the specific dates and facts that establish the representative plaintiffs' standing for a

18 § 11 claim.") Of the two remaining cases on which the Underwriter Defendants rely, one

19 discusses the plaintiff's burden for purposes of summary judgment, not dismissal, see

20 Guenther v. Cooper Life Sciences, Inc ., 759 F. Supp 1437 (N.D. Cal. 1990), and another

21 dismissed the complaint because the plaintiff therein had only alleged the purchase of

22 shares on a date following the filing of a registration statement, but not that the shares had

23 been purchased pursuant to or under the registration statement, see McFarland v.

24 Memorex Corporation , 493 F . Supp. 631, 641-42 (N .D. Cal . 1980).'$

25

26 18Earlier in their Opposition, the Underwriter Defendants make much of Abbey v. Computer Memories, Inc . , 634 F. Supp 870 (N .D . Cal . 1986), wherein the court discusses 27 traceability for purposes of §11 standing at length . See id . The Underwriter Defendants fail to note, however, that Abbey discusses a plaintiffs burden for purposes of summary 28 judgment, and did not address a plaintiffs' pleading obligations .

27 11 a

1 Having reviewed Shapiro and the other authorities referenced above, the Court find s

2 that plaintiffs need not plead more facts to establish their standing than would be required

3 under the ordinary "notice pleading" requirements embodied in the Federal Rules of Civil

4 Procedure. See Fed. R. Civ. P. 8(a)(2) (requiring only that plaintiff plead "a short and plain

5 statement of the claim showing that the pleader is entitled to relief") ; Conley v. Gibson , 355

6 U.S . 41, 47, 78 S.Ct. 99, 103, 2 L .Ed.2d 80 (1957) ("[T]he Federal Rules of Civil Procedure

7 do not require a claimant to set out in detail the facts on which he bases his claim .").

8 Accordingly, plaintiffs have adequately pled facts demonstrating that they hav e

9 standing to raise the §11 claim .

10 2 . Sufficiency of Allegations to State § 11 Clai m

11 Defendants' final argument as to plaintiffs' §11 claim is that plaintiffs are required t o

12 plead their §11 claim in conformance with the heightened pleading requirements set forth

13 in Rule 9(b) of the Federal Rules of Civil Procedure, and that plaintiffs have failed to do so .

14 In response, plaintiffs state that they are not pleading a fraud claim under §11, ( see Opp.

15 at 19), but only that the Registration Statements "contained untrue statements of material

16 fact and omitted to state other facts necessary to make the statements made no t

17 misleading." (See id.)

18 When a complaint contains allegations of fraud, Rule 9(b) of the Federal Rules o f

19 Civil Procedure requires that plaintiffs : (1) specify the alleged fraudulent representations ;

20 (2) allege the representations were false when made ; (3) identify the speaker ; (4) state

21 when and where the statements were made ; and (5) state the manner in which the

22 representations were false and misleading . See In re GlenFed, Inc . Secur. Litig. , 42 F. 3d

23 at 1547 n.7; Schwarzer, Tashima & Wagstaffe, Cal . Prac. Guide : Fed. Civ. Pro. Before

24 Trial (The Rutter Group 2002), 8 :44.

25 Although plaintiffs alleging claims under §11 need not, as noted above, alleg e

26 I scienter or fraudulent conduct on the part of defendants, the Ninth Circuit has held tha t

27 "the particularity requirements of Rule 9(b) apply to claims brought under Section 11 when .

28 . . they are grounded in fraud ." See In re Stac Electronics , 89 F. 3d 1399, 1404-05 (9th Cir.

28 0 IA

1996). Recently, the Ninth Circuit 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). The court in Vess further stated, "`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

9 stated . The proper route is to disregard averments of fraud not meeting Rule 9(b)'s

10 standard and then ask whether a claim has been stated ."' See id . (internal quotation and

11 citation omitted) (emphasis in original). Nevertheless, the court made clear that where a

12 plaintiff "allege[s] a unified course of fraudulent conduct and rel[ies] entirely on that course

13 of conduct as the basis of a claim . . . the claim is said to be `grounded in fraud' or to

14 `sound in fraud,' and the pleading of that claim as a whole must satisfy the particularity

15 requirement of Rule 9(b) ." See id . At 1103-04 (citing In re Stac, 89 F . 3d 1399, 1404-05).

16 Relying on In re Stac, defendants argue that plaintiffs' §11 claims "sound in fraud, "

17 pointing to such allegations in the FAC as "defendants . . . participated in an egregious

18 accounting fraud designed to deceive investors in Exodus" (FAC ¶1) ; "falsif[ied] Exodus'

19 financial results" (id .); and "embarked on a scheme to defraud" (id . at ¶27). Plaintiffs

20 respond that they "have separated their §10(b) and the §11 counts, and the fraud

21 allegations only appear in the §10(b) count but not the §11 count." (See Opp. at 19.)

22 Plaintiffs' argument is unavailing . The FAC makes no effort to distinguish betwee n

23 the Underwriter Defendants and the Individual Defendants, but rather alleges a unified

24 course of fraudulent conduct as to all "defendants," averring consistently and repeatedly

25 that the defendants knew that the statements in question were false and misleading when

26 made . See Vess 317 F. 3d at 1105 ("Fraud can be averred by specifically alleging fraud,

27 or by alleging facts that necessarily constitute fraud[;] the indispensable elements of a

28 fraud claim include a false representation, knowledge of its falsity, intent to defraud ,

29 0 i

justifiable reliance, and damages .") Plaintiffs point 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 . Nor can plaintiffs rely on the form of the FAC, wherein they ultimately, after 96 pages of factual allegations, have pleaded their § 10(b) and § 11 claims in separate counts . See In Re

Stac, 89 F. 3d 1399, 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

8 unconvincing when the gravamen of the complaint is plainly fraud and no effort is made to 9 show any other basis for the claims levied at the Prospectus .") 10 In light of the foregoing, plaintiffs' § 11 claim, as currently pleaded, must satisfy th e

11 heightened pleading requirements of Rule 9(b), which requires, inter alia, that plaintiffs

12 "aver with particularity the circumstances constituting the fraud ." Because, for the reasons

13 discussed earlier, plaintiffs have failed to successfully plead falsity for purposes of thei r

14 § 10(b) claim, plaintiffs' § 11 claim likewise fails .

15 IV. DISCUSSION: INDIVIDUAL DEFENDANTS' MOTION TO DISMIS S

16 The FAC asserts a claim for violation of §10 (b) of the Exchange Act and SEC Rul e

17 10(b)(5) against each of the Individual Defendants, and a claim for violation of §11 of the

18 Securities Act against Hancock . Specifically, plaintiffs allege that the Individual Defendants

19 are liable for making numerous false and misleading statements throughout the class

20 period, which statements, as plaintiffs indicate in their opposition, can be grouped into eight

21 categories, specifically, statements regarding : (1) Exodus' standards as to the

22 creditworthiness of its customers ; (2) number of customers; (3) customer "churn" numbers ;

23 (4) financial results ; (5) cash balances and "Day Sales Outstanding" numbers ;

24 (6) adequacy of funding and risk of bankruptcy; (7) IDC capacity and demand ; and

25 (8) revenue forecasts . (See Opp . at (l).)1 9

26 19The FAC also alleges that statements regarding Exodus' acquisition of 27 GlobalCenter were false when made . As plaintiffs fail to address the arguments raised by the Individual Defendants in their motion to dismiss with respect to this allegation, plaintiffs 28 are deemed to have conceded the insufficiency of such allegation as currently pleaded ,

30 \_J S

1 The Individual Defendants raise four principal arguments in their motion to dismiss :

2 (1) plaintiffs are barred by the statute of limitations from asserting (a) the §10(b) claims

3 based on statements made in the expanded class period, (b) claims against the three new

4 Individual Defendants, and (c) the §11 claim against former Exodus CEO Hancock ;

5 (2) plaintiffs fail to state a § 10(b) claim because they have failed to adequately alleged 6 1 falsity or scienter as to any of the statements alleged to be false, and because the

7 PSLRA's Safe Harbor provisions insulate the forward-looking statements in question from

8 liability; (3) plaintiffs' new §11 claim against Hancock fails because plaintiffs lack standing

9 to raise such claim ; and (4) plaintiffs have failed to adequately allege the §11 claim against

10 Hancock because plaintiffs have failed to state facts with the particularity required by Rule

11 9(b) of the Federal Rules of Civil Procedure .

12 A. Statute of Limitations

13 The Individual Defendants argue that the plaintiffs are barred by the statute of

14 I limitations from bringing (1) certain of the claims by the new plaintiffs, (2) certain of th e

15 claims against the new Individual Defendants, Mohamad, Yeack, and Brown, and (3) th e

16 new § 11 claim against Hancock. 17 1 . Claims by New Plaintiffs

18 As noted, plaintiff's FAC asserts claims on behalf of persons and entities wh o

19 purchased Exodus securities between April 20, 2000 and September 21, 2001, whereas

20 the CCAC class period covered purchases made between March 31, 2001 and June 20,

21 2001, a substantially shorter period . Defendants argue that the one-year statute of

22 limitations bars the claims raised by those members of the newly-alleged class who

23 purchased securities between April 20, 2000 and March 31, 2001 .20

24 see Bureerong v . Uvawas, 959 F. Supp 1231, 1236 n .4 (C.D . Cal . 1997) (holding issue 25 conceded where plaintiff had failed to address it in opposition), and, in any event, the allegation as currently pleaded is insufficient for the reasons stated with respect to the 26 Underwriter Defendants' motion to dismiss . 27 20The Individual Defendants do not argue that the statute of limitations bars any claims by new plaintiffs arising in the period between June 21, 2001 and September 25, 28 2001 .

31 Exhibit D (Part 2 of 2) 0 0

1 As set forth earlier in the discussion respecting the Underwriter Defendants' motio n

2 to dismiss, supra, plaintiffs must plead facts demonstrating conformity with the statute o f

3 limitations, and have failed to do so .21

4 2. Claims Against New Individual Defendant s

5 The Individual Defendants argue that plaintiffs were on actual and inquiry notice, a s

6 of June 20, 2001, with respect to any claims they may have had against newly-added

7 Individual Defendants Mohamad, Yeack and Brown . Plaintiffs first asserted causes of

8 action against the other Individual Defendants in a complaint filed on July 12, 2001, base d

9 on statements made between March 31, 2001 and June 20, 2001 . Plaintiffs offer no

10 reason, either in the FAC or their Opposition, for their failure to assert these claims against

11 Mohamad, Yeack, or Brown, arguing instead that they have no obligation to do so . (See

12 Opp. at 29.) As discussed earlier, plaintiffs must plead facts demonstrating conformity

13 with the statute of limitations . Accordingly, to the extent plaintiffs' claims against Individual

14 Defendants Mohamad, Yeack and Brown are based on statements made betwee n

15 March 31, 2001 and June 20, 2001, such claims are subject to dismissal .

16 3. Section 11 Claim Against Hancoc k

17 For the reasons discussed earlier with respect to the Underwriter Defendants'

18 I motion to dismiss, plaintiffs likewise have failed to adequately plead facts demonstrating 19 conformity with the statute of limitations as to plaintiffs' §11 claim against Hancock .

20 B. Sufficiency of Pleading : Section 10(b) Clai m

21 As noted, in assessing whether plaintiffs have adequately pleaded a § 10(b) clai m

22 I under the PSLRA, the court "must determine whether pa rticular facts in the complaint ,

23 taken as a whole, raise a strong inference that defendants intentionally or with 'deliberat e

24 recklessness' made false or misleading statements to investors ." See Ronconi v. Larkin,

25

26 21The Individual Defendants also suggest that Exodus' disclosure of certain risk factors in its March 31, 2001 Form 10-K, and in various press releases thereafter, was 27 sufficient to put investors on notice that they should begin investigating Exodus' earlier statements. Defendants cite to no authority in support of this proposition, and the Court i s 28 aware of none.

32 . 0

1 253 F . 3d at 429 . "Where pleadings are not sufficiently particularized or where , taken as a 2 whole, they do not raise a `strong inference' that misleading statements were knowingly or 3 with deliberate recklessness made to investors, a private securities fraud complaint i s 4 properly dismissed under Rule 12(b)(6) ." See id.

5 1 . Statements Regarding Exodus ' Standards as to Customer Creditworthiness 6 Exodus' March 31, 2001 Form 10-K contained the following statements : (1) "We do 7 not enter into arrangements unless collectability is reasonably assured at the outset" ; (2) 8 "Existing customers are subject to ongoing credit evaluations based on payment history 9 and other factors"; and (3) "If it is determined that collectability is not reasonably assured, 10 revenue is recognized on a cash basis ." (See FAC ¶63.) Plaintiffs allege that thes e 11 statements were false or misleading when made, and that the Individual Defendants knew 12 or were deliberately reckless as to such falsity, for four reasons . 13 First, plaintiffs rely on two articles, a September 28, 2001 article in which Hancock's 14 successor as CEO of Exodus, Richard Krause,22 stated : "We have a lot of customers who 15 don't qualify to be customers . . . . We shouldn't have had them as customers in the first 16 place, [although] virtually 90 percent of that [was] self-induced . . . . If you can't pay your 17 bills, please go away," and an October 1, 2001 article in which Krause stated : 18 "Unfortunately, in this emphasis on revenue at any cost, we've taken on some obligations 19 for people who aren't customers ." See FAC ¶141(b), (c) (modifications in FAC) . 20 Plaintiffs argue that the above statements are admissions by Exodus that the 10-K

21 statements regarding collectablity were false when made . (See Opp. at 3, 8 .) Krause's 22 statements, however, reflect an assessment made six months after the 10-K statements 23 were made, and thus fail to indicate knowledge of falsity at the time the 10-K statements

24 were made. Moreover, there is no indication in Krause's statements as to when Exodus 25 may have acquired the "customers who don't qualify to be customers ." (See FAC ¶ 26

27 22On September 4, 2001, Exodus announced Hancock's resignation, and that 28 Krause had been appointed CEO and Chairman of the Board of Exodus as of such date . (See FAC ¶94.)

33 141(c).) As a consequence, this allegation fails to demonstrate falsity or scienter as to

2 Exodus' 10-K statements . See In re Vantive , 110 F. Supp 2d 1209, 1217 n .14 ("[E]vents

3 occurring after the alleged class period do not show that the representations made during

4 the class period were false when made, plaintiffs must point to particular contemporaneous

5 facts that establish the falsity of the statement at the time it was made") .

6 Second, plaintiffs allege that information from two former Exodus employee s

7 demonstrates that Exodus in fact approved non-creditworthy and high-risk customers .

8 Specifically, plaintiffs allege that CW 1, the former Controller of Exodus' Professional

9 Services Organization, attended Exodus' Monday morning executive meetings with the

10 Individual Defendants and expressed "his concerns that Exodus continuously failed to

11 establish a reserve for customers known to be non-creditworthy with [accounts receivable]

12 aged over 60 days (to as much as one year), and that, nevertheless, Exodus had

13 continued to invoice and recognize revenue ." (See FAC ¶105(h)). Plaintiffs also allege that

14 CW 10, a former Credit & Collections Analyst for Exodus "responsible for determining the

15 creditworthiness of customers," stated that "Hancock and Mohamad regularly approved

16 high-risk customers that had been rejected by the Credit and Collections and Finance

17 Departments, and that Hancock personally approved a majority of the non-creditworthy

18 customers." (See FAC ¶¶ 104(j), 106(b),(c) .)

19 These allegations are not pled with the particularity required by the PSLRA. First,

20 as to CW1, plaintiffs fail to provide any specific facts sufficient to support CW 1's belief that

21 Exodus had non-creditworthy customers and a lack of proper bad-debt reserves . Although

22 the FAC alleges that CW1's concerns were based on Exodus' structuring transactions as

23 "monthly recurring cost" as opposed to "non-recurring cost" transactions, so as to allow

24 customers to pay on a monthly as opposed to a lump-sum basis,23 ( see FAC 11105-106),

25 plaintiffs fail to provide specific allegations regarding any "monthly recurring cost "

26 23The FAC also alleges that CW 1 "took a healthy beating" whenever he raised his 27 concerns about the monthly-recurring cost issue with the executive management team, and that CW1 was eventually dismissed from attendance at the executive meetings . (See 28 FAC 11105-106.)

34 E n

transactions that were improperly characterized as such and the revenue affected,24 the

2 number of non-creditworthy customers or the identity of any such customers, and the

3 amount by which Exodus' bad-debt reserves were insufficient . Plaintiffs' allegations based

4 on CW 10 fare no better . There is no allegation as to the number, or percentage, of non-

5 creditworthy customers that were "'pushed through' by senior management after rejections

6 by the Credit & Collections and Finance Departments," or the number of the "highest risk

7 customers" that were "routinely approved by Hancock, Case and/or Stolz ." (FAC ¶¶ 106(b),

8 (c).) In addition, although CW10 identifies three customers, out of a customer base of

9 3500-4500 customers,25 specifically, Advertising .com, Freerealtime .com, and

10 Business .com,26 plaintiffs provide no specific facts supporting CW10's assessment of such

11 customers as high-risk or non-creditworthy.27 (See FAC ¶180.) Moreover, there is no

12 allegation as to the amount of revenue attributable to these customers; how revenue was

13 recognized as to such customers; and, apart from the conclusory assertion that th e

14

15 24 Although plaintiffs allege that, according to CW 1, Exodus allowed customers to 16 pay on a monthly versus lump sum basis in order to "financ[e] many deals that customers obviously would not have been able to afford and pay for up front," such structuring alone 17 does not indicate that collectability was not "reasonably assured" as to these customers, and there is no allegation that the account of any specific customer who had made such an 18 arrangement was deemed "uncollectable," or that such customer did not end up paying its monthly invoices for the services rendered by Exodus. Moreover, the FAC fails to explain 19 why the structuring of transactions as "monthly recurring cost" was improper, and, as the Individual Defendants note, Exodus, in numerous SEC filings, disclosed to investors that it 20 structured transactions on a monthly basis . (See , e q., Ind . Defs.' Req . Jud. Not. Ex. 6 at 10.) 21 25As discussed infra, the parties dispute the total number of Exodus customers, with 22 plaintiffs alleging a total of no more than 3,500 customers, and defendants having asserted during the class period a total of over 4,500 customers. 23 26The FAC also states : "Additional examples of high risk customers approved by 24 Hancock or Stolz during 2000 are Buy.com and Beyond .com." (See FAC ¶ 181 .) Plaintiffs, however, fail to allege any source for this information, nor do plaintiffs allege any further 25 facts supporting plaintiffs' assertion that these customers were "high risk. " 26 21Moreover, of these three customers, only one, Advertising .com, is specifically alleged to have been "approved by defendant Hancock ." As to the other two, CW10 states 27 only that Business.com was approved by "executive management," and that the transaction with Freerealtime .com "was `pushed through' by Hancock or other executives ." 28 (See FAC ¶ 180 (emphasis added) .)

35 0 1 1

1 arrangement with Business .com "ultimately resulted in delayed or no payments," whethe r 2 I these or any other customers did in fact fail to pay . (See id.) 3 Third, plaintiffs allege that the statements respecting collectability were false 4 because Exodus was in fact seeking to collect a large amount of unpaid debt from its

5 customers. (See FAC 11116, 174.) Specifically, plaintiffs allege that CW2, a former

6 Exodus Employee who worked in a "Collection Task Force" set up by Exodus, "learned that 7 in 2001, Exodus was trying to collect close to $500 million in debts from customers," and

8 that "[a]mong the debts the Collections Task Force attempted to collect included American 9 Airlines, which owed between $5 and $7 million to Exodus ." (See FAC ¶116. )

10 These allegations are insufficient to demonstrate falsity or scienter because plaintiff

11 fails to provide the requisite facts respecting CW2's source of information . The FAC 12 alleges that CW2 initially "worked in public relations for Exodus until he was laid off in April

13 2001," and that "[i]n August 2001, CW2 was rehired by Exodus to work in Exodus'

14 Collections Taskforce, where he remained until October 2001 ." (See FAC ¶ 104(b).) 15 Consequently, CW2 was a member of the Task Force for a maximum period of three

16 months, which period began anywhere from four to five months after the March 31, 2001 17 statements regarding collectability were made . Although plaintiffs allege that the

18 Collections Task Force was "established during first quarter 2001," ( see FAC ¶ 174), 19 plaintiffs fail to provide the requisite facts regarding CW2's role in the Collections Task

20 Force, how he may have "learned" of the amount of debt subject to collection efforts, or 21 how such amounts were determined and reported . (See FAC ¶116, 174 .) Without such

22 additional facts, plaintiffs' allegations as to the Collections Task Force are insufficient. See

23 ABC Arbitrage v. Tchuruk, 291 F. 3d 336, 352 (5th Cir. 2001) (noting that an informant must

24 be described "with sufficient particularity to support the probability that the person in the 25 position occupied by the source would possess the information alleged) ; In re Secure 26 Computing Corp. Sec. Liter. , 120 F. Supp. 2d 810, 817 (N .D. Cal. 2000) ("[I]f Plaintiffs

27 make an allegation that is based on a statement from a witness, they must reveal all facts

28

36 about that witness that were material to the formation of their belief that the witness ' statement is accurate .") Fourth, plaintiffs allege that CW5, the Senior Manager of Credit and Collections fo r 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 FAC

¶135.) According to plaintiffs, CW5 had the "responsibility to generate bad debt reserve

7 reports and revenue reserve reports on a monthly basis" and "[e]very month, and once a

8 quarter . . . would go through each customer account to determine whether there was 9 collectible revenue." See id . The report is alleged to have been delivered by hand to

10 Hancock, Wegner, Dollahite and Case in "early April ." (See id.) Plaintiffs further allege :

1 1 "After Hancock reviewed the report, Hancock insisted the report was wrong, that th e

12 number was too high and had to be changed . Hancock told CW5's supervisor, Susan

13 Colvin (the Controller), to change the number . The number was later sent out to th e

14 people involved in sales to challenge-but no one challenged the figure ." (See id .)

15 "[I]f a plaintiff is to rely on the existence of [internal] reports as a means o f

16 establishing knowledge, [plaintiff] must 'include adequate corroborating details,' such as

17 the 'sources of [plaintiff's] information with respect to the reports, how [plaintiff] learned of

18 the reports, who drafted them . . . which officers received them,' and `an adequate

19 description of their contents ."' See In re The Vantive Corp . Securities Litigation , 283 F. 3d

20 1079, 1088 (9th Cir. 2002) (quoting Silicon Graphics , 183 F . 3d at 985); see also 15 U.S .C.

21 § 78u-4(b)(1)(B) (providing plaintiff must "state with particularity all facts" supporting

22 plaintiffs belief that statement is false or misleading) .

23 Here, plaintiffs have pleaded "adequate corroborating details," i .e., the source of

24 plaintiffs' information, the author of the report, and the recipients of the report . Under

25 Silicon Graphics, however, plaintiffs have not pleaded an "adequate description" of the

26 reports' content sufficient to enable the court to determine whether the statement s

27

28

37 0 0

respecting collectability were false when made .28 See Silicon Graphics , 183 F . 3d at 985

2 ("Nor does [plaintiff] include an adequate description of [the internal reports'] contents

3 which we believe -- if they did exist -- would include countless specifics regarding ASIC

4 chip shortages, volume shortages, negative financial projections, and so on .")

5 Plaintiffs fail to allege the amount of Foundry's "overall accounts receivable" at the time of

6 the report, or whether the 40% that CW5 describes as "uncollectable" was comprised of

7 numerous, or only a few, customers . More significantly, assuming, arguendo, that the

8 March report has been pled with the requisite particularity, the allegation fails to raise the

9 requisite strong inference of scienter. Plaintiffs allege that the report, which reflected the

10 status of Exodus' accounts receivable as of March, 2001, was handed to defendants

11 Hancock, Wegner, Dollahite and Case in "early April" 2001 . As a result, defendants did not

12 receive the report until after the statements respecting collectability had been published on

13 March 31, 2001, and plaintiffs do not allege that defendants were aware of the contents of

14 the report prior to the time defendants received it.29

15 2. Statements Regarding Number of Exodus Customer s

16 The FAC alleges that throughout the Class Period , the Individual Defendants

17 misrepresented the number of Exodus' customers . (See FAC ¶ 110.) Specifically,

18 plaintiffs allege that the statement in Exodus' April 26, 2001 press release, that Exodus had

19 "a much stronger base of 4,526 IDC customers at the end of the [first] quarter [2001]"30 wa s

20 28The Individual Defendants' argue that the reserve report "do[es] not establish 21 these customer accounts presented collectability issues at the time they signed on ." (See Reply at 4 .) Plaintiffs, however, are challenging not only the statement "collectability is 22 reasonably assured at the outset," but also the statement that Exodus' customers were "subject to ongoing credit evaluations based on payment history and other factors," and 23 that Exodus recognized revenue on a cash basis if it "determined that collectability [was] not reasonably assured ." 24 29CW5 is alleged to have generated bad debt reports on a monthly basis, typically 25 handing them to the named officers by the sixth day of the following month . (See FAC ¶ 135.) Plaintiffs, however, do not allege the contents of the reports for any of the prior 26 months. 27 30Plaintiffs allege that Exodus made five distinct false statements between April 20, 2003 and April 26, 2001, inclusive, as to their customer counts : (1) an April 20, 2000 press 28 release claiming 2830 customers (see FAC ¶ 29); (2) a July 19, 2000 press release

38 # i

false when made because (1) Exodus' internal databases showed that Exodus actually had

2 3500 customers, (see FAC ¶ 110); and (2) "by the fall of 2001, approximately 1,500 active

3 customer accounts were formally cancelled by the Credit and Collections department

4 because said collectors with the Collections Task Force had determined that these

5 customers had previously canceled" ( see FAC ¶176).

6 As set forth in the discussion respecting the Underwriter Defendants' motion t o

7 dismiss, supra, these allegations are insufficient under the PSLRA to show that Exodus'

8 customer count of 4526 was false when made or to raise the requisite strong inference o f

9 scienter.

10 Plaintiffs argue in their Opposition, but do not allege in their FAC, that the fact tha t

11 the reserve report drafted by CW5 in April 2001 showed that 40% of Exodus' overall

12 accounts receivable were not collectable "strongly implies that Exodus' customer rolls were

13 inflated with significant amounts of cancelled customers ." (See Opp. at 11). If plaintiffs are

14 relying on the reserve report to show falsity, plaintiff must plead such reliance . See 15

15 U.S .C. § 78u-4(b)(1) ("[T]he complaint shall specify each statement alleged to have been

16 misleading [and] the reason or reasons why the statement is misleading .") Even were it

17 pled in the FAC, however, the allegation fails to show that Exodus' customer count of 4526

18 was false when made . Plaintiffs fail to plead facts as to whether, and to what extent, the

19 April 26, 2001 statement of "4,526 IDC customers" included "not collectable" accounts .

20 Moreover, plaintiffs fail to allege any facts indicating the number of customers implicated by

21 the reserve report, in that the FAC, by stating 40% of the "overall accounts was not

22 collectible," (see FAC ¶ 135), appears to reference the dollar amount of uncollectible

23 receivables rather than the number of uncollectible accounts .

24

25

26 claiming 3333 customers (see FAC ¶38); (3) an October 19, 2000 press release claiming 3747 customers (see FAC ¶44); (4) a January 24, 2001 press release claiming 4000 27 customers (see FAC ¶56) ; and the April 26, 2001 press release claiming 4526 customers (see FAC ¶67). Plaintiffs, however, plead no facts to indicate, nor do plaintiffs argue, that 28 the earlier customer counts were false.

39 I 11

1 3. Statements Regarding Exodus' Customer Churn Numbers

2 Plaintiffs assert that the Individual Defendants made several false statement s

3 respecting "Exodus' customer `churn,' i .e., the percentage of customers who were lost and

4 needed to be replaced with new customers in a given quarter." (See Opp. at 11 .)

5 Specifically, in the FAC, plaintiffs allege as false an October 19, 2000 Exodus press

6 release stating churn was less than 2%, a January 24, 2001 press release stating churn

7 was 3%, and an April 26, 2001 conference call wherein defendant Case claimed that

8 Exodus' churn was 6%. (See FAC 11 44, 56, 69; see also Opp . at 11 .)

9 To show falsity, plaintiffs allege only generally, and without specific cross-reference ,

10 that "[d]efendants also misrepresented the number of customers by including customers

11 who were not active , who had cancelled , and who had no ability to pay ." (See FAC ¶ 45,

12 57, 71 .) This general statement, without specific reference to pa rticular facts and

13 allegations demonstrating falsity, is insufficient under the PSLRA.

14 Plaintiffs argue, in their Opposition, that the customer churn numbers were fals e

15 because "the fact that 40% of Exodus' accounts receivable were not collectable indicates

16 that as many as 40% of Exodus' customers had either canceled, or had stopped paying or

17 using Exodus' services and should have been deleted from Exodus' customer base," ( see

18 Opp. at 11), and that "the fact that some 1,500 inactive customers were deleted shortly

19 after the Class Period (one-third, or 33% of Exodus' claimed customer base) demonstrates

20 that Exodus was grossly understating the rate at which it was losing customers" ( see FAC

21 at 11-12). As discussed above, however, under the PSLRA plaintiffs cannot rely on

22 arguments raised in their opposition to show falsity, but must plead such allegations in their

23 complaint. See 15 U.S .C . § 78u-4(b)(1).

24 Moreover, even were such argument pled as allegations in the FAC, such

25 allegations would be insufficient . The internal "reserve report," as noted above, appears to

26 reference the dollar amount of uncollectible receivables rather than the number of

27 uncollectible accounts, and, in any event, plaintiffs provide no information as to the

28 relationship between the information in the report and customer churn rates . In addition ,

40 E L J

as with plaintiffs' allegations regarding Exodus' statements as to customer counts, the fact

2 that Exodus' Credit and Collections department cancelled approximately 1500 accounts in

3 late 2001, (see FAC ¶ 176), does not show that the statements about churn were false

4 when made in October 2000, a year earlier, or for that matter in January 2001 and April

5 2001, many months earlier. See In re Vantive , 110 F . Supp 2d at 1217 n .14. ("[E]vents

6 occurring after the alleged class period do not show that the representations made during

7 the class period were false when made, plaintiffs must point to particular contemporaneous

8 facts that establish the falsity of the statement at the time it was made.")

9 4. Statements Regarding Exodus' False Financial Result s

10 Plaintiffs assert that Exodus' financial results, as stated in Exodus' 1 OQ report s

11 regarding Exodus' first quarter 2000 through its first quarter 2001,31 were false or

12 misleading because Exodus recognized revenue in violation of GAAP and SEC rules by

13 engaging in four types of accounting improprieties : (1) recording revenue prior to rendering

14 services; (2) recording revenue on cancelled or non-renewed contracts ; (3) recording

15 revenue from transactions in which collectability was not probable ; and (4) recording

16 revenue and assets in conjunction with bogus barter transactions and failing to disclose

17 such transactions. (See FAC ¶159.)

18 "[T]o adequately plead financial fraud based on improper revenue recognition ,

19 plaintiffs must allege, at a minimum, some particular transactions where revenues were

20 improperly recorded, including the names of the customers, the terms of specific

21 transactions, when the transactions occurred, and the approximate amount of the

22 fraudulent transactions." See Oak Tech , 1997 WL 448168 *7 (N.D .Cal. 1997);see also

23 McKesson , 126 F Supp 2d at 1272 (N.D. Cal. 2000) (holding allegations of irregularities in

24 revenue recognition insufficient where plaintiffs failed to include "such basic details as th e

25 "Specifically, plaintiffs allege that the following reported financial results were false : 26 (1) 1Q00 revenues of $134.1 million and EBITDA loss of $12 .6 million (See FAC ¶ 29); (2) 2Q00 revenues of $179 .6 million and EBITDA loss of $8 .6 million (See FAC ¶ 38) ; 27 (3) 3000 revenues of $229 .6 million and EBITDA loss of $20 .2 million (See FAC ¶ 44); (4) 4Q00 revenues of $280 .4 million and EBITDA loss of $26 .5 million (See FAC ¶ 56); and 28 (5) 1Q01 revenues of $348 .7 million and EBITDA loss of $5 .5 million (See FAC ¶ 67).

41 approximate amount by which revenues and earnings were overstated . . . the products involved in the contingent transactions . . . the dates of any transactions . . . or the identities of any of the customers or company employees involved in the transactions") (quoting Greebel v. FTP Software, Inc., 194 F.3d 185, 204 (1st Cir.1999)). At the outset, the Individual Defendants raise three arguments applicable to all o f plaintiffs' allegations concerning improprieties in the recognition of revenue, none of which is persuasive. First, the Individual Defendants argue that plaintiffs' allegations are insufficient because plaintiffs make specific allegations "as to just 29 of Exodus' alleged

9 3500 customers - amounting to only 0 .82% of the customer base," and fail to "allege a

10 percentage or dollar amount of improper revenue associated with this less than one

11 percent of the customer base ." (See Mot. at 3.) The Individual Defendants cite to no

12 authority to the effect that a plaintiff must allege a specified threshold percentage of a

13 defendant's customers in order to comply with the PSLRA . A transaction or series of

14 transactions with only a few customers, if significant, may suffice . See In re Cylink Sec.

15 Litia ., 178 F. Supp 2d 1077, 1082-83 (N .D . Cal. 2001) (holding allegation that defendant

16 improperly recognized revenue with respect to five transactions, where one such

17 transaction represented 12 .5% of company's revenue, was sufficient .) Here, plaintiffs

18 include allegations as to a significant amount of improperly recognized revenue . For

19 example, plaintiffs allege that CW 11, a former "Credit and Collections Analyst" in Exodus'

20 "Collections Task Force," states that "approximately 40-50% of revenue was recognized

21 inappropriately during the first six months of 2001," ( ee FAC ¶176), and that as a result,

22 "at least $171 million of fraudulent revenue [was] recognized during the first six months of

23 2001 ." (See id .)32

24 Second, citing In Re Cirrus Logic , 946 F Supp 1446, 1457 (N .D. Cal. 1996), the

25 Individual Defendants argue that failure to comply with GAAP is not, standing alone, a

26 basis for securities fraud, as GAAP "tolerates a range of reasonable treatments , leaving

27 32The adequacy of these allegations is discussed below. 28

42 S i

1 the choice among alternatives to management." See Mot. at 4 (quoting In Re Cirrus Logic ,

2 946 F Supp at 1457); see also In re GlenFed, Inc . Sec. Litig ., 42 F.3d 1541, 1549 (9th

3 Cir.1994) (en banc) (holding valuation of assets and setting of loan loss reserves are

4 based on "flexible accounting concepts," which "do not always (or perhaps ever) yield a

5 single correct figure," and that, as a result, plaintiffs must set forth facts explaining why the

6 allegedly fraudulent accounting decision "is not merely the difference between two

7 permissible judgments.") This argument fails. Plaintiffs' FAC does not allege that Exodus

8 chose between two "reasonable treatments" or permissible judgments, but rather that

9 Exodus, in a number of instances, violated GAAP in improperly recognizing revenue and,

10 as a consequence, its reported revenue and EBITDA results were false when stated .

11 Third, the Individual Defendants argue, citing two district court cases, Morse v.

12 McWhorter, 200 F . Supp 2d 853, 899, (M .D. Tenn . 2000) and In re The First Union Corp.

13 Sec. Litig., 128 F. Supp . 2d 871, 894 (W .D.N .C . 2001), that the fact that Exodus' financial

14 results were audited and approved by its independent accountants, KPMG, "undermines

15 any inference of falsity or scienter ." (See Mot. at 4); see also Morse , 200 F. Supp 2d at 899

16 . ("[A] company's reliance on outside auditors is inconsistent with an intent to defraud ."); In

17 re The First Union , 128 F. Supp. 2d at 894 (holding falsity not shown where plaintiff failed

18 to "challenge" opinion of independent accountant.) Neither case, however, found reliance

19 on an independent audit to be dispositive . Rather, in each instance, plaintiffs therein

20 additionally failed to allege facts sufficient to call into question the subject accountin g

21 practices . 22 Accordingly , the Court turns to each of the accounting improprieties specified by

23 plaintiffs in the FAC. 24 Ill 25

26

27 III

28

43 1 a . Recording Revenue Prior to Rendering Service s

2 Plaintiffs allege that according to CW 10, the former "Credit & Collections Analyst"

3 who worked for Exodus from July 1998 through the end of 2001,33 ( see FAC 1 1040)),

4 "defendant Mohamad orchestrated a standard practice to generate . . . installation reports

5 prior to installation work ever beginning ." (See FAC ¶165 .) According to CW10, the

6 installation reports "triggered the onset of monthly invoicing and revenue recognition," and,

7 as a result, "[n]early all Exodus customers were invoiced prematurely for installations that

8 did not occur until approximately three months later, typically the next quarter." (See id. )

9 As the Individual Defendants argue, plaintiffs fail to demonstrate how CW10, whos e

10 "responsibilities primarily involved running credit checks on prospective customers," ( see

11 FAC 1104(j)), obtained knowledge that there was a "standard practice" as to premature

12 invoicing, or that defendant Mohamad initiated any such practice . CW 10 is not alleged to

13 have been involved in either installation or in invoicing . Consequently, plaintiffs have failed

14 to "reveal all facts about that witness that were material to the formation of their belief that

15 the witness' statement is accurate ." See Secure Computing , 120 F. Supp. 2d at 817.

16 Moreover, although plaintiffs identify nine Exodus customers who, according to

17 CW10, were prematurely invoiced under the "premature invoicing scheme" ( see FAC

18 ¶171), plaintiffs fail to allege facts with sufficient particularity to show the reported financial

19 results were false when made, let alone that any of the Individual Defendants had

20 knowledge of such falsity. As to seven of the nine customers, plaintiffs fail to allege the

21 approximate amount of the fraudulent transactions, as well as when such transactions

22 occurred . Of the two remaining, the Lycos, Inc. account, which, according to CW10,

23 "consistently generated approximately $2 million per month in revenue throughout the

24 Class Period," and the Merrill Lynch account, which "called for payment of $2 million per

25 quarter," and which was invoiced for approximately $800,000 "right off the bat," ( see id .),

26 33The FAC states that CW 10 was initially hired as a collector and assigned to collect 27 on invoices from Exodus' customers, and that, in mid-1999, CW 10 "also became responsible for determining the creditworthiness of customers." (See FAC 1 1040)). 28

44 9 0

plaintiffs fail to allege when either of these customers was signed, and thus whether th e premature invoicing as to these customers occurred in the Class Period . Plaintiffs include two additional allegations, both of which are insufficient . First,

plaintiffs allege that CW 12, a former "Sr . Collection Specialist" at Exodus (see FAC ¶ 104(l)), "confirmed the false installation practice" alleged by CW10 . (See FAC 1177.) Second, as noted earlier, plaintiffs allege that CW 11, the former Credit and Collections Analyst in Exodus' Collections Task Force, states that "approximately 40-50% of revenue was recognized inappropriately during the first six months of 2001," ( see FAC ¶176), and

9 that, as a result, "at least $171 million of fraudulent revenue [was] recognized during the

10 first six months of 2001 ." (See id .) In each instance, however, plaintiffs fail to adequately

11 allege the basis of their source's knowledge and information.

12 b . Recording Revenue on Cancelled or Non-renewed Contract s

13 Plaintiffs also allege that the financial statements were false because Exodu s

14 continued to record revenue based on orders that were cancelled . (See FAC ¶¶ 107-109.)

15 In support of this allegation, plaintiffs begin with the fact that "revenue was recorded at the

16 time invoices were generated from the billing system ." (See FAC at 81 n .3 .)34 Next, relying

17 on information received from CW 11, plaintiffs allege that customers who cancelled would

18 continue to be invoiced by Exodus' billing system, but would ignore the invoices based on

19 "side agreements" made between the customer and Exodus . (See FAC ¶ 107.) These

20 side agreements, according to CW 11, allowed customers to terminate their contracts within

21 90 days for any reason, while allowing Exodus' billing system to "continue to invoice the

22 customers after cancellation ." (See Opp. at 12; FAC ¶108(b) .) Plaintiffs allege that Exodus

23 established the side agreements at the direction of defendant Mohamad . (See FAC ¶ 108.)

24 As the Individual Defendants point out, however, plaintiffs fail to identify any

25 I particular customer who was billed subsequent to cancellation and/or who entered into a

26 side agreement, let alone the dates of any such transactions or the amount of revenu e

27

28 34Defendants do not challenge the source or the accuracy of this allegation .

45 1 involved. Without such additional facts, plaintiffs' allegations as to post-cancellatio n

2 invoicing are insufficient to show that the financial results were false or misleading whe n

3 made. See Oak Tech , 1997 WL 448168 *7 ("[P]laintiffs must allege, at a minimum, some

4 particular transactions where revenues were improperly recorded, including the names o f

5 the customers, the terms of specific transactions, when the transactions occurred, and th e

6 approximate amount of the fraudulent transactions .")

7 c.

8 To demonstrate that Exodus improperly recorded revenue from customers wh o 9 lacked the ability to pay, plaintiffs again rely on CW 1 and CW 10 . As noted, CW 1 is the 10 former Controller for Exodus' Professional Services Organization, who is alleged to have 11 attended Exodus' Monday morning executive meetings and expressed his concerns about 12 Exodus' failure to establish adequate bad-debt reserves while continuing to invoice and 13 recognize revenue, (see FAC ¶105(h), and CW 10 is a former credit and collections analyst 14 for Exodus, who stated that "Hancock and Mohamad regularly approved high-risk 15 customers that had been rejected by the Credit and Collections and Finance Departments, 16 and that Hancock personally approved a majority of the non-creditworthy customers ." 17 (FAC ¶¶ 1040), 106(b),(c) . ) 18 For the reasons expressed earlier, these allegations are not stated with th e 19 particularity required under the PSLRA. 20 d. t t 21

22 Plaintiffs allege that Exodus, throughout the class period, improperly recognized

23 revenue from barter transactions with its customers, in particular, "fictitious or over value d

24 barter transactions." (See FAC ¶ 187 .)35 Relying on information obtained from CW1 ,

25 plaintiffs allege that Exodus engaged in improper barter transactions with Oracle ,

26

27 35Plaintiffs do not allege that barter transactions per se are not allowed . Indeed the FAC itself acknowledges that GAAP recognizes such transactions . (See FAC ¶ 188 (citing 28 APB29).)

46 41

1 Innoventry, Alta Vista, Niku, Vulcan, and SANrise ; relying on information obtained from

2 CW 10, further allege that Exodus engaged in improper barter transactions with Inktomi,

3 StorageNetworks and StorageWay . (See FAC 11111-1 12 .) As to all of the transactions,

4 plaintiffs allege that the transactions were improper because Exodus "improperly gross[ed]

5 up revenues based on fictitious or over valued barter transactions ." (See FAC ¶ 187 .)

6 Defendants argue that plaintiffs' allegations are insufficient because, as to some o f

7 the transactions, plaintiffs fail to allege that either CW 1 or CW 10 had personal knowledge,

8 and as to all of the transactions, that plaintiffs fail to allege facts describing the transactions

9 with particularity . In their opposition, plaintiffs address only the transactions involvin g

10 Oracle, Innoventry, Niku, and Inktomi,36 and as to those transactions, fail to specifically

11 respond to defendants' arguments or otherwise demonstrate the sufficiency of the 12 allegations respecting these transactions .

13 To begin with, plaintiffs' allegations as to the Oracle transaction fail because, a s 14 defendants argue, the transaction is alleged to have occurred during the fourth quarter

15 1999, and thus is outside the scope of the class period . Next, plaintiffs' allegations as to 16 the Innoventry transaction are insufficient because plaintiffs fail to adequately describe

17 CW 1's personal knowledge of the barter transaction . Plaintiffs allege that "CW1 believes

18 the Innoventry deal was a barter transaction in which Exodus purchased software licenses

19 from Innoventry that were unneeded, and, in turn, invoiced Innoventry. . . on this $800,000

20 transaction, and recognized revenue associated with the invoices" ; plaintiffs further allege

21 that "CW1 does not believe Innoventry ever made any payments to Exodus whatsoever, 22 nor did Exodus to Innoventry ." (See FAC 1111 (b)) (emphasis added) . Allegations based

23 on "belief' alone, and lacking in specificity as to the basis of the source's knowledge, ar e

24

25 36As plaintiffs fail to address defendants arguments as to the insufficiency of the allegations regarding the transactions with Alta Vista, Vulcan, SANrise, StorageNetworks 26 and StorageWay, plaintiffs are deemed to have conceded the insufficiency of such allegations as currently pleaded . See Bureerong v . Uvawas , 959 F. Supp 1231, 1236 n .4 27 (C .D. Cal. 1997) (holding issue conceded where plaintiff had failed to address it in opposition) . 28

47 • 0

insufficient. See In re Secure Computing , 120 F. Supp. 2d at 817. ("[I]f Plaintiffs make an

2 allegation that is based on a statement from a witness, they must reveal all facts about that

3 witness that were material to the formation of their belief that the witness' statement i s

4 accurate.")

5 With respect to Niku, plaintiffs allege that CW1 became "involved" in a "barter deal "

6 that was "under the umbrella" of his division . (See FAC ¶ 111(d).) According to CW1, on

7 December 27, 2000, Exodus purchased a software license from Niku for $417,000, and

8 Exodus in turn "invoiced Niku 'for services rendered' in the same amount," and recorded

9 $417,000 as revenue on that date . (See id.) According to CW 1, "neither company ever

10 had any intention of using the other's product," and CW 1 ultimately "wrote off the $417,000

11 in revenue associated with the fictitious sale to Niku at the direction of Mike Healy, the

12 Senior Vice President of Finance ."37 (See id .) Although plaintiffs set forth the objective

13 particulars of the transaction and the basis for CW1's knowledge thereof, plaintiffs include

14 no facts indicating the source of CW1's opinion that "neither company ever had any

15 intention of using the other's product ." The statement that the transaction was later

16 "debooked" does not demonstrate that it was "bogus" at the time of entry . Moreover,

17 although plaintiffs allege that, according to CW 1, defendant Mohamad was "spearheading

18 the entire barter transaction," plaintiffs fail to explain what they mean by such statement,

19 and in particular, fail to provide facts demonstrating Mohamad, or any other Individual

20 Defendant, had knowledge of the alleged improper motive underlying the Niku transaction .

21 (See FAC ¶ 111(d).)38

22

23 37According to CW1, the transaction in question also was "debooked in later 2001 ." It is unclear what CW 1 means by the statement that the transaction was "debooked" or that 24 CW1 "wrote off"the transaction, as CW 1 also states that Niku actually wrote Exodus a check in the amount of $417,000. (See FAC 1111 (d).) 25 38In addition, as noted, plaintiffs acknowledge the relatively small size of the 26 transaction. See FAC ¶111(d)) ("Although the $417,000 amount might be insignificant in terms of the Company's gross revenue, deals like these were very important because 27 these amounts 'blow straight through to income ."') To the extent plaintiffs seek to allege that the amount of the Niku transaction is material with respect to the EBITDA statements, 28 the FAC fails to plead facts sufficient to support such allegation .

48 0

Lastly, the lnktomi allegation is insufficient . Plaintiffs allege that Exodus and Inktom i "engaged in a practice of swapping invoices for approximately $500,000 at quarter-end simply to add to each other's revenue for the quarter," and that "neither invoice was ever

paid ." (See FAC 111 2(a).) Plaintiffs fail to allege with sufficient particularity the facts on which CW 10 bases her conclusion that the transactions were entered into "simply to add to each [company's reported] revenue," nor do plaintiffs allege the dates of the improper transactions, and, in particular, whether any such transactions occurred within the class

period . 5. Cash Balance and DSO Numbers 10 Plaintiffs allege that Exodus, in its March 31, 2001 Form 10-K, falsely reported cas h

11 balances of $805 million for the fourth quarter 2000 . (See FAC ¶63). Relying on CW 1,

12 plaintiffs allege that the cash balances were overstated by $100 million as a "result of a

13 practice" and "game" by which Exodus made year-end calls to customers to inquire

14 whether checks had been mailed, and, upon being informed that a particular check had

15 been mailed, included such payment in Exodus' year-end cash balances, both sides

16 understanding that the check would not in fact be mailed until after the first of the year .

17 (See FAC ¶ 128). According to plaintiffs, "[i]n this way, receivables were lowered, DSO

18 was improved, and cash balances were artificially high for Exodus ." (See id .)

19 Plaintiffs' allegations are insufficient. Plaintiffs fail to allege how CW1, the Controlle r

20 for one of Exodus ' business divisions, became aware of an allegedly company-wide

21 scheme to inflate Exodus' cash balances . Moreover, to the extent CW 1's knowledge is

22 based on practices conducted within CW1 's division, plaintiffs must allege such facts with

23 particularity. Fu rther, plaintiffs fail to allege with any specificity the basis for CW 1's

24 conclusion that the cash balances were overstated by $100 million, as plaintiffs fail to

25 identify any particular customers involved in the alleged practice , let alone any particular

26 transaction , the date thereof, or any revenue amounts associated therewith.

27 III

28 III

49 9 0

6. Statements Regarding Adequacy of Funding and Risk of Bankruptc y

2 a . Adequacy of Funding

3 In an April 26, 2001 conference call with analysts, defendant Hancock stated : "[W]e

4 have a fully funded business plan ." (See FAC ¶68 .) Plaintiffs allege that this statement

5 was false when made because Exodus had been presented with a proposed "capital plan"

6 in March 2000 and another proposed "capital plan" in August 2000, which proposals

7 demonstrated that Exodus needed "$3.2 billion to accomplish the goals set forth by the

8 executive staff." (See FAC ¶149.)39

9 Plaintiffs' allegations as to the two capital plans are not pled with the requisit e

10 particularity and, in any event, fail to show that the statement that Exodus had a "fully

11 funded business plan" was false when made . As to the March 2000 capital plan, plaintiffs

12 allege that in March 2000, CW9, Exodus' former Vice President of Facilities who was

13 "responsible for product development," was "asked to put together a capital plan for the

14 rest of the year ." (See FAC IT 104(l), 149.) According to plaintiffs, CW9 "turned in a plan

15 reflecting the need for $3 .2 billion to accomplish the goals set forth by the executive staff,"

16 but the "executives balked at these numbers because, at the time, they had only $750

17 million to work with ." (See FAC ¶ 149.) Plaintiffs further allege that CW9's "plan was

18 dismissed, and Exodus continued building additional centers out, knowing they didn't have

19 the capital to cover the expense of these expansions." (See FAC 1 149. )

20

21 39Plaintiffs assert, in their Opposition, that the statement also was false because 22 Exodus had $1 billion in cash at the end of March 2001, and because, according to plaintiffs, the FAC alleges that as of that date, Exodus "was paying $75 million a month (or 23 $225 million a quarter) in interest on $3 billion of debt," Exodus "was not funded to make its interest payments for the next five quarters (Exodus' announced target date for 24 profitability), much less to fund the existing money-losing operations or to pay for continuing expansion." (See Opp. at 16.) Plaintiffs' opposition misstates the FAC . 25 Plaintiffs allege therein that "Exodus was paying $75 million in quarterly interest on its $3 billion debt." (See FAC 1150) (emphasis added) . With $75 million, as opposed to $225 26 million, in quarterly interest, Exodus would have been able to make its interest payments for more than 3 years, well past the announced target date for profitability. Should plaintiffs 27 elect to amend these allegations, plaintiffs must state with particularity the source of plaintiffs' information respecting the interest payments, as well as facts demonstrating 28 Exodus' inability to make payments notwithstanding insufficient cash reserves .

50 0 0

1 Plaintiffs fail to describe, however, who among Exodus' "executive staff" was

2 involved in this interaction, what "goals" were set forth by the executive staff, and whether

3 such goals were part of Exodus' existing "business plan," or were specific to some other

4 proposal . Moreover, plaintiffs' conclusory assertion that Exodus continued building out

5 even though it lacked the capital to cover the expenses is unsupported by any specific

6 facts regarding those projects. Further, as noted, plaintiffs allege that the plan CW9 put

7 together in March 2000 was "for the rest of the year." Consequently, any inability to fund

8 that plan does not demonstrate the falsity of a statement made in April, 2001 that Exodus

9 had a fully funded business plan.

10 Plaintiffs' allegation as to the August 2000 capital plan is pled with even less

11 particularity, and, consequently, is insufficient as well . Plaintiffs state only that "[i]n August

12 2000, Jim Stoddard and an employee in the Finance Division also submitted a capital

13 plan," which plan "also reflected the need for $3 .2 billion." (See FAC ¶ 149 .) Plaintiffs fail

14 to allege the source of their information, or any specific facts, concerning such plan . For

15 example, plaintiffs fail to allege the time period it covered, the goals it was intended to

16 encompass, which of the Individual Defendants was aware of it, and whether any portion of

17 it was approved or rejected . Without such specific facts, the allegations as to the August

18 2000 capital plan are insufficient to establish that the statement regarding a "fully funded

19 business plan" was false or misleading when made .

20 b . Risk of Bankruptcy

21 Plaintiffs allege that various representations made by Hancock in articles publishe d

22 on August 27, 2001, August 28, 2001 and September 3, 2001, respecting whether Exodus

23 would file for bankruptcy, were false when made . Plaintiffs, however, quote from only two

24 of the articles: an article published in Information Week on August 27, 2003, which

25 reported Hancock as saying : "We're viable . . . We have sufficient cash" ; and an article

26 published in the San Jose Mercury News on August 28, 2001, which stated, "Exodus Chief

27 Executive Ellen Hancock says the company is in no danger of filing Chapter 11 . 'We are

28

51 . •

1 capable of handling the debt and paying for the debt,' she says."40 (See FAC 1192, 93)

2 As noted, Hancock resigned on September 4, 2001, and Exodus filed for bankruptcy on

3 September 26, 2001 . (See FAC ¶97.) Plaintiffs contend that "[t]he inference of falsity is

4 strongly corroborated by the fact Exodus declared bankruptcy only three weeks after

5 Hancock denied that Exodus was in no danger of bankruptcy ." (See Opp . at 16.)

6 As the Court noted in its prior order, the Ninth Circuit has held that tempora l

7 proximity alone is insufficient to raise an inference of falsity or scienter under the PSLRA .

8 See Ronconi v. Larkin, 253 F. 3d 423, 437 (9th Cir 2001) ("We have allowed the temporal

9 proximity of an allegedly fraudulent statement to bolster a complaint, but we have never

10 allowed the temporal proximity between the two, without more, to satisfy the requirements

11 of Rule 9(b)") (quoting Yourish v. California Amplifier, 191 F. 3d 983, 997 (9th Cir. 1999)

12 (emphasis in original) . Here, as discussed, plaintiffs' allegations in the FAC regarding

13 Exodus' lack of adequate funding to meet its business plan and make interest payments,

14 are insufficient as currently pleaded . Although, as plaintiffs argue in their Opposition, the

15 time necessarily involved in retaining bankruptcy counsel and negotiating bankruptcy

16 debtor financing supports an inference that Exodus knew before September 25, 2001 that

17 it would file for bankruptcy, neither of these facts is pleaded in the FAC, let alone set fort h

18 with the requisite specificity .

19 7 . Statements Regarding IDC Capacity and Deman d

20 a. IDC Capacity

21 As in the CCAC, plaintiffs' FAC alleges that defendant Case falsely stated, in a n

22 April 26, 2001 conference call, that Exodus was "opening IDC's to meet known customer

23 demands ." (See FAC ¶69.) In the FAC, plaintiffs additionally allege that Hancock falsely

24 stated , in an article published on CnetNews .com on August 2, 2001, that it was "absolutely

25 not true" that Exodus was faced with a "glut of data centers ." (See FAC ¶ 89.)

26 40The Court hereby GRANTS the Individual Defendants' Supplemental Requests for 27 Judicial Notice, filed January 16, 2003 and February 4, 2003, which include articles referenced in the FAC, such as the above-referenced articles from Information Week and 28 the San Jose Mercury News .

52 0 0

1 In its prior order, the Court held that plaintiffs had failed to plead facts suggestin g

2 that Exodus had excess IDC capacity in the locations where Exodus proposed to open new

3 IDCs or that Exodus was opening new IDCs without first assessing demand in those

4 particular areas. In addition, the Court noted that statements made during the sam e

5 April 26, 2001 conference call demonstrated that defendants had decided not to open

6 certain IDCs after determining that demand was insufficient in those locations . See

7 May 28 Order at 12 .

8 The FAC does not cure the deficiencies noted earlier with respect to the April 26,

9 2001 statement, nor does it adequately allege the falsity of Hancock's August 2, 2001

10 denial that Exodus was faced with a "glut of data centers ." Plaintiffs now allege that both

11 statements were false because (1) Krause, the successor CEO, made statements on

12 September 26, 2001 that Exodus had "overexpanded in some areas in advance of

13 demand," and that all four of Exodus' IDCs in the Washington, D .C . area "are operating

14 under capacity," ( see FAC ¶144(b)); (2) Exodus stated, in a November 30, 2001

15 bankruptcy filing, that it was disposing of nonoperating or redundant assets, including

16 vacant IDCs, ( see FAC ¶144(a)); (3) in an interview with Hancock published August 22,

17 2001 in The Industry Standard , an analyst stated "many of [Exodus'] data centers are at

18 only 50 percent capacity," (see FAC ¶ 144(c)); and (4) an article published September 26,

19 2001 in Network World Fusion , stated "analysts note that many of [Exodus'] centers are 20 running at capacity levels as low as 10%." (See FAC ¶144(d); see also Opp. at 17. )

21 These allegations are inadequate to show that the statements in question were fals e

22 when made, as, with one exception, the events upon which plaintiffs rely all occurred after

23 the alleged class period, and, in any event, none represent contemporaneous facts

24 demonstrating the falsity of the statements at the time they were made. See In re Vantive ,

25 110 F . Supp 2d at 1217 n.14. ("[E]vents occurring after the alleged class period do not

26 show that the representations made during the class period were false when made,

27 plaintiffs must point to particular contemporaneous facts that establish the falsity of the

28 statement at the time it was made.") All of the events occurred anywhere from four t o

53 S

1 seven months after Case's statement and, with one exception, from almost two to almos t

2 four months after Hancock's statement . 3 Although the August 2, 2001 and August 22, 2001 articles are closer in time, th e

4 statements attributed to Hancock therein are readily reconciled, particularly given the fact

5 that "glut" is a term somewhat lacking in precision . In the August 2, 2001 article, wherein

6 Hancock denies that Exodus is faced with a "glut of data centers," Hancock further states

7 that Exodus had opened up four new data centers in the previous quarter, and explains

8 that some of the data centers were half full while data centers in other locations were

9 mostly full. (See RJN Ex. 43 at 3 ; FAC ¶89.) In the August 22, 2001 article, based on an

10 interview with Hancock and wherein the analyst reports that "many of [Exodus'] data

11 centers are at only 50 percent capacity," Hancock is quoted as stating, "[E]ven though we

12 might have some [extra] space in London, that doesn't help us address the French market

13 or the market in Amsterdam or Germany. Last quarter, we opened up four new data

14 centers: one in Amsterdam, one in Paris, one in Dallas and one in Miami . So with all this

15 discussion of glut, we're opening up data centers ." (See FAC ¶ 144(c) .) Read in context,

16 the statements attributed to Hancock in the two articles are not inconsistent, and thus are

17 insufficient to demonstrate falsity or scienter .

18 Accordingly, plaintiffs have not adequately pleaded falsity or scienter based o n

19 statements concerning IDC capacity .

20 b. Customer Deman d

21 The FAG also alleges as false the following statements regarding customer demand :

22 (1) a statement in a January 24, 2001 press release announcing Exodus' fourth quarter

23 2000 results, that Exodus "was continuing to see strong demand" ( see FAC ¶56); (2) a

24 statement in the March 30, 2001 Form 10-K that Exodus was "continu[ing] to focus on

25 supporting the strong demand from large enterprise customers ( see FAC ¶62); (3) the

26 statement by Case in an April 26, 2001 conference call that "we are opening IDCs to meet

27 known customer demands" (see FAC ¶69); and (4) a statement by Hancock in an April 26 ,

28

54 0 0

1 2001 interview on CNN's Moneyline that Exodus was "seeing increased demand fro m

2 enterprise customers" (see FAC ¶70).

3 Plaintiffs allege that the above statements were false or misleading when made fo r

4 the same reasons that Exodus' representations as to its customer base were false,

5 namely, that "[d]efendants failed to disclose that the apparent demand was largely driven

6 by a reliance on phantom customers and on customers who lacked the ability to pay, [and]

7 that Exodus' apparent demand included approximately 1,500 customers who were inactive,

8 and/or had cancelled or otherwise could not pay for services ." (See FAC 1111 0(b), 129,

9 130, 135; see also Opp. at 17 .) For the reasons discussed earlier, these allegations, as

10 currently pleaded, are likewise insufficient to demonstrate the falsity of the above

11 statements respecting customer demand, or to raise the requisite strong inference of

12 scienter.

13 8. False Forecasts

14 Plaintiffs allege the following statements respecting financial forecasts were false o r

15 misleading when made: (1) an April 26, 2001 press release forecasting revenue in the

16 amount of $360 million for Exodus' second quarter and $1 .5 billion for fiscal year 2001 ;

17 (2) an April 26, 2001 conference call in which defendant Case reiterated these revenue

18 forecasts and stated "we are still confident that we should be able to turn cash EPS

19 positive in the first half of next year" ; and (3) a statement in a May 1, 2001 conference call,

20 reaffirming the revenue forecast of $360 million . (See FAC $167, 69, 73 ; see also Opp . at

21 17-18 .) Plaintiffs argue in their Opposition, but do not allege in their FAC, that these

22 forecast statements were false because "they assumed that Exodus would continue to

23 recognize revenues in connection with some 1500 customers who had previously canceled

24 or could not pay their bills, customers who would be removed from Exodus' customer lists

25 before the end of 2001," and because the "forecasts also failed to account for the fact that

26 approximately 40% of Exodus' accounts receivable were uncollectable." (See Opp. at 18).

27 Under the PSLRA, as noted, plaintiffs cannot rely on arguments raised in their

28 1 opposition, but must plead such allegations in their complaint . See 15 U .S.C. § 78u-

55 0

1 4(b)(1). In any event, even had it been pleaded in the FAC, the cancellation of 1500

2 customers from Exodus' active customer counts in the fall of 2001 is insufficient to

3 establish that a forecast made in April or May 2001, was false or misleading when made, in

4 the absence of specific allegations demonstrating the number of customers involved, the

5 corresponding amount of revenue affected, and that the problems giving rise to such

6 cancellations were known at the time the forecasts were made. Nor does such

7 cancellation, without more, implicate the truth of the statement that Exodus would "turn

8 positive" in the first half of 2002 . Finally, as pleaded, plaintiffs' allegation as to the reserve

9 report is, for the reasons stated earlier, insufficient to show either that the forecast

10 statements were false when made, or to raise the requisite strong inference of scienter . 11 9. Scienter: Stock Sales

12 As discussed above, plaintiffs' allegations in the FAC, are insufficient to

13 demonstrate that the statements upon which plaintiffs rely were false or misleading when

14 made. Nor, in considering such allegations in their totality, do they raise a "strong 15 inference" that defendants made "false or misleading statements either intentionally or with

16 deliberate recklessness ." See Gompper v. VISX, 298 F. 3d at 895 (citing Silicon Graphics ,

17 183 F. 3d 985).

18 In a further effort to demonstrate scienter, plaintiffs rely on allegations that th e

19 Individual Defendants engaged "in insider trading ." (See FAC ¶ 197.) As noted in the

20 Court's prior order, the Ninth Circuit has identified three factors relevant to the question of

21 whether a defendant's stock sales gives rise to an inference of scienter : "(1) the amount

22 and percentage of shares sold by insiders; (2) the timing of the sales ; and (3) whether the

23 sales were consistent with the insider's prior trading history ." In re Silicon Graphics, 183

24 F.3d at 986 . 25 Assuming, arguendo, that plaintiffs have sufficiently pleaded falsity as to one o r

26 more of the statements on which they rely, plaintiffs' allegations as to stock sales are

27 insufficient to demonstrate scienter. In its prior order, the Court found that plaintiffs'

28 allegations as to trading were insufficient to raise the requisite strong inference of scienter

.1 56 9 0

because the amounts and percentages of sales by Individual Defendants Dollahite, Wegner, Hancock, Case and Stolz were not sufficiently high,41 and because plaintiffs ha d

failed to adequately plead facts as to the defendants' trading history. Plaintiffs have not succeeded in curing these deficiencies. At the outset, the Court notes that plaintiff's class period of 73 weeks is even longer than the "unusually long class period of sixty-three weeks" discussed in In Re Vantive , and similarly "mak[es] the stock sales appear more suspicious than they would be with a shorter class period ." See In Re

Vantive, 283 F. 3d at 1092.

9 Moreover, even considering the additional sales occurring during the additional 6 2

10 weeks of the expanded class period, the Individual Defendants collectively retained over

11 93% of their holdings, a fact that does not support scienter . (See Reply at 19; Ind. Defs .

12 Req. Jud. Not. Exs. 14-21); see also Silicon Graphics , 183 F. 3d at 987 (holding plaintiffs

13 had failed to raise strong inference of scienter where defendants collectively retained 90%

14 of stock holdings); In re FTC .com Sec. Litig. , 136 F. Supp 2d 1031, 1038 (N .D. Cal . 2000)

15 (holding scienter not established where defendants collectively retained 86% of stock

16 holdings).

17 Nor have plaintiffs shown that the amount of stock sold by any of the Individua l

18 Defendants during the expanded class period is suspicious . Stolz is not alleged to have

19 sold any shares . Hancock sold 371,671 shares (3% of her holdings), Dollahite sold 96,800

20 shares (8% of his holdings), and Mohamad sold 247,971 shares (6% of his holdings) . (See

21 FAC ¶ 197 ; Ind . Defs.' Req. Jud. Not. Exs. 17-20; Mot. at 20.) The percentage of shares

22 sold by Hancock, Dollahite, and Mohamad are not sufficiently high to raise suspicion . See

23 Ronconi v. Larkins , 253 F.3d 423,435 (9th Cir . 2001) (holding sales of 10% and 17% by

24 insiders who made most of alleged misrepresentations not suspicious in amount) .

25 Although Wegner sold 219,630 shares (37% of his holdings) and Case sold 200,00 0

26

27 41In the CACC, neither Case nor Stolz is alleged to have sold any stock during the 28 class period .

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1 shares (38% of his holdings),42 Wegner sold 159,796 of those shares, or 73%, in April and

2 August 2000 and Case sold all of the 200,000 shares in August 2000 . (See id.) Because,

3 as described earlier, the FAC focuses almost exclusively on misrepresentations alleged to

4 have been made in 2001, these sales are not sufficient to support a strong inference of

5 scienter. See In Re Vantive, 283 F. 3d at 1093 ("[S]tock sales are helpful only in

6 demonstrating that certain statements were misleading and made with knowledge or

7 deliberate recklessness when those sales are able to be related to the challenged

8 statements.") Finally, as to Yeack and Brown, Yeack sold 117,600 shares (30% of his

9 holdings), and Brown sold 201,360 shares (45% of her holdings) . (See id.) Because these

10 defendants are not alleged to have made any false statements during the class period,

11 their sales are insufficient to demonstrate scienter. See In re Vantive, 283 F .3d at 1096

12 (holding sales of 49% of holdings by non-speaking defendant insufficient to raise inference

13 of scienter where speaking defendants' sales were not "particularly suspicious") .

14 Plaintiffs further allege that the timing of certain sales by Hancock, Dollahite and

15 Wegner, specifically, sales in May 2001, is sufficiently suspicious to raise a strong

16 inference of scienter . In its prior order, the Court found the fact that Dollahite's first sale of

17 Exodus stock, which occurred on May 30, 2001, was insufficient to raise an inference of

18 scienter. As the FAC adds no new allegations respecting Dollahite's trading history, the 19 analysis remains unchanged . Second, although plaintiffs now allege with greater

20 specificity the trading history for Wegner and Hancock, the allegations remain insufficient .

21 Wegner's May 2001 sales of 59,834 shares for proceeds of $613,257 were not

22 disproportionately high in either quantity of shares or amount of proceeds when compared

23 with his sale of 159,796 shares for proceeds of $11,730,730 during the remainder of the

24 class period . Although Hancock's May 2001 sales of 285,033 shares for proceeds of

25 42As noted, Case , in the CCAC, is not alleged to have sold any stock. Although 26 plaintiffs allege in the FAC that Case sold 100 % of his holdings during the expanded class period , (see FAC ¶ 198), Case's judicially-noticeable Section 16(b) filings with the SEC, 27 (see Ind . Defs.' Req. Jud. Not. Ex . 19), establish that Case had a ce rtain number of vested options, which are included in determining the percentage of sales . See Silicon Graphics , 28 183 F. 3d at 986-87 .

58 i • :

$2,901,873 were high in terms of the number of shares sold, the sales were not proportionately high with respect to the proceeds .43 Consequently, Hancock's sales are not sufficient to raise a strong inference of scienter, particularly where Hancock's sales during the class period represent such a small percentage of Hancock's total shares. (See

Ind . Defs.' Req. Jud. Not. Ex. 17.) Accordingly, without more, plaintiffs are unable to show that defendants' stock sales

give rise to an inference of scienter .44 C. Section 20(a) and Section 15 Claim s

9 To plead a prima facie case under § 20(a) of the Exchange Act, 15 U.S .C. § 78t(a),

10 plaintiffs must plead : "(1) a primary violation of federal securities laws ; and (2) that the

11 defendant exercised actual power or control over the primary violator ." Howard v. Everex

12 Systems, Inc., 228 F .3d 1057, 1065 (9th Cir . 2000). To plead a prima facie case unde r

13 § 15 of the Securities Act, 15 U .S .C . § 770, plaintiffs must likewise plead a primary

14 violation of federal securities laws and that the defendant exercised control over the

15 primary violator. See In re Initial Public Offering Securities Litigation , 241 F . Supp. 2d 281,

16 352 (S .D.N .Y. 2003). There can be no liability under § 20(a) or § 15 if a primary violation

17 of § 10(b) or § 11, respectively, is not sufficiently pled . See Heliotrope General Inc. v. Ford

18 Motor Co. , 189 F.3d 971, 978 (9`h Cir. 1999); Klein v. General Nutrition Companies, Inc .,

19 186 F.3d 338, 344 (3`d Cir. 1999). As plaintiffs have failed to adequately plead a § 10(b) or

20 § 11 claim, plaintiffs' § 20(a) and § 15 claims must be dismissed as well .

21 D. Standing and Sufficiency of Pleadings: § 11 Claim Against Hancoc k

22 For the reasons discussed earlier with respect to the Underwriter Defendants'

23 I motion to dismiss, plaintiffs have adequately alleged that they have standing to bring thei r

24

25 43As noted, Hancock sold 371 ,671 total shares during the class period for proceeds 26 of $8,720,000. (See FAC ¶ 197). 27 As plaintiffs have failed to adequately allege falsity or scienter, the Court need not address whether the forward-looking statements challenged by plaintiffs are protected by 28 the "Safe Harbor" provisions of the PSLRA .

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1 § 11 claim against Hancock, but have failed to adequately plead such claim against

2 Hancock.

3 CONCLUSION

4 For the reasons stated :

5 1 . The Underwriter Defendants' and the Individual Defendants' respective motions

6 to dismiss are hereby GRANTED and the FAC is hereby DISMISSED with leave to amend

7 to cure the deficiencies noted .

8 2 . Plaintiffs' Second Amended Complaint shall be filed no later than 60 days from

9 the date of this order.

10 3. Plaintiffs are directed to file, no later than 30 days from the date of this order,

11 certificates pursuant to §15 U .S .C. §78u-4(a)(2) as to each of the new plaintiffs in thi s 12 action. 13 This order closes Docket Nos . 70 and 74. 14 IT IS SO ORDERED . 15

16 Dated : AUG 19 20 17 MAXI E M . CHESNEY United States District Judg e 18

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UNITED STATES DISTRICT COURT

FOR THE

NORTHERN DISTRICT OF CALIFORNIA

Paul Ruthfield, Case Number: C-01-2661 MMC Plaintiff, CERTIFICATE OF SERVICE

V .

Exodus Communications , Inc., et al,

Defendant .

I, the undersigned, hereby certify that I am an employee in the Office of the Clerk, U.S . District Court, Northern District of California . That on August 19, 2003, I SERVED a true and correct copy(ies) of the attached, by placing said copy(ies) in a postage paid envelope addressed to the person(s) hereinafter listed, by depositing said envelope in the U . S . Mail, or by placing said copy(ies) into an inter-office delivery receptacle located in the Clerk's office. Kevin J. Yourman Jonathan C . Dickey Elizabeth P . Lin Paul J. Collins Jennifer R. Williams John D . van Loben Sels Weiss & Yourman Gibson Dunn & Crutcher 10940 Wilshire Blvd., 24`'Flr. 1530 Page Mill Road Los Angeles, CA 90024 Palo Alto, CA 9430 4 Reed R. Kathrein John K. Grant Ex Kano S . Sams, II Milberg Weiss Bershad Hynes & Lerach 100 Pine Street, Suite 2600 San Francisco, CA 9411 1 Michael D. Braun Stull Stull & Brody 10940 Wilshire Blvd., Ste. 2300 Los Angeles, CA 90024 David M. Furbush Elizabeth E. Karnes Dhaivat H. Shah Brobeck Phle~er & Harrison 2000 University Avenue Palo Alto, CA 94303 Richard W. Wieking, Clerk Dated: August 19, 2003 By - 4wf~ - --Deputy: i ClOrk